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Comparison between U.S. GAAP and Chinese GAAP

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Comparison between U.S. GAAP and Chinese GAAP
05.02.2020
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Introduction

In any business entity, accounting for assets and liabilities among other business aspects is paramount in understanding the level of operations as well as the financial level. Accounting helps the business in making evaluations that facilitate adjustments in agreement with the prevailing circumstances. However, companies are not allowed to execute the accounting process as they wish. They are required to comply with GAAP of a particular country. The principles give guidance regarding the accounting procedure of various entities in the business. Countries like the United States and the Peoples’ Republic of China (PRC) have their GAAP that all entities of activity-based there must follow strictly. The GAAP in the Republic of China have similarities with those in the United States; however, there are significant differences. The paper analyzes some of the similarities as well as the differences in the US and the PRC GAAP.

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US GAAP and Chinese GAAP

Revenue

In the U.S. GAAP revenue recognition guidance, the focus is on two broad areas that include the earned as well as the realized or realizable revenue (Bao, Lee, & Romeo, 2010). The consideration of recognition of income is that it involves transaction exchange and that revenue can only be recognized after the execution of exchange transactions. This is similar to the PRC GAAP. In case of contingent consideration, even when there is a certain occurrence of delivery the revenue not until the contingency is solved, the contingency recognition is considered. The determinant of selling price of deliverables according to the U.S. GAAP is a hierarchy, which necessitates the cost of selling to be grounded on the third-party evidence when VSOE is not available to make the estimation of the selling price (PWC, 2016). The requirement is that every entity makes the best estimate of the cost of sale while maintaining consistency with what used to determine the deliverable sale price on a standalone basis. The GAAP does not give a prescription for the estimation method.

The U.S. generally accepted accounting principles do not allow the usage of revenue recognition method of cost-to-cost for service arrangements. However, in a situation whereby a contract is within a particular scope of guidance regarding individual production or construction, it is allowed. The principles do not have a unique model that is comparable to the continuous transfer model for goods to sell, but they require firms to make use of the fair value of services and products offered as the point of start for accounting for a better transaction (Bao et al., 2010). Additionally, revenue discounting is accepted only in specific situations, encompassing receivables that have the term of payment more than one twelve months and particular industry. The computation of interest should be based on the interest rate that is stated or the prevailing rate of interest in the market if the reported rate is unreasonable.

Contrary to the U.S. GAAP, in the PRC GAAP, when the estimation of the outcome of construction by contract is reliable, the revenue from the contract is recognizable by reference to the complete method percentage (Riccardi, 2015). Additionally, the PRC GAAP includes the cash dividend income such that in the short-term investment received dividends reduce the carrying cost related to the venture cost. In the case of the long-term investment, received dividends from investors accumulated from the post-acquisition are recognizable as investment income after the declaration of dividends.

Assets and Liabilities

An asset refers to any resource that a firm or entity owns and controls in relation to past events as well as transactions. The property has a flow of economic benefits to the business in the future and is paramount to its operations. On the other hand, liability refers to the obligations of the entity from the past trades and happenings. The settlement of debts leads to the outflow of resources from the entity exemplifying economic benefits

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Non-Current Tangible Assets

The property encompasses property, equipment, as well as the plant among others. Like in the U.S. GAAP, in the PRC GAAP, the measurement of these assets is of their actual cost less depreciation. Their cost is reduced to the amount recoverable if there is an occurrence of impairment of the assets. The PRC GAAP has a provision that allows a company or entity to determine the estimated residual value and useful life of non-current assets in agreement with the pattern as well as the nature of the usage of a fixed asset (Riccardi, 2015). The pattern facilitates the selection of a reasonable method of depreciation regarding the asset in which its expected future consumption of economic benefits. The methods of depreciation allowed are the unit of production method, straight-line technique, double-decreasing-balance technique, as well as the annual sum digits method. Contrary, the U.S. GAAP does not require the depreciation approach to the assets.

Despite the fact that there would be a general expectation that appropriateness of essential assumptions in the financial statement needs reassessment every time of reporting, there exists no unambiguous necessity for a yearly review of the residual balance. However, the U.S. GAAP incorporates the testing and measurement model for the asset impairment that has two steps. The first step encompasses the carrying sum with the cash flows that are not discounted. If the undiscounted money flows are more than the book value, there is no recognition of the loss of impairment, although estimates of depreciation review might be necessary for a related asset (PWC, 2016). In the second step, if the undiscounted cash flow is less than the carrying amount, the loss of impairment is measured as the variance amid the fair price of the asset and the carrying cost. The fair price of the property should be based on market participants’ assumptions rather than that of the reporting entity. These steps of testing and measuring asset impairment are not found in the PRC GAAP (Mirza & Nandakumar, 2013).

Intangible Assets

These may include the intangibles generated internally as well as acquired development and research assets. In both PRC GAAP and U.S. GAAP, all costs associated with the investigation and development is expensed when incurred. This makes the recognition of intangible assets generated internally rare. There is no acceptance of capitalization. However, unlike in the Republic of China, in the United States, separate and specific regulations apply in particular areas. For instance, there is distinctive guidance that governs costs associated with software development sales to a third party and other separate rules that govern how cost related to developing software for internal usage, encompassing the amount paid in the arrangement of cloud computing.

Additionally, both in the U.S. and in the PRC GAAP, the cost incurred in the process of acquiring an asset like the legal applications such as legal fees as well as registration fees can be capitalized. However, in the United States, the capitalization is on if the acquired asset has an alternative usage in the future. The chances of using the asset in the future by the entity should estimate more than 50%. In a situation where businesses merge, in the PRC, there is no recognition of an additional intangible asset.

In the Republic of China, the GAAP allows accounting for the depreciation of intangible assets (Mirza & Nandakumar, 2013). The amortization process for intangible assets should be even over its useful life expectation starting with the month the asset is obtained. In the case, the expected valuable life is more than the beneficial duration stipulated in the agreement or the sufficient time outlined by the law, the depreciation period is taken the least of the above. Besides, if the law, as well as the appropriate contract, does not specify the advantageous period, the period for depreciation should not be more than ten years. The specification regarding intangible assets amortization is not well outlined in the U.S. GAAP.

Liabilities

There is a significant difference between the U.S. GAAP and the PRC GAAP when it comes to the obligations. In the United States, the convertible bonds are split into equity components and liability, but in the Republic of China, they are classified as liabilities. Additionally, in the United States, GAAP recognizes the post-employment benefit as defined benefit expense and responsibility throughout the period of service provision expected from the employee (PWC, 2016). Contrary, the PRC GAAP does not outline specific requirements. A loss is recognized when the payment of benefits is executed (Mirza & Ankarath, 2013).

Investments

In the case of passive investments at the PRC, the GAAP addresses the requirements for the accounting related to debt and equity investments. They are classified as longstanding or short-term hoards. Investments classified as short-term are carried out in the marketplace cost and lower cost based on the aggregate portfolio or an individual. However, in case, investment is 10%, and above of the portfolio, assessment should be done individually. On the other hand, in the long-term investments, equity is assessed using the cost method while the debt is evaluated using the cost plus or less the depreciation of discount/premium. In the case of identification of impairment loss, the recoverable amount is written down. The investments in the convertible bonds are accounted for debt investments and the components that accounting is not done separately. Contrary, in the U.S. GAAP, there is no specification regarding investments. Companies holding investments use the historical cost model (PWC, 2016). Investors carry their hoards at a fair price. Unlike in the United States, the PRC GAAP incorporates accounting for associates, subsidiaries, as well as conjointly controlled firms in either separate financial reports or a consolidated financial statement.

Income Tax Accounting

In the United States, the GAAP model for accounting for income tax calls for all companies to record tax that has been deferred as recognized compensation cost as far as it is permitted to make a deduction from a particular instrument. The deferred tax asset is measured based on recognized compensation costs. Any change in the price of the stock does not affect the deferred tax asset or lead to adjustment before settlement or expiration period. Contrary to the U.S. GAAP, the PRC GAAP allows the usage of either a tax accounting method or a tax payable method (Mirza & Ankarath, 2013). In the case of the tax payable method, the present period tax expense is equivalent to the current provision for tax related to that particular time. On the other hand, the method of tax effect recognizes the effect of differences in timing. The deferred tax assets subjected to tax losses are recognized only when sufficient taxable gains in the future are available. The income statement liability or deferral method can also be used but in rare cases. Further, China’s GAAP has the provision for tax refunds with the exclusion of export VAT refund. Reimbursement of the revenues resulting from profit reinvestment after taxation regarding the regulations, as well as other revenues tax refunds, ought to reduce expenses of the current income tax after receiving the actual returns.

Leases

There is a similarity between the PRC and the U.S. GAAP when it comes to leases. An investment lease is classified as a charter in which transferences in substance the entire rewards and risks incident to asset ownership. When the present price of the least amount of disbursements relates to the lease equals the carrying cost of the asset leased that was originally recorded in the lessor’s books, it is necessary to classify it as a finance lease (Penner, Kreuze, & Langsam, 2013). It is recorded at the minimum of the original carrying cost of the leased asset and the PV of the lowest payment of the contract at its inception. Allocation of an unrecognized finance charge is necessary for each period of accounting using the method of the effective rate of interest, annual-sum-digits technique, or method of straight-line.

The lessors should identify the total receipts of the minimum lease at its inception as finance lease receivable and record the residual value that is not guaranteed as an asset at the same period (PWC, 2016). The difference between the unguaranteed residual price and the accumulated receipts of the lowest lease, as well as the present value of the amount collected, should be identified unrealized finance income. If the payment of rent has not been received for more than one period of installment, its recognition as an investment income should be stopped and the unpaid finance previously recorded should be reversed.

Leaseback and Sale Transactions

In both the U.S. and the PRC GAAP, the difference amid the carrying cost and the sales earnings is deferred and depreciated as a modification to the amortization in agreement with the pattern of depreciation of the leased asset when it comes to the finance lease. On the other hand, if it is an operating lease, the deferment and amortization of the variance amid the carrying price and the rummage sale proceeds ought to be in agreement with the proportion of the payment of the lease during the lease term (Mirza & Ankarath, 2013). However, the U.S. GAAP has an onerous regulation for determining when accounting for sale-leaseback is appropriate in the case of transactions that involve real estate. If the rules are not adhered to, the sale-leaseback should be accounted for as a financing.

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Financial Statement Consolidation

The U.S. GAAP presumes the consolidated financial statement to be meaningful and necessary for the entities registering for SEC (Penner et al., 2013). The principles have no provision for that allow any exemption for consolidating subsidiaries in the financial statements for general purpose. Moreover, the PRC GAAP requires an entity to prepare consolidated financial statements in a situation whereby it holds not less than 50% of the capital of another entity or the capital it holds is less than 50% but has control over the other entity, and it belongs to either of the following entities. In addition, any company or an enterprise is allowed to get ready amalgamated financial reports for the management usage voluntarily.

Additionally, unlike the GAAP of the United States, the PRC GAAP has the provision for the unconsolidated subsidiaries encompassing parent companies with an intention to dispose of its affiliates and a subsidiary that is operating long-term restriction that are severe and that have impaired its capability to transfer funds to the parent firm (Mirza & Ankarath, 2013). Also, subsidiaries in the liquidation process, declared bankrupt, planning to cease business operations, have the intention to merge with other enterprises and have negative shareholder’s equity. The government controls them for its administrative purpose, as well as the subsidiaries engaging with other specialized industries such as banking.

Business Combinations

The process of determining whether an acquisition method will apply to a particular transaction starts with understanding whether it involves one or more business acquisitions and whether the combination is within the guidance of business combinations. The U.S. GAAP requires an evaluation of the combining decision under the model of a variable interest entity (Penner et al., 2013). A qualitative assess done if the variable interest has the authority to direct events that can impact the commercial enactment most significantly and has the potential to engross significant losses as well as receiving substantial benefits. All the acquired liabilities and assets that are subject to the contingencies are recognized at the fair value, especially it is determinable during the measurement period. In the case where it is hard to determine the fair price, accounting for the attained contingencies by the companies is done by the existing guidance. If acknowledged at a rational price at the period of attainment, the business entity receiving the other has the mandate to develop a sensible and organized basis for accounting for and assessing obligations as well as resources that arise from the contingencies depending on their nature.

However, the PRC GAAP requires the process of the business combination to use the purchase method though the combinations involving business entities that are under common control are allowed to for their assets and liabilities using the method of pooling of interest or other ways in the similar practice (Mirza & Ankarath, 2013). If the business entity acquiring another obtains all the equity, its accounting records and books need an adjustment to replicate the appraisal price of the possessions even if it loses or retains its individual legal status. Besides, if the acquiring business entity does not acquire the entire equity, it should not adjust the carrying price of the other entity properties in its records of accounting. In the case of a combination where the subsidiaries have net liabilities, the losses in excess investments on equity of such subsidiaries are consolidated. They can be credited with the unrecognized loss on investment.

Inventories and Receivables Such as Bad Debts

According to the PRC GAAP, an entity is supposed to analyze the recoverability of all receivable accounts at the end of every accounting year and make a provision for any possibility of losses in bad debts (Mirza & Ankarath, 2013). Similarly, in the United States, determinants of the bad debts are in agreement with the recoverable amount of the receivables (Penner et al., 2013). However, unlike in the PRC where the effect of discounting is not considered, in the United States, it is allowed. Both in the US and PRC GAAP, the inventories are measured at the lower level cost as well as the net realizable value.

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Borrowing Costs

There is no significant difference between the PRC and the U.S. GAAP in the case of the borrowing costs. It is incurred in connection with particular loans aimed at purchasing or constructing a fixed asset (Mirza & Ankarath, 2013). The borrowings should be capitalized when capitalization conditions are adhered to, and up to the period, the assets are ready to be used as intended.

Conclusion

Generally Accepted Accounting Principles are important because they facilitate coherence in the accounting process across the businesses. They give a clear outline regarding accounting for various entities in the business. The difference between the U.S. GAAP and China’s GAAP exists between the reported financial data CRMs. The PRC and the U.S. GAAP have significant similarities and differences. However, the differences are not big to have adverse effects on a business transferring its operations to either of the countries. The GAAP in both the United States and China are followed strictly by the citizens. The GAAP presence makes sure that the financial reports of different companies in the United States and China are comparable without ambiguity, therefore, making an advantage to tax officials, banks, and financial experts.

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