3 reasons that increase the importance of Annual Audit compliance
It is not a secret that an Annual Audit is very important for the company starting from being a formal method of checking financial records and procedures, identifies weaknesses in accounting procedures of the company, and of course, allow the company to stay compliant.
However, Annual Audit compliance in China has increased its importance due to the following 3 reasons:
1. A foreign-invested enterprise can only distribute dividends after completing the annual CIT filing
For audits of corporate profit distribution, although there are no laws or administrative regulations that explicitly require all companies to conduct audits before making profit distributions if an enterprise is to remit this dividend abroad to foreign shareholders, a special audit report is required under foreign exchange management practices. In order to reflect the seriousness of the financial system, it is recommended that a special audit be conducted before profit distribution to ensure that the correct accounting standards are applied, and the calculation of profits available for distribution is accurate and complete and that the distribution plan complies with the relevant regulatory requirements.
2. An annual audit can aid with the identification of potential compliance issues concerning transfer pricing.
This is because related party transactions are disclosed in the audit report, including
(i) Disclosure of related party relationships
When presenting information about related companies, the company may only present other legal entities or business units in which the company holds, directly or indirectly, more than 20% of its ownership interest in the form of long-term investments.
(ii) Disclosure of the content of related party transactions
For example, information on pricing policies for related party transactions is disclosed; detailed disclosure is required for important and urgently regulated types of transactions such as capital transactions, guarantees, trusteeship, and equity transfers; large asset transactions in enterprise groups, loans for fixed assets and current assets, and receivables of the related party are the focus of current regulation and full disclosure is required.
(iii) Disclosure of transactions between the reporting entity and its related parties is disclosed on a full amount basis, identifying the major related counterparties, and the content of the transactions, etc.
The analysis of data from the related parties returns in the audit report identifies whether the purchase and sale prices of related parties are abnormal; whether the borrowing and lending of related funds are above-market interest rates; whether the pricing of labor, consultancy, and management fees are reasonable, and whether there are potential risks such as payment for non-existent or unrealizable consultancy services.
3. Full implementation of the Chinese Corporate Social Credit System
Credit rating companies and accounting firms are both important intermediaries in the capital markets, providing reports that are trusted by investors. There is much overlap between the knowledge and skills of rating companies, particularly their ability to analyze financial data, and accounting firms. Whereas audit reports focus on expressing an opinion on historical data, credit ratings are an outlook on the future. Financial data is the main basis for assessing a company’s credit rating, while an audit report is an endorsement of trust in the financial data of the audited entity, an assurance of compliance with the preparation of the audited entity’s financial statements, and the truth and accuracy of historical financial data, confirmation of past facts and an indispensable part of the credit rating system.
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