Attention to the accounting treatment in the wake of the coronavirus (Ⅰ)

The impact of the coronavirus on China and the world has been lasting for more than three years, especially strong in December 2022, along with the update of the Joint Prevention and Control Mechanism of the State Council of PRC, from lockdown control management to full openness. This means that epidemic control has come to an end.

It is worth noting that before the 2022 audit, accountants need to pay attention to some special accounting adjustments at the annual closing. These may cause changes in profits and income tax adjustments. We have selected a few key points for your reference.

1. To consider inventory reporting loss and price drop

According to the policy impact of the Joint Prevention and Control Mechanism of the State Council of PRC, many cities in China were fully locked down in the first half of 2022, with all people quarantined at home and enterprises shutting down their production.

(1) For some companies, their inventory has a very short shelf life and is susceptible to corrosion and mold or misses the optimal sales period, resulting in unsaleable goods. In this case, the value of the reported inventory loss (including customs tax/excise tax/import freight/inland freight and other insurance costs associated with the inventory) should be fully assessed as the carrying value of the reported inventory loss of the enterprise. And after approval by the company’s management, if it is confirmed to be an extraordinary loss due to the coronavirus factor, with the relevant documents, the gain on disposal of the inventory, less the book value and related taxes, should be charged to management expenses – Inventory Reporting Loss, in accordance with the provisions of Article 21 of the «Accounting Standards for Enterprises No.1 – Inventories»[1] (hereinafter as “Standard No.1”).

(2) For some of the other enterprises, the inventory has not deteriorated, corroded, molded, etc., but after being idle for 2-3 months, it has been lost or missed the best sales period. Although it can still be sold to the public, we have to compare the Historical Cost and Net Realizable Value* of these inventories and consider whether to provide for inventory decline.

Net Realizable Value

According to the provisions of Article 15 of Standard No.1, Net Realizable Value is the estimated selling price of inventories in the ordinary course of activities, less the estimated costs to be incurred to completion, estimated selling expenses, and related taxes. If the cost of inventory is higher than its net realizable value, a provision for the decline in the value of inventory should be made and included in Management Expenses – Provision for the decline in value of inventory.

How to measure the selling price scientifically?

You can refer to the provisions of Article 17 of Standard No.1, which stipulate that the net realizable value of inventory held for the execution of a sales contract or a contract of labor fee shall be calculated on the basis of the contract price. If an enterprise holds more inventory than the quantity ordered in a sales contract, the net realizable value of the excess inventory shall be calculated based on the general sales price.

[Case Study]

Enterprise A is a trading company that sells rice wine. It purchases 1,000 bottles of rice wine in July 2022, with a total value of CNY 55K in goods, and incurs freight and insurance costs of CNY 5K. The rice wine is a no-additive, all-natural product with a shelf life of only 8 months. The company believed that this rice wine was in short supply and was bound to be sold out within three months.

Unfortunately, due to the impact of the coronavirus lockdown control management, the company stopped production and did not resume sales until November. As of December 31, sales and inventory of this rice wine were as follows:

• As of December 31, the enterprise retailed a total of 300 bottles of rice wine to external customers at CNY 100 per bottle. Sales to suppliers totaled 600 bottles at a wholesale price of CNY 80 per bottle.
• As of December 31, there were 100 bottles of rice wine in stock, but they were nearing the end of their shelf life, so the company will sell them at a special price of CNY 50 per bottle.

The price per bottle of rice wine (not considering taxes) when the rice wine was purchased in July 2022 was (55,000 + 5,000)/1,000 = 60 yuan. The retail and wholesale that occurred by the enterprise before December 31, 2022, were both sold at prices that exceeded the cost price of CNY 60 per bottle and were reasonable and proper commercial sales. However, the product is nearing its shelf life, and if the enterprise does not sell it as soon as possible, it will cause the product to expire and cannot be sold anymore, resulting in substantial reported losses.

Based on the attribute of the merchandise nearing its shelf life and the reference to the market price, the merchandise is confirmed to be sold to the public at CNY 50 per bottle, which can be used as the basis for measuring the net variable value, so we could determine that the sales price of the merchandise at this time is CNY 50 per bottle (excluding the amount of sales costs and related taxes). As a result, the cost of the merchandise is higher than the net variable value, and therefore a provision for inventory decline should be made and included in administrative expenses – provision for inventory decline.

From this case, we can learn that if an enterprise fails to accurately recognize the inventory reporting loss and the provision for the decline in value, it will result in inflated profits and will not only fail to present the fair value of revenue and profit amount to the management but also additional corporate income tax to be paid.

2. To consider whether the depreciation of fixed assets continues

According to Article 14 of the «Accounting Standards for Enterprises No. 4 – Fixed Assets»[2] (hereinafter as “Standard No.4”): Enterprises should depreciate all fixed assets. Depreciation is the systematic apportionment of depreciable amounts over the useful lives of fixed assets in accordance with a determined method.

 

Some enterprises, especially production enterprises, usually recognize depreciation on fixed assets and include it in the corresponding production costs, thus allowing reasonable apportionment and facilitating the calculation of product costs.

During the period of coronavirus lockdown control management, enterprises stop working and producing, and workers are isolated at home, so some enterprises suspend the depreciation of fixed assets. However, this does not comply with the new accounting standards. Enterprises should continue to depreciate fixed assets.

Depreciation should continue to be charged. In the case of a general enterprise, it should be charged to overhead – depreciation; in the case of an industrial enterprise, it should no longer be charged to the cost of production, but to overhead. In addition, some enterprises that are semi-discontinued and half-produced can be differentiated and included in the production cost of the company during the start-up period.

Our sharing will continue in the next article. If you have any questions, please feel free to contact us.

[1] http://www.mof.gov.cn/zhengwuxinxi/zhengcefabu/2006zcfb/200805/t20080519_23107.htm

[2] http://www.mof.gov.cn/zhengwuxinxi/zhengcefabu/2006zcfb/200805/t20080519_23104.htm