In China, the fiscal year ends on December 31.  And afterwards the annual compliance process begins for many companies until the end of June. Some foreign-invested enterprises (FIEs) are no longer required by law to do annual audits, but for those which do, they must comply with PRC regulations.  An annual audit of a company's financial statements will include a review of the income statement, balance sheet, and cash flow statement.

Annual audits enable companies to adapt to tax laws and accounting practices that change over time. Foreign companies undergoing annual audits can see the differences between their current finance and accounting processes and new regulations and to update their own processes.

Annual Audit Requirement for FIEs

FIEs, as companies with foreign investors, periodically transfer out dividend payouts according to their business activities in China to the parent company abroad. However, the basic condition to be able to do this is that the company has to have paid all their tax obligations, and all financial data should be confirmed. The annual audit is therefore a starting point for FIEs to be able to transfer profits abroad.

Most FIEs operating in China are linked to countries in which different accounting systems apply, such as the EU, the US, and Japan. The annual audit process provides an opportunity to find and correct minor accounting mistakes or detect the missing activities with the auditor's assistance.

The purpose of the annual audit is for an independent auditor to check the company's financial statements for compliance with the Chinese GAAP (Generally Accepted Accounting Principles) standards, not the company's financial situation itself. In this way, a foreign company checks its compliance with Chinese regulations and then can present the company's annual performance to its partners or shareholders.

Who Performs the Annual Audit and When?

Annual audit reports for foreign companies in China must be made by a "Certified Public Accountant" according to Chinese GAAP standards.  Generally, the audit process is carried out in January and February. However, financial experts point out the advantages of starting the process in November or early December of the previous year. The general discourse is that early inspection can be done more comprehensively in the broader period of time.

But the main advantage is that companies that start auditing early in November will be able to identify inefficient processes and practices that cause errors, and find the opportunity to make revisions before the new financial year starts.

During the audit report process, necessary corrections are made, and then companies are responsible for calculating and processing the "Annual Corporate Tax File." Companies generally complete the audit report by March.

After the audit report, the Corporate Income Tax (CIT) statement is prepared. The CIT rate is specified as 25% of the company's periodic profit. However, this rate may vary depending on the company size and sectors. For CIT, companies must come to an agreement with the tax authorities. The CIT application must be submitted by May 31. These tax payments are made four times a year, or quarterly.

The processes included in the annual audit are:

1. Capital verification: Accountant (auditors), cash inventory, and accounting records
2. Asset inventory and assessment: The accountant compares the goods and fixed assets in stock with their entries in the ledger.
3. Account check: Accountant checks the company's account to verify recorded transactions.
4. Related party transaction evaluation: The auditor checks the payments made by the company, their due dates and payment dates, and their balances.
5. Expense control: The accoutant compares the expense records with the invoices and other documents of those expenses.
6. Financial statement analysis:  The company's balance sheet and profit statement are analyzed.
7. Preferential tax assessment: It is checked whether the company can benefit from CIT deductions and incentives.

Conclusion

Compliance of company records with current accounting standards is critical, as it ensures the accuracy of the company's accounts, its financial condition, and the determination of taxes to be paid in the following year. Auditors use many techniques such as information gathering, document and document control, comparison, verification, recalculation, etc., to ensure that the company's accounting records comply with Chinese GAAP and if any incorrect or incomplete records are corrected.

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