Summary of Key Findings
The China Securities Regulatory Commission (CSRC) released a report on the supervision of financial reports from listed companies for 2025, indicating that most companies comply with accounting standards. However, some firms have made errors in financial treatment or disclosure regarding eight major categories, including revenue, financial instruments, and research and development (R&D) expenditures. R&D expenditures have become a new focus of regulatory attention. Additionally, there are new issues with the overstatement of revenue and enhanced supervision of financial instruments. The CSRC will strengthen coordination in regulation and require companies and intermediary institutions to make corrections to improve the quality of their financial reports.
1. R&D Expenditures as a New “Minefield”: Don’t Mistake R&D Costs for Assets
With the increasing number of technology companies on the A-share market, the accounting treatment of R&D expenditures has become a new issue. Following a special inspection added to the report, three typical errors were identified:
1. Miscapitalization of outsourced R&D: Some companies directly classify upfront payments made to outsourcing teams for R&D (which have not yet been deemed technically feasible) as “intangible assets,” effectively treating the spent money as company assets that are then amortized over time. However, since the R&D may not be successful at this point, these costs should be recognized as current expenses, reducing the company’s profit for the year. For example, if a company outsources software development and capitalizes the upfront payment before determining its feasibility, and the project fails, the entire “asset” must be written down, resulting in greater losses.
2. Incorrect allocation of costs for customized product development: When developing custom products for clients, the prototypes produced should be sold to the clients, and the company can also apply for patents. Some companies mistakenly classify the cost of raw materials as inventory and other expenses as intangible assets; instead, the costs should be allocated reasonably—producible prototypes should be treated as inventory, while eligible R&D expenses should be classified as intangible assets, rather than simply splitting them based on material, labor, and other costs.
3. Miscapitalization of internal technical platforms: Companies that develop foundational technologies (e.g., software used for further R&D) that are not sold directly should not classify these as intangible assets. Since the benefits from these technologies depend on the success of subsequent projects and there is significant uncertainty, they should be recognized as current expenses unless it can be proven that there is a mature external market (e.g., the technology can be sold to other companies).
2. New Tricks for Overstating Revenue: Import/Export Companies, Avoid Using the “Gross Amount Method”
Four new issues were identified in revenue recognition, with the most common being the misuse of the “gross amount method” versus the “net amount method”. For instance, some import/export companies assist domestic suppliers with exports, earning a small profit from the difference in prices without bearing significant risks (such as price fluctuations or damage to the goods). However, these companies incorrectly calculate their revenue using the gross amount method, rather than the net amount method. The CSRC emphasizes that if a company cannot control the goods (e.g., it cannot set prices or bear major risks), it should use the net amount method to avoid inflating its revenue and making its financial reports appear more favorable.
3. Enhanced Supervision of Financial Instruments: Don’t Misclassify Investments with Limited Lifespan
The issue of financial instruments has risen from third place last year to second place this year, becoming a major problem, second only to revenue-related issues. The focus is on the incorrect treatment of investments in entities with limited lifespans. For example, when investing in limited-life partnerships or closed-end funds, some companies classify these as “other equity instrument investments” (similar to long-term stock investments). However, these investments have a fixed duration (e.g., they must be liquidated upon maturity), and the issuers are not considered “equity instruments.” For instance, purchasing a 5-year closed-end fund should not be classified as an equity investment, as this could mislead investors about the company’s asset structure.
4. Financial Instrument Supervision Upgraded: Don’t Mistake Investments with Limited Lifespan
The issue of financial instruments has risen from third place last year to second place this year, becoming a major problem, second only to revenue-related issues. The focus is on the incorrect treatment of investments in entities with limited lifespans. For example, when investing in limited-life partnerships or closed-end funds, some companies classify these as “other equity instrument investments” (similar to long-term stock investments). However, these investments have a fixed duration (e.g., they must be liquidated upon maturity), and the issuers are not considered “equity instruments.” For instance, purchasing a 5-year closed-end fund should not be classified as an equity investment, as this could mislead investors about the company’s asset structure.
5. Other Issues Such as Asset Impairment: Don’t Mix Different Types of Business Activities
In addition to the above issues, there are also problems with asset impairment and reporting disclosures:
- Incorrect asset impairment calculations: For example, a certain integrated circuit company has two separate businesses that generate revenue independently, but it combines all assets in the same impairment test, leading to inaccurate impairment amounts. Some companies also include revenue from subsequent business acquisitions in the impairment calculation of goodwill, overestimating the value of goodwill.
- Improper reporting and disclosure: Issues such as irregular cash flow statements and non-recurring gains or losses (e.g., money from selling assets) can mislead investors regarding the company’s actual profitability.
5. The CSRC’s Comprehensive Regulatory Approach: Standardization and Mandatory Corrections
The CSRC will take the following steps:
1. Standardize regulatory requirements: Coordinate efforts among various authorities to ensure consistent enforcement across different regions.
2. Punish violations according to laws and regulations: Address identified errors accordingly.
3. Provide guidance on practical issues: Offer clear instructions for common and difficult topics (such as R&D expenditures).
The CSRC also requires listed companies and accounting firms to promptly correct these errors, thoroughly understand accounting standards, and prepare accurate financial reports. After all, financial reports are the primary source of information for investors to evaluate a company’s performance and should not be misleading.
In summary, this report highlights new issues such as R&D missteps by technology companies, revenue overstating by import/export firms, and incorrect classification of financial instruments. The regulatory approach is becoming more stringent to ensure that listed companies provide more accurate financial reports and protect investors’ interests. Ordinary investors should also be aware of these potential pitfalls when reviewing company financial reports to avoid making mistakes.