Superpower 7: The importance of having transparent numbers for your China business
So far you have done all the necessary things to launch your business in China. You have educated yourself about the market, done your research, developed an ecosystem and created a strong strategic plan.
Your next Superpower requires a significant level of detail. At this point, your company is standing on solid ground. But only the transparency of your numbers will tell you if your business has a promising future in China.
In order to acquire Superpower 7, you need have a sound accounting system, as well as invest in an Enterprise Resource Planning (ERP) system in China. These two important tools will become valuable assets for your company and ensure that you know your numbers well and can make key decisions quickly and effectively.
When implemented correctly, an ERP system facilitates better planning by management, improves management control, and increases organizational ability to control day-to-day operations. This enables the company to directly reduce operating costs and lower inventory stock while strengthening relations with suppliers and customers.
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 foreign professionals 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.
Many multinational corporate groups try and reconcile the CAS, the IFRS or the United States’ Generally Accepted Accounting Principles (GAAP) when consolidating financial statements.
Translation of documents should be done carefully. 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”.
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 shortcuts. 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.
Having transparency in your numbers will also facilitate the process to repatriate refunds if needed. The application process to repatriate funds or cross-border payments entails tedious paperwork and explanations. However, as long as you are organized and you have the correct documentation, it's not as complex as it may seem.
If your company cannot provide the documentation required for the transfer of capital, you won’t be allowed to do it. This process can be stressful because every government office and bank may request different documents. Following the appropriate steps and guidelines will give you clarity and help you stay organized.
The ultimate target of any company established in China is to become profitable and be able to pay back investors or reinvest its funds. It is crucial to establish a profit repatriation strategy early on, in order to create a tax optimized structure that helps you develop authentic agreements and contracts from the get-go.
A lot has changed in the past years. Chinese tax authorities have become better educated regarding tax optimized structures and investigate any request to approve profit repatriation. This is important to know for both foreign companies established in China and those dealing with Chinese companies from abroad. Every cross-border contract is scrutinized by the authorities to ensure it is legitimate.
It is also crucial that you understand the advantages and disadvantages of the Chinese taxation structure. The Value Added Tax (VAT) and Fapiao system are two of the major sources of revenue income for the Chinese government.
VAT applies to the sale of goods, provision of processing, repair or replacement services within China and the import of goods into China. Rates vary depending on the taxpayers' sales revenue, type of goods and type of sector.
In an effort to bring more transparency to their taxation system and tackle tax evasion, the Chinese government has established an invoice structure to register any form of transactions.
If you have established your entity in China and have a limited liability company, the first category that you will be designated is as a small-scale taxpayer. As such, you cannot offset the VAT that you are paying off your original expenses. But, if from day one you know that you are going to achieve certain transaction levels, you can immediately apply for the general VAT taxpayer status and reclaim or offset the VAT in purchases of goods and services.
All of these areas are crucial in order to achieve Superpower 7. You should also meet regularly with your finance team to analyze and discuss your company’s numbers, as well as review your budget and strategic planning.
In order to survive the first year and not encounter discouraging obstacles, you should keep your budget updated and evaluate quarterly your fixed costs, overheads, the direct cost of sales, the costs of materials as well as the costs of third-party providers, and any other costs related to your industry or sector.
If your plan is to stay in China for the long term, these are the questions your company should be asking on a regular basis.
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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.