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PwC's Role in Evergrande's Multi-Billion Dollar Scandal Under Intense Investigation

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Robert Tavares

March 22, 2024 - 04:28 am

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PricewaterhouseCoopers Under Scrutiny for Evergrande's $78 Billion Accounting Scandal

Chinese regulatory authorities have initiated an intense examination into PricewaterhouseCoopers LLP (PwC), scrutinizing their role associated with the accounting irregularities at China Evergrande Group, as allegations surface pointing to financial improprieties totaling a staggering $78 billion fraud. The increased focus on PwC comes amidst a broader investigation as the real estate sector faces a profound crisis.

PwC and Evergrande

The Chinese securities watchdog has condemned Evergrande’s key domestic branch, Hengda Real Estate Group, for prematurely recognizing sales and grossly inflating its revenue during the two critical years leading up to 2020, right before the property giant's default. Sources acquainted with the situation reported that authorities now have their gaze fixed on PwC, probing whether the global audit giant may have played a part in these deceitful practices as they carry out their investigations targeting Evergrande’s founder, Hui Ka Yan, who found himself in custody last year.

Presently, the fate of potential penalties against the auditor remains undecided. However, the situation lays heavy on PwC, who has chosen to remain silent on the matter. This inquiry arrives at an inconvenient juncture for PwC, already grappling with repercussions from conflicts in various international divisions, leading to employment reductions in locations ranging from the United Kingdom to Canada. Particularly, PwC Australia, another segment slashing its workforce, has been severely criticized for prematurely divulging confidential government tax details to its clientele. Similarly, PwC UK sustained a substantial fine last year underscoring subpar audits of Babcock International Group Plc’s financials.

Nigel Stevenson, an analyst from the Hong Kong-based accounting research company GMT Research Ltd., has posed severe inquiries concerning PwC’s involvement in the fraudulent activities at Evergrande, especially regarding their awareness of the flawed revenue recognition. GMT Research, having previously doubted the integrity behind Evergrande's financial disclosures, has in December 2023, conjectured the possibility that the developer might not have been profiting at all. Evergrande, in response to this claim, has deemed the report baseless.

Hengda's supposed financial embellishment did not merely cover up its actual revenue but also exaggerated profits by an approximate 91.9 billion yuan ($12.7 billion). These misstated figures represent over three-quarters of the income Evergrande reported between 2019 and 2020, dwarfing the financial misrepresentation seen in the infamous Enron scandal by a factor of twenty. According to Richard Murphy, professor of accounting practice at Sheffield University, standard auditing practices fundamentally include checks for such misstatements, and the risks associated with oversight are considerable and have far-reaching implications for PwC's global reputation.

Evergrande's pre-2021 financial tactics involved recognising revenue from contracted sales of properties yet to be completed and delivered. By reporting such aggressive revenue, Evergrande was able to showcase lower liabilities and more favorable leverage ratios, assisting its issuance of bonds locally and internationally. However, as the developer encountered debilitating cash-flow issues in 2021, it slipped into default, endangering the completion of numerous pre-sold apartment units.

The ramifications for PwC from this accounting scandal could escalate into substantial legal difficulties. With Evergrande presently navigating through liquidation processes in Hong Kong, liquidators striving to recuperate funds for creditors might seek compensation from the deep pockets of PwC, as suggested by multiple legal experts and insolvency practitioners. Adding to the complexity, Evergrande's penalty of 4.18 billion yuan imposed by the regulator signifies even fewer resources for repaying its debts, amidst liabilities reportedly around $332 billion as of mid-2023.

China has historically taken a stern approach towards accounting firms when they stumble in their audits of domestic entities. For instance, Deloitte's China division faced hefty fines and operational suspensions last year due to severe audit deficiencies in their reviews of China Huarong Asset Management Co. This company, ironically, had to be bailed out for massive losses in 2021.

PricewaterhouseCoopers Zhong Tian LLP, a Shanghai-based member of the global PwC network, audited Hengda during the dubious period. PwC, which severed ties with Evergrande in early 2023 citing auditing disagreements, had been the developer's auditor for over ten years. Despite PwC's onshore revenues hitting 7.9 billion yuan in 2022, leading its local competition, this figure is minuscule compared to the firm's international revenue of $50.3 billion for the same period.

PwC, among the Big Four accounting firms, served as the go-to auditor for numerous Chinese real estate companies listed in Hong Kong, validating the finances of several of the country's largest developers. However, default crises have also hit these firms, including Country Garden Holdings Co. and Sunac China Holdings Ltd. PwC, over the past two years, has relinquished its auditing roles for at least ten Chinese property entities, with Sunac and Shimao Group Holdings Ltd. being notable exits.

During the property boom, developers in China capitalized on presales of under-construction homes, promising future completions. Homebuyers, dependent on deposits and mortgages, anticipated that their funds would remain secure in escrow until construction concluded. However, Evergrande's revenue-recognition methods were seemingly discretional, claiming revenue on properties either once a customer accepted them, or based on sales contracts ahead of completion.

After Evergrande's cash-flow crisis hit, it revised its stance, deciding to report revenue only upon the completion or occupation of projects it had pre-sold. This shift evidenced significantly higher liabilities for 2021 and 2022, reflecting what it owed to homebuyers.

Tyran Kam, Fitch Ratings' head of China property, indicated that information broadly accessible at the time did not suggest Evergrande's accounting practices were divergent from industry norms. Credit rating agencies, among other market observers, rested their assessments on the financial statements as audited.

Notably, China Vanke Co., audited by KPMG LLP, declared in its 2022 report a specific three-criteria revenue recognition strategy consistent with their contract stipulations, highlighting industry standards. However, Evergrande might have extended these practices to lengths beyond their peers.

Adding to PwC's dilemmas, Hong Kong's Financial Reporting Council initiated an investigation in 2021, questioning their failure to identify Evergrande's potential collapse. This probe by the city's accounting authority concerned the details within Evergrande's 2020 annual report and its interim documentation for 2021.

Tom Kirchmaier, a professor at London School of Economics' Centre of Economic Performance, contemplates the notion that the auditing process itself is fundamentally flawed, creating an inherent and potentially widespread issue that may extend beyond the walls of PwC.

For more insights and updates on this developing story, stay tuned to Bloomberg.