The development of public enterprises in the People's Republic of China reflects the socialist nature of the economy based on public ownership of the means of production. Within the context of the state-owned economy, the government invests in various enterprises including manufacturing, commerce, banking, communication, construction, agriculture and forestry. There are approximately 800,000 such enterprises which employ some 60 million workers and staff members and contribute significantly to the national economy. Public enterprise profits and taxation payments comprise more than 80 per cent of national revenue, while a large part of governmental expenditure is used for the development of public enterprises.
State-owned enterprises conduct independent accounting systems and are responsible for their own profits and losses. They are expected to use the incomes from the sales of their products and services to meet costs of production and operational expenses and to try to make a profit. In the case of operational losses which are permitted by state policy, the state provides subsidies.
In the light of the policies of economic structural reform and opening up to the outside world, some state-owned enterprises have established joint ventures involving industry and commerce with foreign enterprises. Such joint ventures pay taxes in accordance with the Chinese tax regulations, and share profits according to the terms specified in the contracts.
Affiliated to government departments, some undertakings in scientific research and public health, to name a few, fulfil their tasks assigned by the government with funds allocated through government budgets. They are not enterprises in nature.
The control and accountability of public enterprises under discussion in this chapter mainly refer to state-owned enterprises, not to joint ventures or administrative institutions and undertakings.
State-owned enterprises in China are economic entities. Since the initiation of the economic reform, enterprises have enjoyed expanded decision-making power in management. As legal persons, enterprises, under the guidance of the state plan, make operational decisions according to market demand, and carry out independent productive or operational activities. Diverse in form, they include, for instance, factories, enterprise groups, corporations and state farms. The means of production, however, are owned by the state, i.e. the investment in these enterprises chiefly comes from the government. Although not joint stock companies, a small number of enterprises are experimenting with a shareholding system, under which the government contributes most of the capital while individuals or foreign businesses contribute the remaining part. Therefore, according to the classification procedure stated in the 1985 Tokyo Declaration, the state-owned enterprises discussed here are in between corporate bodies and governmental companies, but by nature they may be identified more closely with the category of governmental companies.
Since the establishment of state-owned enterprises in China in the 1950s, they have operated as the basic units of government departments. For example, the No. 1 Automobile Factory, which was put into production in 1956, was directly controlled by the First Ministry of Machine-Building Industry. The factory was financed exclusively by government investment. Its director was appointed by the department in charge, its production assignments were listed in the unified state plan, and all products were subject to the centralised distribution by the state and sold at state-fixed prices. According to the state provision, the factory retained a small portion of its profits for the collective welfare of the workers and bonus funds, and distributed the remainder to the state. In the process, the factory was left with little decision-making power regarding its own management.
The economic reforms launched in the 1980s brought about a fundamental change in this type of organisational structure. Most state-owned enterprises have introduced contracted or leasing management systems. Under the contracted management system, potential contractors put forward, in conformity with the terms of contracts set by the state for various enterprises, contract schemes for a limited period (3 or 5 years) which include such specific contract goals as the amount of profits to be delivered to the state annually, technical renovation projects to be carried out during the contract period and increases in workers' income levels. The department in charge of the enterprise or the financial department concerned, as the contractee on behalf of the state, examines and evaluates the various contract proposals and chooses the best available. Subsequently, authorisation is given for the use of the enterprise's assets, physical materials and funds for production and operational activities while ensuring accountability to the state. Such contracts are normally evaluated, certified and supervised by state audit institutions.
The transformation of the operational mechanism in state-owned enterprises has resulted in a drastic change in their organisational structure. Management personnel (factory directors and managers) are no longer appointed and controlled by the contracting departments. Instead, the contractors assume such functions for the contract period, during which they have the right to conduct production and operational activities independently. When the contract periods expire, audit institutions examine actual performance and accountability of the contractors together with those of the contractees.
Initially, all staff members including leading personnel and other personnel working in state-owned enterprises were assigned by the state. First, an enterprise's internal functional arrangements, as well as size, were determined by the controlling department. Second, the principal leaders of the enterprise (including executives and functional managers) were generally appointed by the controlling department. Third, ordinary functionaries were university or technical school graduates assigned by the state, or transferred from other enterprises or administrative departments, or promoted from among workers after passing examinations. Wage scales were set by the state and workers were assessed and promoted after certain intervals. The enterprise did not have the power to dismiss its staff, such power being invested in the controlling department. Training of the staff was usually conducted by the department through short-term training courses or work-experience meetings. However, some large enterprises also sponsored their own vocational training programs, as in the case of workers' part-time universities.
The approach to staffing state-owned enterprises has improved since the introduction of economic reforms. As mentioned above, enterprise leaders are no longer appointed by the state and the main positions are taken by the contractors. Once a contractor becomes the factory director or manager, he has the power to decide the size and nature of the internal organisation, in addition to the senior staff required for efficient management of production and operations. He also has the authority to determine wage rates for his staff members in conformity with the wage standard set by the state for different industries, and, on the basis of steady improvement of economic returns, he can link the total payroll with the amount of profits retained by the enterprise after fulfilling the quotas set in the contract. As profits grow, a certain proportion, as stipulated by the state, can be used to increase workers' wages and bonuses. State-owned enterprises engage new staff through selection on merit, and promising university graduates are recruited according to the needs of individual enterprises. Those who are found unfit or who have made grave errors may be demoted or even dismissed, while competent personnel are promoted or given wage increases.
In order to raise the managerial level of state-owned enterprises, a multi-tiered training approach has been adopted. This approach includes, among other things, vocational training and work-experience within the enterprise, expansion of workers' part-time education, and arrangements for workers to take part in various training courses sponsored by government departments or academic organisations. These measures have effectively improved the production techniques and managerial skills of staff members.
Originally, the government provided funds for state-owned enterprises. In terms of fixed capital, the government invested in factory buildings, equipment and other fixed assets, which were administered and used by the enterprises. The principal part of the working capital, such as for inventories, came from government allocations and the remainder from state bank loans. Furthermore, there were only limited creditor's rights and liabilities such as accounts payable and accounts receivable. State-owned enterprises had demanded to offset production cost with income from sales of their products and make a profit so that they could retain a small share as was permitted by the state for workers' collective welfare and bonuses, while the major part of the profit, as well as the tax payments on their sales, would be handed over to the state. Even basic depreciation funds for fixed assets were turned over to the state. If an enterprise needed capital funds for a new project, it had to rely on state allocation. For a small number of enterprises experiencing losses, the government would allocate additional funds after investigating the enterprises involved.
The financing system of state-owned enterprises has witnessed a radical change since the early 1980s. The state no longer makes allocations for either theirfixed assets or operating funds. Instead, the state banks provide loans. For example, all new projects, rebuilding and extension projects or large technical renovation projects of an enterprise are undertaken with loans from the Construction Bank of China in accordance with plans agreed upon by the controlling department, and the enterprise must repay the principal and interest on time. The operating funds needed by the enterprise come from loans from the Industrial and Commercial Bank of China in keeping with its regular inventory reserve plan. A higher interest rate will be charged on the loans outside the plan, and once again the loans must be paid back on time. However, the basic depreciation funds are retained by the enterprise for equipment renewal or additions to fixed assets.
A further step in the reform of enterprise financing has been the introduction of an income tax system in state-owned enterprises, under which the enterprises pay income tax on the basis of gross profits at a rate set by the state. An additional regulatory tax is levied on those enterprises which, due to their favourable resource conditions, earn high profits and retain a large portion of them after normal tax. Furthermore, the state has worked out a profit-sharing method for enterprises, leaving them with a certain percentage of profits for the development of production technology and workers' collective welfare and bonuses.
With the intensification of the economic structural reform in China, a large number of state-owned enterprises have implemented the contracted responsibility system with consequential changes to the method of profit-sharing. First, they must hand over to the state on schedule the amount of profits set out in the contract. If their profits fall short of this amount, enterprises have to make good the shortfall from their own funds. As for enterprises with a surplus after profit delivery to the state, they can retain the surplus, part of it for use as a production technology development fund, and part for workers' collective welfare and bonuses, but they must keep a certain portion as a reserve fund for use as needed to replenish the operating fund or make up for shortfalls in profit delivery in bad years. With regard to those state-owned enterprises incurring losses permitted by state policy, the state will allocate funds to make up for the amount of losses specified in the contract. But if an enterprise is mismanaged and lacks the ability to repay the debt, it will have to go bankrupt and clear its accounts in accordance with state decrees.
In short, the financial reform of China's public enterprises has injected vigour into the enterprises and enhanced their accountability to the state. Accordingly,
it is necessary for state audit institutions to reinforce the supervision of state-owned enterprises through auditing.
In the past, state-owned enterprises were placed under the direct control of the ministries of the central government and local departments in charge of the work. Under such a management system, central government ministers and local department leaders were directly involved in the overall control of all aspects of the enterprises' activities including formulation of policies, decrees and regulations, appointment of executive staff, determination of investment plans, scheduling of production and operation, and distribution of materials and products. This overall control extended to approval of enterprises' financial plans (including budgets for revenues and expenditures), bank loans and the nature of the final accounts.
In order to stimulate the initiative and enthusiasm of state-owned enterprises for production and operation, the central government ministries, in the course of the reform, no longer directly control their affiliated enterprises, notwithstanding that some are major enterprises that have a vital bearing on the development of the national economy.
Under the guidance of state policies, these enterprises, most of which have adopted the contracted responsibility system, have become relatively independent economic entities enjoying full decision-making power. The controlling departments now exercise control over these enterprises primarily through policy-making, and formulation of plans in addition to the examination and supervision of major issues concerning production, technology, operation and finance.
Although a small number of state-owned enterprises remain affiliated to some central ministries, the majority of these have also introduced the contracted responsibility system. They have become independently run economic entities responsible for their own profits and losses, but they maintain certain ties with the controlling departments in the areas of planning, materials supply, funding, profit delivery and approval of financial statements, while those departments in turn exercise guidance, control and supervision.
The new economic mechanism operating since the introduction of economic reforms may be summarised in the following terms: 'The state regulates the market, while the market guides enterprises.' Through economic, legal and necessary administrative means, the state regulates market supply-demand relations in an effort to create a favourable economic and social environment to guide enterprises in making proper operational decisions. Thus, central agencies exercise mainly indirect controls over state-owned enterprises, and strengthen macro-control and supervision while invigorating the various enterprises. Four main functions are involved:
As already mentioned, enterprises now enjoy greater autonomy since the economic structural reforms began. Following the state guidelines, for policies, rules and regulations, enterprises are now responsible for their own profits and losses, are empowered to make their own management decisions and operate their business independently under the guidance of state plans. The transformation and development of the enterprises are thus largely a function of their own manpower, material and financial resources.
Only a few companies among Chinese enterprises have established Boards of Directors which execute the power of decision-making and supervision. Most enterprises have directors appointed by the state, with the directors involved implementing state policies.
Some state-owned enterprises have established management committees composed of enterprise management and workers' representatives. Such committees examine and supervise major planning, final accounts and other major issues concerning their enterprises.
State-owned enterprises in China normally work out, in accordance with state financial regulations and their own specific conditions, financial management measures including, for example, financial planning systems, fixed asset management methods, operating fund management methods, cost management methods, financial analysis systems, etc. These methods and systems have played a pivotal role in effecting budgetary control, ensuring the integrity of state property and materials, preventing losses and waste, consolidating financial supervision and raising economic returns.
State-owned enterprises generally have a relatively sound information system. For instance, statistical statements must be kept by individual enterprises and forwarded to the State Statistics Bureau. Further, accounting statements must be kept according to the provisions of the Ministry of Finance, and be submitted to the financial, taxation and banking institutions and the parent department in charge of operations as the basis for taxation payments, calculation of profits according to contract, procurement of loans from banks, and review of enterprise performance.
State-owned enterprises in China use the standard accounting system approved by the Ministry of Finance. The system encompasses the form and content of enterprise accounts, and provides guidelines for the processing of the main accounting items. Those guidelines extend to depreciation methods and cost accounting. It is mandatory for enterprises to conduct their accounting affairs according to the uniform accounting system, and observe the promulgated guidelines in the preparation of the financial statements.
Safeguarding the legitimate economic interests of enterprises and controlling their economic activities through legislation are important aspects of reinforcing the indirect management of enterprises since the initiation of the economic reforms in China. The Enterprise Law, the Pro.visional Regulations on the Contracted Responsibility System of Public Industrial Enterprises, the Bankruptcy Law, and the Provisional Regulations on Auditing Work are examples of important legislation affecting the control and management of enterprises.
The decision-making power of China's state-owned enterprises in terms of their management and operations has been expanded, especially after the
introduction of the contracted responsibility system. At the same time, the connection between the revenues and expenditures of enterprises and the state budget has been reduced. However, individual enterprises remain subject to national budgetary control as regards taxation, profit and borrowing matters. Accordingly, the government exercises a significant degree of control over the main activities of individual enterprises through the national budget.
The National People's Congress of China has set up a number of special commissions such as the Financial and Economic Commission and the Law Commission, which study, examine and draft relevant motions. Such commissions also investigate the economic activities of state-owned enterprises, particularly issues concerning the national economy.
The Audit Administration of the People's Republic of China, (AAPRC) headed by the Auditor-General, is the Supreme Audit Institution of China. The auditing arrangements are tiered, comprising, in addition to the AAPRC and its local offices, provincial audit bureaux which carry out audits of public enterprises at a localised level under the broad supervision of the AAPRC as the supreme audit institution. These audit institutions, taken together, play a role in the following four areas in the audit of public enterprises:
Three main types of audits of public enterprises are conducted by Chinese audit institutions:
At present, in view of the extensive introduction of the contract system in state-owned enterprises, state audit institutions also undertake contract audit, by which it is meant that when a contract is signed, the audit institution evaluates and reviews the terms of the contract. It also evaluates and reviews the economic performance of the contractor on the expiry of the contract and the manner in which its objectives have been achieved. This comprehensive audit covers the audit of revenues and expenditures, compliance, and value-for-money aspects.
State audit institutions conduct audits of state-owned enterprises in keeping with the authority stipulated in the Constitution of the People's Republic of China.
The Provisional Regulations on Audit Work issued by the State Council in 1985 stipulate that one of the important functions of state audit institutions is to conduct supervision through auditing the revenues and expenditures as well as the economic performance of state-owned enterprises. Regarding the objectives and requirements of this supervision through auditing, the document says that they are 'to strictly enforce the financial and economic discipline, raise economic returns, strengthen macro-control and management and ensure that the economic structural reform will progress smoothly'. Accordingly, all state-owned enterprises are subject to the supervision through auditing by state audit institutions.
The Provisional Regulations on Audit Work also stipulate that large and medium-sized enterprises should establish a system of supervision through internal audit bodies set up to carry out audits of the revenues and expenditures and value-for-money under the general control of enterprise managements.
In 1984 a number of enterprises in China began to undertake internal audit programs and, since then, the work has developed fairly quickly due to the actual needs of enterprises in addition to legislative provisions. Particularly after the adoption of the contract system in enterprises which has given greater autonomy and vigour to the enterprises, they feel the need to have a mechanism for self-control so that they will be able to constantly exercise self-discipline over all their economic activities, abide by the financial and economic discipline, enhance internal control, improve management, and raise economic efficiency. Only by so doing can they ensure both strength and order within the enterprises, improve managerial skills, and achieve transformation and expansion internally. In this, internal audit is playing an active role, and has brought about remarkable progress in enforcing financial and economic discipline, improving management and increasing economic yields. Internal audit has become an indispensable and vital component of China's overall auditing system.
State audit institutions guide and check on the internal audit work of state-owned enterprises, and help train their internal auditing personnel and improve the quality of internal audit work. As a result, the development of internal audit work in state-owned enterprises has expanded the coverage of audit and contributed to the raising of the quality of state audit work.
Two types of commercial audit organisations exist in China. The first is the public accounting firm which is composed of CPAs who undertake audits of Chinese-foreign joint ventures, collective enterprises and private businesses. They may also be entrusted by state audit institutions to audit state-owned enterprises and do other audit work.
The second type is the public audit firms which are set up by experienced auditing personnel after examination and approval by state audit institutions. While they may be engaged by state audit institutions to undertake all kinds of audits including audit of state-owned enterprises, they may also be commissioned by collective and private enterprises to do audits. As yet, state audit institutions have not employed commercial auditors, nor have state-owned enterprises demanded commercial auditors to undertake audit certification.
Auditing by the state audit institutions in China is mainly transaction-based. However, the systems-based audit methodology is now under study.
For the audit of revenues and expenditures and the compliance audit, state audit institutions usually apply traditional audit techniques. But in value-for-money audit, they have also adopted some modern management methods such as value engineering, regression analysis, cost-benefit analysis and break-even analysis, which have proved satisfactory in obtaining audit evidence and supporting audit findings.
State audit institutions have not yet used computers in audit work for the reason that the use of computers for accounting functions is a recent development in Chinese enterprises.
The annual audit plans provide for the audits of state-owned enterprises which are carried out separately at central and local levels. The enterprises attached to the central ministries and local departments are two separate systems, depending on the economic management structure. The former is audited by the Audit Administration of the People's Republic of China (AAPRC) and its representative offices at the localities, while the latter is audited by the audit bureaux of the various provinces, autonomous regions and municipalities, thus forming a multi-tiered audit system. The enterprises affiliated to the central ministries, however, may also be audited by local audit bureaux as authorised by the AAPRC.
Prior to the commencement of an annual plan, the AAPRC puts forward to its local representative offices as well as to local audit bureaux, audit guidelines, the audit focus and requirements for the next year, followed by lists of state-owned enterprises to be audited together with the audit objectives proposed by the various specialised departments of the AAPRC, as potential audit items. Then, the AAPRC incorporates them in the next year's audit plan, listing the mandatory audit items for the various state audit institutions. Such mandatory audit items usually account for part of the annual audit plan so that each lower level audit institution is left with some leeway to select other appropriate items according to local needs, which are then incorporated into the annual plan for implementation. Other impromptu audit items may be added to the plan during the year. The AAPRC regularly checks on the implementation of the audit plan by each audit institution and examines the execution of the mandatory audit items.
The AAPRC has worked out audit procedures to apply to the audits of state-owned enterprises and the development of audit standards are under study by it.
State audit institutions are required to audit the financial statements of state-owned enterprises annually. In practice, however, this requirement is not always met, on account of the large number of enterprises and staff shortages. Accordingly, key enterprises are given priority by the state audit institutions, with special attention given to value-for-money audits.
Generally speaking, compliance audits of state-owned enterprises are only carried out when major violations of the financial and economic disciplines are observed.
With regard to the state-owned enterprises that have not yet adopted contract management, state audit institutions also conduct term-objective audits on the factory directors (managers) and end-of-the-term audits, involving both financial audits and value-for-money audits. But these are usually carried out in connection with the annual final accounting audits.
State audit institutions' audit reports on state-owned enterprises, regardless of whether they are reports on financial audits or value-for-money audits, list the main audit findings, evidence, basis and conclusions. The draft reports are usually sent to the audited units for comments before they are compiled into final audit reports by the audit institutions.
After the review and confirmation, the state audit institutions will make audit decisions, which they will convey to the audited units and the related departments for execution. At the same time, copies of the reports are sent to the controlling departments and that level of government.
If an audited unit disagrees with the audit report, it may apply to the audit institution at higher level for re-examination within 15 days after receiving the report. The audit institution at higher level should conduct the re-examination within 30 days from the date of receiving the application. During the period of re-examination, the original audit conclusions and decisions remain in force. The audit institution at higher level has the power to change audit conclusions and decisions made by the lower level audit institution. Should the audited unit still disagree with the re-examination conclusions and decisions, it may appeal to the institution at the next higher level ultimately, to the AAPRC.
The AAPRC reports annually to the Standing Committee of the National People's Congress on major issues including those concerning state-owned enterprises, while audit institutions at local levels report to the standing committees of the local people's congresses.
In China, the state audit institutions are authorised to direct state-owned enterprises to correct errors in accounting data and remedy breaches of financial rules and regulations. The state audit institutions are empowered to confiscate illegal gains, impose fines, withhold funds and suspend fiscal allocations or bank loans. These decisions of the state audit institutions are binding on the enterprises concerned.
State audit institutions also have the power to determine responsibility for financial and economic violations. The parties involved may be referred to their responsible departments for disciplinary action or, where there have been breaches of the criminal code, to the judicial authorities. Details of such offences may be publicised by state audit institutions in the press or other news media.
In relation to value-for-money audits, the findings and suggestions for improvement made by the audit institutions are referred to individual enterprises for remedial action where necessary. The state audit institutions may conduct follow-up audits in order to ascertain whether appropriate action has been taken and evaluate the level of improvement in particular cases.