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.