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The wrong Chinese accounting method could be limiting your growth

by CBBC
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Fapiao accounting could be limiting your business growth, writes Valur Blomsterberg

In China, fapiaos (the official receipts that are issued and received for goods or services provided) are the most important document for tax reporting. They are the gold standard for a business’s taxable income – and for this reason, many accountants do their bookkeeping based solely on fapiaos. This method of accounting does not require the accountant to do much in terms of actually understanding the business, as everything they need for bookkeeping is printed on the fapiao. This does however tend to create problems for businesses down the road as they attempt to grow.

Fapiao accounting refers to the method that solely recognises revenue and costs based on available fapiaos. The accountant receives input fapiaos (moneys receivable) and output fapiaos (moneys payable) and from there they generate the required financial statements and calculate a business’s tax liability.

Fapiao accounting exists because it is the simplest way to meet tax compliance requirements in China. This article demonstrates the impact that the accounting method used to meet compliance requirement can have on a business’s ability to grow and pinpoints the root cause of those problems.

Incorrect accounting balances

It’s not enough for managers to look at their bank balance to make important financial decisions. They need to understand much more in order to comprehend their current position and future cash flow requirements. Only by doing this can they gain an accurate picture of their business and access the valuable information needed as the basis of future management decisions.

When an accountant performs bookkeeping on the basis of fapiao, the figures on the balance sheet are distorted, most often exaggerating the company’s profit for a given period. This is because of the inherent delay to the receipt of input fapiaos.

Everyone expects fapiaos to be issued immediately, thereby recognising revenue and increasing a business’s tax liability. However, crafty suppliers in China will often manage their own tax liability by delaying their fapiaos. They will often delay issuing fapiaos across multiple accounting periods in order to control their revenue.

Accountants are therefore forced to recognise revenue without the expenses to reconcile them with. The revenue gets recognised immediately on the Profit and Loss statement – incurring corporate income tax if the business is profitable – whereas the deductible expense will be recognised at a later date, only once the accountant has received the input fapiao.

For compliance purposes, some delay is acceptable since the tax authorities are aware of your net tax liability at any given time. However, the biggest cost to businesses is often not having an accurate balance sheet to make important financial decisions. Fapiao accounting can lead to a series of inaccuracies in figures that render them useless for management.

Rarely do businesses or the accountants have procedures in place to correct these kinds of problems, which allows them to compound over time

Accounting based on fapiaos also makes reconciling transactions difficult. Without information on a business’s activity, accountants can struggle to reconcile bulk payments, pre-payments or other transactions that might vary slightly from the fapiaos that were issued. As more time passes, this becomes increasingly difficult.

Rarely do businesses or the accountants have procedures in place to correct these kinds of problems, which allows them to compound over time. This then increases the likelihood that an accountant might re-issue fapiaos for payments that were never reconciled, leading to further tax management problems down the line.

Tax and accounting

Fapiao tax accounting might be simpler for the accountant but it could damage your business

Tax Management

Accounting on the basis of fapiao removes many of the tools accountants have to advise managers on how to best manage their business’s tax liability. Managers might find that their profits vary significantly between financial quarters; meaning that they may pay income tax early, which then needs to be claimed back, and large amounts of VAT might be paid compared to other businesses in the same industry.

Unfortunately, one of the most common tax management problems hurting small businesses is one that is most likely to affect those businesses who struggle to bring in a profit. For small businesses who perform bookkeeping on the basis of fapiao, a spike in revenue when a company issues a large fapiao for goods or services might cause it to be significantly more profitable over a single financial quarter than over the financial year.

If the profits of one financial quarter are offset by losses in another, the company must claim back the corporate income tax. This process can be time-consuming and requires the business to provide proof to the tax bureau that the business did indeed lose money. By not involving the accountant before transactions takes place, the accountant is unable to accrue expenses over a period of time and avoid such revenue spikes.

Additional tax liability

Deducting input VAT in China comes with a couple of requirements; the supplier must be a “general taxpayer” and they must issue a special VAT fapiao – as opposed to a normal fapiao – along with all the necessary supporting documents.

For a supplier to issue a special fapiao, they need to include more information about your business on the fapiao such as; bank name, bank branch name, account number and company address. Non-finance people often neglect the difference between these two types of fapiao, which can lead to a significantly higher tax liability. (Tip: Special VAT fapiaos are green in color and normal fapiaos are red).

When an outside accountant is simply given a fapiao, they are unable to determine whether the supplier is a General Tax Payer, or a Small-Scale Tax Payer. Most accountants simply book the fapiao they are given – no questions asked – often raising the tax liability of the business unnecessarily when a special VAT fapiao should have been requested.

In case a business fails to collect all the supporting documents for fapiaos booked by the accountant, the expense is considered unqualified. For a standard service expense, the tax liability of the business will increase by around 35 percent (16 percent VAT + 25 percent Corporate Income Tax) of the cost; i.e. for a RMB 10,000 fapiao, the business would be liable to pay an additional RMB 3,589.74 in tax.

Managers can easily diagnose some of the problems businesses face as a result of fapiao accounting, such as the lack of accurate financial data. Other issues, such as those affecting the business’s cash flow and tax liability, are not so easily traced back to fapiao accounting.

Establishing whether their accountant is capable of working closely with the business and advising managers on the accounting implications of their decisions is an integral part of solving such problems. From there, managers are able to evaluate what actions are necessary to ensure their business stays on track.

Valur Blomsterberg is the marketing director of cloud accounting company, Megi Software

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