Journal of International Accounting, Auditing and Taxation 15 (2006) 4871

Are IFRS and U.S. GAAP converging? Some evidence from Peoples Republic of China companies listed on the New York Stock Exchange
John L. Haverty
St. Josephs University, 5600 City Ave., Philadelphia, PA 19131, United States

Abstract This research investigates the comparability and convergence of two sets of accounting standards from 1996 to 2002: United States Generally Accepted Accounting Principles (U.S. GAAP) and International Financial Reporting Standards (IFRS). The investigation involves a sample of companies from the Peoples Republic of China (PRC) that are listed on the New York Stock Exchange (NYSE). PRC companies traded on the NYSE generally prepare IFRS nancial statements and provide a limited reconciliation to U.S. GAAP, creating a unique quasi-experimental opportunity to examine differences between two sets of accounting numbers produced by two different sets of accounting standards while holding the company constant. Comparability is measured by using Grays index of comparability, and a set of measures are introduced to capture several dimensions of convergence over time in reported net income, net assets, return on net assets, and earnings per share. The evidence shows lack of comparability, caused largely by the revaluations of property, 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; Peoples Republic of China; International Financial Reporting Standards; IFRS; Accounting harmonization

1. Introduction This research investigates the comparability of two sets of accounting standards from 1996 to 2002: 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: jhaverty@sju.edu.

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

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Financial Reporting Standards1 (IFRS). The research also examines changes in comparability over time, i.e., convergence. The stated goal of the International Accounting Standards Board (IASB) and its predecessor organization, the International Accounting Standards Committee (IASC) has been to bring about convergence of National Accounting Standards and International Accounting Standards. In addition, the United States accounting standard-setting body, the Financial Accounting Standards Board (FASB) has in recent years held the position that it will formulate its policy with due regard to international considerations. This position has been formalized by the signing of the Norwalk Agreement (Financial Accounting Standards Board, 2002) in which both the FASB and the IASB pledged their best efforts to make their existing nancial reporting standards fully compatible as soon as is practicable. Given this environment of cooperation, convergence of U.S. GAAP with IFRS is expected and should be observable in the nancial statements reported by rms over time. Observation of convergence is a complex task, however, and this research presents a methodology to observe convergence using nancial statements prepared by rms reporting under U.S. GAAP and IFRS. The requirement of the United States Securities and Exchange Commission (SEC) that foreign rms listed on a U.S. Stock Exchange such as the New York Stock Exchange (NYSE) provide a limited reconciliation of their net income and net assets nancial statements prepared under IFRS to U.S. GAAP presents an opportunity to test for convergence. This multiple reporting creates a 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 given year. This investigation involves a sample of Peoples Republic of China (PRC) rms listed on the New York Stock Exchange. PRC companies were chosen for this study not only because of the growing worldwide economic signicance of the PRC, but also because the PRC provides a particularly unique testing ground to explore comparability and convergence issues. The PRC and the United States represent vastly different economic systems with signicantly different accounting systems. With the ongoing economic restructuring within the PRC, however, as well as the gradual opening of the PRC to the international economic community, differences between the PRC accounting system and the U.S. accounting system are expected to become smaller over time. Since PRC companies seeking foreign equity capital are required by PRC law to report under IFRS, and those seeking U.S. equity capital are required by U.S. law to reconcile net income and net assets to U.S. GAAP, we have a situation in which we can compare IFRS-produced accounting measurements to U.S. GAAP-produced accounting measurements for the same company in the same year. The fact that the PRC and the U.S. represent vastly different economic and accounting systems leads us to believe that we should expect an initial lack of comparability between IFRS nancial statements produced by PRC rms, and U.S. GAAP nancial statements produced by those same rms. Over time, however, we should observe convergence. Given this scenario, we have a unique situation in which to test for comparability and convergence between IFRS and U.S. GAAP. This research rst 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 given accounting number (such as net income) calculated under IFRS should be fairly close to that same accounting 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 Standards 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 terminology is used in this study.

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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 calculated according to U.S. GAAP should be shrinking over time. In order to test convergence, this research introduces a series of metrics that measure convergence over time. This research provides evidence of non-comparability. The majority (10 of 11) of the PRC companies 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 signicant cause of the lack of comparability is that revaluation of property, plant and equipment is permitted as an option under IFRS, but U.S. GAAP requires reporting property, plant and equipment on an historical cost basis. The non-comparability is tempered, however, by evidence of convergence over time for the PRC companies that did not indicate comparability. The next section discusses International Financial Reporting Standards and provides some background on accounting harmonization. Then, some background on economic restructuring in the PRC and the PRC accounting system is provided. Specic research questions and the methodology of the study are developed. Results are presented, and the concluding section discusses the implications of the results for investors and researchers. 2. Accounting harmonization, convergence, and International Financial Reporting Standards One challenging aspect of international business is the fact that no two countries have exactly the same accounting standards or procedures (Gernon & Meek, 2004). Diversity in accounting standards is caused by cultural, economic, historic, legal, and political reasons since the accounting system in a particular nation reects the unique aspects of that nation. Diversity in standards unfortunately is a considerable barrier to the cross-border ow of capital. In order to properly evaluate an investment in another country, an investor must translate nancial statements prepared under a foreign set of accounting standards into nancial statements in accord with the accounting standards of the investors home country. Despite the forces favoring international diversity of accounting systems, there are also a number of strong forces favoring harmonization of the various national accounting systems. Some of these factors include the explosive growth in cross-border nancing, improvements in communication technology, the formation of cross-national economic blocs such as the European Union and NAFTA, and efforts by the United Nations. As a consequence, attempts have been made to encourage accounting harmonization at the international level as well as the local level of various nations. 2.1. The accounting harmonization movement Internationally, a milestone in the march toward accounting harmonization was the formation of the International Accounting Standards Commission (IASC) in 1973. The IASC was as an independent, private sector body whose objective was to facilitate the cross-border ow of capital by making nancial statements more comparable even though they were prepared under various sets of National Accounting Standards. Membership in the IASC included professional accounting bodies of various nations. Immediately after its founding in 1973, the IASC chose the 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-

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ticular model. Major international players such as the United States, Japan and various European nations were not forced to change their domestic standards to be in compliance with an emerging set of International Accounting Standards created by the IASC. This strategy insured at least passive international support for IASC efforts from the worlds major nancial powers. As the years progressed, however, the IASC gradually reduced the number of permitted alternative accounting methods. In April 2001, the IASC was restructured and renamed the International Accounting Standards Board (IASB, 2002). Its objectives include: (1) developing a set of high quality, understandable, and enforceable global accounting standards; (2) promoting the use and rigorous application of these standards; and (3) bringing about convergence of National Accounting Standards and International Accounting Standards (International Accounting Standards Board, 2002). Since 1973, the IASB and its predecessor organization, the IASC have issued 41 accounting standards (6 have subsequently been superseded). These standards were formerly known as International Accounting Standards (IAS) and are now called International Financial Reporting Standards. The IASB has no authority to enforce compliance with these standards, but many National Accounting Standard-setting bodies have permitted or encouraged use of IFRS as alternatives or supplements to their own National Accounting Standards. Belgium, France, and Italy, for example, passed laws in 1998 allowing IFRS to be used for domestic nancial reporting. Recently, the International Organization of Securities Commissions (IOSCO) has recommended that its members allow multinational issuers to use the 30 IFRS current at that time in their cross-border offerings and listings. In addition, the European Union announced plans to require IFRS for all European Union listed companies no later than 2005. Harmonization efforts also occur at the local level of various nations. The very existence of IFRS and its persuasive promotion on the part of the IASB have inuenced the development of various National Accounting Standards. Accounting bodies of various nations, even if they have not adopted IFRS, sometimes model their own national standards or at least modify their own standards with international standards in mind. The United States, for example, has not adopted IFRS for domestic reporting but has stated that it will formulate accounting policy with due regard to international considerations. Despite extensive cooperation between the IASB and the United States Financial Accounting Standards Board, many differences exist between IFRS and U.S. GAAP. Deloitte Touche Tohmatsu (2002) lists 78 specic differences between IFRS and U.S. GAAP. The signicance of the differences between IFRS and U.S. GAAP will vary from rm to rm depending on the specic economic circumstances facing each rm. The United States permits foreign companies raising capital in the United States to use either their own domestic accounting 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 closer over time. In recent years, U.S. accounting standards have supposedly been created and revised with 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. economys prominent position in the world economy. These trends have been formalized with the signing of 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 nancial reporting fully compatible as soon as is practical. In spite of these forces favoring harmonization, there are still major differences between IFRS and U.S. GAAP, particularly in the range of accounting practices permitted by IFRS. Recent research (Street & Gray, 1999) concluded that there were major differences still to be resolved, notably in the determination of net prot/loss for the period,

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research and development, changes in foreign exchange rates, and business combinations, but noted 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 IFRS to net income and net assets per U.S. GAAP required by the SEC for foreign registrants using IFRS. Evidence of convergence (Street, Nichols, & Gray, 2000) between IFRS and U.S. GAAP was presented for a sample of non-U.S. companies reporting under IFRS and providing a limited reconciliation from IFRS to U.S. GAAP. 2.2. The concept of accounting harmonization Accounting harmonization is dened as . . . a process of increasing the comparability of accounting practices by setting limits on how much they can vary. Harmonized standards are free of logical conicts, and should improve the comparability of nancial information from different countries (Choi, Frost, & Meek, 2001, p. 291). Accounting harmonization is a process leading to the ultimate goal of increasing comparability of nancial information across national borders. Accounting harmonization is a multi-faceted concept, containing at least three components of accounting harmonization (Choi et al., 2001): (1) harmonization of accounting standards, which deals with measurement and disclosure; (2) harmonization of disclosures made by publicly traded 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 is inuenced by a myriad of additional factors. For example, if a nation does not have an auditing and standards enforcement infrastructure, then there is no guarantee that accounting numbers (such as net income or net assets) reported under a particular set of standards represent an accurate application of those standards. Countries with very similar accounting standards may not be comparable for reasons well beyond the similarity of the respective accounting standards. It is possible to have a situation of only apparent accounting harmonization if the standards are relatively 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 rules to the same situation since each national set of accounting standards allows some degree of choice 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 de facto 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 but concluded that harmonization is not yet a reality. They noted that compliance with IFRS was not the same as harmonization since IFRS allowed many alternative accounting treatments. De facto, or informal harmonization, refers to the actual accounting practices of corporations. Canibano and Mora (2000) studied de facto harmonization in the European Union and found evidence of de facto accounting harmonization among global players within the European Union. Street et al. (2000) found that the differences between IFRS and U.S. GAAP are narrowing for a sample of 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 of disclosure and measurement criteria. This results in four forms of accounting harmonization: (1) de jure disclosure harmonization, which concerns regulations governing what is disclosed; (2) de jure measurement harmonization, which concerns regulations governing how reported quantities are measured; (3) de facto disclosure harmonization, which concerns what corporations actually

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disclose; and (4) de facto measurement harmonization, which concerns how corporations actually measure quantities. 2.3. The concept of accounting convergence Recently, the term accounting harmonization has at times been replaced by the term accounting convergence. This term has been dened as: The process pursued by the International Accounting Standards Board (IASB) of eliminating the present differences between National Accounting Standards and the avoidance of future differences to achieve international accounting harmonization (Hussey & Ong, 2005, p. 229). In this sense, accounting convergence is a process that occurs at the standard-setting level intended to achieve a state of de jure accounting harmonization. It is possible to measure de jure harmonization 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 the nancial reports of companies in a multiple reporting scenario over time. Measuring de facto convergence enables us to measure the actual nancial impact of differences in the accounting standards and enables us to examine the actual choices made by rms. If we consider measurement as a system of assigning numbers to qualities of an object, we can consider a set of accounting standards as rules for measuring aspects of the nancial condition of an organization. If the two measuring systems are equivalent, they should produce the same set of accounting numbers. For example, if U.S. standards and IFRS were equivalent, then net income reported 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 the measuring instruments are not equivalent. If the two sets of accounting standards are becoming harmonized 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 of the term convergence in this research, a strictly mathematical measure of increasing closeness over time of two numbers purporting to measure the same thing. Since the purpose of accounting harmonization is to increase comparability of nancial reports produced by different nations, mathematical convergence2 of reported accounting numbers would be a necessary manifestation of increasing de facto accounting harmonization. Financial information produced under different accounting, disclosure, and/or auditing systems is comparable if it is . . . similar in enough ways that nancial statement users can compare it (at least along some dimensions) without needing to be 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 possible to compare accounting numbers even if they do not converge over time. For example, the accounting numbers produced by one system might be different from the accounting numbers

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

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produced by a second system in some consistent and understandable fashion. In such a scenario, the nancial statement user might be able to make simple adjustments to facilitate comparison. Accounting numbers produced by two different sets of accounting standards could also converge but not be comparable. For example, one set of accounting standards might facilitate income smoothing more than another set of accounting standards. In this scenario, the reported net income numbers might converge over time, but the set of accounting standards that facilitates income smoothing would be expected to show less variability than the set of accounting standards that discourages income smoothing. Such a situation would make comparison quite difcult. 3. Economic restructuring in the Peoples Republic of China The PRC is used in this study due to its growing importance in the world economy. It also provides an example of a nation whose accounting system is very different from the United States but is supposedly becoming more similar to Western accounting systems due to its desire to become more integrated into the world economy. In order to understand the accounting system of the PRC, it is necessary to view it in the larger context of the monumental economic restructuring that is taking place within that nation. As part of this restructuring, the PRC has developed an equity market to raise much needed capital for reform and expansion. In addition, the accounting system of the PRC is being transformed from a largely Soviet-era model designed to facilitate central planning to a model more compatible with the PRCs 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 has meant the gradual change in economic philosophy from isolationism to integration with the world economy. Restructuring involves a transformation of the economy to make it more competitive with the other major economic powers, changing it from a centrally planned economic system to something called a socialist market economy. It is important to note that the transformation does not mean that the PRC is now a market economy. The socialist market economy is a unique blend of socialism and capitalism; it is a large portion of socialism along with certain changes toward a market economy. The basic idea of the socialist market economy appears to be preservation of the economys socialist core, state rms and state banks, while making incremental changes in other areas. These changes include establishing markets, eliminating central planning, and allowing non-state-owned industry to prosper (Steinfeld, 1999). This transformation parallels similar but much more abrupt and traumatic transformations in many Eastern European countries over the same time period. The Chinese government is acutely aware of the social disruptions that took place along with the economic transformations in Eastern Europe. As a result, the PRC has chosen a 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-owned enterprises (SOEs). These are sometimes very large businesses nanced and controlled by the central or local governments. They bought from and sold to other SOEs and their debts were largely guaranteed by the state. It is important to note that these SOEs also had an important social role in addition to their economic role. As large employers, they offered a system of guaranteed employment as well as various social services: the SOEs operated their own housing units, schools, hospitals, recreation facilities, and retirement facilities.

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3.2. Accounting in the PRC As the Chinese economic system has been undergoing transformation, Chinese nancial accounting has been transformed as well. The role of accounting information in a centrally planned economy is far different from its role in a socialist market economy. In a centrally planned economy, the users of accounting information are primarily the central planners responsible for making broad macroeconomic decisions as well as decisions on allocating government funds to various state-owned enterprises (SOEs). To serve this group of users needs, the accounting information from the SOEs needs to emphasize uniformity and rigidity and provide information to the central planners to show that the enterprises are meeting state-mandated production quotas, and efciency standards. In a market economy, nancial accounting serves external users, such as banks and equity investors, who provide capital and need high quality information to assess the loan or investment 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 investment opportunity 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 development of a set of accounting standards to govern external nancial reporting for Chinese companies. The PRC has also chosen a government directed method of setting accounting standards, with wide consultation including domestic and international experts. Rather than importing accounting standards, such as IFRS or the Generally Accepted Accounting Principles of another country such as 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 China that incorporates IFRS but reects the unique aspects of the Chinese environment. The government felt this was the most constructive method noting that China was a large, developing country with wide regional development disparities, and the concept of a socialist market economy was quite new to China (Zhang, 1997). Thus, Chinese accounting standards are a rapidly evolving set of standards based largely on IFRS but with unique, evolving aspects, and heavy government involvement. To date 13 standards have been issued by the PRC. The last three of these standards were effective from 1 January 2001. An additional 17 standards are in exposure draft status. Regulations in the PRC nancial markets require reporting under a variety of accounting regimes given the extent to which a companys stock is traded. Companies that have issued Ashares (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 held by foreigners as well as PRC citizens) or N-shares (shares that trade overseas, for example New York, London or Singapore) must follow IFRS. Companies that have issued H-shares (shares that trade in Hong Kong only) may follow Hong Kong GAAP or IFRS. If a PRC company lists shares in the United States, the U.S. Securities and Exchange Commission requires that the company provide a reconciliation of net income and net assets per IFRS to net income and net assets per U.S. GAAP. These reconciliations are parts of a foreign rms Form 20-F registration with the SEC, and are sometimes found in a foreign rms annual report or in a supplemental report to North American investors. Thus, PRC companies listing on the New York Stock Exchange would likely prepare nancial statements under PRC GAAP, IFRS (or sometimes Hong Kong GAAP3 ) and provide reconciliations to U.S. GAAP.
3 Hong Kong was returned to the Peoples Republic of China in 1997. It is governed as a Special Administrative Region under a one countrytwo systems policy and retains its former nancial systems and institutions. International relations

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As noted, the historic, political, and economic factors at work in the Peoples Republic of China have created an accounting system quite different from that of the United States. The pace and extent of economic change, driven by a desire to attract foreign investment and become integrated into the worldwide economy should result in an accounting system that is becoming more similar to IFRS and to U.S. GAAP. It is expected that this situation would cause IFRS reported nancial statements (for PRC companies) not to be comparable to U.S. GAAP reported nancial statements due to the vastly different underlying economic and accounting systems. These differences are expected 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 of two sets of accounting standards, IFRS and U.S. GAAP, in one country, the PRC. The relationship between these two sets of accounting standards is examined through the lens of PRC companies listed on the New York Stock Exchange. The rst two research questions address the issue of comparability: Research Question 1: Are IFRS and U.S. GAAP producing accounting numbers for PRC companies listed on the NYSE that are comparable? Research Question 2: What are the reasons for any observed lack of comparability between IFRS and U.S. GAAP for PRC companies listed on the NYSE? If the accounting numbers produced by IFRS are comparable, then convergence is not really an issue. If, however, the numbers produced by each of the two accounting systems are not comparable, then the issue of convergence over time must be addressed. Research Question 3: Are IFRS and U.S. GAAP producing accounting numbers for PRC companies listed on the NYSE that are converging over time? 5. Methodology These research questions are addressed via a longitudinal study of the PRC rms traded on the NYSE. A rm-by-rm approach is taken in this study since investors look at the market on that basis. An alternative approach would involve averaging across all rms. These PRC rms provide a set of nancial statements under IFRS and also provide a Form 20-F reconciliation of net income and net assets from IFRS to U.S. GAAP. Table 1 lists the universe of 14 PRC rms listed on the NYSE as of August 20, 2003, and shows their NYSE symbol, and industry classication. Form 20-Fs were obtained for each of the 14 companies listed in Table 1. Three companies, shown in italics, did not provide IFRS nancial statements and were dropped from the study, resulting in a sample of 11 rms from a universe of 14 rms. The rms dropped were Aluminum Corporation of China, China Unicom, and CNOOC, which provided statements using Hong Kong GAAP 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 Peoples Republic of China. Hong Kong maintains its own accounting standards (Hong Kong GAAP) which were developed when Hong Kong was a British colony, and were heavily inuenced by British accounting standards.

Table 1 Peoples Republic of China companies listed on the New York Stock Exchange as of August 20, 2003 Company Symbol Industry Total assets 2002 in RMB millions (per IFRS) Not in sample 32,762 375,881 37,188 210,852 Not in sample Not in sample 11,258 48,461 13,665 483,149 10,260 26,086 12,924 1,262,486 152,539 Total Revenue 2002 in RMB millions (per IFRS) Not in sample 13,345 340,042 18,019 75,496 Not in sample Not in sample 2,518 18,474 13,138 244,424 9,443 21,723 7,772 764,394 92,357 Net Income 2002 in RMB millions (per IFRS) Not in sample 86,369 16,080 575 16,864 Not in sample Not in sample 557 3,921 (1,023) 46,910 209 916 1,222 172,600 20,854 Net income 2002 in RMB millions (per U.S. GAAP) Not in sample 247,736 19,515 474 15,794 Not in sample Not in sample 598 3,895 (685) 49,837 230 1,125 1,326 339,845 41,061

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Aluminum Corporation of China China Eastern Airlines Corporation China Petroleum and Chemical Corporation China Southern Airlines Company China Telecom Corporation China Unicom CNOOC Guangshen Railway Huaneng Power International Jilin Chemical Industrial Company PetroChina Company Sinopec Beijing Yanhua Petrochemical Sinopec Shanghai Petrochemical Company Yanzhou Coal Mining Company Total in sample (RMB million) Total in sample (US$ million)

ACH CEA SNP ZNH CHA CHU CEO GSH HNP JCC PTR BYH SHI YZC

Aluminum production Airlines operation Petroleum and petrochemicals Commercial airline services Fixed-line tele-communication Tele-communications Oil and gas Rail transportation Holding company/power plants Chemical products manufacturing Oil and gas exploration Petrochemical production Petrochemical production Coal mining

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

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Table 2 Comparability measures for Peoples Republic of China companies included in the study Company Grays index of comparability 1996 China Eastern Airlines Corporation China Petroleum and Chemical Corporation China Southern Airlines Company China Telecom Corporation Guangshen Railway Huaneng Power International Jilin Chemical Industrial Company PetroChina Company Sinopec Beijing Yanhua Petrochemical Sinopec Shanghai Petrochemical Company Yanzhou Coal Mining Company 0.90 0.82 0.97 0.78 1.04 0.86 1.05 1997 0.80 0.90 0.95 0.58 0.92 0.82 1.03 1998 1.04 0.36 1.07 0.94 1.00 0.50 0.54 0.59 0.85 1999 0.26 0.90 0.22 0.93 1.00 0.90 0.87 0.73 0.79 0.88 2000 0.24 0.89 1.46 1.00 0.92 1.01 0.56 0.91 0.89 0.84 0.92 2001 1.14 0.93 0.80 0.47 0.93 0.92 1.16 0.90 1.38 0.39 0.79 2002 0.35 0.82 1.21 1.07 0.93 1.01 0.51 0.94 0.91 0.81 0.92 Mean 0.68 0.78 0.93 0.84 0.94 0.99 0.71 0.90 0.92 0.73 0.92 Comparability determination At 5% materialitya Not comparable Not comparable Not comparable Not comparable Not comparable Comparable Not comparable Not comparable Not comparable Not comparable Not comparable At 10% materialityb Not comparable Not comparable Not comparable Not comparable Comparable Comparable Not comparable Comparable Comparable 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 comparability index 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 comparability index and the index for the most recent year in the study were between 0.90 and 1.10.

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that provide nancial reports in accordance with IFRS. For each of the 11 rms remaining in the sample, Table 1 also shows some summary statistics, including total assets, total revenue, net income 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 comply with IFRS. The issue is not deemed a problem in this study since the IFRS statements in the study were all audited and attested to by either Pricewaterhouse Coopers, KPMG or Deloitte Touche Tohmatsu. In addition, a 20-F ling is subject to U.S. Securities and Exchange Commission review as well. Annual reports and Forms 20-F for each of the years 19962002 were collected where possible, resulting in potentially 7 years of data. It was not possible to obtain 7 years of data for all companies in the sample since a number of the companies were not listed on the NYSE until after 1996. Net income per IFRS and U.S. GAAP, net assets per IFRS and U.S. GAAP, and earnings per share per IFRS and U.S. GAAP were obtained from the Supplementary Information for North American Shareholders or from the Form 20-F. All net income, net assets, and earnings per share numbers are reported in PRC currency, the renminbi (RMB) also sometimes called yuan. An additional measure, 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 data in the study. The index of comparability is: 1 (Net incomeUSA Net incomeIFRS ) |Net incomeUSA | (1)

This index was rst used by Gray (1980) who called it an index of conservatism. This index has recently been called an index of comparability and has been used to compare accounting numbers reported for the same rm under different accounting regimes (Weetman, Jones, Adams, & Gray, 1998 and Street et al., 2000). Alternatives to Grays index of comparability are the H, I, and C indices developed by van der Tas (1988), rened by Archer, Delvaille, & McLeay (1995), and a T index developed recently by Taplin (2004). These indices measure the concentration of choices made by rms among alternative accounting treatments for a particular issue. They do not, however, measure the nancial impact of those choices, nor are they useful to study differences obtained when different accounting systems are applied to the same rm. In Eq. (1), if Net incomeUSA is the same as Net incomeIFRS , then the value of this index will be 1.0. One disadvantage of this index is that it produces extreme values if the denominator is close to zero. The index has the advantage of highlighting any material differences between the two net incomes. An index less than 0.90 means that reported IFRS net income is at least 10% less than U.S. GAAP reported net income. Conversely, an index greater than 1.10 means that IFRS net income is at least 10% greater than U.S. GAAP reported net income. A threshold of 5% is used in this study as an indicator of materiality. Although there is no commonly accepted level of 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 of materiality. This index was calculated for each company for each year of the study. An average index over all the years in the study was also calculated for each company. Net income per IFRS and net income per U.S. GAAP were deemed comparable at a 5% materiality threshold if both the average comparability index and the index for the most recent year in the study were between

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0.95 and 1.05. They were deemed comparable at a 10% materiality threshold if both the average comparability index and the index for the most recent year in the study were between 0.90 and 1.10. In order to explore the reasons for any observed lack of comparability, an empirical analysis is performed on the 20-F reconciliations for the most recent year in the study, 2002. Prior research using 20-F reconciliations (Harris & Muller, 1999) has grouped the reconciliation adjustments into six major classications plus one category for any adjustments that did not t into the six major categories. These categories, along with a brief explanation of some of the major differences between IFRS and U.S. GAAP are as follows: 1. Goodwill: U.S. GAAP, until very recently, required capitalizing goodwill and amortizing it over 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 comprehensive basis for all temporary differences and requires the use of tax rates that reect future tax rates and laws. IFRS allow managers not to recognize deferred assets/liabilities if the book/tax difference is not expected to reverse in the foreseeable future. IFRS also allow managers to choose whether or not to adjust deferred amounts for changes in tax rates and laws. 3. Foreign exchange adjustments: IFRS provide much more exibility than U.S. accounting standards. In the United States, foreign exchange gains and losses on forward contracts and hedges 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 current exchange 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 and development expenditures. IFRS permit the capitalization of development expenses. 5. Pensions: U.S. GAAP requires the use of the accrued-benet method and current market-based assumptions. U.S. GAAP requires recognition of a minimum pension liability for under funded plans. IFRS permit the use of both accrued-benet and projected benet valuation methods and requires the use of long-term assumptions. IFRS has no requirement to recognize any liability for under funded plans. 6. Tangible asset revaluations: U.S. GAAP values property, plant and equipment on the historical cost basis subject to impairment. IFRS permit upward as well as downward revaluations of property, plant and equipment. Under IFRS this upward revision would result in additional depreciation expense. 7. Other: Any adjustments that do not t into any of the above categories. The reconciliation items as described in the original 20-Fs were categorized using the above taxonomy, 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 deated by IFRS net assets. This procedure results in a total net income adjustment between net income per IFRS and net income per U.S. GAAP expressed as a percentage of IFRS net assets. There are also a set of partial adjustments relating to each of the above categories again expressed as percentages of

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61

IFRS net assets. The partial adjustments will add up to the total adjustment, so it is possible to determine what the major causes are of any reported difference between IFRS net income and U.S. GAAP net income. 5.2. Convergence For those companies deemed not comparable, tests for convergence were conducted in two steps. The rst step involves calculating difference measure for each company and each year in the study. Each difference measure captures the magnitude of the difference between a particular accounting number (e.g., net income) calculated under IFRS, and the corresponding accounting number calculated under U.S. GAAP. The second step involves calculating the trend over time of each of the difference measures for each company in the study. A negative trend would indicate declining differences over time, i.e., convergence. In the rst step of the convergence test, four difference measures for each company and year in the study are calculated: a net income difference measure (DIFFNI ), a net assets difference measure (DIFFNA ), a return on net assets difference measure (DIFFRONA ), and an earnings per share difference measure (DIFFEPS ). DIFFNI was constructed by computing a yearly measure of the magnitude (absolute value) of the differences between net income per IFRS and net income per U.S. GAAP. This difference was then deated by net assets per IFRS in order to correct for the effect of size of the rm on income, and is consistent with Harris and Muller (1999). The index of comparability was not used here to avoid the effect of the extreme values of the index when 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 deating by net assets per IFRS in order to correct for the effect of size of the rm: DIFFNA = |Net assetsUSA Net assetsIFRS | Net assetsIFRS (3)

DIFFRONA is the absolute value of the difference between return on net assets as computed under U.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 under U.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 four difference measures for each company is examined. The beta coefcient of the trend of each difference measure over time is the convergence measure for each company in the study. Four convergence measures are obtained: a convergence measure of net income differences over time (BETANI ), a convergence measure of net assets differences over time (BETANA ), a convergence measure of return on net assets differences over time (BETARONA ), and a convergence measure

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of earnings per share differences over time (BETAEPS ). A negative coefcient would indicate declining 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 IFRS and U.S. GAAP are presented in Table 2. This table reports the index of comparability by company for each year in the study, also the 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 income for China Eastern Airlines per IFRS was approximately 90% of net income for China Eastern Airlines per U.S. GAAP. The last two columns in the table show the comparability determination at two different materiality thresholds. Net income per IFRS and net income per U.S. GAAP were deemed comparable at a 5% materiality threshold if both the average 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 average comparability index and the index for 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 out of 11 companies) of net income, at a materiality threshold of 5%, for PRC companies listed on the NYSE. Even at the more liberal materiality threshold of 10%, a majority (6 out of 11) companies in the study still exhibit materially different measures of net income per IFRS and net income per U.S. GAAP. For virtually all companies listed in this study (10 of 11), the average comparability index is less than 1.00, indicating net income per U.S. GAAP is generally higher than net income per IFRS. Reasons for the observed lack of comparability are explored in Table 3. Each row of this table shows an analysis of the total difference between net income per IFRS for a particular company and net income per U.S. GAAP for the same company for the year 2002. The rst column shows the name of the company. The second column shows the total amount of the adjustments between IFRS net income and U.S. net income for that company, expressed as a percentage of net assets for that company. For example, for China Eastern Airlines, the total amount of the income difference is 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 by an amount equal to approximately 2.19% of IFRS net assets. The next ve columns show the amounts of ve adjustment classications from the Harris and Muller (1999) taxonomy. These are called partial adjustments. This taxonomy originally had seven adjustment classications, but no PRC company in this study reported either a pension adjustment or an adjustment for research and development, so only ve of the seven categories from the Harris and Muller taxonomy are used in this study. Thus, China Eastern Airlines reported a partial adjustment for deferred income taxes of 0.39%, meaning that the effect of differences in deferred taxes reduced U.S. net income from IFRS net income by an amount equal to 0.39% of IFRS net assets. This negative partial adjustment for China Eastern Airlines was offset by positive adjustments of 2.25% for tangible asset revaluations and positive 0.32% for other. Thus, for China Eastern Airlines, the category, tangible asset revaluations, is the most signicant factor affecting the overall difference in net income per IFRS and net income per U.S. GAAP. In fact, the category tangible asset revaluations is the largest partial adjustment category for 8 of the 11 companies in the sample.

J.L. Haverty / Journal of International Accounting, Auditing and Taxation 15 (2006) 4871 Table 3 Analysis of net income adjustments from IFRS to U.S. GAAP for the year 2002 Company IFRS-U.S. net income adjustments Total adjustment as a percentage of IFRS net assets Partial adjustments as a percentage of IFRS net assetsa Goodwill Deferred income taxes 0.39 0.98 0.50 0.42 0.47 0.09 0.07 0.86 0.55 0.21 0.27 0.23 0.64 0.27 0.05 Foreign exchange adjustments Tangible asset revaluations 2.25 3.02 0.34 1.28

63

Other

China Eastern Airlines Corporationb China Petroleum and Chemical Corporationb China Southern Airlines Company China Telecom Corporation Guangshen Railway Huaneng Power Internationalb Jilin Chemical Industrial Company PetroChina Companyb Sinopec Beijing Yanhua Petrochemicalb Sinopec Shanghai Petrochemical Company Yanzhou Coal Mining Company

2.19 2.22 1.06 0.86 0.40 0.08 16.20 0.92 0.41 1.49 1.04

0.32 0.12 1.90

0.29

0.07 0.11

16.13 2.54 1.07 0.93 1.95 0.75 0.10 0.31

a None of the companies in this study reported an IFRS-U.S. GAAP adjustment due to pensions or research and development. 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 briey outlined, and then the revaluations used by the companies in the study are analyzed. IFRS permits valuation of property, plant, and equipment at either historical cost, or at historical cost subject 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 equipment revaluations: Revaluations should be carried out regularly, so that the carrying amount of an asset does not differ 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 previously recognized 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 they exceed 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 transferred directly to retained earnings, or it may be left in equity under the heading revaluation surplus.

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Table 4 Analysis of property, plant and equipment revaluations Company China Eastern Airlines Corporation China Petroleum and Chemical Corporation China Southern Airlines Company China Telecom Corporation Guangshen Railway Huaneng Power International Jilin Chemical Industrial Company Valuation basis except for land use rights Historical cost subject to revaluations Historical cost subject to revaluations Historical cost subject to revaluations Historical cost subject to revaluations Historical cost subject to revaluations Historical cost Historical cost subject to revaluations Revaluation dates 6/30/1996 12/31/2002 9/30/1999 12/31/2000 12/31/1996 12/31/2001 3/6/1996 N/A 9/30/1994 2/28/1995 12/31/2002 PetroChina Company Sinopec Beijing Yanhua Petrochemical Sinopec Shanghai Petrochemical Company Yanzhou Coal Mining Company Historical cost subject to revaluations Historical cost subject to revaluations Historical cost subject to revaluations Historical cost 6/30/1999 4/23/1997 Prior to 2001 N/A Purpose of revaluation Restructuring Periodic Restructuring Acquisition Restructuring Restructuring Restructuring N/A Restructuring HK Stock Exchange listing Periodic Reorganization Reorganization Reorganization N/A Direction of revaluation Upward Downward Upward Upward Upward Downward Upward N/A Upward Upward Downward Upward Upward Upward N/A

An upward revaluation of property, plant, and equipment assets would result in net assets per IFRS being higher than net assets per U.S. GAAP. This would result in a downward adjustment from net assets per IFRS to net assets per U.S. GAAP on a 20-F reconciliation for a company that had revalued its assets upwards. Since the depreciation base would now be higher for a company that had revalued its assets upward, that companys depreciation expense would also be higher resulting in a lower net income. This would result in an upward adjustment from net income per IFRS to net income per U.S. GAAP on a 20-F reconciliation for a company that had revalued its property, plant, and equipment upward. Downward revaluations of property, plant, and equipment are also possible. A downward revaluation under IFRS would require an upward adjustment of xed 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 effect on net income if the downward revaluation were in excess of any previous upward revaluation of the 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 net income to U.S. GAAP net income.

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Fixed asset revaluations for the companies in the study are analyzed in Table 4. Land, according to socialist theory in the PRC, is owned by the people. Therefore land is not owned by a corporation but is rather leased from the people through land use rights for a specied period of time. Land is normally found on the balance sheet of a PRC company as an operating lease, at historical cost subject to amortization. Prior to the adoption of IFRS by PRC companies, land was sometimes revalued upwards. Recently, these revaluations have been reversed since the land was usually granted from a related party. In these cases, the historical cost of the land has been considered nil. Adjustments to land use rights have been relatively minor, and are not considered in this study. Of the 11 companies in the study, only 2, Huaneng Power International and Yanzhou Coal Mining Company, use historical cost to value their property, plant, and equipment. These two companies are comparable at the 10% level of materiality. The remaining nine value their xed assets on the balance sheet using historical cost with revaluations, and follow procedures similar to those outlined above. The vast majority of the revaluations have been upward, at the initial reorganization or restructuring of the enterprise. In the PRC, a huge amount of industrial restructuring took place as a result of the PRCs movement from a planned economy to a more market-oriented and more open economic system. There have been some downward revaluations, however, notably China Eastern Airlines in 2002, China Telecom in 2001, and Jilin Chemical in 2002. There is some suspicion, 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 signicant cause of lack of comparability between IFRS and U.S. GAAP in the PRC companies in the study is the fact that IFRS permits revaluation of xed assets and U.S. GAAP requires historical cost as a basis for valuing property, plant and equipment. Nine of 11 PRC companies in this study have chosen to revaluate their property, plant and equipment. It is worth 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 free interplay 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 Power International, was deemed to be comparable at a 5% materiality threshold. The remaining 10 companies were deemed to be not comparable and were tested for convergence. The results of the convergence testing are shown in Table 5. Each row of Table 5 shows the convergence testing results for a single company. Negative BETA coefcients on this table indicate evidence of convergence for each particular convergence measure. For example, the rst row shows the results for China Eastern Airlines. For this company, BETANI , the coefcient of the trend line of the net income differences over the 7 years of the study, is 0.004. This indicates no evidence of net income convergence. The R2 measure for this coefcient is 0.0866. BETANA , the net assets convergence measure for China Eastern Airlines, is 0.031. This negative coefcient indicates that the differences between net assets per IFRS and net assets per U.S. GAAP are becoming smaller over time, demonstrating convergence. This nding is supported by a relatively high R2 of 0.6533. BETARONA , the return on assets difference measure 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 5 Convergence measures for companies with material differences in net income per IFRS and net income per U.S. GAAP Company Years of data Net income convergence measure BETANI China Eastern Airlines Corporation China Petroleum and Chemical Corporation China Southern Airlines Company China Telecom Corporation Guangshen Railwayb Huaneng Power International Jilin Chemical Industrial Company PetroChina Companyb Sinopec Beijing Yanhua Petrochemical Sinopec Shanghai Petrochemical Companyb Yanzhou Coal Mining Companyb
a b

Net assets convergence measure BETANA 0.031 0.054 0.018 0.020 0.003 R2 0.6533 0.9087 0.3573 N/Aa 0.2191

Return on net assets convergence measure BETARONA 0.004 0.000 0.019 0.061 0.001 R2 0.0499 0.0002 0.4085 N/Aa 0.6899

Earnings per share convergence measure BETAEPS 0.336 0.016 0.018 0.021 0.008 R2 0.1744 0.1017 0.001 N/Aa 0.6716

R2 0.0866 0.4401 0.3578 N/Aa 0.0000

7 5 7 3 7 5 7 4 7 7 7

0.004 0.004 0.007 0.072 0.000

Comparableno material difference at 5% materiality 0.016 0.5525 0.013 0.1870 0.003 0.6085 0.042 0.9322 0.000 0.0049 0.000 0.0025 0.000 0.000 0.0803 0.0003 0.008 0.030 0.7046 0.5687

0.048 0.013 0.001 0.000 0.005

0.4315 0.9057 0.0449 0.0009 0.2011

0.139 0.022 0.012 0.041 0.054

0.5661 0.6253 0.0063 0.0117 0.3415

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

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Table 6 Summary of results by company Company Comparability 5% Materiality China Eastern Airlines Corporation China Petroleum and Chemical Corporation China Southern Airlines Company China Telecom Corporation Guangshen Railway Huaneng Power International Jilin Chemical Industrial Company PetroChina Company Sinopec Beijing Yanhua Petrochemical Sinopec Shanghai Petrochemical Company Yanzhou Coal Mining Company Number of companies
a

Convergence 10% Materiality No No No No Yes Yes No Yes Yes No Yes 5 3 Yes Yesa Net income Net assets Yes Yes Yes Return on net assets Yes Earnings per share Number of measures 2 1 3 1 1

No No No No No Yes No No No No No 1

Yes Yes

Convergence was not tested since comparability at a 5% materiality threshold was indicated Yes 1 Yes Yes Yes Yes 4 Yes 1 Yes Yes 6 Yes 6 Yes 3 1 3 18

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

67

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The rst column of Table 6 shows the name of the company. Columns 2 and 3 show the results of comparability testing. For example, China Eastern Airlines was deemed not comparable at either 5 or 10% levels of materiality. Columns 47 summarize the convergence testing for each company. China Eastern Airlines, for example, showed evidence of net assets convergence and return on net assets convergence. The last column shows the total number of measures indicating convergence for each company. Only one company, Huaneng Power, was deemed comparable at a 5% materiality threshold. At a more liberal 10% materiality threshold, however, 5 of the 11 companies in the study were deemed comparable. Convergence testing was performed on the 10 companies not deemed comparable at the 5% materiality threshold. Three of these 10 companies indicated that measures of net income per IFRS and per U.S. GAAP were converging over time; 6 of the 10 companies indicated that measures of net assets per IFRS and per U.S. GAAP were converging over time, 6 of the 10 companies indicated that measures of return on net assets per IFRS and per U.S. GAAP were converging over time, and 3 of the 10 companies indicated convergence of earnings per share per IFRS and per U.S. GAAP. Of these 10 companies not deemed comparable, only 1, PetroChina Company, indicates convergence on all 4 measures. Two of the companies indicate convergence on three measures, one of the companies indicates convergence on two of the measures, and six of the companies indicate convergence on only one measure. The most frequently appearing convergence measure is net assets, since 6 of the 10 companies tested in this study demonstrate convergence on this measure. This is not surprising since property, plant, and equipment revaluations were shown to be the most signicant cause of lack of comparability. As Table 4 shows, most PRC companies in this study revalued their assets upward upon reorganization, creating a revaluation surplus. This surplus was then reversed when reconciling from IFRS net assets to U.S. GAAP net assets on a rms 20-F reconciliation. Unless there were additional upward revaluations, this surplus remained the same. If a companys assets were growing, the value of this surplus relative to total assets would decrease, resulting in net assets convergence in this study. The effect of property plant and equipment revaluations on a rms net income is less predictable, however. Property, plant and equipment revaluations affect a rms net income via the additional 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 uctuate relative to net income. Thus, IFRS net income and U.S. GAAP net income are less likely to converge over time than would IFRS net assets and U.S. GAAP net assets. This is shown in Table 6 in which 6 of the 10 companies indicate net assets convergence while 3 out of the 10 companies indicate 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 under IFRS and U.S. GAAP. Despite much progress toward de jure harmonization between IFRS and U.S. GAAP, de facto harmonization has not been achieved at least as evidenced by PRC rms reporting under IFRS and reconciling to U.S. GAAP. Generally, net income for PRC companies reported per IFRS is less than net income per U.S. GAAP. The most signicant reason for the observed lack of comparability was the revaluation of xed assets. Since IFRS permits upward revaluation of property, plant and equipment, many PRC rms adopt this option for their IFRS reporting, most likely due to its widespread use under Hong Kong GAAP which also makes use of

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revaluations. U.S. GAAP, however, requires historical cost accounting for its property, plant and equipment. These revaluations obviously affect net assets, but upward revaluations of property, plant, and equipment also cause reported net income differences due to the larger depreciation amounts reported under IFRS on upwardly revalued property, plant and equipment. Despite these comparability difculties, there is evidence of de facto convergence among those PRC companies that were not deemed to be comparable. It is expected that the de jure convergence efforts of the IASB and the U.S. FASB should result in some evidence of de facto harmonization, and this is evidenced 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 PRC companies that are NYSE-listed. NYSE-listed PRC rms are most likely different from nonNYSE-listed PRC rms simply due to the fact that their accounting is subject to U.S. Securities and Exchange Commission review. In addition to this review, the PRC government must itself approve a foreign listing. Other PRC rms would most likely have less sophisticated accounting systems since they are not subject to as much external scrutiny. In addition, the study only analyses certain accounting numbers: net income, net assets, return on net assets, and earnings per share. The possibility of cash ow differences between IFRS and U.S. GAAP was not addressed in this study. Finally, this study only shows that the accounting numbers produced under the various sets of accounting standards are different. It does not purport to show that the differences are important in the valuation of the rm. 7.2. Implications for investors This research demonstrates that IFRS and U.S. GAAP still produce different accounting numbers. It is crucial that investors be aware of the GAAP under which an accounting number is calculated when comparing it to other companies or to benchmark statistics. Despite a long march toward accounting harmonization, investors may be misled if they compare an accounting number for a PRC Company reporting under IFRS to a corresponding benchmark statistic for U.S. GAAP reporting companies. To be specic, reported net income per U.S. GAAP is generally higher than net income per IFRS. On the other hand, reported net assets per U.S. GAAP are generally 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 assets to market value. If a PRC company chooses to revalue its assets under IFRS, net assets per IFRS will likely be higher than net assets per U.S. GAAP. This upward revaluation would result in a higher annual depreciation charge under IFRS than under U.S. GAAP, causing a higher reported net income under U.S. GAAP. Investors in PRC rms are advised to pay particular attention to the valuation basis for assets at a PRC company. In addition, the suspected obsolescence of the plant assets of many state-owned enterprises in the PRC makes write-offs of assets highly likely. This research clearly shows that IFRS and U.S. GAAP are not comparable using Choi et al. (2001) denition of comparability: . . . similar in enough ways that nancial statement users can compare it (at least along some dimensions) without needing to be intimately familiar with more than one system. To be specic, users must know the process by which property, plant and equipment are valued and revalued. In the PRC, this difculty is compounded by the reportedly massive amount of obsolete and non-productive property, plant and equipment held by the PRC

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SOEs. Additionally, the role of judgment in declaration of any impairments leads to the real opportunity for income manipulation. 7.3. Implications for researchers This research underlines the need for researchers to develop viable operational metrics for comparability and convergence. Comparability of a set of nancial statements prepared under IFRS and a set of nancial statements prepared under U.S. GAAP, in this research, is determined by comparing reported net incomes. If net incomes are within plus or minus 5% of each other, the nancial statements are deemed to be comparable. It is possible that other dimensions of a company might not be comparable even if the reported incomes under two different sets of accounting standards are within 5% of each other. The huge impact of upward revaluations of property, plant and equipment leads to an interesting dilemma. Disclosing of property, plant and equipment values at both revalued cost (under IFRS) and historic cost (under U.S. GAAP) would provide more information to shareholders than simply disclosing one of the property, plant and equipment values. Researchers need to investigate the value-relevance of these dual disclosures. In this scenario, a stated goal of convergence might actually work against the interests of the nancial statement users. Particularly in the PRC, historical cost is a questionable concept, since much of the property plant and equipment is still owned by the state in a socialist market economy, and the valuation is not determined by the interplay of free market forces. The development and testing of an operational metric for convergence is an equally complex task. This research shows that convergence is a multidimensional concept, involving many different accounting numbers. Mathematical convergence of one set of accounting numbers does not imply mathematical convergence of a second set of accounting numbers, and this is demonstrated 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 compare PRC standards to IFRS and U.S. GAAP. The sample size of this study might be expanded by including PRC rms 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 ow from operations might be considered in further research. Finally, the metrics introduced in this study might be tested in other contexts in which there is dual or three way reporting by a single entity under different sets of accounting standards. Acknowledgements I would like to thank Kathleen Sinning (the editor) and two anonymous reviewers who provided helpful comments on earlier versions of this manuscript. References
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