J-GAAP: Accounting Changes

On 4 December 2009, the Accounting Standards Board of Japan (ASBJ) has issued ASBJ Statement No. 24, Accounting Standard for Accounting Changes and Error Corrections.

According to ASBJ Statement 24, accounting changes are defined those including:

• Changes in accounting policies,
• Changes in presentation methods, and
• Changes in accounting estimates.

Error corrections are defined separately form accounting changes.

An entity changes should not change its accounting policies unless justifiable reasons for doing so. If an entity changes its accounting policies in accordance with new accounting standards, its should comply with the provisions in that standard. If an entity changes its accounting policies with other justifiable reasons, it should apply the new accounting policies retrospectively so as to restate the prior-year financial statements as if they were already applied in previous years..
If an entity changes its presentation method so that its financial statements are more faithfully representative, it should restate its prior-year financial statements retrospectively.
If an entity changes its accounting estimates, it should account for:

• Such change during the period when the change affects the financial statements in that period; and
• Such change over the periods prospectively when the change affects the financial statements in following more than one periods.

If an error in the amounts previously reported is found in the period, it should be reflected retrospectively in the prior-year financial statements.

The ASBJ provides a summary in English here.

News: Government to Encourage Non-amortization of Goodwill

The Nikkei Newspaper reported on 27 January 2014 that the Ministry of Economy, Trade and Industry (METI) will recommend in its forthcoming report in March that the Accounting Standards Board of Japan (ASBJ) amend its accounting standards to allow non-amortization of goodwill.

The existing Japanese GAAP requires entities to amortize goodwill over the years within 20 years. The balance of goodwill should be written down when certain impairment recognition criteria are met.
Occasionally, amortization of goodwill is criticized because Japanese companies are not able to complete in an equal playing field with competitors that use IFRS or US GAAP, which do not allow amortization of goodwill. For example, Takeda Chemical switched its accounting standards in use to IFRS, because it wants not to amortize its goodwill.

Currently, qualified Japanese companies are allowed to use IFRS. However, the switching to IFRS is not easy because of implementation cost. Moreover, reportedly, the endorsed IFRS, which may have certain modifications to IFRS as issued, would likely to require amortization of goodwill.

J-GAAP: Statement of Comprehensive Income

On June 30, 2010, the Accounting Standards Board of Japan (ASBJ) issued ASBJ Statement No. 25, Accounting Standards for Presentation of Comprehensive Income. Since March 2011 financial reporting, the entities that are required to prepare their consolidated financial statements by the Financial Instruments and Exchange Law must present statements of comprehensive income as a part of consolidated financial statements. Separate (parent-only) financial statements must not include a statement of comprehensive income.
A different approaches to consolidated financial statements and separate financial statements were very controversial. However, it might be understood that the consolidated financial statements prepared in accordance with Japanese GAAP should be comparable with those prepared in accordance with IFRS, whereas the separate financial statements should be prepared for domestic regulations.

Comprehensive incomes is defined as net changes during a period in shareholders equity arising from non-owner transactions. ASBJ Statement 25 requires an entity to present its comprehensive income in addition to net income. Net income is a traditionally determined bottom line number, which is not changed regardless of this Statement.
Differences between comprehensive income and net income should be displayed as "other comprehensive income (OCI)." The components of OCI include:

• Changes in fair value of available-for-sale securities.
• Changes in deferred gains and losses on hedging instruments.
• Changes in foreign currency translation adjustments.
• Changes in accumulated actuarial differences on post-retirement benefits.

Any reclassification from accumulated other comprehensive income to net income should be included in other comprehensive income during the period when the reclassification occurs. Each components are generally displayed as a net amount, i.e., the reclassification adjustments would likely not to be displayed as a separate line item.

This Statement allows two alternative formats: the two statements format and the single statement format.
As amended in September 2013, this Statement requires displays of net income and comprehensive income as follows:
In the two statements format, the statement of income should present the net income during the period, which is followed by the net income attributable to non-controlling interest, and present the net income attributable to the parent's shareholders. In the statement of comprehensive income, the net income should be followed by the other comprehensive income, displaying the comprehensive income.
In the single statement format, the statement of net income and comprehensive income should present the net income during the period, which is followed by the other comprehensive income, and display the comprehensive income as well. The net income attributable to non-controlling interest and the net income attributable to the parent's shareholders should be attached to the total number of net income. The comprehensive income attributable to non-controlling interest and the comprehensive income attributable to the parent's shareholders should be attached to the total number of comprehensive income.
Traditionally, Japanese GAAP defined the net income as that attributable only to the parent's shareholders. However, the IASB defines the profit and the comprehensive income as those attributable both to the parent's shareholders and the non-controlling interest. The September 2013 amendment allows an entity to display the net income in a way of being compatible with IFRS. This practice will be applied first to March 2016 financial reporting.

J-GAAP: Source of Japanese GAAP

The Financial Instruments and Exchange Law (FIEL) prescribes that the registrants comply with the generally accepted accounting principles (standards) unless the related Cabinet Ordinances specifies certain treatments.
The Cabinet Ordinances specifies that the generally accepted accounting principles consists of (1) accounting principles that are set forth by the Business Accounting Council (BAC) and (2) accounting standards that are set forth by qualified independent standard setting body. The Accounting Standards Board of Japan (ASBJ) is designated as such a qualified independent accounting setting body.

The Company Act requires that companies comply with the generally accepted accounting practice in preparing their accounts. Because the FIEL specifies that the BAC's accounting principles and the ASBJ's accounting standards are part of the generally accepted accounting principles, such accounting principles and standards are also part of the generally accepted accounting practice under the Company Act.

The IFRS designated as generally accepted by the Commissioner of the Financial Services Agency is also another set of generally accepted accounting principles for preparing consolidated financial statements under the FIEL.

Other sources of generally accepted accounting principles or practice includes various documents of accounting and auditing guidance set forth by the Japanese Institute of Certified Public Accountants.
The ASBJ's discussion paper on conceptual framework does not represent an accounting standard.

J-GAAP: IFRS in Japan

In August 2007, the International Accounting Standards Board (IASB) and the Accounting Standards Board of Japan (ASBJ) agreed that major differences between IFRS and Japanese GAAP should be eliminated by 2008, and that other minor differences should be eliminated by 2011. Since then, the ASBJ actively worked on projects for eliminating those differences, and as a result, Japanese GAAP has become more compatible with IFRS.

In June 2009, the Business Accounting Council (BAC), an advisory body to the Financial Services Agency (FSA), issued a tentative statement, "An Opinion on How to Treat IFRS in Japan." In this statement, it provides a roadmap for voluntary and mandatory adoption of IFRS.

As for voluntary adoption, certain qualified companies are allowed to prepare their consolidated financial statements in accordance with the "designated IFRS." A qualified company should meet certain conditions:

• It must operate international financing and business activities.
• It must be a listed company.
• It must be equipped with .

Each IFRS should be designated by the FSA through a public due process.
As for mandatory adoption, the BAC's statement set forth a deadline for decision making by end of 2012, and will be implemented for 2015 or 2016 financial reporting.

Since March 2010 financial reporting, the qualified companies are allowed to prepare consolidated financial statements in accordance with the designated IFRS. The number of companies that actually utilize IFRS is 20 as of May 2013, and is increasing.

On June 2011, the Minister of Financial Services issued a statement that postpones the mandatory adoption, which must not be implemented until 2016. Based on his instruction, the BAC resumed its deliberation on the mandatory adoption of IFRS since then.

On June 2013, the BAC issues another statement, "Tentative Policy on How to Cope with IFRS." In this statement, it proposes:

• To relax the conditions for qualified companies that are allowed to use IFRS.
• To allow a use of another set of IFRS, which is endorsed by the FSA with certain possible modifications.

Within 2013, the conditions for qualified companies are relaxed by the FSA. As a result, they just have to be equipped with an an appropriate system that assures fairness of consolidated financial statements in accordance with IFRS (i.e., they do not have to be an multinational enterprise or a listed company). The procedure for endorsement of IFRS is currently (January 2014) discussed by a working group, which is formed in the ASBJ.

In summary, a qualified Japanese listed companies would have several options in preparing consolidated financial statements:

• Japanese GAAP
• U.S. GAAP, for SEC registrants.
• Designated IFRS, for (relaxed) qualified companies
• Endorsed IFRS with certain possible modifications. (under development)

Editorial: Personal Update

I have not updated this blog for a while. After I have been quite busy and I have lost a backup email address due to some technical problem, I have been unable to access to the setting page. Recently, I finally succeed to change my setting, and I am here now.
I apologize to all of you who tried to post messages and comments. I just could not give any approval to post.
Since 2007, accounting standards in Japan has changed significantly. There are many stories that you might be interested in, including how Japan incorporates IFRS. I will try to update information posted in 2007, and upload new information as well.

News: ASBJ and IASB Met to Acheive Convergence

On October 2, 2007, the ASBJ and the IASB issued releases, stating that:

"At the meeting in London on 27 and 28 September 2007 members of the ASBJ and the IASB had two objectives. First, to review the convergence programme and the shared goal of eliminating major differences between IFRSs and Japanese GAAP by 2008, with the remaining differences being removed on or before 30 June 2011. And second, to discuss the arrangements for the ASBJ to input its views into the IASB’s current work programme..."

See the ASBJ's website or the IASB's website.

J-GAAP: Business Combinations

The Business Accounting Deliberation Council, the former public-sector standard-setting body in Japan, issued in October 2003 Accounting Standard for Business Combinations.

The Standard allows entities to select the purchase method and the pooling-of-interest method, depending on the economic substance of business combinations.

If a business combination is qualified as a "purchase transaction," the purchase method should be applied; otherwise, the combination is categorized as "uniting of interests," and the pooling-of-interest method should be applied. Relative ownerships of shareholders of combining entities should be essentially the same, in order to categorize the combination as "uniting of interests." Quantitative threshold is set forth; i.e., 55% v. 45% merger can be accounted for by the pooling-of-interest method. So, business combinations that are categorized as "uniting of interests" would be very rare in practice.

Under the purchase method, an acquiring entity must be identified. Assets and liabilities of the acquired entity should be measured at fair value as of the agreement date. Any excess of acquisition cost over the net assets of the acquired entity should be recognized as goodwill. Goodwill should be amortized over the useful lives but no more than 20 years. If goodwill is impaired, impairment loss should be recognized.

In-process research and development costs of the acquired entity should be recognized, and immediately charged to expense. Restructuring provisions may be recognized when certain criteria are satisfied, but should be written off within 5 years. Any negative goodwill should be amortized over no more than 20 years.

Under the pooling-of-interest method, assets, liabilities, and components of equity of the combining entities should be carried forward as if those entities are merged into without adjustments to book values. No goodwill is recognized.

IFRS No. 3 and SFAS No. 141 eliminated the pooling-of-interest method as an alternative for accounting for business combinations. Those standards also prohibit amortization of goodwill. In those respects, Japanese GAAP for business combinations is different.

Editorial: Academic Perspective in Japan

In Japan, academic community has been heavily involved in the process of standard-setting. Influences of academic community is relatively significant in Japan.

Major schools in academics generally states as follows:

• The asset and liability approach is not only one approach to determining elements of financial statements. The revenue and expense approach is still needed. Information about inflow and outflow is primarily useful for investors' decision making. Investors would form their own expectation on the entity's future cash flows based on such information. Matching, allocation, and realization are still important in accounting.
• Net income is more useful than comprehensive income. Changes in fair value of certain assets and liabilities would deteriorate usefulness of income. Investors generally favor a sustainable concept of income rather than volatile concept of income. Empirical evidences generally support this view. Net income also should be determined as such attributable to common shareholders.
• Fair value accounting should not be applied to non-financial assets and liabilities, and even to financial instruments whose fair value is not readily determinable. Internally generated goodwill should not be recognized because such goodwill is the management's own assertion and is not verifiable.

Editorial: Nikkei Discusses Convergence

During September 6-8, 2007, Nikkei Newspaper discussed convergence of Japanese accounting standards with IASB standards in its series of articles.

Nikkei described in detail how Tokyo Agreement announced on August 8, 2007 was reached. It reported that Chairman Tweedie of the IASB recommended that Japanese companies should have an option to adopt IFRS as an alternative set of acceptable standards for the purpose of preparation of their financial statements that are filed with the Financial Services Agency in Japan. Such initiative was not included in the final agreement, but the next issue became clear.

One of the issues that would be revisited under the agreement is accounting for goodwill. The existing Japanese GAAP requires companies to amortize goodwill that are recognized when the purchase accounting is applied to certain business combinations. Amortization is widely accepted in Japan, mainly because amortization is tax-deductible when companies amortize goodwill in their accounting statements. Prohibiting amortization by accounting standards would require negotiation with tax authority.

Another is performance reporting. Japanese standard setter has repeatedly insisted that net income is necessary to provide information about entity's sustainable financial performance. Nikkei says that on international arena, comprehensive income, which is defined as net change in shareholders' equity, is focused as primary performance indicator. Especially, Japanese companies do not want to include changes in fair value of investments in the periodic net income, which is sometimes boosted by cherry picking unrealized gains on the investments. Comprehensive income is not affected by such practice, because realized and unrealized income is included in it regardless of whether the investment is selectively sold. Business community says that net income (realized income) still should be disclosed even when comprehensive income is disclosed.

Anyway, Tokyo Agreement was announced. Standard-setting process is moving toward international convergence. Recently, the ASBJ issued two exposure drafts on construction contracts and segment reporting, which are essentially the same as IASB standards.

News: ASBJ Issues Exposure Draft on Segment Reporting

On October 4, 2007, the Accounting Standards Board of Japan (ASBJ) issued an exposure draft on segment reporting. The exposure draft is part of the ASBJ's effort toward convergence with IASB standards. Commend period ends on October 19, 2007.

The existing standards on segment reporting requires entities to disclose information disaggregated by business activities and geography. "Risk and reward" approach is adopted.

The ASBJ newly adopted the "management approach," where operating segments are identified based on how the entity is managed internally. An operating segment is defined as a component of entity:

• That relates to operating activities that earn revenues and incur expenses.
• That is reviewed by chief operating decision makers for resource allocation and performance valuation.
• For which, separate financial information is obtainable.

Reportable segments are identified as one or more operating segments. Operating segments are aggregated based on similarities of activities. Certain quantitative criteria should be applied when determining reportable segments.

Information that is required to be disclosed includes:

• Segment profit (or loss) and segment assets (mandatory).
• Segment liabilities, when reviewed regularly by chief operating decision maker.
• External sales, inter-segment sales or transfers, depreciation and amortization, interest income and expenses, proportionate shares of affiliates' income, extraordinary gains and losses, income taxes, and other material non-cash items, when included in segment profit and reviewed regularly by chief operating decision maker.
• Investments in affiliates, additions to tangible and intangible assets, when included in segment assets and reviewed regularly by chief operating decision maker.

Related disclosures are required for each segment as follows:

• Information about goods and services.
• Information about geography.
• Information about major customers.

Impairment losses and amortization of goodwill should be disclosed for each segment regardless of whether they are included in segment profit.

J-GAAP: Balance Sheet

In Japan, balance sheet displays entity's assets, liabilities, and net assets.

Assets should be categorized into current assets, fixed assets, and deferred charges. Liabilities should be categorized into current liabilities and fixed liabilities.

Assets used for discontinued operations are not separated from other assets.

Net assets includes shareholders' equity, remeasurement and translation adjustments (other comprehensive income), minority interest, and stock options and warrants. Shareholders' equity is comprised of stated capital, additional paid-in capital, retained earnings, and treasury shares.

Generally, line items are specifically identified by FSA's regulations. Comparative information for only one prior fiscal year should be disclosed.

News: Exposure Draft on Construction Contracts

On August 30, 2007, the Accounting Standards Board of Japan (ASBJ) issued an exposure draft, which proposes accounting for construction contracts.

The long-lived, existing standards allows constructors to account for construction contracts based on either of "completion method" and "percentage-of-completion method".

Completion method, which is based on a narrower concept of realization, had been widely used in practice, but recently most major constructors are said to have alreadly changed their accounting policies to percentage-of-completion method.

ASBJ's proposed standards would require entities to identify which contracts should be accounted for by percentage-of-completion method. Total revenues and costs must be measurable with reliability. Percentage of completion also must be measurable with reliability. Other unqualified contracts should be accounted for by completion method.

The exposure draft is part of ASBJ/IASB convergence project. The proposed standards would eliminate one of major differences between Japanese GAAP and IASB standards.

Comment period will end on October 1, 2007.

J-GAAP: Income Statement

Display of income statements is specified by Accounting Principles for Business Enterprises.

Income statements are based on "all-inclusive" concepts, in which all gains and losses are included in the statements. General format of income statements is shown as follows:

Sales
Cost of goods sold
--Sales margin
Selling and administrative expenses
--Operating profit
Non-operating (financing) revenues
Non-operating (financing) expenses
--Ordinary profit
Extraordinary gains
Extraordinary losses
--Pre-tax net income
Income taxes--current
Income taxes--deferred
--Net income

Extraordinary gains and losses are generally defined as non-recurring gains and losses and prior-period adjustments. In Japan, retrospective restatement is not allowed in practice.

Extraordinary losses appear to show a rapid increase recently, which include various restructuring or impairment losses. In financial statement analysis, ordinary profit has been deemed as somewhat sustainable income. Entities tend to include more extraordinary losses to boost ordinary profits in future periods.

Discontinued operations are not segregated from continued operations.

Comprehensive income is not displayed elsewhere in financial statements. Changes in components of remeasurement adjustments (other comprehensive income) is displayed on a net or gross basis in statement of changes in net assets.

Currently (as of September 2007), accounting changes are under deliberation toward convergence with IASB standards. Retrospective restatements and prospective adjustments would be required, depending on characteristics of accounting changes.

News: Tokyo Agreement on Convergence

On August 8, 2007, the Accounting Standards Board of Japan (ASBJ) and the International Accounting Standards Board officially announced "Tokyo Agreement" on convergence of accounting standards.

More specifically, major differences between Japanese GAAP and IFRS would be eliminated by 2008, and the remaining differences would be eliminated on or before June 30, 2011.

For their press releases, please visit the web sites of the boards.

• http://www.asb.or.jp/html_e/asbj/pressrelease/pressrelease_20070808_e.php
• http://www.iasb.org/News/Press+Releases/The+ASBJ+and+the+IASB+announce+Tokyo+Agreement+on+achieving+convergence+of+accounting+standards+by+2.htm

News: ASBJ to Agree Convergence Toward 2011

On August 4, 2007, Nikkei Newspaper reported that the Accounting Standards Board of Japan (ASBJ) and the International Accounting Standards Board (IASB) agreed, in major respects, that the ASBJ will work on eliminating all of the existing differences between Japanese GAAP and IFRS by 2011. Nikkei says that the agreement would be announced next week.

More specifically, one of the major differences between two standards is accounting for business combinations. Japanese GAAP requires entities that either the purchase method or the pooling-of-interest method be applied depending on the economic substance of such transactions. If a business combination is judged as “uniting of interest” as a result of applying the specific criteria, the pooling-of-interest method should be applied; otherwise, the transaction is deemed as “acquisition of other entity,” to which the purchase method should be applied. Moreover, any goodwill recognized as a result of applying the purchase method should be amortized over no more than 20 years.

Nikkei reported that the ASBJ is expected to eliminate the pooling-of-interest method from the alternatives, and prohibit amortization of goodwill, as required by IFRS and U.S. GAAP.

J-GAAP: Deferred Charges

On August 11, 2006, the Accounting Standards Board of Japan (ASBJ) issued its Practice Bulletin No. 19, Tentative Treatment on Deferred Charges.

The Commercial Code and its Regulation on Corporate Accounts had long been specified what items are allowed to be carried as deferred charges on the company’s balance sheet. However, the Company Act, which was enacted in May 2006, states that deferred charges may be carried as assets if the generally accepted accounting principles recognizes that such charges are appropriate to be carried as assets. So, the ASBJ was expected to issue some interpretation on deferred charges.

Practice Bulleting 19 carried forward from the previously promulgated accounting requirements of the Commercial Code. It identifies 5 types of deferred charges: founding cost, start-up cost, development cost, stock issuance cost, and debt issuance cost.

Generally, those costs should be charged to expense when incurred. However, those costs have some contributions to future earnings. Based on the “matching” principle, those costs are allowed to be deferred and carried as assets on the balance sheet unless they are expected to have no contributions to future earnings. If a company defers such costs, those costs should be amortized consistently over the predetermined period.

Founding cost and start-up costs are defined as costs that incur when a company is founded and under start-up activities for business. Those costs may be deferred, and, if so, should be amortized over no more than 5 years.

Development cost is defined as cost that incurs when a company is doing activities related to restructuring for adopting new organization, research for entering new market, and exploration for new resources. It should be noted that “research and development costs,” which are mandatorily charged to expense when incurred, are not included in the “development cost,” which is allowed to be deferred. If such cost is deferred, it should be amortized over no more than 5 years.

Stock issuance cost is defined as cost that incurs when a company issues new stock or resells treasury stock for the purpose of financing. Such cost may be deferred, and, if so, should be amortized over no more than 5 years.

Debt issuance cost is defined as cost that incurs when debt securities are issued. Such cost may be deferred, and, if so, should be amortized over the periods to maturity.

J-GAAP: Conceptual Framework

Overview

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:

http://www.asb.or.jp/html_e/asbj/begriff/ConceptualFramework200612.pdf.

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.

J-GAAP: Financial Instruments

General

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.

Measurement

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.

Derivatives

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.

J-GAAP: Intangible Assets

In Japan, the BADC issued Accounting Standard for Research and Development Costs in 1998. The Standard states that research and development costs should be charged to expense immediately when they are paid. This treatment is identical to that of U.S. GAAP. IAS 38 (1998), Intangible Assets, requires that research costs must be charged to expense immediately, but that development costs can be recognized as assets if certain criteria are met. Software production costs are recognized in Japan, depending on how the software will be used, unless they meet the definition of research and development costs.

IAS 38 and Japanese GAAP both require that intangible assets must be amortized over their useful lives and must be reviewed as to whether they are impaired when events indicated that any impairment might exist for such assets. In Japan, useful lives for amortization of intangible assets that are prescribed by tax laws are generally used for financial reporting purposes as well.