J-GAAP: General Principles

Overview

BADC Accounting Principles for Business Enterprises set forth a broad set of "general principles." The set of general principles includes the following seven principles, which cover every aspects of accounting and reporting:

• True and Fair View
• Orderly Bookkeeping
• Distinction between Capital and Earnings
• Clear Presentation
• Continuity
• Conservatism
• Consistency

The principle of materiality is set forth in Supplementary Notes to Accounting Principles for Business Enterprises, and is not included in the set of general principles. However, it is understood that the principle of materiality is as important as other seven general principles.

True and Fair View

The principle of true and fair view is the most prominent principle of the general principles listed in Accounting Principles for Business Enterprises. The Accounting Principles says that an enterprise should provide true and fair view about its financial conditions and operating results.
The concept of true and fair view does not mean absolute truth about enterprises. Financial statements are a product of management's judgements and estimates. The principle of true and fair view requires comparative truth about enterprises' pictures.

Then, what is true and fair view? The Accounting Principles for Business Enterprises do not define the meaning of true and fair view. True and fair view is rather defined operationally; it is thought to be accomplished by complying with all other lower accounting principles.

Orderly Bookkeeping

The principle of orderly bookkeeping requires that an enterprise should keep accurate accounting books in order. In addition, although not directly, the principle of orderly bookkeeping requires that all accounting treatments that enterprise performs be accurate. In this context, the principle of orderly bookkeeping implies the same philosophy of the principle of true and fair view.

Accurate accounting books are those that provide for orderly, complete, and verifiable accounting records.

Distinction between Capital and Earnings

The principle of distinction between capital and earnings requires that an enterprise should distinguish capital and earnings, especially capital surplus and earned surplus.

In Japan, it is emphasized that earnings should be distributable to stakeholders, such as shareholders and tax authorities. From a point of view of distributable income determination, distinction should be made clearly between undistributable capital and distributable earnings.
From a historical point of view, at the time when Accounting Principles for Business Enterprises are promulgated, distinction between capital and earnings was so vague as to cause many financial frauds. The Accounting Principles provided a warning that enlightened business community.

Clear Presentation

The principle of clear presentation requires that an enterprise should present clearly its financial conditions and operating results in a manner that financial statements do not mislead users. This principle applies to display of the body of financial statements and disclosure in notes to financial statements.

In conjunction with the principle of clear presentation, disclosure about accounting principles and post-balance-sheet-date events are required to make users able to understand better financial conditions and operating results.

Continuity

The principle of continuity requires that an enterprise not change its accounting policies without justifiable reasons. If an enterprise changes its accounting policies, the justifiable reasons and the effect on financial statements should be disclosed.

Generally, in practice, the justifiable reasons for accounting changes have been broadly interpreted. Therefore, the principle of continuity has long been criticized for its less rigid application. For example, Fifo method, Lifo method, and average method for inventory cost allocation are applied interchangeably and can be changed flexibly from one period to another.
Moreover, accumulated adjustments of accounting changes are generally not recognized. Accounting changes do not affect retroactively. Enterprises apply newly selected accounting policies without changing the basis of the assets or liabilities to which the former selected accounting policies are applied. Accounting literature is silent about the accumulated adjustments, but tax guidance provides some tax rules that prohibit retroactive adjustments. For example, enterprises do not adjust basis of depreciable assets even when accounting policy for the assets is changed from straight-line method to accelerated depreciation method.

Conservatism

The principle of conservatism, or principle of prudence, requires an enterprise to make prudent accounting choices and estimates when future events would make negative effects on its financial conditions. The principle, however, prohibits too prudent accounting choices and estimates. Many accounting principles, including realization principle, historical cost measurement, and the LOCOM rule, are derived to some extent from the principle of conservatism.

The principle of conservatism is often criticized for its unilateral bias to unfavorable earnings effects. Many accountants say that the principle distorts neutrality of accounting.

Consistency

In Japan, an enterprise often prepares more than one sets of financial statements for different purposes, including purposes of shareholders' approval, extending credits, and filing tax returns. The principle of consistency requires that an enterprise keep one set of accounting records for any different purposes and not distort accounting records by management's intent.

Materiality

The principle of materiality is set forth in the BADC Supplementary Notes to Accounting Principles for Business Enterprises. Therefore, the principle of materiality is not included in general principles of the Accounting Principles.

The principle of materiality requires an enterprise to make cost/benefit judgements on accounting choices and estimates. Every provision of accounting standards do not have to be applied to immaterial items.

The principle of materiality is not inconsistent with the principles of order bookkeeping and fair presentation, because the principle of materiality aims to achieve the purpose of financial statements effectively, which is the same purpose pursued by the principles of order bookkeeping and fair presentation.