Financial transparency seems to be a luxury to foreign businesses operating in China. A lot of foreign business owners or directors stationed in China complain that they are not able to have the visualization over their business by checking the financial reports prepared by their accountants.
The problem is caused by a set of China specific intricacies and constraints.
– Complexity of China accounting and taxation statutory compliance requirements.
– Unorganized business processes and inadequate internal control.
But more importantly, unqualified accountant who has no willingness to understand employer’s or client’s business, and fails to properly treat transactions in accordance to accounting principles.
We’ve come across so many cases where foreign businesses not familiar with China accounting intricacies had employed accountant who failed to sufficiently play their roles. In the worst situation, they ended up losing control over their operations，losing financial transparency, which resulted in imperiled business performance.
In this article, we shaped our experiences into a story to showcase the situation business owner can potentially face by working with unqualified accountants. And what you can do to assess the skills and attitude of the candidate no matter you hire an internal accountant or outsource your accounting function to a service provider.
Axel Digital, where the story happened
Axel Digital is leading full-service digital marketing and e-commerce agency, which provides consultancy and advisory service to foreign consumer brands, guiding them to make entrance into China and navigate through the dynamic market space.
With a team of 30 digital marketing and e-commerce experts officed in Shanghai and Beijing, Axel Digital helps hundreds of brands achieve their commercial targets every year, building online sales and executing creative campaigns that have impact on the market. Axel Digital has been growing its business over the past 5 years in the light of the booming Chinese e-commerce market, and is planning series-A fund raising to develop SAAS dashboard tools to help clients visualize product sales and drive actionable insights.
It has not been a good time recently for Willy Hamilton, managing director of Axel Digital, whose accountant, Yvonne Wang, just submitted her resignation. Yvonne has been working for Axel Digital for 3 years and the accounting book has consistently been meeting high standard in terms of both financial transparency and compliance to China local statuary requirements. Yvonne is marrying her boyfriend in Chengdu and has to leave Shanghai. Willy asked Yvonne to do him a favor by attending the job interview with Gina Chen, the candidate of her successor, as he knows Yvonne can help with assessing the qualification and practical skills of Gina.
The interview starts
Willy: Hi Gina, welcome to this interview, and I guess you have studied the business of Axel Digital and have a good idea of what we are doing. Let me introduce Yvonne, she has been doing a brilliant job as accountant with us for 3 years. She is leaving us soon so I hope you can take over what she does here.
Gina: Yes, I visited your website yesterday and think you have an exciting business with promising outlook. Hopefully I can join the team.
Willy: Please tell us a little about your background.
Gina: Yes. I have bachelor degree in accounting, and 6 years of working experiences with a foreign accounting service firm XYZ & Associates. My work involves bookkeeping, preparing financial statements, and performing tax filing for business clients.
Willy: Yes, I know that firm. How do you think your previous employers evaluate your performance?
Gina: I think my manager in XYZ & Associates was quite satisfied with my work. China accounting standards are quite different from those of western countries, which poses a challenge and administrative burden on foreign businesses. That’s where our expertise comes into play as we helped foreign business maintain full compliance with Chinese accounting rules. Since the 3rd year of my service with XYZ & Associates, I have been independently in charge of books of 6 clients. And never had the tax bureau found defects in the books I prepared and called my clients in for tax inspection.
Willy: That seems quite good. And what did drive you to leave the service provider and apply this job?
Gina: Oh. My clients submit the fapiao and bank transactions data of the previous month to me at beginning of each month, and I need to meet the deadline of preparing their books and complete the tax filing before 15th. of the month, which leads to overtime working every day in the first half of each month. And plus, I don’t think the salary package my employer pays me justify my contribution.
Willy: Well. That seems unfair. Yvonne, do you have any questions to Gina?
Yvonne: Hi Gina, it is interesting to hear that you used to work for an accounting service provider. Looks you got quite some experiences from your previous work. At Axel Digital, we have some special types of transactions due to the way we deliver service to our clients and also how they pay us. I would like to know how would you go about the accounting treatment of these transactions if you are supposed to prepare the book.
Gina: Yes, Yvonne, please describe the characters of the business and I will let you know.
Technical question No. 1: VAT fapiao and revenue fall into different tax period
Yvonne: One item on our service catalog is ‘content production and media activation’. Our clients make prepayments to us for service fees of 3 months in advance and then we deliver the service in subsequent 3 months.
Gina: When do you issue fapiao to client? I guess should be before the prepayment, correct? Normally business in China would not make payments before receipt of fapiao.
Yvonne: Yes, our client expect that we issue fapiao to them before they execute the payment.
Gina: Then, that’s simple, I book the amount issued in fapiao into account receivable and revenue account. And later, when payment is reimbursed by client, I increase the balance in the bank account by the paid amount, and offset the account receivable.
（Yvonne and Willy looked at each other for 10 seconds）
Yvonne: Is that all?
Gina: Yes. What else do I need to do?
Willy: I don’t think it is correct to book the prepayment into the revenue immediately after we receive the payment, as our service is delivered in the subsequent 3 accounting periods. We should recognize the revenue in each period with the percentage of amount equaling to the service delivered in that period in proportion to the total service volume. Otherwise, the figures on the financial reports will be distorted.
Gina: Well, that’s how I treated this type of transactions in books I prepared for my previous clients. If you distribute the revenue into 3 monthly accounting periods exactly adhering to when the service works take place, then the timing of your issuing VAT fapiao will differ from the timing you recognize revenue. You should be careful that this accounting practice is not in compliance to the statutory rules. And you know, the Chinese tax bureau checks such discrepancy in their backend system and will come to ask you to provide the description of the incident, and in the worst case this will cause the tax penalty.
Willy (shaking his hand): I don’t understand why revenue must be recognized in the same period fapiao is issued? (turns to Yvonne) Is this how the treatment of this type of transaction is instructed in China tax law†?
Gina: Well, as far as I know, tax bureau will suspect that business evades the declaration of VAT on purpose when comparing the numbers between the P/L statement and VAT return and detecting that recognized revenue is higher than fapiao issued in one tax period.
Yvonne: I am afraid I don’t think what you said is correct. According to China tax law†, for delivery of labor service, revenue should be recognized according to the progress (percentage of the contract executed) the service is completed at the end of each tax period. And normally tax bureau (especially in coastal cities of China) will not inspect such discrepancy. And if we regularly keep all our business documents well archived, we can act professionally in response to the request from tax bureau and explain to them reasonably the characters of our business transactions with sufficient proof.
Gina: Well, preparing such description causes too much additional work, isn’t it? We are already too busy chasing the tax filing deadline of 15th. each month.
(Listening to what Gina said, Willy can’t help shaking his head)
Willy: Yvonne, do you have other questions to ask her?
Technical question No. 2: How to deal with KOLs not providing fapiao for their services
Yvonne: We have another type of special transaction where we work with a number of KOLs for promoting our clients’ brands and we pay for the service of KOLs on behalf of our clients. As the KOLs tend not to issue fapiao to us, I would like to know how you will address this situation, in terms of chasing fapiao and accounting treatment?
Gina: Well, this KOL services should normally be booked into expenses, but you know, you are not allowed to recognize the transaction as expense unless you got fapiao from the supplier. So, I would prefer to utilize the ‘other receivables’ account to temporarily place this KOL expense, as I always make good use of ‘other receivables’ and ‘other payables’ account for such transactions without fapiao. It is very convenient and efficient. Actually, meanwhile you should try to find fapiao from other sources for substitution so that the KOL expenses can be warranted.
(Yvonne just took a sip of water yet threw out immediately when hearing Gina)
Yvonne: You shouldn’t do that! What I did was to maintain a separate list of expenses without fapiao. And I constantly follow up the list and chase the KOL to provide fapiao by prompting them to come over to tax bureau asking for issuing fapiao. Attempting to acquire fapiao from other sources poses the risks of obtaining fake fapiao. Using illegal fapiao will certainly lead to tax bureau’s inspection and cause heavy penalties.
Willy: Sorry Gina, but I am actually frustrated to hear that you attempt to book the expense into ‘other receivable’ account. If the expenses are not accounted properly into the correct period in which it is incurred, the profit and loss will again be seriously distorted and become useless to me for proper financial analysis and decision making.
Yvonne: Exactly! ‘Other receivables’ account is normally used to carry transactions such as deposits or money lent to employees. Seems that you treat the ‘other receivables’ account as a trash can into which you put everything without fapiao. Later, how can you easily differentiate which booked transactions are actual receivables and which transactions are expenses without fapiao in ‘other receivable’ account?
Willy: I think we finish our interview today and please come back to wait for our notice. Thanks a lot for coming over to our office for the interview.
End of the Story
Willy decided not to hire Gina and he involved Yvonne to interview another 3 candidates. Unfortunately, Willy and Yvonne were not satisfied with anyone of them.
Willy started to do some homework and came up with an idea to retain Yvonne by allowing her to work remotely from Shanghai office. He met Yvonne 3 days after the interviews.
Willy: Yvonne, you see, it would certainly be horrible to manage the business with these accountants. It will be like haunting nightmare working with them.
Yvonne: I believe so, and nor can I envision how you can endure the situation.
Willy: Look Yvonne, I checked and found there is a cloud accounting software Megi (www.megichina.com) for small business running in China. I did a trial use of the product and found it very useful, you can probably still work with us while you work remotely as we can share one set of book anytime and anywhere.
Yvonne: Oh yes, I heard about Megi. It is of excellent usability, and our staff can actually record sales, purchase and expenses in the system, and later accountant can reconcile these transactions with bank statements. It also has integrated general ledger and financial reporting. Can be a perfect tool for Axel Digital to manage financials.
Willy: Exactly. What about you continue to work with Axel Digital after you go back Chengdu, as I can’t lose you as my precious asset. I can keep your current salary package unchanged even though I am aware that the market price for accountants is much lower in Chengdu.
Yvonne (she looks a little bit moved): I would love to continue to service Axel Digital as I have been always happy to work here. I like the open atmosphere and all the colleagues here are already my best friends. However, I don’t think it is technically possible, as I need to handle and process the fapiaos and other documents, and not being physically present poses big challenges to this.
Willy: Look, after introducing Megi cloud accounting software, all the transaction forms are digitalized and processed online. And the archived documents can be uploaded as attachments. The only problem that remains is fapiao, but I know that the digitalization of VAT fapiao has been advancing rapidly in China, so paper fapiao would no longer present as a problem. Meanwhile, I will hire a cashier in Shanghai to take care of the works of binding and review of the vouchers and fapiao, under your remote supervision. Could you stay in Shanghai for another 2 months until I manage to employ the cashier and you train her what to do.
Yvonne (Smiled): That’ll be great, and I really appreciate the arrangements, Willy. I will continue to deliver best jobs. By the way… Could you allow me 15 days off for my marriage at Chengdu?
Willy (opened the drawer in his desk and took out a prepared red packet.): I wish you a happy wedding….
We suggest that you can use the two questions in this story to assess your candidates when hiring an employee accountant or picking an accounting service provider.
We also work with experienced accountants and business advisors who build on Jeenie (www.jeenie.com.cn) and Megi (www.megichina.com) cloud platform. Our professional partners help SME business clients structuring accounting and controlling systems, implementing the cloud accounting application, and share the same view of your financials anytime and anywhere.
† Notice of State Administration of Taxation on Several Issues Relating to Determination of Revenue subject to Enterprise Income Tax. （Guo Shui Han (2008) No. 875）