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The ABCs of International Financial Reporting Standards (IFRS)

Kenichi Akiba
Professor, Graduate School of Accountancy, Waseda University

An increasing number of listed companies in Japan are adopting international accounting standards. Officially, it is called the International Financial Reporting Standards, IFRS, which is pronounced: ɑɪfɑ́ːrs, or ɑɪ-ef-ɑɪ-es. This time I will briefly explain what accounting standards are and what IFRS is.

What are accounting standards?

When investing in stocks, we need financial information to analyze companies. Companies look different, however, depending on the accounting standards that they use. Companies prepare financial statements to provide the stakeholders with information as to the status of funds raised from stockholders and creditors and how they have been managed. Financial statements of listed companies consist of the Balance Sheet (B/S) and the Statement of Profit and Loss (P/L), and also of the Statement of Changes in Net Assets, the Statement of Cash Flows and Notes.

Depending on what accounting standards are used in preparing them, the financial statements represent the different financial status and performance of companies. For example, when are sales are recorded as goods are sold? Some may think that the company concludes the sales contract. Others may think that the goods are shipped, or the receivable is collected. They happen at the same time in cases like sales at the supermarket, but it needs to be discussed when to record sales for such cases as where it takes a long time before the completion of construction, or where it takes a long time to collect the payment for installment sales.

As seen above, if financial statements are prepared based on different standards, we will have different monetary information, and more specifically, accounting information for corporate analysis, including net sales, net income, total assets, and net assets. Accordingly, “Accounting Standards” are established as the rules for preparing financial statements.

Establishment and Utilization of IFRS

In Japan, accounting standards have been developed in conjunction with the legislation, including the Financial Instruments and Exchange Act and the Companies Act. Similarly, in the U.S. and U.K., the respective accounting standards have been developed and utilized. With the globalization of capital markets, however, we began to see movements to internationally harmonize accounting standards adopted by individual countries in the 1990s. They were established by the non-permanent International Accounting Standards Committee (IASC), which was composed of professional accountants’ institutions until 2001. Later, however, they came to be set by a permanent body located in London, the International Accounting Standards Board (IASB), consisting of not only professional accountants but also the preparers of financial statements, investors as their users, and others.

IFRS has been used in Europe and Australia since around 2005, and now it is said to be adopted by more than 120 countries. The IASB is a private group in terms of financial resources and personnel, and thus the introduction and enforcement of IFRS are left to the legislation of each country and jurisdiction. In Japan, voluntary application of IFRS has been accepted since the fiscal year ended March 2010. Right now it is required to make consolidated financial statements of listed companies in Japan in accordance to one of the following accounting standards:

  • Japanese accounting standards established by a private sector, the Accounting Standards Board of Japan (ASBJ);
  • U.S. accounting standards (adopted by about 30 companies, including Sony Corporation and Toyota Motor Corporation); or
  • IFRS (adopted by about 40 companies, including Sumitomo Corporation and Japan Tobacco Inc.).

As the advantages of voluntary application of IFRS, it can be said that listing in overseas markets and diversified fund-raising become possible. Even if not listed in overseas markets, expected effects include attracting global investors by improving the international comparability of financial statements. Furthermore, it is also pointed out as advantageous that IFRS application will make the financial reporting process more efficient as well as improve management control for the whole consolidated group including overseas subsidiaries. However, quite a few companies do not feel the need to use IFRS because they have been accessed by overseas investors despite being listed in Japan, IFRS and management control are inherently different things, and so on.

Characteristics of the IFRS

As its characteristics, IFRS is sometimes said to be a principle-based approach. This is due to the fact that while accounting standards in Japan and the U.S. comprise numerous rules and include a considerable number of specific guidance and numerical criteria, IFRS establishes the principles and gives only minimum guidance. It is a relative matter as to whether a principle-based approach or not, however, and IFRS is more detailed and includes more guidance in some areas.

Moreover, it is sometimes said that IFRS is characteristic in its emphasis on assets and liabilities rather than profits and losses during the period. In addition, it is sometimes pointed out as well that IFRS is characteristic in measuring the fair value rather than the historical cost. Sure enough, for securities which are marketable and held for the purpose of trading, market-to-market valuation is also used in Japan as the fair value shows their expected value and its movements indicate its performance. On the contrary, IFRS as well as accounting standards in Japan does not measure the fair value and record its difference as profit and loss either, however, when it comes to inventory and fixed assets whose value differs depending on how companies utilize them in their business as well as borrowings and corporate bonds issued to raise their funds.

While Japanese accounting standards are revised toward convergence with IFRS, many Japanese companies do not adopt IFRS currently. One of the reasons might be indefinite how IFRS regards its usefulness to users, and therefore, how it will be revised, based on what thinking. If Japan’s proactive comments are reflected and we have a clearer prospect for IFRS, more companies in Japan will adopt IFRS.

Kenichi Akiba
Professor, Graduate School of Accountancy, Waseda University

[Profile]

Professor Akiba graduated from Faculty of Business Administration, Yokohama National University. He registered as a Certified Public Accountant in 1989, and became Representative Partner at Asahi Audit Corporation (now, KPMG AZSA LLC), and Technical Director at Accounting Standards Board of Japan (ASBJ) before assuming the current position in 2009. Currently, he is a member of the Examinations Committee at Security Analysts Association of Japan (2005-), an examiner for Certified Public Accountants Examination (2009-), and a special member of the Working Group, Planning and Coordination Committee, Business Accounting Council (2013-). His major publications include The Essential IFRS (3rd edition) [Essensyaru IFRS (Dai 3 han)] (Chuokeizai-Sha, 2014) and How to Read Accounting Standards: 100 Q&A [Kaikei-kijun no Yomikata Q&A100] (Chuokeizai-Sha, 2014).