Chinese accountants are celebrating Chinese New Year this week, which is early this year, making it less disruptive to the year end closing and auditing process. That is good news, since U.S. listed Chinese companies have less time this year to publish their accounts. Recent SEC changes require Form 20F to be filed on April 30, instead of June 30, for calendar year companies.
Auditing season will begin in earnest next week as the auditors and companies return to work. Last audit season saw a number of Chinese companies fall to fraud allegations as auditors tightened audit procedures, particularly those surrounding cash confirmations. I have talked with a number of audit partners about new procedures they are putting in place to uncover potential frauds. Most of them center on enhanced cash audit processes that do not rely on mailed in bank confirmations. Good auditors are putting unpredictable procedures into their audit routine that may trip up companies that are trying to conceal fraud.
Because many of these enhanced audit procedures were not in place early last audit season, I expect there will be a number of additional Chinese accounting frauds discovered in the next few months. I expect the auditors will have the help of the many short-selling research operations that have targeted Chinese companies. Deloitte Watch, a website I have commented on before, is back with suggested audit procedures for Qihoo 360. Deloitte Watch has previously encouraged Deloitte to focus on Longtop and CCME, leading to the demise of these companies. We will soon see whether they have figured out Qihoo 360 ahead of Deloitte.
I am hopeful that auditors will focus more on companies that use the variable interest entity (VIE) structure this year. As I have previously written, disclosures concerning VIEs are inadequate, and I question whether auditors have assessed whether companies actually have the interest in the residual profits of the VIE that is claimed. The VIE structure continues to get a great deal of attention from investors. Auditors need to examine VIE agreements with an appropriate level of professional skepticism.
Auditing has become a dangerous profession in China. As Sergeant Phil Esterhaus would say on Hill Street Blues: “Let’s be careful out there”.