Foreign companies establishing a presence in China will encounter a host of considerations that do not exist in their home country. Among these, interpreting and understanding China’s system of accounting standards can be particularly challenging.
In this guide, we introduce the accounting standards adopted in China and the difference between Chinese accounting standards and the IFRS.
What accounting standards are adopted in China?
China has its own accounting rules referred to as the Chinese Accounting Standards (CAS). Despite substantial convergence between CAS and the International Financial Reporting Standards (IFRS) that most Western investors are used to, practical implementation and interpretation differences remain.
The CAS framework is based on two standards:
- Accounting Standards for Business Enterprises (ASBEs); and
- Accounting Standards for Small Business Enterprises (ASSBEs).
The ASBE standards are significantly converged with the International Financial Reporting Standards (IFRS) and all listed companies in China must comply with the ASBEs for the preparation of their financial statements. Most foreign-invested entities also generally follow the ASBEs.
The ASSBEs are a counterpart of the ASBEs, providing unified standards for small-size enterprises. The ASSBEs use the ASBEs as a reference but are more similar to tax laws in terms of their tax calculation methods, which simplify the process of making adjustments between accounting standards and tax rules. Small-scale enterprises can choose to adopt either the ASBEs or ASSBEs.
In addition to the CAS framework introduced above, some enterprises adopt the Accounting System for Business Enterprises. The Accounting System for Business Enterprises constitutes 14 chapters that outline the basic principles, methods, and rules for accounting and financial reporting in China. It applies to all types of medium and large companies except for listed companies and financial and insurance companies.
Compared to CAS, the Accounting System for Business Enterprises is targeted at enterprises in specific industries, while CAS is targeted at specific economic businesses (transaction or event) or a specific reporting item. With a growing number of companies voluntarily adopting the CAS framework, the Accounting System for Business Enterprises is becoming less common, even if it is China-specific and easy to implement.
Further, starting January 1, 2021, several accounting standards regarding revenue, leases, and financial instruments, have applied to all entities that adopt the CAS. These new standards include:
- Chinese Accounting Standards for Business Enterprises No.14 – Revenue (2017) (CAS14);
- Chinese Accounting Standards for Business Enterprises No.21 – Leases (2018) (CAS21);
- Chinese Accounting Standards for Business Enterprises No.22 – Recognition and Measurement of Financial Instruments (2017) (CAS22);
- Chinese Accounting Standards for Business Enterprises No.23 – Transfer of Financial Assets (2017) (CAS23);
- Chinese Accounting Standards for Business Enterprises No.24 – Hedge Accounting (2017) (CAS24); and
- Chinese Accounting Standards for Business Enterprises No.37 – Presentation of Financial Instruments (2017) (CAS37).
After January 1, 2022, the following accounting standards and interpretations are in force:
- Chinese Accounting Standards for Business Enterprises Interpretation No.15 (2021);
- Chinese Accounting Standards for Business Enterprises Interpretation No.16 (2022); and
- Chinese Accounting Standards for Business Enterprises No.25 – Insurance Contract (2020) (CAS25) (effective date: 1 January 2023).
Language and currency for reporting
RMB is the base currency for ledgers and financial reports. For enterprises using currencies other than RMB in their business transactions, foreign currencies can be used as the functional currency; however, financial reports are required to be presented in RMB. Furthermore, accounting records must be maintained in Chinese. FIEs can choose to use only Chinese or a combination of Chinese and a foreign language.
Discrepancies between CAS and the tax laws
Though closely related to each other, there are discrepancies between CAS and tax laws, which are referred to as book-tax differences. To put it simply, book-tax difference means that for the same transaction, the tax treatment and timing of recognition as stipulated by the tax laws are different from the accounting treatment as stipulated by the accounting standards.
Such differences mostly come from the different goals served by the accounting standards and tax laws. While the purpose of accounting is to reflect the financial situation of an enterprise accurately and truly, the tax laws ensure the tax revenue of the jurisdiction. Thus, the two regulatory systems differ in accounting elements and measurement principles.
Common book-tax differences
The most common book-tax differences are categorized into two types:
- Temporary differences; and
- Permanent differences.
Below we summarize some differences that arise with regard to the recognition of assets, liabilities, income, expenses, and measurement principles.
Differences in assets
For fixed assets or raw materials purchased
Can be recognized as assets even if qualified invoices are not obtained.
Group restructurings: Impact on assets and liabilities
Assets and liabilities shall be determined either at cost or at fair market value on business combinations.
Any gain or loss when merging the assets and liabilities is not recognized due to a special tax deferral treatment allowed for mergers (if certain conditions are met)
Depreciation method for fixed assets
Difference in liabilities
For liabilities, there is no provision on tax laws because liability is not directly deductible before tax. However, liabilities are often closely linked to costs and expenses. Often, the book-tax differences in liabilities are actually the book-tax differences due to costs and expenses.
In practice, the costs and expenses corresponding to the actual liabilities can be deducted before tax if the documents in accordance with the provisions of tax laws are obtained. For example, where an enterprise leases an office space but fails to pay the rent due to financial difficulty, the liability corresponding to the rent can still be deducted if the enterprise has obtained the invoice from the landlord. Alternatively, where the enterprise hasn’t received the qualified invoice from the landlord, this part of the liability cannot be deducted before tax, even if the enterprise recognizes the liability in accounting.
Besides, according to tax laws, contingent liabilities or accrued expenses are liabilities that an enterprise has not actually incurred and thus shall not be tax-deductible until they are settled. They are temporary differences. The amount payable to government authorities, such as fines and penalties, is however not tax-deductible, thus, it shall be treated as a permanent difference.
Differences in income
For transactions deemed to be sale (e.g., distribution to shareholders as dividends, transfer to creditors in payment of debt, etc.)
The revenue is not regarded as income
The revenue is regarded as income.
Advance payment may also be regarded as income by tax laws if certain conditions are met.
Interest income from treasury bonds and income from qualified investment in Chinese companies
Regarded as income
Not regarded as taxable income as they are tax-exempt
Timing of revenue recognition
Revenue to be recognized when the control of goods is transferred to the customer
On advance payment for goods, the income should be confirmed when issuing invoices (under the value-added tax (VAT) regulations) or on the due dates as agreed in written agreements (under the CIT law)
Differences in costs and expenses
Under CAS, expenses can be recognized when the outflow of economic benefits in the course of ordinary activities is likely to result in a decrease in enterprise assets or an increase in liabilities, and the outflow of economic benefits can be measured reliably. There are very few restrictions on the recognition of expenses, except when expenditure provides future economic benefits and can be capitalized and amortized in future periods, which can be recognized by satisfying the “likely” condition. Such expenses shall be accounted for on an accrual basis rather than on a cash basis, and there are no deduction limits.
However, under tax laws, such as the CIT Law and the CIT Implementation Regulation, there are several requirements for expenses to be pre-tax deductible. For example, for employee welfare expenses, only the part actually paid, and less than 14 percent of the total amount of employee salaries and wages can be deducted before tax.
On the other hand, there are some tax incentives that allow enterprises to get a super deduction on their expenses incurred for certain activities. For example, for manufacturing enterprises (except tobacco manufacturing), an additional 100 percent of R&D expenses could be deducted from the taxable income; thus, the tax basis can be 200 percent of the actual costs for CIT purposes.
Difference in measurement principle
The measurement principles of accounting and taxation serve their own purposes. The purpose of accounting is to reflect the financial situation of the enterprise accurately, so in addition to historical cost, other measurement methods such as replacement cost, net realizable value, present value, and fair value measurement may also be used at the end of the accounting period for assets impairment provisions. Under tax laws, the tax basis is generally based on the historical cost principle or cash basis.
How to deal with book-tax differences?
Since the recognition principle and the measurement principle are different under CAS and tax laws, enterprises should understand and identify temporary differences and permanent differences and accurately adjust the “accounting profits” in the financial statements to the “taxable income” in the tax return.
The comparison of carrying amount and tax base is often the best way to identify book-tax differences, where the difference is temporary.
Many companies prepare CAS-compliant balance sheets and compare them with some worksheets that are prepared on a tax base (e.g., in the case of fixed assets, intangibles, R&D expenditures, and business combinations). In some instances, there may be a book value but no tax base, as in the case of bad debt provisions, which are not tax deductible until they incur. In other instances, there may be a tax base but no book value, as in the case of purchasing fixed assets that are below the capitalization threshold for accounting purposes but can be capitalized for tax purposes under tax laws.
When the “profits” in accounting and “taxable income” in tax laws are different due to their different approach to calculating gains, expenses, or losses, such permanent differences are not tied to an asset or liability and, therefore, cannot be identified with a particular asset or liability in financial reporting.
To identify these differences, enterprises shall review the profit and loss items one by one to evaluate whether a difference in timing of recognition, deduction limit, tax exemption, and super deduction exists. If the business transactions are complex, it is wise to engage a qualified tax agent to prepare or review your tax return.
Chinese Accounting Standards (CAS) vs International Financial Reporting Standards (IFRS)
Although CAS has substantially converged with IFRS, there are additional considerations due to the special circumstances. This leads to accounting treatments that are different from those derived from the principles and descriptions in IFRS.
For foreign entities that report under IFRS and consolidate their Chinese subsidiaries that report under CAS, the information from the Chinese subsidiary needs to be carefully translated, mapped, and converted to fit into the overseas parent company’s accounting books and policies.
Differences in the presentation of financial statements
CAS and IFRS have multiple differences regarding the presentation of the financial statements. As a communication exercise, financial statements are intended to provide investors and other stakeholders with high-quality, decision-useful financial information. The difference on this level is thus of special importance.
For example, CAS and IFRS are different in:
- Accounting year: CAS mandates that the accounting year must start on January 1 and end on December 31 of each year. While under IFRS, the accounting year is not specified and an entity can consistently prepare financial statements for a one-year period, such as the February 1 to January 31 of each year. The IFRS even allows the accounting year not to follow the full calendar year. For example, some entities prefer to report for a 52-week period for practical reasons, which is allowed by IFRS.
- Presentation currency: Chinese accounting laws require that a set of financial statements for statutory purposes must be presented in RMB. Foreign transactions must be converted to RMB in accordance with relevant accounting standards. There is no such requirement in IFRS in terms of presentation currency.
- Title of the financial statements: CAS and IFRS have different titles for the financial statements. For example, the “balance sheet” under CAS is called a “statement of financial position” under IFRS, and the “income statement” under CAS is called a “statement of profit or loss” under IFRS.
- Income statement by nature or by function: Expenses in an income statement are either classified by their nature or by their function. IFRS allows expenses to be presented by functions or by nature, while CAS only permits expenses to be presented by functions. On this aspect, IFRS allows greater flexibility.
- Classification of accounts: A chart of accounts (COA) is an index of all the financial accounts in the general ledger of a company. It offers a digestible breakdown of all the financial transactions that a company conducted during a specific accounting period. On the COA level, CAS and IFRS are different in the classification of accounts. CAS classifies accounts by function, while IFRS classifies accounts by function or by nature. For example, bank charges, are classified as “financial expenses” under CAS while they are usually included in the “administrative expenses” account under IFRS.
Differences in accounting treatment
The accounting treatments of certain subjects, such as land, fair value measurement, and related party identification, etc., could be different due to local requirements.
For example, regarding the valuation methods for fixed assets, under the IFRS, one may choose to appraise fixed assets either using the cost model or applying the revaluation model. CAS, however, only allows fixed assets to be appraised based on their historical cost.
Differences in bookkeeping practices
Bookkeeping differences can be observed between CAS and IFRS in practice. For certain subjects, CAS is more complex in bookkeeping.
For example, under CAS, the value-added tax (VAT)-related sub-accounts are further divided into input VAT, transfer-out of unpaid VAT, VAT deductions and exemptions, output VAT, transfer-out of input VAT, etc. Under IFRS, it might only be an account called VAT payable for bookkeeping.
Besides, CAS requires a specific account name to be used when recording double entries. For example, for the two sub-accounts under lease liabilities, one is called future lease payables (the undiscounted outstanding rental payment), and another one is called the unrecognized financing charges (the difference between the outstanding rental payment and its present value). There are no such requirements under IFRS.
How to bridge the differences between CAS and IFRS?
When designing the COA mapping for a specific entity, the accountant in charge of the conversion should pay attention to transactions where accounting treatments under CAS and IFRS are different. The conversion can be divided into two phases. The first phase is more about difference analysis and preparation, while the second phase is about the implementation.
Once the decision for conversion is taken up, the first step is to identify the differences between the CAS and IFRS, to confirm the accounting policy and accounting mapping of the headquarters and the Chinese subsidiary, and to identify the data gaps.
This phase is crucial to the development of a structured conversion plan that covers the major issues and obstacles.
Phase one can be divided into the following steps:
- Analyze the difference between CAS and IFRS in accounting treatment;
- Analyze the difference in accounting policies and accounting estimates between the China subsidiary and headquarters;
- Analyze the differences between CAS and IFRS on report format;
- Analyze the difference between CAS and IFRS on disclosure requirements;
- Make a list of differences; and
- Calculate the variance and prepare to adjust entries to recognize different accounting treatments for transactions.
Upon completion of the phase one assessment and having developed a list of differences for this specific conversion, the focus then shifts to the implementation phase. In phase two, related adjustments need to be quantified for the periods to be presented, and the financial statements under the new accounting standards will be generated. In practice, two sets of methods might be applied. Method 2 is recommended.
- Import the most detailed account balance table under CAS in the accounting software into Excel as the initial figures;
- Post the adjusting entry to the corresponding account for the initial figures;
- Generate the CAS-adjusted figures by integrating the initial figure with the adjusting entry;
- Analyze the sub-ledger account of the headquarters under IFRS that are corresponding to the sub-ledger account under CAS;
- Prepare reclassification adjustments for accounts;
- Post the reclassification entries to the corresponding accounts of the CAS-adjusted figures;
- Add CAS-adjusted figures and all reclassification entries to generate the final figures for sub-ledger accounts of headquarters under IFRS;
- Generate IFRS financial statements by summarizing the sub-ledger accounts of IFRS;
- If notes to statements are required, differences in the format of statements should be considered; and
- Finally, recheck the difference list to ensure that all discrepancies have been accounted for and adjusted.
- Match sub-ledger accounts of the financial statements under CAS with headquarters’ sub-ledger accounts of the financial statements under IFRS;
- Set up the formula link between sub-ledger accounts of the financial statements under CAS and the headquarters’ sub-ledger accounts of the financial statements under IFRS;
- Post the adjusting entries to the corresponding sub-ledger accounts under CAS; and
- Produce IFRS financial statements by summarizing the automatically generated sub-ledger accounts of IFRS.