China Stocks

[littlejohn]

CSGJ using a VIE interpretation to consolidate revenues and financial equity highlights a liberal accounting method that I overlooked...

I looked at the intial numbers on the company and took them at face value...

The accountants used an interpretation which assesses company equity much more liberally than common sense normally allows...

For example...If you lease a property from the owner for 10 years and then rent it out during that period to earn cash flow you do not have any equity in the property and do not share in any potential equity growth in the property during the ten year lease period...end sentence,,,

From the CSGJ filings...

Consolidation of Variable Interest Entities

In June 2009, the FASB issued new guidance that amended the existing criteria for consolidating variable interest entities (“VIEs”). The Company adopted Financial Accounting Standards (“FASB”) Accounting Standards Codification (“ASC”) Topic 810, Consolidation, which established new standards governing the accounting for and reporting of non-controlling interests (“NCI”) in partially owned consolidated subsidiaries and the loss of control of subsidiaries. The new consolidation criteria requires an ongoing qualitative assessment of which entity has the power to direct matters that most significantly impact the activities of a VIE and has the obligation to absorb losses or benefits that could be potentially significant to the VIE.
VIEs are those entities in which the Company, through contractual arrangements, bears the risks of, and enjoys the rewards normally associated with ownership of the entities, and therefore the company is the primary beneficiary of these entities. The results of subsidiaries or variable interest entities acquired during the year are included in the consolidated income statements from the effective date of acquisition.

ACCOUNTING OF VIE - accounting for the assets, liabilities, and non-controlling interest of a consolidated variable interest entity are accounted for as if the entity were consolidated based on voting interests and the usual accounting rules for which the VIE operates are applied as they would to a consolidated subsidiary as follows:


· carrying amounts of the VIE are consolidated into the financial statements of the Company as the primary beneficiary (referred as "Primary Beneficiary" or "PB");


· inter-company transactions and balances, such as revenues and costs, receivables and payables between or among the Primary Beneficiary and the VIE(s) are eliminated in their entirety


The Company is currently organized using an offshore holding structure commonly used by foreign investors with operations in China. As a Delaware corporation, the Company wholly-own Chine Holdings Ltd. (“Chine Holdings”), a company incorporated in the British Virgin Islands; which owns Jili Zhaoyuan Investment Consulting Co., Ltd. (“JZIC”), a Wholly Foreign-Owned Enterprise (WFOE) established under the laws of the PRC. Through contractual agreements in place between WFOE and Zhaoyuan Shuangji, since August 2008 the Company has substantial control over the daily operations and financial affairs, election of senior executives, and all matters requiring shareholder approval for Zhaoyuan Shuangji Co. Ltd, a PRC company (“Zhaoyuan Shuangji.”) Zhaoyuan Shuangji produces high-grade cement to the industrial sectors in the PRC and internationally.


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The abovementioned contractual arrangements include a series of agreements, including a Strategic Consulting Service Agreement and Operating Agreement, through which JZIC has the right to advise, consult, manage and operate Zhaoyuan Shuangji for a fee. In order to further reinforce JZIC’s rights to control and operate Zhaoyuan Shuangji and to collect consulting and services fees provided by JZIC to Zhaoyuan Shuangji, Zhaoyuan Shuangji’s shareholders have granted JZIC the exclusive right and option to acquire all of their equity interests and voting rights in Zhaoyuan Shuangji through an Exclusive Option Agreement and Authorization Agreements. Pursuant to these agreements, JZIC operates and controls the business of Zhaoyuan Shuangji. Under the present structure, the Company’s agreements with Zhaoyuan Shuangji have a term of ten years with an option to renew.


According to ASC 810-10-25-42, for purposes of determining whether the reporting company is the primary beneficiary of a VIE, a reporting entity with a variable interest shall treat variable interests in that same VIE held by its related parties as its own interests. The related party includes an officer, employee, or member of the governing board of the reporting entity. The operating entity VIE is held by certain related parties including officers of the reporting entity China Shuangji Cement. From the company’s current structure below, China Shuangji Cement Holding Ltd. (“Holdings”) owns 76% of the reporting entity and 24% of the reporting entity is owned by the public float. Wenji Song, our Chairman and President, beneficially owns 51.3% of Holdings. Wenji Song in trust owns 48.7% of Holdings, and the trust includes all the other 197 shareholders of operating entity. Out of those 197 shareholders, Bo Wu, our Secretary and Director, owns 1.2%, Jun Song, our Director, owns 1.7%, Linxin Cui, Director, owns 2.5%, and Shouheng Yuan, our Director and Vice President of Sales, owns 0.9%, respectively, of Holdings. The operating company “Zhaoyuan Shuangji” is owned by the same 198 shareholders which includes Wenji Song and directors. Since the operating company “Zhaoyuan Shuangji” is 100% owned by the same shareholders who owned 76% of the reporting company, the operating company and the reporting company have common ownership. Also, the operating company “Zhaoyuan Shuangji” and the reporting entity have the identical management which they have the same chairman, officers and board of directors.


The consulting service agreement, operating support agreement, exclusive option agreement, and authorization agreement give JZIC the control over Zhaoyuan Shuangji’s daily operations and financial affairs, election of their senior executives and all matters requiring shareholder approval that most significantly impact Zhaoyuan Shuangji’s performance. The legal implication of the those agreements give JZIC the obligation to absorb the majority of losses and the right to receive the majority benefit from the operating entity Zhaoyuan Shuangji. In conjunction with the facts that the operating company Zhaoyuan Shuangji and the reporting entity having the identical management and the common ownership, and that JZIC, through these contractual agreements, effectively controls the operating entity, JZIC is considered to be the primary beneficiary of the operating entity Zhaoyuan Shuangji pursuant to ASC 810. The following key provisions in the agreements show that the Company has a controlling financial interest in Zhaoyuan Shuangji and entitle the Company’s power to direct matters that most significantly impact the activities of Zhaoyuan Shuangji and have the obligation to absorb losses or benefits that could be potentially significant to Zhaoyuan Shuangji:


(1) The power to direct the activities of a VIE that most significantly impact the VIE’s economic performance:


According to the Authorization and Complementary Agreement of Operating Support Agreement (“Complementary Agreement”) dated August 11, 2008, Jili Zhaoyuan Investment Consulting Co., Ltd. (“JZIC”) maintains the right to make decisions about Zhaoyuan Shuangji Co. Ltd. (“Zhaoyuan Shuangji”)’s daily operations, financial management and transactions as stated below:


(a) Article 1.1 of the Authorization Agreement:

“Party C (refers to Wenji Song) hereby irrevocably authorizes Party A (refers to JZIC) to undertake and exercise all of his rights as a holder and owner of registered capital of Party B (refers to Zhaoyuan Shuangji) pursuant to the laws of the PRC and the organization documents of Party B……”


(b) Article 2 of the Complementary Agreement:

“Party B (refers to Zhaoyuan Shuangji) shall not conduct any transaction which may materially affect its assets, obligations, rights or operation unless Party A (refers to JZIC) provides its prior written consent……”


(c) Article 3 of the Complementary Agreement:

“Party B together with its shareholders Party C (refers to Wenji Song) and Party D (refers to Wenji Song (in trust) )hereby jointly agree to accept, from time to time, the corporate policy advice and guidance provided by Party A in connection with the company’s daily operations and financial management and the recruitment, retention and dismissal of the company’s employees.”


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(d) Article 4 of the Complementary Agreement:

“Party B together with its shareholders Party C and Party D hereby jointly agree that Party C and Party D shall cooperate to appoint the person recommended by Party A as the directors of Party B, and Party B shall appoint Party A’s senior managers as Party B’s General Manager, Chief Financial Officer, and other senior officers.”


(2) The obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE:


According to the Complementary Agreement, JZIC serves as guarantor of Zhaoyuan Shuangji and bears the operating risks and losses of Zhaoyuan Shuangji:


(a) Article 1 of the Complementary Agreement:

“Party A agrees to serve as guarantor for Party B in the contracts, agreements or transactions in connection with Party B’s operation between Party B and any other third party, to provide full guarantee for the performance of such contracts, agreements or transactions by Party B.”


According to the Strategic Consulting Service Agreement (“Service Agreement”), JZIC can receive consulting fees from Zhaoyuan Shuangji.


(a) Article 3.1 (b) of the Service Agreement:
“Party B (refers to Zhaoyuan Shuangji) hereby agrees to pay Party A (refers to JZIC) a consulting fee (“Consulting Fee”). The amount of the Consulting Fee shall be decided and settled by Party A and Party B in writing according to the Consulting Services being provided by Party A upon request of Party B on quarterly basis, and be paid within three (3) months after the settlement.”


Therefore, pursuant to the ASC 810, the Company, as the primary beneficiary, is required to consolidate its VIE. Accordingly, the VIE (Zhaoyuan Shuangji) was consolidated through JZIC from the date of the acquisition.

The company shows in their filings dashed lines to the underlying cement companies and has been straightforward in that presentation of consulting arrangements...LJ