Annual Audit for FIEs in China – Interview with Ivy Gu from Dezan Shira & Associates
SHANGHAI – In this exclusive China Briefing interview, Dezan Shira & Assocites’ audit expert Ivy Gu discusses the annual audit process for foreign invested enterprises operating in China and highlights the resulting due diligence benefits, such as the development of efficient internal controls.
Why is annual audit important to foreign invested enterprises (FIEs) in China?
When FIEs first came to China, they were not familiar with Chinese accounting standards and tax rules, which made incorrect accounting treatments or tax filings quite common, especially for small and medium-sized FIEs. Through the annual audit process, auditors will help find these mistakes, help FIEs improve their financial reports in accordance with Chinese accounting standards, and make sure the accounting data are presented appropriately.
Because China is currently going through tax reform, tax laws and regulations are updated quite frequently. The annual audit is a good opportunity to double-check your tax obligations to be sure they have been fulfilled and unnecessary tax payments could be refunded. It can help companies build a better accounting system as well.
What accounting standards are used for audit purposes in China?
Currently, for preparing financial statements, FIEs in China should follow the Accounting Standards for Business Enterprises (ASBEs), disseminated by China’s Ministry of Finance in 2006 (a.k.a. the new Standards). However, in practices, we found a lot of our clients are still using the old standards generally adopted before the new standards came into effect in 2007. Although adopting the new standards is not mandatorily required for unlisted companies, we would usually advise our clients to switch to the new standards because certain reconciliations need to be conducted for audit purpose due to the discrepancies between the two sets of standards.
What are the key areas of annual audit?
Accounts related to purchases and sales are usually the most vulnerable areas, so generally we would spend more time in reviewing these accounts and ensuring the accounting data are genuine and accurate by comparing the transactions with the corresponding contracts, invoices, orders, and inventory changes.
In addition, it is quite common for FIEs who are new to China to conduct most of their transactions with affiliated companies overseas. For example, they would import from their foreign parent company and sell the products domestically or export products purchased from China to their overseas affiliates. These transactions can raise issues in transfer pricing, which often cause concerns with the Chinese tax bureau. Failure to appropriately specify transfer pricing issues may significantly increase the tax risks for FIEs.
How is the audit on representative offices (ROs) different from other types of FIEs?
Because the daily business operations of ROs are relatively simple compared to other types of FIEs, more attentions will be paid on expense accounts on the financial statement of ROs.
What do you think would help FIEs go through the annual audit smoothly?
In order to be prepared for an annual audit, an effective internal control system is crucial and should be put in place as soon as possible. Small and medium-sized FIEs usually do not have a competent internal control system due to inadequate funds or personnel when they are entering China’s market. As the business continues to grow, the negative effects of these poor internal controls will eventually emerge, affecting the way the accounts have been booked, which may ultimately result in material misstatements.
How can Dezan Shira & Associates help FIEs improve their internal control?
We often get requests from the overseas parent companies to conduct a special audit on the financial internal control system of their local establishments in China. Two circumstances are quite common: either they do not have a reasonable and systematic internal control, or they do have a reasonable internal control system in place, they just don’t follow it. Generally, we would talk to the employees at different managerial levels, review relevant supporting documents, and identify red flags in the company’s daily operations. After we get a clear picture of their internal control systems, we do spot checks and see whether the system is effectively enforced.
An internal control audit report will be generated after all the audit procedures have been completed. We then offer our opinions and communicate with the management about the significant internal control weakness of the company, explain why these are crucial, what negative effects it could bring and how to modify and improve these areas.
Ivy Gu is the Head of Audit at Dezan Shira & Associates’ Shanghai Office. Her expertise includes PRC audit, IFRS audit, U.S. GAAP audit and SOX 404 audit, consolidation, due diligence, internal audit and consultant business. She is familiar with many industries, including processing and manufacture, trading, catering, luxury, education, travelling, vehicle manufacture and sales business.
Dezan Shira & Associates is a specialist foreign direct investment practice, providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in emerging Asia. Since its establishment in 1992, the firm has grown into one of Asia’s most versatile full-service consultancies with operational offices across China, Hong Kong, India, Singapore and Vietnam as well as liaison offices in Italy and the United States.
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Annual Audit and Compliance in China
In this issue of China Briefing, we discuss annual compliance requirements for foreign-invested enterprises, including wholly-foreign owned enterprises, joint ventures and foreign-invested commercial enterprises, as well as the less demanding requirements for representative offices. We also highlight the most recent tax and legal changes that will significantly influence the way companies do business in China in 2014.
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