Audits of Chinese Companies Start to Face U.S. Inspections


U.S. regulators have started inspecting China-based audits, kicking off a monthslong process that will determine whether companies from

Alibaba


BABA -0.76%

Group Holding Ltd. to

Yum China


YUMC -2.93%

Holdings Inc. can remain listed on American stock exchanges.

The inspection, which is set to last eight to 10 weeks in Hong Kong, would allow the U.S. audit watchdog to decide by the end of this year whether China is honoring a landmark agreement to give U.S. accounting inspectors full access to audit working papers of New York-listed Chinese companies.

“The time for negotiations is over. The agreement has been signed. And it must be followed completely,“ said

Erica Williams,

chairwoman of the Public Company Accounting Oversight Board, on Thursday. “Any interference with our ability to retain information as needed is a deal breaker.”

Speaking at the Council of Institutional Investors’ fall conference, Ms. Williams said PCAOB teams began arriving in Hong Kong last week and will conduct inspections on audit firms in both mainland China and Hong Kong. The inspectors will look at audits of selected companies and the quality-control systems of the audit firms.

The PCAOB is expected to review the audit work of some of the most valuable Chinese companies listed in the U.S., including Alibaba, Yum China,

NetEase Inc.

and

JD.com Inc.,

The Wall Street Journal previously reported.

PricewaterhouseCoopers’ Hong Kong unit, and the China-based units of KPMG, PwC and Deloitte are their respective audit firms, according to PCAOB records.

All four of them—along with more than 160 Chinese companies—have been identified as noncompliant with the Holding Foreign Companies Accountable Act, which took effect last year. If the PCAOB fails to inspect audit firms in China completely, some 200 Chinese companies that are valued at more than $1.15 trillion would be booted off U.S. stock exchanges starting in early 2024.

Officials from the China Securities Regulatory Commission and China’s Ministry of Finance are also on the ground coordinating and assisting the inspection, according to people familiar with the issue. The PCAOB declined to comment on the inspections.

It is common for representatives from both countries to sit in the conference rooms to observe inspection arrangements and ensure inspectors can conduct their work without any interference, said

Jackson Johnson,

president of Johnson Global Accountancy and a former PCAOB inspector.

Covid-19 lockdowns, corruption crackdowns and more have put China’s economy on a potential crash course. WSJ’s Dion Rabouin explains how China’s economic downturn could harm the U.S. and the rest of the world. Illustration: David Fang

Audit firms’ engagement partners, who supervise the audit work and sign off on the audit report, will typically be asked about the company’s internal controls, revenue-recognition principles, and remote audit policies during the pandemic, Mr. Johnson added.

On top of audit working papers, internal documents including email exchanges between auditors and their issuer clients might be subject to scrutiny if the inspectors deem the information necessary, said

Salvatore Collemi,

founder of Collemi Consulting & Advisory Services LLC, which advises accounting firms on audit quality control.

Chinese authorities for years denied U.S. regulators access to the records, citing national-security concerns. However, the Chinese securities regulator said last month that audit working papers generally don’t contain state secrets, personal data or other sensitive information.

Some Chinese companies have pursued alternative or primary listings in Hong Kong to hedge the delisting risk. Last month, five Chinese state-owned companies said they would delist their American depositary shares, but they might still be subject to retrospective PCAOB inspections.

Write to Michelle Chan at michelle.chan@wsj.com

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