“The key challenge is to get access to all relevant data”

 

CHINA FOCUS TALKS TO KEVIN CHAN, WHO IS IN CHARGE OF FIDUCIA’S CHINA FINANCE & ACCOUNTING DEPARTMENT, ABOUT CHALLENGES IN CHINA’S ACCOUNTING PRACTICE.

 

Please click here to have a look at Kevin Chan's profile

 

China Focus (CF): Is China accounting comparable to that of Western countries?

Kevin Chan (KC): Yes and no. China’s set of accounting rules is similar to international guidelines such as the International Accounting Standards (IAS) or the International Financial Reporting Standards (IFRS). I see the bigger differences in the practical implementation of these rules and the people implementing them. The talent pool in China is limited, and while there is a high number of accounting professionals and graduates every year, the quality is not necessarily there. Not many Chinese accountants have had exposure to IAS or IFRS practices, so there may be an experience gap.

 

CF: What is challenging about accounting in China?

KC: China is still developing its regulatory framework trying to include more principles of the IFRS into its national guidelines. So one of the main challenges companies face is to keep up with the frequent modifications of accounting policies and implementation rules. As a lot of these standards are new, companies have to ensure that both accounting staff and management receive comprehensive training and regular updates.

CF: Could you share some of China’s accounting peculiarities?

KC: Companies here have to declare their tax on a monthly basis, accounting and bookkeeping naturally follow this deadline. That is quite a lot compared to Hong Kong, where companies only need to submit their report for annual audit once a year. Then again, most established companies use monthly bookkeeping closures by internal policy anyway. But China’s extensive bureaucratic jungle is a challenge on its own. There is a so-called annual consolidated inspection for which companies have to submit a lot of documents including the audit report to seven or eight government bodies at the same time.

 

CF: That sounds like a challenging task…

KC: … which is why many companies outsource their on-going accounting work to professional service providers. By doing so, they can concentrate on their core business and still comply with all rules and regulations of China’s accounting system which still differs from international standards in cases such as the accounting for certain government grants or related party disclosures.

Another challenge is location. If a company is located in a remote area they may have difficulties finding qualified accountants with an acceptable level of English. In such a case, we work closely with local staff or accountants who make all bookkeeping entries on-site and forward them to our Shanghai office. We then make sure they are in line with all current accounting and tax requirements before sending the management reports to the overseas headquarters. In the initial stage of a project we usually have one or two site visits which help us understand the whole operation and where possible risk areas lie. You could say that we act as a bridge between the local Chinese entity and its parent company overseas.

 

CF: Chinese companies are considered to be less transparent about their books than their Western counterparts. How can you still ensure to get valuable and reliable information?

KC: In general, you have to distinguish between two categories of transparency: One the one hand, you have the legal reporting requirements which regulate what type of information companies in China have to disclose and how frequent and to whom. On the other hand, there is the quality of the disclosed information and the question whether or not you have reliable data that accurately reflect a company’s financial situation. It would be wrong to say that all Chinese companies lack transparency when it comes to their financial information. You have to look at the individual companies on a case-by-case basis. It is true, however, that when we analyse the financial situation of potential target companies in the mid-market M&A sector we come across transparency issues quite often. A typical case is that the Chinese company has two or more sets of books. The external book is used for tax reporting and the internal book – showing the true figures – is for management reporting. This is where it gets challenging and in order to get access to the right information we conduct a thorough Financial Due Diligence (FDD).

 

 

"We act as a bridge between the local Chinese entity and its parent company overseas."

Kevin Chan, Senior Consultant, Fiducia Management Consultants

 

 

CF: What is an FDD?

KC: If you want to locate and plug the gaps in a company’s finances you have to go right to the financial core of their operation. An FDD is very much like an x-ray: we scan everything connected to a company’s books and accounts, financial activities and procedures. The key challenge is to get access to all relevant data and to analyse them using a structured approach. Sometimes it’s almost like detective work: We try to connect the dots and look for conspicuous patterns in the data.

 

CF: So what do you actually check?

KC: A good FDD usually comes with a large to-do list including balance sheets, income statements, bank and credit card statements or credit agreements to name but a few. We also look at the major contracts with suppliers or customers, check whether quoted prices are really matching with what was paid or received. In addition, we do physical counts of their inventory and fixed assets. However, for revaluations of machinery and equipments, you need a qualified surveyor.

 

CF: When do you consider your search for financial gaps a success?

KC: You can have two types of results: If we cannot find anything suspicious, it might simply mean that the company’s bookkeeping is done correctly, which should count as a success. If our efforts reveal any type of incorrect practice, this practice can be stopped and the responsible people can be tracked down. This might not necessarily be what our clients expect or hope for, but at least financial insufficiencies can be disclosed this way – a success in itself. For example, when we did an FDD for an online recruitment agency we found out that in order to increase their commission some staff had inflated the sales figures by posting outdated or repetitive job adverts.

 

CF: In such a case, do you also look for the offenders?

KC: For the FDD, our work is done as soon as all financial ‘leeks’ are found. From an internal control standpoint, however, it might be helpful to know who the perpetrators are in order to take certain countermeasures.

 

CF: Any other examples of ‘misconduct’ that have you come across?

KC: Kickbacks have been a tradition in China for thousands of years. This is why some people might not even be aware of their illegal nature. We always advise clients on the importance of education and that policies of this kind should be included in the company’s compliance handbook. Make sure that every employee reads and signs it! A typical example would be the IT equipment supplier who pays kickback to the IT department manager of a multinational company who is usually in charge of the procurement of all IT equipment. In order to guard yourself against such malpractice, a good compliance handbook includes an authorisation process for bigger value purchases and minimum price quotation requirements. Also, employees should declare their relationships with suppliers: You never know whether your Head of IT is the cousin or best friend of the Sales Manager of your trusted IT supplier.

 

 

"Sometimes it’s almost like detective work: We try to connect the dots and look for conspicuous patterns."

 

 

CF: It has been six months since the new EIT law took effect. What’s your verdict?

KC: Hard to say, especially since the law is only a few months old. From a local perspective it seems fair that foreign companies are not favoured with a lower tax rate or tax holiday schemes anymore. On the other hand, you hear many foreign companies complaining about inconsistent implementation practices and loopholes in the system. Overall, I think it’s a step in the right direction. It makes China’s tax system simpler and more transparent which benefits all parties.

 

CF: On a personal note, how is life in Shanghai as a Hong Kong citizen?

KC: I like Shanghai. It is an international city and it has a great variety of lifestyles. As long as you can handle your day-to-day Mandarin Shanghai is great to live in, even for a Hong Konger.

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