• Strategy
  • The Economist

Cultural Revolution

New accounting rules have replaced the Little Red Book as China's guide to self-improvement. Can the state handle the truth?

Separating truth from propaganda in China has always been hard, not least when it comes to numbers. Accountants, of all people, were seen as such a threat that during the 1960s they were packed off to re-education camps, dooming the profession for decades afterward. Even in kindlier times, businesses reported information that would interest a centrally planned economy, such as production quotas. The measuring sticks of bourgeois managers — costs, debt, depreciation, and (of course) profit — were ignored.

But since the 1990s China has begun scrubbing up its accounting system. At the beginning of this year it made its biggest move yet when the Ministry of Finance required the 1,200 companies listed on the Shenzhen and Shanghai stockmarkets to adopt, with important exceptions, norms similar to International Financial Reporting Standards. These standards may sound like instruments of accounting torture, but countries all over the world are embracing them. China has given all its other firms the option of complying with them “voluntarily” — a word with many shades of meaning. If the changes are more than just cynical window-dressing designed to attract foreign investment, they will mark a profound shift in what China wants people to know not only about its companies, but also about its economy and its government.

A new accounting system would certainly help China. Most companies are good at keeping tabs on their operations, but the book-keeping is complicated by use of a thick manual that makes bewildering distinctions between different kinds of provisions. The result is a mess. “The records are complete, the question is how do you make sense of them,” says T.J. Wong, a professor of accounting at the Chinese University of Hong Kong.

Murder by Numbers

There is abundant evidence, from trade statistics to fumes spewing out of factories and power plants across the country, that the Chinese economy is doing well. But how well individual companies are doing is far harder to tell. The financial results of companies that global investors wish to buy into can be as unintelligible as the dialect spoken in the company town. It is said (with apparent sincerity) that some Chinese firms keep several sets of books — one for the government, one for company records, one for foreigners and one to report what is actually going on.

Under the new approach, accounts will be prepared under 39 principle-based standards structured to reveal the economic value of a firm, with the aim of using market prices wherever possible. A clear understanding of a firm’s revenues, costs and debt would enhance the efficiency of China’s companies — the avowed goal — as well as making it easier to attract foreign capital and to invest abroad.

More profoundly, by properly reflecting costs, the heavy burden of state control would become more evident, as would the pricing signals that indicate the real desires of the Chinese people. Sleazy transfers of mispriced assets from the state to the private sector would become vastly more difficult. Theoretically, accounting would serve as a force for democracy.

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