How differences between local and international accounting systems may affect your China business
During recent years there has been an increased interest by foreign
investors to establish a presence in China, the second largest market
in the world. This initiative, while extremely promising, can be difficult
at times given the differences between Chinese regulations and
international business standards.
One of the areas that represents the biggest challenge for foreign companies is the Chinese system of accounting, which differs from the international standards and can be hard to understand and interpret correctly.
The current accounting and bookkeeping systems in China are relatively recent, and compared to standards in most Western countries, they tend to be more complicated. Until a few years ago, Chinese accounting standards were still based on a socialist economic model.
Since then, the country has gradually implemented a significant degree of reform regarding the traditional accounting standards and has adopted a modern system that incorporates more stakeholders into the process.
There have been regular updates to the accounting standards used in China, including new laws and regulations. It is crucial for businesses and foreign investors to understand Chinese accounting standards and how these may affect their business.
The main goal of developing the Chinese Accounting Standards (CAS) is to take account of more stakeholders, reduce financial fraud, and optimize the country’s tax strategy. Efforts have been made to converge CAS with the International Financial Reporting Standards (IFRS), and investors with established companies or opening businesses in China should take extra care for compliance.
Accounting and bookkeeping in China are governed by the Chinese Accounting Standards (CAS), also known as the Chinese Generally Accepted Accounting Principles (CGAAP). The CAS framework is based on two standards: Accounting Standards for Business Enterprises (ASBEs); and Accounting Standards for Small Business Enterprises (ASSBEs).
All publicly traded companies in China must eventually adapt to the newer standards and ultimately converge into IFRS. However, many Chinese businesses do not currently use IFRS.
There are several differences between the CAS and IFRS. The Chinese Ministry of Finance issues and monitors the accounting standards for CAS. IFRS emphasize the nature of the account while CAS accounts are based on their function.
In CAS, local currency is utilized. Transactions in foreign currency are converted to the equivalent amount of RMB by using the official rate. Additionally, double entry is completed only in RMB.
The CAS uses the historical cost method more often than the IFRS. This use is especially preferred by private firms, which may have trouble obtaining fair-value data.
CAS require that accounts begin on Jan. 1 of each year and involve more stringent requirements than IFRS. For example, CAS expect the disclosure of the identity of the business partners.
In China, CAS may also require indirect cash-flow statements and comments regarding the fairness of these transactions.
It is mandatory for all types of foreign-invested enterprises (FIEs) in China to comply with annual statutory auditing and other compliance processes, according to the Company Law and other relevant regulations.
FIEs can only distribute and repatriate their profits or dividends back to their home country after completing annual statutory audits and settling relevant tax liabilities. If this process is not finalized, companies face extra expenses, penalties or even the revoking of business licenses.
Generally, multinational corporate groups try and reconcile the CAS, the IFRS or the United States’ Generally Accepted Accounting Principles (GAAP) when consolidating financial statements.
The current ASBEs were issued in 2006 and implemented in January 2007. According to the IFRS Foundation, the 2006 the ASBEs “substantially converged with the IFRS”. After releasing a series of amendments in 2012, the merging of the ASBEs with the IFRS was achieved.
On January 1, 2013, the ASSBEs was enforced and provided unified standards for small-scale enterprises to enhance their internal controls to prevent tax and accounting fraud. The ASSBEs use the ASBEs as a point of reference but are similar to other tax laws, which simplifies the process of making any adjustments when following both accounting standards and tax rules. Small-scale enterprises can choose to adopt either the ASBEs or the ASSBEs.
While CAS and IFRS have demonstrated key similarities, it is sensible that foreign companies take note of the differences because they can easily get them into conflict with the law.
The following are some of the more relevant differences between CAS and IFRS:
The method of valuating fixed assets is one of the most notable distinctions between CAS and IFRS. Firms that use IFRS have the option of choosing their preferred method of valuation for certain types of fixed assets. You can opt to use the historical – cost valuation method or re-evaluating the asset. But when it comes to CAS, the valuation of fixed assets can only be done using the historical-cost method.
When handling some items that are considered common in China, the Chinese Accounting Standards (CAS) are more detailed than the International Financial Reporting Standards (IFRS). In the case of two companies that merge under the control of one entity, with similar interests, CAS requires that you restate the figures. However, IFRS does not give specific rules on such a situation.
IFRS is more detailed compared to CAS when it comes to situations that are not common in China. The use of employee benefit plans can be a good example. Except paying staff using a firm’s stock, CAS do not address some types of staff benefits that are offered by international firms. On this, it is not uncommon to find multinationals getting into trouble, especially when the mother company back at home tries to implement benefit packages for its subsidiaries. To address the challenge, it is important to work with the Chinese Ministry of Finance (MOF) to establish how to record such transactions.
In China, the MOF reviews IFRS updates and decides if they are acceptable for application in the country and if they will be added into the CAS. This could mean two things: The IFRS updates implementation in CAS are delayed or the IFRS updates adoption might not even happen at all. Such delays could become a serious challenge, especially for companies that promptly implement IFRS changes in all their subsidiary firms.
Translation of documents should be carefully done. This situation becomes more relevant when a parent firm abroad asks for detailed financial reports from the Chinese subsidiary. Since companies are required by law to follow these different standards, information from the Chinese subsidiary must be translated. This process is called “mapping”.
Small and medium-sized companies often lack the necessary budget that larger multinationals spend in expensive specialized software to help them with the process, and often have to do these conversions manually.
When mapping books, companies should pay close attention at the discrepancies between Chinese and international accounting standards. The firm’s accountant or trusted advisor should focus on the differences between CAS and the target accounting system, and verify whether the company’s operations are compromised.
If these services are outsourced, it is essential to inform accounting in a timely matter of any need to translate the company’s accounts. Failure to do so may delay the process substantially.
The differences in accounting entry codes are also significant. Conversion is a one-time procedure the outsourced accountant needs to complete when they are first contracted by a new company. Once the accountant determines which Chinese entry matches the foreign entry, these figures can be automatically converted.
Foreign investors should be cautious and recognize accounting firms' tricks to take short cuts. For most companies, the first reaction when it comes to financial issues is seeking the help of accounting firms. But many are known for taking shortcuts to avoid the stringent CAS, which can result in serious delays and non-compliance.
Culture and tradition have a role to play in the divergence of accounting practices. In China, while many businesses maintain proper accounting records, some of the systems incorporate provisions that are confusing. In addition, the business landscape has been characterized by documented cases of corruption, poor planning, little regard for shareholder rights, and even market manipulation.
Though some of these discrepancies may represent a challenge in the short term, as the CAS gets closer and adapts to international standards, foreign investors will be able to adjust and implement best practices more easily.
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DISCLAIMER: All information in this article is verified to the best of our ability and is assumed to be correct at time of release; however, Woodburn Accountants & Advisors does not accept responsibility for any losses arising from reliance on the information provided within. The information provided is for general guidance and does not replace specialized advice.