RED REVOLUTIONARIES IN GREEN EYESHADES:

Cultural revolution: New accounting rules have replaced the Little Red Book as China's guide to self-improvement. Can the state handle the truth? (The Economist, 1/11/07)

There is abundant evidence, from trade statistics to fumes spewing out of factories and power plants across the country, that the Chinese economy is doing well. But how well individual companies are doing is far harder to tell. The financial results of companies that global investors wish to buy into can be as unintelligible as the dialect spoken in the company town. It is said (with apparent sincerity) that some Chinese firms keep several sets of books--one for the government, one for company records, one for foreigners and one to report what is actually going on.

Under the new approach, accounts will be prepared under 39 principle-based standards structured to reveal the economic value of a firm, with the aim of using market prices wherever possible. A clear understanding of a firm's revenues, costs and debt would enhance the efficiency of China's companies--the avowed goal--as well as making it easier to attract foreign capital and to invest abroad.

More profoundly, by properly reflecting costs, the heavy burden of state control would become more evident, as would the pricing signals that indicate the real desires of the Chinese people. Sleazy transfers of mispriced assets from the state to the private sector would become vastly more difficult. Theoretically, accounting would serve as a force for democracy.

Given all these benefits, the decision to shift accounting standards was, says one informed observer, not unlike the one to host the Olympics. It emanated from the top of the Beijing government and was aimed at bringing China into line with the rest of the world. Accounting, however, makes Olympiads look easy.

All China must pull off to host the games is to renovate bits of its big cities. By contrast, international accounting standards are built on foundations that China does not possess, such as experience of truthful record-keeping and deep, clean, markets so that "fair" valuations can be placed on financial instruments, property and softer assets like brands and intellectual property. (These in turn rely on enforceable laws.) What market exists that could put a fair price on the clumps of freshly built office blocks that stand empty in cities across China, asks Gary Biddle, a professor of accounting at the Hong Kong University of Science and Technology.

The decision to adopt international accounting standards was made in November 2005, to be put into effect in little more than a year. The announcement generated praise (for its worthy intentions) and shock (for its ambition). America, despite having the world's deepest financial markets, is concerned about using market-based "fair-value" reporting and will only partially converge with international standards by the end of 2008, if then. Thailand and South Korea have yet to pledge convergence of their own systems with IFRS, despite having many years' more experience than China with market-based accounting systems.

To witness the scale of the work ahead, you need only look at the upheavals in a mainland firm when it lists its shares in Hong Kong, and must therefore bring its accounts up to international standards. In a developed market, the number-crunching ahead of a listing takes months. In China, it can take up to three years. And these are typically the best Chinese companies, able to afford the best advisors.