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.
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.
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.
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.
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.
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.
In IAS 37 (1998), Provisions, Contingent Liabilities and Contingent Assets, provisions are built on the definitions of liabilities. Uncertainty in amount and timing of future cash outflows involves recognition of provisions. The definition of provisions includes constructive obligations as well as legal obligations.
In Japan, recognition criteria for provisions were set forth based on the revenue and expense view. This approach allows entities to recognize liabilities that are not legal obligations, such as provisions for bad debt loans and provisions for future asset-maintenance expenditures. Japanese GAAP sets forth the following criteria; (a) future outflows of cash and other resources are identified, (b) the outflows occur as a result of the events during current or past accounting periods, (c) it is probable that such outflows occur, and (d) the outflows are measurable with reliability. Those criteria are generally consistent with recognition criteria prescribed by IAS 37.
If it is not probable that future outflows of resources occur, contingent liabilities are not recognized under Japanese GAAP. Such treatment is not inconsistent with IAS 37, which states that a contingent liability is not recognized if future outflow of resources is not probable to occur or if it is not measurable with reliability. However, interpretation about “probability” criterion in both standards does not look similar. Japanese GAAP generally requires that it must be “highly probable,” as literally translated in English so as to be recognized in the balance sheet.
