Evergrande’s auditor, PricewaterhouseCoopers (PwC), is under scrutiny after being accused of inflating the floundering real estate giant’s income by 560 billion yuan ($77 billion).
The China Securities Regulatory Commission (CSRC) announced on March 19 that Evergrande overstated its income by 214 billion yuan ($30 billion) in 2019 and 350 billion yuan ($48.6 billion) in 2020 and then raised funds in the financial markets based on falsified data.
The CSRC stated that Evergrande also exaggerated its profits by a total of 91.9 billion yuan ($12 billion), equivalent to more than three-quarters of its reported income from 2019 to 2020. This is roughly 20 times the inflated profit of the Enron scandal in 2001, which ultimately led to the revocation of the license of its auditing firm, Arthur Andersen.
PwC, which audits Evergrande, has now become the focus.
Joshua Ronen, an accounting professor at New York University’s Stern School of Business, believes that it is strange that PwC did not have a going concern qualification in the face of Evergrande’s huge debt.
The “going concern qualification” is a statement made by auditors indicating significant doubt about a company’s ability to continue operating in the foreseeable future (usually the next 12 months from the date of the statement).
“I think a projection of the cash for the next year would have been inadequate to pay all indebtedness and liabilities, so that would call for a going concern qualification, but obviously, not knowing exactly what happened, it’s impossible to say,” he told The Epoch Times.
Mr. Ronen has served as associate director of research for the American Institute of Certified Public Accountants Accounting Objective Study Group and, in that capacity, was intimately involved in formulating the objectives of financial statements, which were ultimately incorporated into the Financial Accounting Standard Boards Conceptual Framework. He also served as president of the Price Institute of Entrepreneurial Studies and director of the Vincent C. Ross Institute of Accounting Research at the Stern School of Business.
In October 2021, the Accounting and Financial Reporting Council in Hong Kong launched an inquiry into the Evergrande Group’s financial statements for 2020 and its interim financial statements for 2021, as well as the audit by PwC for 2020.
The council stated in its bulletin that PwC issued a clean opinion in the audit report for the year 2020 without mentioning any significant uncertainties in Evergrande’s operations. Based on this, the council questioned whether Evergrande’s accounts complied with applicable financial reporting standards and whether PwC complied with auditing standards.
Big Four’s China Branches Frequent Fraud Scandals
PwC is one of the Big Four accounting firms in the world, along with Deloitte, KPMG, and Ernst and Young (EY). Deloitte is headquartered in New York, PwC and EY in London, and KPMG in Amsterdam.The Big Four firms serve as auditors for many internationally renowned companies. Around 99 percent of the audit services of the Financial Times Stock Exchange (FTSE) 100 companies and 96 percent of the audit services of the FTSE 250 companies are provided by the Big Four.
The Big Four also dominate the auditing industry in China. For example, for the audits of the Chinese Communist Party’s central enterprises, PwC accounted for seven, Ernst & Young accounted for 11, and KPMG and Deloitte accounted for three, respectively. According to data from the Chinese Ministry of Finance, the Big Four recorded revenue of 20.6 billion yuan ($2.8 billion) in China in 2021.
As auditing institutions for the world’s largest companies, the Big Four are supposed to ensure the authenticity of corporate financial data. However, in recent years, companies audited by the Chinese branches of the Big Four have been plagued by fraud scandals.
In September 2022, the U.S. Securities and Exchange Commission (SEC) accused the Chinese branch of Deloitte of failing to comply with basic auditing requirements in its audits of U.S. issuers and their subsidiaries. In multiple audit processes, Deloitte’s personnel in China requested clients to select samples for testing and prepare audit documentation on their own, giving the impression that Deloitte China had conducted necessary testing of clients’ financial statements and internal controls.
“We find that Deloitte-China fell woefully short of professional auditing requirements in numerous component audits of Chinese operations of U.S. issuers and audits of Chinese companies listed on U.S. exchanges,” said SEC Chair Gary Gensler.
In February 2021, multiple Chinese media outlets, including Caijing, reported that an employee of Deloitte blew the whistle online about Deloitte’s auditing irregularities. The whistleblower document stated that during the audit of Red Yellow Blue (RYB) Education Company from June 19 to June 23, 2017, Zhang Zhaomo, a member of the audit team, did not allocate and review spot checking of vouchers. Subsequently, the whistleblower found that many dates and amounts in previous drafts were inconsistent with the actual vouchers.
When asked again what to do if the amounts didn’t match, Ms. Zhang replied to simply mark “Y” (meaning the amounts matched) and said that many dates and amounts in her previous work papers were filled in randomly and fabricated.
With Deloitte auditing for RYB, the company was able to list on the New York Stock Exchange in September 2017.
KPMG’s China Branch Accused of Violating Audit Standards
KPMG is another Big Four firm embroiled in a fraud scandal in China.In March, the Public Company Accounting Oversight Board (PCAOB) fined three KPMG China partners $150,000 collectively for violating relevant standards in their audit work for education services provider Tarena International.
An independent audit investigation of Tarena found problems with the company’s 2017 financial statements, including intentionally inflating revenue and improperly charging accounts receivable.
The PCAOB stated that audit engagement partner Choi Chung Chuen and second partner Ma Hong Chao failed to obtain sufficient, appropriate audit evidence to support the revenue reported in Tarena’s 2017 financial statements. Both inappropriately relied on Tarena’s IT-related controls, which had numerous unremediated deficiencies.
Regarding the successive malpractice of the Big Four’s Chinese branches, Mr. Ronen believes that PwC’s U.S. headquarters should exercise more supervision over its Chinese branches.
Big Four’s China Branches Succumb to Party Orders
What greatly damages the Big Four’s reputation is their Chinese branches’ submission to the Chinese Communist Party (CCP) and, in that, refusal to submit audit work papers to the SEC.According to the Sarbanes-Oxley Act passed by the U.S. Congress in 2002, any company that issues public securities in the United States must be subject to inspection by the PCAOB.
However, the CCP ignores this requirement and obstructs the PCAOB’s inspections of Chinese companies, while the Big Four’s China branches refuse to submit audit work papers of Chinese companies to the SEC, citing concerns about violating Chinese laws.
Mr. Ronen believes that the CCP’s prohibition of the Big Four from submitting audit work papers to the PCAOB may facilitate fraudulent behavior by Chinese companies and corruption by the Big Four.
“If the PCAOB, which is a watchdog over auditors in the U.S., were to review audit papers, it may or may not have detected weaknesses it would have opined on. So yes, I think the inability of the American SEC to review audit papers of Chinese auditors is not a good thing,” he said. “If the PCAOB were able to review audit papers of Chinese auditors, I think the quality of Chinese audit would have improved.”
In February 2015, the SEC sanctioned the Big Four’s China branches for refusing to submit “documents related to investigations of potential fraud.”
In 2020, the United States forcefully introduced the “Holding Foreign Companies Accountable Act,” which stipulates that if a company is on the identified delisting list for three consecutive years, it will formally enter the delisting process after the third year. Subsequently, the SEC announced waves of pre-delisting and confirmed delisting lists of Chinese stocks, including Bilibili, ZTO Express, JD.com, Pinduoduo, Tencent Music, and Ctrip.
Under the strong pressure from the United States, the CCP and the Big Four’s China branches finally capitulated. On Dec. 15, 2022, the PCAOB announced that for the first time, the CCP authorities had allowed accounting firms to conduct comprehensive inspections and investigations that meet U.S. standards as required by the Sarbanes-Oxley Act.
