SOE accounting for subsidies | China Accounting Blog | Paul Gillis

SOE accounting for subsidies

The reform of state-owned enterprises (“SOE’s”) is a never-ending saga in China.  While the government professes continued commitment to SOE reform through such policy initiatives as corporatization, mergers, mixed ownership and improved governance, average financial performance of the SOE sector is not improving.  On the contrary, as documented by the most recent book by Nicholas Lardy, a noted China scholar at the Peterson Institute for International Economics in Washington, average ROA of the SOE sector declined from about 5% in 2007 to only about 1,6% in 2016.  The ROA returns are computed by Ministry of Finance using pre-tax profits divided by average assets and are in general a highly imperfect measure of profitability of non-financial enterprises; EBITDA margin would be much more meaningful, but no such data is available.  


However, the most problematic aspect of the SOE’s ROA data is the fact that the returns are computed on the basis of revenues inclusive of subsidies.   Under CAS No. 16 (Accounting Standard for Business Enterprises No. 16 – Government Grants), issued by Ministry of Finance in 2017, Chinese companies are required to credit subsidies received to the income statement, regardless of whether they are related to current operations or fixed asset investment.  CAS no. 16 is essentially aligned with IFRS (IAS 20 – Accounting for government grants and disclosure of government assistance, issued with the most recent amendment in 2008).  Under IAS 20, subsidies related to current operations are to be credited to the income statement, but subsidies related to fixed asset investment can be credited either to deferred income or the acquired asset, thus reducing that asset’s net value.  A credit to an acquired asset is not allowed under CAS.  


The “income approach” under both CAS No. 16 and IAS 20 might make sense under circumstances in which the subsidy received represents a relatively small percentage of a company’s “true” operating revenue.  However, this is not true of many or most Chinese SOE’s.  According to Lardy, more than 40% of SOE’s were losing money in 2016 even after the subsidies.  Out of 966 SOE’s listed on the Shanghai and Shenzhen exchanges in 2015, only 32 failed to receive subsidies.  Thus, the “income approach” results in a serious distortion of the SOE’s underlying financial performance and ROA.  This problem is most egregious in the case of so-called “zombie” companies which survive solely due to subsidies.  


How could this distorted picture of SOE performance be improved or reformed?  Obviously, the Ministry of Finance could simply require the SOE’s to supply ROA data both before and after subsidies.  An “ROA before subsidies” would be a much more “true and fair” measure of SOE performance.  However, the Ministry of Finance might be understandably reluctant to extract such data from the SOE’s lest it result in an even more disturbing picture of the entire SOE sector.  Thus, a more promising start might be for the Shanghai and Shenzhen exchanges to require all listed companies, including SOE’s, to disclose revenue and ROA before and after subsidies.  Such disclosure requirement would be consistent with the exchanges’ stated objective of enhancing the transparency of mainland’s equity markets, thus making them more attractive to both domestic and international investors.   

Copyright ©  2018         Paul L. Gillis all rights reserved