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Wednesday, August 1, 2007

J-GAAP: Conceptual Framework


In December 2006, the ASBJ agreed to issue Discussion Paper, Conceptual Framework of Financial Accounting. Many have asked what is conceptual framework in Japan. Discussion Paper (tentative translation version) can be downloaded at:

Discussion Paper states that it summarizes fundamental premises and concepts underlying financial accounting. It also states that it facilitates communication among related parties and would enhance their predictability of financial accounting in future.

One of the expected roles of Discussion Paper is that it enhances communication with standard-setters in the world. It has contents similar to IASB/FASB conceptual framework, so as to make it easy to deliberate common interests in financial accounting: objectives of financial reporting; characteristics of accounting information; elements of financial statements; and recognition and measurement in financial statements.

Discussion Paper is originally drafted in 2004 by a working group, which is comprised of members from ASBJ Board and staff, academics, and public accounting, and others. The ASBJ Board adopted it as its own document in December 2006. Discussion Paper is still an exposure document, because the IASB and the FASB are now reviewing their concept statements toward setting a common set of framework and the ASBJ intends to continue its discussion on the conceptual issues.

Objectives of Financial Reporting

Discussion Paper on conceptual framework first sets forth, in its Chapter 1, objectives of financial reporting. As other conceptual frameworks do, Discussion Paper states that objectives of financial reporting is to provide information useful for decision making by investors and other financial statement users. More specifically, Discussion Paper says that the information should be focused on an entity's financial positions and performance. It also emphasizes that earnings is important to communicate with users the entity's past performance, so that users can establish their own prospects for the entity's future performance and, therefore, the entity's firm value.

Discussion Paper states that the principal role of financial reporting is to provide information about the entity's financial history rather than fortune tale. Based on such information, investors make their own investment decision at their own risk.

Qualitative Characteristics of Accounting Information

Chapter 2 of Discussion Paper addresses qualitative characteristics of accounting information.It identifies qualitative characteristics that make information useful for users' decision making. Decision Usefulness is supported by two fundamental characteristics: relevance and reliability.

On the other hand, decision usefulness should be achieved in consideration for comparability and internal consistency. Those two characteristics are regarded as restrictive constraints in reaching for decision usefulness. Internal consistency is defined as a quality in which information is consistent with the existing fundamental concepts underlying accounting standards and practices.

Elements of Financial Statements

Chapter 3 of ASBJ's Discussion Paper addresses issues related to elements of financial statements. It identifies the following elements: assets; liabilities; net assets; shareholders' equity; revenue; expense; comprehensive income; and net income.

You may be curious why Discussion Paper identifies similar two elements of net assets and shareholders' equity. Net assets are defined as the excess of assets over liabilities, while shareholders' equity is defined as shareholders' interest in claims to assets. Difference between net assets and shareholders' equity includes changes in fair value of certain financial instruments, translation adjustments, minority interest, and stock options.Comprehensive income and net income are identified as separate elements of financial statements. Comprehensive income is defined changes in net assets during the period from non-owner transactions. Net income is the excess of revenue over expense, as recognized based on the concept of "release from risk," which is slimier concept of realization or matching.

Recognition and Measurement in Financial Statements

Chapter 4 of ASBJ's Discussion Paper addresses recognition and measurement in financial statements. It generally explain when an element of financial statements should be recognized, and identifies various measurement attributes that are used in current practice. Recognition criteria is described based on the analysis for what is a trigger for recognition. Measurement attributes are more widely identified than in FASB/IASB conceptual framework.

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