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In Western countries limited liability companies are generally subject to an annual audit carried out by independent external auditors whose role is to express an objective opinion on the truthfulness and fairness of the financial statements.
In China, auditing is not a legal requirement but is required under the regulations. Prior to the introduction of the ASBE, the primary objective of auditing in China was to carry out inspection on the financial records of a business to ascertain their accuracy and legality (i.e. whether the transactions conducted complied with relevant state laws and regulations). Auditors in China are concerned with protecting the legal interests of the company as well as the interests of the state. Only with the implementation of the ASBE were the concepts of true and fair presentation introduced.
Prior to 2000 financial statements of state-owned enterprises were not required to be audited annually by independent auditors, but periodical or social audits conducted for the purpose of ascertaining the enterprise’s tax liabilities or other purposes might be conducted by the State Audit Bureau or Tax Bureau. Since 2002, except for a few types of specialised industries that have been explicitly exempted, all other state-owned enterprises must be audited at least annually. In addition, the regulations governing the accounting of joint stock companies and foreign investment enterprises require these companies to be subject to annual audit carried out by a registered Chinese certified public accounting firms. When reporting on whether the financial statements of foreign investment enterprises are prepared in accordance with the relevant laws and regulations, auditors may make reference to the following main laws and regulations:
- The PRC Sino-foreign Equity Joint Venture Law (EJV Law) promulgated by the National People Congress (NPC), effective July 8, 1979 and revised March 15, 2001
- Implementing Regulations of the EJV Law promulgated by the State Council (SC), effective September 20, 1983 and revised July 22, 2001
- The PRC Sino-foreign Cooperative Joint Venture Law (CJV Law) promulgated by the NPC, effective April 13, 1988 and revised October 31, 2000
- The PRC Wholly Foreign-Owned Enterprise Law (WFOE Law) promulgated by NPC, effective April 12, 1986 and revised October 31, 2000
- Implementing Rules of the WFOE Law promulgated by SC, effective December 12, 1990 and revised April 12, 2001
- The PRC Small and Medium Enterprises Law (SME Law) promulgated by NPC and effective June 29, 2002 and revised October 18, 2011
- Regulation on the implementation of Enterprise Income Tax Law of the PRC promulgated by NPC and effective January 1, 2008.
The audit report normally contains an introductory paragraph, a management’s responsibility paragraph, an auditor’s responsibility paragraph and an opinion paragraph. The introductory paragraph sets out the areas covered for auditing; the management’s responsibility paragraph sets out the preparation and fair presentation of financial statements; the auditor’s responsibility paragraph sets out the principal audit work and procedures carried out and the results. The opinion paragraph sets out whether the accounts have been prepared in accordance with the relevant laws and regulations. Any reservations in the opinion need to be elaborated on.
In some instances different government bureaus may stipulate their own requirements as to what certified public accountants should give their opinion on. Sometimes these additional requirements have not been agreed by the Ministry of Finance or the CICPA and fall beyond the expertise of what is normally expected of a certified public accountant. In some circumstances these requirements issued by other government bureaus have been retracted.
Only very recently has the impact of accountants or auditors on national economic activities become more apparent. By virtue of the PRC Accounting Law promulgated in January 1985, the function of certified public accountants in carrying out audits was established. This law has now been superseded by the PRC Registered Accountant Law which became effective January 1, 1994.
Following the setting up of the Chinese Institute of Certified Public Accountants in 1988, the status of certified public accountants and professional accounting firms in society received a major boost. In China some accounting firms are direct functional units of certain government bureaus. Although other professional accounting firms are not direct functional units of any government departments, many of them are still financially dependent units and require approval from the State to conduct their business as certified public accountants. In 1998 the State Council set forth regulations that require certified public accountants to be independent from any government bureaus. Many professional accounting firms have transformed (or are in the process of transforming) in order to operate the form of sole proprietorship or partnership with unlimited liabilities.
In December 1988 the Ministry of Finance promulgated the Auditing and Certification Regulations (Provisional) which sets out the roles of certified public accountants, audit scope and procedures and the requirements for maintaining audit working papers. From 1995 to 1996 four General Independent Auditing Standards – Basic Standards, Quality Control, Continuing Education and Ethics were issued. New specific auditing standards applicable in March, 2006 were also promulgated, which complete and clarify the provisional regulations and general standards. In 2010, in order to move forward to be more convergence with International standards on auditing, a revised thirty-eight specific auditing standards had been promulgated. So far, forty-eight specific auditing standards have been issued.
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:
- For houses and buildings: 20 years;
- For airplanes, trains, shipping vessels, machinery, mechanical apparatus, and other production equipment: 10 years;
- For fixtures, tools and furnishings related to production and business operations: 5 years;
- For transport other than airplanes, train, ships: 4 years;
- 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.