Discussion A2

Case 6-1

China Petroleum and Chemical Corporation

China Petroleum and Chemical Corporation (CPCC) is one of a growing number of Chinese companies that has cross-listed its stock on foreign stock exchanges. To provide information that might be useful for a wide audience of readers outside of China, CPCC provides a reconciliation of income and stockholders’ equity from Chinese GAAP to IFRS. Further, to provide information specifically for its North

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American shareholders, the company also provides a reconciliation of net income and stockholders’ equity from IFRS to U.S. GAAP. The following is the section of CPCC’s 2003 annual report providing this information.

Differences between Financial Statements Prepared under the Chinese GAAP and IFRSs

The major differences are:

i. Depreciation of oil and gas properties

Under the PRC accounting rules and regulations, oil and gas properties are depreciated on a straight-line basis. Under IFRS, oil and gas properties are depreciated on the unit of production method.

ii. Disposal of oil and gas properties

Under the PRC accounting rules and regulations, gains and losses arising from the retirement or disposal of an individual item of oil and gas properties are recognized as income or expense in the income statement and are measured as the difference between the estimated net disposal proceeds and the carrying amount of the asset.

Under IFRS, gains and losses on the retirement or disposal of an individual item of proved oil and gas properties are not recognized unless the retirement or disposal encompasses an entire property. The costs of the asset abandoned or retired are charged to accumulated depreciation with the proceeds received on disposals credited to the carrying amounts of oil and gas properties.

iii. Capitalisation of general borrowing costs

Under the PRC accounting rules and regulations, only borrowing costs on funds that are specially borrowed for construction are capitalized as part of the cost of fixed assets. Under IFRS, to the extent that funds are borrowed generally and used for the purpose of obtaining a qualifying asset, the borrowing costs should be capitalized as part of the cost of that asset.

iv. Acquisition of Sinopec National Star, Sinopec Maoming, Xi’an Petrochemical and Tahe Petrochemical

Under the PRC accounting rules and regulations, the acquisition of Sinopec National Star, Sinopec Maoming, Xi’an Petrochemical and Tahe Petrochemical (the “Acquisitions”) are accounted for by the acquisition method. Under the acquisition method, the income of an acquiring enterprise includes the operations of the acquired enterprise subsequent to the acquisition. The difference between the cost of acquiring Sinopec National Star and the fair value of the net assets acquired is capitalized as an exploration and production right, which is amortised over 27 years.

Under IFRS, as the Group, Sinopec National Star, Sinopec Maoming, Xi’an Petrochemical and Tahe Petrochemical are under the common control of Sinopec Group Company, the Acquisitions are considered “combination of entities under common control” which are accounted in a manner similar to a pooling-of-interests (“as in pooling of interests accounting”). Accordingly, the assets and liabilities of Sinopec National Star, Sinopec Maoming, Xi’an Petrochemicals and Tahe Petrochemicals acquired have been accounted for at historical cost and the financial statements of the Group for periods prior to the Acquisitions have been restated to include the financial statements and results of operations of Sinopec National Star, Sinopec Maoming, Xi’an Petrochemicals and Tahe Petrochemical on a combined basis. The consideration paid by the Group are treated as an equity transaction.

v. Gains from issuance of shares by a subsidiary

Under the PRC accounting rules and regulations, the increase in the company’s share of net assets of a subsidiary after the sale of additional shares by the subsidiary is credited to capital reserve. Under IFRS, such increase is recognised as income.

vi. Gain from debt restructuring

Under the PRC accounting rules and regulations, gain from debt restructuring resulting from the difference between the carrying amount of liabilities extinguished or assumed by other parties and the amount paid is credited to capital reserve. Under IFRS, the gain resulting from such difference is recognised as income.

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vii. Revaluation of land use rights

Under the PRC accounting rules and regulations, land use rights are carried at revalued amounts. Under IFRS, land use rights are carried at historical cost less amortisation. Accordingly, the surplus on the revaluation of land use rights, credited to revaluation reserve, was eliminated.

viii. Unrecognised losses of subsidiaries

Under the PRC accounting rules and regulations, the results of subsidiaries are included in the Group’s consolidated income statement to the extent that the subsidiaries’ accumulated losses do not result in their carrying amount being reduced to zero, without the effect of minority interests. Further, losses are debited to a separate reserve in the shareholders’ funds.

Under IFRS, the results of subsidiaries are included in the Group’s consolidated income statement from the date that control effectively commences until the date that control effectively ceases.

ix. Pre-operating expenditures

Under the PRC accounting rules and regulations, expenditures incurred during the start-up period are aggregated in long-term deferred expenses and charged to the income statement when operations commence. Under IFRS, expenditures on start-up activities are recognized as an expense when they are incurred.

x. Impairment losses on long-lived assets

Under the PRC accounting rules and regulations and IFRS, impairment charges are recognized when the carrying value of long-lived assets exceeds the higher of their net selling price and the value in use which incorporates discounting the asset’s estimated future cash flows. Due to the difference in the depreciation method of oil and gas properties discussed in (i) above, the provision for impairment losses and reversal of impairment loss under the PRC Accounting Rules and Regulations are different from the amounts recorded under IFRS.

xi. Government grants

Under the PRC accounting rules and regulations, government grants should be credited to capital reserve. Under IFRS, government grants relating to the purchase of equipment used for technology improvements are initially recorded as long term liabilities and are offset against the cost of assets to which the grants related when construction commences. Upon transfer to property, plant and equipment, the grants are recognized as an income over the useful life of the property, plant and equipment by way of reduced depreciation charge.

Effects of major differences between the PRC Accounting Rules and Regulations and IFRS on net profit are analysed as follows:

	Note	2003 RMB millions
Net profit under PRC GAAP		19,011
Adjustments:
Depreciation of oil and gas properties	(i)	1,784
Disposal of oil and gas properties	(ii)	1,260
Capitalisation of general borrowing costs	(iii)	389
Acquisition of Sinopec Maoming, Xi’an Petrochemical and Tahe Petrochemical	(iv)	326
Acquisition of Sinopec National Star	(iv)	117
Gain from issuance of shares by subsidiary	(v)	136
Gain from debt restructuring	(vi)	82
Revaluation of land use rights	(vii)	18
Unrecognised losses of subsidiaries	(viii)	(182)
Pre-operating expenditures	(ix)	(169)
Effects of the above adjustments on taxation		(1,179)
Net profit under IFRS *		21,593