In 4 Steps to the Annual Compliance Review

Local Chinese GAAP

The first round for the annual compliance review is the annual audit. All foreign invested companies whether Representative Office (RO), Wholly Foreign-Owned Enterprise (WFOE), Joint Venture (JV) or Foreign-Invested Commercial Enterprise (FICE), are required to prepare annual statements including balance sheet, income as well as cash flow statement for the annual audit based on the Chinese GAAP. The annual financial statements and the relevant accounting records need to be audited by a Chinese licensed CPA firm. As you are running an international company in China it is suggested to use a Chinese audit firm with international experience and which has proven to work on international quality standards. Only a CPA firm with international experience can provide you with a platform for an international financial structure.

We have seen many problems arising during the annual audit. This is mostly the result of foreign companies in China underestimating the importance of a good monthly bookkeeping and accounting. The following points are the key issues, which CPA firms will have to pay a lot of attention to and need to keep an eye on audit adjustments which may arise from them:

Sales and cost of goods (COGS) recognition

In some cases, the finished product or merchandise has been delivered and the sales conditions have been fulfilled, but the sales and cost have not been recognized in the financial and tax report. As a result, the sales and COGS would be understated, and VAT/CIT payment would be delayed. That will lead to tax surcharges and penalties.

Cost calculation

The Certain companies have not adopted the correct cost calculation mehtod. For instance the manufacturing costs have not been properly allocated into each product, the bill of material (BOM) has not been correctly defined, the unit price of the material has not been used correctly, etc. All these measures will lead to the wrong cost calculation.

Evaluation of Inventory

The evaluation of inventory is the key issue during the annual closing and audit procedure. Regarding the slow-moving inventory the proper devaluation should be considered according to the net realized value or other provision methods. 

Stocktaking of Inventory and Fixed Assets

The existence and status of the inventory and fixed assets need to be checked during the annual closing. An overall stocktaking needs to be considered by the company and the auditor will make sample checks. The key purpose is to ensure the ending quantity and quality of the inventory and fixed assets. 

Proper expenses accrued

According to the accounting policy, the relevant accrued expenses should be considered and recorded regularly in the periodical reporting to reflect the correct operating result.

Deferred tax calculation

Deferred tax calculation is a complicated process and it is sometimes overlooked by the company. In particular in China, there are many temporary and permanent differences between the accounting and the tax result. Therefore, the company needs to pay more attention to make the proper deferred tax calculation.

International GAAP

For international companies the consolidated financial statements will be needed for the purpose of group consolidation. Therefore, the local WOFE/JV will need a special purpose audit of the financial statements as per December 31^st in line with the International Standards on Auditing (ISA). Moreover, the financial statements need to be prepared according to the internal accounting principles of the headquarters (according to IFRS, HGB, US-GAAP, or HK-GAAP). The results of this audit will be reported in the standard format or within a reporting package as defined by the headquarters.

2^nd level: Annual Foreign Currency Filing

The Foreign Currency Inspection (FCI) as of the period ending December 31^st doesn’t need to be performed by an authorized CPA firm. The company can do the filing by itself. This report is necessary for the company to undergo the annual inspection by the State Administration for Foreign Exchange (SAFE) as required by the foreign exchange regulations in China. The responsibility of the company’s management is to prepare, factually and completely according to the regulations of the SAFE, the Statement of Foreign Investors’ Equity of the foreign invested company. The FCI report will verify the Statement of Foreign Investors’ Equity of the company and confirm the accordance with the relevant regulations promulgated by the SAFE.

3^rd level: Annual Tax Audit and Clearance

According to the requirements of the tax authorities, each foreign entity shall participate in an annual tax clearance. We need to draw your attention to the fact that taxpayers, whose Corporate Income Tax (CIT) is in the form of an audit collection and one of the following situations occurs, are required to submit a tax audit report:

1. Loss of corporate assets

2. Real Estate corporation annual CIT filing

Taxpayers are required to submit a tax audit report if one of the following situations occurs:

If you need more information or have questions on the topic, please feel free to contact us: richard.hoffmann@ecovis.com.