GAAP stands for Generally Accepted Accounting Principles but is sometimes also called US GAAP.
They are a collection of accounting rules and regulations that are used for standardized financial reporting.
All Foreign Invested Enterprises and WFOE companies in China need to follow all statutory annual audit and compliance processes, as stated by the PRC Company Law and other similar laws. It’s compulsory to comply with yearly audits and a litany of relevant tax liabilities so that FIEs can distribute and repatriate profits or any kind of dividends back to their home countries. Anyone who fails to do so can face severe penalties, extra expenses, or even have their business licenses revoked.
FIEs preparing their annual audits and yearly financial reports need to follow something that is called the Chinese Generally Accepted Accounting Principles (GAAP), but is also referred to as the Chinese Accounting Standards (CAS), which are essentially two frameworks.
What is GAAP?
GAAP stands for Generally Accepted Accounting Principles but is sometimes also called US GAAP. They are a collection of accounting rules and regulations that are used for standardized financial reporting. On an international level. These are the regulations that the US Securities and Exchange Commission (SEC) prefers to use that lay out industry-specific principles and concepts to marshal the transparency and consistency of financial reporting to ensure compliance between organizations.
What Are the US GAAP Standards?
GAAP are recommended standards and are not completely infallible. Although they do help in regards to transparency and financial statements, they do not ensure or make any promises that your company’s financial reports are correct or don’t have any errors that could result in misleading investors, accidentally or purposely.
The US SEC is trying to move from this GAAP process to something called the International Financial Reporting Standards (IFRS). The issue facing the SEC is that GAAP is vastly different from IFRS so any kind of progress has been painstakingly slow.
The adoption and conversion from GAAP to IFRS haven’t been as rapid as expected for several reasons. GAAP is not regulated by governments and is more of a combined effort by companies and governments. Because GAAP is not mandatory for businesses, it has created some issues for the SEC even though they still need businesses to adhere to GAAP principles for their annual financial reporting.
Yearly audits are a major requirement from the SEC for companies that issue stocks in the US, these audits need to be performed by independent accounting firms. But if you are a company that doesn’t have external investors, you don’t have to follow these requirements from the SEC. Regardless of appearances and mandates, the SEC has no control or responsibility for the GAAP standards. On a corporate level, it’s the Financial Accounting Standards Board (FASB) that has influence regarding annual financial reporting standards and principles. It’s the job of the FASB Advisory Council (FASAC) to advise the FASB on any issues or to change or influence the GAAP standards.
The SEC has been on the path to leading away from GAAP standards for over a decade and hopes to abandon them in the future. But until they do, GAAP accounting standards are still the choice for annual yearly financial reports.
What Are (CAS) Chinese Accounting Standards?
Chinese Accounting Standards or CAS as we will refer to them going forward. The Chinese Ministry of Finance (MOF) utilized its Accounting Regulatory Department to create and develop the CAS. This set of accounting principles focuses less on profit and more on the assets that each company has. These CAS rules are generally referred to as the Chinese GAAP, and these are the two main legal frameworks below:
- ASBEs – Accounting Standards for Business Enterprises
- ASSBEs – Accounting Standards for Small Business Enterprises
CAS and IFRS Standards are 90% Similar Since 2007
International Financial Reporting Standards (IFRS) are the rules that are commonly used in the western world so that the majority of accounting standards are consistent across numerous borders. Before China streamlined its accounts via the CAS, it was a potential minefield trying to converge them with western accounting practices.
Chinese accounting standards used to be almost incomprehensible to western regulatory boards. China previously used a fund accounting system that laid out assets making it possible to assess productivity. At the time, the vast majority of China’s industrial productivity was controlled by the CCP. In this model, companies needed to produce a report on their productivity at the end of each financial year.
But as more foreign companies are started operating in China the accounting standards needed to be brought into line to correlate in some way to international accounting laws. They needed to be standardized to reflect profits instead of production. The old soviet ways adopted by China are now being cast away and replaced as China moves into a more free-market economy. Being as productive as possible is now replaced by becoming financially viable.
What are the Key Difference Between CAS and International Accounting Standards?
As we mentioned above, the CAS and IFRS are now approximately 90% the same, so it’s a much easier conversion than ever before between the two. Although the CAS and IFRS now seem to be on the same page or nearby. It’s important for foreign enterprises operating in China to know the 10% differences. Here are some of the things you need to know so you don’t get any penalties or accidentally break the accounting regulations.
Chinese GAAP Vs US GAAP & IFRS
- Companies in China must deal directly and submit their accounts to the Chinese MOF. Any conversions on foreign transactions must use the official exchange rate denoted by the Chinese government.
- The Chinese financial year runs from 01 Jan to 31 Dec.
- International standards classify accounts by their nature, while Chinese accounts are classified by function.
- Companies using an IFRS model can decide for themselves which valuation method they use for their fixed assets. Companies using a CAS model generally use a historical cost method, especially if they are a private company as it’s hard to find fair-value info. Accounting fiscal years must start on 01 January.
- Any business partner identities of the companies need to be reported to the MOF. Monthly accounts filings are standard. This is also true for indirect cash-flow statements that pertain to the fairness of transactions.
- Accounting rules across China might not be the same from city to city. They are not hard and fast throughout the whole of China.
Summary and Final Thoughts
Any WFOE or foreign enterprise operating in China must understand the Chinese Accounting Standards (CAS). And also understand the difference between local accounting standards and those on an international level such as the IFRS. Failing to understand those differences can cause major issues, especially if repatriating your profits back to your home countries.
You could also be liable for extra expenses, and other financial penalties, and could even have your Chinese business license revoked if you fail to follow set procedures. So as a foreign enterprise in China, you are responsible for ensuring these bridges are linked together properly.