Corporations around the world are upgrading their accounting systems to accommodate the growing diversity and complexity of transactions and the globalization of business activity and capital markets. Their efforts include adopting internationally accepted guidelines for accounting practices and principles.
In Japan, a series of reforms in accounting guidelines has brought Japanese corporations largely into compliance with internationally accepted accounting standards. And representatives of corporations, accounting firms, and government agencies are working on ways to resolve the remaining differences between Japanese and international standards. However, Japanese business, for the most part, has failed to win wide international acceptance for its financial disclosure. Independent auditors continue to append stern implicit warnings to the English-language financial statements of Japanese corporations about insufficient and inadequate disclosure.
Japanese can and should make their financial disclosure more convincing. We can do that by visibly strengthening our framework for establishing sound accounting standards. At the same time, we should do more than simply comply passively with international trends in accounting standards. We should identify shared Japanese concerns about issues of financial disclosure and voice those concerns actively in the international debate about appropriate standards.
Information about corporations' business results and financial condition furnishes investors with a basis for making investment decisions. Equally important, it furnishes the corporations' managements with crucial tools for steering their companies. Investors and managements thus share a powerful interest in establishing a common basis for making financial comparisons among corporations., They have embraced several reforms, such as "mark-to-market" valuation for salable property assets and securities holdings, to support that comparability. Corporate circumstances vary widely, however, and unifying disclosure practices arbitrarily can be counterproductive. Corporations need to retain sufficient latitude to adapt the presentation of their financial results to their individual circumstances. Likewise, continuity in accounting practices is important in monitoring trends in corporations' business performance and financial condition. That importance should be a consideration in drafting any changes in accounting guidelines. Corporate managements, meanwhile, need to honor the spirit of disclosure, as well as complying with the basic guidelines. They need to come to terms with accurate and ample financial disclosure as a core management responsibility.
Changes in accounting standards can have a big effect on corporate behavior. A good example is the dissolution of longstanding cross-shareholdings among Japanese corporations. That trend is due partly to the adoption of mark-to-market accounting for securities holdings. Any consideration of changes in accounting standards should include measures to publicize the substance of the proposed. Changes and the likely effect on corporate activity.
And the schedule for implementing changes should provide corporations with ample time to prepare for the changes. That preparation time is especially important as accounting standards become increasingly complex and specialized.
Based on the perspective outlined above, we propose the following improvements in corporate accounting systems in Japan.
Different purposes underlie the laws and regulations that the Japanese government has enacted for securities transactions, general commerce, and taxation. And repeated revisions have broadened the gap in orientation between those three sets of laws and regulations. Japan needs to reduce the internal inconsistencies in its three-legged regulatory framework by making the following changes.
The relationship between the Securities and Exchange Law and the Commercial Code
The relationship of the Securities and Exchange Law, the Commercial Code, and the Tax Code
The government should review traditional accounting practices prescribed by the Tax Code. It also should consider revising the Corporate Income Tax Code.
The procedural burden of financial disclosure has increased dramatically in recent years. That is largely on account of the demand for prompter announcements of business and financial results and for fuller disclosure. Corporations that list their shares overseas and otherwise globalize their fund raising undertake additional procedural burdens. In June, Japan will begin a stepwise introduction of electronic disclosure. That will help streamline the work of financial disclosure. But the following measures also are necessary.
Content of kessantanshin disclosure forms
Simplifying the disclosure requirements for the kessantanshin disclosure forms will help corporations respond better to investors' demand for prompter disclosure. The market participants should consider eliminating the requirement for disclosing financial projections in discussion on kessantanshin. They also should give careful consideration to the need for quarterly disclosure and to the appropriate format for such disclosure.
Avoid obliging corporations to prepare separate sets of financial statements under domestic and foreign standards
Japanese corporations that prepare financial statements under International Accounting Standards or U.S. Accounting Standards need to prepare separate sets of statements under domestic accounting standards. That is confusing for investors and a procedural burden for the companies. Japanese authorities should modify their systems to accept financial statements prepared under U.S. accounting standards or International Accounting Standards.
Unify disclosure systems internationally
Efforts are under way through the International Organization of Securities Commissions (IOSCO) to promote cooperation among regulatory authorities in different nations, to foster convergence among different nations' accounting standards and International Accounting Standards, and to secure international consistency in financial disclosure. Japan should participate actively in those efforts.
The Japanese Ministry of Finance's Board of Examiners of Certified Public Accountants issued a report in June 2000 about improving the quality of audits and revising the system of examinations for earning certified public accountant qualifications. In that report, the board called for taking measures as soon as possible to improve the quality of audits and to increase the population of certified public accountants. We agree with the board's proposals, as summarized below.
Improve the quality of audits
In the interest of ensuring audits of higher quality and greater independence, define the role of accountants clearly in the Certified Public Accountants Law, mandate a program of continuing professional education for accountants, require periodic renewal of accountants' professional qualifications, and require accounting firms to rotate the partners assigned to clients periodically. Raise efficiency in auditing by promoting closer coordination between the independent auditors and the corporations' statutory auditors.
Increase the population of certified public accountants
Japan has about 13,000 certified public accountants, which is an insufficient number to provide a sound infrastructure for a modern capital market. We need a lot more certified public accountants to accommodate the broadening range of corporations and local governments that require auditing by certified public accountants and to meet the growing need for accountants in work besides auditing.
We recommend the following measures to improve Japanese accounting for the impairment of fixed assets.
Signs of impairment
The criteria for signs of impairment should focus narrowly on pronounced deterioration in the recoverability of assets that results from conspicuous change in the way the assets are used, from withdrawal from the line of business in which the assets were used, and from equally compelling factors. Sharp declines in the value of individual assets should not, by themselves, qualify as impairment.
Units for determining impairment
Asset grouping for purposes of determining impairment should be on the basis of consolidated accounting and other corporate circumstances.
Methods for evaluating recoverable amounts
The guidelines for evaluating recoverable amounts define fair value, with due consideration to calculated cost and to feasibility.
Fair value accounting for investment property
The International Accounting Standards provide for recording investment property at fair value. Japan, however, should defer adopting that principle for the time being. Real estate assets are far less liquid than securities and thus require special consideration.
Timing for implementing reforms
The timing of implementing reforms should provide ample time for corporations to come to terms with the revised guidelines and to make the necessary preparations.
Accounting standards need to address the issues presented by the corporate realignments that are transforming Japanese industry. Consideration of appropriate standards should include careful analysis of the different kinds of mergers and acquisitions that occur in Japan. Lots of mergers of equals take place, for example, that warrant application of the pooling of interests method. Some business combinations are clearly acquisitions, however and call for application of the purchase method. Consideration of standards for corporate realignments also should address the issue of whether to treat companies on a consolidated or nonconsolidated basis. Collective control by and of affiliated companies is another issue that requires careful consideration.
Japanese auditing standards receive criticism for their alleged lack of adequate guidelines for evaluating corporation's viability as going concerns. That lack, according to the criticisms, diminishes the international credibility of Japanese audits. In fact, auditors have the latitude under Japan's standards to express concerns about corporations' viability as going concerns. Any standardization of standards for evaluating that viability can and should take place in the framework of established practices.
Japanese schedules for the depreciation of fixed assets center on arbitrary guidelines prescribed by the Tax Code. We need to develop depreciation schedules that reflect the ways the assets are actually used.
Legislators are preparing to pass a bill in the present session of the Diet to reform the nation's system of corporate pension plans. The reforms include a measure to allow for returning to the Public Pension Insurance program the portion of pension plan assets that has been managed under the Employees' Pension Fund framework. That measure calls for immediate consideration in regard to its implications for procedural guidelines and for descriptions of pension plan funding that appear the notes to corporations' financial statements.
Theoretical consideration of recording all financial instruments at fair value is under way. That extension of fair value accounting would entail several problems for investors and other users of corporations' financial statements. It would make profit and loss statements more difficult to interpret as indicators of corporations' profitability. This issue calls for a thoroughgoing debate that transcends the simplistic assumption that fair value accounting is always best. Japanese should adopt that perspective in dealing with the Joint Working Group that is considering across-the-board application of fair value accounting.
Corporations should not need to record stock options at fair value and treat them as a cost. That would impose an unnecessary burden on profitability, especially at start-up companies. It thus would prevent the system of stock options from fulfilling its natural and intended role in promoting entrepreneurship.
Organizational measures are absolutely essential to accomplishing the necessary reforms in Japan's accounting systems and to amplifying Japan's voice in international discussion of accounting standards. Those measures need to include the creation of group led by the private sector to establish accounting guidelines.
The Business Accounting Council has prepared a set of accounting standards for corporate accounting, and the Japanese Institute of Certified Public Accountants has prepared a set of practical guidelines. People and companies who operate in the marketplace need to take part in adapting those standards and guidelines to market realities. We need to have a smooth transition to the new framework.