CASE 8.5
ZUAN YAN
Synopsis
In the late 1970s, Deng Xiaoping became the new political leader of the People’s Republic of
China, replacing Mao Zedong who died in 1976. Almost immediately, Deng installed a “socialistic
market economy” in China that was antithetical in many respects to the Marxist economic model that
Mao had imposed on China. Over the past three decades, the new economic system has dramatically
improved the standard of living in China and converted the nation into an economic powerhouse.
Over the past two decades, the Big Four accounting firms have established large practice units
within China. In fact, by 2005, those firms had the four largest accounting practices in China. A
major focus of the Big Four’s Chinese practice units is the provision of independent audits. The two
principal types of businesses within China that require independent audits are FOEs (foreign-owned
326
Zuan Yang—Key Facts
Case 8.5 Zuan Yan 327
1. In the late 1970s, Deng Xiaoping installed a “socialistic market economy” in China to replace
the Soviet-style “command economy” that his predecessor, Mao Zedong, had established shortly
after the People’s Republic of China was founded in 1949.
2. Mao had dismantled China’s accounting profession, insisting that it was a part of the “liberal
3. To sustain the impressive economic revival that China experienced under its new economic
4. In 1993, China adopted an accounting conceptual framework entitled “Accounting Standards for
5. In 2005, China revealed that it would be converging its accounting standards with IFRS and its
independent auditing standards with IAS (International Auditing Standards) as of January 1, 2007.
6. Despite significant progress made by China’s domestic accounting profession over the past three
7. Another challenge facing China’s accounting profession is the need for its members to
8. Because the Big Four accounting firms recognized that China’s robust economy was creating a
9. By 2005, the Big Four firms had created the four largest accounting practices within China as a
10. Despite their success in China, the Big Four firms face several significant challenges in that
market, among them an increasing litigation risk and the need to deal with China’s authoritarian
central government.
11. In 2006, Ernst & Young quickly retracted an unfavorable economic report after Chinese
officials harshly criticized that report.
328 Case 8.5 Zuan Yan
Instructional Objectives
1. To demonstrate how cultural and political values and norms can influence the development and
evolution of a nation’s accounting profession and independent audit function.
Suggestions for Use
This case parallels the ICAI (Institute of Chartered Accountants of India) and Kansayaku cases.
Each of these cases examines the post-World War II history of the accounting discipline within a
major country—China, India, and Japan. Consider covering these cases simultaneously and having
students compare and contrast the challenges that those countries’ accounting professions have faced
Similar to other “active” cases in this text, a good method to use in launching discussion of this
case is to assign individual student groups the responsibility to research, and provide an in-class oral
report on, important recent developments relevant to the case (see the initial case question). Here’s
one suggestion on specific topics to assign students in conjunction with “updating” this case: (1)
Suggested Solutions to Case Questions
1. See “Suggestions for Use” for a specific recommendation on how to distribute the workload for
this item among your students.
2. There is no disputing that ethical and moral values vary across cultures and nations.
Whistleblowing is considered ethical in some cultures and not in others; some cultures consider large
Case 8.5 Zuan Yan 329
you might point out to your students that even within the United States, there have often been
differences of opinion across individual state boards of accountancy on what constitutes ethical
1. Responsibilities
2. The public interest
3. Integrity
4. Objectivity and independence
5. Due Care
6. Scope and nature of services
For the most part, it seems that these principles would not be controversial in most societies.
However, consider the “Public Interest” principle. The definition of “Public Interest” almost
certainly differs between a Communist country and a democratic nation. In both types of countries,
3. Statement of Financial Accounting Concepts No. 1, “Objectives of Financial Reporting by
Business Enterprises,” discusses the broad objectives of the U.S.’s financial reporting system. Those
objectives focus heavily, but not exclusively, on the information needs of investors and creditors.
These key objectives are listed next:
330 Case 8.5 Zuan Yan
more difficult to identify precisely the key objectives of a financial reporting system. Why?
Because there appear to be two “masters” to be served by that system: the investing and lending
community and the central government. To determine the financial reporting objectives within such
—Decision usefulness (of accounting/financial statement data)
—Relevance
—Reliability
—Comparability
—Consistency
An important point to recognize in this exercise is that there are significant differences of
opinion across democratic societies regarding the relative importance of these and other accounting
concepts and principles. One has to look no further than the recent differences of opinion between
the IASB and the FASB on several topics to prove this point. Having said that, some of these
principles appear more applicable to, or, at a minimum, more easily applied within, a free market
economy than a socialistic market economy. For example, a Communistic or socialistic government
4. Sidebar: Recall that a Deloitte partner in this case stated that, “The audit process is the same in
this part of the world [China]; we follow the same methodology and document it in the same way.
But, the material you are dealing with is different” [emphasis added]. This partner is suggesting that
Case 8.5 Zuan Yan 331
Although the process of analyzing and documenting inherent and control risk factors may be similar
for Organization A and Organization B, it would seem reasonable to suggest that the typical level of
inherent risk and control risk posed by an Organization A-type entity would be greater than for the
corresponding risk levels for an Organization B-type entity. So, generally, auditors of Organization
A would likely spend considerably more time and effort assessing their client’s inherent risk and
There is not a universally-accepted definition of “audit failure,” nevertheless, for our purposes,
let us define an “audit failure” as an audit engagement on which a “clean” opinion is issued when
another type of audit opinion was appropriate. [Although I don’t necessarily accept this definition,
it seems to be the “majority” view when it comes to defining an “audit failure”—my definition of
5. A source used in developing this case noted that one reason the Big Four firms have been so
successful in China has been their ability to avoid “toxic” clients. According to that source, the Big
Four use extremely rigorous “screening” procedures in their China practices to avoid high-risk
clients. Such screening procedures are also the key to avoiding potentially high profile and volatile
non-audit engagements. The Big Four firms should recognize that any professional services
332 Case 8.5 Zuan Yan