CAS 21 affects foreign invested enterprises in China and their subsidiaries which are required to follow Chinese Accounting Standards (CAS). The changes will have a significant impact particularly on businesses involved in retail, property, shipping and aviation.
China’s efforts to more closely integrate its massive economy and dynamic markets with the rest of the world’s remains an ongoing exercise. As the two become more closely linked, efforts are underway to adapt China’s Generally Accepted Accounting Principles (GAAP), also known as CAS, to global guidelines, such as the International Financial Reporting Standard 16 (IFRS 16).
When the International Accounting Standards Board’s new IFRS 16 rule became effective in January 2019, China followed suit with CAS 21, which affects foreign invested enterprises (FIEs) in China and their subsidiaries to follow CAS. The changes will have a significant impact on any business that uses lease arrangements to access high-value assets, particularly those involved in the retail, property, shipping and aviation sectors.
The stakes are especially high considering that China is seen to be the world’s premier shipping nation and its retail sector is expected to become the world's largest as early as this year. Meanwhile its aviation sector is set to overtake the US to become the world's largest by 2022.
This makes it even more important to ensure successful compliance. And to do so means to recognise that switching to CAS 21 is a significant undertaking that requires a detailed understanding of the new standard and an in-depth evaluation of the resources needed to make the transition.
Understanding CAS 21
Compliance deadlines for the new standard vary. Companies operating in China and listed on both Chinese and foreign stock exchanges were required to adopt CAS 21 beginning January 2019 while other Chinese companies will start using CAS 21 from January 2021.
Firms with parent companies or subsidiaries listed on foreign exchanges have the option to adopt CAS 21 once they are in compliance with CAS 22, which addresses the recognition and measurement of financial instruments and requires financial assets and liabilities to be initially assessed at face value; and CAS 14, which addresses the fair value accounting of revenue.
It’s also helpful to understand that while IFRS 16 and CAS 21 have many similarities, they differ in important ways. For instance, while IFRS 16’s scope extends to include an investment land lease, CAS 21 does not.
Also, IFRS 16 allows the lessee to use the cost model for the subsequent calculation of a right-of-use asset. It also allows the lessee to use the fair value model or revaluation model for subsequent calculations of the right-of-use asset that meets certain conditions. However CAS 21 only allows the use of the cost model for subsequent calculations of the right-of-use asset.
Other differences have to do with disclosure. While CAS 21 specifies that lease liability shall be presented separately for non-current liabilities due within one year, IFRS 16 does not do so. CAS 21 also specifies that the principle and interest paid be recorded under financing activities of the cash flow statement while IFRS 16 does not require this.
At the outset from an accounting perspective, there is a need to clearly define and identify what constitutes a lease, and the reporting and disclosure requirements must be well understood. Companies should consider modifying their operational strategies to account for the impact of the new accounting standard on the balance sheet, such as the negotiation process, which will determine the structure of future leases.
Further, a significant investment of resources may be needed to gather all the relevant information from the various leases held by an organization – an onerous undertaking. This is especially true of companies that handle multiple leases spread across various geographic locations, which make it exponentially more complicated to analyze key contractual information, such as the value of leases, their start and end dates, and lease payment schedules.
The process of capturing, collating and analyzing all the lease data requires a significant amount of computing power. This means organizations will need to adapt or enhance their internal data processes and IT systems to accommodate the new requirements, such as identification and disclosure, and the constant and consistent monitoring and valuation of leases.
Companies should also obtain a detailed understanding of the costs involved in selecting the most appropriate approach that serves the needs of the various stakeholders in moving to the new accounting system.
For instance, companies with operations in multiple countries should be clear on whether the standards are applicable in all relevant jurisdictions and engage with both internal and external entities to communicate the direct and indirect impact that CAS 21 has on their lease strategy and tax reporting systems, as well as other internal processes and key performance indicators.
Given these considerations, it’s possible that organizations will find their internal resources stretched or inadequate to ensure compliance. It’s advisable to seek assistance from experts that not only understand the intricacies and nuances of the overall accounting system and the new accounting standard but also possess a strong grasp of China’s regulatory landscape.
Jessie Ye is the associate director client services, TMF Group China.