About Integration to IFRS

We are now seeing the movement towards integration of accounting standards of each country to IFRS (International Financial Reporting Standards) for which we have a mixture of supporting and opposing arguments in Japan. The supporting argument stresses the need to improve the possibility of international comparability as well by standardizing the criteria to measure the financial conditions of companies and their business performance, as borderless management is being developed along with the globalization of businesses. The opposing argument, on the other hand, argues that given the difference in laws, culture, history, and the like of each country, it will not result in appropriate standards if the integrated standards are imposed without due regard to such differences. Currently, Japan does not force the adoption of the IFRS on all companies, but instead companies can adopt the IFRS voluntarily. In fact, approximately 20 companies have introduced the IFRS. On the other hand, Japanese accounting standards have been revised in the direction of convergence with, or becoming similar to the IFRS as necessary; and therefore, major differences with the IFRS are disappearing.

Goal of the IFRS

The IFRS aims to establish singular and high-quality accounting standards, in order to be the common world accounting standards. “High quality” means that it can reflect the actual situation of business as accurately as possible. To begin with, accounting is a system not merely for calculating the money but also for showing economic activities; various stakeholders make decisions looking at the financial statements (financial reports) prepared based on accounting, and as a result, economic resources will be distributed rationally. Under such an ideal, the IASB (International Accounting Standards Board) is tackling development and revision of the IFRS. By the way, what does it mean to show the “actual situation of businesses”? As a familiar example, I will discuss “depreciation.”

Significance of Depreciation from the Accounting Point of View

Depreciation is a phenomenon where an economic value as economic resources (the stock) is gradually consumed with the use of noncurrent assets and expensed as the flow; and the accounting methods to show it are depreciation methods. Specifically, there are the straight-line method, which has a certain amount as the expense for every period; the declining-balance method, which has a certain ratio of the book balance as the expense; and the units-of-production method which recognizes expenses according to the used amount. In any case, the acquisition cost, which is recognized as the stock, is established at first, and then the depreciation cost for each period is calculated and accounted by estimating the useful life or the total usable amount and the residual value or by other methods.

The significance of depreciation in accounting is to appropriately calculate profits and losses for the period by selecting one of the above accounting methods, applying it regularly and continuously, and recording the depreciation cost. The basis for such explanation is the dynamic accounting of the German school, which is recently also called the Revenue-and-Expense View from the viewpoint of the U.S. accounting conceptual framework.

By the way, while contributing to an appropriate calculation of profits and losses for the period through an appropriate calculation of cost allocation, does the resulting book balance represent the value as assets in the balance sheets? As for such a question, the traditional dynamic accounting or the Revenue-and-Expense View considers it sufficient to record the balance as the result of regular and continuous calculations, as the main purpose of accounting is to ensure an appropriate profit and loss calculation, and balance sheets are expected to function as the “Connecting Link.”

Counter to this argument, there is increasing support to respect the raison d’être of balance sheets that appropriately represent financial conditions, showing their assets, liabilities, and net assets (the capital) properly. This is called the Asset-and-Liability View, as opposed to the Revenue-and-Expense View, which is often stressed as the thinking underlying IFRS and the U.S. accounting standards. This is an approach to pay attention to the stock (amount of assets) rather than the flow (increase/decrease of resources), which appears to be more reflected in the recognition of lease and option transactions on balance, the measurement of the fair value of financial products, impairment accounting, and the like. As for depreciation, in the extreme, it could lead to a conclusion that it should be enough to measure the balance of noncurrent assets at fair value at the end of the period (the stock) rather than to calculate the continuous decrease of resources (the flow); however, this argument has not gained much support yet.

As a matter of fact, the IFRS does not allow voluntary selection and application from the several depreciation methods, but it requires the selection of the method that best reflects the pattern of consuming the economic value of said noncurrent assets. In the case of large-scale fixed facilities, if it can be divided into several important components, there is the provision for the component accounting to depreciate depending on their useful life, separately. Even the useful life is an estimate at best; and it is therefore required to be reviewed at the end of every period taking into consideration not only the physical useful life but also economic one, in order to reflect the reality of business through these detailed rules. In other words, it is the thinking that in order for the balance of assets (the stock) at the end of the period to represent the financial conditions well, it is necessary to record the depreciation cost as the flow, and therefore, combining the end-of-period balance with the understanding of the expenses during the period, the actual business conditions are appropriately shown.

Response to IFRS

There often is a tendency to regard the thinking of the IFRS and the U.S. accounting standards as all but the Asset-and-Liability View, with the slogan “From the Revenue-and-Expense View to Asset-and-Liability View” walking alone; in reality, however, we should understand it as an attempt to formulate an accounting method that reflects the actual business conditions more accurately. We should understand this point, regardless of whether we are for or against the move towards integration to the IFRS. In any case, since business itself has become globalized and borderless, we need to develop standards to refine the accounting method to reflect the actual business conditions. Japanese standard-setters are also expected to actively participate in this activity, utilizing their experience and accumulation so far, while academics contribute by proposing their academic findings as well.