Analysis on Changes of Accounting Theory After Implementation of Enterprise Bankruptcy Law

Analysis on Changes of Accounting Theory After Implementation of Enterprise Bankruptcy Law WANG Lina School of Political Science and Law, Henan Polytechnic University P. R.China, 454000 linda1010@tom.com Abstract: In the financial crisis, some enterprises may face bankruptcy and have to exit the market due to poor operating status. The PRC Enterprise Bankruptcy Law has been effective since June 1, 2007, which will have a profound impact on bankruptcy accounting theory and cause relevant changes. At present, there are not many articles which discuss enterprise accounting theory from the perspective of the bankruptcy law. This paper combines basic accounting theory with the bankruptcy law from aspects of the application scope of bankruptcy accounting, bankruptcy accounting objectives, bankruptcy accounting structure, bankruptcy accounting entity and so on to discuss relevant changes of accounting theory, which will have certain theoretical and practical significance for enterprises. Keywords: The enterprise bankruptcy law, bankruptcy accounting, bankruptcy management Instruction In August 27, 2006, the new Enterprise Bankruptcy Law was examined and approved in the Tenth NPC Standing Committee. This is a milestone in the transition period of China. The birth of the new bankruptcy law is a historic step forward because it filled the large gap between exit law and regeneration method in a system of rules of a market economy and the promulgation and implementation of the new Enterprise Bankruptcy Law will have far-reaching impact on bankruptcy accounting theory and cause profound changes. 1 Changes of Bankruptcy Accounting Entity Bankruptcy accounting entity is the definition of the accounting scope of bankruptcy accounting. Before the Enterprise Bankruptcy Law was issued and implemented, regarding bankruptcy accounting entity, in the accounting area, there are two representative views. One is the theory of sole accounting entity and the other is the theory of dual accounting entity. The theory of sole accounting entity thinks that the bankruptcy counting entity is the liquidation team which is responsible for the people's court; the theory of dual accounting entity thinks that counting entity includes bankrupted enterprise accounting entity and bankruptcy liquidation team accounting entity. Hereon, we use theory of dual accounting entity to analyze the impact of Enterprise Bankruptcy Law on bankruptcy accounting entity. The application scope of the new bankruptcy law has been extended to all enterprises legal persons, including state-owned enterprises and corporate-type private enterprises, foreign-funded enterprises, listed companies and non-listed companies, limited liability companies and incorporated companies, and even financial institutions. We can see that this bankruptcy law will be also applicable to state-owned enterprises and non state-owned enterprises. However, this will not impact bankrupted enterprise accounting entity. Bankrupted enterprises accounting entity includes all companies in the process of bankruptcy. Before the new Enterprise Bankruptcy Law was issued, the bankruptcy basis for bankrupted state-owned enterprises accounting entity is Enterprise Bankruptcy Law (Trial Implementation), while the basis for bankruptcy of non-state-owned enterprises accounting entity is the civil law and the Supreme People's Court s judicial interpretation. After the new Enterprise Bankruptcy Law was promulgated and implemented, although the bankruptcy basis for bankrupted state-owned enterprises accounting entity and the bankruptcy basis for bankrupted non- state-owned enterprises entity were unified, in general, the scope of bankruptcy enterprise accounting entity has not changed. 587

However, as the Enterprise Bankruptcy Law introduces internationally accepted the bankruptcy administrator system and is operated according to a market-oriented way, which replaced previous liquidation team. Thus, after the implementation of the new Enterprise Bankruptcy Law, the bankruptcy liquidation team accounting entity ceased to exist, replaced by bankruptcy administrator accounting entity. The replacement of bankruptcy administrator with liquidation team does not just mean name change, instead, there are essential differences between them. 1.1 The composition of bankruptcy administrator is different from that of liquidation team. Enterprise Bankruptcy Law (Trial Implementation)Article 24 stipulates that the liquidation team members shall be designated by the people's court from supervision authorities of enterprises, financial sector and professionals, while the bankruptcy administrator shall be mainly appointed from professionals from law firms, accounting firms, bankruptcy liquidation firms and other intermediary agencies who have relevant expertise and obtained professional qualifications by court or the meeting of creditors. 1.2 The responsibilities of bankruptcy administrator are different from that of liquidation team. Enterprise Bankruptcy Law (Trial Implementation) s definition of the responsibilities of a liquidation team is fundamental and it only stipulates in Article 24: the liquidation team is responsible for custody, clearing, valuation, treatment and distribution of bankruptcy properties. The law does not define the behaviors of the liquidation team specifically, therefore, in practice, it is difficult to make accurate judgments for conducts of liquidation team. The new Enterprise Bankruptcy Law defines the responsibilities of bankruptcy administrator clearly and specifically, which will be good for the smooth progress of bankruptcy procedures. The Bankruptcy Law Article 25 specifies that the administrator shall fulfill nine statutory duties and clearly defines the scope of it: these duties include: (a) take over the debtor's property, seals and books, documents, etc.; (b) investigate debtor's property status, and make property status reports; (3) determine the management of internal affairs of debtor's; (d) determine daily expenses and other necessary expenses of debtor; (5) decide whether to continue or cease debtor's business before the first meeting of creditors; (6) manage and dispose debtor's property; (7) participate in litigation, arbitration or other proceedings on behalf of debtor (8) call for a meeting of creditors; (9) other duties that the people's court thinks the administrator should fulfill. 1.3 The monitoring mechanism and responsibilities of bankruptcy administrator are different from that of liquidation team. Enterprise Bankruptcy Law(Trial Implementation)does not have relevant monitoring and accountability measures for business behaviors of liquidation team members, which has led to no law available to be abided in practice. This has constituted a serious threat to the interests of creditors. The new Enterprise Bankruptcy Law stipulates the legal responsibilities of bankruptcy administrator in case of violations of dedication and diligence obligations of bankruptcy administrator or other legal violations, which strictly regulates the behaviors of bankruptcy administrator. For example, the bankruptcy law Article 130 stipulates that if administrator does not faithfully perform their duties in accordance with provisions of this law, the people's court may impose a fine on the administrator in accordance with law; in case of losses incurred to creditors, debtor or third party, the administrator shall be liable for compensation. 2 Changes of the application scope of bankruptcy accounting After the implementation of the new Enterprise Bankruptcy Law, bankruptcy accounting shall consist of bankruptcy reorganization accounting and bankruptcy liquidation accounting, that is, only enterprises which enter the stage of reorganization or liquidation phase shall be applied to bankruptcy accounting. The provision of new Enterprise Bankruptcy Law on bankruptcy reorganization and bankruptcy liquidation has affected the application scope of bankruptcy accounting. 588

2.1 The reasons for relaxing reorganization The new Enterprise Bankruptcy Law relaxes the organization reasons in order to increase the likelihood of success of reorganization. It stipulates that if any enterprise is unable to pay for all of its matured debts, it can directly apply for reorganization. At the same time, in order to take advantage of the corporate management understanding the real situation of the enterprise, it encourages debtors to solve internal issues through legal procedures. When a debtor files an application for bankruptcy reorganization, creditors can apply to implement management of relevant properties and business affairs to the people's court. While in the Enterprise Bankruptcy Law (Trial Implementation), only companies have confirmed that they can not pay for their matured debts, can their supervision authorities apply for reconciliation and rectification for the companies. This provision makes a significant increase of the number of companies which are qualified to enter into the process of bankruptcy reorganization, thereby expanding the application scope of bankruptcy reorganization accounting. 2.2 Changes of liquidation reasons The provision about bankruptcy liquidation of the new Enterprise Bankruptcy Law is also different from that of the Enterprise Bankruptcy Law (Trial Implementation). The Enterprise Bankruptcy Law (Trial Implementation) stipulates that as long as companies can not repay their matured debts and they can not be saved through reconciliation and reorganization, they will enter into the procedures of bankruptcy liquidation. While the new Enterprise Bankruptcy Law s provision about bankruptcy liquidation is more stringent than that of the Enterprise Bankruptcy Law (Trial Implementation). It not only requires that companies can not repay their debts, but also requires that the companies are insolvent, and can not be saved through bankruptcy reorganization, till then, they can enter into the procedures of bankruptcy liquidation. The strict control of reasons for bankruptcy liquidation makes companies in process of bankruptcy liquidation reduced, so that the application scope of bankruptcy liquidation accounting has been narrowed. This is mainly from the point of view of safeguarding social stability and efficient use of resources, in order to encourage companies whose assets value equals to the value of their debts to be reorganized. 3 Changes of composition of bankruptcy accounting In the Enterprise Bankruptcy Law (Trial Implementation), the broad concept of bankruptcy accounting holds that: bankruptcy accounting consists of two parts - bankruptcy liquidation accounting and reconciliation and rectification accounting. The new Enterprise Bankruptcy Law introduces bankruptcy reorganization system to replace the traditional system of reconciliation and rectification, so that the composition of the bankruptcy accounting changes. After the new Enterprise Bankruptcy Law was issued and implemented, bankruptcy accounting should include bankruptcy liquidation accounting and bankruptcy reorganization accounting. Bankruptcy reorganization and reconciliation and rectification are two different concepts. The concept of reconciliation and rectification of China's Enterprise Bankruptcy Law (Trial Implementation) is significantly different from the concept of reorganization system of the new Enterprise Bankruptcy Law. The system of reconciliation and rectification is a system to prevent debtor to be bankrupted through reconciliation between insolvent debtor and creditors by entering a reconciliation agreement to extend, amortize or waive part of the debts. Unlike the system of bankruptcy liquidation which only cares about the interests of creditors, it begins to focus on the survival of debtor's business, and use reconciliation agreement to maintain the survival of debtor's business. However, it still takes the interests of creditors as its center. The key to reach a reconciliation agreement is the concessions of creditors, thus it can only passively avoid insolvency of debtor. At the same time, the system of reconciliation and consolidation rectification has no legal binding force on security interest, which causes the loss of property required by the survival of debtor s business due to the exercise of mortgage right, which will cause great difficulties to the reincarnation of enterprises. Moreover, there is almost no effective supervision in the implementation process of reconciliation and rectification, and debtor's non-compliance with conditions 589

of reconciliation happens frequently. The system of bankruptcy reorganization is a system which was introduced from U.S. bankruptcy law by China. It refers to a special legal form of rectification of production and administration of enterprises which are in trouble and close to be bankrupted, while worth being saved and has possibility of reconstruction, as well as clearance of debtor - creditor relationship, applied by stakeholders, presided by the court and with participation of stakeholders, in order to help the enterprises to get out of trouble and regain operating capability. Bankruptcy reorganization system takes interests of society as its center, depends on authority of the country to interfere with the proceedings of bankruptcy of enterprises and proactively save debtors, as well as promote the resume of production and operation capability of them. This system effectively maintains social stability, reduces the consumption of social wealth, promote social development, and overcome deficiencies of above system of conciliation and rectification. 4 Changes of objectives of bankruptcy accounting Bankruptcy accounting objectives also need to answer such four questions: to whom to provide bankruptcy accounting information; to provide what kind of bankruptcy accounting information; how to provide bankruptcy accounting information; when to provide bankruptcy accounting information. The issue of the new Enterprise Bankruptcy Law primarily affects the answers to the first question and the third question, namely, it impacts users of bankruptcy accounting information and ways of disclosure of bankruptcy accounting information. The new Enterprise Bankruptcy Law introduces the concept of labor claim in order to safeguard and protect the legitimate rights and interests of employees of bankrupted enterprises. Labor claims refer to wages and social insurance that the enterprises are owed to their employees, as well as compensation and other expenses to be paid to their employees, which are required by laws and administrative regulations. In the declaration of creditor s rights, labor claim will enter into force without the need to be declared, it only need to be recorded in the claim form by the bankruptcy administrator and be publicized. At the same time, labor claim has precedence over ordinary claims to be liquidated. With the introduction of labor claim, the users of bankruptcy accounting no longer include just ordinary creditors, but also include labor creditors. Moreover, the new Enterprise Bankruptcy Law introduces the system of bankruptcy administrator and replaces the liquidation team system, thus, the users of bankruptcy accounting information no longer include liquidation team which has been replaced by bankruptcy administrator. Therefore, after the issue and implementation of the new Enterprise Bankruptcy Law, the users of bankruptcy accounting information should include debtor, ordinary creditors, labor creditors, bankruptcy administrator, government departments and other stakeholders. Bankrupted companies should repay debts in accordance with a certain order. Thus, bankruptcy accounting information should be provided in a hierarchy. Different degrees of detailed bankruptcy accounting information should be provided to creditors with different priorities, rather than be disclosed uniformly, which is not conducive to better protect the interests of creditors, nor in consistent with cost-effective rule. Although the priorities of labor claims of employees and mortgage debts in the order of bankruptcy liquidation are controversial in the process of making the new Enterprise Bankruptcy Law, it still stipulates that labor claims shall be liquidated as the first order. For example, Article 113 stipulates that after bankruptcy fees and common benefits debts are firstly repaid by bankruptcy properties, settlement shall be done in accordance with the following order: the first order is: wages and medical care, disability benefits and pension costs which bankrupts owe their employees. They should be credited to employees personal accounts of basic endowment insurance, basic medical insurance costs, and compensation to be paid to employees which is stipulated by laws and administrative regulations. Therefore, before labor claim is fully liquidated, all accounting information related to confirmation, valuation, solvency and liquidity of assets of bankrupted enterprise shall be provided to labor creditors, while for other creditors, some summarized and briefing accounting information can be provided to them. 590

5 Conclusion In sum, we can see that China's new Enterprise Bankruptcy Law will lead to changes of application scope of bankruptcy accounting, bankruptcy accounting objectives, bankruptcy accounting structure, bankruptcy accounting entity and etc. Therefore, enterprises corporate accounting personnel and related legal practitioners are required to fully comprehend the provisions of bankruptcy law by combining with the new changes, in order to improve corresponding quality of them, better safeguard the interests of enterprises and adapt to the needs of a legal market economy. Author s Contact Information: The Author can be contacted from Email: linda1010@tom.com.cn References [1]. Zhang Zhifeng: Junior Accounting Practices, Peking University Press,2005, 24~29 (in Chinese) [2]. Li Shuguang: People's Republic of China Enterprise Bankruptcy Law System Design and Operational Guidelines, People's Court Press, 2006:497~498(in Chinese) [3]. The Group of Bankruptcy Law Drafting: <PRC Enterprise Bankruptcy Law> Interpretation, People's Court Press, 2006: 112~113(in Chinese) [4]. An Jan: <PRC Enterprise Bankruptcy Law> interpretation, Legal Press, 2006: 56~58(in Chinese) [5]. Wang Xinxin: Extensive Talking about the New Bankruptcy Law Legislation, Journal of Capital Normal University (Social Science Edition), 2005, 04 : 20~21 (in Chinese) [6]. Jia Yunfei: Analysis of the Protection of the Workers Interests after the Implementation of the <New Bankruptcy Law>, Cultural Data, 2007,03: 23~25 (in Chinese) [7]. Tan Ayong: On the Protection of Labor s Credit in the Corporate Bankruptcy Based on the Legal System, Administrative Institute of Politics and Law, 2006, 04:11~12 (in Chinese) 591