• auditing expectations gap;
  • auditors;
  • business combination reporting;
  • Chinese listed companies;
  • compliance;
  • enforcement


  1. Top of page
  2. Abstract
  3. Introduction
  4. Chinese auditing and the theory of auditing expectations gap
  5. Business combination accounting regulations
  6. Methods
  7. Results
  8. Implications
  9. Conclusion
  10. Acknowledgment
  11. References

This empirical study investigates the compliance of 344 Chinese listed companies with the Accounting Standard for Enterprises No. 20-Business Combination, a mandatory reporting standard applicable to companies involved in business combinations. China has recently reformed its auditing sector, enabling private firms to provide auditing services. The results of the study show a low level of compliance by Chinese listed companies. While companies audited by Chinese domestic auditors have significantly lower compliance than companies audited by Big Four auditors on supplementary disclosure that is mandatory under the Chinese accounting standards, compliance remains low even after companies receive unqualified reports from these international auditors. There appears to be a lack of commitment, and possibly expertise, among Big Four auditors, in fully applying the reporting requirements of the business combination standard in a Chinese setting. This raises concerns about the independence of Chinese auditing in disclosing reliable information about business combinations. Broader theoretical contributions of the paper go beyond the Chinese context by problematizing whether well-resourced international auditors uphold internationally expected standards or succumb to local non-compliant practices.


  1. Top of page
  2. Abstract
  3. Introduction
  4. Chinese auditing and the theory of auditing expectations gap
  5. Business combination accounting regulations
  6. Methods
  7. Results
  8. Implications
  9. Conclusion
  10. Acknowledgment
  11. References

According to the conceptual framework issued by the International Accounting Standards Board (IASB) in 2010, the purpose of financial reporting is to assist internal and external parties of a reporting entity to make informed decisions about it (IASB 2010; McConnell 2011). This informed decisionmaking lies at the heart of the International Financial Reporting Standards (IFRS), which were established by IASB, a global independent accounting standard setter, as a single set of accounting standards across the world (Peng et al. 2008; Deegan 2009). Within this set of standards, auditors are asked to determine whether that entity has complied with statutory or externally imposed requirements that touch upon the entity's financial performance and position (Deloitte 2012). A reporting entity's compliance with financial reporting obligations is then subject to external audit. Ostensibly, the purpose of external auditing is to examine, by a set of techniques, a reporting entity's annual financial report and express an opinion as to whether the financial report is an accurate reflection of the financial performance and position of that entity. Through “a series of hopes and aspirations inscribed in its most mundane routines” (Power 2003, p. 392), the external audit is supposed to add credibility to financial reports (Sikka 2009). To add international legitimacy to the external audit process, the International Auditing and Assurance Standards Board (IAASB) sets international auditing standards to facilitate the convergence of national and international standards in order to strengthen the level of auditing compliance (International Federation of Accountants [IFAC] 2011).

The importance of the external audit cannot be overestimated as it is relied upon by investors, as illustrated by the case of Arthur Andersen LLP, the first accounting firm to be criminally convicted (Krishnan 2005; Krishnamurthy et al. 2006). Prior to its demise following this conviction, Arthur Andersen was a leading provider of professional services operating in 84 countries. The company's reputation was ruined as a result of the collapse of its major client, Enron, after posting “spectacular year-on-year earnings and profit growth” which failed to accurately reflect Enron's position (Healy & Palepu 2003; Baker & Hayes 2004; Smith & Quirk 2004, p. 91; Benston 2006). Although Arthur Andersen's conviction was quashed in 2005 by the Supreme Court of the United States, it was widely deemed that the auditing and company performance fell well below levels expected from society, creating both an auditing expectations gap (Volosin 2007) and concerns about companies' corporate governance, suggesting that lack of compliance remains not only the fault of listed companies, but also the failure of auditors.

Compliance takes many forms. It may be imposed by regulators through strong regulatory enforcement (deterrence) through penalties and sanctions (Ayres & Braithwaite 1992) or by regulatees through some form of accommodating self-regulation (Murphy et al. 2009). Expected costs and benefits of compliance shape regulatory programs and influence the response of regulatees to regulations (Thornton et al. 2008); here, “enforcement programs can increase the costs of non-compliance, where the expected cost is a function of the probability of detection and the penalty once detected” (Ko et al. 2010, p. 49).

Regulatees may comply because of legal conscience, good practice, or worthiness, depending on the characteristics of the industry and enforcement program (Ko et al. 2010). They may also comply if they deem the regulation as reasonable (Unnever et al. 2004; Murphy et al. 2009) or fair and impartial (Braithwaite 1995, 2003; Tyler 2006; Murphy et al. 2009). Regulatees' professional autonomy (Makkai & Braithwaite 1993) and professionalism (Parker 1999) may also affect compliance.

Within China, there are a number of impediments to the regulatory enforcement of accounting and auditing standards (Chow et al. 1995). The two-dimensional theoretical framework of Xiao et al. (2004) suggests that the nature of the equity market and the idea of the inertia effect of accounting tradition and political influence shaped China's take-up of accounting standards. China's expanding equity market created a need for international accounting standards (IAS)-type and Accounting Standard for Business Enterprises (ASBE)-type accounting standards, but the take-up was “weak and imperfect … generating a relatively weak demand for, and constraints of supply of, accounting standards” (Xiao et al. 2004, p. 195). Recent external influences have brought IAS into China, but these standards require strong professional judgment, and, thus, an element of strong self-regulation. Chinese accountants and auditors have traditionally relied on rules-based standards, such as those expounded in the Chinese Enterprise Accounting System (which still has a strong influence on Chinese accounting), rather than professional judgments (Luo 2010; Xiao et al. 2004). The government faces difficulties in enforcing accounting standards, particularly because of ineffective corporate governance mechanisms and a perceived lack of confidence in Chinese auditors, but still retains its political control by acting as the accounting regulator.

Difficulties in corporate governance mechanisms are compounded by the deficient qualifications of internal auditors and the lack of understanding of auditing duties (Lin et al. 2008). Lin et al. (2008) aver that Chinese audit committees are ineffective in the sense that they seldom appoint auditors or determine audit fees, and perform, at best, a ceremonial role. There is, therefore, a sense that the enforcement of accounting regulations and the detection of non-compliance with accounting standards are in an inchoate state within the auditing and accounting milieu of China.

This article considers compliance with Chinese business combination reporting, and examines, in particular, aggregate Chinese accounting business combination regulatory compliance by analyzing the annual reports of Chinese listed companies for the year ending 2009. This alleviates the possibility of our data reflecting teething problems associated with new rules, as the end of 2009 falls three years after the rules were introduced. By examining all Chinese listed companies, this study complements prior research that considers a few case studies.

We believe this to be an important paper because it looks at compliance with a developing country's reporting requirements on a number of levels. On one level, the study empirically examines the extent of compliance with business combination reporting by Chinese companies, in what might be crudely called the “milieu” of a developing economy. Many compliance studies focus on companies that come from developed economies (see e.g. Street & Bryant 2000), which generally enjoy democratic structures and well-developed governance systems, but there have been some compliance studies that have focused on companies from democratic developing countries (see for example, Taplin et al. 2002; Setyadi et al. 2011). By contrast, this paper focuses on companies that hail from a single party state that has experienced unprecedented rapid economic growth, but low gross domestic product (GDP) per capita (Avent 2010), and a country that has converged its own accounting standards with international standards (Lin et al. 2008). The paper's strength rests in its empirical data.

At another level, the study analyzes the effect that the so-called “advanced first world” Big Four international auditors have on this compliance. These effects are contrasted with the effects of domestic Chinese auditing. This is particularly important because much criticism has arisen in the West about the quality of both Chinese-based auditors (Lynch 2011; Sanderson 2011) and Big Four international auditors (Mavin 2012; Carlin et al. 2009; Sikka 2009, 2012). Further, China has recently adopted Western rules of accounting through the IASB which has issued the IFRS to promote the convergence of different national accounting standards with IFRS (Peng et al. 2008). The IASB's efforts have resulted in the convergence toward IFRS by a considerable number of countries, including China. On 15 February 2006, the Accounting Department of the Ministry of Finance1 of the People's Republic of China formally announced the issuance of the Accounting Standards for Business Enterprises (ASBE), which became mandatory for listed Chinese enterprises from 1 January 2007.

The purpose of the ASBE was to assist management in promoting the harmonization of financial statement presentation, to assist auditors in formulating opinions, and to assist domestic and foreign investors, shareholders, governments, taxation departments, trade unions, and other users, in understanding the financial statements. However, there was concern that the convergence of accounting standards would not lead to the convergence of accounting practices if firms did not comply with the standards (Street & Bryant 2000), particularly in emerging market economies where competent accountants, auditors, and regulators were not plentiful. As pointed out by Eccher and Healy (2007), the standards developed by the IASB were mainly formed for highly developed capital markets, rather than for developing or transitional markets. Biondi and Zhang (2007), for example, have noted that, in practice, there are divergences between IFRS and Chinese standards.

The Chinese stock market is still far from being standardized as a result of its regulatory framework. In particular, financial reporting and information disclosure are underdeveloped, compared with the standards in most developed countries (Liu et al. 2008). A major problem is the lack of transparent and reliable accounting information to assist investors and other market participants in making decisions. The ASBE are substantially in line with IFRS but there are modifications to certain standards which reflect China's unique circumstances and environment (Heng & Noronha 2011), including, for example, the standard on business combination accounting (Deloitte Touche Tomhatsu 2006; Biondi & Zhang 2007). In an analysis of the impact of ASBE on financial results of mainland Chinese listed companies, Heng and Noronha (2011) noted some inconsistency between the reporting expectations of ASBE and the actual reporting by mainland Chinese listed companies.

Therefore, to examine the extent to which Chinese companies comply with ASBE and the extent to which international auditors increase this level of compliance, the relevant research questions pertaining to this study are:

  • To what extent do Chinese companies comply with ASBE/IASB on business combination reporting?
  • Is Chinese-listed companies' compliance with ASBE/IASB on business combination affected by whether the auditor is a Big Four or non-Big Four auditor?

Chinese auditing and the theory of auditing expectations gap

  1. Top of page
  2. Abstract
  3. Introduction
  4. Chinese auditing and the theory of auditing expectations gap
  5. Business combination accounting regulations
  6. Methods
  7. Results
  8. Implications
  9. Conclusion
  10. Acknowledgment
  11. References

The institutional arrangement for auditing regulations of Chinese listed companies has a short history. Established in 1982, the audit system of China is currently administered and controlled by the Chinese government (Yang et al. 2006). In contrast to the auditing system under the Westminster system of government which makes the Auditor-General independent of the government, the Chinese auditing institution falls under the direct leadership of the Premier of the State Council (CNAO 2012). Indeed, under Articles 62, 67, 80, and 86 of the Constitution of the People's Republic of China, the Auditor-General, who is nominated by the Premier and appointed or removed by the President of the Stage, should be a member of the State Council (CNAO 2012).

Nevertheless, the legal status of auditing and supervision in China, written in Article 91 of the Constitution of the People's Republic of China, provides for auditing independence in the following terms:

The State Council shall establish an audit institution who will take charge of auditing revenues and expenditures of public finance of departments of the State Council and local governments at various levels, revenues and expenditures of state banking institutions, state enterprises and undertakings. The audit institution shall be under the direct leadership of the Premier of the State Council and exercise its power of supervision through auditing independently in accordance with the law and subject to no interference by administrative organ or public organization or individual. (CNAO 2012)

Indeed, the idea of encouraging the establishment of audit independence is seen as a potential reform for China's audit system (Yang et al. 2006).

China has moved from a public-only auditing system to a new system that enables private actors to provide some auditing services. This change complements China's introduction of more autonomous forms of enterprise, including private enterprises and state-controlled enterprises. However, concerning auditing, Western structures clearly distinguish National Audit Offices (or Auditors-General) that audit and supervise the public administration, from private auditors that deal with private companies, including listed companies. In China, under Law 144 of 1998 (as amended by Law 157 of 1998), the Central Auditing Organization (CAO) is responsible for the auditing process of the public sector, monitoring the management of public sector entities and government departments:

The CAO is responsible for the external audit of public sector entities, including about 130 central government departments and administrative units, 120 service agents, 29 governorates, 50 economic authorities and more than 160 state-owned enterprises, political parties, trade unions, national and party news media, and all units subsidized by the State. The CAO may also audit and examine the work and accounts of any other entity, as assigned by the President of the Republic, the People's Assembly or the Prime Minister. (IAACA 2012)

In terms of the auditing for private enterprises, including publicly listed companies, the audit profession is managed by the Chinese Institute of Certified Public Accountants (CICPA) and supervised by the Ministry of Finance. The Chinese Auditing Standards Board (CASB) operates under CICPA and develops practice standards for Chinese accounting firms. These standards are issued by the Ministry of Finance (World Bank 2009). In 2010, CASB and the IAASB fully united Chinese auditing standards with international standards. There is limited literature on how these Chinese audit institutions enforce the related regulations, detect non-compliance, and penalize violations.

There are relatively high expectations of accounting professional judgment enshrined in the new Chinese accounting standards, but in practice these expectations are not always met (Luo 2010). Theories of auditing and the expectations gap have been documented by Volosin (2007). Agency theory, for example, is associated with the conflicting interests of an entity's shareholders and managers, where audited financial reports are provided to shareholders about the ongoing development of the entity, run by the relatively better-informed manager. By way of other examples, lending credibility theory assumes that audited financial reports provide assurance to shareholders of the sound stewardship function of managers (Volosin 2007), while policeman theory assumes auditor tasks are confined to the detection and prevention of fraud. Generally, these theories identify a gap between what stakeholders expect the auditor to do and what the auditor should do (Volosin 2007). The expectation gap may stem from over-expectations by stakeholders of the auditing function (Kadous 2000), the auditing profession's refusal to perform fraud detection (Dewing & Russell 2001), the auditing profession's self-regulation (Sikka et al. 1992) or the auditing profession's protection of self-interest (Sikka et al. 1998).

Such an expectations gap has been identified in a number of countries, including Bangladesh (Chowdhury et al. 2005), Egypt (Dixon et al. 2006), Saudi Arabia (Haniffa & Hudaib 2007), Malaysia (Fadzly & Ahmad 2004), Singapore (Best et al. 2001), and Iran (Pourheydari & Abousaiedi 2011). Lin (2004) also detected an auditing expectations gap in China because of government controls and state intervention in the auditing function which, in turn, eroded auditor independence. Lin (2004) noted that Chinese audits were predominantly compliance audits, even though there was an expectation from audit beneficiaries that audits should also be responsible for the detection of fraud and irregularities. There was, in other words, a tension between the self-interest of auditors who were keen to avoid detection duties and the needs of the public who wanted a credible auditing service (Lin 2004). Moreover, despite widespread criticism of the self-regulation of the Western auditing profession, Chinese stakeholders appear to value this form of professionalism as it is perceived to lead to improved auditor independence (Lin 2004).

Introductory Part 1 of the Law of the People's Republic of China on Certified Public Accountants makes provisions for foreign audit firms working in China (CICPA 2011). Part 2 of the Law regulates the practices of current Chinese-based auditing partners of Big Four accounting firms operating in China, while Part 3 of the Law makes other provisions for foreign auditing firms operating in China (CICPA 2011).

Article 44 of the Law allows foreigners' participation and registration in the Chinese accounting system under the principle of reciprocity:

The establishment of representative office of a foreign accounting firm in China must be reported to and approved by the Finance Department of the State Council. The application for the establishment of a Sino-foreign joint venture accounting firm jointly run by a foreign accounting firm and a Chinese accounting firm must be examined and agreed upon by the department in charge of foreign economic relations and trade of the State Council or the departments as authorized by the State Council and the governments at provincial level before being reported to and approved by the Finance Department of the State Council. (Article 44 of the Law, CICPA 2011)

Currently there are four joint foreign-Chinese accounting firms operating in China, namely Ernst & Young with Hua Ming, KPMG with Hua Zhen, Deloitte with Hua Yong, and PWC with Zhong Tian (MOF 2012).

Business combination accounting regulations

  1. Top of page
  2. Abstract
  3. Introduction
  4. Chinese auditing and the theory of auditing expectations gap
  5. Business combination accounting regulations
  6. Methods
  7. Results
  8. Implications
  9. Conclusion
  10. Acknowledgment
  11. References

Historically, accounting for business combinations has been one of the most controversial issues in financial reporting (Ayers et al. 2002). Business combination accounting procedures may create earnings volatility, and it is also difficult to accurately measure the assets and liabilities acquired in the business combinations (Dorata & Zaldivar 2010). Regulators, investors, and business executives have expressed a desire for more transparent financial reporting of business combinations so that a company's financial results will be more readily apparent when viewed by someone outside the company (Sevin et al. 2007). In particular, it is important to know how combined entities account for the difference between the price paid for the acquired company (target) and the book value of stockholders' equity on the target's balance sheet.

There are two methods available for business combinations accounting: the purchase method and the pooling of interests method. Custódio (2010) concludes that these two methods differ mainly in the way the acquired company's assets are reported in the combined entity's balance sheet. The purchase method of accounting for business combinations recognizes this difference by adjusting the target's assets and liabilities to fair market values on the statements of the acquiring firm (the combining party). Any excess value that cannot be allocated to identifiable tangible and intangible assets is then assigned to goodwill. The income statement of the newly combined entity incorporates the target's net income from the date of combination.

In contrast, the pooling method prevents the acquiring company's financial statements from recognizing the difference between acquisition prices and the target's book value. This accounting method consolidates the financial statements of the target and the acquiring company and combines the income reported by the target with the acquiring company's income as of the beginning of the acquisition year. In summary, the acquired asset's book value does not change after a business combination when the pooling method is used, but it does when the purchase method is used.

Ayers et al. (2002) note the concerns of the Financial Accounting Standards Board (FASB) (which has set the US accounting standards since 1973) regarding the existence of two methods to account for almost identical transactions, suggesting that firms intentionally use the pooling method because this presents a more favorable impression of the company's financial position. Custódio (2010) also suggests that US companies prefer to use the purchase method to deal with business combinations because the purchase method recognizes the fair value of the acquired net assets and any acquired goodwill in the acquirer's balance sheet. As a consequence, the purchase method normally leads to a mechanical increase in the book value of acquired assets. Doing the opposite is more difficult to implement in the US. Choosing the pooling instead of the purchase method implies that the deal must qualify for pooling and satisfy all 12 US criteria necessary for using the pooling method.2

In June 2001, the FASB issued Statement 141, Business Combinations (SFAS 141) and Statement 142, Goodwill and Other Intangible Assets (SFAS 142). These statements changed the accounting for business combinations and goodwill in two significant ways. Firstly, SFAS 141 prohibited the use of the pooling of interests method and required that the purchase method of accounting be used for all business combinations initiated after 30 June 2001. Secondly, SFAS 142 changed the method of accounting for goodwill from an amortization period not to exceed 40 years, to an approach that does not require any amortization, but only regular testing for impairment (Sevin et al. 2007).

Following FASB, and its quest for the harmonization of accounting standards across the globe, the IASB focused on the information needs of investors and creditors in global capital markets. This led to a reduction in the number of allowable methods and a move toward the fair value accounting model (purchase method of business combinations accounting) in order to achieve global convergence of accounting standards (Deloitte Touche Tomhatsu 2006). Baker et al. (2010) argued that the IASB, in alliance with the FASB, set out to ensure that virtually all business combinations were acquisitions, and that there should be only one method of accounting for business combinations. The IASB and FASB did not allow the pooling of interests method for business combinations.

By contrast, those responsible for setting the Chinese accounting standards did allow the pooling of interests method of accounting for business combinations, despite the prohibition of this method by both the FASB and the IASB. The decision by Chinese standards setters to authorize the pooling of interests method reflects the large scale industrial reorganization taking place in China (Xu & Uddin 2008). Baker et al. (2010) argue that the pooling method provides greater flexibility to banks and large industrial groups when recognizing their operations, without the need to refer to unreliable fair market value measures, as required by IFRS 3 Business Combinations.

It is argued that, far from being a neutral and unbiased technology, the accounting standards setting process often seeks to adjust standards to fulfill certain political economic exigencies (Baker et al. 2010). Indeed, the Chinese accounting standards setting body has often paid as much attention to political economic factors, such as increased production, employment, and industry reorganization, as it has to pressures from the global capital market (Tsai 2006). For these reasons the setters of the ASBE constructed two types of regulations for business combinations.

A business combination is defined by Article 2 of ASBE 20 Business Combinations as an event or transaction that brings together two or more separate entities into one reporting entity.

However ASBE 20 Business Combinations does not apply to business combinations related to joint ventures or contracts other than ownership shares (Article 4).

Two types of business combinations are identified under ASBE 20 Business Combinations: business combinations “under common control” (UCC),3 and business combinations “not under common control” (NUCC). ASBE 20 Business Combinations Article 10 states that:

A business combination not under common control is a business combination in which the combining enterprises are not ultimately controlled by the same party both before and after the business combination.

In contrast, ASBE 20 Business Combinations Article 5 states that:

A business combination under common control is a business combination in which all of the combining enterprises are ultimately controlled by the same party both before and after the business combination and on which the control is not transitory.

As shown in Table 1, ASBE allows both UCC and NUCC combinations, and, thus, two methods of accounting for business combinations. In contrast, IFRS only allows NUCC combinations and, thus, only the purchase method. Goodwill is recognized under NUCC but not under UCC. In addition, the fair value measurement method is required by the purchase method, whereas the book method is required under the pooling of interests method.

Table 1. Difference in Accounting Standard for Business Enterprises (ASBE) and International Financial Reporting Standards (IFRS) treatment of business combinations
 Under common control (only ASBE)Not under common control (IFRS & ASBE)
  1. ASBE, Accounting Standard for Business Enterprises; IFRS, International Financial Reporting Standards.

Method usedPooling of Interests MethodPurchase Method
Goodwill recognitionNOYES
Measurement of acquired asset and liabilitiesBook valueFair value
Affected account in financial statement1. Additional paid-in account1. Goodwill account
2. Retained earnings account2. Defer tax asset account (Gain on Bargain Purchase account is filled in case of negative goodwill)

Liu et al. (2008) documented the general level of implementation of the new Chinese accounting standards (ASBE) by Chinese listed companies and expressed concerns about the difficulties arising from their compliance with the ASBE. Similarly, in a business combination context, Liu et al. (2008) pointed out the difficulties of reconciling the accounting of business combinations in the case of dual-listed companies. In 2007, 15 dual-listed companies conducted business combinations UCC, with the pooling of interests method being adopted in mainland China and the purchase method in Hong Kong. The ASBE required companies to disclose all significant events and important accounting policies, and apply and provide sufficient information on accounting estimations. However, some companies failed to do so. Liu et al. (2008) found several areas of non-compliance, including failure to disclose the risk associated with their financial instrument, failure to disclose the method of determining fair value, and failure to disclose the determination of the recoverable amount of assets. This study takes up the issues of reporting compliance raised by Liu et al. (2008) by asking to what extent Chinese companies comply with ASBE/IASB on business combination reporting.

Auditing is supposed to provide assurance about an entity's compliance with financial reporting. Liu et al. (2008) found that of the 1,570 companies listed on both stock exchange markets in 2007, 1,464 companies had an unqualified audit opinion report and 106 (about 6.75 percent) had a qualified audit opinion on their financial statements. Out of 99 companies audited by Big Four accounting firms, only one (about 1.01 percent) of them received a qualified audit opinion. Overall, few companies did not follow the disclosure format required by the ASBE in 2007. Again, these audit findings identified by Liu et al. (2008) in a Chinese context are considered in this study by asking whether Chinese listed companies' compliance with ASBE/IASB on business combination is affected by whether the auditor is a Big Four or non-Big Four auditor.


  1. Top of page
  2. Abstract
  3. Introduction
  4. Chinese auditing and the theory of auditing expectations gap
  5. Business combination accounting regulations
  6. Methods
  7. Results
  8. Implications
  9. Conclusion
  10. Acknowledgment
  11. References

The financial statements of all of the public listed companies (1,364 companies) from the Shanghai Stock Exchange (879 companies) and the main board of the Shenzhen Stock Exchange (485 companies) were examined for evidence of business combinations during 2009. To be included in the final sample, a business combination transaction had to meet the following criteria:

  • the business combination had to be completed by the end of 2009;
  • the combining party had to have prepared the consolidated financial statement (including the target company's assets and liabilities) after the business combination (the combining party having obtained the control of combined party).

Only annual reports were examined in this study because these are formally audited by independent auditors. Focusing on compliance with business accounting reporting rules is a particularly important design strategy, as the reports themselves indicate the level of compliance. Indeed, this manuscript adds to the knowledge generated by previous open-ended questionnaires on auditor compliance (Xiao et al. 2004), which considered the viewpoints of five regulators, two academics, and one auditor. Xiao et al. (2004, p. 196) noted “the politically sensitive nature of the interviews.” We encountered the same experience. Some eight years after the work of Xiao et al. (2004), compliance/non-compliance is politically very sensitive. More importantly, for reasons of reliability and completeness, it was timely to look at the actual level of compliance and then reflect on that in terms of the findings of Xiao et al. (2004).

Similarly, we reflect on Lin et al. (2008) who conducted a survey instrument seeking responses about, inter alia, compliance issues from four stakeholder groups: financial analysts; fund managers/loan officers; external auditors of Certified Public Accountant firms; CEOs/deputy general managers/CFOs/heads of internal audits/company secretaries of Chinese listed companies; and independent directors. Again, in light of the results obtained by Lin et al. (2008), we reflect on our results from public listed companies' compliance using empirical data.

The ASBE 20 Business Combinations rules were used to derive nine items of compliance and these are summarized in Table 2 (divided into three categories) and displayed in Figure 1.


Figure 1. Chinese business combination accounting compliance. BCCI = business combination compliance index; UCC = under common control; NUCC = not under common control.

Download figure to PowerPoint

Table 2. Summary of the business combination mandatory disclosure under CAS20
BCCI itemsThe original rules from ASBE 20 Business Combinations
  1. ASBE, Accounting Standard for Business Enterprises; BCCI, Business Combination Compliance Index; IFRS, International Financial Reporting Standards; NUCC, not under common control; UCC, under common control.

Segment One: General requirements for both UCC & NUCC 
1. Disclosure of the business combination either as UCC or NUCC.ASBE 20 Business Combinations, Chapter I General provisions. Article 2 Business combinations are classified into business combinations under the common control and the business combinations not under the same control.
2. Provision of rationale behind choice of business combination (UCC or NUCC).

ASBE 20 Business Combinations, Chapter IV Disclosure. Article 18 (2) requires the disclosure of the grounds for the judgment of the business combination.

ASBE 20 Business Combinations, Chapter II Business Combinations under the Common Control. Article 5 A business combination under the common control is a business combination in which all of the combining enterprises are ultimately controlled by the same party or the same parties both before and after the business combination and on which the control is not temporary (at least one year).

3. Disclosure of the date on which the business combination will take place.

ASBE 20 Business Combinations, Chapter II Business Combinations under Common Control. Article 6 The assets and liabilities that the combining party obtains in a business combination shall be measured on the basis of their carrying amount in the combined party on the combining date.

ASBE 20 Business Combinations, Chapter III Business Combination Not under Common Control. Article 12 The acquirer shall, on the acquisition date, measure the assets given and liabilities incurred or assumed by an enterprise for a business combination in light of their fair values.

4. Disclosure of the rationale behind the choice of the combining date.

ASBE 20 Business Combinations, Chapter IV Disclosure. Article 18 & 19 (1) requires the disclosure of the basis for the determination of the combining date.

ASBE 20 Business Combinations, Chapter II Business Combinations Under Common Control. Article 5 The combining date refers to the date on which the combining party actually obtains control of the combined party.

5. Disclosure of acquisition method.

UCC – Pooling method

NUCC – Purchase method

Segment Two (UCC only): Only applicable to business combinations that are UCC 
6. Disclosure of information on the revenue, net profit, and cash flow of the combined party from the beginning of the current period in which the combination occurs, to the combining date.ASBE 20 Business Combinations, Chapter IV Disclosure. Article 18 (3) requires the disclosure of the information on the revenue, net profit, and cash flow of the combined party from the beginning of the current period, in which the combination occurs, to the combining date.
7. Disclosure of the carrying amounts of the assets and liabilities of the combined party on the balance sheet date of the prior accounting period, as well as on the combining date.ASBE 20 Business Combinations, Chapter IV Disclosure. Article 18 (3) requires the disclosure of the carrying amounts of the assets and liabilities of the combined party on the balance sheet date of the prior accounting period, as well as on the combining date.
Segment Three (NUCC Only): Only applicable to business combinations that are NUCC 
8. Disclosure of goodwill and the method used to determine goodwill.ASBE 20 Business Combinations, Chapter IV Disclosure. Article 19 (4) requires the disclosure of the amount of business reputation and the determination method adopted.
9. Disclosure of fair value of the subsidiary on the combining date.ASBE 20 Business Combinations, Chapter IV Disclosure. Article 19 (2) requires the disclosure of the composition, carrying amount, and fair value of the combined party, as well as the method for the determination of the fair value thereof.

Segment One: General Regulations contains five items which are mandatory disclosure items for all business combinations. Segment Two: UCC Only contains two items that are applicable to UCC business combinations only, and Segment Three: NUCC Only contains two items that are applicable to NUCC business combinations only. Hence, there are seven items applicable to each type of business combination: Items 1–7 are applicable to UCC combinations, and Items 1–5, 8, and 9 are applicable to NUCC combinations. The interaction between the different items is summarized in Figure 1. As shown in this figure, business combinations classified as UCC must use the pooling method, which requires a number of mandatory disclosures concerning revenue, cash flow, profits, and book value. If the business combination is classified as NUCC, the purchase method is mandatory and some disclosures must be made about goodwill and fair value.

Compliance with each of these items was measured in terms of disclosure (compliance) or non-disclosure (non-compliance) with the exception of Item 5, for which compliance required not only the disclosure of the acquisition method used, but also the use of the correct method (pooling method for a UCC business combination and purchase method for a NUCC business combination), unless justification was provided for this deviation. Unexpectedly, both the pooling and purchase methods were applied for some business combinations and these were also considered non-compliant.

We analyze compliance with items sequentially, as suggested by Figure 1. Thus, we only calculate compliance rates for Item 5 (acquisition method) where Item 1 (UCC/NUCC) is disclosed. We also calculate compliance rates for Items 6–9 only for business combinations where these are applicable, depending on whether the business combination is disclosed to be UCC or NUCC. Including business combinations where Item 1 is not disclosed reduces compliance rates.

Finally, a Business Combination Compliance Index (BCCI) was produced, based on the total number of compliant items per business combination. Hence, the BCCI ranges from a minimum of 0 (compliant with no items) to 7 (compliant with all applicable items), and provides an overall summary of the level of compliance for each business combination. The BCCI weighs all items equally, which provides an overview; however, given that Items 1, 5, and 8 may contain the most relevant and reliable information for business combinations, we also analyze compliance rates for each item separately.

Statistical analysis was performed using the PASW Statistics package, release 18.0.2. Differences between mean BCCI scores for business combinations audited by a Big Four auditor or a non-Big Four auditor were tested, using a two sample, independent samples t-test.4 For individual items, differences in compliance rates for business combinations audited by a Big Four auditor or a non-Big Four auditor were tested using Fisher's Exact tests.

Furthermore, to assess the extent to which Big Four-audited business combinations were fully compliant or were similar to non-Big Four-audited business combinations, a compliance improvement statistic “R” was calculated. R summarizes the fraction of non-compliance that is removed when audited by a Big Four auditor relative to the fraction of non-compliance occurring when audited by a non-Big Four auditor, and is defined as:

  • display math(1)

where CA and CN are the compliance percentages for business combinations audited by a Big Four auditor and non-Big Four auditor, respectively. A value of 40 percent for R indicates that the level of non-compliance when audited by a Big Four auditor is only 40 percent of the level of non-compliance when audited by a non-Big Four auditor. When R = 0, the level of non-compliance is the same for Big Four and non-Big Four-audited business combinations, and R = 100 percent for complete compliance for Big Four-audited business combinations. Positive values for R indicate compliance is higher for Big Four audited companies and negative values for R indicate compliance is higher for non-Big Four audited companies. Values of R greater than 50 percent indicate Big Four-audited business combinations are closer to fully compliant than non-Big Four-audited business combinations.5


  1. Top of page
  2. Abstract
  3. Introduction
  4. Chinese auditing and the theory of auditing expectations gap
  5. Business combination accounting regulations
  6. Methods
  7. Results
  8. Implications
  9. Conclusion
  10. Acknowledgment
  11. References

During 2009, 582 business combinations were disclosed by 344 companies. The BCCI scores for these business combinations ranged from the minimum of 0 out of 7 (34 or 6 percent of business combinations) to the maximum of 7 out of 7 (17 or 3 percent of business combinations). The mean BCCI was 2.98, representing a very low compliance rate of only 43 percent. The mean BCCI was significantly higher6 when the company was audited by a Big Four auditor (P < 0.001). The distributions are summarized in Table 3 on the basis of whether the auditor was a Big Four auditor or non-Big Four auditor, as well as on the overall total of all 582 business combinations. Although significantly higher, the mean BCCI was still only 3.88 out of a possible 7 when the company had been audited by a Big Four auditor, and for one of these business combinations there was no compliance with any of the BCCI items (a score of 0 out of 7).

Table 3. Distribution of Business Combination Compliance Index (BCCI) scores by auditor type
  1. BCCI values equal the number of the 9 items complied with and takes a maximum value of 7, as only two of the Items 6, 7, 8, and 9 apply to any particular business combination (see Table 2). Table 4 reports compliance with individual index items. The lower quartile, median, and upper quartile were 2, 3, and 4 for Non-Big Four and 2, 4, and 5 for Big Four auditors, respectively.

Non-Big Four33849012896512055072.841.59
Big Four1811151212412753.881.95

All companies with a business combination receiving a BCCI score of 0 were found to have received an unqualified audit opinion. With such a low compliance level in business combination accounting and the silence of auditors on this matter, both the transparency of financial statements and the auditing function appear poor.

Compliance rates for Item 1 (NUCC or UCC) were particularly high (90 percent, Table 4), however, compliance rates were extremely low for Item 2 (32 percent), with companies rarely providing justification as to why the business combination was considered to be under common control or not. Compliance rates were also low for Item 4 (32 percent) and 7 (34 percent) with companies similarly rarely disclosing the basis upon which the combination date was determined.

Table 4. Compliance summary for the nine items
ItemOverallBig FourNon-Big FourP-valueR
  1. Notes: Item 5 was not applicable for 59 of the 582 business combinations because Item 1 (NUCC or UCC) had not been disclosed. Items 6 and 7 only apply to the 221 business combinations disclosed to be NUCC and Items 8 and 9 only apply to the 302 business combinations UCC.

  2. For Item 2, the overall compliance of 52% when audited by the Big Four was 49% (23/47) when NUCC, and 80% (16/20) when UCC. The overall compliance of 30% when audited by a non-Big Four auditor was 43% (110/255) when NUCC, and 20% (40/201) when UCC. Thus, the difference in compliance for Item 2 between Big Four and non-Big Four is a result of the treatment when NUCC, as opposed to UCC.

  3. R = (CA-CN)/(100%-CN) where CA and CN are the compliance percentages for business combinations audited by a Big Four auditor and non-Big Four auditor, respectively. R was a measure of the improvement in non-compliance when audited by a Big Four auditor, relative to the level of non-compliance when audited by a non-Big Four auditor (see (1)).

  4. NUCC, not under common control; UCC, under common control.

190% (523/582)89% (67/75)90% (456/507)0.838−10%
232% (189/582)52% (39/75)30% (150/507)0.00031%
374% (429/582)88% (66/75)72% (363/507)0.00257%
432% (187/582)56% (42/75)29% (145/507)0.00038%
565% (340/523)82% (55/67)62% (285/456)0.00153%
659% (130/221)90% (18/20)56% (112/201)0.00377%
734% (76/221)95% (19/20)28% (57/201)0.00093%
850% (152/302)55% (26/47)49% (126/255)0.52612%
945% (135/302)77% (36/47)39% (99/255)0.00062%

Table 4 also provides the compliance rates separately for Big Four and non-Big Four-audited companies, together with the statistical significance of any difference between these two rates. Compliance rates differed significantly by auditor for all items, except Item 1 (P = 0.838) and Item 8 (P = 0.526). For the other seven items, compliance rates were significantly higher for business combinations audited by a Big Four auditor. The final column in Table 4 shows a higher degree of compliance for the Big Four-audited business combinations relative to those audited by non-Big Four auditors (the percentage of non-compliance by non-Big Four audited business combinations removed when audited by a Big Four auditor). Item 1 compliance was slightly worse for those audited by a Big Four auditor, however, there was substantially greater compliance for Items 6 and 7 (business combinations UCC only).

As the choice of combination method (Item 5) depends on the combination type (Item 1), the data for these two items is cross tabulated in Table 5. On no occasion was the purchase method incorrectly used for a business combination UCC, whereas on 12 occasions the pooling method was incorrectly applied to a business combination disclosed to be NUCC. Because of the use of the pooling method instead of the purchase method on these 12 occasions, a slight majority of business combinations use the pooling method (Table 5). On three occasions, both purchase and pooling methods were applied to the same business combination. The compliance rate for business combinations NUCC was 55 percent (167/302), while for business combinations UCC it was significantly higher (P < 0.001) at 78 percent (173/221). Thus, not only was the incorrect accounting method used more frequently for business combinations NUCC, but non-disclosure was also more prevalent.

Table 5. Item 1 and item 5 disclosures
Item 1Item 5Total
PurchasePoolingBothNot disclosed
  1. Notes: The 12 cases where pooling was used for NUCC and three cases where both methods were used for NUCC, deviate from ASBE. Because no justification was disclosed as to why this deviation was applied, these are clear violations.

  2. An anonymous reviewer suggested that disclosure of one item (such as Item 1) may imply disclosure of another item (such as Item 5) if it is assumed that the appropriate (compliant) choices are made. For example, the 120 companies disclosing Item 1 as NUCC, but not disclosing Item 5, might be assumed to be using the purchase method as this is required under ASBE. We report results without this assumption for several reasons. First, ASBE requires explicit disclosure. As pointed out by this reviewer, auditing requires and allows professional judgment and discretion when applying standards. We found evidence of these deviations, suggesting assumption of implicit disclosure is dangerous. Second, of the 144 cases where Item 5 might be considered implicitly disclosed only four cases (3%) disclosed either Items 6 and 7 (when UCC) or Items 8 and 9 (when NUCC), as required under ASBE. If non-disclosure of Item 5 was simply a result of implied disclosure because of the disclosure of other items, then we would expect to see full disclosure of these later items. Furthermore, where both Item 1 and Item 5 were not disclosed, disclosure of Items 6 to 9 do not permit reliable inferences of disclosure for Items 1 and 5. Of these 44 cases, none make the appropriate disclosures of Items 6 to 9.

  3. ASBE, Accounting Standard for Business Enterprises; NUCC, not under common control; UCC, under common control.

Not disclosed6904459

Compliance rates for Item 5 differed significantly depending on whether the business combination was audited by a Big Four auditor or non-Big Four auditor, and there was also variation between the Big Four auditors (Table 6).

Table 6. Summary of non-compliance for disclosure of measurement method (item 5) by auditor
AuditorNot disclosedPooling for NUCCBoth methods for NUCCNo. of business combinationCompliance rate
  1. NUCC, not under common control.

KPMG4101362% (8/13)
PWC4202979% (23/29)
E&Y5013080% (24/30)
Deloitte0003100% (3/3)
Non-Big Four1999250759% (297/507)
TOTAL21212358261% (355/582)

The compliance rate of 62 percent for KPMG was insignificantly better (P = 1.000) than for the non-Big Four domestic Chinese auditors (59 percent). Furthermore, one of the 13 business combinations audited by KPMG incorrectly used the pooling method for a business combination NUCC. The compliance rate of 79 percent for PWC was significantly (P = 0.031) higher than the non-Big Four-audited business combinations, however, PWC incorrectly audited two business combinations NUCC using pooling. E&Y had a compliance rate of 80 percent, similar to PWC and significantly (P = 0.021) better than the non-Big Four auditors, however, E&Y audited a business combination for which both methods were incorrectly applied. Deloitte returned a 100 percent compliance rate, however, this was based on only three business combinations, and, as a consequence, is not significantly different (P = 0.272) to the non-Big Four rate. Thus, while the 100 percent compliance rate for Deloitte is impressive, the lack of business combinations audited by Deloitte makes it difficult to make conclusions with confidence concerning their compliance rate.


  1. Top of page
  2. Abstract
  3. Introduction
  4. Chinese auditing and the theory of auditing expectations gap
  5. Business combination accounting regulations
  6. Methods
  7. Results
  8. Implications
  9. Conclusion
  10. Acknowledgment
  11. References

The results of this study reveal that, in responding to accounting changes, reporting entities are resistant to implementing the new rules, at least in business combination accounting. Findings from this study have several major implications for theory, the listed companies, the auditors, the regulatees, the regulators, and China's business combination regulations.

Audit quality can be defined as the probability that an error or irregularity is detected and the willingness to report any material manipulation or misstatements that will increase the material uncertainties or/and going concern problems (Bradshaw et al. 2001). In other words, high audit quality is associated with an absence of material omission or misstatement in financial statements. This study, however, shows that the auditors of Chinese listed firms do not pay much attention to compliance with business combination disclosure. Although consistent with the tenets of the general theory of the auditing expectations gap, this is somewhat surprising in a Chinese domestic setting, given that Chinese auditors have a reputation for compliance audits (Lin 2004), and are familiar with rules-based standards (Xiao et al. 2004). The new accounting standard ASBE 20 Business Combinations requires mandatory business combination disclosures and, therefore, requires considerable effort in the conduct of the audit. The audit profession appears not to have enforced change where change was required. This may be consistent with the inertia effect of accounting tradition detected by Xiao et al. (2004) or what Lin et al. (2008, p. 741) call “the persisting influences of the old business administration system stemming from the centrally planned economy.” The results show that in comparison to the companies audited by Big Four auditors, those companies audited by Chinese domestic accounting firms had lower levels of compliance in business combination reporting. Consistent with Lin et al. (2008), this implies that the assumptions of the principal–agency relationship, which underlies Western notions of compliance, has not been fully impounded in Chinese auditing, possibly because the ideals of corporate governance are still in the early stages of development in China (Lin et al. 2008).

The past literature has been reluctant to specify a more specific theoretical framework of regulation than the general theory of the auditing expectations gap for the study of Chinese listed companies and the auditors in the compliance of ASBE. However, the results of our study suggest that the core issue behind the lack of compliance rests at the hands of Chinese public listed companies and auditors. Indeed, this study raises issues directly related to the theoretical constructs informing the auditing expectations gap (Volosin 2007). The past literature has raised examples of how auditing fails to meet the expectations of the public it serves in both developed countries (Sikka et al. 1992, 1998; Kadous 2000; Dewing & Russell 2001; Volosin 2007) and developing countries (Chowdhury et al. 2005; Dixon et al. 2006; Haniffa & Hudaib 2007; Pourheydari & Abousaiedi 2011).The results of this study support Lin's (2004) detection of a general auditing expectations gap in China, but question his assertion that Chinese auditors have a tradition of carrying out compliance audits. The findings from our study reveal low compliance scores, suggesting that compliance audits are not rigorously applied. Xiao et al. (2004) make the assumption that Chinese accountants and auditors have traditionally relied on rules-based standards, but our results show that despite clear Chinese rules for business compliance, they have not been followed.

Another general sense of the prevailing theory of the auditing expectations gap is provided by the low business combination compliance among companies audited by a Big Four auditor. Big Four auditors operating in China conduct business with a Chinese-based auditing partner (Qing & Armstrong 2012), so it is possible Big Four auditors audit consistently with the practices of their Chinese-based auditing partners. A possible explanation for this is the argument by Murphy et al. (2009) and Tyler (2006) that regulatees are more likely to comply if they perceive the regulations as being fair and impartial. Big Four auditors may only comply up to a level perceived by their Chinese auditing partners as being fair and reasonable.

Thus, our study supports the misgivings in the previous literature about the work of Big Four auditors. Although Big Four auditors have a reputation for producing quality audits, they fail to live up to this reputation in a Chinese setting. This lack of compliance of business combination reporting appears to represent a level of auditing expectations gap that has implications for other developing countries moving toward international accounting standards and permitting Big Four auditors to operate in their countries. In the pursuit of large foreign audit fees, it appears Big Four auditors are willing to relax their reputation for producing quality audits and lower their standards in compliance audits.

The descriptive results for each item within the BCCI and the final scores in the BCCI appear to raise questions about the robustness of regulatory oversight among the institutions operating in China. Following the findings of Heng and Noronha (2011), there appears to be inconsistency between the expectations of ASBE and the reality of reporting among Chinese listed companies. The poor compliance level observed in this study in relation to ASBE 20 Business Combination disclosures shows that this result has not been achieved in China, at least with respect to the third year following adoption of the ASBE. What is clear is that there has been some evasion of externally imposed requirements.

In terms of the literature on self-regulation, Ayres and Braithwaite (1992) offer a number of enforcement strategies to the regulator which encourages voluntary compliance with ASBE 20 Business Combinations and offers alternative measures, such as persuasion, warning letters, civic penalties, criminal penalties, license suspension, or license revocation. In the light of these results and the open-ended field work of Xiao et al. (2004), and the questionnaire survey instrument of Lin et al. (2008), it would appear that further research investigating the viewpoints of both the management of Chinese listed reporting entities and their auditors would be valuable. If it is possible to obtain honest and open answers within the authoritarian Chinese political environment, such responses might tease out further reasons for non-compliance of business combination regulations and potential alternative regulative measures for the achievement of full compliance by the entities.


  1. Top of page
  2. Abstract
  3. Introduction
  4. Chinese auditing and the theory of auditing expectations gap
  5. Business combination accounting regulations
  6. Methods
  7. Results
  8. Implications
  9. Conclusion
  10. Acknowledgment
  11. References

The regulator has an opportunity to enforce ASBE 20 Business Combinations by considering incentives for business entities and auditors to commit to compliance. This could be reinforced by increased inspections by the regulator (Ko et al. 2010), the nurturing of compliance professionalism (Parker 1999), and the advancement of professional autonomy (Makkai & Braithwaite 1993). There may also be scope for the regulator to consider the regulatees' motivations for non-compliance with ASBE 20 Business Combinations. As Braithwaite (2003) points out, if business entities and auditors fail to perceive these regulations as fair, valid, or appropriate, ASBE 20 Business Combinations may not be seen as legitimate.

Lin (2004) found that the Chinese public had relatively high expectations of the Chinese audit profession. Given Chinese auditors' familiarity with rules-based accounting it would not be unreasonable for the Chinese public to expect that all business combinations should be disclosed, properly classified, well described, and made available to the financial report users immediately. What is clear from the results of this study is that business entities and auditors are neither fully committing nor capitulating (Braithwaite 1995, 2003) to the requirements of ASBE 20 Business Combinations. If listed reporting companies and their auditors are not willing or able (Xiao et al. 2004) (it's hard to tell which) to comply with the disclosure requirements stipulated under the mandatory standard, then there appears to be room for the regulator to consider the reasons for regulatee disengagement or resistance before assessing the need for externally imposed punitive action. As Lin (2004) points out, however, complexities arise because the Chinese state authority regulates and oversees the audit process, acts as regulatee in instances where it has full or partial ownership of listed state-owned enterprises, and, in effect, determines the level of auditor independence in China. As a consequence, non-compliance raises questions about the future role of the Chinese state authority in the integrity of reporting and regulation.

Low levels of compliance have been documented for other developing countries – for example, Indonesia, Malaysia, Philippines, and Thailand (Taplin et al. 2002; Setyadi et al. 2011) – and there are many instances of the presence of an auditing expectation gap in developing countries. This may occur because auditing is relatively new; Lin et al. (2008) found low compliance in Chinese listed companies may be a result of the relatively new adoption of corporate governance systems.

These findings have significant implications for international investors with an eye on both Chinese and non-Chinese listed companies. It is difficult for international investors to invest in Chinese projects if information within the annual reports of Chinese listed companies is misleading or inaccurate. Past literature shows that the level of accounting compliance with IAS is positively associated with companies audited by major international audit firms (Street & Gray 2002; Ali et al. 2004). Moreover, in a developing country setting, there is some evidence that Big Four audit firms have slightly higher compliance than non-Big Four audit firms, although overall compliance is relatively low (Setyadi et al. 2011). Prior studies in a developing country setting also show (e.g. Becker et al. 1998; Balsam et al. 2003; Francis & Ke 2006) that earnings quality increases for firms with Big Four auditors. Yet there is a considerable Western literature that questions the reputations of these large international auditing companies (Sikka et al. 1992, 1998; Sikka 2009, 2012). In the case of China, the Big Four auditors' lack of compliance raises questions about their reputation in foreign countries. The inability of these auditors to ensure that company accounts comply with regulations bears a resemblance to the difficulties faced between Arthur Andersen and its major client Enron prior to the demise of Arthur Andersen (Healy & Palepu 2003; Baker & Hayes 2004; Smith & Quirk 2004; Benston 2006). It appears that large international accounting firms continue to face difficulties in ensuring that their clients conform to regulations aimed at making sure that the market can obtain complete and accurate information concerning the accounts of their companies.

  1. 1

    The Ministry of Finance of the People's Republic of China is the national agency of the Central People's Government which administers macroeconomic policies, fiscal policy, economic regulations, and government expenditure for the state.

  2. 2

    Before 30 June 2001 in the US, in order to qualify to use the pooling of interests method, the transaction had to satisfy 12 requirements related to its structure (e.g. at least 90% of the transaction consideration had to be shares). If any requirements were not met, the purchase method was applied.

  3. 3

    Under IFRS, there are many forms of “under common control” transactions which touch upon business combinations. Two methods of accounting are allowed, “depending on a determination of the extent [of] common control” (Baker et al. 2010, p. 111). With respect to the pooling of interests method, a business combination relating to entities under common control “is recorded using the book values of the combining entities and no goodwill is recognized” (Baker et al. 2010, p. 111). With respect to the purchase method, a business combination relating to entities not under common control is “[accounted] for based on the fair value of the net assets acquired, and goodwill is recognized, subject to impairment text, but goodwill is not amortized” (Baker et al. 2010, p. 111). It is important to note that in an attempt to avoid disharmony with IFRS, Baker et al. (2008) suggest a new approach to accounting for business combinations taking into account measures of influence and group dependence. According to these two examples above, the basis of accounting to be used for common control transactions is unresolved in IFRS.

  4. 4

    This t-test is equivalent to performing a regression with one independent variable indicating whether the business combination was audited by a Big Four auditor or non-Big Four auditor. Multiple regression was also performed using additional independent variables of size (logarithm of total assets), profitability (return on assets), leverage (total debt divided by total assets), stock exchange (Shanghai or Shenzhen), and government ownership (percentage of shareholding by the Chinese government). However, none of these control variables were statistically significant and the results for Auditor remain unchanged. Hence, for conciseness, we omit regression results from the paper.

  5. 5

    A reviewer suggested CA − CN as an alternative definition to R which is linear in CN. These values can be easily computed from the CA and CN values we present, but our definition of R emphasizes improvements from CN = 90% to CA = 95% relative to CN = 0% to CA = 5%. R views the former as a large increase relative to the possible improvement (10%) and the latter as a relative small improvement versus the possible improvement of 100%.


  1. Top of page
  2. Abstract
  3. Introduction
  4. Chinese auditing and the theory of auditing expectations gap
  5. Business combination accounting regulations
  6. Methods
  7. Results
  8. Implications
  9. Conclusion
  10. Acknowledgment
  11. References
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