Chinese Auditors Are on the Hook After Clients Are Caught Cooking the Books: “There has long been suspicion that Chinese companies have a tendency to fabricate results when necessary. And that seems to be a well-grounded concern”

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SHANGHAI—An accounting scandal has disrupted dozens of initial public offerings and other fundraising plans in China, intensifying investor concerns about the amount of trust they can place in audited financial results in the country.

In recent weeks, a string of Chinese companies have halted financing plans, with many saying the China Securities Regulatory Commission was investigating their auditor, Ruihua Certified Public Accountants, for suspected violation of securities law. The regulator and Ruihua officials didn’t respond to requests for comment.

The apparent investigation into Ruihua, China’s second-largest homegrown accounting firm by revenue, follows revelations of overstated earnings by a client.

In May, the securities commission began a probe of Ruihua’s smaller rival GP Certified Public Accountants Co., after finding that GP client Kangmei Pharmaceutical Co. had inflated cash holdings by more than $4 billion.

With economic growth at its slowest since at least 1992, investors and analysts say many companies are experiencing financial distress, which in turn is revealing accounting problems that were easier to hide when credit was freely available and businesses were growing rapidly.

Beijing is probably also pressuring accountants to be more rigorous, they say, especially since foreign investors are now playing a larger role in China’s financial markets.

Economic and market weakness has prompted greater scrutiny of listed companies and auditors, as regulators seek to contain financial risk and “purify the market environment,” said Landing Zhang, chief executive of Shanghai asset-management firm CYAMLAN Investment.

The reliability of financial statements is one of several challenges facing investors in China. There are also question marks over the quality of local credit ratings and official economic data, while critical commentary by analysts and investors is often censored.

Chinese bookkeeping is also a sore point in Washington, since Beijing doesn’t allow U.S. authorities to inspect audits of Chinese companies listed in New York.

“There has long been suspicion that Chinese companies have a tendency to fabricate results when necessary. And that seems to be a well-grounded concern,” said Paul Gillis, an accounting professor at Peking University’s Guanghua School of Management.

Mr. Gillis said part of the reason is that it is extremely difficult to bet against companies by selling stocks short in China. “It’s short sellers who tend to identify most of the fraudulent companies because they have the incentives to do so.”

Auditors declined to endorse—or endorsed only partially—a record 219 annual reports last year, nearly double the 113 in the previous year, according to Wind Information Co., a data provider. These actions suggest an auditor has found issues with the results or has doubts about the company’s status as a going concern.

Earlier this year, the securities commission found a Ruihua client, Kangde Xin Composite Material Group Co., had overstated profits for the four years through 2018 by $1.7 billion. After endorsing Kangde Xin’s financial statements for three years, Ruihua said it couldn’t express any opinion about the most recent annual report. Ruihua has said it completely fulfilled its auditing duties.

Since then, at least 23 listed companies that are Ruihua clients have flagged delays to refinancing plans, which can mean selling shares or convertible bonds, as have 28 IPO candidates. The Shanghai Stock Exchange has also postponed reviews of four Ruihua-linked applications to list on its new Science and Technology Innovation Board.

This is isn’t the first time Ruihua and peers have gotten into trouble. In 2017, the Ministry of Finance and the CSRC suspended Ruihua and rival BDO China from auditing public companies for roughly two months, according to the ministry’s website, after each was hit by two disciplinary actions within two years.

Ruihua was also fined by the market regulator in December 2018 because of problems with a client’s annual reports, and three years ago, served a one-year ban for some work related to the interbank bond market, after failing to assist a regulatory probe into a client that defaulted.

The local arms of international accountancy networks are the largest players in China, but vie with many local outfits, to whom they have lost market share in recent years, according to the Asian Corporate Governance Association.

Firms affiliated with the Big Four—PricewaterhouseCoopers, Deloitte Touche Tohmatsu, Ernst & Young and KPMG—and midtier player BDO are the five largest players.

Their combined revenue made up 26% of the total Chinese accounting market, according to a 2018 report by the Chinese Institute of Certified Public Accountants. In the U.S., arms of the Big Four and BDO audit about half of all listed companies, according to Audit Analytics.


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