Are IFRS and U.S. GAAP Converging

Journal of International Accounting, Auditing and Taxation15 (2006) 48–71

Are IFRS and U.S. GAAP converging?Some evidence from People’s Republic

of China companies listed on theNew York Stock Exchange�

John L. Haverty ∗St. Joseph’s University, 5600 City Ave., Philadelphia, PA 19131, United States

Abstract

This research investigates the comparability and convergence of two sets of accounting standards from1996 to 2002: United States’ Generally Accepted Accounting Principles (U.S. GAAP) and InternationalFinancial Reporting Standards (IFRS). The investigation involves a sample of companies from the People’sRepublic of China (PRC) that are listed on the New York Stock Exchange (NYSE). PRC companies tradedon the NYSE generally prepare IFRS financial statements and provide a limited reconciliation to U.S. GAAP,creating a unique quasi-experimental opportunity to examine differences between two sets of accountingnumbers produced by two different sets of accounting standards while holding the company constant. Com-parability is measured by using Gray’s index of comparability, and a set of measures are introduced to captureseveral dimensions of convergence over time in reported net income, net assets, return on net assets, andearnings per share. The evidence shows lack of comparability, caused largely by the revaluations of prop-erty, plant and equipment permitted under IFRS, but not permitted under U.S. GAAP. There is, however,substantial evidence of convergence over time.© 2006 Elsevier Inc. All rights reserved.

Keywords: Convergence; People’s Republic of China; International Financial Reporting Standards; IFRS; Accountingharmonization

1. Introduction

This research investigates the comparability of two sets of accounting standards from 1996 to2002: United States’ Generally Accepted Accounting Principles (U.S. GAAP) and International

� Data availability: The data used in this study can be obtained from public sources.∗ Tel.: +1 610 660 1656(O)/+1 610 544 9120(R); fax: +1 610 660 1126.

E-mail address: [email protected].

1061-9518/$ – see front matter © 2006 Elsevier Inc. All rights reserved.doi:10.1016/j.intaccaudtax.2006.01.004

J.L. Haverty / Journal of International Accounting, Auditing and Taxation 15 (2006) 48–71 49

Financial Reporting Standards1 (IFRS). The research also examines changes in comparability overtime, i.e., convergence. The stated goal of the International Accounting Standards Board (IASB)and its predecessor organization, the International Accounting Standards Committee (IASC) hasbeen to bring about convergence of National Accounting Standards and International AccountingStandards. In addition, the United States accounting standard-setting body, the Financial Account-ing Standards Board (FASB) has in recent years held the position that it will formulate its policywith due regard to international considerations. This position has been formalized by the sign-ing of the Norwalk Agreement (Financial Accounting Standards Board, 2002) in which both theFASB and the IASB pledged their best efforts to make their existing financial reporting standardsfully compatible as soon as is practicable. Given this environment of cooperation, convergence ofU.S. GAAP with IFRS is expected and should be observable in the financial statements reportedby firms over time. Observation of convergence is a complex task, however, and this researchpresents a methodology to observe convergence using financial statements prepared by firmsreporting under U.S. GAAP and IFRS.

The requirement of the United States Securities and Exchange Commission (SEC) that foreignfirms listed on a U.S. Stock Exchange such as the New York Stock Exchange (NYSE) provide alimited reconciliation of their net income and net assets financial statements prepared under IFRSto U.S. GAAP presents an opportunity to test for convergence. This multiple reporting createsa quasi-experimental situation in which the company is held constant, and accounting numbers(e.g., net income and net assets) are calculated according to IFRS and U.S. GAAP for a givenyear.

This investigation involves a sample of People’s Republic of China (PRC) firms listed onthe New York Stock Exchange. PRC companies were chosen for this study not only because ofthe growing worldwide economic significance of the PRC, but also because the PRC providesa particularly unique testing ground to explore comparability and convergence issues. The PRCand the United States represent vastly different economic systems with significantly differentaccounting systems. With the ongoing economic restructuring within the PRC, however, as wellas the gradual opening of the PRC to the international economic community, differences betweenthe PRC accounting system and the U.S. accounting system are expected to become smaller overtime. Since PRC companies seeking foreign equity capital are required by PRC law to report underIFRS, and those seeking U.S. equity capital are required by U.S. law to reconcile net income andnet assets to U.S. GAAP, we have a situation in which we can compare IFRS-produced accountingmeasurements to U.S. GAAP-produced accounting measurements for the same company in thesame year. The fact that the PRC and the U.S. represent vastly different economic and accountingsystems leads us to believe that we should expect an initial lack of comparability between IFRSfinancial statements produced by PRC firms, and U.S. GAAP financial statements produced bythose same firms. Over time, however, we should observe convergence. Given this scenario, wehave a unique situation in which to test for comparability and convergence between IFRS andU.S. GAAP. This research first examines if the accounting numbers produced by IFRS and U.S.GAAP are comparable for PRC companies. If IFRS and U.S. GAAP are comparable, then a givenaccounting number (such as net income) calculated under IFRS should be fairly close to that sameaccounting number (such as net income) calculated under U.S. GAAP. The research then explores

1 The International Accounting Standards Committee (IASC) was restructured into the International Accounting Stan-dards Board (IASB) as of April 2001. Standards issued by the IASC were known as International Accounting Standards(IAS). As of April 2001 they are now called International Financial Reporting Standards (IFRS). The current terminologyis used in this study.

50 J.L. Haverty / Journal of International Accounting, Auditing and Taxation 15 (2006) 48–71

the reasons for any observed lack of comparability. Finally, the research examines convergence.If IFRS and U.S. GAAP are converging, then the differences between a given accounting number(such as net income) calculated according to IFRS and the same accounting number calculatedaccording to U.S. GAAP should be shrinking over time. In order to test convergence, this researchintroduces a series of metrics that measure convergence over time.

This research provides evidence of non-comparability. The majority (10 of 11) of the PRCcompanies in this study report a net income under IFRS that is materially different (at a 5%materiality threshold) from net income under U.S. GAAP. The most significant cause of the lackof comparability is that revaluation of property, plant and equipment is permitted as an optionunder IFRS, but U.S. GAAP requires reporting property, plant and equipment on an historicalcost basis. The non-comparability is tempered, however, by evidence of convergence over timefor the PRC companies that did not indicate comparability.

The next section discusses International Financial Reporting Standards and provides somebackground on accounting harmonization. Then, some background on economic restructuring inthe PRC and the PRC accounting system is provided. Specific research questions and the method-ology of the study are developed. Results are presented, and the concluding section discusses theimplications of the results for investors and researchers.

2. Accounting harmonization, convergence, and International Financial ReportingStandards

One challenging aspect of international business is the fact that no two countries have exactlythe same accounting standards or procedures (Gernon & Meek, 2004). Diversity in accountingstandards is caused by cultural, economic, historic, legal, and political reasons since the accountingsystem in a particular nation reflects the unique aspects of that nation. Diversity in standardsunfortunately is a considerable barrier to the cross-border flow of capital. In order to properlyevaluate an investment in another country, an investor must translate financial statements preparedunder a foreign set of accounting standards into financial statements in accord with the accountingstandards of the investor’s home country.

Despite the forces favoring international diversity of accounting systems, there are also anumber of strong forces favoring harmonization of the various national accounting systems.Some of these factors include the explosive growth in cross-border financing, improvements incommunication technology, the formation of cross-national economic blocs such as the EuropeanUnion and NAFTA, and efforts by the United Nations. As a consequence, attempts have beenmade to encourage accounting harmonization at the international level as well as the local levelof various nations.

2.1. The accounting harmonization movement

Internationally, a milestone in the march toward accounting harmonization was the forma-tion of the International Accounting Standards Commission (IASC) in 1973. The IASC was asan independent, private sector body whose objective was to facilitate the cross-border flow ofcapital by making financial statements more comparable even though they were prepared undervarious sets of National Accounting Standards. Membership in the IASC included professionalaccounting bodies of various nations. Immediately after its founding in 1973, the IASC chosethe politically expedient strategy of allowing a wide variation in permitted accounting methods.Disclosure of the accounting method was emphasized instead of forcing compliance with a par-


ticular model. Major international players such as the United States, Japan and various Europeannations were not forced to change their domestic standards to be in compliance with an emergingset of International Accounting Standards created by the IASC. This strategy insured at least pas-sive international support for IASC efforts from the world’s major financial powers. As the yearsprogressed, however, the IASC gradually reduced the number of permitted alternative accountingmethods.

In April 2001, the IASC was restructured and renamed the International Accounting StandardsBoard (IASB, 2002). Its objectives include: (1) developing a set of high quality, understandable,and enforceable global accounting standards; (2) promoting the use and rigorous applicationof these standards; and (3) bringing about convergence of National Accounting Standards andInternational Accounting Standards (International Accounting Standards Board, 2002). Since1973, the IASB and its predecessor organization, the IASC have issued 41 accounting standards(6 have subsequently been superseded). These standards were formerly known as InternationalAccounting Standards (IAS) and are now called International Financial Reporting Standards. TheIASB has no authority to enforce compliance with these standards, but many National AccountingStandard-setting bodies have permitted or encouraged use of IFRS as alternatives or supplementsto their own National Accounting Standards. Belgium, France, and Italy, for example, passed lawsin 1998 allowing IFRS to be used for domestic financial reporting. Recently, the InternationalOrganization of Securities Commissions (IOSCO) has recommended that its members allowmultinational issuers to use the 30 IFRS current at that time in their cross-border offerings andlistings. In addition, the European Union announced plans to require IFRS for all European Unionlisted companies no later than 2005.

Harmonization efforts also occur at the local level of various nations. The very existence ofIFRS and its persuasive promotion on the part of the IASB have influenced the development ofvarious National Accounting Standards. Accounting bodies of various nations, even if they havenot adopted IFRS, sometimes model their own national standards or at least modify their ownstandards with international standards in mind. The United States, for example, has not adoptedIFRS for domestic reporting but has stated that it will formulate accounting policy with due regardto international considerations. Despite extensive cooperation between the IASB and the UnitedStates Financial Accounting Standards Board, many differences exist between IFRS and U.S.GAAP. Deloitte Touche Tohmatsu (2002) lists 78 specific differences between IFRS and U.S.GAAP. The significance of the differences between IFRS and U.S. GAAP will vary from firmto firm depending on the specific economic circumstances facing each firm. The United Statespermits foreign companies raising capital in the United States to use either their own domesticaccounting standards or IFRS but requires a note reconciling net income and net assets to U.S.GAAP.

There is considerable strength to the argument that IFRS and U.S. GAAP are becoming closerover time. In recent years, U.S. accounting standards have supposedly been created and revisedwith international considerations in mind. IFRS, due to the political realities facing the IASB,must necessarily be created and revised with U.S. GAAP in mind due to the U.S. economy’sprominent position in the world economy. These trends have been formalized with the signingof the Norwalk Agreement (Financial Accounting Standards Board, 2002), in which the U.S.and the IASB pledged to use their best efforts to make their existing financial reporting fullycompatible as soon as is practical. In spite of these forces favoring harmonization, there arestill major differences between IFRS and U.S. GAAP, particularly in the range of accountingpractices permitted by IFRS. Recent research (Street & Gray, 1999) concluded that there weremajor differences still to be resolved, notably in the determination of net profit/loss for the period,


research and development, changes in foreign exchange rates, and business combinations, butnoted that these differences were not insurmountable. Evidence of non-comparability (Harris &Muller, 1999) has been presented using the reconciliation of net income and net assets per IFRSto net income and net assets per U.S. GAAP required by the SEC for foreign registrants usingIFRS. Evidence of convergence (Street, Nichols, & Gray, 2000) between IFRS and U.S. GAAPwas presented for a sample of non-U.S. companies reporting under IFRS and providing a limitedreconciliation from IFRS to U.S. GAAP.

2.2. The concept of accounting harmonization

Accounting harmonization is defined as “. . . a process of increasing the comparability ofaccounting practices by setting limits on how much they can vary. Harmonized standards are freeof logical conflicts, and should improve the comparability of financial information from differentcountries” (Choi, Frost, & Meek, 2001, p. 291). Accounting harmonization is a process leadingto the ultimate goal of increasing comparability of financial information across national borders.

Accounting harmonization is a multi-faceted concept, containing at least three componentsof accounting harmonization (Choi et al., 2001): (1) harmonization of accounting standards,which deals with measurement and disclosure; (2) harmonization of disclosures made by publiclytraded companies in connection with securities offerings and stock exchange listings; and (3)harmonization of auditing standards. Even this is a limited list since accounting harmonization isinfluenced by a myriad of additional factors. For example, if a nation does not have an auditing andstandards enforcement infrastructure, then there is no guarantee that accounting numbers (suchas net income or net assets) reported under a particular set of standards represent an accurateapplication of those standards. Countries with very similar accounting standards may not becomparable for reasons well beyond the similarity of the respective accounting standards. Itis possible to have a situation of only apparent accounting harmonization if the standards arerelatively similar, but if either the culture of compliance or the system of enforcement is inadequate.

Development of an operational measure of accounting harmonization is a complex issue.Two sets of accounting standards may be “in harmony” but may apply different sets of rulesto the same situation since each national set of accounting standards allows some degree ofchoice of treatment. In addition, some standards are silent on the treatment of a particular issue.Scholars (Canibano & Mora, 2000) note there are two forms of harmonization: de jure and defacto harmonization. De jure, or formal harmonization, refers to the harmonization of regulations.A recent example of an attempt to measure de jure accounting harmonization is Larson and Kenny(1999), who found some measurable progress toward accounting harmonization in the 1990s butconcluded that harmonization is not yet a reality. They noted that compliance with IFRS was notthe same as harmonization since IFRS allowed many alternative accounting treatments. De facto,or informal harmonization, refers to the actual accounting practices of corporations. Canibanoand Mora (2000) studied de facto harmonization in the European Union and found evidence ofde facto accounting harmonization among global players within the European Union. Street etal. (2000) found that the differences between IFRS and U.S. GAAP are narrowing for a sampleof non-U.S. companies that reconcile IFRS reported net income to net income per U.S. GAAP.De facto and de jure harmonization can each be broken down into two components, the degree ofdisclosure and measurement criteria. This results in four forms of accounting harmonization: (1)de jure disclosure harmonization, which concerns regulations governing what is disclosed; (2) dejure measurement harmonization, which concerns regulations governing how reported quantitiesare measured; (3) de facto disclosure harmonization, which concerns what corporations actually


disclose; and (4) de facto measurement harmonization, which concerns how corporations actuallymeasure quantities.

2.3. The concept of accounting convergence

Recently, the term “accounting harmonization” has at times been replaced by the term “account-ing convergence”. This term has been defined as:

The process pursued by the International Accounting Standards Board (IASB) of eliminatingthe present differences between National Accounting Standards and the avoidance of futuredifferences to achieve international accounting harmonization (Hussey & Ong, 2005, p.229).

In this sense, accounting convergence is a process that occurs at the standard-setting levelintended to achieve a state of de jure accounting harmonization. It is possible to measure de jureharmonization by focusing on the range of choices provided by various accounting standards.This research, however, measures accounting convergence in a de facto sense by examining thefinancial reports of companies in a multiple reporting scenario over time. Measuring de factoconvergence enables us to measure the actual financial impact of differences in the accountingstandards and enables us to examine the actual choices made by firms.

If we consider measurement as a system of assigning numbers to qualities of an object, we canconsider a set of accounting standards as rules for measuring aspects of the financial condition ofan organization. If the two measuring systems are equivalent, they should produce the same set ofaccounting numbers. For example, if U.S. standards and IFRS were equivalent, then net incomereported under U.S. accounting standards and net income reported under IFRS should be the same.If the two sets of accounting numbers are different under each set of accounting standards, then themeasuring instruments are not equivalent. If the two sets of accounting standards are becomingharmonized over time, then it is likely that the numbers purporting to measure the same quality(e.g., net income) of an organization would be moving closer over time. This is the meaning ofthe term convergence in this research, a strictly mathematical measure of increasing closenessover time of two numbers purporting to measure the same thing. Since the purpose of accountingharmonization is to increase comparability of financial reports produced by different nations,mathematical convergence2 of reported accounting numbers would be a necessary manifestationof increasing de facto accounting harmonization. Financial information produced under differentaccounting, disclosure, and/or auditing systems is comparable if it is “. . . similar in enough waysthat financial statement users can compare it (at least along some dimensions) without needing tobe intimately familiar with more than one system” (Choi et al., 2001).

It is important to note that convergence and comparability are not the same things. It is pos-sible to compare accounting numbers even if they do not converge over time. For example, theaccounting numbers produced by one system might be different from the accounting numbers

2 The FASB (1998) defines convergence to mean national accounting standards moving toward each other with theobjective of increasing quality. The FASB also notes that the IASB also uses the term convergence in a slightly differentfashion, the movement of national standards toward higher quality IFRS. This research ignores the subtle political differ-ence in these two definitions of convergence. The term convergence will be used in this research in a strictly mathematicalsense: two sets of different measures of the same thing that come closer over time. In this sense, convergence is intendedto serve as evidence of accounting harmonization.


produced by a second system in some consistent and understandable fashion. In such a scenario,the financial statement user might be able to make simple adjustments to facilitate comparison.

Accounting numbers produced by two different sets of accounting standards could also con-verge but not be comparable. For example, one set of accounting standards might facilitateincome smoothing more than another set of accounting standards. In this scenario, the reportednet income numbers might converge over time, but the set of accounting standards that facili-tates income smoothing would be expected to show less variability than the set of accountingstandards that discourages income smoothing. Such a situation would make comparison quitedifficult.

3. Economic restructuring in the People’s Republic of China

The PRC is used in this study due to its growing importance in the world economy. It alsoprovides an example of a nation whose accounting system is very different from the United Statesbut is supposedly becoming more similar to Western accounting systems due to its desire tobecome more integrated into the world economy. In order to understand the accounting system ofthe PRC, it is necessary to view it in the larger context of the monumental economic restructuringthat is taking place within that nation. As part of this restructuring, the PRC has developed anequity market to raise much needed capital for reform and expansion. In addition, the accountingsystem of the PRC is being transformed from a largely Soviet-era model designed to facilitatecentral planning to a model more compatible with the PRC’s growing international aspirations,culminating in membership in the World Trade Organization.

3.1. Economic restructuring and opening in the PRC

Since 1978, the PRC has been undergoing a process of opening and restructuring. Opening hasmeant the gradual change in economic philosophy from isolationism to integration with the worldeconomy. Restructuring involves a transformation of the economy to make it more competitivewith the other major economic powers, changing it from a centrally planned economic system tosomething called “a socialist market economy.” It is important to note that the transformation doesnot mean that the PRC is now a market economy. The socialist market economy is a unique blendof socialism and capitalism; it is a large portion of socialism along with certain changes toward amarket economy. The basic idea of the socialist market economy appears to be preservation of theeconomy’s socialist core, state firms and state banks, while making incremental changes in otherareas. These changes include establishing markets, eliminating central planning, and allowingnon-state-owned industry to prosper (Steinfeld, 1999). This transformation parallels similar butmuch more abrupt and traumatic transformations in many Eastern European countries over thesame time period. The Chinese government is acutely aware of the social disruptions that tookplace along with the economic transformations in Eastern Europe. As a result, the PRC has chosena path that has been much more deliberate and much less traumatic.

The cornerstones of the Chinese socialist economic system were and still are the state-ownedenterprises (SOE’s). These are sometimes very large businesses financed and controlled by thecentral or local governments. They bought from and sold to other SOE’s and their debts werelargely guaranteed by the state. It is important to note that these SOE’s also had an important socialrole in addition to their economic role. As large employers, they offered a system of guaranteedemployment as well as various social services: the SOE’s operated their own housing units,schools, hospitals, recreation facilities, and retirement facilities.


3.2. Accounting in the PRC

As the Chinese economic system has been undergoing transformation, Chinese financialaccounting has been transformed as well. The role of accounting information in a centrally plannedeconomy is far different from its role in a socialist market economy. In a centrally planned econ-omy, the users of accounting information are primarily the central planners responsible for makingbroad macroeconomic decisions as well as decisions on allocating government funds to variousstate-owned enterprises (SOE’s). To serve this group of users’ needs, the accounting informationfrom the SOE’s needs to emphasize uniformity and rigidity and provide information to the centralplanners to show that the enterprises are meeting state-mandated production quotas, and efficiencystandards. In a market economy, financial accounting serves external users, such as banks andequity investors, who provide capital and need high quality information to assess the loan orinvestment potential of an individual enterprise. As the users of an accounting system change,the accounting system must also change to provide relevant information to the appropriate users.International lenders and investors need credible information to compare a Chinese investmentopportunity with similar investments in their own nation as well as other nations.

The Chinese government has recognized these issues (Zhang, 1997) and has begun the develop-ment of a set of accounting standards to govern external financial reporting for Chinese companies.The PRC has also chosen a government directed method of setting accounting standards, withwide consultation including domestic and international experts. Rather than importing accountingstandards, such as IFRS or the Generally Accepted Accounting Principles of another country suchas the United States, they have chosen to study these and other available accounting standards.They have used these existing standards and developed a set of accounting standards for Chinathat incorporates IFRS but reflects the unique aspects of the Chinese environment. The govern-ment felt this was the most constructive method noting that China was a large, developing countrywith wide regional development disparities, and the concept of a socialist market economy wasquite new to China (Zhang, 1997). Thus, Chinese accounting standards are a rapidly evolvingset of standards based largely on IFRS but with unique, evolving aspects, and heavy governmentinvolvement. To date 13 standards have been issued by the PRC. The last three of these standardswere effective from 1 January 2001. An additional 17 standards are in exposure draft status.

Regulations in the PRC financial markets require reporting under a variety of accountingregimes given the extent to which a company’s stock is traded. Companies that have issued A-shares (shares that trade in the PRC only) must follow regulations issued by the Ministry of Finance(PRC GAAP). Companies that have issued B-shares (shares that trade in the PRC but can be heldby foreigners as well as PRC citizens) or N-shares (shares that trade overseas, for example NewYork, London or Singapore) must follow IFRS. Companies that have issued H-shares (shares thattrade in Hong Kong only) may follow Hong Kong GAAP or IFRS. If a PRC company lists sharesin the United States, the U.S. Securities and Exchange Commission requires that the companyprovide a reconciliation of net income and net assets per IFRS to net income and net assets perU.S. GAAP. These reconciliations are parts of a foreign firm’s Form 20-F registration with theSEC, and are sometimes found in a foreign firm’s annual report or in a supplemental report toNorth American investors. Thus, PRC companies listing on the New York Stock Exchange wouldlikely prepare financial statements under PRC GAAP, IFRS (or sometimes Hong Kong GAAP3)and provide reconciliations to U.S. GAAP.

3 Hong Kong was returned to the People’s Republic of China in 1997. It is governed as a Special Administrative Regionunder a “one country–two systems” policy and retains its former financial systems and institutions. International relations


As noted, the historic, political, and economic factors at work in the People’s Republic of Chinahave created an accounting system quite different from that of the United States. The pace andextent of economic change, driven by a desire to attract foreign investment and become integratedinto the worldwide economy should result in an accounting system that is becoming more similarto IFRS and to U.S. GAAP. It is expected that this situation would cause IFRS reported financialstatements (for PRC companies) not to be comparable to U.S. GAAP reported financial statementsdue to the vastly different underlying economic and accounting systems. These differences areexpected to decline over time, however, as the movement toward convergence gains momentum.

4. Research questions

The questions addressed by this research involve the overall comparability and convergence oftwo sets of accounting standards, IFRS and U.S. GAAP, in one country, the PRC. The relationshipbetween these two sets of accounting standards is examined through the lens of PRC companieslisted on the New York Stock Exchange. The first two research questions address the issue ofcomparability:

Research Question 1: Are IFRS and U.S. GAAP producing accounting numbers for PRC com-panies listed on the NYSE that are comparable?Research Question 2: What are the reasons for any observed lack of comparability betweenIFRS and U.S. GAAP for PRC companies listed on the NYSE?

If the accounting numbers produced by IFRS are comparable, then convergence is not reallyan issue. If, however, the numbers produced by each of the two accounting systems are notcomparable, then the issue of convergence over time must be addressed.

Research Question 3: Are IFRS and U.S. GAAP producing accounting numbers for PRC com-panies listed on the NYSE that are converging over time?

5. Methodology

These research questions are addressed via a longitudinal study of the PRC firms traded on theNYSE. A firm-by-firm approach is taken in this study since investors look at the market on thatbasis. An alternative approach would involve averaging across all firms. These PRC firms providea set of financial statements under IFRS and also provide a Form 20-F reconciliation of net incomeand net assets from IFRS to U.S. GAAP. Table 1 lists the universe of 14 PRC firms listed on theNYSE as of August 20, 2003, and shows their NYSE symbol, and industry classification.

Form 20-F’s were obtained for each of the 14 companies listed in Table 1. Three companies,shown in italics, did not provide IFRS financial statements and were dropped from the study,resulting in a sample of 11 firms from a universe of 14 firms. The firms dropped were AluminumCorporation of China, China Unicom, and CNOOC, which provided statements using Hong KongGAAP rather than IFRS. Table 2 lists the 11 remaining PRC companies that constitute the sample

and defense are the responsibility of the central government of the People’s Republic of China. Hong Kong maintains itsown accounting standards (Hong Kong GAAP) which were developed when Hong Kong was a British colony, and wereheavily influenced by British accounting standards.

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Table 1People’s Republic of China companies listed on the New York Stock Exchange as of August 20, 2003

Company Symbol Industry Total assets 2002 inRMB millions (perIFRS)

Total Revenue2002 in RMBmillions (per IFRS)

Net Income 2002in RMB millions(per IFRS)

Net income 2002 inRMB millions (perU.S. GAAP)

Aluminum Corporation of China ACH Aluminum production Not in sample Not in sample Not in sample Not in sampleChina Eastern Airlines Corporation CEA Airlines operation 32,762 13,345 86,369 247,736China Petroleum and Chemical

CorporationSNP Petroleum and

petrochemicals375,881 340,042 16,080 19,515

China Southern Airlines Company ZNH Commercial airlineservices

37,188 18,019 575 474

China Telecom Corporation CHA Fixed-linetele-communication

210,852 75,496 16,864 15,794

China Unicom CHU Tele-communications Not in sample Not in sample Not in sample Not in sampleCNOOC CEO Oil and gas Not in sample Not in sample Not in sample Not in sampleGuangshen Railway GSH Rail transportation 11,258 2,518 557 598Huaneng Power International HNP Holding company/power

plants48,461 18,474 3,921 3,895

Jilin Chemical Industrial Company JCC Chemical productsmanufacturing

13,665 13,138 (1,023) (685)

PetroChina Company PTR Oil and gas exploration 483,149 244,424 46,910 49,837Sinopec Beijing Yanhua

PetrochemicalBYH Petrochemical production 10,260 9,443 209 230

Sinopec Shanghai PetrochemicalCompany

SHI Petrochemical production 26,086 21,723 916 1,125

Yanzhou Coal Mining Company YZC Coal mining 12,924 7,772 1,222 1,326

Total in sample (RMB million) 1,262,486 764,394 172,600 339,845

Total in sample (US$ million) 152,539 92,357 20,854 41,061

Companies listed in italics reported under Hong Kong Accounting Standards and were excluded from the study.

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Table 2Comparability measures for People’s Republic of China companies included in the study

Company Gray’s index of comparability Comparability determination

1996 1997 1998 1999 2000 2001 2002 Mean At 5% materialitya At 10% materialityb

China Eastern Airlines Corporation 0.90 0.80 1.04 0.26 0.24 1.14 0.35 0.68 Not comparable Not comparableChina Petroleum and Chemical Corporation 0.36 0.90 0.89 0.93 0.82 0.78 Not comparable Not comparableChina Southern Airlines Company 0.82 0.90 1.07 0.22 1.46 0.80 1.21 0.93 Not comparable Not comparableChina Telecom Corporation 1.00 0.47 1.07 0.84 Not comparable Not comparableGuangshen Railway 0.97 0.95 0.94 0.93 0.92 0.93 0.93 0.94 Not comparable ComparableHuaneng Power International 1.00 1.00 1.01 0.92 1.01 0.99 Comparable ComparableJilin Chemical Industrial Company 0.78 0.58 0.50 0.90 0.56 1.16 0.51 0.71 Not comparable Not comparablePetroChina Company 0.87 0.91 0.90 0.94 0.90 Not comparable ComparableSinopec Beijing Yanhua Petrochemical 1.04 0.92 0.54 0.73 0.89 1.38 0.91 0.92 Not comparable ComparableSinopec Shanghai Petrochemical Company 0.86 0.82 0.59 0.79 0.84 0.39 0.81 0.73 Not comparable Not comparableYanzhou Coal Mining Company 1.05 1.03 0.85 0.88 0.92 0.79 0.92 0.92 Not comparable Comparable

a Financial statements prepared under IFRS were deemed comparable to those prepared under U.S. GAAP at a 5% materiality threshold if both the average comparabilityindex and the index for the most recent year in the study were between 0.95 and 1.05.

b Financial statements prepared under IFRS were deemed comparable to those prepared under U.S. GAAP at a 5% materiality threshold if both the average comparabilityindex and the index for the most recent year in the study were between 0.90 and 1.10.


that provide financial reports in accordance with IFRS. For each of the 11 firms remaining inthe sample, Table 1 also shows some summary statistics, including total assets, total revenue, netincome per IFRS, and net income per U.S. GAAP. Researchers (Street, Gray, & Bryant, 1999)have noted a disturbing amount of non-compliance with IFRS by companies that claim to complywith IFRS. The issue is not deemed a problem in this study since the IFRS statements in the studywere all audited and attested to by either Pricewaterhouse Coopers, KPMG or Deloitte ToucheTohmatsu. In addition, a 20-F filing is subject to U.S. Securities and Exchange Commission reviewas well.

Annual reports and Forms 20-F for each of the years 1996–2002 were collected where possible,resulting in potentially 7 years of data. It was not possible to obtain 7 years of data for all companiesin the sample since a number of the companies were not listed on the NYSE until after 1996. Netincome per IFRS and U.S. GAAP, net assets per IFRS and U.S. GAAP, and earnings per share perIFRS and U.S. GAAP were obtained from the Supplementary Information for North AmericanShareholders or from the Form 20-F. All net income, net assets, and earnings per share numbersare reported in PRC currency, the renminbi (RMB) also sometimes called yuan. An additionalmeasure, return on net assets, was calculated by dividing net income by net assets.

5.1. Comparability

In order to test comparability, an index of comparability was calculated for each year of datain the study. The index of comparability is:

1 − (Net incomeUSA − Net incomeIFRS)

|Net incomeUSA| (1)

This index was first used by Gray (1980) who called it an “index of conservatism.” This indexhas recently been called an “index of comparability” and has been used to compare accountingnumbers reported for the same firm under different accounting regimes (Weetman, Jones, Adams,& Gray, 1998 and Street et al., 2000). Alternatives to Gray’s index of comparability are the H, I,and C indices developed by van der Tas (1988), refined by Archer, Delvaille, & McLeay (1995),and a T index developed recently by Taplin (2004). These indices measure the concentration ofchoices made by firms among alternative accounting treatments for a particular issue. They do not,however, measure the financial impact of those choices, nor are they useful to study differencesobtained when different accounting systems are applied to the same firm.

In Eq. (1), if Net incomeUSA is the same as Net incomeIFRS, then the value of this index will be1.0. One disadvantage of this index is that it produces extreme values if the denominator is closeto zero. The index has the advantage of highlighting any material differences between the twonet incomes. An index less than 0.90 means that reported IFRS net income is at least 10% lessthan U.S. GAAP reported net income. Conversely, an index greater than 1.10 means that IFRSnet income is at least 10% greater than U.S. GAAP reported net income. A threshold of 5% isused in this study as an indicator of materiality. Although there is no commonly accepted levelof materiality, the 5% threshold is consistent with other researchers (Adams, Weetman, Jones,& Gray (1999) and Street et al., 2000) who report results based on both 5 and 10% levels ofmateriality.

This index was calculated for each company for each year of the study. An average indexover all the years in the study was also calculated for each company. Net income per IFRS andnet income per U.S. GAAP were deemed comparable at a 5% materiality threshold if both theaverage comparability index and the index for the most recent year in the study were between


0.95 and 1.05. They were deemed comparable at a 10% materiality threshold if both the averagecomparability index and the index for the most recent year in the study were between 0.90 and1.10.

In order to explore the reasons for any observed lack of comparability, an empirical analysis isperformed on the 20-F reconciliations for the most recent year in the study, 2002. Prior researchusing 20-F reconciliations (Harris & Muller, 1999) has grouped the reconciliation adjustmentsinto six major classifications plus one category for any adjustments that did not fit into the sixmajor categories. These categories, along with a brief explanation of some of the major differencesbetween IFRS and U.S. GAAP are as follows:

1. Goodwill: U.S. GAAP, until very recently, required capitalizing goodwill and amortizing itover a period not to exceed 40 years. For accounting periods beginning after December 15,2001, there is no amortization, but the goodwill must be reviewed for impairment each year.IFRS requires capitalizing the goodwill and amortizing it over a period not to exceed 20 years,along with an annual test for impairment. IFRS permits the charging of goodwill to owners’equity in the year of acquisition.

2. Deferred income taxes: U.S. GAAP requires recognition of deferred income taxes on a com-prehensive basis for all temporary differences and requires the use of tax rates that reflectfuture tax rates and laws. IFRS allow managers not to recognize deferred assets/liabilities ifthe book/tax difference is not expected to reverse in the foreseeable future. IFRS also allowmanagers to choose whether or not to adjust deferred amounts for changes in tax rates andlaws.

3. Foreign exchange adjustments: IFRS provide much more flexibility than U.S. accountingstandards. In the United States, foreign exchange gains and losses on forward contracts andhedges are recognized in net income or a component of equity in the period in which they occur.IFRS do not specify an accounting method. The United States requires the use of the currentexchange rate when translating goodwill and fair value adjustments on foreign acquisitions.IFRS permit a choice between current and historical exchange rates.

4. Research and development expenditures: U.S. GAAP requires expensing of all research anddevelopment expenditures. IFRS permit the capitalization of development expenses.

5. Pensions: U.S. GAAP requires the use of the accrued-benefit method and current market-basedassumptions. U.S. GAAP requires recognition of a minimum pension liability for under fundedplans. IFRS permit the use of both accrued-benefit and projected benefit valuation methodsand requires the use of long-term assumptions. IFRS has no requirement to recognize anyliability for under funded plans.

6. Tangible asset revaluations: U.S. GAAP values property, plant and equipment on the historicalcost basis subject to impairment. IFRS permit upward as well as downward revaluations ofproperty, plant and equipment. Under IFRS this upward revision would result in additionaldepreciation expense.

7. Other: Any adjustments that do not fit into any of the above categories.

The reconciliation items as described in the original 20-Fs were categorized using the abovetaxonomy, and the total amounts in each category were accumulated. In order to adjust for size,the total net income adjustments as well as the partial adjustments were deflated by IFRS netassets. This procedure results in a total net income adjustment between net income per IFRS andnet income per U.S. GAAP expressed as a percentage of IFRS net assets. There are also a setof partial adjustments relating to each of the above categories again expressed as percentages of


IFRS net assets. The partial adjustments will add up to the total adjustment, so it is possible todetermine what the major causes are of any reported difference between IFRS net income andU.S. GAAP net income.

5.2. Convergence

For those companies deemed not comparable, tests for convergence were conducted in twosteps. The first step involves calculating difference measure for each company and each year inthe study. Each difference measure captures the magnitude of the difference between a particularaccounting number (e.g., net income) calculated under IFRS, and the corresponding accountingnumber calculated under U.S. GAAP. The second step involves calculating the trend over time ofeach of the difference measures for each company in the study. A negative trend would indicatedeclining differences over time, i.e., convergence.

In the first step of the convergence test, four difference measures for each company and yearin the study are calculated: a net income difference measure (DIFFNI), a net assets differencemeasure (DIFFNA), a return on net assets difference measure (DIFFRONA), and an earnings pershare difference measure (DIFFEPS). DIFFNI was constructed by computing a yearly measure ofthe magnitude (absolute value) of the differences between net income per IFRS and net incomeper U.S. GAAP. This difference was then deflated by net assets per IFRS in order to correct forthe effect of size of the firm on income, and is consistent with Harris and Muller (1999). Theindex of comparability was not used here to avoid the effect of the extreme values of the indexwhen U.S. GAAP net income is close to zero. The net income difference measure is:

DIFFNI = |Net incomeUSA − Net incomeIFRS|Net assetsIFRS

(2)

DIFFNA is constructed in a similar fashion by computing a yearly measure of the magnitude(absolute value) of the differences between net assets per IFRS and net assets per U.S. GAAP,again deflating by net assets per IFRS in order to correct for the effect of size of the firm:

DIFFNA = |Net assetsUSA − Net assetsIFRS|Net assetsIFRS

(3)

DIFFRONA is the absolute value of the difference between return on net assets as computed underU.S. GAAP and return on net assets as constructed under IFRS:

DIFFRONA = |Return on net assetsUSA − Return on net assetsIFRS| (4)

DIFFEPS is the absolute value of the difference between earnings per share as computed underU.S. GAAP and earnings per share as computed under IFRS:

DIFFEPS = |Earnings per shareUSA − Earnings per shareIFRS|Earnings per shareIFRS

(5)

In the second step of the convergence test, the trend over time of each of the above fourdifference measures for each company is examined. The beta coefficient of the trend of eachdifference measure over time is the convergence measure for each company in the study. Fourconvergence measures are obtained: a convergence measure of net income differences over time(BETANI), a convergence measure of net assets differences over time (BETANA), a convergencemeasure of return on net assets differences over time (BETARONA), and a convergence measure


of earnings per share differences over time (BETAEPS). A negative coefficient would indicatedeclining differences over time, i.e., convergence.

6. Data analysis and results

6.1. Comparability

The data pertaining to the comparability of accounting numbers of PRC companies under IFRSand U.S. GAAP are presented in Table 2.

This table reports the index of comparability by company for each year in the study, alsothe average comparability index for each company over all the years available. For example,the 1996 index of comparability for China Eastern Airlines was 0.90, indicating that net incomefor China Eastern Airlines per IFRS was approximately 90% of net income for China EasternAirlines per U.S. GAAP. The last two columns in the table show the comparability determinationat two different materiality thresholds. Net income per IFRS and net income per U.S. GAAP weredeemed comparable at a 5% materiality threshold if both the average comparability index andthe index for the most recent year in the study were between 0.95 and 1.05. They were deemedcomparable at a 10% materiality threshold if both the average comparability index and the indexfor the most recent year in the study were between 0.90 and 1.10.

The results show that IFRS and U.S. GAAP do produce materially different measures (10 outof 11 companies) of net income, at a materiality threshold of 5%, for PRC companies listed on theNYSE. Even at the more liberal materiality threshold of 10%, a majority (6 out of 11) companiesin the study still exhibit materially different measures of net income per IFRS and net income perU.S. GAAP. For virtually all companies listed in this study (10 of 11), the average comparabilityindex is less than 1.00, indicating net income per U.S. GAAP is generally higher than net incomeper IFRS.

Reasons for the observed lack of comparability are explored in Table 3. Each row of this tableshows an analysis of the total difference between net income per IFRS for a particular companyand net income per U.S. GAAP for the same company for the year 2002. The first column showsthe name of the company. The second column shows the total amount of the adjustments betweenIFRS net income and U.S. net income for that company, expressed as a percentage of net assets forthat company. For example, for China Eastern Airlines, the total amount of the income differenceis 2.19% of China Eastern Airlines IFRS net assets. This amount is called the total adjustment.A positive percentage here indicates that U.S. net income was higher than IFRS net income byan amount equal to approximately 2.19% of IFRS net assets. The next five columns show theamounts of five adjustment classifications from the Harris and Muller (1999) taxonomy. Theseare called partial adjustments. This taxonomy originally had seven adjustment classifications, butno PRC company in this study reported either a pension adjustment or an adjustment for researchand development, so only five of the seven categories from the Harris and Muller taxonomy areused in this study. Thus, China Eastern Airlines reported a partial adjustment for deferred incometaxes of −0.39%, meaning that the effect of differences in deferred taxes reduced U.S. net incomefrom IFRS net income by an amount equal to 0.39% of IFRS net assets. This negative partialadjustment for China Eastern Airlines was offset by positive adjustments of 2.25% for tangibleasset revaluations and positive 0.32% for other. Thus, for China Eastern Airlines, the category,tangible asset revaluations, is the most significant factor affecting the overall difference in netincome per IFRS and net income per U.S. GAAP. In fact, the category tangible asset revaluationsis the largest partial adjustment category for 8 of the 11 companies in the sample.


Table 3Analysis of net income adjustments from IFRS to U.S. GAAP for the year 2002

Company IFRS-U.S. net income adjustments

Total adjustmentas a percentage ofIFRS net assets

Partial adjustments as a percentage ofIFRS net assetsa

Goodwill Deferredincometaxes

Foreignexchangeadjustments

Tangible assetrevaluations

Other

China Eastern AirlinesCorporationb

2.19 −0.39 2.25 0.32

China Petroleum andChemical Corporationb

2.22 −0.98 0.05 3.02 0.12

China Southern AirlinesCompany

−1.06 0.50 0.34 −1.90

China Telecom Corporation −0.86 0.42 −1.28Guangshen Railway 0.40 −0.07 0.47Huaneng Power

Internationalb−0.08 −0.29 0.11 0.09

Jilin Chemical IndustrialCompany

16.20 0.07 16.13

PetroChina Companyb 0.92 −0.86 2.54 −0.75Sinopec Beijing Yanhua

Petrochemicalb0.41 −0.55 1.07 −0.10

Sinopec ShanghaiPetrochemical Company

1.49 0.21 −0.23 0.27 0.93 0.31

Yanzhou Coal MiningCompany

1.04 −0.27 −0.64 1.95

a None of the companies in this study reported an IFRS-U.S. GAAP adjustment due to pensions or research anddevelopment.

b Some of the partial adjustments do not add to the total adjustment due to rounding.

In order to understand the effect of these revaluations, the procedures under IFRS are brieflyoutlined, and then the revaluations used by the companies in the study are analyzed. IFRS per-mits valuation of property, plant, and equipment at either historical cost, or at historical costsubject to periodic revaluation. U.S. GAAP permits only historical cost. A summary of IAS 16(Hussey & Ong, 2005, p. 99) outlines the basic accounting for property, plant and equipmentrevaluations:

• Revaluations should be carried out regularly, so that the carrying amount of an asset does notdiffer materially from its fair value at the balance sheet date.

• The entire class of assets to which that asset belongs should be revalued.• Depreciation is charged in the same way as under the cost basis.• Increases in revaluation value should be credited to equity under the heading “revaluation

surplus” unless they represent the reversal of a revaluation decrease of the same asset previouslyrecognized as an expense, in which case it should be recognized as income.

• Decreases as a result of a revaluation should be recognized as an expense to the extent that theyexceed any amount credited to the revaluation surplus relating to the same asset.

• Disposal of revalued assets can lead to a revaluation surplus that may be either transferreddirectly to retained earnings, or it may be left in equity under the heading “revaluation surplus.”


Table 4Analysis of property, plant and equipment revaluations

Company Valuation basis except forland use rights

Revaluationdates

Purpose of revaluation Direction ofrevaluation

China Eastern AirlinesCorporation

Historical cost subject torevaluations

6/30/1996 Restructuring Upward

12/31/2002 Periodic Downward

China Petroleum andChemical Corporation



12/31/2000 Acquisition Upward

China Southern AirlinesCompany



China Telecom Corporation Historical cost subject torevaluations

12/31/2001 Restructuring Downward

Guangshen Railway Historical cost subject torevaluations


Huaneng Power International Historical cost N/A N/A N/A

Jilin Chemical IndustrialCompany



2/28/1995 HK Stock Exchangelisting

Upward

12/31/2002 Periodic Downward

PetroChina Company Historical cost subject torevaluations

6/30/1999 Reorganization Upward

Sinopec Beijing YanhuaPetrochemical


4/23/1997 Reorganization Upward

Sinopec ShanghaiPetrochemical Company


Prior to2001

Reorganization Upward

Yanzhou Coal MiningCompany

Historical cost N/A N/A N/A

An upward revaluation of property, plant, and equipment assets would result in net assets perIFRS being higher than net assets per U.S. GAAP. This would result in a downward adjustmentfrom net assets per IFRS to net assets per U.S. GAAP on a 20-F reconciliation for a company thathad revalued its assets upwards. Since the depreciation base would now be higher for a companythat had revalued its assets upward, that company’s depreciation expense would also be higherresulting in a lower net income. This would result in an upward adjustment from net income perIFRS to net income per U.S. GAAP on a 20-F reconciliation for a company that had revalued itsproperty, plant, and equipment upward.

Downward revaluations of property, plant, and equipment are also possible. A downwardrevaluation under IFRS would require an upward adjustment of fixed assets from IFRS to U.S.GAAP on a 20-F reconciliation, and a downward adjustment of net income from IFRS to U.S.GAAP on a 20-F reconciliation. In addition, a downward revaluation could result in a direct effecton net income if the downward revaluation were in excess of any previous upward revaluation ofthe same asset. This would result in a lower net income per IFRS after the downward revaluation,and would require an upward adjustment of net income on a 20-F reconciliation of IFRS netincome to U.S. GAAP net income.


Fixed asset revaluations for the companies in the study are analyzed in Table 4. Land, accordingto socialist theory in the PRC, is owned by the people. Therefore land is not owned by a corporationbut is rather leased from the people through land use rights for a specified period of time. Land isnormally found on the balance sheet of a PRC company as an operating lease, at historical costsubject to amortization. Prior to the adoption of IFRS by PRC companies, land was sometimesrevalued upwards. Recently, these revaluations have been reversed since the land was usuallygranted from a related party. In these cases, the historical cost of the land has been considerednil. Adjustments to land use rights have been relatively minor, and are not considered in thisstudy.

Of the 11 companies in the study, only 2, Huaneng Power International and Yanzhou CoalMining Company, use historical cost to value their property, plant, and equipment. These twocompanies are comparable at the 10% level of materiality. The remaining nine value their fixedassets on the balance sheet using historical cost with revaluations, and follow procedures similarto those outlined above. The vast majority of the revaluations have been upward, at the initial reor-ganization or restructuring of the enterprise. In the PRC, a huge amount of industrial restructuringtook place as a result of the PRC’s movement from a planned economy to a more market-orientedand more open economic system. There have been some downward revaluations, however, notablyChina Eastern Airlines in 2002, China Telecom in 2001, and Jilin Chemical in 2002. There is somesuspicion, however, that PRC state-owned entities have large amounts of unproductive property,plant, and equipment that may generate downward revaluations in the future.

Thus, the most significant cause of lack of comparability between IFRS and U.S. GAAP inthe PRC companies in the study is the fact that IFRS permits revaluation of fixed assets and U.S.GAAP requires historical cost as a basis for valuing property, plant and equipment. Nine of 11PRC companies in this study have chosen to revaluate their property, plant and equipment. It isworth noting, however, that the concept of historical cost may not be appropriate in the PRC.U.S. GAAP makes the implicit assumption that historical cost has been determined by the freeinterplay of market forces. This assumption is clearly not appropriate in the PRC.

6.2. Convergence

The examination of comparability indicated that only 1 of the 11 companies, Huaneng PowerInternational, was deemed to be comparable at a 5% materiality threshold. The remaining 10companies were deemed to be not comparable and were tested for convergence. The results ofthe convergence testing are shown in Table 5.

Each row of Table 5 shows the convergence testing results for a single company. NegativeBETA coefficients on this table indicate evidence of convergence for each particular convergencemeasure.

For example, the first row shows the results for China Eastern Airlines. For this company,BETANI, the coefficient of the trend line of the net income differences over the 7 years of thestudy, is 0.004. This indicates no evidence of net income convergence. The R2 measure for thiscoefficient is 0.0866. BETANA, the net assets convergence measure for China Eastern Airlines,is −0.031. This negative coefficient indicates that the differences between net assets per IFRSand net assets per U.S. GAAP are becoming smaller over time, demonstrating convergence. Thisfinding is supported by a relatively high R2 of 0.6533. BETARONA, the return on assets differencemeasure is −0.004 and the corresponding R2 is 0.0499 indicating weak convergence. BETAEPS,the convergence measure for earnings per share, is 0.336, demonstrating no evidence convergence.Table 6 summarizes the results of the study by company for both comparability and convergence.

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Table 5Convergence measures for companies with material differences in net income per IFRS and net income per U.S. GAAP

Company Yearsof data

Net income convergencemeasure

Net assets convergencemeasure

Return on net assetsconvergence measure

Earnings per shareconvergence measure

BETANI R2 BETANA R2 BETARONA R2 BETAEPS R2

China Eastern Airlines Corporation 7 0.004 0.0866 −0.031 0.6533 −0.004 0.0499 0.336 0.1744China Petroleum and Chemical

Corporation5 0.004 0.4401 −0.054 0.9087 0.000 0.0002 0.016 0.1017

China Southern Airlines Company 7 −0.007 0.3578 −0.018 0.3573 −0.019 0.4085 0.018 0.001China Telecom Corporation 3 −0.072 N/Aa 0.020 N/Aa 0.061 N/Aa 0.021 N/Aa

Guangshen Railwayb 7 0.000 0.0000 0.003 0.2191 −0.001 0.6899 0.008 0.6716

Huaneng Power International 5 Comparable—no material difference at 5% materialityJilin Chemical Industrial Company 7 0.016 0.5525 0.013 0.1870 0.048 0.4315 −0.139 0.5661PetroChina Companyb 4 −0.003 0.6085 −0.042 0.9322 −0.013 0.9057 −0.022 0.6253Sinopec Beijing Yanhua

Petrochemical7 0.000 0.0049 0.000 0.0025 −0.001 0.0449 0.012 0.0063

Sinopec Shanghai PetrochemicalCompanyb

7 0.000 0.0803 −0.008 0.7046 −0.000 0.0009 0.041 0.0117

Yanzhou Coal Mining Companyb 7 0.000 0.0003 −0.030 0.5687 −0.005 0.2011 −0.054 0.3415

a Data for China Telecom is N/A due to the small number of observations.b These companies are comparable at a 10% level of materiality.

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Table 6Summary of results by company

Company Comparability Convergence

5% Materiality 10% Materiality Net income Net assets Return onnet assets

Earningsper share

Number ofmeasures

China Eastern Airlines Corporation No No Yes Yes 2China Petroleum and Chemical

CorporationNo No Yes 1

China Southern Airlines Company No No Yes Yes Yes 3China Telecom Corporation No No Yesa 1Guangshen Railway No Yes Yes 1

Huaneng Power International Yes Yes Convergence was not tested since comparability at a 5% materiality thresholdwas indicated

Jilin Chemical Industrial Company No No Yes 1PetroChina Company No Yes Yes Yes Yes Yes 4Sinopec Beijing Yanhua

PetrochemicalNo Yes Yes 1

Sinopec Shanghai PetrochemicalCompany

No No Yes 1

Yanzhou Coal Mining Company No Yes Yes Yes Yes 3

Number of companies 1 5 3 6 6 3 18

a China Telecom data were available for only 3 years, so a conclusion on convergence might be questionable.


The first column of Table 6 shows the name of the company. Columns 2 and 3 show the resultsof comparability testing. For example, China Eastern Airlines was deemed not comparable ateither 5 or 10% levels of materiality. Columns 4–7 summarize the convergence testing for eachcompany. China Eastern Airlines, for example, showed evidence of net assets convergence andreturn on net assets convergence. The last column shows the total number of measures indicatingconvergence for each company.

Only one company, Huaneng Power, was deemed comparable at a 5% materiality threshold. Ata more liberal 10% materiality threshold, however, 5 of the 11 companies in the study were deemedcomparable. Convergence testing was performed on the 10 companies not deemed comparable atthe 5% materiality threshold. Three of these 10 companies indicated that measures of net incomeper IFRS and per U.S. GAAP were converging over time; 6 of the 10 companies indicated thatmeasures of net assets per IFRS and per U.S. GAAP were converging over time, 6 of the 10companies indicated that measures of return on net assets per IFRS and per U.S. GAAP wereconverging over time, and 3 of the 10 companies indicated convergence of earnings per share perIFRS and per U.S. GAAP. Of these 10 companies not deemed comparable, only 1, PetroChinaCompany, indicates convergence on all 4 measures. Two of the companies indicate convergenceon three measures, one of the companies indicates convergence on two of the measures, and sixof the companies indicate convergence on only one measure.

The most frequently appearing convergence measure is net assets, since 6 of the 10 companiestested in this study demonstrate convergence on this measure. This is not surprising since prop-erty, plant, and equipment revaluations were shown to be the most significant cause of lack ofcomparability. As Table 4 shows, most PRC companies in this study revalued their assets upwardupon reorganization, creating a revaluation surplus. This surplus was then reversed when recon-ciling from IFRS net assets to U.S. GAAP net assets on a firm’s 20-F reconciliation. Unless therewere additional upward revaluations, this surplus remained the same. If a company’s assets weregrowing, the value of this surplus relative to total assets would decrease, resulting in net assetsconvergence in this study.

The effect of property plant and equipment revaluations on a firm’s net income is less pre-dictable, however. Property, plant and equipment revaluations affect a firm’s net income via theadditional depreciation expense as the result of upwardly revalued assets. If income is volatile,however, the size of the additional depreciation expense under IFRS accounting would fluctuaterelative to net income. Thus, IFRS net income and U.S. GAAP net income are less likely to con-verge over time than would IFRS net assets and U.S. GAAP net assets. This is shown in Table 6in which 6 of the 10 companies indicate net assets convergence while 3 out of the 10 companiesindicate net income convergence and earnings per share convergence.

7. Conclusions

This study provides evidence that despite movement toward harmonization and convergence,the PRC companies listed on the NYSE report materially different measures of net income underIFRS and U.S. GAAP. Despite much progress toward de jure harmonization between IFRS andU.S. GAAP, de facto harmonization has not been achieved at least as evidenced by PRC firmsreporting under IFRS and reconciling to U.S. GAAP. Generally, net income for PRC companiesreported per IFRS is less than net income per U.S. GAAP. The most significant reason for theobserved lack of comparability was the revaluation of fixed assets. Since IFRS permits upwardrevaluation of property, plant and equipment, many PRC firms adopt this option for their IFRSreporting, most likely due to its widespread use under Hong Kong GAAP which also makes use of


revaluations. U.S. GAAP, however, requires historical cost accounting for its property, plant andequipment. These revaluations obviously affect net assets, but upward revaluations of property,plant, and equipment also cause reported net income differences due to the larger depreciationamounts reported under IFRS on upwardly revalued property, plant and equipment. Despite thesecomparability difficulties, there is evidence of de facto convergence among those PRC companiesthat were not deemed to be comparable. It is expected that the de jure convergence efforts of theIASB and the U.S. FASB should result in some evidence of de facto harmonization, and this isevidenced by the convergence measures in this study.

7.1. Limitations

This study is limited since it is not generalizable beyond the small but important subset of PRCcompanies that are NYSE-listed. NYSE-listed PRC firms are most likely different from non-NYSE-listed PRC firms simply due to the fact that their accounting is subject to U.S. Securitiesand Exchange Commission review. In addition to this review, the PRC government must itselfapprove a foreign listing. Other PRC firms would most likely have less sophisticated accountingsystems since they are not subject to as much external scrutiny. In addition, the study only analysescertain accounting numbers: net income, net assets, return on net assets, and earnings per share.The possibility of cash flow differences between IFRS and U.S. GAAP was not addressed in thisstudy. Finally, this study only shows that the accounting numbers produced under the various setsof accounting standards are different. It does not purport to show that the differences are importantin the valuation of the firm.

7.2. Implications for investors

This research demonstrates that IFRS and U.S. GAAP still produce different accounting num-bers. It is crucial that investors be aware of the GAAP under which an accounting number iscalculated when comparing it to other companies or to benchmark statistics. Despite a longmarch toward accounting harmonization, investors may be misled if they compare an accountingnumber for a PRC Company reporting under IFRS to a corresponding benchmark statistic forU.S. GAAP reporting companies. To be specific, reported net income per U.S. GAAP is generallyhigher than net income per IFRS. On the other hand, reported net assets per U.S. GAAP aregenerally lower than net assets reported per IFRS. Most likely, these differences are related: U.S.GAAP requires assets to be valued at historic cost, while IFRS permits revaluation of net assetsto market value. If a PRC company chooses to revalue its assets under IFRS, net assets per IFRSwill likely be higher than net assets per U.S. GAAP. This upward revaluation would result in ahigher annual depreciation charge under IFRS than under U.S. GAAP, causing a higher reportednet income under U.S. GAAP. Investors in PRC firms are advised to pay particular attentionto the valuation basis for assets at a PRC company. In addition, the suspected obsolescence ofthe plant assets of many state-owned enterprises in the PRC makes write-offs of assets highlylikely.

This research clearly shows that IFRS and U.S. GAAP are not comparable using Choi et al.(2001) definition of comparability: “. . . similar in enough ways that financial statement userscan compare it (at least along some dimensions) without needing to be intimately familiar withmore than one system.” To be specific, users must know the process by which property, plant andequipment are valued and revalued. In the PRC, this difficulty is compounded by the reportedlymassive amount of obsolete and non-productive property, plant and equipment held by the PRC


SOE’s. Additionally, the role of judgment in declaration of any impairments leads to the realopportunity for income manipulation.

7.3. Implications for researchers

This research underlines the need for researchers to develop viable operational metrics forcomparability and convergence. Comparability of a set of financial statements prepared underIFRS and a set of financial statements prepared under U.S. GAAP, in this research, is determinedby comparing reported net incomes. If net incomes are within plus or minus 5% of each other,the financial statements are deemed to be comparable. It is possible that other dimensions ofa company might not be comparable even if the reported incomes under two different sets ofaccounting standards are within 5% of each other.

The huge impact of upward revaluations of property, plant and equipment leads to an inter-esting dilemma. Disclosing of property, plant and equipment values at both revalued cost (underIFRS) and historic cost (under U.S. GAAP) would provide more information to shareholders thansimply disclosing one of the property, plant and equipment values. Researchers need to investi-gate the value-relevance of these dual disclosures. In this scenario, a stated goal of convergencemight actually work against the interests of the financial statement users. Particularly in the PRC,historical cost is a questionable concept, since much of the property plant and equipment is stillowned by the state in a socialist market economy, and the valuation is not determined by theinterplay of free market forces.

The development and testing of an operational metric for convergence is an equally complextask. This research shows that convergence is a multidimensional concept, involving many dif-ferent accounting numbers. Mathematical convergence of one set of accounting numbers doesnot imply mathematical convergence of a second set of accounting numbers, and this is demon-strated clearly by this research. Net assets convergence does not imply convergence of net income.Researchers need to introduce multiple measures of convergence.

Future research directions suggested by this study include using this methodology to comparePRC standards to IFRS and U.S. GAAP. The sample size of this study might be expanded byincluding PRC firms that are listed on other stock exchanges than the NYSE such as NASDAQ.Accounting numbers other than net income and net assets, such as cash flow from operationsmight be considered in further research. Finally, the metrics introduced in this study might betested in other contexts in which there is dual or three way reporting by a single entity underdifferent sets of accounting standards.

Acknowledgements

I would like to thank Kathleen Sinning (the editor) and two anonymous reviewers who providedhelpful comments on earlier versions of this manuscript.

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Are IFRS and U.S. GAAP Converging

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