Accounting Fraud in China
Accounting fraud is a serious problem in China. Whereas fraud in Western companies tends to be a very convoluted scam, like the infamous Enron or Madoff schemes, Chinese companies tend to be straightforward and almost simplistic. A very common ploy involves revenue recognition. Companies often put their sales on the book as gross revenue, thereby inflating the amount of money they’re actually making. Revenue is also often recognised inaccurately or far too early, being recorded before they’ve actually been completed. Experts like Paul Gillis suggest this practice is common in China. Another example is related to party transactions, where prices are manipulated on the basis of personal relationships in the case of, among other activities, acquisitions.
Companies can also be found to have simply made-up revenue or customers. Overall, expert advice suggests that when a foreign company is looking to buy a Chinese company, it needs to be very thorough and vigorous in its audit. The basic assumption should be that there are some accounting discrepancies that wouldn’t stand up to Western regulations. Not discovering and rectifying these discrepancies from the very start can lead to very serious consequences further down the line. Below are several examples of the types of fraud conducted.
AgFeed Industries Inc.
The AgFeed Industries Inc. scandal involved four executives from China using various means to favourably manipulate revenue numbers for nearly 3 years, from 2008 to mid-2011. These methods included creating fake invoices for the sale of pigs and animal feed, as well as increasing the weight of the pigs in an attempt to drive up the revenue for the animals that were actually sold. The company was publicly traded in the United States and when the fraud was brought to the attention of the American executives, a cover-up was attempted. Investigation was hindered and the individuals in charge of audits were accused by the SEC of colluding with the fraud by not adequately following up on executives’ see-through attempts to explain the discrepancies in numbers. It is suggested that Chinese executives proceeded to try spinning off the divisions struck by fraudulent accounting practices. The case is currently under investigation.
China Public Procurement
China Public Procurement is a Hong Kong-listed Chinese company specialising in IT. On 8th February 2010, it announced that it had won a $48 billion dollar contract for the supply of construction materials and equipment with a company that turned out to be false. The subsidiary of China Railway Construction Materials Group that it purported to have dealt with was revealed months later to have been a fabrication created by the company to drive up the company profile and revenue. The investigation was conducted by PwC under pressure from Hong Kong’s stock exchange, but it wasn’t until November of 2012 that the fabrication was confirmed. Currently, no investigation into the company has been announced by Hong Kong regulators.
Hontex is a Taiwanese-owned Chinese fabric maker who, in December 2009 was discovered to have significant cases of accounting fraud that resulted in suspicious features in its IPO. It came to light, after its auditor was offered bribes by Hontex employees, that the company had fabricated sales and cash in banks for years in anticipation of its listing. The fabric maker has since been ordered to return the money it raised from its IPO to investors.
In June 2011, Real Gold’s founder, Wu Ruilin, was found to have used the Chinese assets of the company as security for the private companies that he owned when he applied for loans. Despite the fact that this pledge had been publicly available at the State Administration for Industry and Commerce since 2010, Deloitte (who were employed as Real Gold’s auditors) did not notice the discrepancy.
Moulin Global Eyecare
Moulin Global Eyecare, a Hong Kong-listed glasses producer with factories on mainlined China, listed faked sales revenues and customers, some of which were located in the United States and patently not in business with them. When the company failed in 2006, their liquidators discovered that they had gone to extreme extents to cover up the non-existent revenue. The executives had evidently set up fake companies in debt to Moulin, in an attempt to buy some breathing room when coming up with the cash on its account books. The chairman and his son were sentenced to lengthy prison sentences for misleading investors and inflating sales.
Perhaps the most damning habits of Chinese companies listed in the United States are the attempts to cover-up accounting fraud during audits. This is a common feature of fraud investigations by the SEC into Chinese companies. For example, the cash-confirmation test conducted by BDO resulted in a series of rather blatant acts of fraud and obstruction on the part of Shanghai-based pro-biotics provider China-Biotics. In addition to providing “official” documentation that contained chops suspected to be fake or belonging to a different company, China-Biotics constructed a fake bank website in an attempt to mislead auditors. Furthermore, when a bank statement was requested, the company provided one that included mathematical errors which were corrected in a “revised” bank statement that was provided shortly thereafter.