FINANCIAL INSTRUMENTS

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2 FINANCIAL INSTRUMENTS

3 Financial Instruments While the EBC notes many similarities between the accounting standards of financial instruments under IFRS and J-GAAP, there is one area where further alignment is recommended. Under J-GAAP, certain securities such as non-listed equity securities are generally recognised at historical cost. The EBC recommends that all investments in equity securities be measured at fair value, as in IFRS. Changes in fair value would be recognised in Other Comprehensive Income for investments not held for trading, similar to the debt securities under J-GAAP and the available-for-sale category under IFRS.

4 Financial Instruments A comprehensive analysis should also consider new accounting guidance under IFRS 9. The EBC believes that the valuation of all securities at fair value improves the relevance and transparency of financial statements, providing stakeholders with an assessment of investment decisions of management in deploying the balance sheet. By aligning the accounting treatment under J-GAAP with IFRS, the EBC expects efficiency gains for issuers of financial statements who need to prepare financial statements under both regimes. The EBC notes that the recently published exposure draft regarding Japanese Modified IFRS does not seek an exemption for the measurement of investments in equity instruments.

5 Financial Instruments RECOMMENDATION Japan should align J-GAAP with IFRS to require all equity investments to be accounted for at fair value.

6 GOODWILL

7 Goodwill J-GAAP and IFRS differ significantly in the guidance provided on how to account for goodwill arising in a business combination. While IFRS mandates the impairment-only approach, J-GAAP requires amortisation over a maximum period of 20 years if the goodwill amount is not negligible, and otherwise no impairment is required. The impairment-only approach has led to substantial criticism in Europe, with goodwill growing to significant amounts, as it opens the door to potential earnings management.

8 Goodwill It remains to be seen if the standard setter for IFRS, the IASB, will yield to this criticism and revert to systematic amortisation. The EBC appreciates the arguments that can be made to support both views and advocates that the ASBJ should work closely with the IASB to come to a position that results in alignment of J-GAAP and IFRS in this area. RECOMMENDATION The ASBJ should revisit the conceptual and practical merits of alternative subsequent accounting methods for goodwill and work closely with the IASB to resolve the issue on a global basis.

9 VACATION ACCRUALS

10 Vacation Accruals IFRS requires vacation accruals to be recognised. J-GAAP does not, partly due to the labour market s low rate of vacation usage in Japan and the fact that such entitlements are generally not paid out when the employee leaves. IFRS requires an entity to recognise vacation accruals because a liability is created when an employee has provided service in exchange for employee benefits to be paid at a later date and an expense is incurred when the entity consumes the economic benefits from services provided by an employee. RECOMMENDATION Japan should require recognition of vacation accruals under J-GAAP.

11 PROPERTY, PLANT & EQUIPMENT (PPE)

12 Property, Plant & Equipment (PPE) Many companies use tax regulation to determine residual value and useful life of PPE for J-GAAP reporting. Depreciation methods must be reasonable and applied systematically every year. In practice, a significant number of J-GAAP filers use the double-declining method, which avoids reconciling differences between financial and tax reporting and generally achieves greater tax deductions in earlier years. However, it creates differences with IFRS, which generally prohibits using this method as default and uses residual life and useful life assumptions that reflect usage patterns rather than tax tables.

13 Property, Plant & Equipment (PPE) The EBC recommends the IFRS approach to provide readers of financial statements with a more accurate reflection of usage patterns and related costs, and enable companies to maintain existing tax advantages, even if this results in a new reconciling item with tax reporting. RECOMMENDATION Japan should align accounting for PPE under J-GAAP with IFRS while considering implications for taxation.