The ancient Chinese idea of the soul was dualistic and materialistic. Every person was thought to have two souls: the po and the hun. These were different kinds of souls, and probably represent the historical reconciliation of the northern po and the southern hun. (Early China had more than one culture; the one from the north China plains left the bulk of classical literature and is therefore considered to be the real "Chinese" culture.) The po appeared around the sixth century B.C., somewhat earlier than the hun (but the southern traditions were not written down until some centuries after the northern ones). As the northern Chinese expanded and had increasing contact with the southern people, the idea of the hun and the po met. By the third century B.C. (at the latest) they had fused into a single concept of the dual soul.
The po was the earth soul, characterized by yin. It appeared at the moment of conception. The hun was made of lighter stuff - chi - and was yang. (Chi is the "spirit" that animates everything and permeates the universe.) The hun came into existence at the moment of birth. The po soul was sustained by eating food, the hun soul by breathing chi. (Eating and breathing, the two essentials of life, were thus nicely accounted for.) The two souls separated on death and had different destinations.
The souls were also fundamentally materialistic. They were not immortal, they needed sustenance, and (to some extent) they depended upon the preservation of the body. Both souls eventually ceased to exist as individuals and dissolved back into their constituents: the po into earth and the hun into chi. The length of survival could be increased by feeding them through the sacrificial offerings (meat, rice, wine etc.) that were a part of the rites of ancestor worship. The preservation of the body was also thought to prevent the dissolution of the po soul, by keeping it with the body. This also prevented it from wandering and inflicting misfortune upon surviving relatives. The ancient Chinese, like the Egyptians, spent a great deal of effort in trying to prevent the decomposition of the body.
Each soul had its own afterlife. The hun went to heaven, according to the earliest ideas, and later to its own special underworld. The po either stayed with the body or went to an underworld. (There was no suggestion that these were places of reward or punishment.)
Heaven is a very early Chinese notion. According to Shang Chinese (c. 1700 to 1100 B.C.) ideas, Heaven was the dwelling place of God-on-High (Shang-di). Later, Heaven became an impartial governing principle, in scholarly philosophical theory anyway. Heaven was always a strictly hierarchical place, and its bureaucracy developed in pace with that of the earthly Chinese government. (Given that the Chinese government has been characterized by bureaucracy since its inception, it seems only natural that they should have ascribed the same characteristics to heaven and the underworld.)
According to Shang ideas, not all hun went to heaven - only those of the powerful were admitted (that is, those of earthly kings). The government of Heaven was responsible for overseeing human activities. There were (in its later development) four Departments: Fate, Longevity, Good Deeds, and Evil Deeds. Each Department kept detailed personal dossiers on all living people. If a person did enough good deeds, their dossier might be evaluated and transferred to the Department of Longevity (which might then grant them a longer life span). The records were updated on a daily basis and were subject to transfer from one Department to another. This record keeping was a major function of the celestial bureaucracy.
The idea of the Yellow Springs is also early, dating from the eighth century B.C. it was the destination of those po souls which did not stay with the body. It was a miserable place where souls were under the bondage of the Lord or Queen of the Earth. No doubt this was because the Yellow Springs faithfully reflected the hierarchical nature of the mortal world - if a person had a poor and miserable time while alive, they would have the same in the afterlife.
Life could be made easier for the po if it was provided with the necessary amenities: food, clothing, money, precious objects, and servants. These would be placed in the tomb by the surviving relatives. The servants (human and animal) were at first provided by immolating the actual servants of the deceased in the tomb, but with time (during the first half of the first millennium B.C.) this practice ended and inanimate representations of the attendants were placed in the tomb instead.
Other developments occurred during the second and first centuries B.C. One of these was the appearance of a new and truly immortal spirit - the hsien. A person became a hsien by cultivating the right esoteric practices. These spirits ascended to Heaven, and because the hun (being mortal) could not exist in the same place as the immortal hsien, the hun were summarily evicted.
This meant that a new home had to be found for the hun. Mount Tai (specifically the lower slopes, not the summit) suited the purpose. A new underworld was opened, presided over by the Lord of Mount Tai (who was already in existence and co-opted into the position). The Lord of Mount Tai was the grandson of the god of heaven, whereas the human Emperor was the Son of Heaven.
This underworld was not a hell - Mount Tai was second only to Heaven in the scheme of things. It too had a bureaucratic government, with the capital at Liang-fu. The power of this bureaucracy gradually expanded until it had the power to send to the mortal world for those souls whose allotted span of time on earth was up, according to the Register of Death.
A newly dead soul had to report to the capital and register. By the second century A.D., their conduct in life had become the subject of investigation. If the soul refused to cooperate, it would be imprisoned and tortured (as was the practice in actual Chinese judicial practice). Mount Tai was for the hun only; the Lord of Mount Tai had no jurisdiction over the po.
The po souls continued to go to the Yellow Springs, which grew its own bureaucracy. The capital was at Gao-li and, as in Mount Tai, the dead soul was required to report there and register.
These ideas changed dramatically as Buddhism brought into China the idea of immortal souls, heaven and hell as opposing sites of reward and punishment, and the idea of reincarnation. Early translations of texts often rendered niraya (the Buddhist word for hell) as "the underworld prison in Mount Tai." These ideas changed Chinese conceptions of heaven and the afterlife, but the foreign ideas themselves were adapted to Chinese culture. In particular, the underworld bureaucracy remained intact (the Buddhist hell was administered by bureaucrats) and continued to be feature of popular Chinese tradition.
Further Reading (all available in the University of Queensland library)