Accounting Firm Caught Up in China Evergrande’s Fraud Case, Exposes Audit System Flaws

The China Evergrande Centre building sign is seen in Hong Kong, China, on Dec. 7, 2021. Tyrone Siu/Reuters

China’s security regulator late last month accused China Evergrande Group of exaggerating its revenue by a whopping $78 billion, making it possibly one of the largest financial fraud cases in history. In connection with the fraud, Chinese authorities are investigating the role of PricewaterhouseCoopers LLP (PwC) one of the world’s “Big Four” accounting firms, which served as Evergrande’s auditor for 14 years. 

Joshua Ronen, a professor of accounting at New York University, said the incident underscores the flaws in the current audit system, necessitating reforms.

On March 19, Chinese regulators accused Evergrande and its founder of overstating its revenue by 214 billion yuan ($19.6 billion) in 2019 and 350 billion yuan ($48.4 billion) in 2020, totaling 564 billion yuan ($78 billion) over two years. Evergrande also inflated its profits by a total of 91.9 billion yuan ($14.4 billion). Subsequently, Evergrande issued five corporate bonds totaling 208 billion yuan ($32.5 billion) based on the falsified data.

These figures make the Evergrande case the largest financial fraud case in history. By comparison, Enron overstated profits by $600 million in 2001; WorldCom committed a $11 billion financial fraud from 1999 to 2002; and in 2020, Luckin Coffee fabricated $300 million in sales, all seemingly pale in comparison.

It is worth noting that the Enron scandal led to the collapse of its auditing firm, Arthur Andersen LLP. Since then, the global “Big Five” accounting firms were reduced to the “Big Four”—PwC, Deloitte, KPMG, and Ernst & Young.

Today, Evergrande’s alleged profit manipulation exceeds Enron’s twenty times over.

PwC’s Unqualified Audit Reports for Evergrande

Despite serving Evergrande for 14 years, PwC continued to issue unqualified audit reports. An unqualified audit report means that the business financial statements are transparent and compliant with generally accepted accounting principles, and that the auditor did not find an issue with the company’s financial records.

In 2020, the Chinese regime gradually tightened credit policies for the real estate sector. The following year, many major real estate companies faced a crisis of fund chain rupture. Evergrande, in particular, found itself in deep trouble with debts totaling 24.3 trillion yuan ($336 billion), a debt-to-asset ratio of 132.6 percent, already insolvent.

Mr. Ronen told The Epoch Times that in the face of Evergrande’s massive debt, it was strange that PwC did not issue a “going concern” that the company will unlikely have enough funds to pay all debts and liabilities.

A “going concern” is a statement made by auditors indicating significant doubt about a company’s ability to continue operating in the foreseeable future without the threat of liquidation.

In October 2021, the Financial Reporting Council (FRC) said it had launched an inquiry into Evergrande. It found that as of the end of 2020, Evergrande had cash and cash equivalents of 159 billion yuan ($22 billion), but that this did not cover its liabilities of 15 trillion yuan ($2.1 trillion) and loans due in 2022 of 1.67 trillion yuan ($230 billion). In the 2020 annual accounts, Evergrande did not make a clear statement about the significant uncertainty of its going concern. Despite signs of insolvency, PwC still gave an unqualified opinion in its audit report.

In August 2022, the FRC expanded its investigation into Evergrande, including its 2020 annual accounts, 2021 interim accounts, and PwC’s 2020 audit report. However, these actions by regulatory authorities did not prompt PwC to become more cautious. It still issued an unqualified audit report for Evergrande that year.

Negligence or Complicity in Fraud?

PwC received substantial audit fees from Evergrande. According to annual reports, from 2010 to 2020, Evergrande’s audit fees totaled 288 million yuan ($400 million).

Insiders revealed online that PwC’s project team at Evergrande enjoyed the “best benefits,” with team members receiving the highest incomes, and Evergrande providing them with hotel accommodation and generous payments.

Regarding PwC’s misconduct, Mr. Ronen advised that PwC’s U.S. headquarters should exercise more oversight over its Chinese branches and should maintain sufficient quality control over its operations in China and Hong Kong.

The exterior of the PWC London offices in London, England, on March 31, 2021. Leon Neal/Getty Images

Flaws in the Audit System

Mr. Ronen also pointed out that PwC’s involvement in the Evergrande financial fraud highlights a long-standing flaw in the audit system, namely, that audit firms issue qualified certificates for companies while also receiving compensation from them, leading to conflicts of interest between auditors and companies.

After the Enron fraud scandal was exposed, Mr. Ronen proposed a reform of the audit system. In Mr. Ronen’s proposed system, companies would purchase financial statement insurance rather than appointing and paying auditors. In this case, insurance companies would appoint and pay auditors to assess the financial statements of their potential clients. Audit opinions published along with financial statements would help insurance companies determine coverage and premiums.

At the time, Mr. Ronen published an article in The New York Times titled “A Market Solution to the Accounting Crisis.“ The article said, ”The amount of insurance coverage that corporations obtain, and the premiums they pay, should be disclosed. Those corporations with higher coverage and lower premiums would distinguish themselves in the eyes of investors. Every company would be eager to get such coverage.”

The proposed changes were adopted by the chairman of the U.S. Securities and Exchange Commission under the Bush administration. However, the plan fell through due to lobbying opposition from accounting firms.

Anders Corr, the publisher of the Journal of Political Risk and an Epoch Times contributor, told The Epoch Times that when the compensation of accounting and audit firms comes from the company they audit, there are inherent conflicts of interest.

PwC declined to comment to The Epoch Times.