Accounting standards vary across the world. Each country has its own presentation of financial statements that it must follow. While a country may adopt a certain set of standards, such as IFRS (International Financial Reporting Standards) or GAAP (Generally Accepted Accounting Principles), there will still be differences in how the income statement, balance sheet, statement of cash flows and statement of shareholder’s equity will be reported on a local statutory basis. In addition to the financial statements themselves, a set of notes will be included that expand upon the statements. Some of these notes may be specifically required by a country.

Chinese GAAP, also known as the Chinese Accounting Standards (CAS), are based on two specific standards – Accounting Standards for Business Enterprises (ASBEs) and Accounting Standards for Small Business Enterprises (ASSBEs). They are unique because they originated during a Socialist period, when the state was the full owner of industry. Thus, unlike Western accounting standards that measure profit or loss, Chinese GAAP was more of a measurement of assets available to a company. Since 2006, China has largely adopted IFRS, which has largely replaced the CAS. However, there are some differences that remain.

Multinational enterprises that choose to establish a subsidiary in China must comply with local accounting standards. All regulatory documents, tax liabilities and local financial statements must be filed on time, each year, before any dividends may be repatriated to the parent company. Failure to file statutory reports in a timely manner may result in fines or potential revocation of a business license.

A company that establishes a subsidiary or branch in China can expect the below differences in Chinese GAAP when compared against IFRS or U.S. GAAP:

Delayed Implementation of New Financial Standards:

While Chinese GAAP is primarily based on IFRS standards, it does not automatically adopt new standards that are implemented into IFRS. Instead, the Chinese Ministry of Finance must review the standards to ensure they are appropriate for China. This process can be quite intensive and may result in only partial adoption of a standard or no adoption at all.

Financial Reporting Must Begin on January 1:

Chinese GAAP requires that financial reporting must occur over a calendar year – from January 1 through December 31. No variations are allowed outside of this start date.

In contrast, both U.S. GAAP and IFRS allow companies to present their financial statements over any twelve-month period. Reporting does not necessarily need to begin on January 1.

Rules Specific to Chinese GAAP or IFRS / US GAAP:

For certain transactions that are more common in China than elsewhere in the world, accounting standards have been more fully developed within Chinese GAAP than in IFRS. For example, when two companies merge in China that are controlled by the same entity and have similar interests, Chinese GAAP requires that comparative figures be restated.

Conversely, there is no specific rule for comparative restatement under either U.S. GAAP or IFRS.

For situations that are not common in China, but happen frequently elsewhere in the world, both U.S. GAAP and IFRS have more detailed rules than China. Examples include additional rules for employee benefit plans. Certain employee benefits are not very common in China that are common in other countries. When a Chinese subsidiary of a parent company offers specific benefits not normal in China to its employees, the Chinese Ministry of Finance may need to be contacted for specific instructions on how to record and present the transaction.

Fixed Assets Capitalization Threshold:

Under Chinese GAAP, fixed assets related to production and operations of a company with a service period longer than one year are capitalized. In addition, fixed assets must be valued under the historical cost method.

Under U.S. GAAP, companies are allowed to determine their own capitalization policies for all fixed assets. Companies may choose the historical cost or re-evaluation method.

Similar to U.S. GAAP, companies using IFRS are allowed to determine their own capitalization policies for all fixed assets. Companies may choose the historical cost or re-evaluation method.

Impairment:

Chinese GAAP requires impairment to be carried at the lower of net book value and the recoverable amount on a single item basis. The recoverable amount is determined to be the higher or net selling price or present value of estimated future cash flows from continuous use.

In contrast, U.S. GAAP indicates that testing must be performed when conditions indicate possible impairment of an asset. The testing is based upon specific asset groupings where cash flows may be identified. Impairment is only recorded if the tests result in undiscounted future cash flows are indicated as below book value.

Additional Concerns

When a parent company must consolidate its books, including those of the local Chinese subsidiary, it may run into differences or problems if the parent company does not have a robust accounting system or ERP. For larger companies, this is generally not an issue, since they typically invest in strong accounting systems that are capable of handling subsidiaries across the world.

For smaller companies, an expensive accounting system is not feasible. Thus, smaller companies may need to make any statutory adjustments manually. This can be quite onerous and time-consuming. It also leaves open the possibility for mistakes, particularly if management is unfamiliar with Chinese GAAP.

To minimize the likelihood of mistakes when preparing local Chinese statutory financial statements, management should employ an individual with expertise in local CAS to review or prepare statements before submitting any documentation for regulatory purposes. A local accountant can assist in ensuring that the company complies with Chinese regulations properly.

By collaborating closely with local experts in Chinese GAAP, as well as the Chinese Ministry of Finance, multinational enterprises can avoid potential regulatory issues.

Please contact us (inquiries@chinalawsolutions.com) to get a recommendation on an accounting firm which can assist your business in China. All inquiries are treated as confidential.