Over the last three decades, China has progressed to a market-driven system and developed its own accounting and bookkeeping procedures. For overseas companies setting up in China, the oversight of certain accounting standards and financial reporting practices is inevitably considerable.
Statutory Requirement for Financial Reporting in China
According to Article 208 of the Company Law of the People’s Republic of China (China Company Law), a company must prepare a financial accounting report at the end of each fiscal year and have it audited by accounting firm. Therefore, local statutory audits are mandatory according to China Company Law. Meanwhile, the fiscal year for enterprises in China is from January 1st to December 31st, which is a mandatory requirement for all types of enterprises in China.
Auditors will express an opinion on whether the relevant financial statements fairly state the company’s financial position at year-end, operating performance, and its cash flow according to the China Accounting Standards (CAS).
For foreign invested enterprises, annual statutory audit reports not only enhance the degree of accountability and reasonableness of the financial statements, but also serve as a reliable source of opinion on the financial information when they are delivered to the group for consolidations.
China Accounting Standards
Financial reporting practices in China are governed by the China Accounting Standards (CAS) – also known as the Generally Accepted Accounting Principles in China (PRC GAAP). The CAS framework consists of three standards:
- Accounting Standards for Business Enterprises (ASBE);
- Accounting Regulations for Business Enterprises (ARBE)
- Accounting Standards for Small Business Enterprises (ASSBE).
The ASBE is commonly known as “Chinese new GAAP,” which is similar to International Financial Reporting Standards (IFRSs). For example, the accounting treatment for leases under CAS is the same as IFRS: canceling the classification of leasing transactions at the lessee in financial lease and operating lease, and requiring the lessee to recognize the right to use assets and lease liabilities for all leases (except short-term lease and low-value asset lease with simplified treatment), and acknowledge depreciation and interest expenses respectively. As a result, those companies that adopt the new GAAP may be required to consider the major GAAP differences between Chinese GAAP and German GAAP.
ARBE is commonly known as “Chinese old GAAP.” ARBE are more appropriately applied by companies with small or medium operational scales with less complex transitions and accounting systems, and ASSBE uses ASBE as a reference and is intended to make it easier for small and tiny businesses to follow accounting standards and tax laws. The tax calculation methods in the ASSBE are designed to be closer to tax laws, thus simplifying the process of making year-end adjustments.
Converting CAS Compliant Financial Reports between CAS and German GAAP
For foreign invested enterprises, GAAP conversion plays an important role in group reporting, which would not be possible without converting the GAAP differences between different accounting reporting frameworks.
There are several discrepancies between CAS and German GAAP, both of which provide more detailed rules for certain practices.
The chart below gives the main examples of the differences in accounting treatment between CAS and German GAAP:
CAS vs German GAAP
| China Accounting Standards | German GAAP |
| Percentage of completion method is allowed for revenue recognition | Revenue recognition strictly follows the completed contract method |
| Expenses can only be presented by function | Expenses may be presented either by function or by nature, whichever provides information that is more reliable and relevant |
| An impairment loss on fixed asset must NOT be reversed under ASBE but allowed under ARBE | An impairment loss on an asset (except goodwill) can be reversed |
| Operating lease-Leasee (only under ASBE) Recognition of a right-of-use asset and a lease liability followed by depreciation and interest costs captured over lease term | Operating lease-Leasee Rental expense is recognized on a straight-line basis over the lease term |
In addition to the above, there are significant differences in the presentation and format of financial statements.
The information on the Chinese financial reports must be converted to fit the reporting standards of the target jurisdiction (German GAAP or Group Accounting Manual), through a process called “mapping”. Accountants must first map the accounts on the financial report to the target accounting standard.
Accountants also need to pay special attention to the differences in the accounting standards used in China and the standards of the target jurisdiction (German GAAP or Group Accounting Manual) and identify any financial activities that may be affected. For certain companies, this is a manual process. Large companies can develop specialized software to perform this function in real-time, depending on their requirements.
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