Partner Assurance, Head of German Business Group
The requirement for the mandatory application of the new Chinese accounting standards (China Accounting Standards – CAS) is already in place for publicly listed companies, financial institutions, and certain government enterprises. However, it has never been specified whether and when these new standards will have to be applied by the rest of the economy and this has led to the concomitant application of two different systems of accounting standards.
Now the city of Shanghai has taken the lead: According to an instruction dated 26 January 2010 (Hu Cai Kuai 2010 No. 8) all medium and large-sized companies are subject to a mandatory application requirement beginning with the 2011 financial year. In addition, an interim stated objective is to endeavour to have at least 50 per cent of these companies apply the new accounting standards by the year 2010. To this end, companies are to be addressed in a targeted approach by the subordinate departments of the municipal finance ministry. As CAS is more complex than the old China generally accepted accounting standards (old China GAAP), the new requirement will have an effect on a company’s administrative organisation and costs.
The campaign launched by the city of Shanghai illustrates that the significance of CAS will not remain limited to the previous scope of application. Rather, it is an indication that a broad-based field test should be initiated in order to determine whether the privately organised economy is ready for the new CAS, which are more complex compared to the previous accounting standards. Also, it is apparent that China has a shortage of well-trained accountants, in particular outside the large urban conurbations around Shanghai and Beijing.
The Shanghai initiative coincides with the activities of the Ministry of Finance (MoF) in Beijing: A new standard for small and medium sized-enterprises (SMEs) is being drafted by the MoF, which should come into effect in 2011 for application across Mainland China. This new standard mirrors international developments, as the International Accounting Standards Board (IASB) is also working on an accounting standard for SMEs. The definition of an SME is still under consideration. Whether Shanghai will align its efforts with the central government’s plans remains to be seen.
While the MoF is still considering whether new criteria are needed to define an SME, an ordinance from 2003 (Guo Jing Mao Zhong Xiao Qi (2003) No.143, the Ordinance) lists quantitative criteria to describe small, medium, and large entities. The size criteria vary according to industry. All size-related criteria must be cumulatively satisfied for a company to enter the next (higher) size category. The following table shows how the size categories are defined.
The instruction in the Ordinance offers the following explanation concerning the size criteria:
- The concept of industry includes the following conclusive list of industries: Mining, processing trade, energy generation, and utility networks (electricity, gas, water). Industries not included in the list are to be governed by separate provisions;
- The number of employees is calculated as of 31 December of the respective year;
- Construction industry revenues are to be calculated on the basis of completed projects (in contrast to the new accounting requirements, which specify revenue recognition in accordance with the percentage of completion method).
In the absence of a still to be developed SME accounting standard, we will take a closer look at the existing CAS. The CAS represent a large step in the direction of International Financial Reporting Standards despite a number of significant remaining differences. There are numerous discrepancies between the previous and new accounting standards respecting the recognition and measurement of assets and debts. The following table provides an overview of typical differences of recognition and measurement that have an effect on foreign-invested separate entity financial statements.
In addition, there are many differences relating to the disclosure of balance sheet and income statement items; the minimum note disclosures according to CAS tend to be more extensive than the disclosures required under the previous accounting standards. A new SME accounting standard will most likely lean closer towards CAS than towards the old China GAAP.
A number of uncertainties in the practical implementation of the new guideline are to be expected. Thus, for example, it remains unclear what effects these provisions will have on the requirement for preparation of consolidated financial statements. Whereas the old accounting requirements expressly stipulated preparation of consolidated financial statements only for publicly listed companies and state-owned enterprises, the new accounting standards do not provide for any exceptions. This would mean that each company, which is considered to be a parent company within the meaning of the new consolidation standard, must prepare a set of consolidated financial statements as soon as it satisfies the size criteria.
Due to the requirement for uniformity of accounting methods within the group, this would mean that all companies in the consolidated group would have to apply the new accounting standards, regardless of their location. In this way, subsidiaries outside the city of Shanghai would also be forced to apply the new accounting standards. It is also uncertain whether the size-related criteria are to be applied to the individual companies or to the consolidated group, and what the consequences are, if not all size criteria are met cumulatively. Another legislator, however, does not provide exemptions to groups: Parent companies incorporated in Hong Kong have to prepare consolidated financial statements regardless of their size.
Companies in Shanghai that satisfy the size-related criteria for at least medium-sized companies are advised to familiarise themselves with the new provisions without delay, to the extent that this has not yet taken place. In doing this, the following aspects should be observed:
- Clarification of the issue whether mandatory application is to be expected as early as 2010 (voluntary early application is possible at any time);
- The completeness and correctness of the introduction of the new accounting requirements must be ensured - to this end, a project plan should be prepared;
- A detailed analysis about the differences concerning recognition, measurement, and disclosure of balance sheet and income statement items must be prepared;
- Determination of any additional note disclosures that may have to be made and the department required to provide them;
- An opening balance sheet must be prepared;
- Determination of the expected effects on tax expenditure;
- Preparation of a group accounting manual for the group’s companies in China;
- Checking to see if the IT systems and current internal processes in the company are capable of generating the additional required information (including the note disclosures);
- Is the accounting department adequately staffed – quality and quantity wise – to handle the additional tasks and is the required professional know-how in place.
Company finance departments will be especially burdened by the forthcoming changes. The accounting personnel in most companies will need to have additional training in the new CAS before the new requirements can be mastered, so it is important to begin preparing now. As is often the case, stress and additional expenditures can be avoided by ensuring that one’s organisation is ready to comply with changes to tax and accounting practises.