Institutions and accounting standard transformation: Observations from Japan

Naohiro U rasaki

Faculty of Business Administration,KinkiUniversity,Japan

Institutions and accounting standard transformation: Observations from Japan

Naohiro U rasaki*

Faculty of Business Administration,KinkiUniversity,Japan

A R T IC L E I N F O

Article history:

Received 11 M arch 2013

A ccep ted 12 October 2013

Availab le online 27 January 2014

Single setof accounting standards IFRS

Financial instruments

Substance over form

Fair value

D ichotom y of accounting system s Accounting standards for SM Es

This paper describes the transformation o f Japan’s accounting standards over the past 2 decades and the driving forces behind this transformation.It also analyzes the current state of Japan’s accounting standards,which are characterized by the dichotomy o f accounting systems inherited from the country’s po litical,econom ic and legal institutions.The discussion in this paper em phasizes that a single set o f accounting standards is not always ef ective for every entity.

?2014 Production and hosting by Elsevier B.V.on behalf o f China Journalof Accounting Research.Founded by Sun Yat-sen University and City University o f Hong Kong.

1.Introduction

Theeconom ic downturn that began in 1991 after the co llapseo f the Japanese Asset Price Bubble is referred to as the Lost10 years,a period thathasalso been thought to extend to the recent decade(2001–2010).During these 2 decades,Japanese accounting systems d rastically changed to help restart the Japanese economy based on government po licy.The necessity o f the fnancial system reform is emphasized in the Financial System Reform(M inistry o f Finance,1997)report as follows.

“In the‘aging’society of the 21st century,in o rder to ensu re the con tinuation o f Japan’s econom ic vitality,it is necessary to fnd a more ef cient way o f investing private assets which reach up to 1200 trillion yen.It is important to p rovide funds for the developing industries that carry the com ing era on their shou lders.Further,to make a contribution to international society commensurate w ith its econom ic strength,it is im perative that Japan provides a smooth supp ly of funds for the world.”1The fnancial system reform was initiated by Prime M inister Hashimo to in Novem ber 1996.The Securities and Exchange Council,the Business Accounting Council(BAC),the Financial System Research Council,the Insu rance Council and the Comm ittee on Foreign Exchangeand Other Transactionsbegan formulating a plan for reform measures to be com pleted by 2001.To promote the reform process asa unifed scheme,a“Financial System Reform Consultative Committee”consisting of representatives from each o f the councilswas set up to discuss the issues crossing each council’s scope(M inistry of Finance,1997).

W ith a view to reconstructing Japan’s fnancialm arkets to m ake them in ternationally com petitive and comparable w ith those in New York and London,the fnancial system was rapid ly refo rm ed acco rding to th ree principles:“free”to ensure a freem arket that im plemented market princip les,“fair”to ensure a transparent, trustworthy market and“global”to ensure an internationalmarket that was ahead of its time(M inistry o f Finance,1997).Transform ing the accounting standardswas a reform efortmade to regenerate the vitality of Japan’s fnancialmarkets.Due to this ef ort,Japan’s accounting standards are currently considered to be at a level sim ilar to those of theWest(Saito,2011).

This paper describes the transform ation o f Japan’s accounting standardsover the past 2 decades and the driving forcesbehind this transformation.It also analyzes the current state o f Japan’s accounting standards, which are characterized by the dichotomy o f accounting systems inherited from the country’s po litical,econom ic and legal institu tions.The discussion in this paper em phasizes that a single set of accoun ting standards is not always efective fo r every entity.

2.Efects of f nancial liberalization and globalization on the equity f nance of Japanese listed companies

The progress of fnancial liberalization and globalization since the 1980s has caused the f nancial service sector to develop rapid ly and,as a resu lt,the performance of the f nancial economy began to drive econom ic fuctuations thatwerepreviously d riven by the realeconomy(Ogawa and K itasaka,1998).Due to the circumstances characterizing the last20 yearsof the20th century,deregu lation o f the Japanese f nancialsystem changed the f nancing method o f Japanese listed com panies from indirect to direct.The deregulation policy previously described is cited as the Japanese version of the“Big Bang,”which was successfully conducted a decade earlier in the United K ingdom.The change that Japanese accoun ting system s have undergone since 1997 is comm only referred to as the“A ccounting Big Bang.”

Fig.1 dep icts the trends o f the f nancial assets,f nancial liabilities and equity ratios of com paniesacross 33 industries,excluding banks listed on the Tokyo Stock Exchange and the Osaka Stock Exchange from 1985 to 2001.2The repo rting periods fo r the com panies in the samp le end in M arch of each year.The samp le includes the fo llow ing fgures(year, sam ple/total number of listed companies,sam ple%):1985,961/1,864,51.6%;1986,993/1,922,51,7%;1987,1,089/2,015,54.0%;1988, 1,257/1,961,64.1%;1989,1,431/2,004,71.4%;1990,1,525/2,049,74.4%;1991,1,589/2,093,75.9%;1992,1,639/2,125,77.1%;1993,1,677/ 2,160,77.6%;1994,1,701/2,187,77.8%;1995,1,743/2,225,78.3%;1996,1,767/2,250,78.5%;1997,1,792/2,253,79.5%;1998,1,800/2,254, 79.8%;1999,1,804/2,254,80.0%;2000,1,804/2,254,80.0%;2001,1,807/2,255,80.1%.The equity ratio increased from 28.5%in 1985 to 42.2%in 2001.Consistentw ith this trend,the f nancial liabilities ratio decreased from 57.2%in 1985 to 45.9%in 2001.The upward change in the equity ratio refects thatmanagement choseequity f nance instead of debt f nance by considering themeritso f capitalcosts according to the circum stances of fnancial liberalization and globalization.

In addition to these trends,the fnancialassets ratio did not change signif cantly from 1985 to 2001.However,the ratio washigher than 56%during the period and reached 61.8%in 1990 during the bubb le economy. According to the relatively high ratio of fnancial assets to total assets of Japanese listed companies,the valuation o f fnancial assets was considered an im portant issue for investors to m ake in form ed econom ic decisions.The data d id no t include info rm ation on the app reciation o f m arketab le secu rities fo r trading purposes and investments in mutual-ho lding securities among business partners.Themore important issueswere the recognition andmeasurement of fnancial derivatives,3The turning poin t in the transformation o f Japanese accounting standards in to those relying on the substance-over-form princip lewas the issuance of accounting standards for fnancial instrum ents set by the BAC in 1999.The standards in troduced mark-to-market valuation with immediate prof t recognition for securitiesheld for trading,valuation w ithout immediate prof t recognition for those not held for trading,devaluation for loans receivables and hedge accounting procedures(Saito,2011,p.191).which fnancialperformance did not cover in the data due to a lack of accounting standards.Hence,investors did not have enough in formation related to the results of Japanese listed companies’f nancial risk management.

Figure 1.Trendso f fnancial assets,fnancial liabilities and equity ratios.Source:U rasaki,2002,cf.Chap ter 2.

Table 1 shows the fnancial ratios relevant to the f nancial assetsof Japanese listed companies in 1998 and 2001.4The 1998 ratioswere calculated based on the fnancial data of 1,800 listed com panies repo rted from April 1997 to M arch 1998.The ratios in 2001 were calcu lated based on the data o f 1807 listed com panies reported from April 2000 to M arch 2001.Industries were classifed according to the N ikkei Economic Electronic Databank System(NEEDS).The Business Accounting Council5The BAC isoneof the councilssetby the FinancialService Agency.It consistso fa Planning and Coordination Committee,an Internal Control Comm ittee and an Audit Comm ittee.Before organizing the Accounting Standards Board of Japan in 2001,the council p layed a m ajor ro le in setting accounting standards.The council cu rrently issues auditing and internal control standards.(BAC)issued accounting standards for fnancial instruments in 1999.These standards require com panies to m akem ark-to-m ark valuations o f certain securities and hedge accoun ting to ind icate their f nancial risk m anagem ent perfo rm ance for the repo rting period ending M arch 2001.

The securities held for trading purposesare classifed as current assets and requiremark-to-market valuationsw ith immediate p rof t recognition.The securities-held-for-trading ratio refers to the ratio of securities to total assets.This ratio indicates a remarkab le change from 1998 to 2001.The ratioso f every industry excep t for the communication industry decreased due to several factors.M anagementm ight have simply chosen not to indicate the app reciation o f their securities.Further,they could have been making an ef ort to avoid increases in their taxable incom e or contro l their reporting earnings.The pu lp and paper,rubber,steel,nonferrousm etals,shipbuilding andmarine transportation industries showed rate decreaseso f over 70%in 2001. To the contrary,investment securities classif ed asnon-current assets increase inmost industries.This change m eans thatm anagem en t inten tionally transferred securities classifed as cu rrent assets to non-curren t assets because the investm en t securities did not require app reciation by m ark-to-m arket valuation.

In addition to them anagementbehavior related to ho lding securities,theaverage rateof the fnancialassets ratio o f the 33 industries is 56.2%,and nearly 60%if real estate,gas,railway/bus and electricity rates are excluded.By com paring theaverage rateo f thedepreciab le tangibleassets ratio(17.1%)among the industries, the relative signif cance of the f nancial assets to total assets can be recognized.The fnancial assets ratioso falmost one third of industries reachesover 60%.Even in themanufacturing industry,some companiessuch as Sony Corporation and Panasonic have rates over 80%.For example,among the 137 companies in the electronic equipment industry,the rates of 48 companies(51.8%of 137)are over 70%,and the rates of 13 companies(9.5%of 137)are over 80%.

Table 1 Relevant fnancial ratios o f Japanese listed com pan ies in 1998 and 2001.Source:U rasaki,2002,cf.Chap ter 2.

In acco rdance w ith the f nancial statem ent data taken from Japanese listed com panies,fnancial asset valuation isbecom ing am ajo r issue form odern corporate accounting practices to recognize an entity’seconom ic substance.As previously described,the core p rinciples involved in recognizing and measuring traditional accounting standards6The accoun ting p rincip les fo r business en terprises were established in 1949.These accounting standardswere amended several times upon promulgations of the developm en t of the Japanese economy.However,the core concep ts related to income determ ination have not changed due to the consistency and durability of the logic upon which the accounting p rincip les are based.Takeda(2008)demonstrates systematically that these accounting principleswere built up as an accounting theory to determ ine a periodic income based on revenues and expenses,known as the revenue and expense approach.H e also clarif es that the accounting postu lates underpinning the accoun ting princip les could be constructed in three ways.are historical cost,realization and conservatism.In other words,the revenue and expense views o f income determ ination underpin traditional corporate accounting p ractices in Japan.

3.International convergence of Japanese GAAP

Saito(2011,p.191)pointsout that the historical costmethodmade dubiousaccounting practices possible, including themuch-criticized arbitrary realization o f capitalgains on securities,which were intended to camouf age business resu lts.In the 1990s,a lot of criticism was directed toward the inadequacy of the p rinciples involved in recognizing and measuring the f nancial instrumentsused in active fnancial risk management.In addition to this debate,two other direct factors stimu lated the standard setters to fx new rules for f nancial instruments:

(1)The deregulation po licy o f the Japanese governm en t related to the fnancial system since 1997.

(2)The external pressu re of harm onizing Japanese accoun ting standards w ith International Financial Reporting Standards(IFRSs)for cross-bo rder f nancing.

In January 1999,the BAC issued accounting standards for fnancial instrum ents.These standards became operative for fnancial statements covering periods beginning on or after Ap ril 1,2000.The standards for f nancial instruments require that securities held for trading purposes and derivatives should be measured at their fair valuesand that gainsand losses shou ld be recognized in fnancial statements.Review ing the recognition and measurement o f f nancial instruments,the standards introduced asset and liability views o f income determ ination into Japanese accounting p ractice.Them ilestones in the p rogress toward reporting f nancial instruments at fair value are indicated as follows.Table 2 summarizes themeasurement bases o f the fnancial instrum en ts.

·1985 JICPA,Accounting for Futures.

·1990 BAC,Opinion on Accounting Standards for Futures and Options Contracts.

·1996 Amendments o f Banking Law and Securities and Exchange Law,Requirements o f fair value accounting for trading securities held by fnancial institutions.

·1997 BAC,Issues on Accounting Standards for Financial Instrum ents.

·1998 BAC,Opinion on Setting o f Accounting Standards for Financial Instruments,ED.

·1999 BAC,Accounting Standards for Financial Instruments.

·2000 JICPA,Guidelines on Accounting for Financial Instruments.

Japanese GAAP cu rrently consists of accoun ting standards and im p lem en tation guidance on the accoun ting standards o r p ractical solutions issued by the A ccounting Standards Board o f Japan(ASBJ).The accounting and reporting standards also include the accoun ting standards set by the BAC(cf.footnote 5) and practicalguidelines issued by the Japanese Institute o f Certifed Public A ccountants(K oga and Yao,2011, p.3).The ASBJ is o rganized as a p rivate institution to m ake Japanese accoun ting standardsm ore consisten t with those of other major countries and thereby facilitate Japan’s participation in the IASB(Saito,2011, p.194).

Table 2 M easurement bases of fnancial instruments.

Table 3 List of A ccounting Standards of the Accounting Standards Board of Japan.Source:K oga and Yao,2011,pp.7–8,the ASBJwebsite (https://www.asb.or.jp/asb/top.do).

In the1990s,theComm ittee of European SecuritiesRegu lators comp leted itsequivalenceassessment of the Japanese GAAPw ith IFRSs in accordancew ith themandate o f the European Comm ission.The comm ittee proposed that the comm ission consider that Japanese GAAP could be assessed asequivalent to IFRS,subject to the remedies of additional disclosures(Koga and Yao,2011,p.6).In August 2007,the ASBJand IASB jointly announced the Tokyo Agreement to accelerate convergence between Japanese GAAP and IFRS. The agreement stated that the remaining dif erences wou ld be removed on or before June 30,2011(Koga and Yao,2011,p.6).

In Decem ber 2009,the Japanese Financial Service Agency revised the o rdinances to allow Japanese listed com panies satisfying certain criteria to p repare consolidated fnancial statem en ts acco rding to IFRS from their fscal years ending 31 M arch 2010.The ASBJand IASB agreed that they shou ld continue the convergence ef ort and estab lish a closer relationship.Hence,Japanese GAAP w ill continue being developing (K oga and Yao,2011,p.6).Tab le 3 presents a list of accounting standards released by the ASBJ.The accounting standard for fnancial instrum ents issued by the BAC in 1999 has been amended to the ASBJ accounting standard No.10.Table 4 shows a list o f the im plementation guidance on ASBJ accounting standards.

Table 4 L ist of imp lem entation guidance on A ccounting Standards from the A ccounting Standards Board of Japan.Source:K oga and Yao,2011, pp.8–10,the ASBJwebsite(https://www.asb.or.jp/asb/top.do).

4.Financial reporting and regulations

Governm en t and bu reaucratic dom inance and statu tory con trol are prim ary features of Japan’s corporate d isclosure regulations.7Bureaucratic dominance and statutory control over the regulation system are entirely consistentw ith and illustrative of the cu ltural characteristics of high power distance and high uncertainty avoidance.These characteristics are designed to remove amb igu ity and uncertainty from the regulation system.H ofstede(1984,p.159;2001,p.152)classifes Japan asa low individualistnation w ithmoderate to high levelsof power distance and high uncertainty avoidance.Japan’s ranking asa low individualist country is consistentw ith thew idely recognized“group consciousness”of Japanese society.Itsmoderate to high power distance is consistentw ith the importance of relative rank related to Japan’s f xed social positions and w ith the Japanese belief in themo ral basis o f government.These norms and values are realized in a greater levelof active invo lvementof the D iet(the Japanese Parliam ent)and bureaucracy in every area o f socialand econom ic policy formulation and administration in Japan com pared w ith Anglo-American nations(Harrison and M cK innon.1986.p.243).Itshigh uncertainty avoidance ranking is also broadly consistent w ith the pattern of interpersonal relations in Japan.Social order is clearly established and defned through group m em bership and rank.The country p laces an emphasis on particularistic relations rather than universal ethics,producing a very detailed set of situational codes of conduct that aremeticulously observed(M cK innon,1986,p.88).The responsibility for regulations vests in governm ental departm en ts,includ ing the M inistry o f Justice,theM inistry o f Financeand the Financial Service Agency,which separated from theM inistry o f Finance in 1998.The M inistry o f Justice regulates the disclosures of Japanese corporations through the 2005 Corporate Law,which was reformed from the Commercial Code 1899 as amended.The M inistry o f Finance regu lates disclosures through the 2001 Financial Instrumentsand Exchange Act thatwas promulgated by revising the Securities and Exchange Law 1947 as amended.The Act applies to every listed corporation.The Corporate Law and the Financial Instruments and Exchange Act are accompanied bym inisterial ordinances that specify disclosure requirements in detail.Through the Financial Instruments and Exchange Act,the Financial Service Agency also closely controls the operations o f the Japanese stock exchanges and licensed securities com panies.

Asalreadym entioned,corporate accounting and repo rting in Japan are tightly regulated by the Corporate Law,the Financial Instrumentsand Exchange Actand theCorporate Income Tax Law.Each Law has itsown purpose.The Corporate Law aims to protect the interests o f creditors due to shareholders’lim ited liability, and the Financial Instruments and Exchange Act seeks to p rotect the interests o f investors.The Corporate Income Tax Law purports to compute a fair taxation base in conjunction w ith national f scal po licies.

The follow ing three corporate accounting ob jectivesare comm only accep ted in light of the purposeso f the Act and Laws:

(1)to ascertain the degree to which the stewardship function o fmanagement is performed for business en tities;

(2)to com pute the d isposable incom e o f businessentities(an am oun t availab le fo r d ividends and corporate incom e tax)and

(3)to provide useful in formation for investment decision m aking by shareho lders and creditors.

The Corporate Law p rescribes ob jectives(1)and(2)for the purpose of creditor protection.The Financial Instrumentsand Exchange Act considersob jectives(1)and(3)important for investors.TheCorporate Income Tax Law follows objective(2).The Act and Laws imp lement specif c corporate accounting requirem ents to achieve their ob jectives.

Objective(2)is o f primary concern to shareho lders and managem ent in view of the grow th and development of business entities.However,the percentage of individual shareholders in the Japanese stock market has been relatively low due to the cross-ownership o f corporations and the power of institutional investors. Hence,m anagem ent attitudes toward disclosure have related to large institu tional investors.Consequently, the interests or in formational needs of investors,who do not have the authority to require business entities to obtain necessary in formation,are not always satisfed by these entities’disclosures.

Needless to say,oneo f thebasic conceptsbehind accounting ob jectives is the in fuence of accounting on the national economy.This concep t exists implicitly and persistently.It is specifed in the Financial Instruments and Exchange Act and the original 1949 proposal for setting the Business Accounting Principles,which state thataccounting standardsand lawsshou ld eventually contribute to the developmentof Japan’snationaleconomy asawhole.In the future,corporateaccounting and reporting in Japan w illbedeveloped to provideuseful in formation for them icroeconom ic investment decisionsm ade by shareholders and creditors.

Standard setting in Japan has also been dom inated by the governm ent.A ccounting standards are form ulated by the BAC,which isa deliberative councilattached to the Financial Service Agency.Rep resen tation on the BAC is broad,m ainly com prising representatives from Japanese academ ia,the Japanese Institute o f Certif ed Pub lic Accountants(JICPA),8The pro fession is relatively small(25,083CPAs for a population of 126m illion in Japan,January 2013)and prim arily engaged in audit, taxation and management consulting.The CPA Law grants the M inistry o f Finance jurisdiction over the examination,registration, deregistration and suspension of CPAs.the Japanese Stock Exchange and Keidanren(the rep resentative body of large corporations).However,as noted,the responsibility for setting accounting standards has been moved from a government body to a p rivate sector organization.A lthough some of the old accounting standards not shown in Tab le 3 are still ef ective,9Fo r exam p le,some of the standards include the Accounting Princip les for Business Enterprises and W orking Rules for Financial Statem ents,Foreign Currency Transactions,Im pairm ent o f Fixed Assets,Cash Flow Statem ents and Tax Efect A ccounting.the ASBJhas advanced many new accounting standards to rep lace theo ld standardsor amended some of theexisting standards to dealw ith new accounting eventsand converge with IFRS(Koga and Yao,2011,p.5).

As themanagerso f listed and unlisted stock companies,directorsare required to make accounting records of business transactions and prepare f nancial statements(referred to in the Law as“accounts,”i.e.,single fnancial statem ents,and“consolidated accounts,”i.e.,consolidated f nancial statem ents)in acco rdance w ith relevan t provisions of the Law.A rticle 431 of the Co rpo rate Law p rescribes that the accoun ting o f a stock com pany shallbe sub ject to businessaccounting p racticesgenerally accepted as fair and appropriate.Fu rther, A rticle 432 o f the Law adds the follow ing p rovision on accounting records:“a stock com panymust p repare accurate accounting books in a timely manner as prescribed by the applicable Ordinance of the M inistry ofJustice.”A rticle 3 o f the Ordinance on Company Accounting also p rescribes the fo llow ing:“W ith regard to the interpretation of terms and the application o f p rovisions set forth in the Ordinance,generally accepted corporate accounting standards and other accounting practices shall be taken into consideration.”

Figure 2.A ccounting comm unication and accountants’judgm ents.Source:Takeda(1982),cited from Fig.11.1,a framewo rk o f accountingmeasurement and communication.

Fig.2 depicts a framework of accounting communication and accountants’judgments.A change in environm ent fo r an entity would in fuence an accountant’sm otivation for choosing accounting po licies.Once an accoun tant decides to adop t a po licy on certain accoun ting issues that acco rdsw ith the relevance of available p rocedu res,they m ust con tinue to use reasonab le and appropriate accountingm ethods fo r the issues until the next certain change occursdue to emerging environmentalobstacles.The availab le p roceduresare included in the businessaccounting p racticesgenerally accep ted as fair and app rop riate,the generally accepted corporate accounting standardsand other accounting p racticesconsisting o faccounting standardsand guidance released by the BAC and ASBJas indicated in the p receding section.

As the managers of listed and unlisted stock companies,directorsmust prepare balance sheets,income statements,business reportsand supp lem entary schedulesevery f nancial year in accordancew ith the applicab leordinanceof theM inistry of Justice(A rticle435 of theCorporate Law).These f nancialstatementsmustbe audited by internalauditors in caseswhere the company hassuch auditors(A rticle436 o f theCorporate Law), and m ust also be audited by externalaud ito rs in caseswhere the com pany has such auditors(A rticle 436–2 o f the Corporate Law).Further,theymust be lodged at an annual generalmeeting to be held w ithin 3months fo llowing the balance sheet date(A rticle 437 of theCorporate Law),andmadepub licly available immediately fo llowing them eeting by newspapers and/or the company’swebsite.

5.Dichotomy of accounting systems

A longw ith theprogressof accounting standards convergingw ith IFRS,10Saito(2012,pp.192–194)briefy summarizes the backgrounds and objectives related to several accounting standards issued in the 1990s and 2000s,such as consolidated fnancial statem ents,fnancial instrum ents,im pairm ent o f long-term assets,em p loyee retirem ent benef ts and business com binations.the necessity of accounting standards for smallandmedium-sized entities(SM Es),including auditingmatters,hasbeen discussed since the late 1990s.The interests related tomost SMEmanagement common ly focuson how to compute taxable income to as little an am ount as possib le w ithin the app licable provisions of the Japanese Corpo rate Incom e Tax Law. Because owner-m anagers usually lack the suf cien t business accoun ting expertise and ability to calculate taxable incom e,Japanese tax accountan ts consult fo r SM Es and p lay an inevitable role in preparing and lodging their tax returns to the Japanese tax authorities.Further,owner-managers do not havemuch incentive for general purpose f nancial reporting due to their debt fnancing.In addition to these features,SM Es have no rigid internal control systems,and managers can easily override the systems.

In a sense,the owner-m anagers of SM Es do not have m uch need to app ly Big GAAP,as described in Table 3,which app ly to generalpurpose f nancial reporting and emphasize the transparency and comparability of the accounting in formation to inf uence investors’econom ic decisions.Focusing on the dif erences among such attributes,it is necessary to institutionalize the accounting standards that correspond w ith SM E characteristics.Hence,itwou ld be better to promu lgate accounting standards for SM Es than to app ly theaccounting standards to larger entities to imp rove thesocial reliability o f the fnancialstatementsprepared by SM Es.Such a philosophy underpins the institutionalization o f accounting for SM Es(Kawasaki,2012, p.10).Table 5 shows the progress o f the institutionalization o f accounting for SMEs in Japan.

A tan early stage in thediscussion,each pro fessionalbody had itsown politicalintent to expand itsbusiness opportunity,and each dif ered in its recognition of how to estab lish accoun ting standards for SM Es.These diferences brough t disorder to the discussion o f accounting institutionalization(K awasaki,2012,p.9).To resolve the confusion,the fou r interested groups(the Japanese Institu te o f Certif ed Public A ccountants, the Japan Federation o f Certifed Public Tax Accountants’Association,the Japan Chamber of Commerce and Industry and the Accounting Standards Board of Japan)pub lished the Accounting Guidance for SM Es in August 2005(JICPA/JFCPTAA/JCCI/ASBJ 2005,Takeda,2006).However,this“guidance”isnot generally adopted by Japanese SM Es(Kawasaki,2012,p.9.).

Kawasaki(2012)points out that the Small and M edium Enterprise Agency exam ined this situation and reorganized the Study G roup of Accounting for SM Es in February 2010,and that the Accounting Standards Board o f Japan installed the Con ference for the Accounting Standards for Unlisted Companies in M arch 2010.The former agency released a report entitled“The Interim Report of the Study Group for Accounting for SM Es”in Septem ber 2010,and the latter issued a report entitled“The Report of the Conference for the Accounting Standards for Unlisted Companies”in August 2010.Both reports conclude that new accounting rules shou ld be established for SMEs in Japan(the Small and M edium Enterp rise Agency,2010,pp.34–38).

In February 2011,the Small and M edium Enterprise Agency and the Financial Services Agency jointly installed the Review Comm ittee for Accounting for SM Es and itsW orking G roup.The Review Comm ittee released theexposured raftentitled“The Basic Accounting Guidelines for SM Es”and co llected public feedback (The Review Comm ittee for Accounting for SM Es,2011).A fter review ing comments on the draft,the comm ittee released“The Basic Accounting Guidelines for SM Es”in January 2012.

Fig.3 p resents the probabledichotomy of Japanese corporate accounting systems that hasoccurred during the current decade-long period o f accounting standard development.11The discussion in this section largely depends on a series of papers by T.K awasaki(Professor,Konan U niversity).The autho r acknow ledges his help ful comm ents and perm ission to use his quotations.Listed f rms and large entities are required to app ly Japanese GAAP and m ay choose to app ly U.S.GAAP,Pure-IFRS and Japanese-IFRS to be issued in com ing years.SM Es are able to choose the A ccoun ting Guidance for SM Es o r the Basic A ccounting Guidelines fo r SM Es.The form er ism ainly usefu l for com paniesw ith accoun ting adviso rs.Those companiesare relatively larger than other companies in termso f revenueand capitalsize.Therefore,the companiesw ith accounting advisorshave an incentive to apply the Accounting Guidance for SM Es,which are the standards simp lif ed from Big GAAP.

On the contrary,the Basic Accounting Guidelines for SM Es aremainly useful for comparatively smaller SM Es such asm icro entities.The prem ise o f these guidelines can be summarized into four points(Small and M edium Enterp rise Agency,2010,pp.22–23).

(1)The“Basic Guidelines”shallp rovide SMEmanagersw ith understandable ru les to properly contro l their businesses(i.e.,accounting useful for m anagem en t).

(2)The“Basic Guidelines”shall produce accoun ting in form ation that has necessary and suf cien t conten t to in form the credit decisionsm ade by fnancial institutions and the business trade(i.e.,accoun ting that o fers businessopportunitieswith stakeholders).

(3)The“Basic Guidelines”shallsustain the accounting that is compatiblew ith the tax accounting p ractices that are common among Japanese SM Es(i.e.,accounting that ref ects practices).

Table 5 Progress of the Institu tionalization of A ccounting for SM Es in Japan.Source:K awasaki,2012,p.8.

F igure 3.D ichotom y of Japanese corporate accounting system s.Source:K awasak i,2012,cf.Fig.1,fu ture shape of the A ccoun ting Institution in Japan,p.19.

(4)The“Basic Guidelines”shall lead approp riate accounting that does not require undue costs from the SMEs(i.e.,accounting that is feasib le for SM Es).

According to these prem ises,the Small and M edium Enterprise Agency p resented four basic po licies for creating accounting rules for SM Es(Small and M edium Enterp rise Agency,2010,pp.35–36).

(1)Theaccounting ru les shall ref ect accounting treatmentsmade in the SM Es’accounting practicesas conventions that include Corporate Income Tax Law and the BAC’s Accounting Principles for Business Enterprises.

(2)The accounting ru les shall include accoun ting standards that refect the broad d iferences in the SM Es’cu rrently accounting practices.

(3)The accoun ting ru les shall be easy to understand and sim p lif ed fo r SM E m anagers.

(4)The accounting ru les shall require SMEs to keep accounting records.

Such a dichotomy of accounting systemscan also be observed in China,K orea,U.K.and theU.S.in terms of the appropriateness of Big GAAP for SM Es,the cost/benef t of adop ting the standards and the lack o f managers’need for the standards according to the attributes of their businesses.

The Chinese M inistry of Finance issued accounting standards for small entities in 2011 and the standards are ef ective for fnancial years starting January 1,2013.The KASB developed the Korean Accounting Standards for Non-Pub lic Entities based on Korean GAAP w ith somem odif cations.Korean Accounting Standards for N on-Public Entities were pub lished in 2009.The KASB expects to converge its standards fo r non-public en tities w ith IFRS fo r SM Es over the long term.Unlisted com panies(w ith the excep tion o f fnancial institutionsand state-owned companies)can choose between fu ll IFRS and the Korean Accounting Standards for Non-Pub lic Entities.12

In the U.K.,the ASB pub lished an updated version o f the FinancialReporting Standard for Smaller Entities(FRSSE)in June 2008 to ref ect the changes in company law arising from the Companies Act 2006.No changes weremade to the GAAP-based requirements.The updated FRSSE(ef ective Ap ril 2008)applies to accounting periods beginning on or after Ap ril 6,2008,the date from which the accounting and reporting regimes for smaller companies in the Companies Act2006 becameefective.Because early adoption isnot perm itted,smaller companies shou ld continue to use the FRSSE(efective January 2007)to cover their earlier accounting periods.13h ttp://www.frc.org.uk/Ou r-W ork/Codes-Standards/A ccounting-and-Reporting-Policy/FRSSE.aspx.

In the U.S.,the FASB issued the d iscussion paper en titled“Private Company Decision-M ak ing Framework”in Ju ly 2012.It intended to develop a fram ework for evaluating the f nancial accounting and reporting guidance issued by the FASB and Private Com pany Council for p rivate companies(FASB,2012,cf.The purpose of this invitation to comment).The AICPA issued the exposure d raft entitled“Proposed Financial Reporting Framework for Small-and M edium-Sized Entities”in Novem ber 2012.According to the d raft(AICPA,2012, p.4.,cf.the o f cial version of the framework AICPA,2013),the FRF for SMEs is a self-contained,special purpose framework intended for use by privately held SMEs in p reparing their f nancial statements.The FRF for SM Es d raws on a blend o f traditional accounting and accrual income tax accounting methods.It isa less comp licated and less costly accounting framework for SM Es that do not require f nancial statements based on U.S.GAAP.

As Fig.3 show s,a com pany’s accounting practices are considered to com prise a system of know ledge fo rm ed by m anagem ent judgm en ts on business transactions.M anagem en t judgm en ts depend on corporate cultures14H ofstede defnes culture as“the collective p rogramm ing of the m ind wh ich distinguishes the member of one hum an group from another”(1984,p.21).He described the contentofmentalprogram sas values,wherea value is“a broad tendency to prefer certain states of afairs over others”(1984,p.14).Therefore,corporate cu lture can be considered as the co llective programm ing of the businessmind that distinguishes a mem ber of one business en tity from another.An institution is a kind of balanced and stab le value system(Takeda 1982).created th rough personal in teractions w ithin organizations.The m ost in fuential factor w ithin ano rganization is the owner-m anager’s personality.In a sense,the co rporate culturesof SM Esheavily depend on m anager behavior.Theowner-m anagerso f SM Esordinarily believe itunnecessary to account for external factors such as f nancial reporting.In the accounting sense,they tend to focus on the calculation of taxable income.

The preceding draft(AICPA,2012,p.4)emphasizes the fo llow ing points.Special purpose frameworks m ust be constructed to account for the needs,sizes and types o f entities in diverse econom ic settings.These frameworks,w ith theexcep tion o f the contractualbasiso faccounting,are commonly referred to asother comp rehensive bases o f accounting(OCBOA)in the United States.Special purpose frameworks include cash-, m odif ed-cash-,tax-,regulatory-and contractual-based accounting frameworksam ong others,and use a definite set of logical,reasonable criteria that app lies to everym aterial item appearing in the f nancial statem ents.

There have been m ovem ents to set nationally unique accoun ting standards fo r SM Es.Nationalaccounting standardshave been converged w ith IFRS to fo rm single setsof high quality,understandable,enforceab le and globally accepted fnancial reporting standards w ith clearly articulated princip les(IFRS Foundation,2013, para.2);however,they are not required by SM Es in every country.15Ball(2006,pp.15–17)insists that uniform accounting standards do not always produceunifo rm accounting practicesam ong countries. H e gives exam p leso f the relevant obstacles,such as theextent and nature of governm ent involvem ent in the economy;the politicsbehind government involvement in fnancial reporting practices(e.g.,the political in fuence ofmanagers,corporations,labor unionsand banks); the legal system s(e.g.,common versus code law;shareholder litigation rules);the securities regulation and regulatory bodies;the depth and structu re of the fnancialm arkets(e.g.,the closeness of the relationship between banks and client com panies);the roles of the press, f nancial analysts and rating agencies;the size of the corporate sector;the structu re of the corpo rate governance(e.g.,relative roles of labor,managementand capital);the extentof p rivateversus public ownership of corporations;the extento f fam ily-contro lled businesses; the extent of corporatemembership in related company groups(e.g.,Japanese keiretsu or Korean chaebol);the extent o f fnancial interm ediation;the role of sm allshareholders versus institu tions and corporate insiders;the use of fnancial statem ent information such as earn ings in m anagem en t compensation and the status,independence,training and compensation of auditors.Thereare two typeso f SM Es:those that adopt higher levelso f accounting standards drawn from localaccounting standardsand converged w ith IFRS for listed and larger com panies,and those that choose smaller GAAP consisting o f p rinciples that faith fully refect the needs of smaller orm icro entities.

6.Concluding remarks

In this paper,we describe the transformation of the accounting standards in Japan over the past 2 decades and review the driving forcesof this transformation according to the circumstanceso f fnancial liberalization and globalization.W ealso analyze the current situation of accounting standardsand discover a dichotomy o f accounting systems resu lting from the Japanese po litical,econom ic and legal institutions.Establishing the leading criteria(Takeda,2006)for constructing accounting systemsand standards ishelp ful for understanding thedif erencesbetween localand global corporate accounting.These leading criteria include the follow ing fve conditions.

(1)En tity o f business activities:the entity is listed o r un listed.

(2)Field of business activities:the en tity’s f eld of business activities is local or global.

(3)Stakeho lders in theentity:stakeho lders in theentity are lim ited to a certain number of interested parties or diversifed un lim ited and potential investors.

(4)Function of the entity’s f nancing:the entity has direct-or indirect-oriented f nancing.

(5)Reporting objective o f the entity:the entity’s reporting objective is to p rovide useful information that determ ines its value or to p repare reliable in formation based on accounting records.

Each of these criteria form sa corporate culture,which is a co llective programm ing o f businessm inds that distinguishes themember of one businessentity from another.The content ofmental p rograms is def ned as values,where a value is a b road tendency to p refer certain states of business af airs over o thers(cf.foo tno te 14).As already noted in Fig.2(A ccoun ting Comm unication and A ccountants’Judgm en ts),a com pany’s accounting p ractices comprise a system of know ledge formed by managem ent judgmentsmade in relationto business transactions.M anagem en t judgm ents depend on corporate cultures that have been created through personal interactionsw ithin organizations.

One of the ob jectiveso f the IFRSFoundation(IFRSFoundation,2013,para.2)is to p romote and facilitate the adop tion o f IFRS through the convergence of national accounting standardsand IFRS.Behind this objective is the drive to app ly IFRS to the same transactions regardlessof the contextand in conjunction w ith thesocial,po litical,econom ic and cu ltural factorso f each country.The accounting standardsused to evaluate a f rm’svalue based on the p rincip le o f substance over form are dif cu lt to apply to SM Es in Japan due to the country’s corporate cultures.

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*Tel.:+81 6 6721 2332;fax:+81 6 6729 2493.

E-mail address:naohiro.urasaki@hotmail.co.jp

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h ttp://dx.doi.org/10.1016/j.cjar.2013.10.001