Let’s Talk Accounting -What Foreign Invested Enterprises (FIE) should know about accounting in China and its principle differences from international accounting standards

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Small enterprises, large multinational firms, joint ventures, branches, subsidiaries and etc. cannot escape one of the most important aspects of business operation- accounting. As an FIE, it is even more crucial to understand the New Chinese Accounting Standards (known as New PRC GAAP or ASBE) in order to comply with auditing requirements, make it possible for tax benefits and to properly consolidate the Chinese accounts with the parent company.

How did the change in Chinese accounting standards come about anyway? Once upon a time…

China used Soviet-style fund accounting based on a socialist, controlled and planned economy. Since the economic reforms in 1979 and the drastic economical growth from 1992, Chinese accounting standards has transitioned to a socialist commodity based system and then finally to a socialist market based system. Additionally, membership in the WTO, the increase in foreign direct investment, growing development of securities markets and international mergers and acquisitions has pushed Chinese accounting standards to converge with international standards (IFRS).  This entails the transformation from industry-specific, rule-based accounting standards, to a principle-based, conceptual accounting framework which requires flexible, effective, fair and consistent professional judgment during practice. The New Chinese Accounting Standards, adopted by all enterprises since Jan. 1st, 2007, are 38 specific accounting standards and one Basic Standard issued by the Ministry of Finance (MOF).

A notion FIE managers should keep in mind is that even though New PRC GAAP is very similar to IFRS, it is not equivalent and thus IFRS cannot be directly used in China. New PRC GAAP is designed to incorporate Chinese economical characteristics, customized for the Chinese business environment. Some important features of the New Chinese Accounting Standards are:

a)      New PRC GAAP accounts are based on function, IFRS accounts are based on nature. For example, taxi expenses can be recorded as cost of sales under account by function and booked as transportation under account by nature.

b)      New PRC GAAP commonly uses the historical cost method instead of the fair-value method used by IFRS. In China, markets are yet to be completely developed and active and therefore fair market value identification is challenging.

c)      All double-entries must be in RMB. Transactions from parent companies or foreign sources must be converted first, otherwise foreign currency recordings are deemed invalid.

d)     Fiscal year under New PRC GAAP is always Jan. 1st-Dec. 31st , regardless of the fiscal year term for the FIE’s parent company.

e)      In general, New PRC GAAP allows for fewer accounting methods and includes fewer specific categories, particularly in areas not fully developed in China. Therefore, when converting IFRS statements to New PRC GAAP, it is particularly important to follow New PRC GAAP rules and even consult the Ministry of Finance if necessary to determine which items can be included.

f)       In China, FIEs are also required to undergo an auditing process, which entails specified paperwork, including the filing of tax documents before May 31st and the Industry and Commerce Annual Inspection of Foreign Companies, before the 30thof June. FIEs are required to provide the auditors with all the enterprise’s documents, books and reports. The accounting statements to be submitted for an annual audit include the balance sheet, income statement, statement of cash flows and relevant supporting notes. The audited financial statements must be submitted to several government authorities within four to six months of the year end, including the local offices of the SAIC, SAT, the local Finance Bureau and the SAFE.

As an FIE, you interact with several parties to whom different accounts can be presented for different purposes. For parent companies or foreign investors, an account which boosts sales and profits can be used. For Chinese tax authorities, an account that undermines performance can be used. For internal evaluation, an accurate account can be used. And lastly for government audits, it is even more crucial that statements are prepared in compliance for the auditing progress. In order to achieve all of the above, FIEs must correctly interpret Chinese accounts and follow proper methodology.

Here are some recommendations for FIEs:

  1. Choose the right method in recording operational expenses, taking into the risks and how they affect the accounts mentioned above.
  2. Translation is critical in applying formal rules and complying with Chinese standards.
  3. Implement dependable internal auditing and financial control systems. Internal auditing is suggested to be twice a year minimum.

Be aware this is only a general description of the differences between CAS and IFRS. Always seek for proper advice for your own specific business situation. Contact the Maxxelli Consulting team for more information.

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