To: International Accounting Standards Board (IASB)
Subcommittee on Corporate Accounting
Committee on Financial and Capital Markets
Keidanren
We appreciate the opportunity to submit public comments on Equity Method of Accounting—IAS 28 Investments in Associates and Joint Ventures (hereinafter, the "Exposure Draft"). Our comments are as follows:
General Remarks
We understand that the original purpose of the Exposure Draft was to resolve practical issues relating to the application of IAS 28 without fundamentally reviewing the equity method.
However, the Exposure Draft as actually published includes proposals that clearly do fundamentally review the equity method. For example, it includes a proposal to treat obtaining significant influence the same as obtaining control of a subsidiary (Question 1) and a proposal not to eliminate unrealized profits and losses resulting from transactions with an associate (Question 4).
Given that the proposals do in effect fundamentally review the equity method, this Exposure Draft should have been published by means of a thorough process employing a discussion paper. The approach adopted by the IASB in publishing this Exposure Draft is inappropriate: although it is in effect undertaking a fundamental review, the accounting standard will end up being altered by means of a simplified process. We are extremely concerned about this situation.
Specific Remarks
Question 1
We disagree with the proposals. They make no distinction between accounting for conversion of a company into a consolidated subsidiary—which uses fair value measurement taking the point at which control was obtained as a major change in circumstances—and accounting for obtaining significant influence under the equity method. In this respect, the proposals do represent a fundamental review of the equity method and we suspect that they may also not represent answers to the application questions. We are concerned that a simplified process has been used to make proposals such as these.
Question 2
We disagree with the proposals. Our reasons are similar to those given in our response to Question 1.
Question 3
(a)
We agree with the proposal not to require a catch up adjustment. Considering that additional investment is undertaken with an expectation of recovering the investment through future profitability, requiring an investor to take on unrealized losses originating in past events all at once when making an investment is inconsistent with the reality of investment. Furthermore, if catch up adjustments were to be required, even a company with a promising future could be excluded as an investee merely because of excess liabilities. We are concerned that this could lead to waning appetite for investment in promising startups and the like.
However, we propose that a catch up adjustment should be allowed in specific circumstances. For example, if an investor makes an additional investment to compensate for the losses of a company with excess liabilities, there may be instances in which making a catch up adjustment would better represent the financial reality in the financial statements. We therefore propose that, rather than imposing a blanket ban on catch up adjustments, they should be allowed in specific circumstances.
(b)
We disagree with the proposal.
Paragraph 38 of the current IAS 28 and paragraph 45(b) of the Exposure Draft stipulate that after a net investment has been reduced to nil, no additional losses should be recognized. Accordingly, we believe that stakeholders (preparers and users of financial statements) generally understand that, in cases where a net investment has been reduced to nil, no additional losses are recognized; that is to say, no additional net losses are recognized.
In contrast, however, paragraph 52 of the Exposure Draft proposes requiring the recognition of net losses up to the amount of other comprehensive income, which could cause considerable confusion among stakeholders.
Furthermore, items within other comprehensive income can increase or decrease due to factors that entities cannot control such as market price, so we are concerned that net profit or loss could end up fluctuating unnecessarily.
Question 4
We strongly disagree with the proposal.
Accounting for transactions with associates has always been closely connected to the debate regarding the nature of equity method investment (i.e., whether it is a one-line consolidation or a measurement method), so setting that debate aside to fundamentally revise the standard is inappropriate as an approach. In specific terms, it would be consistent for profits or losses relating to transactions with an associate to be partially recognized if taking the one-line consolidation view, and to be recognized in full if taking the measurement method view. Thus, we have serious reservations about fundamentally altering the standard from partial recognition to full recognition as it risks implying in effect that equity method investment is by nature a measurement method.
Many Japanese entities consider profits and losses under the equity method to be part of their business profits and losses. For example, when Japanese entities operate businesses overseas via joint ventures, they often end up using the equity method in their actual accounting for such businesses. From the entity's perspective, it invests human resources and undertakes equity method investment as an actual business, so there is a deeply rooted belief that to ensure consistency with the financial reality, profits and losses under the equity method should be considered part of business profits and losses. For many entities that undertake equity method investment as a business it would be completely impossible to accept what is proposed in the Exposure Draft because it would result in a wider discrepancy between the accounting treatment and the financial reality.
In addition, investment in an associate enables significant influence in the investee to be retained, so recognition of gains or losses relating to transactions between associates in full allows scope for profit manipulation through improper adjustment of the price of a transaction between associates, which could undermine sound investment activities and fair business activities.
The requirements of IFRS 10 and IAS 28 are not so totally inconsistent that the current IAS 28 needs to be fundamentally negated. Specifically, IFRS 10 requires that profit or loss be recognized in full for transactions in which a subsidiary becomes an associate, but this does not necessarily negate the partial recognition approach of IAS 28 for other transactions with associates. In fact, the legitimacy of using the provision in IFRS 10 to fundamentally negate the provision in IAS 28 regarding all transactions with associates is extremely doubtful. It is possible to resolve the inconsistency between the two by, for example, making adherence to IAS 28 the general principle for transactions with associates, but prioritizing IFRS 10 for transactions in which a subsidiary becomes an associate.
It is extremely problematic that, although the IASB is avoiding substantial alteration of the standard, it is at the same time making the current efforts to address issues by increasing disclosure requirements, while also making piecemeal attempts to substantially alter the standard easily in the form of answers to the application questions, as is the case with this proposal.
Question 5
(b)
We strongly disagree with the proposal.
If "significant or prolonged" is removed, a temporary decline in the fair value below the carrying amount at even one single point during the fiscal year would be regarded as an indicator of impairment, regardless of the fair value at the end of the fiscal year, giving rise to the need for an impairment test. Given that fair values (stock prices) are affected not only by a company's performance and prospects, but also by a variety of other factors, treating a temporary decline as an indicator of impairment would end up increasing expenditure for impairment tests unnecessarily. The reasons for removing this phrase are unconvincing, considering the significant practical impact of its removal.
However, if the phrase "significant or prolonged" is to be removed, we would like the IASB to consider adding a proviso in the form of a phrase such as "excluding temporary or insignificant declines."
(c)
As the current IAS 28 does not clearly define the unit of accounting for fair value measurement of investments in associates, we believe an issue arises in determining whether objective evidence of impairment exists when investments are made at a price that includes a premium on top of the market price of a stock. Specifically, whether the target of the fair value measurement is considered to be an individual stock or an entire investment (equity in the business) can affect whether a premium should be added to the market price of a stock during fair value measurement. This could affect determination of whether objective evidence of impairment exists. The Exposure Draft does not specifically mention this point, so even if the accounting treatment proposed in the Exposure Draft is applied, fair value measurement relating to investments in associates in the above cases is still unclear, and the issue regarding application of IAS 28 remains unresolved. We would therefore like the IASB to clarify how this should be handled.
In this regard, we believe that the unit for measurement of fair value should be the entire investment (equity in the business) including the premium, given that investments in associates are generally business investments by nature, and IAS 28 stipulates that the premium (an amount equivalent to goodwill) should be recorded as an asset. If the unit for measurement was an individual stock, the market price of the stock would be the fair value, so even if there was no change in the external operating environment or the company's circumstances, an investment in an associate including a premium on top of the market price would give rise to objective evidence of impairment immediately following acquisition. This is also inconsistent with the provision in paragraph 41A of IAS 28 that objective evidence of impairment must be as a result of one or more events that occurred after the initial recognition of the net investment, and it is therefore inappropriate.
Accordingly, we would like the IASB to consider making it clear within the standard that fair value measurement relating to investments in associates should be undertaken for the entire investment including the premium.
Question 7—Disclosure requirements
(b)
We disagree with the proposal. As stated in our response to Question 4—Transactions with associates, we oppose any alterations to accounting treatment, so we disagree with this disclosure requirement resulting from amendment of the accounting treatment.
(d)
We disagree with the proposal.
IFRS 12 already requires disclosures that include carrying amounts, net profits or losses from continuing operations, and other comprehensive income categorized by joint venture or associate. Therefore, the benefits to the users of financial statements of adding a new requirement for disclosure of a reconciliation between the opening and closing carrying amounts would not be worth the costs for the preparers of statements.
Question 8—Disclosure requirements for eligible subsidiaries
(b)
We disagree with the proposal. Our reason for disagreeing is similar to the one stated in our response to Question 7(b).