J-GAAP: Institutional Background

Standard-Setting

Before we identify differences between Japanese GAAP and IASs, it would be beneficial for readers to review accounting standard-setting process in Japan.

Since the end of World War II, Japanese GAAP have been set forth by the Business Accounting Deliberation Council (BADC) and its predecessors. The BADC was originally formed as an advisory body to the Minister of Finance (MOF), and is now an advisory body to the Prime Minister of Japan and the Commissioner of Financial Services Agency (FSA), based on recent restructuring of the government. More specific missions of the BADC include establishing accounting and audit standards and recommending strategic plans for domestic and international activities.

In July 2001, a new accounting standard-setting body was formed in private sector. The Financial Accounting Standards Foundation (FASF) is a supervisory foundation, and, as an independent force, the Accounting Standards Board of Japan (ASBJ) is now working on developing Japanese GAAP. The FASF is funded mainly by business community and public accountants. The ASBJ has currently 13 voting members, including 3 full-time members. It issues or revises accounting standards, implementation guidelines, and practice bulletins applicable to business enterprises. The Board is supported by approximately 15 staff members, most of which are fellow members from major accounting firms and larger listed companies. The BADC has just issued accounting standards for business combination in October 2003, which was one of the accounting issues that were previously addressed before the establishment of the ASBJ, and will no longer add a new project for pursuing setting accounting standards.
The ASBJ is now actively working toward developing accounting standards or implementation guidelines relating to various issues, including presentation of shareholders’ equity and its changes during the period, earnings per share, stock compensations, leases, impairment of assets, business combinations and other implementation issues.

The purpose of the establishment of the ASBJ is to develop domestic accounting standards in its own independent decision making, through a distillation process of experience in financial markets and accounting community. It also presumably includes contributing to international harmonization or convergence of accounting standards.

Financial Reporting Environment in Japan

In Japan, financial reporting is governed by two different sets of laws and regulations. The Commercial Code (CC) requires that all “merchants,” including joint stock companies, must keep books and prepare balance sheets. Especially, joint stock companies must submit their accounts to the annual shareholders’ meetings for their approval. The Securities and Exchange Law (SEL) requires public companies to file their consolidated and parent-only financial statements with financial regulators. Thus, public companies must prepare three sets of financial statements. Financial statements required by the CC and those required by the SEL are essentially the same, but still different in some respects. For example, the CC does not require companies to prepare cash flow statements, while the SEL do require public companies to prepare cash flow statements. There still remain minor differences in display of financial statements, and the SEL generally requires additional extensive footnote disclosures.

In addition, the Corporate Income Tax Law and its regulations set forth comprehensive tax rules in very detail, so that financial statements prepared under the CC and the SEL are significantly influenced by the tax rules. The accounting system in Japan is comprised of three different regulations; the CC, the SEL, and the tax rules. The three components are closely tied and have affected each other. In this sense, the accounting system in Japan has been characterized as “Triangular Legal System.” However, recent moves relating to the accounting system are generally recognized as going toward harmonization of financial statements required by the CC and the SEL. The CC recently removed their own accounting requirements, which are now moved to the ordinances of Ministry of Justice, and requires that larger companies must prepare consolidated accounts, which would be identical, for public companies, to the consolidated financial statements required by the SEL and its related regulations and GAAP.

Tax laws and regulations are becoming relatively independent from accounting treatments prescribed by GAAP. Because interperiod allocations of income taxes are now in practice since 1999, conformity between accounting earnings and taxable income have become less important.

Another important move was that the FSA amended its regulations in 2002, allowing Japanese SEC registrants to file with Japanese financial regulators their consolidated financial statements that are in accordance with U.S. GAAP. Previously, only SEC registrants that had already prepared consolidated financial statements in accordance with U.S. GAAP before Japanese regulators first required preparation of consolidated financial statements during 1970’s have been allowed to file U.S. GAAP consolidated statements, while other SEC registrants must prepare their consolidated financial statements in accordance with Japanese GAAP to file with Japanese regulators even though they prepare consolidated financial statements in accordance with U.S. GAAP for U.S. filing.

Update

In 2005, the Commercial Code is reorganized into newly enacted "Company Act" and "Commercial Code (for non-company merchants)."

The Company Act continues to rely on accounting professionals to set forth generally accepted accounting principles, which is applicable to preparation and presentation of financial statements by all companies. The Company Act eliminates most of the previous accounting requirements.

In 2007, the Securities and Exchange Law and other regulations are integrated into the "Financial Instruments Law." The new Law encompasses traditional securities transactions and relatively new financial instruments. Accounting and disclosure rules specified in the SEL are carried forward to new Law.

The Financial Instruments Law requires FSA registrants to report the effectiveness of "internal control," which will be mandatory for 2008 fiscal years.