Bookkeeping & accounting compliance services in China.

China does not follow international accounting policies and guidelines, although it has been moving in this direction for a while and with its accession to the World Trade Organisation will be fully compliant within a few years. Many of the accounting regulations are the same or similar to international practice, however it is important for organisations in China to understand the differences.

Tax deductibility for instance is different and a lack of understanding of this could lead to significant tax charges on such items as intercompany transactions. China treats transfer pricing with high importance and as with many other countries it wants its fair share of the international tax pie. Meanwhile proper planning and compliance can reduce an organisation’s tax burden.

Another area where differences lie is in depreciation of capitalised assets. China specifies that companies must use the straight-line method unless they obtain approval from the Ministry of Finance for use of an accelerated method. The period over which a company may depreciate its assets also can vary to that of the holding companies own country’s accounting practice. The depreciation rates per China’s income tax law are:

1. For houses and buildings: 20 years;
2. For airplanes, trains, shipping vessels, machinery, mechanical apparatus, and other production equipment: 10 years;
3. For fixtures, tools and furnishings related to production and business operations: 5 years;
4. For transport other than airplanes, train, ships: 4 years;
5. For electronic equipment; 3 years.

Companies therefore on the one hand need to comply with their HQ’s requirements, being usually their countries GAAP, whilst on the other hand maintain compliance with China’s rules and regulations. LehmanBrown provides assistance in setting up accounting procedures and systems to bridge this.

In Western countries, although amendments and revisions to accounting practices or standards do not have legal binding power, they are formulated according to an existing national legal framework which is provided in most cases by Companies Ordinance or Acts. Companies Ordinance or Acts together with other regulations applicable to individual industries, such as the Banking Ordinance for financial institutions and Listing Rules or Securities Acts for listed or public companies, provide a framework upon which accounting professional bodies formulate accounting and auditing standards. These standards form the basis for establishing accounting principles, and perhaps conventions, that allow enterprises flexibility in formulating their own accounting policies best suited to their individual circumstances. The ultimate objective, in a nutshell, is to produce a set of financial statements that are ‘true and fair’.

Until 1994, China lacked a regulatory framework on which accounting and auditing standards could be set since the country’s first national Companies Laws were not effective until 1 July 1994. The lack of such a framework also rendered the formulation of other regulations, such as the national Securities Laws and Listing Regulations, more difficult and time consuming.

Nevertheless, having realised the need for establishing acceptable accounting principles to enable PRC enterprises to attract foreign investment or have their stocks listed on overseas markets, the MOF promulgated a separate set of accounting regulations for selected joint stock companies in January 1992.

In addition, MOF was made effective on July 1, 1993, and were the first set of accounting standards – Accounting Standards for Enterprises – applicable to all PRC enterprises. Although it might be confusing at times which accounting regulations or standards should be applied, together with the then Accounting Regulations for Foreign Investment Enterprises of the PRC, they have provided relatively uniform accounting practices for enterprises to follow in preparing their financial statements. More importantly because of the lack of a complete regulatory and conceptual framework, these accounting rules or regulations are so comprehensive that they encompass accounting concepts, disclosure requirements, accounting entries, control procedures, record keeping and some aspects of auditing requirements and liquidation.

With the introduction of the Accounting Law in 1999, the Regulations on Financial Reporting of Enterprises in 2000 and the Accounting Systems for Business Enterprises in early 2001, which harmonises the different accounting standards and regulations applicable to different enterprises, the framework of modern Chinese accounting has finally become clear. With the implementation of the Accounting Systems for Business Enterprises in 2006, accounting standards in China have become more convergent with IAS and IFRS.

On the basis of the accounting standards, the MOF issued a series of industry-specific accounting systems in 1992 covering industry, commodity distribution, construction, real estate, finance and insurance, transport and communications, foreign economic cooperation, tourism and catering, and agriculture, as well as a separate system for foreign-invested enterprises (FIEs). These unified systems form and integral part of China’s legal system governing accounting.

To cope with enterprise reform and comply with WTO requirements, China made a major revamp to its enterprise accounting system in 2000. The MOF promulgated the Accounting System for Business Enterprises to be applied to joint stock limited companies starting 1 January 2001 on a temporary basis, while other types of enterprises were also encouraged to follow the new system. Under the Accounting System, a unified system of accounting is established for all types of industry, ownership structure, organisation and operation mode and is applicable to large and medium enterprises except those engaged in finance and insurance. On the basis of the Accounting System, industry-specific accounting measures will be formulated for different industries and enterprises according to their characteristics while a specially designed accounting system will be developed for small enterprises. In addition, financial and insurance enterprises will be subject to a special accounting system for financial and insurance enterprises to accommodate their unique requirements.

The Accounting System for Business Enterprises currently in force is formulated on the basis of the Accounting System for Joint stock Limited Companies and its supplemental provisions and specific accounting standards. It consists of general provisions, account titles and financial statements, as well as examples of key accounting events and selections of major accounting rules. The general provisions list the broad principles for the recognition, measurement and reporting of accounting elements and key business activities. In the sections on account titles and financial statements, the types of account titles to be adopted for business activities and instructions for use are specified, while samples of financial statements and instructions on their compilation are given. In the appendix, examples of how major accounting events are handled are given.

Under the Accounting Laws, the Regulations on Financial Reporting of Enterprises and the ASBE, financial statements or reports should comprise a balance sheet, income statement, statement of changes in equity, cash flow statements and notes to the financial statements. The regulations also cover classification of assets and liabilities in the balance sheet.

The general accounting principles or concepts employed in China’s accounting regulations include accuracy, completeness, consistency, comparability, timeliness, materiality, accrual basis, matching, prudence, substance over form and going concern. By and large, the principles mirror those of IAS and IFRS . Other major features of these regulations are as follows:

• The historical cost convention is prescribed. Assets are required to be recorded at purchase cost (less any necessary impairment provision) and revaluations are strictly prohibited except when allowed by other State provisions.
• The concept of fair market value is not commonly used due to the limited existence of open markets.
• These regulations also require companies to use the calendar year, which is January 1 to December 31, as their financial year.
• The double-entry bookkeeping method should be adopted. Records in accounts and books have to be made in Renminbi (Yuan) (the lawful currency of the PRC). Transactions and balances denominated in foreign currencies have to be converted into Renminbi at the official rate, which may differ from the current market rate. All records and balances of transactions made in foreign currencies and the exchange rate used must be maintained for reference.
• A clause in these regulations specifically requires the appropriation of a collective Welfare Fund and a Statutory Reserve Fund from profit after tax.
• Due to the infancy of the new systems, certain footnote disclosures may not be as comprehensive as those acceptable elsewhere in the world. Yet, in certain areas, the Chinese standards are extremely stringent. This includes disclosing the corporate identity of related parties and commenting on the fairness of transactions conducted between related parties, and preparing the cash flow statements using both the direct and indirect methods.

The old standards are neither broad nor flexible enough to allow discussion or maneuverability on particular subjects. For the first time, ASBE gives management the authority to exercise professional experience and judgment. While the setting of the ASBE has in theory narrowed the gap between accounting issues in China and those of the Western world, the rigour of applying the ASBE may vary from province to province and from company to company.

(a) Accounting Entity

An accounting entity can be an enterprise, and enterprise group or the accounting department of an enterprise.

(b) Continuity Postulate

The Accounting System stipulates that the accounting treatment to be adopted by enterprises under normal circumstances should be based on the continuity postulate. For instance, the historical costing method is used for the assets and liabilities of an enterprise, and the depreciations method on the basis of historical costing is used for fixed assets.

(c) Accounting Period and Accounting Year

According to the Accounting System, an enterprise should account for its transactions or events and prepare financial statements in distinct accounting periods. Accounting periods may be a year, half year, a quarter or a month, commencing on the first day thereof according to the calendar year.

(d) Measurement Currency and Reporting Currency

Renminbi is the reporting currency of enterprises. While a certain foreign currency may be used as the reporting currency for enterprises heavily engaged in foreign currency transactions, all foreign currency transactions should be converted into renminbi when financial statements are prepared and submitted. 

Accounting records and financial reports should be compiled in Chinese. FIEs, foreign enterprises and other foreign organisations in China may use one foreign language concurrently with the Chinese language.

Not all input VAT is deductible.

Some examples of Input VAT that are deductible are:

• The amount of Input VAT printed on the VAT invoice acquired from the seller
• The amount of Input VAT printed on the paid import VAT receipt acquired form Customs
• Input tax on the purchase of agricultural products is calculated by multiplying 13%.

Some examples of those Input VAT that are not deductible:

• Non-VATable Goods and services, VAT exempted activities, welfare, and personal consumption.
• Goods and services with abnormal losses.

Value-Added Tax (VAT) is levied on both domestic and foreign enterprises in China on the transfer of taxable goods and services at each stage of the production process.

VAT is levied on sales by producers, wholesalers and retailers as well as at the retail level whereby goods and services are sold to the end consumer. Commercial activities known as “mixed sales activities” which involve the sale of goods and certain services may also attract either VAT or business tax liabilities.