2012/SOM2/EC/021 Agenda Item: 6 The Situation and Issues Faced by IFRS Purpose: Information Submitted by: Japan Second Economic Committee Meeting Kazan, Russia 30-31 May 2012
APEC Economic Committee / IFRS Roundtable The Situation and Issues Faced by IFRS May 30, 2012 Japan Ministry of Economy, Trade and Industry(METI) Nobuyuki Hiratsuka 1. ABAC Initiatives Until Now With the understanding that one should consider shared issues and accounting standards effects on economics and management towards IFRS introduction, ABAC summarized IFRS related items among the recommendations to the 2010 and 2011 summits. These recommend the necessity of establishing a task force which conducts studies on smooth introduction of IFRS, sufficiently investigates effects on economies and management, and becomes a forum for discussions. IFRS Related Part in Recommendations to APEC Summit (Excerpt) (2010) ABAC supports the G20 s initiatives to achieve a single set of high quality, global accounting standards. It believes that the introduction of robust common accounting standards such as International Financial Reporting Standards (IFRS) would enhance further development of capital markets in the APEC region, and promote sustainable economic growth. Nonetheless, various elements of IFRS should be studied to minimize cyclical effects on private sector economic activities. The studies should focus on impacts of accounting policies on the real economy and management of companies... In addition, the APEC region should commit itself to make effective contributions to the global discussions on the accounting standards.... Establish a task force to discuss studies on smooth introduction of IFRS to ensure appropriate communication among the International Accounting Standards Board (IASB), APEC and ABAC. IFRS Related Part in Recommendations to APEC Summit (Excerpt) (2011) Despite there being overall support for implementation of IFRS, many private sector organizations have their concerns. As pointed out last year, ABAC has concerns on some of the newly proposed accounting standards, including fair value measurement (IFRS 7 and IAS 39) and pension (IAS 19) given they may have significant impact on companies Profit and Loss statements. In addition, the proposed changes on lease accounting (IAS 17) may have potential business and economic impact, such as on the availability of financing for SMEs. During the implementation of IFRS, it is important to examine the economic and business impact of the accounting standards, so that the economies are activated as a whole.... Establish a task force to discuss studies on smooth introduction of IFRS to ensure appropriate communication among IASB, FASB, APEC and ABAC. Undertake an impact study on certain provisions, such as those related to lease financing and insurance contracts noted above, and make suitable adjustments, to avoid negative business and economic impact. Continue to encourage a dialogue between business groups and IASB/FASB on ways that would align IFRS principles with the interests of SMEs and other business groups, such as insurance companies, that will be affected. Adoption by economies of IFRS should take into account ways of satisfactorily dealing with the concerns raised by business groups. 1
2. International Conditions Surrounding IFRS G20 Situation The G20 reconfirmed the achieving of a single set of high quality global accounting standards which was in the Final Declaration of the Cannes Summit held in November 2011, and it fostered awareness about issues concerning completion of the project for convergence of accounting standards of the International Accounting Standards Board (IASB) and Financial Accounting Standards Board (FASB) (MOU item) and completion of the proposal for reform of the IASB governance framework. Until now, the G20 announced a summit declaration which aims at a single set of high quality global accounting standards for each economy. Currently, while maintaining the goal of a single set of high quality global accounting standards, completion of the IASB and FASB accounting standards convergence project is now becoming an issue. Also, regarding completion of the IASB and FASB accounting standards convergence project, standards should be announced by mid-2013, extending the previous deadline which was the end of 2011. Seoul Summit Declaration Excerpt (November 2010) We re-emphasized the importance we place on achieving a single set of improved high quality global accounting standards and called on the International Accounting Standards Board and the Financial Accounting Standards Board to complete their convergence project by the end of 2011. Cannes Summit Final Declaration Excerpt (November 2011) We reaffirm our objective to achieve a single set of high quality global accounting standards and meet the objectives set at the London summit in April 2009, notably as regards the improvement of standards for the valuation of financial instruments. We call on the IASB and the FASB to complete their convergence project and look forward to a progress report at the Finance Ministers and Central Bank governors meeting in April 2012. We look forward to the completion of proposals to reform the IASB governance framework. Finance Ministers and Central Bank Governors Meeting, Communiqué Excerpt (April 2012) We support... the efforts of the IASB and FASB to achieve convergence to a globally accepted set of high quality accounting standards and urge them to meet their target of issuing standards on key convergence projects by mid-2013, at the latest, in order to achieve a single set of high quality international accounting standards IASB Governance Regarding governance of IASB, each economy has opinions on the issue of ensuring transparency of standard setting. Based on each economy s opinions on this issue, IASB announced a draft due process this May which ensures setting standards while considering the effects on economic activities in each economy and region. 2 3. Japan s Achievements toward IFRS (1) Japan supports the objective to achieve a single set of high quality global accounting standards (G20 Cannes Summit Final Declaration). Japan has already converged, and obtained EU equivalency assessment in December 2008. Also, since March 2010, Japan approved voluntary application of IFRS (with no carve out items), and companies that want to list on a market in the EU can voluntarily apply IFRS and list on the market. EU Equivalency Assessment In August 2007, the Accounting Standards Board of Japan and the IASB announced their agreement to accelerate the convergence by eliminating major differences between Japanese GAAP and IFRS by 2008, and the remaining differences before the end of 2011. The Japanese authorities do not require any reconciliation for Community issuers which prepare their financial statements according to IFRS. Therefore, it is appropriate to consider Japanese GAAP equivalent to adopted IFRS from 1 January 2009. (Commission regulation (EC) No. 1289/2008 of 12 December 2008) 3
3. Japan s Achievements toward IFRS (2) ~ Recent Discussions of Business Accounting Council ~ In Japan, industry, labor, investors, academia and government related people meet together in this council to discuss and obtain agreement among related parties about awareness of issues such as the necessity of verifying cost/benefits in application of IFRS. Way to Proceed in Discussions and Investigations of the Business Accounting Council In the Business Accounting Council, in deliberation of international accounting standards, instead of limiting these to technical discussions of accounting standards, it will be appropriate to more broadly consider issues such as accounting standards effects on economic activities of diverse companies including unlisted companies and small and medium enterprises, and surrounding systems such as tax law, Companies Act, various industry regulations, and financial and capital markets, then sort these issues out, and discuss and investigate while showing a systematic path. While also considering overseas initiatives, it may be appropriate to proceed with discussions and investigations using overseas inspections to accurately understand the international situation, broadly listening to opinions of related parties, and carefully and sufficiently investing time, according to the actual status and current status without preconceptions, including by academic study. Each economy s handling of international accounting standards is changing in response to conditions. Among these, it is important to form strategic considerations and a grand design based on Japan s public interest, regarding what kind of character Japan s standards currently have, international positioning, how Japanese companies and financial and capital markets should be, and what kind of accounting standards would be appropriate for these. Main Topics which Must be Studied Currently Approach of Japan s accounting standards and disclosure system Analysis of conditions and diplomatic policies of foreign economies, and international requests Approach of accounting which contributes to economic activities Effects of principle-based accounting Effects on regulatory environment (industrial regulations, public procurement regulations), contracts environment, etc. Effects on and approach to handling unlisted companies, small and medium companies Communication between investors and companies Handling in accounting firms Investigation of voluntary application Approach of the domestic accounting standards setting body (ASBJ) Governance of the international accounting standards setting body (IASB) 4 4. Specific Examples of IFRS Issues for Economic Activities 1. Net income is a very important index of economic activities. There are concerns that IFRS changes properties of net income. Net income will continue to be a useful index of business results, so shouldn t results of company conduct be properly reflected? 2. Introducing fair value measurement causes greater fluctuations in business results, and especially during economic recessions it causes much worse results. We must avoid having estimates of fair value measurement creating greater fluctuations in business results and economic cycles. We must carefully study the scope to which fair value measusrement should apply. Aiming at continuous value creation and stable business results also leads to encouragement of stable investment. 3. There are also opinions that there are effects of changes in business practices of agriculture (agriculture accounting) and the marine shipping industry (lease accounting), and effects on communication between companies and investors due to greater disclosure volume. 5
4. IFRS Issues for Economic Activities (1) Importance of Net Income Financial accounting aims to report the company s economic activities to interested parties such as investors and creditors who provide capital to the company. It is a tool for communication between the company and interested parties. Under accounting, as part of communication between the company and interested parties, there is the Income Statement which calculates the income the company earned in one year and shows business results, and the Balance Sheet which shows the current status of assets and liabilities. As part of communication between the company and interested parties, measurement of the company s performance is very important. Instead of forecasts, there is a need to measure actual income compared to investment. Income Statement (Revenues) Sales Dividends received Gain on sale of securities etc. (Expenses) Cost of sales Personnel expense Interest expense etc. Net income (Assets) Assets Cash Accounts receivable Securities Facilities etc. Balance Sheet (Liabilities) Accounts payable Borrowings (Shareholders equity) Equity Profit carried forward 6 4. IFRS Issues for Economic Activities (2) Change in Properties of Net Income due to IFRS For net income, one expects provision of information on actual results at the point in time when there is no longer uncertainty of results expected from investments. This is also considered an important index for the company which prepares the information, and investors who use it. On the other hand, IFRS emphasizes comprehensive income. This includes price fluctuations of assets etc., at the stage when results which are the aims of investment are not yet certain. Therefore, comprehensive income is not a comprehensive business results index which replaces net income. Also, IFRS has the problem that there are items not reflected in net income, even at a point in time when there is no longer uncertainty of results expected from investment. For company management, net income is a most important business results measured value concerning sustainable activities of the company. This index shows results of management efforts, and it should continue to be used. When certain assets are sold, even if there is revenue such as a cash payment, this is not deemed as revenue which comprises net income. Statement of comprehensive income (Revenues) Sales Dividends received etc. (Expenses) Cost of sales Personnel expense Interest expense etc. Net income Other comprehensive income Records changes in amounts of assets etc. due to market changes. Even for assets without market prices of investments in unquoted entity instruments etc., the company s estimates are used to calculate asset prices, and the changed amount is recorded. For foreign currency translation of assets and liabilities of foreign subsidiaries, the change amount is recorded. Change in properties of Comprehensive income net income 7
(Reference) Foreign economies Understanding of Issues Australia has mandatory application since 2005 of Australian standards (same as IFRS) which passed through an approval process. On the other hand, companies concerned about the usefulness of income indices of IFRS have increasingly moved to disclose another index (basic income). In response, the Australian Securities & Investment Commission issued a warning in July 2010, and announced a draft regulation (disclosure guidance) in March 2011. New Zealand s comments on the agenda consultation mentioned an increase in companies which disclose alternative business results indices (Non-GAAP indices) in financial statements. It commented on the need for a response to the view that IFRS financial statements cannot reflect companies business results. In Korea, application of IFRS has been mandatory since 2011. Accordingly, operating income was no longer disclosed, and there were concerns about a decline in usefulness for investors. Thus it imposed the obligation to disclose operating income in a note to income statements. Also in Europe, company performance and net income are recognized as most important items (Jérôme Haas, President of the French Accounting Standards Authority). Status in Australia (as of December 2010) Analysis of the June 2010 year end financial statements of the top 30 companies listed in Australia showed that 20 of these companies disclose alternative indices such as basic income. This income based on alternative indices was a total A$14.8 billion (approximately 1.2 trillion yen) greater than the legally determined income (income based on IFRS) of these 20 companies. 85% of companies prepare tables of adjustments to legally determined income. (Source) Institute of Chartered Accountants in Australia Essential Guidance for the December 2010 reporting season Australian Securities & Investment Commission Guidance (Draft) Outline Strictly limits the disclosure of financial information not based on accounting standards For alternative income indices including basic income etc., the method of disclosure differs depending on the company, so comparability between companies is lost. This is sometimes used as a way to eliminate the effects of bad news. Financial information not based on accounting standards, such as alternative income indices including basic income, gives a sincere and fair appearance, so only in exceptional cases which require disclosure, only disclosing the information in notes is allowed. Documents related to financial reports clearly explain how financial information not based on accounting standards was calculated. 8 4. IFRS Issues for Economic Activities (3) Effects of Fair Value Accounting In measurement of assets and liabilities, fair value is the market price for items which have a market price; for items which have no market price, the present value of future revenues and expenses which the object will generate is measured by estimated calculation. That fluctuating price is reflected in the income statement, which is a business results index. There are concerns that with assessment by estimation, market price declines or worse company results can bring worse future estimations resulting in even worse income, which could amplify business results fluctuations and the economic cycle, which would inevitably impair company conduct which aims at continual value creation. There may be very large effects on company results during a financial crisis. Effects on business results fluctuations and economic cycle amplitude Exacerbates the amplitude of business results fluctuations due to economic cycle changes FY2003 FY2004 FY2005 FY2006 FY2007 FY2008 FY2009 Nikkei: right scale Net income Comprehensive income (Source) Kunio ITO Significance, Effects and Issues of Comprehensive Income Disclosure, Company Accounting, March 2011 Edition (Japanese language) 9
4. IFRS Issues for Economic Activities (4) Effects of Fair Value Accounting ~ Unlisted Shares, Agriculture Accounting Fair value of unlisted shares Agriculture Accounting (Fair value of palm trees) Investments in unquoted equity instruments without market prices are assessed using future economic forecasts, etc., and their fluctuating values are reflected in the income statement which shows business results. Is it OK to use uncertain estimate information to comprise business results? At the stage of planting palm trees, earnings are generated in the company. This is done so at the stage of planting palm trees, the present value future earnings to be generated by those palm trees are reflected as current earnings. Does recording earnings in an accounting year without actual sales reflect the actual state of company economics? Also, in forecasts of future market conditions, won t unrestricted arbitrariness arise in recording earnings? Emerging markets strongly request that IASB revise standards for items especially related to Asia, Latin America, the Middle East and Africa, such as agriculture, inflation and Islamic Sharia law. Especially Malaysia s palm oil manufacturing companies point out that fair value measurement of palm trees without planned sale is unnatural and misleading, and the time spent to calculate fair value is wasteful. (Financial Times article, April 1, 2011). (Source) Lecture materials, Professor Tomo SUZUKI, University of Oxford 10 5. Summary: Toward achievements for developing IFRS As the economy globalizes, and company development and capital raising increasingly extend across borders, international harmonization of accounting standards is becoming increasingly important. In discussions about internationalization of accounting systems, in addition to financial policy, it is important to look from the viewpoints of economic and industrial policy and create proper content, instead of merely considering harmonization and unification of accounting standards as the goals. IFRS impacts on economics and business differ in each economy due to different business models and industrial structures. Solution methods also differ in each economy, because there are differences in domestic economic environments. On the other hand, from the viewpoint of properly developing industry which supports growth and the economy, many problems faced due to IFRS can be shared among economies. For example, from the viewpoint of effects on economic activities, many economies are conscious about maintaining the new income concept. While aiming to achieve high quality global accounting standards, IFRS not only has issues in finance, but also the economic issue of the need to contribute to more stable growth of the global economy. Therefore, while each economy strives to conform to internationalization of accounting standards, it must understand how accounting standards affect the economy and company activities, and introduce accounting standards with true merits in accordance with the real economy. Opinions on issues pointed out by ABAC are steadily becoming accepted by accounting standards setting bodies and regulatory authorities. As pointed out by industry etc., in order to achieve smooth internationalization of accounting standards, there are matters which can be shared regarding how they affect economic activities, despite differences in each economy s domestic systems. Especially the APEC region has shared interests as a production zone in a globalized world. In the case of Japan, IFRS is not only an issue for financial institutions; it is also an issue for manufacturing industry and other parts of the real economy. They are also linked with the Asia Pacific region via relations with many overseas subsidiaries and supply chains. For these industries, for recovery of the global economy, there is a need to contribute to more stable growth. Therefore, we must develop a business environment for investment to expand R&D activities and business activities to solve problems of global warming and other global scale problems, and to maintain employment. Intensive cooperation to foster innovative growth is part of 2012 APEC s priority challenges in Russian year. It is important to strongly consider the relation to this, study how accounting standards (IFRS) which are essential to society s infrastructures for appropriate corporation value evaluation, could affect this growth, and work to foster and share awareness of issues concerning IFRS in a forum for government level economic discussions like in APEC, and have the government and private sector follow up on IFRS issues in cooperation with ABAC. 11