First China Pharmaceutical Group, Inc.  The company acquired XYT, and in doing so, ended up with a note receivable from the CEO and Chairman of XYT.  The company recorded the note as an asset.  Upon further review, the SEC “requested the Company remove the note as an asset and restate it against retained earnings.”  After talking to legal and accounting experts, the company “received a legal opinion from its PRC legal counsel that this action as requested by the SEC is against PRC law.” (emphasis added)  In essence, the company was using local statutes as an excuse to deviate from SEC requirements.

The press release goes on to say “The Company has presented numerous arguments against this treatment and offered different accounting treatments to the SEC that would, the Company believes, be compliant with both U.S. GAAP and PRC law.  However, the SEC’s position remains unchanged and is requiring the company to restate the ‘Note Due from Related Party’ against retained earnings… The Company believes that it will be able to provide adequate disclosure to also satisfy accounting standards in the PRC.”

This raises a lot of issues for me.  First, why does the note receivable have to go to retained earnings?  ASC 310-10-S99-2&3 mention cases where related party receivables are recorded as contra equity, similar to common stock issued on a subscription basis.  But the press release specifically mentions retained earnings.  Does the SEC view this as an expense or a dividend?

Second, would a US company be able to use “the law made me do it” excuse?  Suppose a US company wanted to list on a foreign stock exchange and the exchange required some accounting that is not US GAAP; does the SEC or other branch of the government have a law prohibiting them from filing non-GAAP statements in a foreign country (so long as Reg FD is followed)? I guess the US tax law prohibits companies from issuing financial statements to investors using the FIFO method if they used LIFO for tax.  But I can’t think of any others.

Third, I have heard a lot of people question whether the SEC has any real power to affect financial reporting quality for foreign registrants.  This anecdote suggests the SEC is more than just a paper tiger.

Fourth, suppose the company’s initial assessment is correct: local laws can proscribe compliance with non-domestic accounting standards.  What does that mean for the goal/dream of a single set of global accounting standards?]]>