Open Journal of Social Sciences, 2015, 3, 128-133
Published Online November 2015 in SciRes. http://www.scirp.org/journal/jss
How to cite this paper: Shan, J.X. (2015) Case Studies of Local CPA Firms’ Audit Quality. Open Journal of Social Sciences, 3,
Case Studies of Local CPA Firms’ Audit
Management School, Jinan University, Guangzhou, China
Received 26 October 2015; accepted 13 November 2015; published 16 November 2015
Copyright © 2015 by author and Scientific Research Publishing Inc.
This work is licensed under the Creative Commons Attribution International License (CC BY).
Using two state-owned enterprises’ financial fraud cases, Nanjing Zhongbei Group Co., Ltd. and
Nanjing Textiles Import & Export Corp., Ltd., which were audited by the same local CPA firm, we
found that the auditors of the two companies were almost the same and the fraud time of the two
companies was close. We further analyze the reasons why the CPA firm still issues standard opi-
nions for such fraud and “sick” auditors violate again. Finally, we propose some policy suggestions.
Financial Fraud, Local CPA Firm, Audit Quality
In 2010, the China Securities Regulatory Commission punished Nanjing Zhongbei Group Co., Ltd., a local
state-owned enterprise, for its illegal information dis closure. The company’s annual reports hid huge bo rrowing
up to 1.3 billion yuan and the related-party guarantee of more than 40 million yuan in 2003 and 2004. In 2014,
the China Securities Regulatory Commission punished Nanjing Textiles Import & Export Corp., Ltd., another
local state-owned enterprise, for its inflated profits. The company made up profit more than 300 million yuan
from 2006 to 2010, which was the most serious SOEs’ financial fraud in recent 10 years.
The financial reports of listed companies must be audited by the CPA firm. The CPA firm of the two listed
companies was the same local CPA firm, Nanjing Lixin Yonghua CPA firm. The auditors all issued standard
opinions during the fraud period of the two companies. Confusingly, the two companies’ fraud time was rela-
tively long and the amount of money was huge, especially Nanjing Textiles Import & Export Corp., Ltd., whose
inflated profits were more than 300 million yuan from 2006 to 2010, but the auditors didn’t find any problems
and still issued standard opinions.
The audit quality of local CPA firms is a focus of concern in the domestic academia and practice. In China,
J. X. Shan
the government controls both the audit market and state-owned listed companies to a large extent. The actual
controller of local state-owned enterprises is the State-owned Assets Supervision and Administration Commis-
sion, so local state-owned enterprises are controlled by the local government. In the initial stage of Chinese CPA
firm, they were affiliated to the government and the extension of the ministry of finance. Although the CPA
firms completed decoupling reformation in 1998, the government still plays an important role in the develop-
ment of local CPA firms. Both local state-owned enterprises and local CPA firms are influenced deeply by the
local government; they are closer. When there is relationship between companies and accoun ting firms, they are
more likely to receive clean audit opinions . However, if the actual situation of listed companies deviates
from the standard opinion s, it w ill cause great losses to investors and disrup t ord er in the cap ital marke t.
This paper is a case study of two state-owned enterprises’ financial fraud, whose CPA firm is the same local
CPA firm. In the second part, we will introduce the details of the two companies. In the third part, we will in-
troduce the details of the local CPA firm. In the fourth part, we will analyze the real reasons why the CPA firm
still issues standard opinions for such fraud and “sick” auditors violate again. Finally, we propose some policy
suggestions. This study enriches the research field of the audit quality of local CPA firms and provides new
evidence. It is a huge obstacle for the healthy development of the China capital market. The regulator should
play more attention on such issues.
2. Case Introduction
2.1. Nanjing Zhongbei Group Co., Ltd. Financial Fraud Case
Nanjing Zhongbei Group Co., Ltd., founded in 1979, mainly engages in public passenger transport. It listed on
the Shanghai Stock Exchange in 1996.The actual controller of the company is Nanjing State-owned Assets Su-
pervision and Administration Commission, so the company is a local state-owned enterprise.
In March 2010, the China Securities Regulatory Commission issu ed an administrative penalty decision to the
company. They found that the company’s annual reports hid huge borrowing up to 1.3 billion yuan and the re-
lated-party guarantee more than 40 million yuan in 2003 and 2004. Such a large amounts of money flowed to
the Nanjing Wanzhong Co., Ltd. through various ways.
The absolutely controlling shareholder of Nanjing Wanzhong Co., Ltd. is its trade unions. Its members are
mainly workers in Nanjing Zhongbei Group Co., Ltd. and Nanjing Wanzhong Co., Ltd. Besides, part of the
managers of Nanjing Zhongbei Group Co., Ltd. have important role in Nanjing Wanzhong Co., Ltd. at once. It
can be inferred that Nanjing Zhongbei Group Co., Ltd. enjoys much more interest and controls Nanjing Wanz-
hong Co., Ltd. Therefore, no matter Nanjing Zhon gbei Group Co., Ltd. repays loan, pays bills or r emits money
to shareholder funds to Nanjing Wanzhong Co., Ltd., its biggest beneficiaries is still Nanjing zhongbei Group
Nanjing Linxin Yongh ua CPA firm provided audit s ervices for Nanjing Zhongb ei Group Co., Ltd. from 1998
to 2005, a total of seven years. During the seven-year period, the auditors all issued standard opinions without
reservation, that is, in 2003 and 2004, the company’s financial fraud years, the auditor still issued standard opi-
2.2. Nanjing Textiles Import & Export Corp., Ltd. Fina nci al Fraud Case
Nanjing Textiles Import & Export Corp., Ltd., founded in 1978, mainly engages in textiles import and export. It
listed on the Shanghai Stock Exchange in 2001. The actual controller of the company is also Nanjing State-
owned Asse t s S u pe rvision and Administration Commission, so the company is a local state-owned enterprise.
In May 2014, the China Securities Regulatory Commission issued an administrative penalty decision to
Nanjing Textiles Import & Export Corp., Ltd. They found that the company made up profits about 344 million
yuan from 2006 to 2010. Tabl e 1 shows the p rofits of Nanjing Textiles Import & Export Corp., L td. from 2006
to 2010. We can see that the inflated p rofits are 31.09 million, 42.23 million, 152 million, 60.53 million, 58.64
million respectively. Figure 1 can show the gap between the disclosure profits and the actual profits clea rly. Its
disclosur e profits are higher tha n its actual profits fro m 2006 to 2010, especially in 2 008. It means the company
made up profit in these five years.
No matter the time span or the amount of inflated profits, it was more serious than Lv Da Di (now called
Yuntou Ecology) and Wanfu Biotechnology Agricultural Development Co., Ltd.’s financial fraud, two serious
J. X. Shan
Table 1. Profits of Nanjing Textiles Import & Export Corp., Ltd. from 2006 to 2010.
2006 2007 2008 2009 2010
Disclosure profits (million) 24.40 27.93 15.80 15.83 −1.05
Inflated profits (million) 31.09 42.23 152.00 60.53 58.64
Actual profits (million) −6.69 −14.30 −136.20 −44.70 −59.69
Inflated profits/Disclosure profits 127% 151% 962% 382.43% 5591%
Figure 1. The actual profits and disclosure profits of Nanjing Textiles Import & Export Corp.
financial fraud in China capital market. Lv Da Di made up profits less than 300 million yuan before it listed on
the market. Wanfu Biotechnology Agricultural Development Co., Ltd. made up profits 213.68 million yuan
from 2008 to first half of 2012, a total of five and a half years.
The company used various metho ds of financia l fraud. Here were several main methods:
1) Virtually increase the revenue of contracts an d forge income.
2) Carry forward less operating costs.
3) Export-tax rebate cheat: the company forged export goods documents and the amount of taxation was
about 10.34 million yuan.
4) Adjust current account so as t o adjust the ba d debt pre paration .
Nanjing Linxin Yonghua CPA firm provided audit services for Nanjing Textiles Import & Export Corp., Ltd.
from 2001 to 2011, a total of eleven years. During the eleven-year period, the auditors all issued standard opi-
nions without reservation, that is, during the company’s financial fraud year, the auditor still issued standard
opinions. However, as analyzed above, the methods of financial fraud were not very complicated. They were
relatively common and the fraud time lasted for five years, but the auditors didn’t find any problems.
3. Analysis of the CPA Firm
The financial reports of listed co mpanies must audited by the CPA firm, so the CPA firm is an important part of
the financial fraud.
The two SOEs were audited by the same CPA firm, Nanjing Lixin Yonghua CPA firm, before they were pu-
nished by China Securities Regulatory Commission.
This CPA firm is a local CPA firm. It is called Nanjing Yonghua CPA firm before, which is restructured from
profits(million yua n)
Disclosure pr of its
J. X. Shan
Nanjing CPA firm in December 1998, a former CPA firm affiliated to the Jiangsu Department of Finance. In
February 2001, it becomes a member firm of Haohua international CPA firm. In May 2007 , it joins Lixin CPA
management company and changes its name to Nanjing Linxin Yonghua CPA firm.
Nanjing Lixin Yonghua CPA firm is a relative powerful local CPA firm in Jiangsu. It is the earliest account-
ing firm engaged in auditing and assets evaluation business in Jiangsu. Besides, it is one of the largest CPA
firms and assets evaluation firms in Jiangsu. In 2011, it is one of China’s top hundred CPA firms and its com-
prehensive evaluation of quality index ranks first in Jiangsu. All of these experiences show that Nanjing Linxin
Yonghua CPA firm is a relative pow erfu l CPA firm in Jiangsu and the auditors’ ability is also professional.
We further analyze the methods of financial fraud of the two listed companies. As analyzed in the case intro-
duction, The main method of Nanjing Zhongbei Group Co., Ltd. is related-party transaction and the major me-
thods of Nanjing Textiles Import & Export Corp., Ltd. are various but relatively common. These methods wer e
not complicated. They are relatively common since they have been used by previous fraud companies many
times. What’s more, the fraud time of the companies is relatively long. One lasts for two years and another lasts
for five years. However, the auditors didn’t find any problems. If they follow the normal audit process, it is im-
possible that they can’t find any problems.
Based on the above analysis, it can be indicated that the auditors’ ability is not the main reason why they can’t
find any problems of the companies’ financial statements.
We also found that the auditors of the two companies were almost the same. Table 2 shows the audit opinions
and the auditors of Nanjing Zhongbei Group Co., Ltd. In 2003 and 2004, the auditors, Xumin Chu, Aiguo Zhang
and Xiaoshuang Sun, issued standard opinions, who were punished by the China Securities Regulatory Com-
mission. Table 3 shows the audit opinions and the auditors of Nanjing Textiles Import & Export Corp., Ltd. The
three auditors still sign ed for Nanjing T extiles Import & Export Corp., Ltd. and issued standard opinions, which
was untruthful opinions, misleading investors.
Why the CPA firm still issues standard opinions for such fraud and “sick” auditors violate again? If not be-
cause of their ability, what is the real reason?
4. Cause Analysis
4.1. Common Interes ts
The government, loc a l SOEs and local CP A firms have a common interest.
First, in order to meet the Chi na Secur ities Reg ulator y Commissions ea rning s targ ets for IPO, seasoned equity
offerings or to avoid delisting, local SOEs, especially the loss-generating SOEs, will choose earnings manage-
ment and intervention in the auditor’s audit opinions. In China, if the listed companies loss continuously for
three years, they will be compulsorily delisted. By this standard, Nanjing Textiles Import & Export Corp., Ltd.
should have been compulsorily delisted because its real profits are negative for five consecutive years. However,
the company avoids delisting through financial fraud and now it still lists on the capital market.
Table 2. The audit opinions and the auditors of Nanjing Zhongbei Group Co., Ltd.
Year The audit opinion the auditors
2003 Standard opinion Xumin Chu, Aiguo Zhang
2004 Standard opinion Xiaoshuang Sun, Aiguo Zhang
Table 3. The audit opinions and the auditors of Nanjing Textiles Import & Export Corp., Ltd.
Year The audit opinion The auditors
2006 Standard opinion Aiguo Zhang, Xumin Chu
2007 Standard opinion Xumin Chu, Wenliang Gu
2008 Standard opinion Xiaoshuang Sun, Xiaojie Zhu
2009 Standard opinion Aiguo Zhang, Min Wu
2010 Standard opinion Wenliang Zhu, Yongkuan Li
J. X. Shan
Second, the ultimate controller of state-owned enterprises is the local government. There is a link between
SOEs’ profits and the government’s performance. The government officials have motivation to conspire with
SOEs for better achievements and future prom oti on.
Third, the competition of CPA industr y is more and more fierce. Most local CPA firms’ business comes from
local enterprises. The local government has a certain influence on the development of the local CPA firms, in-
cluding access to potential business. In order to survive in the fierce competition and get more business, the
CPA firms and auditors tend to choose collusion. For example, th ey will issue clean audit opinions for the listed
companies even though they know the companies don’t meet the standard.
The government can gain political achievement, the SOEs can obtain capital and better p erf ormance and the
CPA firms can get access to business. All of them get benefit from the event, but there is no doubt that it will
cause great harm to investors and disturb the normal order of the capital market.
4.2. Lower Collusion Cost
The government and the state-owned enterprises have the motivation to do earnings management and intervent
in the audit opinions for raising more funds or for better performance, etc. Selecting the relevant CPA firms can
reduce the cost of collusion . Local CPA firms have a certain relationship with the local government and the
government still has impact on local CPA firms, which can ensure better communication and reduce the cost of
The government controls both the audit market and state-owned listed companies to a large extent in China.
In the initial stage of Chinese CPA firm, they were affiliated to the government and the exten sion of the ministry
of finance. The CPA firm completed decoupling reformation in 1998, but the government still plays an ex-
tremely important role on the development of local CPA firm now. The government acts as a social regulator
supervises the CPA industry directly, including the CPA professional qualification, professional standards, su-
pervision and discipline. Local state-owned enterprises are controlled by local government, so local CPA firms
and local state-owned enterprises are clo ser. There is a link between regional CPA firms and local governments.
The government intervents in the auditor choice of the SOEs to a large extent, which leads to collusion among
the government, regional CPA firms, and local enterprises . In addition, the local state-owned listed compa-
nies and local CPA firms speak a common language and have a relatively common circle, which make them
communicate with each other easier.
The state-owned listed companies, which have political connection, obviously tend to choose the local small
CPA firms because of geographical preference. If the listed companies’ earnings quality is the same, the proba-
bility of companies with political connection obtain non-standard audit opinions significantly lower than com-
panies without political connection . However, such standard opinions may be not consistent with the real
performance of the enterprises, which will cause huge losses to investors.
4.3. Low Violation Cost
Although there are some regulations of punishment, the punishment is still light. In the financial fraud case of
Nanjing Zhongb ei Group Co., Ltd., the China Securities Reg ulatory Commission gave warning to Nanjing Lin-
xin Yonghua CPA firm, confiscated the illegal income 175,000 yuan and fined 200,000 yuan. The auditors,
Xumin Chu and Aiguo Zhang, were fined 80,000 yuan respectively. Xiaoshuang Sun was fined 40,000 yuan.
From the perspective of the amount of punishment, such punishment is not serious compared to the amount of
The financial case of Nanjing Textiles Import & Export Corp., Ltd. is more serious. The amount of fraud is
larger and the fraud time is longer. However, the CPA firm and the auditors were not under any penalties. Only
the company was warned and fined 500,000 yuan by the China Securities Regulatory Commission. Its senior
executives were fined. The auditors still audit for other companies after th e fr au d c ase . The y contin ue their work
even though they violate.
The low cost o f vi olation is also the reason why the auditors violate again and again.
5. Policy Suggestions
Auditing is an important part to ensure the true and reliable financial reporting. The certified public accountants
J. X. Shan
should maintain independence and issue unbiased audit opinions. They are responsible for investors not for in-
terest. If the CPA firms conspire with the listed companies, meaning intermediary institutions perform practi-
cally no function, it will cause huge losses to investors. It is a huge obstacle for the healthy development of the
China capital market.
Finally, we put forward the following policy suggestions and measures:
1) Strengthen the external supervision and implement the audit institutions rotation system. The regulatory
authority should make relevant regulations of the auditor choice and rotation so as to regulate the auditor choice
of the state-owned listed companies. As the two cases studied in this paper, Nanjing Lixin Yonghua CPA firm,
provide audit services for 7 years and 11 years respectively, it is easier for them to form collusion. If the compa-
nies haven’t been investigated by the China Securities Regulatory Commission, Nanjing Lixin Yonghua CPA
firm may continue to provide audit services for the companies. It can hinder the communication between enter-
prises and intermediaries and strengthen supervision through th e audit institutions rotation.
2) Strengthen the punishment dynamics so as to increase the cost of violation. In the Enron’s financial fraud
case, the intermediaries are punished severely. JP Morgan and CitiBank are fined up to 300 million dollars. An
Daxin CPA firm collapses after the event. The company’s senior executives were sentenced to 100 years in
prison and fined nearly 200 million dollars. However, in the Nanjing Zhongbei Group Co., Ltd. financial fraud
case, Nanjing Lixin Yonghua CPA firm is only warned and fined 200,000 yuan. In another fraud case, the CPA
firm has not been punished. Such punishment is obviously too light. It’s not enough to deter the high frequency
of illegal behavior.
3) Establish a faith file for a CPA to record his illeg al behavior. In the era of big data, it is more convenient to
save information and estab lish files. The regulatory authority can use information technology to record the illeg-
al behavior of a CPA since he works as an auditor. If the CPA doesn’t do his duty and violates the regulation,
for example, issues untruthful auditor opinions, the regulatory authority should give attention to this phenome-
non as well as give him warning. If the situation is serious, the auditor should be punished. This can constrain
the CPA’s behavior and reduce his short-sighted behavior.
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