Cynical PCAOB release | China Accounting Blog | Paul Gillis

Cynical PCAOB release

On December 30, 2016, The Public Company Accounting Oversight Board (PCAOB) issued Staff Questions and Answers (Q&A) about the audits of mainland China issuers by registered firms outside of mainland China. The Q&A is not an official PCAOB position, but is intended to guide PCAOB staff when dealing with the relevant issues. 

The Q&A explains how a 2005 Ministry of Finance (MOF) Circular titled Interim Provisions on Auditing Operations Conducted by Accounting Firms Concerning the Overseas Listing of Domestic Chinese Companies (the “MOF Rule”) applies to audits of US listed Chinese companies by overseas accounting firms. The MOF Rule includes provisions related to the conduct of auditors based outside of Mainland China that perform audit work in Mainland China. The rule does not apply to the work done by the mainland affiliates of the Big Four (because they are not considered based outside of mainland China), but it does apply where the Hong Kong firm signs off on work done by the mainland. The Big Four are subject to the same restrictions on providing working papers to the PCAOB or SEC and that was the subject of the case between the SEC and the firms that was settled with fines and a promise to comply in the future. 

While the Big Four audit most of the US listed Chinese companies, several smaller US based accounting firms audit some of the smaller companies, particularly including those that came to market as reverse mergers and are often traded on over-the-counter markets. Some of these accounting firms have even set up offices in China, although these offices are usually registered as consulting firms and are not licensed to audit in China. There is a question as to whether these consulting firms should be able to participate in the audit, since they are not accounting firms, but the PCAOB does not take up that issue. 

The most important part of the MOF Rule is a requirement that audit working papers be retained on the mainland and not transmitted overseas, a requirement rooted in China’s concerns about inadvertent disclosure of state secrets. The PCAOB Q&A says that despite that rule, auditors must make working papers accessible to the PCAOB. While there are procedures in place to allow auditors to obtain permission to share working papers in the event of a disciplinary investigation, there is no agreement between China and the US to share working papers for inspection. Consequentially, the Q&A cynically sets up a requirement that no firm can comply with. The PCAOB needs to find a way to reach agreement with Chinese regulators to conduct inspections, discontinue the need for inspections, or deregister the firms it cannot inspect. Telling the firms that they will be punished if they do not break Chinese law in order to supply documents is not useful guidance. 

And I wonder if the PCAOB ever intends to enforce the rule anyway. It has been more than a decade since the PCAOB first unsuccessfully attempted to conduct inspections in China. Despite being blocked from doing inspections by Chinese regulators, the PCAOB has yet to bring actions to deregister any Chinese accounting firm for failing to make themselves available for inspection.

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