Accounting standards, the institutional environment and issuer incentives: Effect on timely loss recognition in China

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Abstract
Accounting income of Chinese companies reporting under both domestic ASBE accounting standards and International Accounting Standards (“IAS”) is shown to lack timely incorporation of economic losses. This is less surprising for ASBE-compliant income, because although ASBE standards are based on IAS, they lack important asymmetric rules, such as lower-of-cost-or-market, and impairment of long-term assets. More striking is the absence of timely loss incorporation in financial statements certified by international auditors as IAS-compliant. IAS resemble common-law standards and are widely believed to increase financial reporting quality. The timely incorporation of losses has become perhaps the single most important feature of income reporting under common law (Basu (1997), Ball, Kothari and Robin (2000)). We attribute the result to the comparatively low incentive of managers and auditors to recognise economic losses in a timely fashion and, conversely, to comparatively high political and tax influences on financial reporting practices. Our results imply that financial reporting cannot be improved simply by governments mandating accounting standards that evolved endogenously in different economies. The most fruitful area for Chinese accounting reform lies not in simply adopting or imitating international accounting standards, but in reforming domestic institutions such as the legal system, corporate governance and auditor training and independence. © City University of Hong Kong.