Consolidated Statements: How to Adjust the Financial Accounting of Mainland China Subsidiaries

Taiwan's official Statement of Financial Accounting Standards No. 7 (SFAS 7), on consolidated financial statements, states that "When preparing consolidated financial statements, for similar transactions and items of business under comparable conditions, the accounting policies adopted must be consistent with those of the parent company." So unless a subsidiary's transactions or economic environment are obviously different, the parent company will need to use consistent accounting policies in its consolidated reporting. For companies based in Taiwan, preparing consolidated financial statements usually means including the accounts of subsidiaries in mainland China. There are, however, certain differences between accounting principles in mainland China and those in Taiwan. In the preparation process, one must always make sure that adjustments have been made in the substantive parts of the subsidiary's "reporting package". This article will summarize the frequently encountered differences in accounting principles between Taiwan parent companies and their mainland subsidiaries.

1. Recognition of Start-up Costs

Under PRC regulations, expenses incurred while establishing a company must be gathered under "long-term prepaid expenses". In the month that production operations begin, a one-time entry is made in the operating results for that month. Taiwan's standards, on the other hand, stipulate that start-up period expenditures be entered as current period expenses as long as their future economic benefits are not yet clearly identifiable. Therefore, the "long-term prepaid expenses" asset item entered by a mainland subsidiary prior to the onset of production will have to be shifted to the expense column, which will affect current net profit in the consolidated statements.

2. Recognition, costs and depreciation of fixed assets

Definition of fixed assets : Under mainland China's regulations, "fixed assets" refers to buildings, machinery, and equipment and instruments whose useful life exceeds one year, as well as items that are not important equipment for production but have a unit value over 2,000 RMB and useful lives of over two years. In Taiwan, the main standard for determining fixed asset expenditures follows the Income Tax Act, whereby an item may be regarded as a fixed asset if the service life is greater than two years and the amount expended exceeds NT$60,000.

Calculation and scope of interest capitalization : According to regulations in mainland China, with the exception of project loans for building fixed assets, all other loan costs are recognized as expenses in the period they are incurred. Interest capitalization extends to interest on project loans, amortization of discounts or premiums, application costs, and exchange gains/losses on foreign currency-denominated loans. In Taiwan, however, interest to be capitalized includes interest on non-project loans, and the scope of capitalization is limited to interest expense.

Residual Value and Service Life : Mainland China follows the local tax laws in setting the residual value of fixed assets at 10%. The service lives of buildings, mechanical and electronic equipment, and production tools and instruments are set at 20, 10 and 5 years, respectively. In Taiwan, service lives are established based on estimated economically useful lives. Some of the more important fixed asset service lives are 2 years for molds and dies, 3 years for computer equipment, and 5 to 10 years for mechanical equipment. Residual or salvage value is mostly calculated using the straight line method and the stipulated years of service plus one.

In short, the things for Taiwan-based enterprises to consider include whether the scope of capital expenditures assumed by their mainland subsidiaries is not overly broad, whether the economic environment for the industry is comparable to Taiwan's, and whether the local service lives are different, making adjustments as needed. To keep the amount of assets in consolidated statements from becoming overestimated or distorted over time, the degree of impact accumulated in past and future years should also be considered when assessing the impact of differences in accounting principles.

3. Income Tax Calculation

Under mainland China's regulations, enterprises may, in accordance with their specific circumstances, choose to apply either the "taxes payable method" or the "tax effect accounting method" in their income tax accounting. Taiwan's regulations require enterprises to carry out cross-period and same-period tax allocation, which is more like the mainland's "tax effect accounting method".

Taiwan's enterprises can therefore require their mainland subsidiaries to adopt the "tax effect accounting method" in their routine accounting calculations. However, mainland China has yet to recognize loss carry-forwards as income tax benefits; and since the mainland's tax credit for purchase of equipment can only be used to offset new income after equipment is purchased, mainland enterprises cannot in practice recognize an income tax benefit. This can figure in the overall considerations when asking mainland subsidiaries to adjust accounting principles. Inconsistencies are frequently encountered between the financial and tax accounts of mainland subsidiaries, however, and it is advisable to take as the basis for tax calculation the set of accounts that shows the larger profit. Also, a careful assessment needs to be made of whether loss carry-forwards can be realized. Finally, for those who have tax or customs cases being pursued by the mainland authorities, particular attention should be paid to contingent matters in making estimates.

The above summarizes the more frequently seen areas where differences in accounting principles between Taiwan and mainland China require adjustments before preparing consolidated financial statements. Besides complying with the rules in official accounting standards, applying consistent accounting principles to the individual entities brought together in a consolidated statement helps managers, investors and analysts grasp companies' financial conditions and operating results, and with the additional transparency they can make better-informed decisions.