What issues will be the focus of attention?, When the China Securities Regulatory Commission reviews the financial reports of listed companies

The annual comprehensive financial report review of A-share listed companies by the China Securities Regulatory Commission is undoubtedly a joint test for audit institutions and listed companies.

On September 8th, the China Securities Regulatory Commission released the Accounting Supervision Report on the 2022 Annual Financial Reports of Listed Companies. This report is based on a sampling review organized by the China Securities Regulatory Commission, covering a wide range and providing a very detailed analysis of the main issues exposed in the financial reports of listed companies.

Among the 5158 listed companies that disclosed their annual reports on schedule, 235 were issued audit reports with non-standard audit opinions. Including 37 opinions that cannot be expressed, 94 reservations, and 104 unqualified opinions with explanatory paragraphs.

The first financial reporter found that in the sampling review of last year's financial reports, the China Securities Regulatory Commission focused on seven major categories of issues. This includes accounting errors or financial information disclosure issues related to income, long-term equity investments and corporate mergers, financial instruments, asset impairment, non recurring gains and losses, as well as other recognition and measurement issues, as well as reporting and disclosure related issues.

The China Securities Regulatory Commission stated that the next step will be to sort out the problem clues found in the review of listed companies, follow up in a timely manner, and carry out subsequent regulatory processing in accordance with regulations. At the same time, an annual financial information disclosure supervision coordination meeting will be organized to unify the regulatory standards for typical problems discovered in regulatory work.

Five types of "inappropriate" revenue recognition

In the spot check of financial reports, income related issues are more prominent.

The review by the China Securities Regulatory Commission mainly includes five aspects: firstly, failure to properly merge contracts and identify individual performance obligations; The second is the failure to properly identify individual performance obligations and determine the main responsible persons and agents; Thirdly, it was not correctly judged whether revenue could be recognized according to the time period method; The fourth is the improper measurement of performance progress and the transfer of operating costs; The fifth reason is that the accounting treatment for the transaction of renting back the house at a low price after cooperative construction was not properly carried out.

Taking "failure to correctly determine whether revenue can be recognized according to the time period method" as an example, the China Securities Regulatory Commission reviewed and analyzed that some listed companies have disclosed in their accounting policies that they meet the conditions for recognizing revenue according to the time period method, and disclosed that their payment methods are to charge 30%, 40%, and 30% of the contract amount respectively based on the completion of product assembly, installation acceptance, and final acceptance report.

"In fact, based solely on the phased payment arrangement mentioned above, it cannot be guaranteed that at any point during the entire contract period, if the contract is terminated due to customer or other reasons, the amount received can compensate for the incurred costs and reasonable profits. The basis for recognizing revenue on a timely basis is insufficient," said the China Securities Regulatory Commission.

For example, in the case of "failure to properly measure the progress of performance and carry forward operating costs", the China Securities Regulatory Commission found through review and analysis that some listed companies engaged in engineering supervision business use the time period method to recognize revenue, and estimate the progress of performance based on the proportion of actual completed work and confirmed by the owner. At the end of the reporting period, the listed company only failed to recognize revenue from supervision services and did not transfer contract performance costs to operating costs on the grounds that it did not obtain confirmation documents from the owner and could not properly estimate the progress of performance.

The China Securities Regulatory Commission believes that in the above circumstances, listed companies should re estimate the performance progress on each balance sheet date, and evaluate whether using this method to measure performance progress is appropriate in the absence of timely or uncooperative confirmation documents provided by the owner, taking into account specific facts and circumstances.

The issue of asset impairment is prominent

Asset impairment provision is an important aspect that affects the quality of financial reporting. The review by the China Securities Regulatory Commission found that listed companies have prominent problems in at least five aspects.

Firstly, the expected credit loss of accounts receivable was not provisioned in a timely manner; The second is the improper measurement of inventory impairment losses; Thirdly, there are doubts about the rationality of assumptions and parameters related to impairment of goodwill; Fourthly, the impairment loss of short-term rental assets has not been properly provisioned; The fifth mistake is to mistakenly treat changes in expected credit loss rates as changes in accounting policies.

In terms of failure to timely provision for expected credit losses of accounts receivable, the China Securities Regulatory Commission reviewed and analyzed that some listed companies in this period have made significant provisions for expected credit losses of related accounts receivable on the grounds that a certain customer has no executable property.

However, the client has had multiple lawsuits in the previous period, with doubts about their financial condition and actual payment ability, and their credit risk has significantly decreased. The listed company did not properly analyze the changes in its credit risk, but continued to calculate expected credit losses for related accounts receivable using the original combination method with a lower loss rate, resulting in significantly lower expected credit losses for multiple reporting periods. The related losses were concentrated in a one-time confirmation in the current period. The China Securities Regulatory Commission pointed out that this does not comply with the relevant provisions of the standards.

In terms of "improper measurement of inventory impairment losses", review and analysis have found that some listed companies have recognized large inventory impairment provisions based on the sales price after the balance sheet date when calculating the net realizable value of ending inventory due to a significant decrease in inventory selling price after the balance sheet date.

"Listed companies should consider whether the event that leads to a decrease in the selling price of inventory between the balance sheet date and the date of financial statements is a new occurrence after the balance sheet date, or the latest progress of an event that already existed before the balance sheet date." The China Securities Regulatory Commission emphasizes that generally, unless there is evidence that the event provides new or further evidence of impairment of inventory that has occurred on the balance sheet date, it should not be considered in calculating the net realizable value of inventory.

Doubts about the assumptions and parameters related to impairment of goodwill are also a typical issue. The review and analysis by the China Securities Regulatory Commission found that the rationality of key assumptions, parameters, and other information used in the goodwill impairment testing process of some listed companies is questionable, or there are contradictions between them and other information in the financial statements.

For example, some listed companies, without significant changes in their operating environment, use parameters such as projected revenue growth rate and sales gross profit margin for goodwill impairment testing, which differ significantly from the actual revenue growth rate and sales gross profit margin in their historical years.

There are contradictions between the profit expectations based on which some listed companies confirm the recoverable amount of goodwill related asset groups, the profit expectations based on which the company recognizes deferred income tax assets, and the subsequent sales expectations disclosed by the company.

Some listed companies have also recognized large amounts of goodwill in the current period, and have made provisions for impairment of goodwill after the end of period impairment test. There is a significant difference in the two accounting estimates within less than a year.

Some listed companies disclose that due to changes in the industry environment, they are unable to reasonably determine whether the goodwill related asset group can continue to operate. Therefore, they use the net amount after deducting disposal costs from fair value as the recoverable amount of the asset group. However, when evaluating the fair value of the asset group, listed companies also use the income method to determine the fair value of some individual assets in the asset group. The key assumption of the income method is that the value of related assets can be recovered through continuous operation, which contradicts the judgment of listed companies on the operation of goodwill related asset groups.

7 Major Issues in Long term Equity Investment and Business Mergers

In the spot check review, the China Securities Regulatory Commission found that there are many issues related to long-term equity investment and corporate mergers. Mainly reflected in 7 aspects.

One is the incorrect measurement of the fair value of the remaining equity at the level of loss of control in the consolidated financial statements;

The second is the incorrect accounting of the fair value of the deferred income recognized by the acquiree due to government subsidies on the purchase date in a business merger not under the same control; Thirdly, the disposal income of subsidiary equity was not properly accounted for; The fourth is the failure to carefully assess the recoverability of the disposal price of long-term equity investments; Fifth, failure to properly consider the guarantee obligations assumed when disposing of subsidiaries; Sixth, the scope of the consolidated financial statements was not properly determined; The seventh is an accounting error in the unrealized internal transaction gains and losses when the scope of the consolidated financial statements changes.

Taking "the fair value of remaining equity when controlling the loss of control at the level of erroneous measurement of consolidated financial statements" as an example, the China Securities Regulatory Commission's review and analysis found that some listed companies disposed of equity in subsidiaries and lost control, transitioning from investing in subsidiaries to investing in joint ventures. After losing control, the listed company erroneously offset the unrealized internal transaction gains and losses formed during the merger period at the level of consolidated financial statements based on the proportion of equity held in joint ventures.

Some listed companies have also achieved non common control enterprise mergers through multiple transactions in stages, transitioning from investments in joint ventures to investments in subsidiaries. After being included in the scope of consolidated financial statements, the listed company erroneously continued to offset unrealized internal transaction gains and losses between the original and affiliated enterprises.

"For the above two types of transactions, in the consolidated financial statements, whether it is the remaining equity investments held after the loss of control that will be accounted for using the equity method, or the equity investments already held before the merger date that will be accounted for using the equity method, they need to be remeasured at fair value. In terms of accounting treatment, it should be considered that the original unrealized internal transaction gains and losses have been fully realized, and the listed company does not need to continue offsetting," the China Securities Regulatory Commission said.

Five Misunderstandings in Financial Instrument Recognition and Measurement

There are many differences in the recognition and measurement of financial instruments among listed companies. The review by the China Securities Regulatory Commission has found at least 5 major processing errors.

One is the incorrect accounting of financial liabilities arising from accounts receivable that have been endorsed or discounted but cannot be terminated for recognition; The second is the improper measurement of the fair value of equity instrument investments; The third is the improper measurement of contingent consideration settled on one's own shares; The fourth is the inappropriate classification of financial assets; The fifth issue is the improper accounting of derivative instruments embedded in the main liability contract.

Taking the first article as an example, the China Securities Regulatory Commission found through review and analysis that some listed companies mistakenly recognize short-term loans based on the face value of discounted but not terminated recognized notes receivable, and the difference between the actual amount received after deducting discount interest is recognized as financial expenses in a lump sum.

"Listed companies should initially measure their financial liabilities at fair value, and the discounted interest paid in a lump sum should be reflected in the interest expenses subsequently recognized in installments using the effective interest rate method," the China Securities Regulatory Commission said.

For example, "the fair value of equity instrument investments was not properly measured." The China Securities Regulatory Commission reviewed and analyzed that some listed companies measured their equity investments at fair value, classified them as trading financial assets or other equity instrument investments, but subsequently measured them at initial investment cost. Some invested units have significantly improved their financial operations compared to the initial investment and have maintained high cash dividends for many years; Some invested units are currently in the IPO application stage and have completed multiple rounds of financing; Some invested units have deteriorated in their business conditions and have been listed as dishonest individuals.

The China Securities Regulatory Commission pointed out that the above situation may indicate that costs cannot properly reflect the fair value of the equity of the invested entity, and listed companies should not always measure it at initial cost.

Not disclosing non recurring gains and losses in accordance with regulations

The review by the China Securities Regulatory Commission also found that some listed companies have not properly disclosed non recurring profit and loss items in accordance with relevant regulations. Mainly reflected in five aspects.

One is to include all losses incurred from large-scale store closures in non recurring gains and losses. The China Securities Regulatory Commission explained that in general, the decision of a listed company to close its stores due to poor management or other reasons is a normal business activity decision made by the company to maintain its ability to continue operating, and should not be reported as non recurring gains and losses.

The second is to include equipment depreciation, personnel wages, and other losses during the shutdown period in non recurring gains and losses. "During the normal shutdown period of the company, the depreciation expenses of production equipment belong to operating costs and are closely related to the company's normal business operations. They should not be reported as non recurring gains and losses," the China Securities Regulatory Commission said.

The third is to include the economic loss compensation for production and business suspension issued by the government at a fixed amount every month during the suspension period in the regular income statement. The regulatory authorities believe that this compensation is only issued during the shutdown period and has certain special and occasional characteristics, which may affect investors' proper evaluation of the operating performance and profitability of the listed company. It should be reported as non recurring gains and losses.

The fourth is to include guarantee losses related to one's own business model in non recurring gains and losses. The China Securities Regulatory Commission emphasizes that some listed companies provide guarantees to suppliers and customers for their purchase and sales business, or provide guarantees for the operation of invested units such as subsidiaries and joint ventures, but mistakenly record related guarantee losses in non recurring gains and losses.

"Listed companies should comprehensively consider factors such as the financial guarantee object, commercial rationality, and transaction characteristics to determine whether the financial guarantee is related to the company's normal business operations. Generally, the guarantee losses borne by listed companies in carrying out normal business operations should not be disclosed as non recurring gains and losses," the China Securities Regulatory Commission said.

The fifth is to include asset disposal gains and losses related to one's own business model in non recurring gains and losses.

Listed companies engage in decentralized housing management business. They first sign rental contracts with the owners as lessees, and then sublet the houses as lessors. According to the relevant provisions of the leasing standards, listed companies need to first recognize right of use assets and leasing liabilities, and then terminate the recognition of right of use assets and leasing liabilities after transferring to leasing, and recognize asset disposal gains and losses.

"If the sublease of right of use assets is a normal business model of a listed company, the disposal of right of use assets is sustainable and has a significant impact on the appropriate evaluation of the company's performance by financial statement users. Listed companies should not include relevant disposal gains and losses in non recurring gains and losses," the China Securities Regulatory Commission said.

There are many other issues, and regulatory measures will keep up

In addition to the five typical problems mentioned above, the China Securities Regulatory Commission has also identified a large number of other confirmation and measurement issues, mainly including 11 aspects.

One is to mistakenly include properties that cannot be sold separately as investment properties; The second is the accounting treatment error on the conversion date of investment real estate; Thirdly, the amortization of land use rights was not timely provisioned; The fourth is to confirm in advance the disposal gains and losses of assets related to relocation compensation; Fifth, the "bottom-up" equity incentive plan was not properly accounted for; Sixth, the portion of future deductible amounts generated by equity incentives that exceed cost expenses has not been recognized in owner's equity; Seven is the improper accounting of deferred income tax related to leasing; Eight is the failure to prudently recognize deferred income tax assets; 9. Inappropriate differentiation between debt restructuring and expected credit losses; 10. Improper handling of equity transactions; Eleven is an inappropriate recognition of the nature of government subsidy refunds.

In addition, the China Securities Regulatory Commission also found that some listed companies have some problems in their financial reporting and disclosure. Including improper offsetting of internal debt and claims within the group; Incorrect listing of monetary funds held in subsidiaries for sale; Underdisclosure or incorrect disclosure of relevant information, etc.

"Overall, listed companies are able to better comply with the Enterprise Accounting Standards and financial information disclosure rules, but there are still some listed companies that have accounting errors or financial information disclosure issues in areas such as income, long-term equity investments and corporate mergers, financial instruments, asset impairment, and non recurring gains and losses." The China Securities Regulatory Commission stated on the 8th that in response to these issues, the Commission will continue to do the following work in the next step.

One is to sort out and review the problem clues discovered by listed companies, promptly follow up and carry out subsequent regulatory processing in accordance with regulations. The second is to organize an annual coordination meeting on the supervision of financial information disclosure based on typical problems found in regulatory work, and unify regulatory standards. Thirdly, we will continue to strengthen practical guidance through case analysis and other forms to enhance the consistency and effectiveness of the implementation of corporate accounting standards and financial information disclosure rules. The fourth is to closely monitor market hotspots and difficult accounting issues, strengthen investigation and research, and enhance professional technical support.

The China Securities Regulatory Commission (CSRC) proposes that listed companies and accounting firms and other intermediary institutions should attach great importance to the issues raised in accounting regulatory reports, continuously improve their understanding and application level of enterprise accounting standards and financial information disclosure rules, timely discover and correct errors in financial reports, prudently carry out financial information disclosure related work of listed companies, and continuously improve the quality of accounting information disclosure in the capital market.