Accounting In China In Transition: 1949-2000 9789812799555, 9789810248277

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ACCOUNTING AND BUSINESS IN ASIA — Vol. 2

ACCOUNTING IN CHINA 1949 - MiQ

Allen Huan] Ronald Ma

World Scientific

ACCOUNTING IN CHINA IN TRANSITION: 1949 - 2000

ACCOUNTING AND BUSINESS IN ASIA Series editors:

Ronald Ma (UNSW and Griffith University) Amy Lau (Oklahoma State University and Hong Kong Polytechnic University)

Volume 1: Financial Reporting in the Pacific Asia Region edited by Ronald Ma Volume 2: Accounting in China in Transition: 1949-2000 Allen Huang and Ronald Ma

ACCOUNTING AND BUSINESS IN ASIA — Vol. 2

ACCOUNTING IN CHINA IN TRANSITION: 1949 - 2000

Allen Huang Ronald Ma

V f e World Scientific wfc

• Singapore • Hong Kong New Jersey • London London'Singapore*

Published by World Scientific Publishing Co. Pte. Ltd. P O Box 128, Farrer Road, Singapore 912805 USA office: Suite IB, 1060 Main Street, River Edge, NJ 07661 UK office: 57 Shelton Street, Covent Garden, London WC2H 9HE

British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library.

ACCOUNTING IN CHINA IN TRANSITION: 1949-2000 Copyright © 2001 by World Scientific Publishing Co. Pte. Ltd. All rights reserved. This book, or parts thereof, may not be reproduced in any form or by any means, electronic or mechanical, including photocopying, recording or any information storage and retrieval system now known or to be invented, without written permission from the Publisher.

For photocopying of material in this volume, please pay a copying fee through the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, USA. In this case permission to photocopy is not required from the publisher.

ISBN 981-02-4827-X

Printed in Singapore.

To Shao Ting and Ursula

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CONTENTS Preface

xi

Chapter 1 Introduction

1

Chapter 2 Brief History of Accounting in China up to 1949 2.1 Indigenous Accounting Systems 2.2 Adoption of Western Double-Entry Bookkeeping

7 8 9

PART A: ACCOUNTING IN MAO'S CHINA Chapter 3 Establishment Phase: 1949 - 1957 3.1 Political, Economic and Social Developments in the Establishment Phase 3.2 Business Enterprises under a Centrally-Planned Economy 3.3 Development of New Accounting Systems and Practices 3.3.1 Uniform Accounting Systems 3.3.2 Fund Accounting 3.3.3 Product Cost, Debit-Credit Accounting and Accounting Education

13 14 21 23 25 26 28

Chapter 4 Great Leap Forward: 1958 - 1962 4.1 Political Motivation for and the Economic Outcome of the GLF 4.2 Accounting under the GLF

30

Chapter 5 Recovery Phase: 1963 - 1965 5.1 Accounting in the Recovery Phase

37 38

Chapter 6 Cultural Revolution: 1966 - 1978 6.1 Accounting under the CR

40 43

30 34

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ACCOUNTING IN CHINA

PART B: ACCOUNTING IN DENG'S CHINA Chapter 7 Political Scene in Deng's China 7.1 Marriage of Static Political System to Dynamic Economic Reform 7.2 Cycles of Economic Reform in the 1980s 7.3 Political Accommodation to Economic Reform 7.4 Communist Ideological Issues Revisited

47

Chapter 8 Initial Economic Reform: 1978 - 1984 8.1 Economic Reform 1978-1984 8.1.1 Economic Reform in the Rural Sector 8.1.2 Economic Reform in the Urban Sector 8.1.3 Open-Door Policy 8.2 Accounting Development 1978-1984

53 53 53 55 56 57

Chapter 9 Planned Commodity Economy: 1984 - 1991 9.1 Economic Reform 1984 - 1991 9.1.1 Macroeconomic Reform 9.1.2 Microeconomic Reform 9.2 Accounting Reform 1984 - 1991 9.2.1 Accounting for SOEs 9.2.2 Certified Public Accountants

61 62 62 63 65 65 68

Chapter 10 Socialist Market Economy Since 1992 10.1 Economic Reform since 1992 10.1.1 Macroeconomic Reform 10.1.2 Microeconomic Reform 10.2 China's Stock Exchange 10.3 Reform of State Owned Enterprises 10.4 Reform and Internationalisation of Accounting since 1992 10.4.1 Establishment of Basic Accounting Standard (Conceptual Framework)

69 69 69 72 73 78

49 50 50 51

80 80

CONTENTS

10.4.2 New Industry-Based Accounting Regulations 10.4.3 Current Regulatory Framework for Accounting 10.4.4 Setting of Detailed (or Specific) Accounting Standards 10.4.5 Structure of Current Chinese Accounting System 10.4.6 Growth of the Accounting Profession

84 86 88 91 94

Chapter 11 Towards A Successful Outcome for SOE Reform 11.1 Classification Scheme for SOEs 11.2 Proposed Ownership Structures 11.3 Turning Around Loss Making SOEs 11.3.1 Restructure and Recapitalisation 11.3.2 Downsizing and Unemployment 11.3.3 Loss Culture 11.3.4 Corporate Governance 11.3.5 Long-Run Decision Making 11.3.6 A Caveat on the Pace of Reform 11.4 Debt Defeasance Programme 11.5 Corporatisation, Listed Companies and the Stock Exchange

96 98 98 101 102 103 103 104 105 105 106 108

Chapter 12 Conclusion

109

References

114

Index

119

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PREFACE

The Committee on Accounting History of the American Accounting Association has described accounting history as "... the study of the evolution in accounting thought, practices, and institutions in response to changes in the environment and societal needs" (1970, p. 53). This description indicates the following relationships exist between accounting and its environment. First, since accounting serves the needs of society, accounting practices and development are shaped by the environment within which it operates. Second, as society progresses and adapts to new challenges accounting will do likewise. Accounting writers have identified a wide range of environmental variables which can have significant influences on accounting; these include political, economic, social, cultural and other factors (see Radebaugh and Gray, 1997). However, difficulties are often encountered when attempts are made to observe and trace the relationship between accounting and its environment. For example, when a specific period of the accounting history of a nation is examined, only certain environmental factors would be relevant, of which some would be more influential than others. Further, an environmental factor might have an impact on accounting in one period but not in a subsequent period, when another environmental factor might become more important. In other words, most environmental factors do not remain continually relevant when society changes over time. Lastly, the typically slow evolution of changes in society and the economy makes the corresponding accounting response difficult to detect. These problems make observation of the cause and effect relationship between the environment and accounting a more difficult task. The history of accounting in the People's Republic of China (PRC) is a special case for several reasons. On its formation the PRC broke off completely from the country's past, including its accounting past. Further, a large number of significant political and economic events have

xii

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been compressed into a relatively short period of time. A unique window of opportunity is, therefore, presented to the observers. For the purpose of this book, the history of the PRC is classified into two distinctive periods, that is, Mao's China (1949 - 1978, including the two turbulent years after his death) and Deng's China (from 1979 to the present day). Each period is made up of a number of sub-periods or phases, and each phase is characterised by one or more major political or economic event(s). The two main periods corresponding to Mao's China and Deng's China provide a vivid illustration of different environmental factors in play and of how those factors impacted on society, the lives of citizens and institutions, including accounting. The events which mark off the two main periods and the sub-periods within them are such distinctive events and their impact on society is so large that the associated accounting changes are relatively easy to discern. Furthermore, the fact that these events happened so close together within a limited time frame facilitates accounting history research. A brief outline of the major events and the associated accounting changes in the two main periods and the sub-periods is given below. The birth of the PRC in 1949 witnessed the abolition of the accounting systems and practices employed under the previous Kuomintang regime. It may be said that accounting in the PRC commenced on a blank page, with the adoption of Soviet-based accounting systems to service the needs of a centrally-planned and centrally-controlled economy. During the period of Mao's rule, China experienced two violent political mass movements which inflicted great damage and suffering on the nation. Hence, there was little accounting developments of note in this period. China in the post-Mao period could not have been more different. The Chinese Communist Party under Deng's leadership disavowed political struggle and mass movements and set itself the arduous and ambitious task of converting the centrally-planned and centrallycontrolled economy into a market economy "with Chinese characteristics". This period comprises three phases or waves of economic reform and modernisation, a process which continues to the

PREFACE

xiii

present day. The economic reform brought about the need for accounting reform and, as a result, fundamental changes in accounting took place throughout the period, as described below. Three major kinds of accounting changes associated with the economic changes over the period can be discerned. First, the objective of accounting has changed from serving the needs of a centrally-planned and centrally-controlled economy to serving the needs of a marketoriented economy. Second, the accounting system has changed from a fund accounting system accompanied by specific industry-based accounting regulations to a system more similar to modern western accounting systems. Third, the users of accounting information have expanded from the government being the sole user to multiple and diverse user groups. These developments and changes in accounting can only be explained in the context of the environmental developments and changes in the political, economic and social history of the PRC. It is tempting to end this discussion with a speculation on the future. Will China eventually and effectively harmonise its accounting system with that of the West? This question cannot be answered except by reference to the economic reform taking place in China. Accounting is the handmaiden to the economic reform and its future development depends wholly on the success or otherwise of the economic reform programme. The reform of China's state owned enterprises (SOEs) has taken centre stage in determining the course of future events. The literature on accounting in China has generally focused on specific accounting developments, such as the establishment of the fund accounting system and the specific industry-based accounting regulations in the 1950s or the attempts to harmonise with the international accounting standards in more recent years. However, there appears to have been little attempt to date to trace the association between accounting changes and political, economic and social events that led to those changes, for example, see Zhong (1988), Lefebvre and Lin (1990), Liu and Eddie (1995) and Scapens and Hao (1995). The present authors attempt to trace the cause and effect relationship between political and economic events and accounting

xiv

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developments in the PRC by describing the major political and economic events to provide the background for accounting changes in the relevant periods and sub-periods. For example, it shows that the establishment of fund accounting in the early 1950s was associated with the establishment of a centrally-planned and centrally-controlled economic system. Similarly, the move away from fund accounting in the late 1980s was associated with the drive towards a market-oriented economy and globalisation. The main objectives of this book are to demonstrate how closely accounting and the environment within which it operated have been associated, why accounting experienced those particular changes that have been referred to above and why accounting is what it is today in the PRC. It is hoped that the reader will find this work interesting in a number of ways. First, it would help the reader understand why accounting in the PRC has changed in a particular fashion as it directly relates these accounting changes to changes in the political and economic environment in specific periods. Second, in order to understand the present or speculate on the future we need to understand the past. This is true for all things including accounting. In the accounting context a matter of topical interest concerns the pace at which Chinese accounting standards will be harmonised. Researchers who wish to address this question first need to understand how Chinese accounting standards have arrived at their present stage. This line of inquiry inevitably traces the association between accounting modernisation and the SOE reform process and leads to the plausible hypothesis that future accounting development must wait on progress in the reform of SOEs. The authors wish to acknowledge the financial assistance provided by Griffith University in the preparation of this work, and to thank David Lim, Colin Mackerras, You Poh Seng and Tom Nguyen for their constructive criticisms and encouragement. The authors are responsible for any deficiencies that may remain. A.H. and R.M. Nathan, Brisbane June 2001

chapter 1 Introduction

Since its inception in 1949 to the end of the 20th century, the People's Republic of China (PRC) has exhibited two distinct patterns, that is Mao's China (1949 - 1978)1 and China after Mao (since 1979), in terms of the dominating forces which have shaped China's society, its institutional arrangements and its citizens' lives, as well as accounting developments. In Mao's China, "continuous revolution and class struggle" was taken as the basic maxim of the Chinese Communist Party (CCP) and the political factor clearly dominated every aspect of society (MacFarquhar and Fairbank, 1987). The constantly recurring mass political movements launched by the Party and Mao and the political climate in the different phases of Mao's era dictated economic and accounting developments. Accounting was designed exclusively to serve the needs of the CCP in ruling the nation. Chairman Mao, as he was always referred to, was the founder of the CCP and the PRC. Prior to 1949 Mao led the Communist guerrillas to survive the first war with the Nationalist army and the Sino-Japanese War, and to win the second war with the Nationalist army. These victories earned Mao a high and well-deserved prestige among the party 1

Mao's rule nominally ended in 1976 when he died, but his influence continued and the disruptive situation of the Cultural Revolution lingered on for two more years until 1978 when Deng Xiaoping resumed his power in the Central Committee of the Chinese Communist Party and introduced a series of reform programmes to the country.

2

ACCOUNTING IN CHINA

members and the people, and established him as the supreme ruler of the CCP and the PRC. Mao was an ideologist, who wanted to establish a communist Utopia based on the political theories of Marx and Lenin and the limited experience of the then Soviet Union. He was also a strong nationalist, who wanted to turn the PRC into a political, economic and military super-power. However, Mao did not have sufficient knowledge and practical experience in running the country, neither did he have the patience in pursuing a firm and steady growth of the economy. Instead, he resolved to use political measures and mass movements (similar to what he did effectively during the war) to arouse people's enthusiasm for the socialist cause and for economic development and, in his later years, to eliminate his political enemies. As a result, this period of Chinese history was characterised by a series of political and mass movements (the most notorious ones being the Great Leap Forward movement and the Cultural Revolution), which dictated nearly every aspect of life in China, be it economic, social or cultural. Therefore, it is imperative that the political factor is treated as the root cause for the accounting practices and changes therein observed in this period. Part A of this book documents and analyses the political developments and their impact on accounting practices and changes therein between 1949 and 1978 when China was under Mao's rule. The political influence on other aspects of society, for example, economic and social changes, and their influence on accounting will be examined. In Mao's China there were four distinct patterns of political events and associated economic events, which in turn determined the pace and direction of accounting development and changes. These four patterns were: (a) (b) (c) (d)

Establishment Phase: Great Leap Forward: Recovery Phase: Cultural Revolution:

1949 - 1957 1958-1962 1963 - 1965 1966 - 1978

INTRODUCTION

3

In contrast to developments in Mao's China, there was a distinct divergence between political and economic events in the post-Mao period. While maintaining its rule over the country the CCP abolished completely the continuous revolution and class struggle strategy and took on as its central tasks economic development and modernisation, which dominated the Party's agenda and people's lives. Hence accounting has developed at an unprecedented pace to meet the needs of economic growth. Part B of the book deals with the political, economic and accounting developments in the post-Mao period. When Mao ruled China, Deng Xiaoping was twice exiled to the political wilderness. After Mao's death in 1976, Deng re-emerged and asserted his dominance of the CCP. About this time a number of relatively young party members who strongly supported economic reform was elected to the Politburo of the Central Committee and formed Deng's power base. Deng and his supporters launched a reform programme which has had such a significant and long-lasting effect on China that it has been hailed as a second revolution and a new "Long March" in the CCP's history. The programme of economic reform inaugurated by the Third Plenum of the Eleventh Central Committee of the CCP in December 1978 had its origins in the political misfortunes of the Cultural Revolution decade (1966 - 1976) and the problematic performance of the Chinese economy during the 1960s and 1970s. The reformers had a number of economic objectives. The first objective was to address certain strategic structural imbalances in the economy, that is, to shift the emphasis in development from heavy industry towards light industry, from industry towards agriculture, from investment towards consumption, from state businesses towards collective and private businesses. The second objective (which was the underlying motive for the first) was to raise efficiency in the use of labour, land and capital through the introduction of market systems in which economic decisions would be made by enterprise managers rather than government officials. The third objective was to gain access to the benefits of the global economy by expanding foreign trade and encouraging foreign

4

ACCOUNTING IN CHINA

investment. However, the political motivations underlying the reforms were as important as the economic objectives in giving impetus to the new policies. At the international level, Chinese leaders were increasingly aware that China was being outperformed by its neighbours and rivals in East and Southeast Asia, most irksomely by its political alter ego, the Kuomintang regime in Taiwan. Internally, the credibility of the Communist regime had been seriously shaken by the ideological confusion, political infighting and social disorder of the Cultural Revolution, and there was increasing frustration and discontent among the population over restrictions on economic and social life, as well as the lack of further progress in raising low living standards (Hamrin, 1990). The Third Plenum of 1978 is considered a turning point in the contemporary history of China as it marks the end of the Mao era and the beginning of the Deng era. At this meeting Deng and his supporters abolished Mao's maxim, "continuous revolution under the dictatorship of the proletariat and class struggle", as the basic tenet of CCP policy. It was proclaimed that the central tasks of the CCP were to achieve economic development and modernisation. The main strategies deployed for fulfilling the tasks would be economic reform and an "open door" policy (T. Li, 1998). While the objective set forth was to develop the economy and raise living standards, a clearly defined goal was not announced at the time. The call for economic reform was not accompanied by a political reform programme. Deng was not an advocate of political reform, and his policy was supported within the CCP. This meant that the economic reforms were to be implemented within the framework of an old and rigid political and legal system which administered the centrally-planned and centrally-controlled economy of the 1950s. There was, however, an important compromise on one issue. Deng and his supporters took the view that where economic reform would otherwise be impeded, then the necessary piece of political reform could be instituted in order to facilitate economic progress. The net outcome is that the CCP remains firmly and totally in control of the country while an economic reform

INTRODUCTION

5

programme is instituted vigorously and determinedly. This situation has remained to this day. As a result, since 1979 there has been a distinct divergence between political and economic events. While economic development has been taking place at an unprecedented pace, the fundamental political structure has remained unchanged, except where modifications have been made to administrative mechanisms to meet the needs of the economic reform. Indeed, China's economic reform programme has brought about a transformation from a centrally-planned economy towards a market economy under the autocracy of the CCP. Therefore, in the Deng and the post-Deng eras, economic reform and development have dominated the Party's agenda and the lives of ordinary citizens. Accounting since 1979 has also developed at an unprecedented pace in order to keep pace with economic development. As China's leaders had no past experience in undertaking economic reform they decided to take a cautious and gradual approach. An interesting feature of the reform process has been the step-by-step, trial and error approach. New ideas and methods would be tested on particular sectors of the economy, regions of the country and types of enterprises and the responses observed before deciding what to do next, a practice described by Deng as "touching stones while walking across a river" (Scapens and Hao, 1995). After more than 20 years of reform, it would appear that the ultimate objective is to create a market-oriented economic system, officially described as "a socialist market economy with Chinese characteristics". In other words, it is to establish a marketoriented economic system which fits in with China's political and social environments, in particular, the absolute leadership of the CCP. The entire period can be divided into three distinct phases of economic reform, which in turn determines the pace of accounting development, as shown below (T. Li, 1998): (a) Initial Economic Reform: December 1978 - September 1984 (b) Planned Commodity Economy: October 1984 - December 1991 (c) Socialist Market Economy: Since 1992

6

ACCOUNTING IN CHINA

This book is organised as follows. Chapter 2 provides a brief account of earlier Chinese indigenous bookkeeping. The rest of the book is classified into two parts, Part A comprising Chapters 3 to 6 on Mao's China and Part B comprising Chapters 7 to 12 on Deng's China. The focus of analysis is not to describe in detail how accounting was practised but to show how accounting reacted to the changes in the political, social and economic environments in the two very different periods in the history of the PRC.

chapter 2

Brief History of Accounting in China up to 1949'

China is one of the oldest civilisations in the world and has a recorded history that dates from some 3,500 years ago and a prehistory that stretches back much further. Since the establishment of the first feudal empire in the Qin Dynasty (221-206 B.C.), China over 2,000 years had undergone many cyclical changes of dynasties, resulting from peasant uprisings or dynasty wars and accompanied by alternating periods of unification and division in the country. In spite of these upheavals, China remained a self-sufficient agrarian feudal society. The Chinese feudal system remained intact until the defeat of China by Britain in the First and Second Opium Wars of 1840 and 1842, and by other western countries in a series of essentially "colonial wars". At the beginning of the twentieth century, western forces and influences had so deeply penetrated China that it had become a semi-feudal and semi-colonial society. In the late Qing Dynasty (1644 - 1911), a revolutionary leader, Dr Sun Yet-sen, formed a political party, called the Nationalist Party or Kuomintang (KMT), and in 1911 led the revolution which ended the Qing Dynasty and established the Republic of China (ROC), which was a western style republic. However, the government had little economic or 1

This chapter is based on Huang and Chang (1997).

8

ACCOUNTING IN CHINA

military power as China was virtually partitioned and controlled by a number of warlords, that is politicians with private armies. After Dr Sun's death in 1925, his successor, Chiang Kai-shek, waged war on the warlords. Chiang succeeded in this military mission and China was once again formally unified. 2.1

Indigenous Accounting Systems

A crude single-entry bookkeeping system was developed in ancient China and was further developed and refined in later centuries. By the Qing Dynasty (1644 - 1911) the Chinese single-entry bookkeeping system was fully developed, with its own distinctive features. For example, the recording of business transactions was made in columnar form, top-down and from left-to-right, consistent with the writing of Chinese calligraphy. In the late Ming Dynasty (1368 - 1644) and the Qing Dynasty, Chinese double-entry frameworks known as the Longmen (literally "dragon gate") Account and the Four Feet Account emerged. In the Longmen Account system, transactions were grouped into and recorded under four categories: Received, Paid, Keeping and Owing. Income items were recorded as Received, and expense items as Paid. Increases in assets and decreases in liabilities were recorded as Keeping, while decreases in assets and increases in liabilities were recorded as Owing. Received and Owing items were classified under "Receipt" in the top half of the ledger, while Paid and Keeping items were classified under "Disbursement" in the bottom half of the ledger. The double-entry principle was expressed as: "The Receipt appears with the Disbursement and the amount is equal". At reporting date, the total of each of the four categories was obtained to give the equation: Received - Paid = Keeping - Owing. This balancing method of calculating the profit for the year was described as "settling Longmen". The Four Feet Account system, which was developed under the influence of the Longmen Account, was a more sophisticated system. It entailed the preparation of an income statement, called Cai Xian Jie Ce,

BRIEF HISTORY UP TO 1949

9

in which all revenues appeared in the top half of the statement and all expenses, losses and taxes in the bottom half. Profit (loss) was calculated as the excess (deficit) of the total of items recorded in the top half of the statement over that in the bottom half. It also entailed the preparation of a second statement called Cun Chu Jie Ce, which is equivalent to a balance sheet. In this report capital and liabilities were recorded in the top half of the statement and assets were recorded in the bottom half. A profit (given by the income statement) would be recorded in the top half of this balance sheet and a loss in the bottom half. The top half was called Tian Fan (ie, heaven) and the bottom half Di Fan (ie, earth). The process of balancing the two was described as Tian Di He (meaning "matching heaven with earth"). 2.2

Adoption of Western Double-Entry Bookkeeping

However, the Chinese double-entry system was not a fully developed system and was inferior to western double-entry bookkeeping in two important ways. At a conceptual level, the Chinese did not fully grasp the principle underlying "Italian capital-income accounting", that is, the ingenious integration of asset and capital (ie, equities) accounts and operating accounts (ie, accounts of revenues and expenses). In the western system an important objective is the recording and disclosure of the investment in resources and the return on the investment. At a technical level, the Chinese numerals used in Chinese bookkeeping were cumbersome and mathematically less tractable than the Hindu-Arabic numerals adopted in the West. The principle of positional notation was not observed in the Chinese books of account and arithmetical calculations were performed on the abacus and not on the page of the journal or ledger. When modern industry and commerce emerged in China the need to reform Chinese accounting and to adopt the western accounting system became clear by the end of the nineteenth century. The western accounting system (ie, the "debit-credit system") was first adopted in 1912 by the government-owned Bank of China, and by 1916 its entire

10

ACCOUNTING IN CHINA

accounting system had been converted to the new system, replacing the traditional Chinese system. This policy was soon followed by other banks in the country. By the 1930s the western accounting system had been adopted by all government agencies, government-owned enterprises and modern financial institutions. However, the direct use of the debitcredit system in non-government business sectors met resistance, because the recording symbols, the form of the various accounts, the HinduArabic numerals and indeed the entire framework were so different. Eventually, a hybrid bookkeeping system designed by academics, which retained certain aspects of Chinese accounting and incorporated certain modern features of the western system, found acceptance by private Chinese firms (Lu, 1992). This dual approach, that is, the use of western accounting co-existing with the use of a hybrid system, lasted until 1949. When the Communists took over in 1949 the western accounting system used by the KMT government and enterprises owned by the KMT bureaucrats and foreigners was discarded, as the Communist government and the enterprises it owned were organised under completely different political and economic systems. The Communists adopted a new accounting system based on the Soviet model. The hybrid accounting system used by the Chinese private firms was also replaced by this new accounting system when these firms were nationalised in mid 1950s. This change in the accounting system marked the first incident of the political influence on accounting in the Mao era.

PART A ACCOUNTING IN MAO'S CHINA An Extreme Case of Subservience to the Political Will

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chapter 3

Establishment Phase: 1949 - 1957

For nearly half a century prior to the establishment of the PRC China was devastated by a series of wars, including civil wars and the Sino-Japanese War. These battlefields produced one of China's greatest leaders, Mao Zedong. In 1921 Mao and his comrades formed the CCP based on the political theories of Marx and Lenin and the experience of the Russian Revolution. The CCP established revolutionary bases in the mountain areas. Between 1927 and 1937, Chiang's Nationalist army was engaged on a ten-year long offensive against Mao's Communist guerrillas. This civil war was suspended when the Japanese invaded China in 1937. The Sino-Japanese War lasted from 1937 to 1945, and for a short time during this period the Nationalists and the Communists were united in the fight against the common enemy. With the Japanese surrender in 1945, the civil war was resumed. In less than five years the KMT was defeated and took refuge in Taiwan. In 1949 the PRC was formally established. Mao had played a dominant role in leading the CCP and its troops to the military victories from which his unchallengeable authority was derived. After the onset of the Sino-Japanese War in 1937, Mao developed for the CCP the strategies and policies which enabled the Party and its troops to survive the harsh political and economic conditions and miraculously to expand rapidly during the eight years of the war. Mao's preeminent position within the Party was already indisputable by the mid-1940s. Not only was Mao the subject of a major

14

ACCOUNTING IN MAO'S CHINA

personality cult, but by 1943 his leading colleagues had ceased voicing doubts about his theoretical contribution to communist ideology and in 1945 the "Thought of Mao Zetong" was enshrined in the CCP's new constitution. The success of Mao's strategies and policies in the war against the KMT army from 1945 to 1949 further bolstered his ultimate authority. Throughout the establishment period Mao was clearly the unchallenged leader of the CCP and the PRC (Teiwes, 1987). 3.1

Political, Economic Establishment Phase

and

Social

Developments

in

the

The wars caused massive destruction to the nation and the PRC was indeed founded in 1949 on a devastated land. Society and its institutions were fragmented, public order disintegrated and morale plummeted. The economy was near collapse. Long-term structural problems characteristic of pre-modern economies, such as low per capita income, short life expectancy, low rates of savings and investment, and the predominance of traditional methods of production, were compounded by the loss of both physical and human capital and the hyperinflation that had accompanied a long period of war. In addition, traditional Chinese society was characterised by parochialism. In most rural areas the awareness and interests of the peasants were limited to events in their villages and nearby areas. Even in China's cities, the lives of ordinary people were bound by small social groups, with little awareness of events at either the municipal or national level. The Communist government faced the awesome tasks of gaining political control, rehabilitating the economy, and achieving national unity and social transformation (Lardy, 1987a; Teiwes, 1987). As the CCP leaders lacked experience in tackling these formidable problems, China turned to the Soviet Union for assistance and adopted the Soviet model of socialism which provided patterns of organisation at various administrative levels, development strategies, modern military techniques, and policies and methods in a wide variety of specialised areas. The Soviet Union was regarded as the ideological leader of

ESTABLISHMENT PHASE

15

socialist revolution and communism, and had set an example of rapid economic growth. Further, the Soviet Union was China's only source of military and economic aid. More fundamentally, the Chinese leadership's decision to "lean to one side" was a long-term ideological orientation toward Soviet Russia. This involved a sense of being part of a common movement antagonistic to international capitalism and imperialism. Given China's desire for development and the fact that the Soviet Union was the only existing example of a state which was socialist and had achieved rapid growth from a backward economic base, the decision to follow the Soviet path was all but inevitable (Teiwes, 1987). During the establishment phase, the influence of the Soviet model was seen in nearly every aspect of the people's life: the emulation of Soviet methods, the study of Soviet theory, placing Soviet experts in key ministerial, military, scientific, managerial and educational advisory posts, dispatching Chinese students and specialists to Russia, and the publication of large numbers of translated Soviet texts (D. Guo, 1999). The ultimate aim of the CCP was to establish a highly centralised political system of a socialist nation following the Soviet model, with a centrally-planned and centrally-controlled economy and the CCP as the ruling party. However, as the conditions and circumstances in China differed substantially from those of the Soviet Union, Mao and the CCP initially took a gradual and progressive approach to the building of socialism. The Party was the ultimate locus of authority, with the key policies determined by the Central Committee of the CCP and the final decisionmaking vested in the Politburo and the Standing Committee of the Politburo. In this period the government and administrative arrangements underwent a number of changes and adopted a number of different forms. In 1949 a temporary supreme organ of state power pending the establishment of a system of people's congresses, was designated as the Chinese People's Political Consultative Conference (CPPCC). A key strategy Mao used in the first years of the PRC was the "united front", the essence of which was to maximise support and

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minimise hostility. The principle of this strategy was to gather a wide collection of allies by setting relatively limited goals and defining the enemy class as narrowly as possible, a strategy contributing significantly to the revolutionary success. This united front practice, applied to the postliberation situation, was reflected in the general programme and institutional arrangements proclaimed at the founding of the PRC. Into the united front and CPPCC were drawn the so-called democratic parties, the small middle-class and intelligentsia-based groups. Not only did delegates from these parties vastly outnumber those formally representing the CCP, but significantly eleven of the twenty-four ministers appointed in the new government were minor party representatives or unaffiliated "democratic personages". Equally significant was the moderate, conciliatory nature of the CCP blueprint for the future: the Common Programme. The hallmark of this document was "gradualism". In addition to gradualism, the Common Programme adopted the classic united front tactic of narrowly defining enemies as "imperialism, feudalism and bureaucratic capitalism". Not only were rich peasants excluded from the list of enemies, but the need to maintain the "rich peasant economy" became a key aspect of the CCP's rural policies. A "new democratic state" was established that was a "people's democratic dictatorship" in which the peasantry, petty bourgeoisie and national bourgeoisie joined the working class as ruling classes (Teiwes, 1987). However, in later years the definition of the ruling classes was narrowed considerably and during the Cultural Revolution the democratic dictatorship was replaced by the proletariat dictatorship. In September 1954 the PRC replaced the temporary arrangements made in 1949 by adopting a state constitution. Although Mao claimed in mid-1954 that the constitution was "based mainly on our own experience but has drawn upon what is good in the constitution of the Soviet Union", in fact, the document basically followed the pattern of the Stalin constitution of 1936. The system of people's congresses, theoretically the highest organs of state power, was formally established. The basic structure consisted of "elected" congresses from the local to national levels. The National People's Congress (NPC) and People's Congress at

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provincial and local levels constituted the government, with the NPC and the Congress at the provincial level being the legislative bodies. Theoretically, the congresses appointed government administrative bodies at each level. These administrative organs were legally responsible both to the congresses that appointed them and to higherlevel administrative organs. The CPPCC remained in existence but its role was changed to the provision of advice and expertise in the administration of the country. In addition, an ostensibly independent judicial system of courts and people's procurators was set up (Teiwes, 1987). The central government administrative function was performed by the State Council. The institutional relationships were fundamentally influenced by the Soviet model. The Soviet-style command economy required a set of administrative practices that enhanced the centralised control mechanism within the state structure. As a result, a vast number of administrative decisions related to economic management fell to the State Council and the central government ministries. The economic aims during this establishment period were to revive the nation's economy and to establish a socialist planned economy based on public ownership in the form of state ownership (by the people of the country as a whole) and collective ownership (by the people in a community). The CCP leaders realised that socialism could not be built on the basis of a small peasant economy; it must have a foundation of large-scale industry and collective farming. In this respect, China closely followed the Soviet model in principle with features of high rates of reinvestment, emphasis on capital-intensive high-technology projects, agriculture as a major source of funds for industrial growth, and priority investment in heavy industry. A series of mass campaigns and economic measures in rural and urban areas was introduced in order to achieve these economic aims (Lardy, 1987a; Teiwes, 1987). In 1950, in the countryside campaigns of class struggle against the landlords were launched throughout the nation, as part of a land reform programme. The major steps taken were a class identification of all village inhabitants, followed by the confiscation and redistribution of

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land and other productive property as part of the land reform. Work teams were sent by the governments to all villages to lead the campaigns and to mobilise the entire village against the landlords through such devices as "speaking bitterness" meetings and mass trials. These methods subjected the landlords to public humiliation, and the trials also resulted in the execution of members of this class on a significant scale. The land reform succeeded in redistributing about 43 per cent of China's cultivated land to about 60 per cent of the rural population (Teiwes, 1987). Accompanying the land reform and campaigns were severe measures taken against the old social system dominated by the landlords, "despots" or "local bullies" and secret societies, and the establishment of a new social system under Communist control. The land reform gained the trust of the peasant masses in the new regime and also increased rural productivity. However, after the land reform the rural sector continued to be based on individual households and hence to remain unorganised, which was not consistent with the socialist blueprint. More importantly, the rural productive forces had not been "freed" to offer support to the nation's industrialisation plan. Therefore, agricultural cooperativisation in the countryside began soon after the distribution of the landlords' land to the peasants. This was initially planned to be a gradual transformation process with three steps. The first was to organise mutual aid teams (MATs), where labour was pooled but ownership rights over land and other productive factors were retained by individual peasants. The second step was to form the lowerstage Agricultural Producers' Cooperatives (APCs), where productive property was now controlled by the collective but each peasant received a "dividend" according to his relative contribution of land, labour, tools and animals. The final step was the higher-stage APC (or full collective), where the dividend was abolished and payment was made strictly according to the labour provided. Therefore, ownership of the land and other productive property was vested in the APCs, a form of collective ownership in the countryside. The final step was envisaged to take some years to complete, but with Mao's intervention it was rushed to completion within one and a half years. In a later stage of the

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cooperativisation process the target of the class struggle shifted from the landlords to rich peasants (Lardy, 1987a; Teiwes, 1987). By the end of 1956 agricultural cooperativisation was completed. It was considered an enormous achievement in social and institutional transformation, in which the great bulk of the Chinese people was brought under socialist forms of organisation. It was thought that the completion of the APCs programme would free the rural productive forces, allow the state to obtain more easily the agricultural surplus and, thus, pave the way for industrialisation. In urban areas a number of mass movements and political campaigns was launched in the first few years of the PRC to gain political control in the cities. The most important of these were the campaign to suppress counter-revolutionaries, the Three-Antis campaign against corrupt personnel, the Five-Antis drive against the hitherto respected national bourgeoisie, and the thought reform campaign aimed at intellectuals. All these movements were extremely intense and violent and generated considerable tension and apprehension in society. In addition, intense psychological pressure was brought to bear by various measures, including forced confessions in small groups as well as mass trials attended by tens of thousands. These campaigns indicated to broad sections of society the full extent of the Party's aims for social transformation (Teiwes, 1987). The political campaigns were accompanied by a series of economic measures. The enterprises owned by the KMT government and bureaucrats and foreign investors were confiscated and transformed into publicly owned enterprises under direct government control. Other enterprises owned by the national bourgeoisie (Chinese capitalists) went through a lengthy process in which the ownership structure was transformed, first from private ownership to partnership with the state and then from partnership with the state to state ownership. The whole process typically took several years to complete. Small private enterprises and handicrafts in the urban areas were typically transformed into collective owned enterprises. As a result, the PRC entered a new phase of socialist construction and transformation which resulted in

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nation-wide economic planning and the country's First Five-Year Plan for the period 1953 to 1957, which was finalised in 1955 (Lardy, 1987a). By 1956, the state had completed the take-over of private industry and commerce, while agriculture and handicrafts had been collectivised. By 1957, a strong centralised state had been established after decades of disunity, and the country had taken major steps on the road to industrialisation and had achieved an impressive rate of economic growth. The living standards of the people had made noticeable, if modest, progress. Further, the nation's social system had been transformed according to Marxist precepts in a relatively smooth fashion. The political system and administrative structure established in this phase largely remain unchanged in subsequent periods except for some rearrangements of government administrative functions. During this establishment period Mao, recognising that he lacked the knowledge of macroeconomic management, left this to colleagues who were more capable in this field and tended to limit his interventions largely to those areas he knew best - agriculture and revolution above all else. In these years Mao apparently took major initiatives on only three occasions. On the first, he ordered the involvement of Chinese troops in the Korean War despite the reservations of the great majority of his associates. The second instance was the Chairman's initiative in speeding up the pace of agricultural cooperativisation despite the Party's official decision to take a longer term and a more gradual approach. The third initiative was Mao's efforts in the face of substantial reservations within the Party elite to promote intellectual criticism of the Party through the Hundred Flowers movement in 1956-57 (analysed in a later section). Mao even proposed to divide the leadership into two "fronts". Under these arrangements Mao would retreat to the "second front" where he could contemplate matters of theory and overall policy while divorced from daily operations. Mao was generally satisfied with the progress and development achieved in the establishment phase. Overall, in these years Mao played a positive role and, in contrast to later periods, Mao's impact on policy making was relatively limited (Teiwes, 1987).

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In the establishment phase the political climate was relatively relaxed and there existed some degree of freedom in independent thinking and academic research, despite the class struggle in the countryside and the thought reform campaign directed at the intellectuals. Different opinions could be expressed and constructive criticisms could be heard and accepted, especially those which were beneficial to the economic reconstruction. The advice of prestigious non-Communist figures was genuinely sought and there was respect in society for science and intellectuals. The Party's policies overall were rational and based on the social and economic circumstances in the period. 3.2

Business Enterprises under a Centrally-Planned Economy

Prior to 1949 there existed four major types of business enterprises: enterprises owned by the CCP in the liberated areas, enterprises owned by the KMT government and bureaucrats; enterprises owned by Chinese capitalists; and enterprises owned by foreign investors (Lu, 1992). Enterprises owned by the KMT government and bureaucrats and by foreigners were immediately confiscated when the CCP took control and transformed them into state-owned enterprises (SOEs). Enterprises owned by Chinese capitalists went through a nationalisation process in which the ownership structure was transformed, first from private ownership to partnership with the state and then from partnership with the state to state ownership. Small enterprises and handicrafts in cities and towns were organised into collective-owned enterprises (COEs). Until the early 1980s when an economic reform took place, there existed only these two types of business enterprises, that is, SOEs and COEs. In the planned economy structure established under the First FiveYear Plan, the commerce and industry sectors were characterised by the following features: (a) public ownership, comprising state ownership and collective ownership, with the former overwhelmingly dominant; (b) SOEs, placed under the direct control of relevant (ie, industry classified) central ministries, resulting in a large number of central ministries under the State Council; (c) state plan-directed production activities; (d) state-

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set prices accompanied by a system of commodity allocation; and (e) a state investment and financial control system. The SOEs, according to the PRC's constitution, were owned by the state representing "all the people". The key features of SOEs and the economic management at the micro level can be summarised as follows: (a)

All factors of production (such as plant, equipment, and raw materials) were owned by the state and SOEs were delegated the authority and the responsibility to use and manage them (Zhong, 1988).

(b)

A comprehensive state economic plan was developed each year based on demand factors, which was converted into production plans for individual SOEs (Ren, Alexander and Kedslie, 1995). Purchases of raw materials and sales of finished goods were made exclusively through the state supply and distribution channels respectively at prices set by the state. This planned pricing system was accompanied by a planned wage system. The SOEs were merely production units which had no link with the marketplace.

(c)

All SOEs operated under a rigid and restrictive financial control system. The Ministry of Finance (MOF) would allocate funds (at zero cost) to individual SOEs, the amount of which was determined to be necessary to carry out the assigned production task. All profits made would be remitted to the state, while operating losses would be replenished by government subsidies. Funds accumulated through the depreciation of fixed assets were either transferred to a specific fund account to be used for replacing fixed assets or remitted to the state for reallocation, depending upon the economic situation and the requirements of state administration (Scapens and Hao, 1995). (The corresponding fund accounting system is discussed in the following sub-section.)

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Under such a system, SOEs were literally appendages to the government and had little autonomy in making decisions and little responsibility in making efficient use of economic resources. Each enterprise, as the Chinese saying goes, had an "iron bowl" with which it consumed "the rice cooked in a single big pot", meaning that it was assured of full financial backing out of government resources regardless of its performance. This policy in the management of SOEs dampened initiative, offered no incentive to enterprises and workers, and hindered the effective management of economic activities (Lu, 1992). COEs, by definition, were owned by the group of people who operated them. In reality, however, they were normally attached to and under the control of government organs. The people who owned and worked in these enterprises had no right to dissolve the business and distribute the residual value. Furthermore, it was common practice for the government to administratively transfer sizeable collective enterprises to state ownership. COEs were not part of the centrally planned system and they accounted for only a very small proportion of the total output. At the macroeconomic level, the planning system literally treated the nation's economy as a huge factory with each enterprise being a workshop of that factory and dictated every aspect of business operations for enterprises, which is a mission impossible (Ren et al., 1995). In addition, the strong bias in favour of the development of heavy industry and urban development created severe distortions in resource allocations among the main sectors of the economy, viz, agriculture, light industry and heavy industry. 3.3

Development of New Accounting Systems and Practices

The complete overturn of the political, economic and social systems when the Communists came to power heralded the end of the western accounting system used by the KMT government-owned and foreign enterprises and the hybrid accounting system used by the Chinese private firms. In the establishment phase there was an urgent need to set up a new accounting and financial reporting system relevant to the new

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political, economic and social structure, that is, a system which could provide the necessary information to the state for reviewing and supervising the economic activities of its different units, monitoring the execution of the state plan and budget, maintaining control over the economy, and producing new state plans. The specific tasks of accounting development were to establish nation-wide unified accounting systems and practices to accompany and support the highly centralised political and economic systems and to facilitate the state comprehensive planning. Accounting development in this phase, as in the case of the political and economic development, also took the "lean to one side" attitude and was heavily influenced by the Soviet Union, although there were certain unique features reflecting the political and economic conditions in China. In December 1949, the Department of Administration of Accounting Affairs (DAAA) under the MOF, was given the responsibility to institute uniform nation-wide accounting systems and administer the accounting work in the entire country. Two important tasks were, first, to unify the accounting system across different economic units and, second, to use the accounting system to assist in the economic recovery. These aims led to the promulgation of uniform accounting regulations as a tool of the centralised economy (D. Guo, 1999). A unified fiscal system was adopted in which the central government stripped local governments of the power to spend based on the tax revenues. In March 1950 the central government issued a document, Decisions on the Unification of the Financial and Economic Work of the State, followed by a series of regulations, such as the General Budgetary Accounting System for Administrative Departments of the Central Government and the Unit Budgetary Accounting System for Local Governments, designed to unify accounting practices in both the central and local government spheres. As a result, the revenues and expenditures of all government organs were recorded under the budgetary accounting and control systems and subject to centralised control (D. Guo, 1987).

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3.3.1 Uniform Accounting Systems For business enterprises the first move was to establish uniform accounting systems (UASs) for enterprises operating in different sectors or industries. In March 1950 the Finance and Economic Commission of the State Council issued instructions to all the commerce and industry ministries to draft industrialised UASs. By the end of 1950, UASs for 22 ministries were approved and issued by the State Council and the MOF, including ministries for the heavy industry, light industry, textile industry, fuel industry, railway, transportation, commerce and trade, and communication (D. Guo, 1999). Each UAS reflected the production and operation plan of a particular industry, and the accounting information was prepared mainly to enable the state to compile that part of the national economic plan and monitor its execution. In fact, the UASs served as channels for collecting statistical data for government planning and control purposes. All enterprises (ie, SOEs and COEs) were required to comply strictly with the relevant UAS. While the UASs varied from industry to industry in terms of account titles and accounting procedures because of differences in the nature of the business, they were relatively similar in terms of the underlying principles and purposes. Each UAS covered the following areas: general principles applied; uniform financial statements; chart of accounts; account books; accounting source documents; accounting procedures; and a diagram of the accounts organisation system. The most characteristic feature of the UASs was their prescriptive and procedural nature. Lou and Enthoven (1987) observed that UASs were formulated in great detail, were rigid and procedural, so as to satisfy the need for consistent and comparable information in planning and decisionmaking by central and local governments. Accountants were required to follow precisely the UAS procedures and to assist the government to exercise central planning and control (Ren and Alexander, 2000). The UASs differed sharply from internationally recognised accounting practices and, ironically, they produced inconsistent practices among enterprises in different sectors or industries. However, they were

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established to operate in a centrally planned economy and serve a purpose entirely different from that of financial reporting in a market economy. 3.3.2 Fund Accounting The adoption of UASs was accompanied by a fund accounting system, based on entirely new basic accounting concepts and principles, to comply with the state fund allocation and financial control system. The conventional accounting equation was replaced by one consistent with fund accounting: Fund Applications = Fund Sources The new term "fund", as opposed to "capital", was used to reflect the socialist, as opposed to capitalist, nature of the economy. "Fund" was defined as the monetary expression of property, goods, materials and financial assets used in the production process. "Fund sources" referred to the channels by which funds were obtained, while "fund applications" referred to the existing form, use or distribution of funds such as property, goods, materials and financial assets. Fund applications must equal fund sources at all times. Furthermore, for the state to exercise financial control over enterprises and to facilitate central planning, all funds had designated uses and were divided into three categories: fixed funds, current funds and specific purpose funds. Fixed funds were those used for purchasing or constructing fixed assets; current funds were those used for day-to-day business operations; and specific purpose funds were funds designated for specific purposes, such as R&D projects, workers' welfare and major repair projects. Funds belonging in one category could not be used for needs designated in another category, vividly described as "Money for soybean source cannot be used for vinegar". Total assets must equal

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total fund sources in each category at all times and the three subequations shown below must be disclosed: Fixed assets = Fixed funds Current assets = Current funds Specific assets = Specific funds The fund accounting system and its features are clearly shown in the balance sheet (or, more accurately, the Funds Balance Statement), a simplified version of which is shown in Table 3.1.

Table 3.1

A Simplified Balance Sheet under the Fund Accounting System

Fund applications Fixed assets Original cost Less: depreciation Carrying value Subtotal of fixed assets Current assets Stocks Accounts receivable Cash and bank balance Subtotal of current assets Specific assets Bank deposit under specific fund Other assets under specific fund Subtotal of specific assets Total Fund Applications Sources:

Fund sources Fixed fund sources State fixed fund Enterprise fixed fund Fixed fund loans Subtotal of fixed fund sources Current fund sources State current fund Enterprise current fund Current fund loans Subtotal of current fund sources Specific fund sources State fund for specific purposes Enterprise fund for specific purposes Bank loans for specific purposes Subtotal of specific fund sources Total Fund Sources

Lefebvre and Lin (1990) and Tan et al. (1992).

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Among the three types of fund sources in the balance sheet the major fund sources were state funds, and other funds, such as enterprise fund and loans, typically accounted for only a small proportion of total fund sources. Certain characteristics of the fund accounting system, which were consistent with the nature of the economic system, should be highlighted: (a) there were no intangible assets and (b) land, belonging to the state, was not recognised as an asset. In addition to the balance sheet, other major financial statements were the income statement and the statement of product cost. The product cost statement, which was regarded as a key report, provided a detailed account of product cost information to meet state planning needs and to facilitate cost cutting activities. All expenses, including administrative and selling expenses, were included in the product cost, as accountants were not familiar with notions of period costs or variable costing (Scapens and Hao, 1995). 3.3.3 Product Cost, Debit-Credit Accounting and Accounting Education A unique aspect of the new enterprise accounting practice in this period was the participation of workers in gathering and measuring product cost. Usually the smallest production unit (eg, a production group or a shift) was treated as a basic unit for measuring the cost of production. Workers were given the responsibility for keeping records of the consumption of raw materials, labour hours and other expenditures as well as output. These basic units, however, were not cost centres and workers were not financially linked to the cost performance (ie, their pay was not tied to the production cost). Rather, the practice was designed to serve two purposes: (a) to show that workers were the masters of the enterprise in the new regime and thus should participate in its management, and (b) to control and reduce production cost by providing a means of comparison and emulation of production efficiency among production units. In addition, this practice provided a good foundation of information and source documents for the accounting system. The debit-credit accounting method which was widely used by government organs and modern business firms prior to 1949 continued to

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be used by both governments and business enterprises. The debit-credit method was acceptable because (a) this was also the method used by the Soviet Union, (b) it was regarded mainly as bookkeeping technology rather than as part of a capitalist system, and (c) in the establishment phase focus was placed on economic development rather than the ideological debate. Overall, accounting development in this period was adequate and consistent with the political and economic systems it served. Accounting made its contribution towards the overall success of the establishment phase (D. Guo, 1999). Accounting education achieved significant advancement during this period. Many universities started to offer a four-year degree programme for accounting major students and a number of finance and economic colleges were founded to offer accounting and related courses. At the same time, distance learning and evening university courses were offered to students who worked full time. Research in accounting was quite active and a number of accounting journals were published. However, as determined by the political climate in this period, everything that was taught and learned was either translated from the Russian or based on the Soviet model. Western accounting was completely banned and western textbooks were destroyed. All university students were required to take up Russian as their foreign language and the teaching of English was abolished. As a result, both academic and practising accountants were totally ignorant of developments in western accounting until China re-opened its door to the West more than 20 years later (D. Guo, 1999).

chapter 4 Great Leap Forward: 1958 -1962

Unfortunately, the achievements of the establishment phase and the successful completion of the First Five-Year Plan were not followed through in implementing the Second Five-Year Plan (1958 - 1962). The gradual development approach adopted in the past was abandoned. In 1958 two radical programmes were launched, viz, the people's commune movement and the Great Leap Forward (GLF), which were intended to increase the rate of economic development. The key strategy adopted was to mobilise certain targeted social groups, in particular the farmers and the workers, and plunge the country into a frenzy of productive activity. The two programmes turned out to be disastrous. 4.1

Political Motivation for and the Economic Outcome of the GLF

There were two key political factors which were relevant to the launch of these two programmes. The first was the Hundred Flowers campaign that was transformed, ironically enough, into the Anti-Rightist campaign. With the completion of the collectivisation of agriculture and the steady growth of industrialisation, the CCP leaders realised that more help from the intellectual and professional classes was needed. However, the tight political control and, in particular, the thought reform campaign had frightened the intellectuals, most of whom chose to be disassociated for fear of transgressing the Party's guidelines. To remedy this situation, towards the end of the establishment phase a campaign labelled "Let a

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hundred flowers bloom, let a hundred schools contend" was launched. The original intention of the campaign was to arouse enthusiasm among the intellectuals, who were invited and encouraged to display independent thinking, express freely and debate their opinions, offer new ideas, and even criticise the Party and the government officials. After a slow initial response, the campaign gained momentum and then went far beyond Mao's and the Party's intent. Some intellectuals questioned the relevance of Marxist economic theories to China and even the relevance of Mao's Thought to their academic fields. Feeling the campaign was getting out of control, Mao in late 1957 turned the Hundred Flowers campaign into the so-called Anti-Rightist campaign. Those who had spoken out in criticism were labelled "rightists" and treated as enemies of the Party and the people. In this campaign some 550,000 scholars and others were labelled "rightists" and were dismissed from their official positions and sent to the countryside and factories to undergo labour reform. The psychological pressures brought by "struggle sessions" were intense and resulted in a large number of suicides (Goldman, 1987). After the Anti-Rightist campaign there was no voice of opposition in the whole nation to the Party and the government. Moreover, most people including the Party and government officials adopted a strategy and attitude called "better err to the left than the right", which had a significant impact on the two radical programmes (viz, the commune and the GLF) and the manipulation of statistical data in the following years (Goldman, 1987; Teiwes, 1987). The second political factor was Mao's increasing interference in economic affairs. During the establishment phase, Mao volunteered to be in the "second front" of the leadership as he knew very little about urban economics, and especially the technicalities of finance and planning. As he was, by and large, not involved in running the economy and the administrative functions, Mao felt that he was being isolated and losing control. At a party conference in 1958 Mao complained bitterly that the Ministry of Finance had for several years been sending the Politburo position papers so technical and complex that he simply had to sign them without even reading them (Lieberthal, 1987). This situation

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naturally limited Mao's role in the Party hierarchy, and he was determined to change this by forcing through a strategy of development that shifted the action from the areas in which he lacked strength to those where he felt more confident, such as rural policy and revolutionary issues. Mao was also not satisfied with the gradual approach which he himself had advocated earlier and the associated slow pace of economic development and social transformation. His judgement that the whole process could be speeded up was supported by the faster than expected completion of the agricultural cooperativisation as a result of his intervention. In addition, Mao believed that his experience in organising the large-scale battles during the war was relevant in managing the economic re-construction of the country. He deeply believed in the power of political and mass movements and the importance of arousing the enthusiasm of the masses, as he said in one of his speeches: "[If] 600 million 'paupers' ... take their destiny into their own hands ... they can overcome any difficulty on earth" (quoted in Teiwes, 1987). The GLF began with the People's Communes movement. In 1958, the Agricultural Producers' Co-operatives from adjacent towns and villages were reorganised and combined to form People's Communes, in order to achieve benefits from economies of scale and to boost agricultural output. Under the commune system, the previous mix of private and collective activities was shifted decisively towards the latter, and principles of income distribution were fundamentally altered. A large share of net earnings was distributed on a per capita basis, consistent with communist principles. The rural markets for peasants to exchange or sell agricultural products, regarded to be detrimental to the state planning and control system and to the transformation to socialism, were closed altogether. The People's Communes also subsumed the functions of government in the countryside. The political motivations for the commune movement were to accelerate the social transformation towards a socialist or communist system and gain further control over labour resources in the countryside. The economic motivations were to promote essentially self-financed development in the countryside that

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would in turn provide inputs (especially food) for urban industrial growth, especially in heavy industry. The GLF strategy for industry was characterised by a further intensification of investment in capital intensive projects and a focus on steel output. The rising target for steel production in 1958 exemplifies the GLF strategy in industry. The initial target in February 1958 was 6.2 million metric tons, nearly a 20 per cent increase over that of previous years. Three months later the target was raised to 8.0-8.5 million metric tons, and by August to 10.7 million metric tons. Soon after, Mao was proposing a target of as high as 12 million metric tons, and in 1959 this was raised to 30 million metric tons. To achieve these targets, a programme which focused on "backyard steel furnaces" was implemented throughout the country. Capital investment targets were similarly raised throughout the GLF period. For example, the investment target proposed at the beginning of 1958 was 14.6 billion yuan, but ultimately investment in state-owned units reached 38.6 billion yuan. During 1959 the rate of investment rose to as high as 43.4 per cent of national income (Lardy, 1987b; Lieberthal, 1987). The rapid expansion in industry and urban development was accompanied by an unprecedented increase in the non-agricultural labour force and urban population. In 1957 the number of workers and staff in state units was about 24 million. This increased by 85 per cent to 45 million in 1958. The peak level of employment in state units was 50.4 million at the end of 1960, more than double the number in 1957. The rapid increase in urban population led to an increasing demand for grain from the rural sector. This demand put pressure on cadres in the countryside to manipulate output figures to produce astonishing results. Acceptance of these data on agricultural output had several major repercussions. First, it provided the impetus for an increase in the rate of investment and a substantial acceleration of industrial growth. Second, the image of rural prosperity led to a massive miscalculation in planning in the agricultural sector. Government officials decided to cut back on the total sown area and allocate a higher share to non-grain crops. A large part of the labour force in the countryside was directed to work on

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water conservancy and irrigation projects which were expected to raise crop yields substantially (Lardy, 1987b). Food production fell dramatically, due partly to bad planning and partly the mismanagement of agriculture brought about under the commune system. By the end of 1960 the GLF had produced economic disaster in the hinterland, and during 1961 this fundamental economic malaise spread throughout the cities. The 1960 grain harvest dropped dramatically to its lowest level since 1950 and set off the famine of 1960 to 1962, in which millions died amidst great suffering. Production in the industry sector was substantially cut, as there was not sufficient food to feed the urban population. Tens of thousands of construction and manufacturing enterprises were closed and nearly 30 million urban dwellers were forcibly resettled in the countryside. The economy has indeed collapsed. (Lardy, 1987b) 4.2

Accounting under the GLF

The GLF campaign and the accompanying atmosphere of fear and hate had a seriously adverse effect on the accounting and financial control systems set up in the earlier establishment period. These systems provided a vast amount of statistical data crucial to the central planning process, and most of these statistics were also lost. Thus, the GLF campaign brought about detrimental changes within the economic planning, financial control and administrative structures. Further, the political environment it created, such as the anti-intellectual and antiprofessional atmosphere and the widespread fear and mistrust among the populace, such as the fear to speak up and the belief that it is: "better err to the left than the right", were extremely detrimental to the management control system and accounting practices. Accounting development suffered a major set-back in this phase. It was thought that as political and mass movements could be used to arouse the enthusiasm of the masses, similarly the devolution of power to lower levels of the workforce would generate intense enthusiasm among the workers, leading to miraculous growth in efficiency and

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output. Hence, emphasis was placed on relaxing the central control system and simplifying working practices. Consistent with this, the MOF introduced simplified rules and procedures for accounting systems and reporting. For example, in the chart of accounts of the manufacturing industry the number of accounts was reduced from 85 in 1955 to 44 in 1958 (Lu, 1992). However, under the influence of the political climate in this phase, what actually occurred at the lower levels of government and administration went far beyond the simplification of rules and procedures. The financial control system and the set of accounting procedures were perceived to bind the "hand and foot" of the masses and dampen their enthusiasm and were, therefore, mostly removed. The practice in the earlier establishment phase of workers' participation in gathering and measuring product cost was abolished for a number of reasons: (a) record-keeping was time consuming and regarded as a nonproductive activity which added no value to the output, so that time spent on accounting work was a waste; (b) workers and other employees preferred participation in a productive activity to accounting and office activities, as the latter were seen to be the job of intellectuals and professionals whose status in a working class society was unclear; and (c) most importantly, the cadres at the lower administrative levels had an incentive to abolish the practice so that manipulation of data became possible. They did not want detailed records to be kept and standardised financial control and accounting systems in place, in order that their "creativity" could be realised and miraculous achievements could be reported. It was the norm in this phase for cadres to report highly inflated production output figures, thus gaining praise from their superiors as well as promotion (Bai, 1988; Liu and Turley, 1995). During the GLF period, many accounting officers were transferred to other, often manual, labour. Accounting rules and procedures were ignored and because accounting records were limited, reliance was often placed on people's conscience. In extreme cases, financial controls were entirely abolished and no accounting records were kept. In some parts of the country there existed little or no financial reporting. As a result, it

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became difficult to determine exactly the state of the national economy (Liu and Turley, 1995). Education in accounting suffered a set-back. Accounting courses at universities were curtailed and many accounting colleges were closed or merged. Distance learning and evening university courses were abolished. Academics and students were required to spend much of their time in production activities in factories. Accounting journals did not publish any research materials (indeed, there was no research work to be published) but became part of the Party's propaganda machine promoting the GLF programme (D. Guo, 1999).

chapter 5

Recovery Phase: 1963 - 1965

To deal with the national crisis caused by the GLF, the government had little option but to adopt strategies of retrenchment. Construction projects were stopped, industrial production cut back, and workers sent back to their villages in 1961 and 1962. There were fierce debates and struggles within the party leadership about the future direction of the country's development, and the recovery policy was not fully implemented until 1963. A document named "Twelve Articles on People's Communes" was drafted at the end of 1961 and the implementation of this document spelled the end of the GLF. Between 1963 and 1965, the then Chairman of the PRC, Liu Shaoqi, the General Secretary of the CCP, Deng Xiaoping and other Party leaders carried out an impressive programme of economic recovery (called the Liu-Deng Programme). Following the Liu-Deng Programme, the communes were reduced in size to a manageable level and the distribution of income was tied to the input of peasants. In fact, peasants were encouraged to work on an individual household basis and to take up output quota contracts with the communes. In addition, the rural markets were re-opened. In the industry sector, a number of measures was implemented. Industrial production was cut back considerably and construction projects kept at a low level. The rate of investment was substantially reduced and there was a shift away from investment in metallurgy and machinery

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toward investment in consumer goods and selected industrial goods that could be used to support agricultural production. A more balanced strategy of economic development among agriculture, light industry and heavy industry was pursued. The Liu-Deng Programme worked effectively and brought production in 1965 in almost every sector back up to the levels achieved on the eve of the GLF. However, Liu and Deng were later to become victims of the Cultural Revolution (Lardy, 1987b). Mao suffered a major set-back in his leadership and authority in the aftermath of the GLF movement. Because of his initiative in the GLF and his misjudgments over the political and economic situation, Mao was forced to make a self-criticism at the "Seven Thousand Cadres Conference" held in 1962. Mao admitted at the conference that he should take the key responsibility for the mistakes and disasters of the GLF (Lardy, 1987b). As a result, Mao had to surrender authority to his colleagues and adopt a low profile in the Party leadership. Liu, Chairman of the PRC, was placed in charge of the state and Deng was put in charge of Party affairs. However, Mao continued to see himself as the leader of the Party and spent the next three years planning a comeback to eliminate his political enemies, resulting in the Cultural Revolution. 5.1

Accounting in the Recovery Phase

In the recovery phase, the importance of accounting was recognised once more and accounting rules and regulations for each industry were reestablished. Also, many of the accounting positions which had been eliminated between 1957 and 1959 were reinstated. In 1963 the government promulgated the Regulations on Duties and Rights of Accounting Personnel, which sought to protect accounting staff from outside interference in their work and to assure the quality of accounting information. Accounting education was also given considerable prominence; for example, in 1965 a total of 18,200 students were studying accounting, compared to 2,400 in 1962 (Liu and Turley, 1995).

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39

A legacy of the GLF was the adoption of a new double-entry bookkeeping method, the so-called increase-decrease method. As the debit-credit method was imported from the "bourgeois world", it was considered not suitable; for example, the masses found the debit-credit method difficult to understand. It was argued that the increase-decrease method was simpler, less specialised, and in harmony with the revolution (Lu, 1992). This method used "increase" and "decrease" as recording symbols. There were two classes of accounts: (a) fund source or revenue accounts; and (b) fund application or expense accounts. If a transaction involved both a source or a revenue account and an application or an expense account, an increase (or decrease) would be entered into both classes of accounts; if a transaction involved only one class of accounts, then an increase would be recorded in one account and a decrease in another account within that class. The increase-decrease method was popular in small and medium size enterprises. In fact, the principle underlying this method and the debit-credit method is the same.

chapter 6

Cultural Revolution: 1966 - 1978

The "Great Proletarian Cultural Revolution", as it was called, lasted from the beginning of 1966 to the death of Mao some ten years later. This extraordinary political and mass movement, which convulsed the entire population, was largely brought about by Mao and designed to bring down his political rivals and thus restore his position as the supreme leader of the Party and the country. In the recovery phase the crisis caused by the GLF gradually eased, but tension among the leaders began to emerge as Mao sought to regain his power, which had been eroded substantially by his serious misjudgements on the GLF and the commune movement. Liu Shaoqi and Deng Xiaoping had successfully implemented a series of policies designed to restore social cohesion and economic productivity, such as restoration of the statistical system and technical norms, and a return to private farming in agriculture and the use of material incentives in industry. In Mao's view, these measures were creating a degree of inequality, specialisation, hierarchy, and dissent that was incompatible with his vision of a socialist society, but this view was largely ignored by his peers. As a result, Mao became determined to destroy the state system which he himself had established some fifteen years earlier. For this purpose, Mao built his power base on three elements or groups in Chinese society: the disadvantaged urban young, who later became notoriously known as the "Red Guards"; opportunistic intellectuals, who

CULTURAL REVOLUTION

41

provided Mao with theoretical justifications for the Cultural Revolution (CR); and the army, the most crucial element, over which Mao had considerable personal influence (Harding, 1991). The CR was launched by Mao as a mass movement against "old ideas, old culture, old customs and old traditions" (eg, superstition) in order to create a new and healthier cultural environment, which initially gained support from Party members, the government hierarchy and a wide range of groups in society. Mao began with a "Red Guard" movement by arousing the enthusiasm of university and school students who were called "Chairman Mao's Red Guards". The Red Guards movement soon degenerated into factionalism and chaos in the cities, but the emergence and mobilisation of the Red Guards served a number of purposes for Mao: (a) students and city youths were organised into a political force which created many social and economic problems for the existing Party and government hierarchy; (b) the movement aroused the "revolutionary enthusiasm" of the masses, not just the youths, and diverted attention away from "production" to "revolution"; and (c) it destroyed the balance of political and social forces in society and ignited a bigger mass movement. .

The CR was soon directed into a mass movement involving students, workers, peasants and other groups and transformed into a class struggle against the restoration of capitalism by revisionists. Soon after the beginning of the Red Guard movement Mao thought that there existed a "bourgeois command" pursuing a "bourgeois dictatorship" within the Party, opposed to his notions of a "proletariat command" and a "proletariat dictatorship". Mao, therefore, established a "Small Leading Group" comprising his wife and his key political allies to direct the CR. Mao and this Small Leading Group (SLG) immediately directed the mass movement against the existing Party apparatus and government hierarchy, in particular Liu and Deng, and called for a mass seizure of power from those in authority who were "taking the capitalist road" (Harding, 1991). The SLG was soon placed above and in control of the Party and state government structures. At the provincial and local levels, CR committees were established which assumed the same role as the

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SLG. The constitution of the PRC was amended; the "people's democratic dictatorship" was replaced by "the proletariat dictatorship". This mass seizure of power soon got out of control and degenerated into factionalism, violence and chaos throughout the entire nation. The masses split into factions in the process of the power struggle, resulting in faction conflicts and violence. The Party apparatus and the government bureaucracy were paralysed. Liu and Deng, marked as the leaders of the bourgeois command and counter-revolutionary revisionists, were arrested and detained; Liu died in prison in 1969 and Deng was exiled to manual labour in a remote province. China's economy suffered tremendously during this period as a result of the chaos and violence brought about by the CR, the abandoning of the balanced approach to economic development and the re-emergence of the disruptive development strategy adopted earlier in the GLF. This strategy had leaned towards heavy industry and once more created serious distortions between various sectors of the economy. In the countryside the commune system was reinforced, while a climate of fear and distrust reappeared in the management of economic activities. For example, slogans such as "revolution comes before production" and "we would rather have socialist weed than capitalist plant" often frustrated industrial activities, as the ability of planners and managers to respond to problems and opportunities was severely constrained by fear of political reprisal. Prior to 1977, total productivity growth was zero (Brayshaw and Teng, 1995). According to official figures, three quarters of a million deaths were attributable to the CR (Harding, 1991). The growth in per capita income was slow and the rise in living standards even slower (Lu, 1992). According to China's own assessment made shortly after the end of the Cultural Revolution, the economy was on the verge of collapse. Mao's era came to an end when he died in 1976 and in the same year his accomplices, that is, his wife and her allies, known as the "Gang of Four", were arrested. This marked the end of the Cultural Revolution, but the disruptive situation lingered on for two more years.

CULTURAL REVOLUTION

6.1

43

Accounting under the CR

In the CR phase, accounting development suffered another major setback. Accountants and accounting teachers were exiled to the countryside to perform manual labour. Accounting education at university was almost completely stopped for about ten years. The number of accounts in the chart of accounts of the manufacturing industry, restored to 58 in 1963, was cut down once again to 32 in 1973 (Lu, 1992). Financial control mechanisms and accounting procedures were denounced as being inconsistent with and opposed to the revolution. In many organisations and enterprises, the revolutionary masses took over all accounting work and prepared accounting reports in whatever way they thought was appropriate for promoting the CR. Where accounting records were not kept, the practice of "accounting without books" was not uncommon.

Summary of Part A In Mao's China, as distinguished from the post-Mao period, political factors dominated every aspect of society. The political and mass movements launched by Mao and the associated climate of fear and hate created within the society clearly dictated social, economic as well as accounting changes. While dominance of the political factor in this period could be attributed in large part to the political system and the centralised government structure, Mao's position within the Party, his ideology and his leadership style played a critical role. Mao had little knowledge in running a nation and its economy, but he was a grand master in instigating political and mass movements to achieve his ends. Although Mao maintained the position of supreme leader of the Party and nation, there existed considerable opposition to his leadership. When Mao gained the upper hand in the power struggle, his strategies and initiatives were implemented. But when his strategies resulted in

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disastrous outcomes, Mao had to retreat and surrender his authority to other Party leaders. Mao's rises and falls in the power struggle within the Party marked the four distinct phases of the political scene. In the establishment phase, entirely new accounting systems and practices were adopted under the influence of the Soviet model to serve the new political system and the centralised government structure. Accounting had an important role in this period as the will of Mao and the Party was to gain political control and to revive the war-torn economy. Accounting suffered a considerable set-back during the GLF phase when the mass movement was directed against intellectuals and professionals, scientific methods, rules and procedures. Accounting recovered some lost ground in the recovery phase when the country's priority was to overcome the crisis caused by the GLF and bring the economy back on track. During the Cultural Revolution accounting suffered grievously once again and the practice of "accounting without books" stood accounting on its head. In Mao's China, accounting changes resembled a yo-yo in motion, as Mao's political star waxed and waned.

PARTB ACCOUNTING IN DENG'S CHINA

A Nation in Search of a New Economic Order

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chapter 7 Political Scene in Deng's China

Since the economic reform programme commenced in 1979 China has made dramatic changes in many aspects but its fundamental political system has remained intact. The key characteristic of the political system of the PRC is the absolute ruling status over the country of the CCP under the control of a paramount Party leader; the first was Mao, then Deng Xiaoping, and now Jiang Zemin. According to its constitution, the PRC is a socialist country under the People's Democratic Dictatorship which is founded on the alliance of workers and peasants, under the leadership of the CCP. The Central Committee of the CCP determines the key policies, with the ultimate authority vested in the Politburo and the Standing Committee of the Politburo, which has always been under the control of a key figure. A number of other political parties which are recognised by the CCP as legitimate political entities participate in the Chinese People's Political Consultative Conference and provide advice and expertise in the administration of the country. The National People's Congress (NPC) and People's Congress at provincial and local levels constitute the government, with the NPC and the Congress at the provincial level being the legislative bodies. The government administrative function is performed by the State Council at the national level and government bodies at provincial and local levels. This fundamental political and administrative structure was established in the 1950s to oversee a centrally-planned and centrally-

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controlled economic system where there existed only two types of business enterprises, state-owned enterprises (SOEs) and collectiveowned enterprises (COEs). There was no private sector or market. Since the start of economic reform and the adoption of an open door policy in 1979 China's economic structure and ownership of business enterprises have changed considerably. The economic planning and control functions of the central government have been dramatically reduced and gradually replaced by the market assuming the role of economic resource allocation and wealth distribution in a country heading towards a marketoriented economy. Many large SOEs have been transformed into share companies jointly owned by the State, institutional and individual investors, as well as foreign investors. Smaller SOEs and the majority of COEs have been sold to individual owners or privatised. These changes have resulted in new types of business enterprises in China, such as share companies, listed companies, individual-owned enterprises and sinoforeign joint ventures. As a result, a private sector has emerged which has grown at such a fast pace that it will soon be larger than the state sector. The market now plays a dominant role in allocating resources and directing business operations. While the fundamental political structure has remained intact, some critics have argued that it is incompatible with the market economy that the country is seeking to establish and that a reform to the political system is imperative. However, the CCP leaders have resolved to maintain the status quo with respect to the political system while pursuing economic reform. Consequently, since 1979 there has been a distinct divergence between political and economic events. While the economic reform has been moving rapidly, the political system has remained basically intact, with some necessary modifications to the administrative structure in order to meet the needs of economic reform.

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7.1

49

Marriage of Static Political System to Dynamic Economic Reform

At the Third Plenary Session of the Eleventh Central Committee of the CCP held in December 1978, Deng re-emerged as the leader of the Party. A Resolution of the Central Committee of the CCP was passed which provides an assessment of Mao's leadership and the political development since 1949. In the Resolution, the political and mass movements, especially the Cultural Revolution and Mao's initiatives in launching those movements, were criticised and condemned. However, the Mao Zedong Thought was distinguished from Mao's personal misdeeds and errors. This was considered to represent the wisdom of the collective leadership and it remained the basic theory for guiding the Party and the nation in their course of action. At this Third Plenary Session, a decision was also made to take on as the central task for the CCP the achievement of economic development and modernisation. Deng Xiaoping, the new paramount leader after Mao, played a key role in setting China on the track of economic reform and he was referred to as the "Chief Designer" of the reform and the open-door policy. Deng's thoughts and attitude towards political control and political change, which were later termed Deng Xiaoping Theories, clearly shaped the political scene in the Deng era and beyond. A strong advocate of economic reform, Deng at the same time insisted on adherence to his "Four Basic Principles", which are the socialist road, the dictatorship of the proletariat, the leadership of the Communist Party, and MarxismLeninism-Mao Zedong Thought. He pushed strongly for the development of both material civilisation (ie, economic development and modernisation) and spiritual civilisation (ie, the Communist ideology), which he represented as "ruling with two arms", and advocated the tough use of both arms. Therefore, while Deng welcomed western capital investment, managerial expertise, and market systems for economic development, he strongly opposed capitalist ideology and western democracy.

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7.2

Cycles of Economic Reform in the 1980s

Economic reform, especially in the 1980s, proceeded in cycles or waves. Each cycle began with a new policy initiative by reform leaders. It was followed by experimental implementation, evaluation, and relevant research by reformist intellectuals and officials; and came to an end with the emergence of problems and criticism from opponents of reform, requiring a period of readjustment before pressures built or opportunities arose for another reform initiative. One reason for the cycles of reform was the tension between the more conservative elders represented by Chen Yun and Peng Zhen, and the bold younger reformers led by Hu Yaobang and Zhao Ziyang, both appointed in turn Party General Secretary in the 1980s. Deng maintained his position as paramount leader by arbitrating between these competing wings of his political coalition. In this period there were repeated calls from the reformists for political reform, especially when the reform programme ran into difficulties or when problems such as corruption and embezzlement emerged. Each time the reformists would gain Deng's support in the economic arena, but lost out to the conservative elders on political issues. The reformists' political agenda was at odds with Deng's and cost two of the Party General Secretaryship. Hu was dismissed from the post in 1986 and his successor, Zhao, was placed under house arrest in 1989 (Hamrin, 1990). Further, in sharp contrast to the Mao period, since 1979 political and mass movements have been discouraged and tight restrictions placed on mass gatherings, as evidenced by the Tiananmen Square incident of June 1989 and the Fa Lun Gong incident of 1999. Political stability has become an overriding objective over any other political task. It is clear that the hegemony of the CCP cannot be compromised. Deng's two arms are not equal in all respects. 7.3

Political Accommodation to Economic Reform

It has been clearly stated that the central task of the CCP is to achieve China's economic development and modernisation. The primary objective of governments at all levels has been set to achieve high

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economic growth. Deng and other conservative elders did recognise that there needed to be some change in the Party's role to accommodate the complex and dynamic economic environment created by economic reform. Minor changes have been observed, such as the recruitment of more educated and reform-minded people as Party members and the promotion of younger and more professional members to leadership posts. There were two changes in the structural role of the Party in state and society. These were the attempts to separate the Party from the government administration and to reduce the role of the Party committee in state enterprises and other basic-level units (Hamrin, 1990). It has been reported that the CCP has allowed farmers to directly elect their village chiefs for more than a decade. Direct elections for township chiefs have taken place, with the tacit consent of Party officials. Political changes closely linked to the economic reform have also been reported (Business Week, 19.3.01, p. 32): Meanwhile, democracy is coming to China's labour movement, as Beijing begins to allow workers to elect local representatives to the officially sanctioned trade union for thefirsttime. And cities such as Shenzhen and Qingdao are now choosing government officials after openly recruiting several skilled candidates for each job - a shift from the tradition of picking officials based on their Communist pedigree. 7.4

Communist Ideological Issues Revisited

A number of key ideological issues concerning the nature of Marxism and socialism has been revisited and their traditional interpretation debated. A key issue regarding socialism is whether it necessarily implies egalitarianism or whether it could embrace the notion that some people and people in some regions will become richer than their fellow citizens. It was resolved to uphold the latter interpretation and to promote the development of the private sector with its accompanying inequalities. Other issues debated include: whether China can have a

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market economy under a socialist political system, whether stock exchanges belong solely in a capitalist society, whether private ownership would change the nature of China's socialism, etc. The consensus position taken by the CCP leaders is clear on these issues, that is a market economy and most market mechanisms do not belong solely in a capitalist system and can be integrated with China's socialism. These new interpretations of the above ideological issues were considered to have advanced the Marxist theories of socialism and, more importantly, paved the way for bold economic reform and the establishment of a market economy in China (T. Li, 1999).

chapter 8

Initial Economic Reform: 1978 -1984

8.1

Economic Reform 1978 -1984

The decision to reform the economic system taken at the Third Plenum of the Eleventh Central Committee of the CCP in December 1978 laid down the general direction for economic reform. In this initial reform period, a number of important economic policies was promulgated. In particular, policies in three interrelated areas were implemented. First, rural markets for agricultural products which existed in the 1950s were reopened and new markets for certain light industrial and consumer goods were established. Second, the role played by the markets for agricultural and consumer goods was recognised in the state planning function. Third, private businesses and foreign investment ventures were encouraged to develop. In other words, while central planning still dominated the economy, the market had started to play a supplementary role. In this commencement phase the focal point of the economic reform was the rural sector and reform in the urban area was relatively slow. What was important was the explicit recognition of the role of market mechanisms and the market-place (T. Li, 1998, 1999). 8.1.1 Economic Reform in the Rural Sector China had chosen to start its economic reform in the countryside for a number of reasons. First, it was imperative for the rural sector to

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produce sufficient food to feed China's large population. At the dawn of its reform in 1978 after 30 years of communist rule, China's food production was insufficient for this purpose. Second, it was relatively easier to introduce changes to the much disliked People's Commune system and the benefits would be widely felt since the rural sector contained about 90 per cent of the population. Third, the rural reform was a learning stage in which the CCP leaders would gain the necessary experience and confidence to subsequently undertake the more complex and arduous urban reform. The rural reform started with the abolishment of the People's Commune and the production brigade (usually comprising the entire population of a village) as basic production units and their replacement with the peasant household as the basic production unit. As a result of this reform land, production facilities and agricultural loan quota were allocated to peasant households, and peasant families became responsible for their agricultural activities and output. The state plan for agricultural production covered increasingly fewer products and was eventually abolished and replaced by a contract procurement system between peasant households and the government. Under this system, peasants were obliged to sell an agreed quantity of produce at set prices to the government and had discretion over any surpluses. At the same time, local markets were re-established throughout the country for peasants to trade their surplus produce. This reform provided peasants with incentives to improve their efficiency and productivity and resulted in a boom in the agricultural sector and a more abundant supply of food and other agricultural products. The increase in efficiency and productivity in the rural sector led to farmers accumulating capital funds and inevitably brought about the emergence of surplus labour. A policy was adopted to encourage farmers to engage in non-agricultural activities and to develop collectively owned and, at a later stage, individually owned enterprises (COEs and IOEs, respectively). IOEs normally obtained their equity from close or extended family members. Enterprises were also collectively owned by towns or villages, the so-called township-village enterprises (TVEs).

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Typically, these TVEs and IOEs in the early stages were engaged in light industrial, commercial and transportation businesses and subsequently expanded into other areas. Since 1979 the TVEs and IOEs have developed at an extremely fast pace and have contributed significantly to economic growth. They have also played a critical role in absorbing the excess labour force in the countryside. By 1999, after only 20 years' development TVEs contributed to two thirds of the GDP produced by the rural sector, representing one quarter of China's GDP, and employed around 130 million people (T. Li, 1999). 8.1.2 Economic Reform in the Urban Sector While the rural reform was a great success, the crucial test of China's economic reform programme lies in the much more difficult urban reform. The essence of the urban reform lies in reforming the SOEs. Prior to the economic reform China, modelled on the former Soviet Union, had a highly centralised and controlled economic system. A comprehensive state economic plan set out all the production and operating activities carried out by the SOEs. All resource allocation and wealth distribution were also governed by the state plan. There did not exist an open market or a market-determined pricing system for commodities. Broadly speaking, the crux of the urban reform is to move away from the inefficient planned economic system to a more efficient market-oriented system and to transform the SOEs from government-run factories to legally independent players in the market-place. These ambitious goals were not initially set out and only became clear at a much later stage. At the macroeconomic level, a number of changes were introduced during this commencement phase. First, the role of the state plan in managing the economy was gradually reduced. For example, the majority of agricultural products and increasingly commodities and consumer goods were removed from the ambit of the state plan. The production targets set for SOEs were reduced, and SOEs were allowed, upon fulfilling the assigned target, to seek markets for their raw materials

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and finished products. As a result, markets and trading mechanisms were developed as supplements to the economic planning system. Second, the state fund allocation system was amended. The State reduced the amount of funds allocated at zero cost to SOEs through government financial bureaux and increased the amount of interest-bearing bank loans made by state banks to the SOEs (Liu and Eddie, 1996). Third, the previous profit remittance system was replaced by a corporate income tax system and a profit-sharing scheme of the after-tax income (discussed below). At the microeconomic level, the reform was characterised by the delegation of certain types of management authority from government bureaucrats to SOE managers and the provision of incentive schemes to business enterprises. A number of reform measures was introduced. First, once SOEs had fulfilled their quotas set in the state plan they could trade in the market-place and had the authority to make decisions guided by market forces. SOEs in light and consumer goods industries were removed from the state plan and were given autonomy in organising their production and sales activities. Second, an income tax system was introduced which replaced the previous profit remittance system for SOEs and a profit-sharing scheme was implemented in which the aftertax profit was shared between the SOE and the government. As a result, unlike past practice, a SOE no longer handed over the entire profit to the government, although any loss was still replenished by governmentallocated funds or bank loans. SOEs were given some discretion over the use of the retained profit, which might be used for expanding production and improving workers' welfare. This profit-sharing scheme provided incentives to the SOEs' managers and workers. These reform measures motivated the SOEs to become involved in the market-place and to trade as business enterprises independently of the government. 8.1.3 Open-Door Policy In the meanwhile, an open-door policy was adopted to attract foreign capital, promote China's international trade, and import advanced technology and managerial expertise. Flexible policies and measures

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were deployed which included the creation of Special Economic Zones (SEZs) and "open cities" (which offer special privileges to foreign enterprises), various forms of joint ventures, and the provision of generous incentive schemes. The open door policy was an integral part of the first phase of the economic reform programme. By the end of 1999, there were around 62,300 enterprises with accumulated foreign capital totalling US$459.6 billion (China Statistical Yearbook 2000, p. 604). 8.2

Accounting Development 1978 -1984

The Cultural Revolution had brought chaos and confusion to the accounting system. As a first step in the reform programme, a debate was launched on the nature and function of the debit-credit system. It was resolved that the debit-credit system is an accounting technique which can serve both capitalist and socialist systems. As a result, the debit-credit method was re-adopted by the government and business enterprises. In other moves, financial control systems and accounting procedures were strengthened. There were several important new developments in accounting in this period. First, the Uniform Accounting Systems (UASs) were revised in 1981. The old UASs established in the 1950s were incapable of addressing the new business activities brought about by the economic reform. The UASs were revised to include additional accounts, modified uniform financial statements (although still subject to the three accounting sub-equations) and new procedures. Certain disclosures began to appear for the first time in the financial statements: bank loans and enterprise funds (retained earnings) in the balance sheet, and income taxes and retained earnings in the income statement. Second, a government-controlled audit system was established. Consistent with the delegation of management authority to them, the SOEs were placed under a profit-sharing scheme with the government and were required to pay income taxes. However, there did not exist an independent accounting profession to perform an attest function on the

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financial statements prepared by the SOEs. The central government at the Fifth National People's Congress held in December 1982 established the position and office of Auditor-General, and similar positions and offices were established at provincial and local government levels (Dick, 1983). The key role of the state audit system was to ensure that the government's revenue raising from taxation was properly conducted. Third, as managers of SOEs began to make economic decisions based on demand and supply in the market-place, management accounting, which was unknown in China prior to the reform, became an important area of study and application. The open-door policy encouraged the importation of western management methodology and western management accounting into China. The changes in the Chinese enterprise accounting system have since been linked to the dissemination and application of western management accounting. This technology transfer first took place through the publication in Chinese of selected management accounting methods and techniques, primarily from American textbooks and journals. Education was another important way of spreading these methods. Training programmes and seminars were conducted; foreign academics were invited to give lectures; management accounting was included in the syllabus of institutions of higher education and various professional training programmes. Practitioners began to use some western management accounting techniques in their work to meet the new decision-making role required of accounting by management. According to two surveys conducted in 1981 among Chinese accountants employed in SOEs, cost-volume-profit analysis (including other short-term decision-making analysis) and responsibility accounting were the most favoured techniques in the Chinese context, while long-term decision models, such as capital budgeting, attracted little interest (Bromwich and Wang, 1991). The reason is because improvement of efficiency and profit maximisation were becoming important objectives of SOE management under the incentive schemes implemented whereas there did not exist an economic environment for making long-term managerial decisions.

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Fourth, foreign capital began to flow into China with the adoption of the open-door policy and joint venture accounting was developed to deal with foreign investment. In July 1979, the National People's Congress approved the Law of the People's Republic of China on Joint Ventures Using Chinese and Foreign Investment. Soon after the Ministry of Finance issued the Trial Accounting Regulations for Joint Ventures Using Chinese and Foreign Investment, which was enacted in 1985. In 1992 the regulations were expanded to cover all enterprises with foreign investment, including wholly foreign-owned enterprises, and renamed Accounting Regulations for Enterprises with Foreign Investment. The accounting system for joint ventures (subsequently, all types of foreign investment) was the first accounting system in the PRC to be based on international accounting principles (Scapens and Hao, 1995). The fund-based accounting model was replaced by the conventional historical cost model, embracing the accounting equation, concepts, and measurement and disclosure requirements typical of western accounting systems. Certain treatments of accounting transactions were unique, reflecting Chinese conditions. For example, land, which belongs to the State, cannot be traded as an asset and can only be held under lease (up to 70 years). The full cost of leasing was recorded as an intangible asset and amortised. In the translation of monetary items denominated in foreign currencies, historical rates were stipulated and it was not permissible to make adjustments to reflect changes in the exchange rates. Furthermore, the lower of cost and market rule for inventory valuation could only be used in limited circumstances and would need the prior approval of a financial bureau. It is believed that the introduction and implementation of the joint venture accounting system enhanced the promotion of foreign investment in China. This resulted in further accounting reforms, for example, reforms relating to accounting systems used in the SEZs. Subsequent development on accounting for share enterprises and setting of accounting standards since 1993 are generally based on the joint venture

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accounting regulations, which can be regarded as the precursor to accounting reform in the 1990s (Scapens and Hao, 1995).

chapter 9

Planned Commodity Economy: 1984-1991

The success of the rural reform and the initial urban reform in the commencement phase provided the CCP leaders with the confidence and experience necessary to undertake the reform of the entire economic system. After five years of reform the Chinese economy had changed from a sole public ownership system to public-cum-private ownership and from a planned economy to a mixed economy with both state planning and the market working side by side. Although public ownership and state planning remained dominant, the private sector was developing at an extremely fast pace and the market increasingly assumed the role of resource allocation in the economy. Consequently, at the Third Plenum of the Twelfth Central Committee of the CCP held in October 1984 a decision was made to abandon the centrally-planned and centrally-controlled economic system and to replace it by a planned commodity economy based on a predominantly public ownership structure. It was perceived that the economic role of the market-place would be substantially enhanced. In hindsight, this reform programme was relatively modest.

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9.1

Economic Reform 1984 -1991

9.1.1 Macroeconomic Reform In this second phase of economic reform the focus shifted from the countryside to the urban area. At the macroeconomic level, a number of major reform programmes was implemented. First, the role of the state plan in managing the economy was substantially reduced, and a distinction was made between a compulsory plan and a guiding plan. The compulsory plan only covered a small number of key commodities and consumer goods, while most commodities were placed under the guiding plan. The production targets set for SOEs were substantially reduced to levels which met the minimum requirements of the state plan. Regional trade and economic policies were amended to ensure a free flow of goods and commodities and, as a result, a nation-wide market was established. By the late 1980s the market had a more important role than the state plan in the allocation of economic resources (T. Li, 1998). Second, the fund allocation system was completely abolished and the allocation of state funds by government financial bureaux to SOEs ceased. The state funds were replaced by loans from the four state specialty banks made under the supervision of the People's Bank of China. Third, governments and their functional departments previously in charge of the SOEs' business operations were required to be severed from the SOEs and to delegate decision-making in a number of important areas, such as production, purchasing, sales and personnel, to the SOEs. The SOEs were recognised as separate organisations independent of the government which owned them. As a result, the relationship between the government and the SOEs changed considerably. The role of the government changed from direct administrative control of the SOEs to one of indirect control through its control over the approval of bank loans and in the making and implementation of economic policies. Theoretically, the State retained its power as the owner of the means of production, but is no longer directly involved in the production process.

PLANNED COMMODITY ECONOMY

63

The command over the use of the means of production had been transferred to the SOEs (Jackson, 1984). Fourth, price controls were lifted and the market soon overtook the state plan system in setting prices. The planned-controlled and the market-guided mixed economic system resulted in a dual track pricing system that continued in existence over a period of time. At first commodities which were still under the control of the state were subject to two pricing systems, state-set prices based on planned production and distribution levels and market prices determined by supply and demand forces in the market-place. As the same commodity was produced by the SOE, first, to meet the target set in the state plan and, subsequently, to meet market demand, a distinction was made between "product under the state plan" and "product outside the state plan", with the price of the former being usually much lower, although the commodity was the same. This dual track pricing system caused various problems, including corruption. In the late 1980s a considerable effort was devoted to resolving these problems. Eventually the market determined pricing system became dominant and market prices were employed in the state plan (T. Li, 1999). Finally, during this period other types of enterprise ownership, such as joint ventures, share enterprises, town and village enterprises, and individual-owned enterprises, emerged and played an increasingly important role in China's economic development, at the expense of the SOEs. China's economic enterprise system had changed from public ownership to multiple ownership. By 1992 the reform momentum had carried macroeconomic reform further than had been envisaged in 1984. 9.1.2 Microeconomic Reform The significant microeconomic reform was the reform of the SOEs. The Chinese did not attempt to privatise the SOEs, an approach that would in later years be adopted by the former Soviet Union and Eastern European countries. Instead, measures were introduced to restructure the SOEs. A key measure was the implementation of the "contract responsibility

64

ACCOUNTING IN DENG'S CHINA

system", which aimed at enhancing SOEs' profits through the provision of significant financial incentives to their managers and employees. Under this system, managers and employees of SOEs entered into a contract with the state which covered certain operating tasks, such as planning, production and sales and set certain output targets. SOEs were further delegated autonomy in making various managerial decisions with regard to business operations. If the terms of the contract were met, SOEs would retain a proportion of their profits which could be used for business expansion, the payment of bonuses or improvement of workers' welfare facilities. If the SOEs failed to meet the contract, they must make up any shortfall in payments to the state from their own funds (Scapens and Hao, 1995). The process of the reform was evolutionary and the responsibilities of SOEs were gradually increased during the period. The SOEs were first converted from purely production factories into cost centres where managers were given incentives to minimise production cost, while the state handled pricing and distribution of the products. Then, with further delegation of decision making and price liberalisation, SOEs became profit centres where managers were given autonomy to decide on product pricing, material sourcing, product mix, marketing and distribution. Thereafter, SOEs were forced to compete in the market and some of the SOEs were given the authority to make certain investment decisions. The government retained control over a number of important financial decisions, such as capital investment decisions and wages and salaries. By the end of 1993, over 90 per cent of the SOEs were governed by the contract responsibility system (Xiang, 1998). The reforms at both the macroeconomic and microeconomic levels, in particular the loosening of the financial control system and the SOE reform, led to the development of "share enterprises" and the establishment of two stock exchanges. Share enterprises comprise SOEs or COEs which issue shares to other enterprises, to employees or to the public. The first type of issue constitutes a kind of business merger, the second is similar to an employee incentive scheme, and the third represents a transition of the enterprise towards a corporate form.

PLANNED COMMODITY ECONOMY

65

Subsequently, share enterprises became known as share companies, some of which are listed on the stock exchange. The framework governing the development of share companies was not clearly defined, rather an evolutionary approach was adopted. A number of problems arose in this second phase of economic and enterprise reform. First, government influence and intervention in the management of SOEs was common. As the government was the major owner and retained certain important decisions, SOEs were hardly run as independent entities. Second, as both the banks and SOEs were under government control, bank lending decisions were largely based on factors other than economic assessment. As a result, bank loans to SOEs spun out of control and a large part of the loans became non-performing. Third, the contract responsibility system did not work as well as expected. It led to undesirable short-run behaviour of some SOE managers, such as the reporting of inflated profit figures and poor maintenance of production equipment. It can be concluded that reform of the SOEs had proved difficult and vexatious. 9.2

Accounting Reform 1984 -1991

9.2.1 Accounting for SOEs The reform programmes at both the macroeconomic and microeconomic levels in this phase were intended to transform the SOEs as production units of the state planning apparatus into relatively independent commodity producers competing in the market with other market players. In particular, the autonomy over financial and managerial decisions delegated to the SOEs changed considerably the status of SOEs and their relationship with the State. These changes had a significant impact on the accounting practices and financial management of the SOEs. Under the planned economy, the sole purpose of the SOEs' financial information was to assist the planning and execution of the state plan and, hence, the government (in particular, the government financial bureaux, administrative and statistics departments) was the only user of financial statements. Under the new economic system the purpose and

66

ACCOUNTING IN DENG'S CHINA

users of the financial information of SOEs changed and expanded considerably for a number of reasons: (a) the financial information was used by the government in the formulation of its macroeconomic policies and the preparation of the state plan; (b) SOEs' financial statements were used by the government to also design the profit sharing scheme, determine the profit retained by the SOEs, and determine the various types of taxes, including income taxes, that SOEs would have to pay; (c) as bank loans became a significant source of funds, banks became important users of SOEs' financial statements; (d) as independent commodity producers and players in the market, SOEs began to deal with suppliers, customers and business partners and to report to minority stakeholders; and (e) the use of financial information by the management of SOEs changed from serving a single purpose of discharging the responsibility placed on them by the state plan to serving multiple purposes, associated with the stewardship of assets, managerial performance, taxation, etc. According to Liu and Eddie (1995), the key function accounting played in this period was to provide information for enterprise management, rather than government planning needs under the planned economic system. Accounting reforms in this phase focused on three areas: reform of the UASs, establishment of accounting for enterprises with foreign investment and establishment of accounting for share enterprises. The latter two reforms were influenced by global accounting standards, such as those in the US, the UK and the International Accounting Standards (IASs). (a)

Reform of the UASs

The increasing complexity in business practices led to further modifications to the UASs in 1985 and 1989 (Liu and Eddie, 1996). Several major changes were made. First, the three accounting subequations and the strict rule that designated funds had to be used for designated purposes were abolished. Second, new items were disclosed in the balance sheet, for example, bank loans and enterprise funds

PLANNED COMMODITY ECONOMY

67

(retained earnings) increasingly replaced government funds as major sources of funds, while intangible assets, such as brands, patents and goodwill, began to appear in balance sheets prepared by joint ventures and other business combinations. Third, a degree of flexibility was introduced into the UASs. For example, SOEs were allowed a choice of accounts or additional accounts as required by their unique business nature. Fourth, bank loans were a special feature accorded special accounting treatment. Bank loans obtained by SOEs in this period were, in fact, government funds channelled through banks (that is, funds which in the past were allocated to enterprises at no cost). The only differences between bank loans and allocated funds were that in the former case interest was charged and the principal had to be repaid. Under the contract responsibility system and profit sharing scheme, the repayment of the bank loans was treated as an appropriation of profits after taxes, which confused many western trained accountants (Huang and Chang, 1997). (b)

Accounting for Foreign Investment

Foreign capital began to flow into China with the adoption of the opendoor policy. As the UASs differed markedly from international accounting practice, in 1985 the MOF enacted the Accounting Regulations for Joint Ventures Using Chinese and Foreign Investments, which specifically addressed some of the issues posed by foreign investment. In 1992 the regulations were expanded to cover all enterprises with foreign investment, including wholly foreign-owned enterprises, and renamed Accounting Regulations for Enterprises with Foreign Investment. This is discussed in section 5 below. (c)

Accounting for Share Enterprises

The emergence of share enterprises created some special accounting problems, for example, an enterprise jointly held by owners which operated in different industries would have difficulty in choosing a particular UAS for its accounts. The Accounting Regulations for Trial

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ACCOUNTING IN DENG'S CHINA

Share Enterprises, based on international accounting conventions and similar in many respects to the Accounting Regulations for Enterprises with Foreign Investment (1992), was enacted in 1992. This is discussed in section 5 below. 9.2.2 Certified Public Accountants The open-door policy and the economic reform programme brought about a need for the services of certified public accountants (CPAs). The annual reports of Sino-foreign joint ventures were required to be audited by Chinese CPAs, and in 1980 the MOF issued the first Provisional Regulations Concerning Establishing Public Accounting Firms, which marked the beginning of public accounting practice in the PRC. One week later, the first public accounting firm, the Shanghai Certified Public Accountants, was established. In 1986, the State Council issued the Regulations of the People's Republic of China on Certified Public Accountants, which is the first legal framework governing accounting practice, including the examination, education and experience requirements, registration, scope of business, and professional rules of CPAs. It designates the MOF at the national level and the finance bureau at the provincial level as the regulatory body responsible for administering matters relating to CPAs and CPA firms. In 1988, the Chinese Institute of Certified Public Accountants (CICPA) was established. Unlike its counterpart in the West, the CICPA is under the jurisdiction of the MOF. CPA firms did not have independent status, but were either attached to government financial bureaux, university accounting departments or some large SOEs. The CICPA controls certain matters relating to CPAs, such as registration and examinations, and acts as a liaison between CPAs and government agencies.

chapter 10

Socialist Market Economy Since 1992

While the intent in the first two phases of the economic reform was to break out of the old centrally-planned economic system, the intent of the third phase of reform which is still in progress, is to ultimately develop a new economic system, a "socialist market economy with Chinese characteristics", that is, a market economy consistent with the political and economic circumstances of China, in particular the autocracy of the CCP. 10.1

Economic Reform since 1992

10.1.1

Macroeconomic Reform

At the macroeconomic level, further reform in a number of major areas has fundamentally changed the nature of China's economic system and established a preliminary model of a market economy with strong government intervention. There are five notable achievements. First, the government has largely abandoned the use of economic plans in managing the economy and controlling the SOEs and the market has assumed a dominant role in economic resource allocation. By 1998, all the compulsory plans for agricultural products have been abolished and only nine key agricultural products are subject to the state guiding plans. In the case of industries, only 12 commodities accounting for 4.1 per cent of the total output are controlled by the state compulsory plan, a

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ACCOUNTING IN DENG'S CHINA

reduction of 90 per cent compared to the pre-reform period. The production of over 95 per cent of consumer goods and their prices are now determined by market forces (T. Li, 1998). A nation-wide market, driven by market forces and accessible to the outside world, for all consumer goods and the majority of commodities has been established, which has played a dominant role in directing production, determining prices and allocating resources. At the same time, a labour market, which had not existed previously, has emerged as a result of the greater mobility of the population and increased employment opportunities. Capital markets have also developed significantly since the early 1990s, as indicated by the Shanghai and Shenzhen Stock Exchanges. Second, the role of the government has changed further from direct involvement in the planning and control of the economy to indirect management of the economy through the use of macroeconomic policies. The SOEs were converted into legally independent corporations, that is, limited liability companies or share companies under the governance of the Companies Law (1993). At the same time, a state Department of State-Owned Property and state-owned investment corporations were established to assume the state ownership role of the limited liability or share companies. This was intended to be a further step towards, first, the separation of government from its enterprises and second, the separation of ownership from management in the SOEs. The government retains a dominant ownership of the SOEs but the intention is for the government not to be directly involved in their management. Thus, the key roles of the government were radically changed. It has been given new responsibilities: first, establishing an appropriate framework for the market in terms of legal systems and economic regulations and second, achieving government economic objectives through the use of administrative measures and fiscal, monetary, foreign exchange and other economic policies. Third, China's banking system has undergone major changes, especially since 1995. Prior to 1978, banks in China had a passive role; they kept the accounts for enterprises and looked after their funds. In 1983, the People's Bank of China (PBOC) became officially the central

SOCIALIST MARKET ECONOMY

71

bank and the other state-owned banks were organised as special purpose banks serving particular industry sectors, that is, they took on the function of issuing and managing bank loans to the SOEs (funds previously channelled to SOEs under the fund allocation system). Since 1995, a number of important changes has been introduced to the banking system. The PBOC has assumed the role of a central bank in charge of implementing the central government's monetary policy, with activities similar to those of central banks in western countries - issuing banknotes, managing the foreign exchange, formulating financial policies and controlling the money supply. The special purpose banks have been converted into commercial banks, which have the responsibility for channelling state funds to SOEs and also operate independently as financial intermediaries in the market. Fourth, major changes were introduced to the taxation system. All types of taxes were classified as central government taxes, local government taxes and taxes shared between the central and the local government. A taxation system based on turnover taxes was established. More importantly, a unified corporate income tax system was implemented and applied to all domestic enterprises. The Enterprise Income Tax Law promulgated in 1994 imposes a standard corporate income tax rate of 33 per cent on all large and medium-size SOEs. Fifth, the dual exchange system was abandoned on 1 January 1994. Prior to that date there were two exchange rates for a given foreign currency, a market rate and an official rate. For example, on 31 December 1993 the market rate for the US dollar was 8.70 yuan and the official rate 5.80 yuan. On 1 January 1994, the official rate was abolished and only the market rate was quoted. At the present time only limited conversion facilities are available on the current account. The long-run aim of this measure is to make the Chinese yuan an internationally exchangeable currency.

72

10.1.2

ACCOUNTING IN DENG'S CHINA

Microeconomic Reform

At the microeconomic level, the reform programme in its third phase focuses on transforming SOEs under the contract responsibility system (CRS) into corporations with a separate legal identity. Under the CRS, the SOEs were still attachments of the government and not independent legal entities. The state was still the sole owner of the SOEs, thus bearing unlimited liability, and the SOEs were still to a large extent dependent on the government. For example, the management team would be appointed by the government, capital expenditures on new investment projects would be decided and supplied by the government, and if any SOEs did not perform well the government had the responsibility to look after their employees, etc. The SOEs under the CRS were not genuinely independent players in the market and were not developing into efficient modern business enterprises in a marketoriented economy. The purpose of the corporatisation drive was to revitalise the SOEs by converting them into separate legal entities with limited liability which would be truly independent market players. This corporatisation has taken a variety of forms, such as public listed companies, other public companies, share companies, or joint ventures. In a corporatised SOE the state might no longer be the sole owner. Generally, it is the dominant shareholder, with a variety of minority shareholders. Corporatisation helps to clarify the ownership structure of the SOEs, which facilitates raising capital, restructuring ownership and undertaking other reorganisations. Corporatisation also lays a foundation for the implementation of the Bankruptcy Law. Many large SOEs have been corporatised and most medium to small SOEs have been divested by way of lease or outright sale. According to Xiang (1998), China's large SOEs now possess a high degree of managerial autonomy and closely resemble modern corporations in the West that are characterised by a separation of ownership from management. The present writers disagree with this perception and this issue is discussed in Chapter 11.

SOCIALIST MARKET ECONOMY

73

10.2 China's Stock Exchange The rebirth of the stock market in China was a result of the economic reform.1 The ultimate objective of the reform is to turn SOEs into independent market players and modern business enterprises, resembling their western counterparts, as part of the move to the establishment of a market-oriented economy. The stock market would not only help SOEs raise needed capital but also facilitate their transformation into modern business enterprises. The re-emergence of the securities market in China can be traced back to the mid-1980s. In 1981 the Chinese government began to issue treasury bonds to its citizens and in 1986 the government permitted trading in treasury bonds. This resulted in the establishment of regional exchange points in five large cities around the country. Also, in the early 1980s some SOEs and COEs began to issue shares, or more accurately, non-voting participatory certificates, to their employees, related enterprises and in a small way to the public, in a move to become share companies. Non-redeemable shares were first issued in Beijing in 1984, followed by a series of issues in Shanghai and other major cities. In 1987 permission was given to trade in the shares in an over-the-counter market in all the major cities (Zhang, 1997). However, the tyranny of distance limited trading in the regional centres to clean regional shares. This limitation eventually led to the re-establishment of the Shanghai Stock Exchange as a national centre in December 1990. The Shanghai Stock Exchange and the Shenzhen Stock Exchange were officially opened for trading in equities and bonds in December 1990 and July 1991 respectively. The number of companies listed on the market was initially very small, but has increased rapidly in recent years. A distinct feature of the Chinese market is the existence of two types of shares, A shares and B shares. A shares are restricted to ownership by 1

The stock market in China was first established in 1919 in Shanghai, at that time one of the international financial centres of the Far East. When the CCP took over China in 1949, the market was closed and from then till the late 1980s, the words "stock" or "stock market" were not part of the people's vocabulary.

74

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Chinese legal persons and individuals. B shares were available only to foreign investors, but in March 2001 the B-share market was opened to Chinese investors as well. The two types of shares have the same rights and obligations, and the main reason for issuing B shares was to enable the country to earn foreign exchange. By June 2000, there were 509 companies listed on the A Board and 54 on the B Board in Shanghai, while the corresponding figures in Shenzhen were 450 and 54. In the meantime, some of the largest and better managed SOEs have gained listing on foreign markets. In October 1992 China Brilliance Automotive, a SOE which manufactures minivans, was listed on the New York Stock Exchange (called N shares). Since then more SOEs have gained listing on stock exchanges outside China, including Hong Kong (H shares), London (L shares), Singapore (S shares), Tokyo (T shares), Canada and Australia. Enterprises listed on the two Chinese stock exchanges are governed by, among other regulations, the Companies Law (1993, revised 1999) and the Securities Law (1998, in effect 1 July 1999). Prior to April 1998 there were two relevant organisations, the State Council Securities Affairs Commission (SAC) and the Securities and Exchange Supervisory Commission (SESC), responsible for making policies relating to securities and for implementing and administering various laws and regulations and overseeing the day-to-day functioning of the stock market respectively. The two organisations merged in April 1998 to become the China Securities Regulatory Commission (CSRC), which performs the functions and duties previously undertaken by the SAC and the SESC. The CSRC is headquartered in Beijing and has offices in ten major cities across the country including Shanghai and Shenzhen. To date all the listed companies on the stock exchanges have been formerly SOEs. Although the government in the past 20 years has been trying to distance itself from the management of business enterprises, it still plays a key role in running a socialist market economy and managing the stock market, and the influence of politics on the stock market is extremely strong. As a result, the Chinese stock market has demonstrated a number of "Chinese characteristics", as discussed below.

SOCIALIST MARKET ECONOMY

75

First, the selection of companies to be listed on the market is made by the government, not the market, and the number and identity of companies listed each year are subject to the government plan. Each year the State Planning Commission and the CSRC decide on the total amount of capital that can be raised from the market and then allocate the set quota to relevant industrial and commercial ministries and to provincial and local governments. These ministries and local governments in turn distribute the quota to business enterprises under their management. To be listed, selected companies need to gain approval from the CSRC. It can be seen that the selection process is clearly under the control of the governments at different levels. Second, the issue price of initial public offers (IPO) is also under government control and is not determined by the market place. To guarantee the success of IPOs and the capital raising for SOEs, the government and the CSRC have a ruling that the issue price of IPOs should not exceed 15 times the amount of the after-tax profits earned in the immediate past three years prior to the listing, although the newly issued Securities Law relaxes this rule. In addition, the actual issue price of IPOs is determined by the local governments or government ministries to which the listed companies belong, and not by supply and demand factors in the market. Third, the unique share ownership structure of Chinese listed companies is shown in Table 10.1. Excluding shares traded on foreign stock exchanges, about 70 per cent of shares are non-trading shares owned by the government or a government organisation or associated party. The main reason for the state majority ownership is to ensure that control is maintained over the listed companies. Only about 30 per cent of the shares are traded on the two Chinese stock markets. These "Chinese characteristics" have given rise to several problems. First, the selection of companies to be listed on the market is not based on the financial performance of the individual companies, rather, other factors such as political and economic considerations and even personal preferences of individual government officials have played

76

ACCOUNTING IN DENG'S CHINA

Table 10.1

Share Ownership Structure of AH Listed Chinese Companies 30 June 1998 Share Type

Percentage Ownership

Non-Trading Shares (1) Issuers' (Sponsors') Shares (a) State Owned Shares a (b) Domestic Legal Persons' Shares b (c) Foreign Legal Persons' Shares (2) Designated Legal Subscribers' Shares c (3) Employees' Shares (4) Other

66.32 56.54 34.05 21.06 1.42 6.40 2.08 1.31

Trading Shares (1) Traded on Domestic Market in RMB (A Shares) (2) Traded on Domestic Market in Foreign Currency (B Shares) (3) Traded on Foreign Stock Exchanges (H, L, N, S and T Shares)

33.68 23.14 5.65 4.88

Notes: (a)

(b)

(c)

State owned shares are those which were converted from that proportion of enterprises' assets belonging to the state fund or from the government investment in the share companies. They are directly held by the government or government designated organisations. Domestic legal persons' shares are those which were converted from that proportion of enterprises' assets belonging to the enterprises through accumulated profits or investment from related or unrelated business partners. These legal persons are mostly other SOEs, banks and government owned trust funds and investment companies. Designated legal subscribers' shares are those shares issued to enterprise subscribers or related business parties.

Source: Yuan, 1999.

SOCIALIST MARKET ECONOMY

77

an important part in the selection process (Hao, 1999; Wei, 1999; Xu, 1999). Consequently, many listed companies have performed poorly and an increasing number of companies have reported losses (Wei, 1999; Zhang and Zhou, 1999). Second, the controlled issue price and the high proportion of non-traded shares have led to an imbalance of demand and supply in the market-place. As a result, there is a huge difference (sometimes over 10 times) between the issue price and the prices subsequently traded on the share market, which makes subscribing to IPOs an extremely profitable exercise. Consequently, most of the funds raised from the IPOs have benefited subscribers, often connected to government officials, rather than the issuer company. Third, the stock market is extremely volatile and vulnerable to speculation and rumours. To control the volatility the CSRC has prescribed that the price change on any stock should not exceed 10 per cent per day compared with the closing price on the previous day, or five per cent for companies in an unusual financial situation. Fourth, there is lack of an effective monitoring mechanism. As in the case of the listed companies, the stock exchanges, securities companies (that is companies investing in securities) and other financial intermediaries are also either under government administrative control or the governments are the major shareholders (Q. Guo, 1999; Xing and Lin, 1999). Fifth, as the state still holds the majority of shares in the listed companies and thus controls the board of directors, the management of the listed companies is little different from that of non-listed SOEs, which defeats the objective of transforming SOEs to modern business enterprises through listing. The CCP and the government face a dilemma on the ownership issue of the listed companies. If the government relinquishes the majority ownership of shares, it loses control of the companies to private owners. China by its constitution is a socialist country, which is characterised by the state ownership of all business enterprises on behalf of its people (that is, ownership by the whole people or socialist public ownership). A loss of the government's controlling interest over the companies would be inconsistent with the constitution and might

78

ACCOUNTING IN DENG'S CHINA

ultimately affect the legitimacy of the CCP rule. To date the Chinese government has not been able to resolve this issue. The above problems are exacerbated by the poor accounting, financial disclosure and auditing standards and practice. It has been reported that listed companies have been following different sets of accounting standards issued by various government authorities, such as the Shenzhen Municipal Government, the Shanghai Municipal Government and the MOF (Q. Guo, 1999). The accounting and auditing firms operating in the market were formerly attached to government organisations and their responsibilities and legal obligations have not been firmly established. As a result, the information supplied by the companies to the market is often not entirely reliable nor relevant. Manipulation of financial results and disclosure of misleading information are not uncommon. In spite of the problems, the institution of the stock exchange has been a favourable influence for better accounting practices and for harmonisation, as noted in Chapter 11. 10.3 Reform of State Owned Enterprises The economic reform has changed fundamentally the business landscape in China. The ownership structures of China's industrial and commercial enterprises are now highly diverse. The SOEs' share of the economy has been shrinking continuously and much of the industrial output is now produced by non-state sectors, with COEs being the largest contributor and IOEs, foreign owned enterprises and other mixed types of enterprises playing an increasingly important role in the economy, as shown in Table 10.2. Table 10.2 shows that SOEs have reduced substantially in number, accounting for only 0.8 per cent of all enterprises, but they are among the largest in size, accounting for 26.1 per cent of the gross industrial output. The SOEs are independent legal entities, which could be limited companies wholly owned by the state, share companies jointly owned by

Table 10.2

Types of Enterprises, 1999

Number (000)

Type of enterprise

State-owned enterprisesa Collective-owned enterprises Other ownership

Total

Notes: (a)

(b) (c) (d) Source:

Gross o (US$

61.3

0.8

429,

b

1,659.2

20.9

538,

c

6,126.8

77.2

276,9

91.8

1.1

398,0

7,939.1

100.0

Individual-owned enterprises d

Per cent (%)

1,643

The number comprises 100 per cent state owned enterprises (includi corporations and state-owned joint ownership enterprises) and listed and which the state owns a majority interest. These include township and village enterprises, joint ventures with SOEs formerly privately owned but have been registered as collective units with fu Individual-owned enterprises are mainly sole proprietorships and partnership This category includes listed companies, share companies, limited liability c ventures and wholly foreign-owned companies. China Statistical Yearbook 2000.

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ACCOUNTING IN DENG'S CHINA

the state and other parties, or listed companies on the Chinese and foreign stock exchanges with the Chinese government retaining a controlling interest. Generally SOEs are allowed to participate in joint ventures with COEs and foreign investors.2 The steady decline of the share in the total output produced by SOEs from 77.6 per cent in 1978 to 26.1 per cent in 1999 is shown in Table 10.3. According to EAAU (1997), in 1996 half of the SOEs were reporting losses,3 and the sector as a whole made a loss. EAAU also reported that the four big state owned specialised banks had a high level of bad SOE loans which came to 20-30 per cent of total loans, or 25 per cent of GDP. This bad debt could threaten banks viability (p. 332). Shen (2000, p. 160) reports that the accumulated debt of SOEs has reached two trillion yuan. 10.4 Reform and Internationalisation of Accounting since 1992 In consistency with the corporatisation of the SOEs and the development of the market-oriented economic system, fundamental changes were introduced to the accounting system in this reform phase. The UASs were discarded and the fund-based accounting equation and method were abolished and replaced by a modern western accounting system. The accounting role has shifted from the provision of information to internal management to the provision of information to external decision-makers in the market-place (Liu and Eddie, 1996; Chan and Rotenberg, 1999). 10.4.1

Establishment of Basic Accounting Standard (Conceptual Framework)

As a result of earlier reforms, accounting practices in China in 1993 can be classified into two categories: those which followed international 2

It is not clearly defined whether the term "SOEs" includes those listed companies which were all formerly SOEs. The term is used in a comprehensive manner in this book. 3 An estimate of 43 per cent is reported by J. Ma (2000).

SOCIALIST MARKET ECONOMY

Table 10.3

Industrial Output of Non-SOEs and SOEs and Percentage of Loss Making SOEs Percentage share of output From nonFrom SOEs SOEs

1978 1980

423.7 515.4

22.4 24.0

77.6 76.0

Percent of loss-making SOEs n.k. n.k.

1985

971.6

35.1

64.9

10.7

1986

1119.4

37.7

62.3

n.k.

1987

1381.3

40.3

59.7

n.k.

1988

1822.4

43.2

56.8

12.2

1989

2201.7

43.9

56.1

16.3

1990

2392.4

45.4

54.6

27.6

1991

2662.5

43.8

56.2

25.8

1992

3459.9

48.5

51.5

23.4

Total Output*

1993

4840.2

53.0

47.0

28.8

1994

7017.6

62.7

37.3

34.3

1995

9189.4

66.0

34.0

38.0

1996

9959.5

66.4

33.6

43.0

1997

11373.3

70.2

29.8

n.k.

1998

11904.8

73.5

26.5

n.k.

1999

12611.1

73.9

26.1

n.k.

Note: Sources:

81

* Output measured in current prices. Adapted from J. Ma (2000, pp. 93-94) 1996-99 China Statistical Yearbook 2000.

conventions and generally applied to enterprises with foreign investment, share enterprises and enterprises in certain SEZs; and those which adopted the traditional UASs and generally applied to the SOEs and COEs. In each category, there were many specialised systems depending

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on the type of ownership or industry. In total, there were more than forty accounting systems in use, which caused much confusion and indicated a need for a unified set of accounting standards (Scapens and Hao, 1995). The MOF could have adopted one of two alternative approaches to remedy the situation. It could adopt a complete set of accounting standards, including both fundamental and detailed standards, based on international accounting conventions. This can be regarded as a radical approach. Alternatively, it could adopt a set of fundamental standards, which can serve as a general model for setting detailed standards in the future. Under this approach, the existing detailed systems could be improved and retained in use until they are replaced by new detailed standards in a future period. The MOF decided to adopt this latter more evolutionary approach (Zhang, 1992, quoted in Scapens and Hao, 1995). In December 1992, after much deliberation and co-operative effort among various parties, the Ministry of Finance issued two fundamental standards: Accounting Standard for Business Enterprises and Financial Management Regulations for Business Enterprises (hereafter referred to as the 1992 Standard and the 1992 Regulations respectively), which came into effect on 1 July 1993. They are general standards which are applicable to all business enterprises in China and also serve as guidelines for setting future detailed standards. The 1992 Standard comprises ten chapters under the following headings: general provisions; general principles; assets; liabilities; owner's equity; revenues; expenses; profit; financial statements; and supplementary provisions. It spells out three objectives: (a) to meet the needs of developing a socialist market economy; (b) to unify accounting standards; and (c) to ensure the quality of accounting information. It is also designed to guide the setting of specific standards. The 1992 Standard contains the following sections: (a) four internationally recognised accounting assumptions, that is, accounting entity, going concern, accounting period, and monetary measurement; (b) twelve general accounting principles, that is objectivity, relevance, comparability, consistency, timeliness, understandability, accrual basis, matching principle, conservatism, historical cost, separation of revenue

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expenditure and capital expenditure, and materiality; (c) six elements of financial statements, that is assets, liabilities, owners' equity, revenue, expenses, and profit, and their composition and classification, and (d) financial statements, comprising a balance sheet, a profit and loss statement, a statement of changes in financial position or a cash flow statement, and supplementary statements and notes. In addition, the 1992 Standard stipulates rules on detailed matters, such as the debit-credit bookkeeping method, the recognition and measurement of accounting elements, the recording and reporting of business activities, and accounting terminology. From the above description, it can be seen that the 1992 Standard is a mixture of general principles and detailed rules. Judged from the viewpoint of western accounting conventions, the 1992 Standard is more of the nature of a conceptual framework which can serve as a structure for standard setting, than an accounting standard itself. Aiken, Lu and Ji (1995) have traced the similarity of the 1992 Standard to a conceptual framework, as shown in Figure 10.1. The 1992 Regulations comprise twelve chapters under the following headings: general provisions; sources of finance; working capital; fixed assets; intangible, deferred and other assets; short- and long-term investment; cost and expenses; operating revenue, profit and profit appropriation; foreign currency transaction; business dissolution; financial statements and financial statement analysis; and supplementary provisions. The 1992 Regulations contain stipulations on the treatment of the financial affairs of business enterprises, as well as accounting matters such as the classification and measurement of business transactions, accounting policies and methods, and disclosure of financial information. The issue of the 1992 Standard and the 1992 Regulations was considered a landmark for Chinese accounting reform. It is a departure from the state financial control system under the centrally-planned economy, especially for SOEs, and a major step towards harmonisation with IASs.

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However, many problems remain. The 1992 Standard, as a conceptual framework, is weak by comparison with the frameworks of the US, UK or IASC; it is not as comprehensive, complete or well structured. It neglects some fundamental issues and lacks sufficient discussion of other issues. For example, the 1992 Standard asserts that accounting information should meet the information needs of governments, management and other relevant parties, but there is no adequate discussion of the objectives of financial reporting and the information needs of the users of accounting information. The general principles, most of which are similar to the qualitative characteristics in other frameworks, are listed sequentially, but no explanation is given of their relative importance, potential conflicts and possible trade-offs. On the other hand, the 1992 Standard includes too many rules, the rules are too detailed in nature, and they are likely to be subject to frequent changes and amendments. (For a detailed discussion see Xiao and Pan, 1995). The co-existence of the 1992 Standard and the 1992 Regulations as fundamental standards also poses a problem. While they are intended to complement each other, there is some overlap in both measurement and disclosure areas which can be confusing for preparers. 10.4.2

New Industry-Based Accounting Regulations

Fourteen industry-based accounting regulations to accompany the 1992 Standard became effective on 1 July 1993. As it may take years to develop a full set of detailed accounting standards, these accounting regulations constitute a transitional arrangement to provide technical guidelines. They include the accounting systems for enterprises in manufacturing, merchandising, transportation, rail transportation, air transportation, communication and postage, tourism and catering, construction, real estate development, agriculture, foreign economic cooperation, banking and finance, insurance, and leasing. The new accounting regulations are based on the modern western

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Accounting assumptions (Ch. 1: General rules)

J_

Entity

Accounting period I

Going concern

Monetary unit

Accounting principles (Ch. 2: Basic principles) Objectivity Relevance Comparability Timeliness Consistency Understandability Accrual basis Matching principle Conservatism Historical cost Separation of revenue expenditure and capital expenditure Materiality Accounting elements

X Assets (Ch. 3)

Liabilities (Ch. 4)

—cz Recognition 1

I

Owners' equity (Ch. 5) I Measurement

Revenue (Ch. 6) Recording I

Financial statements (Ch. 9: Financial statements) Balance sheet Profit and loss statement Statement of changes in financial position Supplementary statements and notes Figure 10.1 The Structural Model of the 1992 Standard Source: Adapted from Aiken et al (1995)

Expenses (Ch. 7)

I

Reporting

Profit (Ch. 8) I

85

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accounting framework and accounting equation. The fund-based accounting equation "Total Fund Applications = Total Fund Sources" is replaced by the modern accounting equation "Assets = Liability + Owners' Equity". Assets are classified into current assets and noncurrent assets. The latter comprise long-term investment, fixed assets, intangibles, and deferred items. It was more complex to decompose total fund sources into liability and owners' equity. Generally, all payables, loans (including current fund loans, fixed fund loans and bank loans for specific purposes), and workers' welfare funds are treated as either a current liability or long-term liability. All state funds (including current, fixed and specific purpose funds) and enterprise fixed and current funds are treated as state-owned capital, while investment from other SOEs and enterprises is treated as legal persons' capital. Retained earning accumulated under the contract responsibility system are treated as a capital surplus, while accumulated losses are deducted from the stateowned capital. On the other hand, in some aspects these new regulations follow the old UASs. Accounting policies are largely unchanged, and detailed rules on the recording of transactions, a chart of accounts and the format of financial statements are prescribed. Financial statements prepared under the new regulations look comparable with financial statements prepared in the West, but the similarity is superficial and there exist substantial differences. In fact, the new regulations are not compatible with the international accounting conventions. 10.4.3

Current Regulatory Framework for Accounting

Prior to the economic reform, accounting was entirely governed by administrative rules and regulations enacted mainly by the State Council (SC) and the MOF. These rules and regulations were basically developed by experts in the relevant areas and promulgated by the MOF without going through any legislative process. This regulatory framework, which satisfied the needs of a centrally-planned economic system for accounting information for central planning and control,

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remained largely unchanged until the mid-1980s. By then it had become evident that the old framework with its purely administrative functions was incompatible with the new environment created by the economic reform. The economic reform has brought about a series of changes in the government's role in macro-economic management, the ownership structure of enterprises and the establishment of capital markets, while the open-door policy has resulted in a rapid increase in foreign investment. As a consequence, the use of administrative rules was no longer adequate nor appropriate. Since 1985, accounting regulation in China has gradually adopted a unique three-level legislative and administrative framework, as set out in the Accounting Law enacted in that year. The highest level is the NPC, the supreme law-making body in China; the second level is the SC, which is the highest organ of the state administration; and at the third level are various commissions, ministries and state bureaux under the SC, including the CSRC, the State Planning Commission, the State Commission for Restructuring Economy, the MOF, the State Taxes Bureau and the State Auditing Bureau. The first two levels, the NPC and the SC, are endowed with legislative power to issue laws and regulations. The NPC has enacted a number of important laws which have a significant impact on accounting and business practices, including the Accounting Law (1985, revised in 1993, 1999), the Companies Law (1993, revised in 1999), the Law on State-Owned Enterprises (1988), the Law on Sino-Foreign Joint Ventures (1979, revised in 1990), the Taxes Law (1992), and the Taxes Law on Enterprises with Foreign Investment and Wholly Foreign-Owned Enterprises (1991). The SC provides regulatory support and issues detailed implementation rules and regulations. It also has legislative authority for approving regulations, administrative rules and decrees stipulated by the various Commissions and Ministries under its authority. The more relevant accounting regulations promulgated by the SC include the Detailed Implementation Rules for the Law on Sino-Foreign Joint Ventures (1983), the Detailed Implementation Rules for the Taxes Law (1993), the Detailed Implementation Rules for the Taxes Law on

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Enterprises with Foreign Investment and Wholly Foreign-Owned Enterprises (1991), and the Certified Public Accountants Regulations (1986). At the third level, various Commissions and Ministries under the SC are empowered with the authority and responsibility to stipulate detailed explanatory notes, administrative rules and regulations and to monitor the implementation of state laws and regulations. The Commissions are responsible for specific tasks which have impact on a number of Ministries and Departments and their status within the government hierarchy are slightly higher than that of the Ministries. Although these administrative rules and regulations are not laws, in practice they are as mandatory and powerful as the state laws and regulations. In addition the CICPA, a quasi-government cum professional body under the supervision of the MOF, issues professional and ethical working rules to guide its members. It is also authorised to supervise the registration of CPAs and CPA firms. The Chinese regulatory framework is summarised in Figure 10.2. 10.4.4

Setting of Detailed (or Specific) Accounting Standards

In 1993, China obtained a loan of US$3 million from the World Bank for the development of a full set of accounting standards which would be in line with international accounting conventions. One of the (then) Big-6 accounting firms, Deloitte Touche Tohmatsu, was contracted to provide consulting services to the MOF in the preparation of the new Chinese accounting standards. Initially it was planned to complete and issue all the new standards within three years, but this proved to be too ambitious. Since 1995 the MOF has issued 32 accounting standards in the form of exposure drafts.

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First level

National People's Congress (NPC)

State Council (SC)

Second level

Third level Planning Commission

Ministry of Finance (MOF)

China Securities Regulatory Commission (CSRC)

Economic Restructuring Commission

State Taxes Bureau

Department of Administration of Accounting Affairs (DAAA)

Chinese Institute of Certified Public Accountants (C1CPA)

Figure 10.2

89

The Chinese Regulatory Framework for Accounting

State Auditing Bureau

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The first detailed accounting standard was issued in 1997 and by the end of 2000 ten detailed standards have been issued, as shown below: (a) Disclosure of Related Party Relationships and Transactions (1997) (b) Events Occurring After the Balance Sheet Date (1998) (c) Revenue (1998) (d) Investments (1998) (e) Construction Contracts (1998) (f) Changes in Accounting Policies and Accounting Estimates, and Corrections of Accounting Errors (1998) (g) Cash Flow Statements (1998) (h) Debt Restructuring (1998) (i) Non-Monetary Transactions (1999) (j) Contingencies (2000) The first six standards apply only to listed companies and the last four to all business enterprises. The standard setting process is an ongoing one and it is expected that the remaining standards will be issued in the near future. Each of the detailed standards contains three documents: the Standard, the Guide (Directive) and the Explanations. The first two have legal effect. The Standard is short and brief, comprising an introduction, definition of terms, the contents, and supplementary provisions which stipulate that the MOF is responsible for the interpretation of the standard and the effective date. The Guide is a much larger document than the Standard and comprises sections on basic requirements, interpretations and explanations, and examples of business transactions and accounting treatments. The contents in the Guide are detailed and procedural, and cover accounting procedures, account titles, formulae and calculations, interpretations, stipulation, and so on. The Explanations usually spell out the objectives of a standard, arguments for or against a particular accounting method, more detailed explanations of terminology, different views on certain accounting procedures, and so on.

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10.4.5

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Structure of Current Chinese Accounting System

The current accounting system in China has a three-level structure, as shown in Figure 10.3. At the first level are the Accounting Law (1985, revised in 1993, 1999), various taxation laws and other regulations, based on which at the second level are the Basic Accounting Standard for Business Enterprises (1992) and the Financial Management Regulations for Business Enterprises (1992). At the third level are the fourteen Industry-Based Accounting Regulations and Industry-Based Financial Management Regulations, ten detailed Accounting Standards (up to year 2000), Accounting Regulations and Financial Management Regulations for Share Enterprises, and Accounting Regulations and Financial Management Regulations for Enterprises with Foreign Investment. All business enterprises are required to adopt the 1992 Standard and the 1992 Regulations and four of the ten detailed accounting standards, while listed companies should adopt all the detailed standards. Enterprises with foreign investment (e.g., Sino-foreign joint ventures and wholly foreign-owned ventures) and share enterprises continue to apply the accounting regulations previously set for these two types of enterprises. All other types of enterprises are required to apply one of the fourteen sets of industry-specific accounting and financial management regulations pertinent to the industry in which the particular enterprise operates. The Accounting Regulations for Enterprises with Foreign Investment (amended 1992) and the Accounting Regulations for Share Enterprises (1998) both stipulate rules for accounting issues which are common to all enterprises with foreign investment and all share enterprises across industries respectively, that is, rules based on western general accounting principles, the accounting equation, concepts, financial statements, and measurement and disclosure requirements. They also include rules and regulations which are unique to China. Furthermore, the two types of enterprises may adopt rules contained in the new industry-based regulations which are specific to the industries in which they operate and the new detailed accounting standards.

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Therefore, the current accounting regulations applicable to enterprises with foreign investment and share enterprises are a combination of western and Chinese rules stipulated in the 1992 Standard, the relevant regulations (ie, governing foreign investment or share enterprises), the new industry-based accounting regulations and the new detailed standards. Both sets of regulations prescribe a chart of accounts, the format of financial statements, detailed rules for the recording of transactions, financial control procedures, accounting policies, measurement and disclosure requirements, and the appropriation of profit. These detailed stipulations leave little room for exercising professional judgment, an essential feature of western accounting practice. Lastly, accounting methods used for a number of transactions differ from those in the West. The promulgation and implementation of the detailed accounting standards, which are an ongoing process, are a giant step closer to the adoption of international accounting conventions, although differences are inevitable. There are two views with respect to the implementation and applicability of a full set of accounting standards. One is that the current industry-based regulations and the new detailed standards will coexist for a period of time and then the former will be phased out completely. The second view is that the two sets will co-exist indefinitely. The new detailed standards will apply to share enterprises and other large enterprises, while the industry-based regulations are more suitable and will be retained for small- to medium-size enterprises. In summary, both the industry-based accounting regulations and the detailed accounting standards are being used in China. While the future is not for us to see, one thing that is certain is that successful harmonisation will depend on a successful outcome to the economic reform, a subject that is pursued in Chapter 11.

Accounting Law

Various Tax Laws

Basic Accounting Standard for Business Enterprises

14 Industry-Based Accounting Regulations

10 Detailed Accounting Standards (up to 2000)

14 Industry-Based Financial Management Regulations

Figure 10.3

Structure of the Chinese Accounting System

Source: Adapted from Liu and Turley (1995).

Financial M Regulations Enterprises

Accounting Regulations for Share Enterprises

Financial Management Regulations Share Enterprises

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10.4.6

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Growth of the Accounting Profession

As discussed earlier, the need for a CPA system was brought about by the open-door policy and the economic reform (see sub-section 4.2.2). In the previous phases of reform two important regulations governing CPA firms and CPAs were promulgated, that is the Provisional Regulations Concerning Establishing Public Accounting Firms issued by the MOF in 1980 and the Regulations of the People's Republic of China on Certified Public Accountants issued by the State Council in 1986. The regulations designate the MOF as the regulatory body at the national level and the finance bureaux at the provincial level responsible for administering matters relating to CPAs and CPA firms. In 1988, the Chinese Institute of Certified Public Accountants (CICPA) was established. Unlike its counterpart in the West, the CICPA is under the jurisdiction of the MOF. The CICPA controls certain matters relating to CPAs, such as registration and examinations, and acts as a liaison between CPAs and government agencies. In 1993, the State Auditing Bureau and auditing bureaux at different government levels were established and charged with the responsibility for the audit of the financial affairs of SOEs. This created a "double-track" control system which placed SOEs under the supervision of both the MOF and the Auditing Bureau. Subsequently, the Auditing Bureau expanded its functions; it authorised the establishment of audit firms, the registration of certified public auditors through evaluation of their qualifications and work experience, and the acceptance of enterprises' financial statements audited by certified public auditors. As a result, within a period of two years, audit firms and certified public auditors outnumbered accounting firms and certified public accountants and a separate association, the Chinese Institute of Certified Public Auditors, was established. The situation of "two institutes" and "two types of practitioners" created confusion and conflict. In 1995 the two institutes were merged to form the new Chinese Institute of Certified Public Accountants, under the supervision of both the MOF and the State Auditing Bureau.

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Public accounting firms in China faced a special "Chinese" problem. For a number of historical reasons, they were not entirely independent but were attached to various sponsoring agencies. Many CPA firms were under the direction and supervision of government finance bureaux, while others were attached to government departments or organisations. Also, many universities of finance and economics, accounting departments within universities and social science research institutes had established public accounting firms, with the participation of accounting teachers and researchers. This practice was inconsistent with the socialist market system and with international practice as well. There were difficulties experienced in transforming the accounting firms into independent and impartial social intermediary organisations. A twoprolonged attack was directed at resolving this problem, one through institutional reform and the other through new regulatory requirements. First, the CICPA started a structural reform of the CPA firms in 1995, in line with the requirement for establishing a market economic system. The goals and principles set for the reform are: establishing a managerial system of CPA firms which fits the economic system; forming an operational system that requires CPAs to bear legal responsibility and CPA firms to operate independently; and enhancing CPAs' awareness of risk and the importance of ethics and professionalism (Y. Li, 1999). Second, the Regulations of the People's Republic of China on Certified Public Accountants, revised and promulgated in 1993, required all CPA firms to "delink" themselves from their sponsoring organisations by the end of 1999 in four crucial aspects: personnel, finance, business activity and firm name. The delinked CPA firms are required by the revised Regulations (1993) and related stipulations of the MOF to be restructured as partnerships or limited liability CPA firms. The revised Regulations (1993) heralded a new era for CPA development. An environment has been created which is conducive to Chinese CPAs working in the international accounting arena and to foreign CPAs entering the Chinese accounting market.

chapter 11

Towards A Successful Outcome for SOE Reform

The reform of the SOEs, which is the core of the economic reform process, has not been as successful as the Chinese leaders might have expected. Several fundamental problems associated with the old system have not been resolved after 20 years of reform. First, the SOEs continue to depend on outmoded technologies and obsolete equipment, some of which are up to 50 years old. Their plants are obsolete, inefficient, and highly polluting. Second, the traditional SOE model is organised along the lines of a social institution which provides pensions, housing, medical care, child care, education, food, recreation and transportation for workers and their families, as well as financial and other support for a large number of retired workers and their dependants. These "social costs" are high relative to production costs and unsustainable in the long term. Third, nepotism is often a serious problem, since most heads and managers of SOEs are members of the CCP and are appointed by the government. Where effective control and incentive mechanisms are not in place managers are not motivated to improve their performance or to respond to market forces, rather management performance may be influenced by political and personal relationships. The above causes have led to unhappy consequences. The SOEs remain mired in inefficiency and low productivity, as compared with other types of enterprises. Recent government statistics show that,

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among all SOEs and non-state-owned enterprises with an annual sales revenue of over 5 million yuan, the SOEs employ around 70 per cent of industrial assets but produce only one quarter of the total industrial output (China Statistical Yearbook, 2000). Many SOEs are behind in their tax payments, carry excessive debt or overdue debt, or are caught in a cycle of "triangular debt", that is, they receive at best partial payment from customers and are therefore only able to pay in part their own suppliers. Corrupt practices are commonly seen, such as the transfer of SOE assets to individuals. As a result, many SOEs are loss-making and continue to rely on government cash subsidies or bank loans to survive. Certain common perceptions of the SOE problem are succinctly summarised by Shen (2000, pp. 136-137): Inefficiency was rooted in the monolithic ownership pattern, in management practices, in lack of financial independence, and in the absence of market and economic incentives. Reform, therefore, was an issue of diversifying ownership rights, accentuating management responsibility, initiating financial independence, and introducing a marketdetermined reward and penalty system. The present writers hypothesise further that some of the difficulties in dealing with the SOE reform may be traced to government reluctance to surrender control over the SOE sector for a number of reasons. The first is political and ideological. It is centred on the maxim that "assets belong to all the people", which is embraced by both Party members and workers. The abandonment of this core precept can lead to questions about the legitimacy of the Party's ruling status. A second reason is political and economic. It is the government's fear of unemployment and workers' unrest which might flow from the SOE reform, adding to the already high unemployment in the cities and putting further pressure on local government authorities responsible for the welfare of the unemployed. Because of this paradoxical stand on the SOE reform, the reform measures so far have been implemented in a piecemeal fashion to address perceived specific problems and are

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unlikely to succeed. The reform of SOEs needs to proceed as a major structural reform of the economy as a whole, including a genuine separation of government ownership from control over enterprise management. J. Ma (2000) has offered a useful analysis of the underlying problems. He classifies SOEs into three types: government enterprises, public corporations and joint stock companies, and explains the different policy environments, corporate governance structures and legal frameworks associated with each type that need to be addressed. A somewhat different classification is explored below. 11.1 Classification Scheme for SOEs Figure 11.1 classifies SOEs into enterprises which have and those which do not have a profit maximising objective. This classification has a special advantage in addressing loss-making SOEs, the focus of interest. If a loss-making SOE which is unlikely to be successfully turned around belongs in the profit maximising objective set, it should be liquidated. If it belongs in the non-profit maximising objective set, liquidation is probably not an option and the government may have to consider a policy of subsidies or grants to support the SOE's operations. 11.2 Proposed Ownership Structures Profit maximising objective enterprises correspond to private sector companies in western countries. These enterprises may be listed or unlisted. In the case of profit maximising objective SOEs, there is no reason why the government should involve itself in their ownership. The government could hold some shares but only as an investor with profit making in mind. It should limit its holding to, say, 20-25 percent in any individual company and should not participate in any aspect of control or management. The shares may be held through a specially created body, such as a government investment trust, with a clause in its constitution which prohibits it from exercising its voting rights or participating in

State-Owned Enterprises (SOEs)

Profit Maximising Enterprises

Performance Objective

Listed Companies

Unlisted Companies

Non Max Ent

Strategic or pillar Industries

Proposed Ownership Mainly Diffused Private Ownership

Figure 11.1

Classification of SOEs Based on Performance Objective and Pr

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management in any way. (This would similarly apply to government majority ownership in non-profit maximising objective SOEs.) Non-profit maximising objective enterprises are companies for which profit making is not the sole, dominant, or major objective. There are two types. The first is found in strategic or "pillar" industries, e.g., munition production, iron and steel, and shipyards. The second type comprises public utilities, e.g., water, electricity, etc. The key factor is that profit making is not the dominant or major objective. Although certain commercial activities may be conducted, it is often difficult or impossible to separate out the commercial from the non-commercial activities for the purpose of performance evaluation. Whether an industry or a company should be classified as a non-profit maximising objective entity is related to the existing circumstances in China's present stage of development. It should be noted that many of the enterprises in this group have been privatised in western countries. With respect to the non-profit maximising objective entities, there seems little reason for private investors to be involved until and unless their commercial and profit making activities become significant. There is an exception to this general rule. A well managed enterprise in this group which has a steady (i.e., non-volatile) earnings stream growing over time would be very attractive to private investors, and the government might well wish to display this showcase of business professionalism and to recoup some of the capital investment by listing, say, 20 per cent of the company's shares on the stock exchange, all the more desirable on a foreign exchange. Such cases are uncommon. The above discussion suggests that the present strength of government ownership in SOEs, i.e., about 70 per cent in listed companies and 100 per cent in unlisted companies, is misconceived. Rather, the government should have zero or minimal holdings in profitmaximising objective companies, whether they are listed or not and should wholly or largely control the ownership in non-profit maximising objective enterprises. But in all cases it is undesirable for the government to intervene in the management of enterprises and it has been

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suggested earlier that all government ownership in enterprises be vested in a government investment trust, which is not permitted to participate in the management of any enterprise. For the non-profit maximising objective sector the government would be required to set up participating boards which are independent of it and which have the responsibility for appointing and supervising the board of directors of the non-profit maximising enterprises. 11.3 Turning Around Loss Making SOEs Profit maximising objective SOEs, listed and unlisted, can be classified as (a) profitable, (b) loss-making but can be turned around, and (c) lossmaking and are unlikely to be successfully turned around. The government should set up a supervisory body to examine the SOE's performance and recommend the appropriate action. In the case of profitable enterprises corrective action might need to be taken in those areas where deficiencies exist. Generally, outstanding profitable enterprises would contain valuable lessons for other SOEs. Case studies of outstanding SOEs, e.g., PetroChina, should be compiled and used as teaching material. Unprofitable enterprises which are unlikely to be successfully turned around should be liquidated. In the case of non-profit maximising SOEs performance evaluation criteria based on profitability similar to those used in the profit maximising objective group cannot be employed. Rather, the supervisory body should set performance targets in terms of both physical input and output levels and in terms of relevant financial indicators for the evaluation of management. There is a host of problems associated with turning loss-making companies around, which apply to both large and small SOEs. According to Shen (2000, p. 159), 99 per cent of SOEs are medium and small in size and most of the loss-making SOEs would be included in this group. Generally, problems that might be encountered in restoring a sick non-profit maximising objective enterprise to health would be similar to

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those in the profit maximising objective group. These problems faced by the reform process are discussed below. 11.3.1

Restructure and Recapitalisation

In a command economy lacking Adam Smith's hidden hand there is a danger that development of certain industry sectors and enterprises within those sectors may not reflect market needs. For example, in the Chinese economy there has been a tendency to over-invest in the heavy industries. In the reform process enterprises belonging in an overdeveloped industry sector might be more readily considered for liquidation than enterprises in an under-developed sector. The reform process is usually associated with downsizing. There is a special aspect of downsizing which involves spinning off one (or more) division or department of an enterprise. Sometimes the division that has been spun off can be encouraged to develop on its own and both the parent entity and the new entity might develop vigorously, suggesting that divisionalisation in the original enterprise might not have been desirable in the first place. In other cases the spun-off division may be liquidated or merged with another SOE. Generally, there could be situations in which it might be desirable for two or more SOEs to be scaled back and then amalgamated to form a new enterprise. Divestures, mergers and alliances might be the means by which an expert and experienced reform oversight committee can use to achieve greater efficiency in restructuring (Shen, 2000). Most SOEs would need to be recapitalised. This provides an opportunity to construct an appropriate capital structure that addresses the public versus private ownership issue and the proportion of debt to equity issue. Accumulated debts which the company is unable to repay need to be forgiven (see section 11.4; Shen, 2000) and new equity and new debt funds raised to replace obsolete technology and machinery. For profit maximising objective SOEs it would be contrary to the spirit of the reform for the funds to be supplied by the government, and a major effort

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would be required to convince the private sector to contribute to the rescue of loss-making SOEs. 11.3.2

Downsizing and Unemployment

Earlier on we spoke of the CCP's concern for workers' welfare under the SOE reform, in particular unemployment from the liquidation of SOEs. Unfortunately, the turn-around process will almost inevitably be associated with downsizing in order to increase efficiencies and cut costs. Hence the reform process delivers a double whammy to the unemployment problem, from the liquidation of some SOEs and from the downsizing of other SOEs. However, a form of disguised unemployment would otherwise exist. Delays in implementing the reform programme may only increase the urgency and intractability of this and interrelated problems. This issue needs to be viewed in the context of a larger problem. China's labour force increases by millions of workers every year on account of, partly, demographic factors and partly, labour shedding by agriculture. Deng's strategy of trial and error counsels decision makers to proceed at the pace determined by success elsewhere. The creation of SEZs have proven very successful in the economic development of China's coastal areas. The government has embarked on a policy of promoting similar developments in the hinterland to generate new employment opportunities, which addresses a continuing reform programme and the overall unemployment problem. 11.3.3

Loss Culture

Another problem is the existence of a loss culture in a company which has suffered many years of losses, which often runs deep down to lower management and staff levels. This means that there could be a need to appoint a new chairman, board of directors and managing director (that is, the chief executive officer (CEO)), as well as other managers. As private enterprise is a new phenomenon for China, there does not exist a market for directors and managers. This problem of obtaining qualified

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and motivated people to turn companies around could be a most difficult one. 11.3.4

Corporate Governance

According to Cheffins (2000), "corporate governance concerns the systems by which companies are directed and controlled". The adoption of a proper system of corporate governance is important. However, differing conditions exist in different countries. In the UK and Australia emphasis is laid on executive accountability and the significant role of the independent Chairman and other independent board members, whereas in some other countries it is not uncommon for the Chairman and CEO to be the same person. It has been reported that new regulations will require all listed companies in China to set aside at least a third of their board seats for independent directors (Dow Jones Newswires, cited in Australian Financial Review, 9 May 2001, p. 12). This is a step in the right direction. There is a point that needs to be made. In the past decade there has been much debate in Australia on the supervisory role of an independent board over the executive functions of senior management. In recent years there has been a number of high profile company failures, largely or partly on account of mismanagement, including the payment of huge bonuses to senior executives in years when poor profits or losses were made. While the concept and principles of corporate governance have been accepted, there is a gap between acceptance and implementation in the corporate sector in Australia. As China does not have much experience in corporate governance, Chinese reformers need to learn from western experience. However, they need to adopt a cautious and discriminating approach in designing corporate governance systems which are consistent with the cultural and business environment in China, and monitor the implementation of these systems in practice.

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105

Long-Run Decision Making

A communist country might encounter difficulties with the use of appropriate long-run decision making models, such as capital budgeting models. There may not be well developed capital markets in which information on equity and debt costs can be obtained for computing the company cost of capital or hurdle rate, yet it is important that the correct investment decisions be taken for the turn-around operation to succeed. Under the reform process a large number of SOEs would be faced with the need for capital expenditures, and would be competing with one another for scarce funds. A systematic approach by SOEs to capital expenditure issues would be desirable. As a temporary measure an advisory body comprising bankers, industrialists, accountants and academics could be established and charged with the task of setting industry-specific hurdle rates for capital budgeting. An individual SOE might use the rate (or rates) relevant to its own circumstances as a surrogate rate(s) or as a benchmark in constructing its own hurdle rate(s). In this way excessive diversity in the use of discount rates may be avoided. It is possible that the advisory body could oversee the production of a small manual on good capital budgeting practice relating to issues such as the subjectivity of estimates, different concepts and measures of risk, capital rationing, etc., particularly for the use of the smaller SOEs. 11.3.6

A Caveat on the Pace of Reform

Some consideration for the speed of implementation of the reform programme is indicated by the enormity of several of the problems discussed above. With regard to the unemployment issue, the rates at which some SOEs are liquidated and other SOEs turned-around should be reflected in the degree of success of the government and the private sector in creating new job opportunities. Similarly, the number of SOEs that can be turned-around in a defined period should be reflected in the market's ability to meet the demand for new capital funds required for

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restructuring and modernisation, including the purchase of new plant and equipment. The objective of the reform programme is not changed. However, the SOEs reform horizon may need to be extended to take account of economic and demographic circumstances at national, regional and provincial levels. Priority may also need to be given to the liquidation or turning-around of SOEs with certain specific attributes, for example, capital-intensive versus labour-intensive enterprises. 11.4 Debt Defeasance Programme The problems of the SOEs' indebtedness do not bode well for the banking system. The core business of Chinese banks is lending to the SOEs and, as a result of massive losses made by SOEs, the state-owned commercial banks are now carrying a huge amount of debt. Much of this debt is non-performing debt, but appropriate provision is not provided in the banks' books because the SOEs continue to make interest payments out of new loan monies. However, it is generally believed the debts will not be repaid. The banks survive and continue to do business because they are able to depend, firstly, on massive indirect government subsidies in the form of interest income on government and governmentguaranteed loans and loans to SOEs (the interest on the last often payable out of new loans) and, second, on the continued flow of deposits made by Chinese households. These deposits can be regarded as contingent liabilities of the government as the government implicitly guarantees bank deposits. If the government guarantees and subsidies were to cease, the banks could become insolvent and the Chinese banking system would collapse. In a hypothetical situation, if the government were to permit foreign banks to accept deposits from Chinese households, there could easily be a run on the Chinese banks resulting in a deposit drain for those banks and the closure of a large number of SOEs, with further dire consequences for the Chinese banks (Dean, 2000). Indeed, as the globalisation of the Chinese economy gathers pace, there is increasing pressure on the government to liberalise the regulations governing the

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107

scope of foreign bank business. The Chinese banks need to be released from carrying the burden of the SOEs' massive bad debts and to have a healthy balance sheet so that they would be able to compete with foreign banks. A feasible approach to the bad loan problem would be for the government to create specialised entities which can perform two functions: one, purchasing the "loan assets" from the banks and two, relieving the SOEs of their debt burden through some debt defeasance arrangement. The objective of this dual-faceted exercise is, first, to clean up and restore the credibility of the balance sheets of the banks and the SOEs and, second, to put the banks in a stronger position to compete with foreign banks and to enable the SOEs to obtain new funds from the debt and equity markets to modernise and compete with other business enterprises on equal terms in the market-place. The loss to the government from purchasing the bad loans from the banks will be immense, but this is a sunk cost representing losses accumulated over many years of appalling government policies, mismanagement and corruption, which need now to be crystallised and excised. The debt defeasance programme only relates to non-performing loans. Viable loans, that is loans which a profit making enterprise or an enterprise undergoing rejuvenation are able to service (i.e., to meet interest payments and principal repayments on due dates ) will remain on the books of the bank (as asset) and the SOE (as liability). It must be emphasised that this is a once-only exercise. In future years in accordance with the requirements of company law companies which are not solvent, i.e., companies which cannot meet an amount owing on the due date, will not be allowed to trade while banks will be responsible for pursuing lending policies based on best business practice. The central bank could be given the power to ensure that commercial banks are not directed to make "policy loans", i.e., subsidies and grants to SOEs.

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11.5 Corporatisation, Listed Companies and the Stock Exchange The government has corporatised all SOEs believing that this would effect a separation of control from ownership. This will only happen if corporatisation is associated with widely diffused ownership which has not been the case in the SOE reform. To facilitate this separation, irrespective of the size of its shareholding the government should vest its ownership interest in a separate body, which has a clause in its constitution prohibiting it from employing its voting or other ownership rights in the enterprise. About 1,000 former SOEs have been listed on the two stock exchanges. The intention in creating the stock exchanges was to separate management from ownership and control. It was expected that listing on the stock exchange would automatically expose SOEs to market forces and improve their efficiency and performance. The efficiency and performance of listed companies have generally been poor. Since the objectives behind corporatisation and listing were not achieved, there is some ambiguity on whether corporatisation and listing have been successful reform processes. While listing on the stock exchange provides motivation to efficiency and management performance, the share price itself is not a good performance measure for a number of reasons, e.g., share prices are often volatile particularly in periods of erratic investor behaviour. Nonetheless, because investors place reliance on periodical profit disclosures, stock market activities indirectly provide strong support for timely, relevant and reliable disclosures. From an accounting viewpoint, the corporatisation and listing of the SOEs have speeded up the adoption of modern accounting systems and international accounting standards.

chapter 12

Conclusion

China's economic reform programmes have been successful in many aspects, in particular the rural reform, the liquidation of the planned economy and its replacement by a market-based economic system. The growth of the economy has been staggering. The GDP grew from 362.4 billion yuan in 1978 to 8,191.1 billion yuan in 1999, a multiple of 22 times or an annual compound growth rate of 16 per cent over a 21-year period (China Statistical Yearbook, 2000, p. 53).' Although the growth of the economy is most evident in the large cities, the marked improvement in the standard of living is widespread throughout China. (The 16 per cent growth rate had been inflated by two factors. First, the 1978 base figure was low on account of the Cultural Revolution and, second, the real growth rate was in fact lower at about nine per cent.) The present writers have documented China's economic reform which began in the late 1970s and shown how accounting has responded to the reform. The economic reform programmes, in particular the reform of SOEs and the open-door policy, have brought about an accounting reform, which resulted in fundamental changes in the Chinese accounting system. While the Chinese economy was transformed from a centrally-planned and centrally-controlled system to a planned commodity economic system, and then from the latter to a marketoriented system, Chinese accounting in turn changed its key role from ' US$1 = 8.28 yuan, average exchange rate in 1999.

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serving the government planning and control needs to serving the information needs of SOEs' management, and from the latter to the information needs of external users in the market-place. The current accounting systems in China comprise multiple sets of standards and regulations for various types of business enterprises, including industrybased accounting regulations, new accounting standards, and accounting regulations for foreign investment and share enterprises. All these regulations and standards are based on the 1992 Standard which serves as a conceptual framework. These changes have transformed Chinese accounting and there is partial harmonisation of the new Chinese accounting standards with the International Accounting Standards (IASs). Certain fundamental differences are inevitable, as China does not have a tradition steeped in the rule of law nor a stock market characterised by a large number of small investors. The accounting reforms, in turn, have assisted in the economic reform process in facilitating the provision of relevant, reliable and timely information to decision makers. The problems facing Chinese accounting today are basically: (a) the adoption of a full set of accounting standards based on and consistent with the IASs; (b) the education and training of a large number of qualified accountants necessary to serve a rapidly growing economy; and (c) the liberalisation of the Chinese mindset, that is, a conversion from trust in a system based on strict rules and regulations to one which requires the exercise of professional judgment. Harmonisation with the IASs, setting new standards, or training qualified accountants are not difficult tasks for China. In the final analysis, accounting is the handmaiden of the economic reform. Success in the transformation of the accounting profession and the accounting system will depend, to a large extent, on the economic reform, that is the reform of the SOEs. It is a pertinent question why China chose to reform the SOEs and turn them into profitable businesses, in contrast to the former Soviet Union and the Eastern European countries which chose to privatise their state enterprises. The answer is that state ownership of industrial assets is a central tenet in the CCP ideology, as it ensures state control of the

CONCLUSION

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economy. The government has shown no intention of privatising the large SOEs and has formulated specific policies to ensure the dominance of state ownership of the large industrial enterprises in core industries such as automobile, petrochemicals, and iron and steel (Xiang, 1998). Consequently, the reform programmes have not been able to offer solutions for the SOEs which can address the contradictions that arise when socialism is merged with capitalism. Maintaining the autocracy of the CCP and implementing a market-oriented economic system have proved to be incompatible, leading to an impasse in the economic reform. There was once a period when reforms to the political system were hotly debated. This phase came to an abrupt end after 1989 for a number of reasons. One was the turbulence caused by the Tiananmen Incident of 1989. Another was the experience of the former Soviet Union which began its reform process in the political arena without first undertaking economic reform to boost its economy. As a consequence, its reform programme was unsuccessful and led to the Soviet Union's collapse and disintegration. Although the problems of the two countries are not comparable, the failure of the Soviet Union's political reform would have made an indelible impression on the CCP. However, current problems encountered in China's reform programme indicate that the autocratic rule of the CCP and a market-oriented system cannot co-exist in their present forms indefinitely and the incompatibility will have to be resolved at some stage. The problem lies in the contradictory policies of the government which seeks to revolutionise SOEs by submitting them to market forces but at the same time frustrates those forces through a policy of maintaining government majority ownership and control. There are several core issues some of which have a political overtone. The first issue concerns a central tenet of the CCP, which is that "assets belong to all the people". It has been proposed in Chapter 11 that the government should not retain ownership in profit-maximising objective entities whereas it should retain dominant ownership in nonprofit maximising objective entities, i.e., strategic and public utility industries or enterprises. However, government ownership should be divorced from government control over enterprise management. The

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second issue concerns a new role for the government in nurturing the private sector. These two issues are briefly discussed below. As for the ideological issue, it may be argued that state dominant ownership of strategic enterprises and public utilities will suffice. However, because of concern over the unemployment effect as well as the absorptive capacity of the private sector, it might be prudent for the government to divest itself of profit-maximising entities only after they have been turned around and then through a gradual process over an extended period. The second issue is that the government must adopt new responsibilities in promoting the growth of the private sector. Corporatisation and the stock market are necessary steps, but they clearly have not been sufficient. The government needs to create and maintain a private sector infrastructure under which individual enterprises can grow and prosper. Banks and other financial institutions are already in place and once the banks have been relieved of their bad loans the government should be careful not to intervene in their commercial activities. The design, implementation and maintenance of an appropriate corporate governance system is important. Business structures in western countries have evolved over time through the interaction of government and the business community. This has not taken place in China because of the pace of economic development and the burden falls largely on the government to set up and maintain a comprehensive business infrastructure. Formidable problems in this development process are to design and maintain a corporate governance system appropriate to Chinese conditions; to train and motivate managers and employees; to address the incomplete legal system issue and to enforce the rule of law; and to root out and destroy all forms of corruption and nepotism. Over time a private sector, including the financial and corporate sectors and the stock market, will emerge which will dominate the economy. The government, however, need not be unduly concerned. It would retain control over the financial and corporate sectors through legislation governing specific industries, such as insurance, banking and mining and environmental issues, as well as a multitude of government

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rules and regulations governing such matters as taxation, foreign exchange, authority over mergers and take-overs and restricted ownership of special entities, e.g., media, gas pipelines, etc. What has been necessarily surrendered by the government in the development of the private sector would not be control per se, but government control over enterprise management. The surrender of part of the CCP's power and control over the economy is a truly breathtaking prospect. The stakes are high. If a political reform can bring about a successful outcome of the economic reform programme, the prize is the restoration of China's prosperity and standing in the world community. But if the SOE reform were to ultimately fail, then China's future will be bleak.

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Goldman, M., "The Party and the Intellectuals", in R. MacFarquhar and J.K. Fairbank (eds.), The Cambridge History of China - The People's Republic, Part 1: The Emergence of Revolutionary China 1949 - 1965, Vol. 14, Cambridge University Press, 1987. *Guo, D.Y., "Chinese Accounting Reform in the Twentieth Century", Accounting Research Journal, September 1999, pp. 7-14. *Guo, Q.H., "An Assessment on the Information Disclosure Requirements of Chinese Companies", Investment and Securities", January 1999, pp. 65-69. Hamrin, C.L., China and the Challenge of the Future - Changing Political Patterns, Boulder, San Francisco & London, Westview Press, 1990. *Hao, J.L., "Ten Pending Problems of China's Stock Market", Investment and Securities, January 1999, pp. 80-83. Harding, H., "The Chinese State in Crisis" in R. MacFarquhar and J.K. Fairbank (eds.), The Cambridge History of China - The People's Republic, Part 2: Revolutions within the Chinese Revolution 1966 1982, Vol. 15, Cambridge University Press, 1991. Huang, A. and Chang, X., "Financial Reporting in China", in R. Ma (ed.), Financial Reporting in the Pacific Asia Region, World Scientific, 1997. Hughes, N.C., "Smashing the Iron Rice Bowl", Foreign Affairs, Vol. 77, No. 4, July/August 1998, pp. 67-78. Jackson, S., "Profit Sharing, State Revenue and Enterprise Performance in the PRC", The Australian Journal of Chinese Affairs, July 1984, pp. 97-112. Lardy, N.R., "Economic Recovery and the 1st Five-Year Plan", in R. MacFarquhar and J.K. Fairbank (eds.), The Cambridge History of China - The People's Republic, Part 1: The Emergence of Revolutionary China 1949 - 1965, Vol. 14, Cambridge University Press, 1987(a). , "The Chinese Economy Under Stress, 1958-1965", in R. MacFarquhar and J.K. Fairbank (eds.), The Cambridge History of China - The People's Republic, Part 1: The Emergence of

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MacFarquhar, R. and Fairbank, J.K. (eds.), The Cambridge History of China - The People's Republic, Part 1: The Emergence of Revolutionary China 1949 - 1965, Vol. 14, Cambridge University Press, 1987. Radebaugh, L.H. and Gray, S.J., International Accounting and Multinational Enterprises (4th ed.), John Wiley & Sons, 1997. Ren, M.C. and Alexander, D., "Issues in Developing Accounting Standards in China: A Contextual Perspective", China Accounting and Finance Review, Vol. 2, No. 3, 2000. Ren, M.C, Alexander, D. and Kedslie, M., "The Trend of Accounting Reform in China", in J. Blake and S. Gao (eds.), Perspectives on Accounting and Finance in China, London, Routledge, 1995. Scapens, R.W. and Hao, Z., "Chinese Accounting Reform: Reasons and Effects", in J. Blake and S. Gao (eds.), Perspectives on Accounting and Finance in China, London, Routledge, 1995. Shen, R., China's Economic Reform - An Experiment in Pragmatic Socialism, Praeger, London, 2000. Tang, Y.W., "Bumpy Road Leading to Internationalization: A Review of Accounting Development in China", Accounting Horizons, Vol. 14, No. 1, March 2000, pp. 93-102. Tang, Y.W., Chow, L. and Cooper, B.J., Accounting and Finance in China: A Review of Current Practice, Hong Kong, Longman, 1992. Teiwes, F.C., "Establishment and Consolidation of the New Regime", in R. MacFarquhar and J.K. Fairbank (eds.), The Cambridge History of China - The People's Republic, Part 1: The Emergence of Revolutionary China 1949 - 1965, Vol. 14, Cambridge University Press, 1987. *Wei, J., "Four Issues on China's Stock Market", Investment and Securities, January 1999, pp. 75-79. Xiang, B., "Institutional Factors Influencing China's Accounting Reforms and Standards", Accounting Horizons, Vol. 12, No. 2, 1998, pp. 105-119. Xiao, J.Z.Z. and Pan, A., "The Chinese Approach to Accounting Standards and a Conceptual Framework", in J. Blake and S. Gao

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119

Index Accounting Law, 87,91 Accounting reform, 59-60, 65-69, 80-93, 109-110 Accounting standards, 66, 78, 80, 82-84,88-93,108,110 Agricultural Producers' Cooperatives (APCs), 18-19 Aiken, M., 83, 85 Alexander, D., 22, 23, 25 Accounting Regulations -for Share Enterprises, 91, 93 -for Enterprises with Foreign Investment, 67-68, 91,93 Bad debts, 80, 106-107 Bai, Z.L., 35 Banking system, 70-71, 106 Basic Accounting Standard for Business Enterprises, 80-85, 91-93 Brayshaw, R., 42 Bromwich, M., 58 Centrally-controlled economy, (see Centrally-planned economy) Centrally-planned economy, ix, 15, 21,47-48,61,83,109 Certified public accountants (CPAs), 68, 88, 94,95, Chan, M.W.L., 80 Chang, X., 7, 67 Cheffins, B. R., 104 Chen Yun, 50 Chiang Kai-shek, 8, 13

China Securities Regulatory Commission (CSRC), 74-75, 77,87 Chinese Institute of Certified Public Accountants (CICPA), 68, 88, 94,95 Collective-owned enterprises (COEs), 19,21,23,48,54,73, 78,80-81 Companies Law, 70, 74, 87 Contract responsibility system, 6365, 72, 86 Cultural Revolution, 1-4, 40-44,49, 57 Dean, J., 106 Debt defeasance, 106-107 Deng Xiaoping, ix, 1, 3, 37, 38, 4042,47,49-51, 103 -Four Basic Principles, 49 -Theory, 49 Dual exchange system, 71 Economic reform -rural sector, 53-55 -urban sector, 55-56 -macroeconomic reform, 6263,69-71 -microeconomic reform, 6365,72 Eddie, I., x, 56, 66, 80 Enthoven, A., 25 Establishment Phase, 13-29

120

INDEX

Fa Lun Gong incident, 50 Fairbank, J.K., 1 Financial Management Regulations for Business Enterprises, 82, 91,93 Five-Antis campaign, 19 Five-Year Plan -First, 20, 30 -Second, 30 Fund accounting, xi, 22,26-28, 59, 80,86 Fund-based accounting {see fund accounting) Gang of Four, 42 Goldman, M., 31 Gray, S.J., viii Great Leap Forward (GLF), 2, 3040,42,44 Great Proletarian Cultural Revolution {see Cultural Revolution) Guo, D., 15, 24,25, 29, 36 Guo, Q., 77,78 Hamrin, C.L., 4, 50, 51 Hao Z., x, 5,22, 28, 59, 60, 64, 82 Hao, J.L., 77 Harding, H., 41,42 Harmonisation, xi, 78, 83,92, 110 Hu Yaobang, 50 Huang, A., 7, 67 Hundred Flowers movement, 20 Ideological issues, 51-52, 97, 110112 Increase-decrease method, 39 Indigenous accounting, 7-10 Individually owned enterprises (IOEs), 54-55, 63, 78

Industry-Based Accounting Regulations, 84, 86,91, 92, 110 Industry-Based Financial Management Regulations, 9193 Jackson, S., 63 Ji, X.D., 83, 85 Jiang Zemin, 47 Joint venture accounting, 59 Kedslie, N., 22, 23 Korean War, 20 Kuomintang (KMT), 4, 7, 19, 21, 23 Lardy, N.R., 14, 17, 19, 33, 34, 38 Lefevre, C , x, 27 Lenin, 2, 13 Li, T., 4, 5, 52,53, 55, 62, 63, 70 Li, Y., 95 Lieberthal, K., 31,33 Lin L., x, 27 Lin, S., 77 Liu Shaoqi, 37,40,42 Liu-Deng Programme, 37-38 Liu, W., x, 56, 66, 80 Liu, Z., 35, 36, 38,93 Lou, E.X., 25 Lu, W., 10,21, 23, 35, 39,42, 43, 83,85 Macfarquhar, R., 1 Ma, J., 80, 98 Management accounting, 58 Mao Zedong, ix, 1-6, 13, 18, 20, 38, 40-44,47 -Thought of, 14,31,49

INDEX

Market economy with Chinese characteristics, ix, 5, 69 Marx, Karl, 2, 13 Marxism, 51-52 Mutual aid teams (MATs), 18 National People's Congress (NPC), 16-17,47,58-59,87,89 Nationalist Party, {see Kuomintang) Open-door policy, 56-59, 87, 109 Pan, A., 84 Peng Zhen, 50 People's Bank of China (PBOC), 62,70-71 People's communes, 32, 54 Pillar industries, 100 Planned commodity economy, 6165 Price controls, 63 -Dual track pricing system, 63 Qin Dynasty, 7 Qing Dynasty, 7-8 Radebaugh, L.H., viii Recovery Phase, 37-39 Red Guards, 40-41 Reform, {see economic reform and SOE reform) Ren, M.C., 22, 23, 25 Rotenberg, W., 80 Scapens, R.W., x, 5, 22, 28, 59, 60, 64,82 Securities Affairs Commission (SAC), 74

121

Securities and Exchange Supervisory Commission (SESC), 74 Share enterprises, 59, 63-68, 81,9192,94, 110 Shen,R.,97, 101, 102 Small Leading Group (SLG), 41 Socialist market economy, 69-72, 74,82 SOE reform, xi, 55-56, 78-80, 97108 Soviet Union, 2, 14-16, 24, 29, 55, 63,110-111 Special Economic Zones (SEZs), 57,59,81 State Council (SC), 17, 21, 25,47, 74, 86-87, 89, 94 State-owned enterprise (SOE), xi, 21-23,48,56-58,62-67,7073,78,81,97-108,110-111 Stock exchanges, 73-78 Sun Yet-sen, 7 Teiwes,F.C, 14-20, 31,32 Teng, Z., 42 Third Plenum of the Eleventh Central Committee of the CCP, 3,53 Three-Antis campaign, 19 Tiananmen Square incident, 50, 111 Township-village enterprises (TVEs), 54-55 Triangular debt, 97 Turley, S., 35, 36, 38,93 Uniform Accounting Systems (UASs), 25-26, 57, 66, 80-81, 86 -Reform of UASs, 66-67

122

INDEX

Wang, G., 58 Wei, J., 77 Xiao, J.Z.Z, 84 Xiang, B., 64, 72, 111 Xing, T.C., 77 Xu, L., 77 Zhang, Y., 82 Zhang, W.G., 73 Zhang, Y.C., 77 Zhao Ziyang, 50 Zhong, J.Z., x, 22 Zhou, Y.G., 77

About the

Book

The history of the People's Republic of China can be classified into two distinctive periods: Mao's China (1949 - 1978) and Deng's China (from 1979 to the present). Each period contains a number of sub-periods or phases, and each phase is characterised by one or more major political or economic events. This book gives an outline of the major events and the associated accounting changes over time. During the period of Mao's rule, China experienced two violent political mass movements, which inflicted great suffering on the nation. There were few accounting developments in this period. In contrast, Deng's China set itself the ambitious task of transforming the centrally planned and centrally controlled economy into a market economy "with Chinese characteristics". There has been an accompanying development in Chinese accounting, in which its key role of serving the Government's planning and control needs is transformed into serving the information needs of decisionmakers in the market-place. The economic reform in Deng's China has made considerable progress, which is particularly evident in the urban and coastal regions. The transition from a planned economy to a market economy is incomplete and certain vexatious problems have yet to be resolved. The resolution of the state owned enterprise reform issues will set a precedent for the further reform of Chinese accounting.

About the Authors Allen Huang is a senior lecturer in accounting at Griffith University, Australia. He was educated in | China and Canada, and completed his PhD studies in Australia. His main teaching and research interests are in financial and international accounting, and he has published in these fields.

Ronald Ma is Emeritus Professor of The University of New South Wales and an Honorary Professor at Griffith University, Australia. He has published widely in accounting, economics and finance journals. He was a w a r d e d the Citation for Meritorious Contribution to Accounting Literature by the Australian Society of Accountants (now the Australian Society of CPAs) in 1979.

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