Accounting & Bookkeeping in China

www.lehmanbrown.com

This article was prepared by LehmanBrown International Accountants.

This article is intended for general information purposes only and is not intended to provide, and should not be used in lieu of professional advice. The publisher LehmanBrown assumes
no liability for readers’ use of the information herein and readers are encouraged to seek professional assistance with regard to specific matters. Any conclusions or opinions are based on
the specific facts and circumstances of a particular matter and therefore may not apply in all instances.
Table of Contents

1. Introduction

2. Development of the Chinese Accounting System

₋ Historical Overview & Government Framework
₋ Globalisation of the Chinese accounting system
₋ Development of China Accounting Standards (CAS)

3. Differences between CAS & IFRS & US GAAP

₋ Impact of these differences on Financial Statement and Ratios
₋ Impairment of Assets
₋ Impact on Balance Sheet
₋ Impact on Ratios
₋ Estimation on Inventory cost
₋ First-in, First-out (FIFO)
₋ Weighted Average cost
₋ Last-in, First-out (LIFO)
₋ Example of the three methods
₋ Depreciation method and expenses
₋ Straight line method
₋ Accelerated method
₋ Unit of production method
₋ Example of the three methods
₋ Interest & Dividends expense
₋ Asset valuation
₋ Historical cost method
₋ Re-evaluation method

4. Tax Filing
₋ Online & in person
₋ Fapiao Vs or & invoice

5. In Summary

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1. Introduction:

Financial reporting is an important part of your everyday business and it can explain major aspects of how your company performs
and facilitates comparison with your main competitors and industries. Furthermore, modern accounting needs to be able to analyse
the financial health of companies in order to better allocate funds and other resources accordingly across an organisation.

Different legislation and accounting standards might vary from one country to another and can influence financial reporting and
ratios. There are two major globally recognized accounting standards:

1. International Financing Reporting Standards (“IFRS”)

2. US Generally Accepted Standards (“US GAAP”)

However while China does not utilise IFRS or GAAP, over the last decade, reform of accounting standards domestically has
brought China closer in line with International Accounting Standards. For this reason many of these accounting standards may
seem uncommon for many Foreign Invested Enterprises ("FIEs") with cross border interests operating in China. It is important to
understand and navigate these differences in reporting, understand the impact within the ratios and your compliance with China
Accounting Standards (“CAS” or otherwise known as "PRC GAAP"). By staying informed and up-to-date with the rapid reformation of
China’s Accounting Standards, an organisation can place it’s primary focus on growing operations in China.

2. Development of the Chinese Accounting System

Historical Overview
China’s accounting system has developed significantly since the economic reforms of 1978 initiated by the Deng Xiao Ping
administration.

Prior to 1978, there was no specific accounting system for China. Due to this historical pretext, China had adopted an accounting
model similar to the one used in the Soviet Union in order to plan the economy, which in turn was substantially different to the
systems developed in the West.

Over the past twenty years, different measurements and the adoption of International Financial Reporting Standards (“IFRS”) were
taken and eventually People’s Republic of China Generally Accepted Accounting Standards (“PRC GAAP”) consisting of 16 specific
standards was put into force in 2000.

In China responsibility for formulation of the accounting regulations rests with the Ministry of Finance (“MOF”). To develop
and implement accounting standards, in 1998, the Ministry of Finance established an accounting standards board composed of
representatives from major Chinese enterprises. The purpose of this committee was to provide advice on the overall planning and
development of an applicable accounting standard system.

Currently China has undertaken a program to restructure its State-Owned Enterprises (“SOEs”) by transforming them into
enterprises, which can issue shares and have limited liability, thus forming joint - stock limited companies. Most of these enterprises
will in all likelihood eventually go public. A new set of China Accounting Standards (“CAS”) was adopted by all listed companies as of
1st January 2007 and is now being phased in over time for all companies. CAS was revised firstly in 2010, and then most recently as
of 2014.

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Globalization of the Chinese Accounting System

Accounting information is playing an increasingly important role on the exchange markets both domestically and internationally.
Inaccurate accounting information can directly affect the quality of the exchange markets and investor confidence. Simultaneously,
International Accounting regulations can also negate the language barrier in order to let corporations from different countries
exchange financial information. This exchange of information can bring forth investment from new sources and is also useful for
companies to compare themselves with their international competitors. More importantly, waste of resources can be avoided, thus
improving the efficiency of international trading, reducing the cost of transactions and boosting the development of international
trading and investment activities.

Initially the Chinese accounting system was based on compilation of assets owned by a particular company with no measurement of
Profit and Loss (“P&L”). This in turn made it challenging for investors to recognise the profitability of an organisation.

While Chinese Accounting Standards (“CAS”) is beginning to lean towards more established International Standards, it facilitates
companies with an international capital market presence to enter the Chinese market. Companies that follow international
accounting standards in the preparation of their financial statements can perceive a lower listing cost on cross border securities
issuances. This also ensures the reliability and transparency of accounting information.

However, a high quality accounting standards require more robust and sophisticated management systems within a corporation.
When a company in China makes an investment overseas, they can bring with it, a higher standard of management practice in order
to strengthen their international competitive power.

Development of China Accounting Standards (“CAS”)

Due to the rapid economic growth in China throughout the past 20 years, Chinese Accounting Standards have been developing in
order to meet the international market’s requirements.

In 2001 joint stock limited companies offering shares adopted the Accounting Standard of Business Enterprises (“ASBE”). The
Accounting Regulations for Selected Joint Stock Limited Companies was subsequently abolished.

In 2002, Foreign Invested Enterprises (“FIEs”) were next to adopt ASBE. The Accounting Regulations for Foreign Investment
Enterprises of the PRC were then replaced.

On 15 February 2005 the Ministry of finance formally announced the adoption of the Accounting Standard of Business
Enterprises (ASBEs) which consist of a Basic Standard and 38 specific ASBEs.

Since 2006, a new “Accounting Standards for Business Enterprises” (“CAS Standards”) has been published comprising of 38
specific accounting standards. The accounting standards were updated again in 2014 with three more specific accounting
standards issued and five existing accounting standards undergoing revision.

In November 2009, the government set a target for 2011 that Financial Institutions will be required to prepare all of their
financial statements in accordance with IFRS standards.

In April 2010, the Ministry of Finance made further refinements to ASBE in accordance with revisions made to IFRS.

Furthermore Financial Institutions are also required to prepare another statement utilising CAS standards.

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3. Differences between CAS & IFRS & US GAAP

Unfortunately even in light of the recent reforms, the use of International Standards and accounting methods cannot be merged
seamlessly with China compliance CAS Standards.

In the below table, some of the key variances between CAS, IFRS & US GAAP are identified taking into account; Presentation of
Financial Statements, Consolidation Statements, Fixed & Intangible Assets (eg: Goodwill), Inventories, Deferred Taxes and Equity.

Chinese Accounting Standard International Financial Reporting US Generally Accepted

(CAS / PRC GAAP) Standards (IFRS) Accounting Standards (US GAAP)

IFRS is a set of accounting rules

and standards for financial US GAAP is a set of accounting
CAS is a set of accounting rules
reporting used in over 110 rules and standards for financial
Introduction and standards for financial
countries and many other reporting used in the United
reporting in China
countries are converging to IFRS States of America
(including China)

Revenue or Expenses Revenue or Expenses

Assets or Liabilities, Revenue or Expenses Assets or Liabilities
Performance Elements
Gains or Losses, Assets or Liabilities Gains or Losses
Comprehensive Income Comprehensive Income

One-Step Test of Impairment: One-Step Test of Impairment:

Impairment of Assets Once impairment has been Two-Step Test of Impairment once impairment has been
recognized it cannot be restored recognized it cannot be restored

Last In, First Out ("LIFO") Last In, First Out ("LIFO")
Estimation of Last In, First Out ("LIFO")
First In, First Out ("FIFO") First In, First Out ("FIFO")
Inventory Cost Weighted-Average Cost
Weighted-Average Cost Weighted-Average Cost

Can be made over certain

Inventory Reversal Prohibited Prohibited
conditions

Capitalization of Can be capitalized under certain Can be capitalized under certain

Prohibited
Development Cost conditions conditions

Straight-Line Method Straight-Line Method Straight-Line Method

Depreciation Methods
Accelerated Methods Accelerated Methods Accelerated Methods
and Expenses
(for some industries not all) Unit of Production Method Unit of Production Method

Classified as an Operating Cash

Interest & Dividends Classified as a Financing Cash Classified as an Operating Cash
Outflow OR Financing Cash
Expense Outflow Outflow
Outflow

Historical Cost
Historical Cost or
Asset Valuation Historical Cost Re-evaluation of Assets (under
Fair value for Valuing Assets
certain conditions)

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Impact on Financial Statements & Ratios

All of these differences within the respective Accounting Standards have a significant impact on a company’s financial statements
and ratios as well as the overall profitability of the company. Management should be aware of these differences in the accounting
methods and their impact in order to have a better understanding of the company’s financial situation.

Below, some of the key differences between CAS, IFRS and US GAAP are outlined with some practical examples to understand the
impact of the variances on the Financial Statements and Ratios.

Impairment of Assets

CAS & US GAAP states that once impairment has been recognised it cannot be restored, while IFRS uses a Two-Step test of
impairment. These differences in Accounting Standard between CAS & IFRS could have a significant impact on your balance sheet
and ratios as illustrated below:

Impact on Balance sheet:

- ­Long-term assets will be reduced by the impairment
­- A deferred-tax category is created (this has an impact on Tax Liabilities)
­- If there is an impairment loss or gain, a stockholder’s equity will move in the same direction

Impact on Ratios:
- A stockholders equity ratio will move in the same direction if there is a gain or loss on impairment
­- Return on Assets (“ROA”) & Return on Equity (“ROE”) will follow the same trend.
­- Has an impact on Cash Flow & Liquidity Ratios
­- Debt to Assets ratios will follow the same trend as the impairment

Estimation of Inventory Cost:

Inventories are physical products that your company will sell to generate revenue and profit. Inventory costs represent a significant
feature on your Balance Sheet. According to Western Standards, inventories occupy a significant part of a balance sheet statement
and are considered very high; but due to certain logistical reasons, high inventory ratios are often necessary in China.

Under CAS, IFRS & US GAAP, there are three key methods to report inventories: FIFO, Weighted Average Cost and LIFO (which is not
permitted under IFRS). All methods are permitted under CAS, but they all have a different impact on a balance sheet and ratios. The
three methodsare summarized below:

First-in, First-out (FIFO)

This method considers that the oldest goods purchases are sold first and the remaining inventories are the newest. This impacts
the balance sheet and ratios in periods of pricing fluctuation. For example in a period of rising price, the cost of your inventory
increases faster, because the oldest units sold were assigned a lower cost and vice-versa for period of decreasing price.

Weighted Average Cost:

This method considers assigning a Weighted Average Cost to all goods sold and the ones stored in the inventory during your
accounting period. It is calculated by compiling the total cost of the units available for sale during the period, divided by the
total of units available for sale during the period.

Last-in, First-out (LIFO):

This method is only permitted under CAS & US GAAP. It considers that the most recent goods purchased are sold first and
those stored in the inventory as the oldest. As a result, the cost of goods sold is more accurate according to the cost of goods
purchased. This impacts the balance sheet and ratios during a period of price fluctuation. For example in a period of rising
prices, the cost of inventory tends to be lower than the cost of units sold and vice versa for a period of decreasing price.

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Example Case Calculation:
Company ABC asked LehmanBrown International Accountants to present them the differences between all methods with focus on
LIFO, because it could not be applied under their home regulations.

In 2007 they bought 30,000 units at 12 RMB and sold 25,000 of them at 15 RMB.

In 2008, they bought 50,000 units at 15 RMB and sold 40,000 units at 18 RMB.

Depending on which method used, the final inventories will differ for the period.

The chosen method will therefore have a significant impact on the balance sheet and ratios; highlighting the need to consult an
accountant to have a clearer understanding of the financial impact.

FIFO Method Weighted Average Cost LIFO Method

225,000 RMB 220,909 RMB 210,000 RMB

Depreciation Method and Expenses:

Long life fixed assets such as property, plant and equipment, buildings, machinery, etc. are assets that are expected to provide
your company long-term economic benefits. Usually they represent a significant investment from your part and they have specific
accounting Depreciation Method and Expenses rules to be applied.

Straight-Line Method:
This method is permitted under CAS, IFRS & US GAAP. This Straight-Line Method is probably the most common appraoch for
many enterprises. It consists of subtracting the expected residual value of expenses divided by its useful life. This method
allocates the expense proportionally over the expected lifetime of the assets.

Accelerated Method:
This method is fully permitted under IFRS & US GAAP. However under CAS, this method is permitted only if a business is in one
of the following industries:

1. Biopharmaceutical Manufacturing
2. Manufacturing of Special Machinery or Transportation Equipment
3. Manufacturing of Electronic Devices
4. Manufacturing of Instruments & Metres, Software Production and Information Technology

This method is similar to the Straight-Line Method, but it allows for allocating greater expenses earlier in the year, which will have a
greater impact on financial statements and a company’s tax filing.

Unit of Production Method:

This method is only permitted under IFRS and US GAAP. Unfortunately, this method is not permitted under CAS, but it is
important for an organisation to understand. Furthermore, an organisation’s Head Office outside of China might use this
method which consists of allocating expenses against the use of assets over a certain period.

Example Case Calculation:

If Company ABC purchases new machinery for their factory in Tianjin. The cost is 100,000 RMB and has a residual value of 1,000
RMB over 5 years. Production is expected to be 2,000 units for the first two years and 3,500 units in the final three years. (For
the Accelerated Method: Assume that it is applied at 20%)
Straight-Line Method Accelerated Method Unit of Production Method

19,800 RMB 23,760 RMB 12,655 RMB

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Depending on which method a company uses, the depreciation expense may vary and this will have an overall affect on a variety
of financial statements and ratios (Fixed & Total Asset Turnover, Operating Profit Margin, Operating Return on Assets and Return
on Assets). It is important to note that over the 5 year period, the same amount will have been recorded as expenses, however
depending on a company’s specific requirements one particular method may enable tax savings and an increase in profitability.
Choosing the appropriate Depreciation Method therefore is a key consideration.

Interest & Dividend Expenses:

Interest & Dividends expenses appear on the Cash Flow statement. In this statement, cash flow is classified by three categories:

Operational Activities
Investment Activities
Financing Activities

These classifications have a significant impact on the financial statements and ratios of a business. However according to the various
accounting principles, expensed interest should be classified as financing outflow under CAS, while under US GAAP it has to be
classified as operational cash outflow. IFRS provides a more flexible way of presenting interest & dividends expenses as operational
or investment categories.

Asset Valuation:
Long-term assets play a significant role in an organisation’s ‘Real’ & ‘Book’ values. There are two methods for conducting a valuation
on long-life fixed assets and the use of one or the other will have a significant impact on the book values.

Under CAS & US GAAP, only the historical cost can be compounded as the value of an asset, whereas under IFRS, both historical cost
& re-evaluation methods are allowed. However, you cannot use both methods in tandem.

Historical Cost:
The book values are carrying amounts under historical cost (purchase cost) and deduct accumulated depreciation &
amortization.

Re-Evaluation Method:
This method is more costly, because it necessitates a constant re-evaluation of your assets. The book value is the fair value of
the last re-evaluation minus the accumulated depreciation & amortization.

According to the CFA institute, one key difference between the two models is that the cost model allows only decreases in the values
of long-life assets, however the re-evaluation model may result in an increase in the values of long-life assets to amounts greater
than the historical cost.

4. Tax Filing

Online & In Person

In order to file a company’s books with the Local Tax Bureau ("LTB") in China, LehmanBrown uses the Yongyou ("UFIDA") accounting
software system. UFIDA is the largest and most common accounting software system used in Mainland China and we use this
alongside our own system, which can enable simple inputting into SAP or Oracle systems if required to report overseas

In Mainland China, tax filings are conducted online via a software system provided by the tax bureau which is installed on a
designated workstation within a company. A company will then be assigned specific log in credentials to access the system and
process CIT filings

Fapiao Invoice
From our experience, those without an understanding of the Chinese accounting system underestimate the importance of the Fapiao
invoice and can find it confusing. A Fapiao is not only a tax receipt, but is also a bill and an invoice which is used to support contracts
& warranty.

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Even if a company is not required to declare revenue in China, the Fapiao is a key form of documentation for transactions. It is a
means for the government to both detect and monitor tax evasion; and it provides a business with the actual record of an amount
paid for goods and services.

For reimbursement on any travel expenses, a Fapiao should be used as an official receipt and submitted accordingly by the claimant.

A Fapiao can be requested from any business in China, although one should keep in mind that most companies in the interest of
avoiding tax will try to give you a regular receipt ("shouju") instead.

We recommend you to always request a Fapiao, so you can earn tax breaks at the end of the financial year.

5. In Summary

As China modernises its accounting system and with a fast evolving accounting sector, it can prove difficult for many firms to keep on
top of new legislation and accounting standards.

Accounting & Bookkeeping standards differ from one country to another, even though most countries Generally Applied Accounting
Principles (“GAAP”) have been modified to be in compliance or similar to International Financial Reporting Standards (“IFRS”).
However they are still many countries that operate within their own GAAP regulations.

China’s Accounting Standards (known as “CAS” or “PRC GAAP”) have remained largely autonomous from globally recognized
principles and thus providing cross-border businesses and multi-national (‘MNCs”) businesses with a challenge when ensuring
compliance to the principles used in their Head office jurisdiction. For example, there are different rules for impairment of assets,
inventory costs & reversal, capitalization of development costs, depreciation expenses, interest & dividend expenses and asset
valuation. Those different methods can have an impact on your business ratios, profitability and tax burden. It is therefore imperative
for a foreign invested enterprise to have a clear understanding of CAS and the variances between CAS and other global standards

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About Us
Founded in 2001, LehmanBrown is a China-focused accounting, taxation and business advisory firm, operating in Beijing, Shanghai,
Hong Kong, Macau, Shenzhen, Guangzhou and Tianjin. Our firm also manages an extensive affiliate network, providing service
throughout China and reach across the globe.

Combining years of international expertise with practical Chinese experience and knowledge, LehmanBrown offers expert advice and
support to both local and international clients. Within the mid - tier, we are regarded as a market leader and our clients enjoy access
to a combination of senior and experienced counsellors from both China and abroad.

At LehmanBrown we recognise that you are unique, that you have unique requirements and we are committed to providing
individually tailored financial solutions. LehmanBrown is dedicated to providing personalised service by working closely with our
clients to understand your individual business needs. This enables us to offer the most up-to-date and expert advice.

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雷博国际会计成立于 2001 年，是一家获得许可，主要从事有关中国范围内会计、税务和财务咨询服务的公司，在北京、上海、
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综合多年的国际经验和对中国市场的深刻理解和实践体验，我们向广大国内外的客户提供高质量的专业服务和意见帮助。
在雷博国际会计的服务过程中，我们作为市场中的佼佼者，您将得到来自中国本土以及其它国家的高级资深专家热忱的咨
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我们深刻认识到每一位客户都是独一无二的，并都有其独特的业务需求。雷博国际会计承诺将根据客户的不同业务需求，
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