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Friday, July 27, 2007

J-GAAP: Financial Instruments


In Japan, the BADC issued Accounting Standard for Financial Instruments in 1999. BADC's Accounting Standard was amended by the Accounting Standards Board of Japan (ASBJ) in 2006 and reformatted as ASBJ Standard No. 10, Accounting Standard for Financial Instruments.

ASBJ 10 and IAS 39 (revised 2000), Financial Instruments: Recognition and Measurement, both establish a comprehensive set of standards for various aspects of accounting for financial instruments. IAS 32 (revised 1998), Financial Instruments: Disclosure and Presentation, sets forth requirements for disclosure and presentation of financial instruments.

Recognition and Derecognition

Japanese GAAP and IAS 39 both state that a financial asset or financial liability must be recognized when parties are agreed on a contract that gives one party a right to receive cash or other financial assets and poses the other party an obligation to pay cash or other financial assets. Both also adopt the “financial-component approach” to derecognition of financial assets and liabilities.


As for subsequent measurement of financial assets, Japanese GAAP provides different measurement methods for loans, securities, and derivatives. It states that loans must be carried at the face amount or amortized cost. Japanese GAAP categorizes investments in securities into four categories; (a) securities held for trading purposes, (b) equity investments in subsidiaries and affiliates, (c) debt securities held to maturities, and (d) others. Trading securities must be marked to market with recognizing changes in fair value in net income. Equity investments in subsidiaries and affiliates must be carried at cost on the parent-only financial statements unless the fair value declines significantly below the cost. Debt securities held to maturities must be carried at amortized cost. Amortization is based on either the interest method or the straight-line method. “Other” securities, which would be categorized in “available-for-sale” investments under IAS 39, must be carried at fair value in the balance sheet. Resulting increases in fair value from remeasurment of “other” securities, net of tax, are presented in a separate component of net assets, but not included in shareholders’ equity. Resulting loss are presented in a separate component of net assets or included in net income.

IAS 39 identifies all financial assets into four categories; (a) financial assets held for trading, (b) financial assets held to maturity, (c) loans originated, and (d) financial assets available for sale. Although such categorization is different, measurement methods required by IAS 39 generally concur with those required by Japanese GAAP. However, several minor differences can be identified. For example, as for available-for-sale financial instruments (compared with “other” securities under Japanese GAAP), IAS 39 allows entities to recognize changes in fair value in net income. Japanese GAAP requires entities to recognize gains in equity, but give them a choice to recognize losses in equity or in net income. Japanese GAAP also allows the average of fair value during the closing month of the fiscal year. As for restoration of the value of loans, IAS 39 requires restoration, but Japanese GAAP does not allow restoration.

As for financial liabilities (except for obligation resulting from derivative instruments), IAS 39 requires applying the amortized cost method to subsequent measurement of financial liabilities. Japanese GAAP previously required measuring those financial liabilities at face amount. Under the former Japanese GAAP, if an entity issues bonds at the amount less than the face amount, the discount was displayed as an asset (like a prepaid interest). Such discount asset was required to be amortized by the straight-line method. The current ASBJ 10 requires that financial liabilities should be measured at amortized cost, as similarly required by IAS 39.


Derivative financial instruments are generally measured at fair value in the balance sheet under both IAS and Japanese GAAP. As for interest rate swaps and forward foreign exchange contracts, which are frequently-used instruments in practice, Japanese GAAP provides some exception to fair value measurement of derivative instruments. Japanese GAAP allows accrual accounting to “plain-vanilla” interest rate swaps that are held for hedging interest-bearing financial assets or liabilities that have essentially the same duration. It also allows entities to adopt the “synthetic instrument approach,” as discussed earlier, to forward foreign exchange contracts that hedge foreign currency risk exposures.

Japanese GAAP also gives entities an option to adopt either of deferral hedge accounting and mark-to-market hedge accounting. If deferral hedge accounting is adopted, deferred gains and losses on hedging instruments are carried as a separate component of net assets, but not included in shareholders' equity on the balance sheet. IAS 39 states that if exposures to the volatility of fair value of the existing assets and liabilities and firm commitments are hedged (fair value hedge), an entity may accelerate recognition of changes in fair value on hedged items whereas the hedging instruments are measured at fair value with recognizing changes in fair value through net income. If exposures to the volatility of future cash flows of anticipated transactions, entities may defer changes in fair value on hedging instruments in the shareholders’ equity.

Combined Financial Instruments

As for combined financial instruments, Japanese GAAP generally applies a separate accounting to bond with warrants and convertible bonds. Undetachable bonds with warrants and convertible bonds are now termed as bonds with stock options, according to the 2001 amendment to the Commercial Code. As for bonds with stock options that require holders to substitute the amount redeemed at the exercise of the stock option as the payment at the issuance of the new stock (previously referred to as convertible bonds), an issuer may or may not adopt the separate accounting. If it does not adopt such accounting, bonds with stock options, as a whole, would be presented as a liability section in the balance sheet.


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