6.1.1 Financial Registration

An FIE should apply to the financial authority for financial registration within 30 days after submission of application for business registration or change of registration details. To apply for financial registration, an enterprise should complete the Financial Registration Form for Foreign-invested Enterprises, supported by the following documents: approval certificate for establishment of an enterprise; feasibility study report and its approval document; FIE contract (agreement), articles of association (copy) and their respective approval documents; business licence (copy); and information on the FIE's financial management system and related rules formulated in accordance with the relevant state regulations.

An FIE should submit its financial accounting statements and status report of its financial position to the competent financial or administrative authority and local tax office on a regular basis. The format, content and schedule for submission should follow the relevant stipulations by MOF. Annual financial statements and liquidation reports should be accompanied by an auditor's report prepared by Chinese certified public accountants (CPAs).

6.1.2 Establishment of Financial Accounting Department

FIEs should establish a financial accounting department in the place where it is located, to be manned by qualified financial and accounting personnel responsible for handling financial and accounting matters in accordance with the law. (MOF has strict management guidelines regarding the qualifications of financial and accounting personnel.)

6.1.3 Investment Capital

To establish an enterprise, a certain amount of capital is required as stipulated in the relevant regulations and application for business registration at the industry and commerce administration departments is also necessary.

(a) Forms of Investment

Investors may make contribution to the registered capital of an enterprise in cash, in kind, or in intangible assets. Investors making contribution in kind and in intangible assets must provide proof of ownership and right of disposal, or other proof of their validity as required by law. Investors are not allowed to contribute leased assets or collateral assets.

Investors making contribution in intangible assets (excluding land-use rights) should provide asset appraisal or valuation reports. In general, the value of the contribution may not exceed 20% of the total registered capital of the enterprise.

If foreign investors are making contribution in cash, it should be in foreign currencies. However, profits in renminbi made from investment in other FIEs within the Chinese territory may be used as contribution in cash.

When the full amount of registered capital has been paid up, the FIE should appoint a Chinese CPA to compile a capital verification report.

(b) Investment Recovery

In general, during the operation period of the enterprise, investors are not allowed to withdraw their share capital by any means except through transfer of business as provided by law.

For Sino-foreign contractual joint ventures (JVs) whose contract stipulates that all the fixed assets should be handed over to the Chinese party upon expiry of the JV, provisions can be made in the JV contract that the foreign party may recover its investment during the term of the JV. However, the foreign party should still be jointly responsible for the JV's liabilities in accordance with the relevant laws and regulations as well as the provisions of the contract. Any pre-tax investment recovery should be reported to the competent financial authority for examination and approval.

(c) Sources and Uses of Capital Reserve

The sources of an enterprise's capital reserve include: the balance from investors' capital contribution in excess of the prescribed amount of registered capital; the balance resulting from the different conversion/exchange rates used in the assets account and the paid-up capital account; income in the form of donations.

The designated uses of an enterprise's capital reserve include: in the event of heavy losses where the un-allocated profits of the previous year, the reserve funds and development funds of the enterprise are inadequate to make up for the shortfall, the board of directors may pass a resolution authorising the use of such funds in making up for the losses; upon the board of directors' decision and completion of the relevant procedures, the funds may be used to increase the capitalisation of the enterprise.

6.1.4?Assets Management

The recognition and measurement of assets have been detailed in the section on the accounting system. Summarised below are the administration measures and procedures in relation to the use and safekeeping of assets.

(a) Management of Current Assets

• Cash and bank deposits

The cash of an enterprise should be kept by a designated person; bank deposits should be deposited into bank accounts opened in the name of the enterprise.

• Prepayments and receivables

Prepayments and receivables should be handled and collected in accordance with stipulations in the contract or agreement.

• Foreign currency capital

Receipts, payments and deposits of foreign currency capital should be handled in accordance with the foreign exchange control regulations of the state. Conversion between the foreign currency and the accounting currency should be carried out according to the relevant regulations of the Ministry of Finance.

• Inventory

Inventory must be classified accurately, priced reasonably and kept properly, with a sound collection and return procedure and regular stock-taking system in place.

In issuing or collecting merchandise, self-produced semi-manufactures, raw materials, finished products, and in collecting low-value consumables and packaging materials, the standard accounting treatment should be adopted in calculating or amortising their actual costs.

For inventory with a face value greatly different to its realisable net value and the face value needs to be adjusted, adjustment can be made by the enterprise upon approval granted by the supervisory finance department or the central government department in charge of the industry.

• External Investment using tangible or intangible assets

Enterprises using tangible or intangible assets to invest in other enterprises must have the assets re-valued. For short-term investment, the difference between the re-valued amount and the face value will be treated as loss for the current period. But for long-term investment, the difference would be treated as deferred investment loss and would be amortised evenly on a yearly basis during the investment period.

(b) Fixed Assets

• Fixed assets as investment input

For fixed assets used as investment input, their account value should be the reasonable price agreed in the contract or agreement, or the price set according to market price plus the relevant expenses involved. In determining the value of the equipment contributed by the investor as investment in kind in the enterprise, the original invoice issued by the equipment manufacturer should be produced.

• Depreciation

Depreciation of fixed assets is generally calculated using the straight line method or production/service output method, depreciating on a monthly basis starting from the month after the fixed assets were first put into use. For fixed assets which have ceased to be used, depreciation would stop in the month after they have ceased to be used. As for fixed assets requiring other depreciation methods or change in the existing depreciation method, approval has to be sought.

• Construction projects

Before proceeding with a construction project, an enterprise must prepare its budget, purchase the equipment and materials required, carry out accurate project costing, make efforts in saving project costs, and work out a project completion plan.

(c) Intangible Assets

In calculating the value of intangible assets, relevant detailed information must be available, which includes copy of ownership certificate, bases and standards for calculation etc. Valuation of proprietary technology, franchise and goodwill must be assessed and recognised by authorised certification bodies or Chinese chartered accountants.

6.1.5 Standards of Costs and Expenses and Approval Procedures

(a) Costs and Expenses

Any payments in relation to the production and operation of an enterprise should be treated as costs and expenses.

(b) Wage Expenses

The levels of wage expenses under costs and expenses are determined by the board of directors in accordance with state regulations on FIE-related labour management, taking into consideration the economic benefits of the enterprise, and in compliance with the principles of "pay according to work and equal pay for same work".

(c) Insurance and Welfare for Chinese Staff

Insurance and welfare expenses for serving Chinese staff can be treated as costs, expenses, insurance and welfare and kept by the enterprise for use in paying for the medical, insurance and welfare expenses of serving staff.

(d) Retirement Fund and Unemployment Insurance Fund for Chinese Staff

Pension and retirement fund and unemployment insurance fund for Chinese staff set aside by the enterprise in accordance with the standards set by the government can be treated as costs and expenses and handed over to the organisation in charge of retirement and unemployment insurance for management. The funds can only be used for labour insurance and not for any other purposes.

(e) Housing and Cost of Living Allowances for Chinese Staff

Allowances for housing and cost of living set aside by the enterprise in accordance with the standards set by the finance department and labour department can be treated as costs and expenses. Housing allowance should be retained by the enterprise in the form of a subsidy fund and used for subsidising the construction, maintenance and purchase of housing for the Chinese staff. Cost of living allowance should be handed over to the local finance department.

(f) Entertainment Fee

Entertainment fee related to production and operation paid from costs and expenses of the enterprise must not be higher than the following ceilings:

For enterprises engaged in industrial production, agriculture, husbandry and commerce with annual net sales of Rmb15 million or below, entertainment fee should not exceed 0.5% of their annual net sales; while those with annual net sales of over Rmb15 million, entertainment fee should not exceed 0.3% of their annual net sales.

For enterprises engaged in tourism, catering, transportation, construction, installation, design, consultancy, finance, leasing and other services with annual business revenue of Rmb5 million or below, entertainment fee should not exceed 1% of their annual revenue; while those with annual business revenue of over Rmb5 million, entertainment fee should be exceed 0.5% of their annual revenue.

For cross-sectoral enterprises, the ceiling of entertainment fee should be calculated according to the respective net sales or business revenue. Where it is difficult to draw the line, entertainment fee can be determined by the principal operation item under the respective sector.

(g) Travel Allowance, Meal Allowance and Director's Fee

The standards and management method for business travel allowance, meal allowance and director's fee should be determined by the board of directors at reasonable levels and be reported to the supervisory finance department or the central government department in charge of the enterprise.

(h) Labour Union Fund

Enterprises should put aside 2% of their total payroll each month as labour union fund, and this item should be treated as costs and expenses. The labour union fund is managed and used by the labour union of the enterprise concerned according to the relevant regulations of the All-China Federation of Trade Unions

(i) Rebates (Commissions)

Rebates (commissions) received by enterprises in accordance with contracts or agreements in the course of their operation should be treated as operation income or used to offset costs and expenses. Rebates (commissions) paid in accordance with contracts or agreements should be added to costs and expenses.

6.1.6 Management and Distribution of Income and Profit

(a) Recognition of Income

Income from the operation of an enterprise refers to payment received or the right to receive payment from products or merchandise sold, projects completed, services or labour services provided.

In the case of a cooperative JV using product sharing as the income distribution method, the investors are considered to have realised their income when they have received their share of the products. The amount of such income is calculated as per the sale price of the products sold to a third party or as per the prevailing market price.

Except otherwise stated in the contract or articles of association, the sale price of an enterprise's export products (or merchandise) should be ascertained by adding reasonable charges and profit margins to the costs if such products (or merchandise) are not directly sold by the enterprise.

(b) Profit Distribution

• Order of priority for profit distribution

Enterprises should pay income tax on the profits they earn in accordance with the law. After-tax profits should be distributed in the following order of priority:

(i) Paying all kinds of fines such as breach-of-contract fines, late charges, late interest charges and other penalties;
(ii) Making up for previous years' losses;
(iii) Contributing to reserve funds, enterprise development funds, staff incentives and welfare funds;
(iv) Profit distribution to investors.

• Principles of profit distribution to investors

Equity JVs should distribute profits according to the actual proportion of capital contribution by the respective investors; cooperative JVs should follow the terms as stated in their contracts; whereas foreign enterprises should do so according to their articles of association.

Investors failing to honour their contractual obligations in terms of capital contribution as stipulated in state regulations or other provisions in the contract will not be eligible for profit distribution.

• Conversion of profit in renminbi and profit repatriation

Unless otherwise stated in the contract or articles of association, profit to be distributed in cash is on principle in the currency of the income from the enterprise's operation. Investors may convert their profit in renminbi into foreign currencies but have to be responsible for the possible profit and/or losses in currency exchange.

Foreign investors may remit their profit overseas, or they may reinvest it in China.

(c) Reserve Fund, Enterprise Development Fund, Staff Incentive and Welfare Fund

The ratios of contribution to reserve funds, enterprise development funds, staff incentives and welfare funds are determined by the board of directors. Among these, reserve funds must account for at least 10% of an enterprise's after-tax profits. When the reserve funds reach 50% of the enterprise's registered capital, further contribution is not required. It is not mandatory for an enterprise to set aside an enterprise development fund.

Reserve funds are intended primarily to make up for an enterprise's operating losses. Development funds are usually used for expanding the enterprise's scale of production or operation; and upon approval by the original approval authority, such funds may also be used to increase investment. Staff incentives and welfare funds are earmarked for ad hoc incentive programmes and collective benefits such as subsidies for the purchase, construction, maintenance and repair of staff housing.

6.1.7 Liquidation

(a) Liquidators and Their Responsibilities

Upon dissolution of an enterprise in accordance with the contract, articles of association or due to other reasons, a liquidation committee should be formed within 15 days. In general, the liquidation committee should consist of directors of the enterprise and representatives of the creditors. Chinese CPAs or lawyers may also be hired to sit on the committee. If deemed necessary, the competent financial authority may send its staff to supervise the work of the committee. If the enterprise declares bankrupt, the case should be filed with the people's court for bankruptcy proceedings.

After the liquidation committee announces the liquidation of the enterprise, it will inform the creditors who will declare the outstanding debts owed to them within a specified period. The committee will then draw up a liquidation plan, prepare balance sheets and other financial statements, assets lists, debts and liabilities lists, and give its opinions to the board of directors on asset disposal. Upon approval by the board of directors, the liquidation plan will be filed with the competent financial and administrative authorities for the record and implementation.

(b) Liquidation Assets and Valuation

Liquidation assets include all the properties of the enterprise at the time of announcing the liquidation and the assets acquired during the liquidation period. However, three types of assets are excluded: first, the balance in the staff incentives and welfare funds and housing funds for mainland workers, and all properties and facilities purchased or constructed with such funds; second, the balance in the enterprise's insurance and other benefits for its mainland workers; third, the balance in the enterprise's trade union funds and the properties purchased or constructed with such funds.

The price of liquidated assets is normally determined on the basis of the net face value of the assets. It may also be determined by re-evaluation or by the amount of cash obtained from the sale of the assets.

(c) Debt Repayment Responsibility

Enterprises with legal entity status in China (that is, limited liability companies and joint stock limited companies) should repay their debts with all the companies' registered assets. For enterprises without the status of a legal entity, the investors involved should bear unlimited liability for debt repayment and other related liabilities.

In a Sino-foreign cooperative JV where it is stipulated in the contract that the foreign party can recover its investment with priority during the term of the cooperation and that all the fixed assets will be handed over to the Chinese party upon expiry of the JV, both the Chinese and foreign parties should be jointly liable for debt repayment in the event of liquidation.

(d) Order of Priority in Debt Repayment

After all liquidation expenses are paid up, debts will be repaid in the following order of priority:

(i) Overdue workers' wages and labour insurance fees;
(ii) Overdue national taxes;
(iii) Overdue debts.

(e) Distribution of Residual Assets

In a liquidation exercise, after deducting all the debts and losses, the residual assets will be used to cover undistributed profits, capital surplus, other funds and the liquidation expenses. After all these deductions, the balance that exceeds the amount of the paid-up capital is the net liquidation proceeds, which will be deemed as profit and, as such, subject to income tax. The residual after-tax assets will be distributed to investors according to the following order of priority:

For equity JVs, distribution would be made according to the actual proportion of capital contribution of the respective investors. For cooperative JVs, distribution would follow the terms stated in their contracts and articles of association. For foreign enterprises, distribution would be made according to their articles of association.

(f) Cancellation of Financial Registration

When the liquidation process is complete, the liquidator will present a liquidation report accompanied by an income and expenditure statement for the liquidation period, and a verification report by a Chinese CPA, to the competent financial authority, and proceed with cancellation of the financial registration of the enterprise.

6.1.8?Regulations Governing FIEs Implementing the Accounting System for Business Enterprises

The Accounting System for Business Enterprises promulgated by the Ministry of Finance on 29 December 2000 became effective for FIEs starting from 1 January 2001. At the same time, the Accounting System for Foreign Investment Enterprises of the People's Republic of China and its related regulations governing account titles and financial statements promulgated by the Ministry of Finance on 24 June 1992 were revoked. The regulations governing the Accounting System for Business Enterprises for FIEs are as follows:

(a) Implementation of the Accounting System for Business Enterprises by FIEs has resulted in changes in the accounting policies adopted. Apart from the following items which adopt the retroactive adjustment method, all other changed items adopt the prospective application method:

• Short-term investment impairment reserve, long-term investment, fixed assets, intangible assets, work-in-progress and trust lending impairment reserve under the Accounting System for Business Enterprises.

For the balance between receivables bad debt reserve and inventory impairment reserve under the Accounting System for Business Enterprises and that under the old system, the retroactive adjustment method is adopted.

• For investments made before the implementation date of the Accounting System for Business Enterprises and are still valid on the date of implementation, they should be handled according to the regulations of the Accounting System for Business Enterprises starting from the day the system was implemented. In other words, all investments and investment proceeds recognised in accordance with the Accounting System for Foreign Investment Enterprises before the implementation of the Accounting System for Business Enterprises are not subject to retroactive adjustment. However, any subsequent recognition of investment proceeds and adjustment to investment face value should be handled in accordance to the Accounting System for Business Enterprises.
  
  
• In implementing the Accounting System for Business Enterprises, if the unamortised organisation expenses and the construction period exchange loss balance of the FIE are substantial and the direct transfer of which to the income statement of the current period creates a great impact on the profit of the enterprise, they can be handled using the retroactive adjustment method. But if such amounts are relatively small and the direct transfer of which to the income statement of the current period does not create a great impact on the profit of the enterprise, such balances can be transferred to the income statement of the current period directly.

(b) Any other issues arising from the implementation of the Accounting System for Business Enterprises by FIEs can be handled as follows:

• Balance under "Marketable Securities" is transferred to "Short-term Investment".
  
  
• Balance under "Prepayment" and balance under "Advance Collection" are transferred to "Accounts Prepaid" and "Advance Receipt" respectively.
  
  
• Balance under "Inventory Realisation Loss Reserve" is transferred to "Inventory Impairment Reserve".
  
  
• Credit balance under "Construction Period Exchange Loss" should be treated on a case-by-case basis: for balance to be settled at the time of liquidation, it should be transferred to "Long-term Prepaid Expenses"; for balance to be used to offset the losses incurred during the current financial year in the production and operation of the enterprise, it should be transferred to "Long-term Prepaid Expenses"; for balance to be amortised equally in the five years starting from the year the enterprise commenced production and operation, if its direct transfer to the income statement of the current period creates a great impact on the profit of the enterprise, it can be handled using the retroactive adjustment method; but if such direct transfer does not create a great impact on the profit of the enterprise, the balance can be transferred to the income statement of the current period directly.
  
  
• Other deferred expenses balances should be treated according to different circumstances: for items that can benefit the subsequent accounting period, they should be transferred to "Long-term Prepaid Expenses"; for those that cannot benefit the subsequent accounting period, they should be transferred to the income statement of the current period directly.
  
  
• Balance under "Deferred Investment Loss" should be treated according to different circumstances: credit balance should be transferred to "Long-term Prepaid Expenses"; debit balance should be transferred to "Deferred Income".
  
  
• Payable company debt, payable company debt premium and impairment balance should be transferred to "Payable Bonds".
  
  
• Balance under "Payable Wages" (or "Payable Wages and Welfare") should be treated according to different circumstances: if it falls under the total payroll payable to the staff (including all kinds of wages, bonuses and allowances under the total payroll), it should remain under "Payable Wages"; but if falls under funds such as pension for the Chinese staff, welfare and insurance expenses and various allowances stipulated by the state, it should be transferred to "Payable Welfare Expenses".
  
  
• For "Payable Welfare Expenses", apart from the various items transferred from "Payable Wages", they also cover bonuses and welfare fund set aside by the FIE from its after-tax profits. Other welfare expenses should be entered directly under the income statement of the current period.
  
  
• Balances under "Reserve Fund", "Enterprise Development Fund" and "Profit Capitalised on Return for Investment" are transferred to "Surplus Reserve".
  
  
• The item "Deferred Income" is added under "Projected Liabilities" in the balance sheet.
  
  
• Under "Paid-in Capital" in the balance sheet, the item "Of which: investment by the Chinese party (closing balance of non-renminbi capital) and investment by the foreign party (retained non-renminbi capital)" is added.
  
  
• For foreign-invested tourism enterprises, on the basis of the Accounting System for Business Enterprises, their income statement and supporting statements should be prepared in accordance with the formats stipulated in the Account Titles and Financial Statements of Foreign Investment Tourist Enterprises.

(c) In preparing comparative financial statements adopting the retroactive adjustment method, if any accounting policy change occurs during the periods the comparative financial statements are prepared, the net profit and loss and other relevant items should be adjusted accordingly. For any cumulative effect arising from policy change in the previous comparable periods, adjustment should be made to the retained income brought forward in the comparative financial statements. The amount of other relevant items in the financial statements should also be adjusted at the same time.