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Similarities and DifferencesA comparison of IFRS, US GAAP and JP GAAP2010

December 2010

Similarities and Differences - A comparison of IFRS, US GAAP and JP GAAP - 2010 1

Contents

page

Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

How to use this publication . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

Summary of similarities and differences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

Accounting framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

Financial statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

Consolidation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

Business combinations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34

Revenue recognition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40

Expense recognition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50

Assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60

Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85

Financial liabilities and equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94

Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101

Derivatives and hedging . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103

Other accounting and reporting topics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114

Earnings per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114

Foreign currency translation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115

Interim financial reporting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117

Discontinued operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117

Related-party disclosures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 119

Segment reporting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 119

Events after the reporting period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120

IFRS for small and medium-sized entities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120

Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 122

Similarities and Differences - A comparison of IFRS, US GAAP and JP GAAP - 20102

Preface

Starting with the European Union’s (EU) compulsory measure for listed companies within the EU to prepare consolidated financial statements in accordance with International Financial Reporting Standards (IFRS), we are witnessing a growing trend towards adoption of IFRS. With the creation of a single global accounting standard, transparency and comparability of financial reporting is expected to improve for those entities who participate in cross-border capital-market transactions.

In this surrounding, the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) both continued their preparation for convergence, and at the G20 Seoul meeting in November 2010, the importance of high quality uniform accounting standards was confirmed by the participating countries. While in Japan, the “Tokyo Agreement” in August 2007 between the ASBJ (The Accounting Standards Board of Japan) and the IASB provided a framework for discussion of convergence between JP GAAP (Accounting Principles Generally Accepted in Japan) and IFRS. As a result, currently differences among IFRS, US GAAP and JP GAAP are gradually decreasing. However differences still remain in some areas among those three standards.

In parallel with the international move towards accounting convergence, the US announced its full adoption of IFRS-based financial statements without reconciliations for non-US listed entities and also issued a proposed “Road Map” which permits adoption of IFRS for US listed entities. In February 2010, the US SEC published a work plan regarding the incorporation of IFRS into the financial reporting system for US issuers. The final decision is expected in 2011. In Japan, in response to the growing trend for international transformation of accounting standards, the Financial Services Agency (FSA) issued in June 2009, an “Opinion on the Application of International Financial Reporting Standards (IFRS) in Japan (Interim Report)”. The voluntary adoption of IFRS has started from the first quarter of 2010 and the decision on the mandatory adoption of IFRS is expected by 2012.

Under these circumstances, this publication focuses on and explains the major differences among IFRS, US GAAP and JP GAAP. This publication does not address all the differences among those three standards. However it explains the differences we consider specifically important. We hope that this publication will be useful in identifying the key differences among the three standards and help you gain a foothold for introduction of IFRS which is expected to be a single accounting standard used worldwide.

Koji HatsukawaChief Executive OfficerPricewaterhouseCoopers Aarata


How to use this publication

This publication is prepared by PricewaterhouseCoopers Aarata for those who wish to gain a broad understanding of the key similarities and differences among IFRS, US GAAP and JP GAAP. The first part of this document provides a summary of the similarities and differences among IFRS, US GAAP and JP GAAP. It refers to subsequent sections of the document where key differences are highlighted and explained in more detail.

No summary publication can do justice to the many differences of detail that exist among IFRS, US GAAP and JP GAAP. Even if the guidance is similar, there can be differences in the detailed application, which could have a material impact on the financial statements. This publication focuses on the measurement similarities and differences most commonly found in practice. When applying the individual accounting frameworks, readers should consult all the relevant accounting standards and, where applicable, their national law. Listed companies should also follow relevant securities regulations – for example, requirements regulated by the Financial Services Agency in Japan or the US Securities and Exchange Commission and local stock exchange listing rules.

This publication takes account of authoritative pronouncements issued under IFRS, US GAAP and JP GAAP up to July 2010 and is based on the most recent version of those pronouncements. We have added a note on certain recent developments or exposure drafts in the box at the end of each topic. Hot topics updated after July 2010 but before November 2010, such as the Lease exposure draft and Consolidation staff-draft etc. are included. Please be reminded that this publication is not all encompassing and not all of the recent developments or exposure drafts are included.


Summary of similarities and differences

4


SUBJECT IFRS US GAAP JP GAAP PAGE

Accounting framework

Historical cost or valuation Generally uses historical cost, but intangible assets, property, plant and equipment (PPE) and investment property may be revalued to fair value. Derivatives, certain other financial instruments and biological assets are revalued to fair value.

No revaluations except for certain types of financial instruments.

No revaluations except for certain types of financial instrument.

16

First-time adoption of accounting framework

Full retrospective application of all IFRSs effective at the end of the reporting date for an entity’s first IFRS financial statements, with some optional exemptions and limited mandatory exceptions. Reconciliations of profit or loss in respect of the last period reported under previous GAAP, of equity at the end of that period and of equity at the start of the earliest period presented in comparatives must be included in an entity’s first IFRS financial statements.

First-time adoption of US GAAP requires retrospective application. There is no requirement to present reconciliations of equity or profit or loss on first-time adoption of US GAAP.

Full retrospective application of all JP GAAP effective at the reporting date for an entity’s first JP GAAP financial statements. There is no requirement to present reconciliations of equity or profit or loss on first-time adoption of JP GAAP.

16

Financial Statement

Statement of financial position (Balance sheet)

Certain minimum items are presented on the face of the statement of financial position.

The presentation of a classified statement of financial position is used unless a liquidity presentation provides more relevant information.

Items presented on the face of the balance sheet are similar to IFRS.

Generally, the presentation of a classified balance sheet is required.

Items to be presented in balance sheet which are required in the Financial Instruments and Exchange Act are more detailed compared to IFRS and US GAAP.

The presentation of a classified balance sheet is required.

17

Statement of comprehensive income (Income Statement)

All items of income and expenses are presented either in:

(1) a single statement of comprehensive income; or

(2) two statements: an income statement and a statement of comprehensive income.

Expenses may be presented either by function or by nature. Certain minimum items are presented on the face of the statement of comprehensive income though there is no prescribed standard format.

The income statement may be presented as either a single-step or a multiple-step format.

SEC regulations require all registrants to categorize expenses in the income statement by their function.

Entities may utilize one of three formats in their presentation of comprehensive income:

A single primary statement of •income and comprehensive income

A two-statement approach (a •statement of income and a statement of comprehensive income)

A separate category highlighted •within the primary statement of changes in shareholders’ equity

Present in a multi-step format. JP GAAP requires five categories of income to be presented: gross profit or loss, operating profit or loss, profit or loss from ordinary activities, pre-tax profit or loss, net profit or loss.

Expenses are basically presented by function.

Presentation of income statement which is required in the Financial Instruments and Exchange Act is more detailed compared to IFRS and US GAAP.

Presentation of comprehensive income is not required. However, an entity will be required to show the comprehensive income in the consolidated financial statements for annual periods ending on or after March 31, 2011.

19

Statement of comprehensive income (Income Statement) – Exceptional (significant)

items and extraordinary items

Does not use or define the term but requires separate disclosure of items that are of such size, nature or incidence that their separate disclosure is necessary to explain the performance of the entity.

Extraordinary items are prohibited to be presented.

Similar to IFRS. However, US GAAP does not use the term exceptional items, but individually significant unusual or infrequent occurring items are presented on the face of the income statement or disclosed in the notes.

Extraordinary items are defined as being both infrequent and unusual, and are rare in practice.

JP GAAP requires exceptional items to be presented separately in a “special gain or loss” category of the income statement. The scope of items to be presented is boarder than IFRS and US GAAP. Extraordinary items are also included in exceptional items. The treatment of the extra depreciation cost has been superseded for annual periods beginning on or after 1 April 2011.

20

Statement of equity Presented as a primary statement for all entities.

Permitted to be presented either as a primary statement or within the notes to the financial statements.

Similar to IFRS. 20



Statement of cash flow (Cash flow statements) – definition of cash and cash

equivalents (Treatment of bank over draft)

Bank overdrafts may be included in cash.

Bank overdrafts are not included in cash. Changes in the balances of overdrafts are classified as financing cash flows.

Similar to IFRS. 20

Disclosure of critical accounting policies and significant estimates

Within the notes to the financial statements, entities are required to disclose:

The judgments that management •has made in the process of applying its accounting policies that have the most significant effect on the amounts recognised in those financial statements; and

Information about the key •assumptions concerning the future—and other key sources of estimation uncertainty at the balance sheet date—that have significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year.

Disclose a summary of significant accounting policies used within the notes.

For SEC registrants, the application of critical accounting policies and significant estimates is normally disclosed in Form 10-K.

An entity discloses its critical accounting policy including significant estimates in accordance with the Financial Instruments and Exchange Act. Items, such as uncertainty in the future, are required to be disclosed outside of the financial statements.

21

Changes in accounting policy New accounting policy is adopted retrospectively unless specifically exempted.

Similar to IFRS. The effect of changes in prior periods is included in the current year income statement. The nature and amounts of the changes need to be disclosed.

An entity shall account retrospectively for annual periods beginning on or after 1 April 2011.

21

Correction of errors Same as Changes in accounting policy.

Similar to IFRS. Generally included in net income for the period as an extraordinary item.

An entity shall account retrospectively for annual periods beginning on or after 1 April 2011.

21

Changes in accounting estimates

Be included in the financial statement items in the current period and future, if applicable.

Similar to IFRS. Similar to IFRS. However, changes in depreciation-related estimates are adjusted retrospectively and the effects are presented in a “special gain or loss” category as an extra depreciation cost.

This treatment has been superseded for annual periods beginning on or after 1 April 2011.

21

Comparatives Generally, one year of comparatives is required for all numerical information.

A third balance sheet is required for the first adopter of IFRS and in the situations such as changes in accounting policy.

Comparative financial statements are not required; however, SEC requirements specify that most registrants provide two years of comparatives for all statements except for the balance sheet, which requires only one comparative year.

The Financial Instruments and Exchange Act require to disclose one year (prior year) of comparatives for all information including notes to the financial statements.

21

Consolidation

Consolidation model Based on control, which is the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities. Control is presumed to exist when parent owns, directly or indirectly through subsidiaries, more than one half of an entity’s voting power. Control also exists when the parent owns half or less of the voting power but has legal or contractual rights to control, or de facto control (rare circumstances). The existence of currently exercisable potential voting rights is also taken into consideration of all facts and circumstances that affect potential voting rights except the intention of management and the financial ability to exercise or convert.

A bipolar consolidation model is used, which distinguishes between a variable interest entity (VIE) model and a voting interest model.

The VIE model is discussed below. Under the voting interest model, control can be direct or indirect and may exist with half or less ownership. ‘Effective control’, which is a similar notion to de facto control under IFRS, is very rare if ever employed in practice.

Also has a concept similar to IFRS in determining the scope of consolidation. “Control” means to control other entity’s decision-making body. For the following cases, there is a rebuttable presumption that control exists. Parent substantially owns more than half of an entity’s voting power, and parent holds between 40% or more and less than 50% of the voting rights of an entity, but holds more than 50% when combining voting rights held by a party having a close relationship with the parent, or certain facts exist indicating that parent controls the decision-making body of the entity.

25



6


Special purpose entities (SPE)

Consolidated where the substance of the relationship indicates control.

An overall assessment of all facts and characteristics of the SPE, including the allocation of risks and benefits between the parties, its design, the nature of its activities and its governance, and an understanding of the economics and objective behind the creation of the SPE are necessary to determine who the controlling party is.

Consolidation requirements focus on whether an entity is a VIE regardless of whether it would be considered an SPE.

Often, an SPE would be considered a VIE, since they are typically narrow in scope, often highly structured and thinly capitalised, but this is not always the case. For example, clear SPEs benefit from exceptions to the variable interest model such as pension, postretirement or postemployment plans.

The guidance above applies only to legal entities.

Legally specified SPE and other entities operating similar business as SPE in which the change of operation is restricted are not considered to be subsidiaries when certain requirements are met, and hence are precluded from consolidation.

26

Employee share (stock) trusts Consolidated where substance of relationship indicates control (SIC 12 model). Entity’s own shares held by an employee share trust are accounted for as treasury shares.

Similar to IFRS except where specific guidance applies for Employee Stock Ownership Plans (ESOPs) in SOP 93-6.

No specific guidance exists as employee share trusts are not common.

28

Definition of associate Based on significant influence, which is the power to participate in the financial and operating policy decisions; presumed if 20% or greater interest.

Similar to IFRS, although the term ‘equity investment’ is used instead of ‘associate’.

Similar to IFRS. Several examples for the determination of significant influence are provided.

28

Disclosures about associates Detailed information on associates’ assets, liabilities, revenue and profit/loss is required.

Similar to IFRS. Similar to IFRS. 28

Presentation of jointly controlled entities (joint ventures)

Both proportionate consolidation and equity method are permitted.

Equity method required except in specific circumstances.

Equity method is required. 29

Uniform accounting policies Consolidated financial statements are prepared by using uniform accounting policies for like transactions and events in similar circumstances for all of the entities in a group.

Similar to IFRS, with certain exceptions when a subsidiary has specialised industry accounting principles. Equity method investee’s accounting policies may not conform to the investor’s accounting policies, if the investee follows an acceptable alternative US GAAP treatment.

Similar to IFRS. However, exceptional treatment is allowed for foreign subsidiaries and associates.

31

Business combinations1

Types: acquisitions or mergers

All business combinations, except a business combination between entities or businesses under common control (see below), are acquisitions, thus the acquisition method of accounting is only allowed.


Fair values on acquisition All identifiable assets acquired and liabilities assumed (including contingent liabilities) are fair valued. Goodwill is measured as the excess of the sum of (i) the consideration transferred generally measured at acquisition-date fair value (ii) the amount of any non-controlling interest in the acquiree and (iii) the acquisition-date fair value of any previously held equity interest in the acquiree over the net of the acquisition-date amounts of the identifiable assets acquired and the liabilities assumed.

Liabilities for restructuring activities are recognised only when acquiree has an existing liability at acquisition date. Liabilities for future losses or other costs expected to be incurred as a result of the business combination cannot be recognised.

Similar to IFRS. Similar to IFRS in general. Intangible assets such as legal rights which can be separately transferred and to which an independent value can reasonably be allocated are recognised as an asset.

Restructuring liabilities can be recorded when certain conditions are met, even if the liabilities aren’t incurred at the acquisition date.

35

1 The IASB and FASB issued new standards on business combination in January 2008 and December 2007 respectively and many historical differences were eliminated.



Contingent consideration The acquisition-date fair value of contingent consideration is recognised as part of the consideration transferred. Subsequent changes in contingent consideration do not adjust the amount of goodwill recognised, unless it is a measurement period adjustment.

Similar to IFRS. Initially measured at fair value. In subsequent periods, changes in the fair value of contingencies classified as assets or liabilities will be recognised in earnings.

Contingent consideration is not recognised at the acquisition date. Subsequently, when the transfer or delivery of the contingent consideration becomes substantive and when the fair value is reasonably determinable, such contingent consideration is adjusted to goodwill or recognised as profit or loss, depending on the nature of the contingent consideration.

35

Acquired contingencies The acquiree’s contingent liabilities are recognised separately at the acquisition date as part of allocation of the cost, provided they arise from past event and their fair values can be measured reliably.

The contingent liability is measured subsequently at the higher of the amount initially recognised or, if qualifying for recognition as a provision, the best estimate of the amount required to settle (under the provisions guidance).

Contingent assets are not recognised.

Acquired contingencies are recognised at fair value if fair value can be determined during the measurement period. If fair value can not be determined, companies should typically account for the acquired contingencies using existing guidance.

An acquirer shall develop a systematic and rational basis for subsequently measuring and accounting for assets and liabilities arising from contingencies depending on their nature.

In principle, contingent liability of an acquiree is recognised when general requirements for provisions are met.

Contingent asset are not recognised.

36

Goodwill Capitalised but not amortised. Goodwill is reviewed for impairment annually and when indicators of impairment arise. Testing performed at either the cash-generating unit (CGU) level or groups of CGUs, as applicable.

Similar to IFRS, although the level of impairment testing may be different and the impairment test itself is different.

Goodwill is capitalised and amortised over a period up to 20 years. When an indicator of impairment is identified, an impairment test shall be performed. However, no annual impairment testing is required.

36

Bargain purchase (“Negative goodwill”)

The identification and measurement of acquiree’s identifiable assets, liabilities and contingent liabilities, the non-controlling interests (if any), the acquirer’s previously held interest (if any) and the consideration transferred are reassessed. Any excess remaining after reassessment is recognised as a gain in profit or loss on the acquisition date.


Subsequent adjustments to assets and liabilities (measurement period)

Adjustments against goodwill to the provisional fair values recognised at acquisition are permitted provided those adjustments are made within 12 months of the acquisition date to reflect new information obtained about facts and circumstances that existed as of the acquisition date. Adjustments made after 12 months are recognised in profit or loss. Measurement-period adjustments to the provisional amounts are recognised as if the accounting for the business combination had been completed at the acquisition date. Thus, the acquirer should revise comparative information for prior periods presented in financial statements as needed, including making any change in depreciation, amortisation or other income effects recognised in completing the initial accounting.

Similar to IFRS. Similar to IFRS and US GAAP, adjustments should be made against goodwill within 12 months from the date of the business combination. When adjustments are made in a fiscal year following the first fiscal year of the business combination, adjustments related to prior years should be charged to profit and loss.

37

Non-controlling interests at acquisition

Stated either at full fair value or at the non-controlling interest’s proportionate share of the acquiree’s identifiable net assets.

Measured at fair value. Measured at proportionate share of minority interests (non-controlling interests) in identifiable net assets of acquiree.

37



8


Business combinations involving entities under common control

Not specifically addressed. Entities elect and consistently apply either acquisition method or merger accounting (otherwise known as ‘predecessor accounting’) for all such transactions.

Specific rules exist for accounting. Generally recorded at predecessor cost reflecting the transferor’s carrying amount of assets and liabilities transferred.

Merger accounting is applied (book value prior to the transfer).

38

Revenue recognition

Revenue recognition – general

Based on several criteria, which require the recognition of revenue when risks and rewards and control have been transferred and the revenue can be measured reliably.

Similar to IFRS in broad principle, although there is extensive detailed guidance for specific types of transactions that may lead to differences in practice.

There is no comprehensive standard for revenue recognition. It is generally interpreted that “completion of transfer of goods or rendering of services” and “receipt for corresponding consideration” are the conditions to meet the concept.

41

Revenue recognition – contingent consideration

For the sale of a good, one looks to the general recognition criteria which include the probability that economic benefit will flow to the entity and the amount of revenue can be reliably measured. Assuming that all of the revenue recognition criteria are met, revenue related to contingent consideration may be recognised.

Even when delivery has clearly occurred (or services have clearly been rendered) the SEC has emphasized that revenue related to contingent consideration should not be recognised until the contingency is resolved.

No specific guidance. However, similar to IFRS in practice.

42

Rendering services IFRS requires that service transactions be accounted for by reference to the stage of completion of the transaction. This method is often referred to as the percentage-of-completion method. The stage of completion may be determined by a variety of methods (including the cost-to-cost method).

US GAAP prohibits the use of the cost-to-cost percentage-of-completion method to recognise revenue under service arrangements unless the contract is within the scope of specific guidance for construction or certain production-type contracts.

Generally, companies would have to apply the proportional-performance (based on output measures) model or the completed-performance model.

There is no standard which explicitly specifies the accounting for service transactions. However, it is a common practice that revenue is recognised based on passage of time, for services rendered over time pursuant to written arrangements, otherwise upon completion of the service. In general, the percentage-of-completion method is not applied to those other than construction contracts or made-to-order software development.

43

Multiple-element arrangements – identification of transaction

Revenue recognition criteria are applied to each separately identifiable component of a transaction to reflect the substance of the transaction – e.g., to divide one transaction into the sale of goods and to the subsequent servicing of those goods or to combine two or more transactions when they are linked in such a way that the whole commercial effect cannot be understood without reference to the series of transaction as a whole.

Revenue arrangements with multiple deliverables are separated into different units of accounting if the deliverables in the arrangement meet all of the specified criteria outlined in the guidance. Revenue recognition is then evaluated independently for each separate unit of accounting.

There are no general guidelines for identifying multiple-element arrangements but limited guidelines exist for software transactions and construction contracts.

43

Multiple-element arrangements – fair value allocation

The best evidence of the fair value of separately identifiable components of a transaction is the price that is regularly charged when an item is sold separately. At the same time, under certain circumstances, a cost-plus-reasonable-margin approach to estimating fair value would be appropriate. Under rare circumstances, a reverse residual methodology may be acceptable.

US GAAP does not allow an estimated internal calculation of fair value based on costs and an assumed or reasonable margin.

When there is objective and reliable evidence of fair value for all units of accounting in an arrangement, the arrangement consideration should be allocated to the separate units of accounting based on their relative fair values.

As for years beginning after June 15, 2010, companies will be required to apply the new guidance which requires estimating a selling price for multiple deliverables in which VSOE or third-party evidence is not available. Accordingly, the residual method will be eliminated and estimation methods such as cost plus a reasonable margin will become acceptable.

No standard for measuring multiple-element arrangement is provided.

43



Customer loyalty programmes

IFRS requires that the fair value of the award credits (otherwise attributed in accordance with the multiple-element guidance) be deferred and recognised separately upon achieving all applicable criteria for revenue recognition.

Currently, divergence exists under US GAAP in the accounting for customer loyalty programs. There are two very different models that are generally employed.

No specific guidance. However, it is common to use the provision method by recognising the full amount of revenue at initial recognition including the awards credit and the estimated future expense for goods and services.

44

Construction contracts Accounted for using percentage-of-completion method. Completed contract method is prohibited.

Similar to IFRS; however, completed contract method is permitted in rare circumstances.

Similar to IFRS; however, completed contract method is applied if application requirements for percentage-of-completion method are not met.

46

Expense recognition

Employee share-based payment transactions

Expense for services received is recognised based on the fair value of the equity awarded or the liability incurred.

Similar model to IFRS, although many areas of difference exist in application.

Similar to IFRS, however, there is no standard for cash-settled transaction.

50

Employee benefits: pension costs – defined benefit plans

Projected unit credit method is used to determine benefit obligation and plan assets are recorded at fair value. Actuarial gains and losses can be deferred. If actuarial gains and losses are recognised immediately, they can be recognised in profit or loss or outside profit or loss through other comprehensive income in the statement of comprehensive income.

Similar to IFRS but with several areas of differences in the detailed application. Actuarial gains and losses cannot be deferred and are recognised in accumulated other comprehensive income with subsequent amortisation to the statement of operations.

Similar to IFRS but with several areas of differences in the detailed application.

There is no concept for other comprehensive income in JP GAAP.

54

Assets

Acquired intangible assets Capitalised if recognition criteria are met; amortised over useful life. Intangibles assigned an indefinite useful life are not amortised but reviewed at least annually for impairment. Revaluations are permitted in rare circumstances.

Similar to IFRS, except revaluations are not permitted.

There is no recognition criterion. Examples of intangible assets are as below: Goodwill, patent, lease right, trademark, design right, mining right, fishery right and others.

60 62

Internally generated intangible assets

Research costs are expensed as incurred. Development costs are capitalised and amortised only when specific criteria are met.

Unlike IFRS, both research and development costs are expensed as incurred, with the exception of some software and website development costs that are capitalised.

Research and development costs are expensed as incurred. Some software costs are capitalised, consistent with US GAAP.

60

Advertising cost Costs of advertising are expensed as incurred. IFRS does not provide for deferrals until the first time the advertising takes place, nor is there an exception related to the capitalisation of direct response advertising costs or programs.

Prepayment for advertising may be recorded as an asset only when payment for the goods or services is made in advance of the entity’s having the right to access the goods or receive the services.

The cost of sales materials, such as brochures and catalogues, is recognised as an expense when the entity has the right to access those goods.

The costs of other than direct response advertising should be either expensed as incurred or deferred and then expensed the first time the advertising takes places. This is an accounting policy decision and should be applied consistently to similar types of advertising activities.

Certain direct response advertising costs are eligible for capitalisation if, among other requirements, probable future economic benefits exist.

Direct response advertising costs that have been capitalised are then amortised over the period of future benefits (subject to impairment considerations).

There is no specified guidance for advertising cost. Advertising costs are expensed based on the term of advertising or the distribution of catalogues and others.

61

Property, plant and equipment

Historical cost or revalued amounts are used. Regular valuations of entire classes of assets are required when revaluation option is chosen.

Historical cost is used; revaluations are not permitted.

Similar to US GAAP. 62 64

Property, plant and equipment – depreciation

An entity is required to depreciate separately the significant components of PPE if they have different useful lives (component approach).

An entity is generally not required to apply a component approach for depreciation.

A component approach of depreciation is not required.

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10


Asset retirement obligations IFRS requires that management’s best estimate of the costs of dismantling and removing the item or restoring the site on which it is located be recorded when an obligation exists.

The estimate is to be based on a present obligation (legal or constructive) that arises as a result of the acquisition, construction or development of a long-lived asset.

If it is not clear whether a present obligation exists, the entity may evaluate the evidence under a more-likely-than-not threshold.

US GAAP requires that the fair value of an asset retirement obligation be recorded when a reasonable estimate of fair value can be made.

The estimate is to be based on a legal obligation that arises as a result of the acquisition, construction or development of a long-lived asset.

Similar to IFRS.

When an asset retirement obligation is incurred, the liability should be recognised at the discounted value based on the estimated undiscounted future cash flows for dismantling properties. Discount rate should be risk free rate before tax that reflects time value of money.

If the estimate for undiscounted future cash flows is significantly changed, the adjustment for this change is provided to the carrying amounts of asset retirement obligations and related properties.

63

Non-current assets held for sale or disposal group

Non-current assets are classified as held for sale if their carrying amount will be recovered principally through a sale transaction rather than through continuing use. A non-current asset classified as held for sale is measured at the lower of its carrying amount and fair value less costs to sell.

Similar to IFRS. There is no standard for a non-current asset held for sale or disposal group. However, the treatment is similar to IFRS in practice.

65

Leases – classification

A lease is a finance lease if substantially all risks and rewards of ownership are transferred. Substance rather than form is important.

Similar to IFRS, but with more extensive form-driven requirements.

Similar to IFRS, but with more extensive form-driven requirements.

65

Leases – lessor accounting

Amounts due under finance leases are recorded as a receivable. Gross earnings allocated to give constant rate of return based on (pre-tax) net investment method.

Similar to IFRS, but with specific rules for leveraged leases.

Similar to IFRS. 66

Impairment of long-lived assets held for use

Impairment is a one-step approach under IFRS where the carrying amount is compared with the recoverable amount. If impairment is indicated, assets are written down to higher of fair value less costs to sell and value in use. Reversal of impairment losses is required in certain circumstances, except for goodwill.

Impairment is a two-step approach under US GAAP. Firstly, impairment is assessed on the basis of undiscounted cash flows. If less than carrying amount, the impairment loss is measured as the amount by which the carrying amount exceeds fair value. Reversal of losses is prohibited.

Similar to US GAAP. A two-step approach is applied. Reversal of losses is prohibited.

68

Capitalization of borrowing cost

Borrowing costs directly attributable to the acquisition, construction or production of a qualifying asset are capitalized.

Capitalization of interest cost is required while a qualifying asset is being prepared for its intended use.

Borrowing cost are expensed.

Interest paid on borrowings to finance self-constructed fixed assets and work in process for real estate development business may be capitalized.

69

Investment property Measured at depreciated cost or fair value, with changes in fair value recognised in profit or loss.

Treated the same as for other properties (depreciated cost). Industry-specific guidance applies to investor entities (for example, investment companies).

Treated the same as for other properties (depreciated cost). Measured at depreciated cost. Only cost model is permitted.

70

Inventories Carried at the lower of cost and net realisable value. FIFO or weighted average method is used to determine cost. LIFO prohibited.

Reversal is required for subsequent increase in value of previous write-downs.

Similar to IFRS; however, use of LIFO is permitted.

Reversal of write-down is prohibited.

Similar to IFRS.

Because an entity can choose either to apply the reversal method or non-reversal method, reversal of previous write-downs is permitted.

71

Biological assets Measured at fair value less estimated costs to sell (unless fair value can not be reliably measured), with changes in valuation recognised in profit or loss.

Not specified. Generally historical cost used.

Not specified. Generally historical cost is used.

71



Financial assets – classification

[IAS 39] Classified as either available-for-sale, held-for-trading, held-to-maturity, or loans and receivables based on an entity’s intent to hold the financial assets.

[IFRS 9] Classified based on an entity’s business model for managing the financial assets and the contractual cash flow characteristics of the financial asset.

Similar to IAS 39. However, the classification of nonderivative financial assets generally depends on whether the asset meets the definition of a debt security under ASC320.

Similar to IAS 39. However, financial assets are classified as securities or loans and receivables based on their legal form.

73

Financial assets – measurement

[IAS 39] Depends on classification of investment – if held to maturity or loans and receivables, they are carried at amortised cost; otherwise at fair value. Gains/losses on fair value through profit or loss classification (including trading instruments) is recognised in profit or loss. Gains and losses on available-for-sale investments, whilst the investments are still held, are recognised in other comprehensive income.

[IFRS 9] Financial assets are measured at amortised cost when an entity’s objective of the business model for managing financial assets is to collect contractual cash flows, and the cash flows are solely payments of principal and interest of the principal amount outstanding. Other than that are measured at fair value.

Similar to IAS 39. However, Impairment triggers as well as impairment measurement for securities will produce different results for US GAAP compared to IAS 39.

Similar accounting model to IAS 39. Gains or losses on measuring outstanding available-for-sale investments at fair value are recognised in equity. In principle, receivables are measured at historical cost less allowances for doubtful accounts.

73

Impairment [IAS 39] A financial asset is impaired if there is objective evidence of impairment and if that loss event has an impact on the estimated future cash flows of the financial asset that can be estimated reliably,

[IFRS 9] Impairment is not applied to financial assets measured at fair value through profit or loss and equity instruments measured at fair value through OCI. The impairment requirements in IAS 39 are applied to financial assets categorised as measured at amortised cost.

When a shortfall in fair value that is other than temporary occur, an entity should determine whether impairment accounting is necessary.

Impairment accounting is triggered when fair value has significantly declined unless there is a possibility of recovery.

77

Derecognition of financial assets

An entity derecognises the asset if an entity transfers substantially all the risks and rewards of ownership of the asset. It continues to recognise the asset if it retains substantially all the risks and rewards of ownership of the asset.

If an entity neither transfers nor retains substantially all the risks and rewards of ownership of the asset, it needs to determine whether it has retained control of the asset. The asset is derecognised if the entity has lost control.

If the entity has retained control, it continues to recognise the asset to the extent of its continuing involvement (partial derecognition).

The evaluation is governed by three key considerations:

legal isolation, •

the ability of the transferee (or •beneficial interest holder in transferee SPE) to pledge or exchange the asset (or beneficial interest), and

no right or obligation of the •transferor to repurchase.

If a transaction qualifies for derecognition, the transferor must recognise any retained ongoing interest at fair value.

Financial assets must be derecognised when contractual rights of the financial asset are exercised, lost or the control to those rights is transferred.

The following three requirements must be met for the transfer of control:

Transferred assets are legally •safeguarded,

Transferee obtains contractual •rights of the transferred assets, and

There is no right and obligation of •the transferor to repurchase the transferred assets.

79

Liabilities

Provisions – general Liabilities relating to present obligations from past events recorded if outflow of resources is probable (defined as more likely than not) and can be reliably estimated.

Similar to IFRS. However, ‘probable’ is a higher threshold than ‘more likely than not’.

Similar to IFRS. There is no specific definition for ‘probability’. However, it is interpreted similar to US GAAP.

85



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Provisions – restructuring

A provision for restructuring costs is recognised when, among other things, an entity has a present obligation.

A present obligation exists when, among other conditions, the company is demonstrably committed to the restructuring. A company is usually demonstrably committed when there is legal obligation or when the entity has a detailed formal plan for the restructuring.

The guidance prohibits the recognition of a liability based solely on an entity’s commitment to an approved plan.

Recognition of a provision for onetime termination benefits requires communication of the details of the plan to employees who could be affected. The communication is to contain sufficient details about the types of benefits so that employees have information for determining the types and amounts of benefits they will receive.

No detailed guidance on restructuring provision is provided. Provisions are recorded based on general principle for provision.

86

Contingencies Disclose unrecognised possible losses and probable gains.

Similar to IFRS. Similar to IFRS. However, probable gain is not disclosed.

87

Deferred income taxes – general approach

Full provision method is used (some exceptions) driven by statement of financial position temporary differences. Deferred tax assets are recognised if recovery is probable (more likely than not).

Similar to IFRS but with many differences in application.

Similar to IFRS but with certain variations in application.

89

Investments in subsidiaries – treatment of deferred tax

on undistributed profit

With respect to undistributed profits and other outside basis differences related to investments in subsidiaries, branches and associates, and joint ventures, deferred taxes are recognised except when a parent company (investor or venturer) is able to control the ultimate distribution of profits and it is probable that the temporary difference will not reverse in the foreseeable future.

With respect to undistributed profits and other outside basis differences, different requirements exist depending on whether they involve investments in subsidiaries, in joint ventures or in equity investees.

Similar to IFRS. 90

Government grants Government grants are recognised once there is reasonable assurance that both (1) the conditions for their receipt will be met and (2) the grant will be received. Revenue-based grants are deferred in the statement of financial position and released to profit or loss to match the related expenditure that they are intended to compensate.

Grants that involve recognised assets are presented in the statement of financial position either as deferred income or by deducting the grant in arriving at the asset’s carrying amount, in which case the grant is recognised as a reduction of depreciation.

If conditions are attached to the grant, recognition of the grant is delayed until such conditions have been fulfilled. Contributions of long-lived assets or for the purchase of long-lived assets are to be credited to income over the expected useful life of the asset for which the grant was received.

Both capital-based grants and revenue-based grants are recognised as revenue when received. However, there is specific treatment provided by corporate-tax law and tax special measurement law, where government grants are offset against acquired assets. This treatment is also acceptable for accounting purpose.

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Leases – lessee accounting

Finance leases are recorded as asset with a corresponding obligation for future rentals and are depreciated over the useful life of the asset. Rental payments are apportioned to give a constant interest rate on the outstanding obligation. Operating lease rentals are charged on a straight-line basis.

Similar to IFRS. Specific rules should be met to record operating or capital lease.

Similar to IFRS. 92

Leases – lessee accounting: sale and

leaseback transactions

Profit arising on a sale and finance leaseback transaction is deferred and amortised. If an operating lease arises, profit recognition depends on whether the transaction is at fair value. Substance/linkage of transactions is considered.

Timing of profit and loss recognition depends on whether seller relinquishes substantially all or a minor part of the use of the asset. Losses are immediately recognised. Specific strict criteria should be considered if the transaction involves real estate.

Similar to IFRS, for finance leases. There is no explicit requirement for operating leases, however, in practice, it is treated in the same method as IFRS requires.

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Financial liabilities and equity

Financial liabilities versus equity classification

Capital instruments are classified, depending on substance of issuer’s contractual obligations, as either liability or equity, except for certain puttable instruments which are classified as equity even with contractual obligations when certain conditions are met.

Contracts that may be settled in an issuer’s own shares must be carefully evaluated for classification.

Some redeemable and mandatorily redeemable preference shares are classified as liabilities.

Application of the US GAAP guidance may result in significant differences to IFRS, for example, certain redeemable instruments are permitted to be classified as ‘mezzanine equity’ (i.e., outside of permanent equity but also separate from debt).

Contracts that may be settled in an issuer’s own shares must be carefully evaluated for classification, though the criteria for equity classification are different compared to IFRS.

Mandatorily (date certain) redeemable preference shares are classified as liabilities.

There is no detailed guideline for the classification as liability or equity. Financial instruments are classified as liability or equity based on legal form in principle.

Redeemable preferred shares are classified as equity.

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Convertible instruments Convertible instruments (where the conversion feature results in a fixed number of shares for a fixed amount of cash) is accounted for on split basis, with proceeds allocated between equity and debt.

Conventional convertible debt is usually recognised entirely as liability, unless there is beneficial conversion feature.

Convertible instruments may be split into equity and liability components or treated as a single instrument by accounting policy election. In practice, they are generally treated as a single instrument.

96

Fair value option [IAS 39] The amount of change in the fair value is recognised in profit or loss.

[IFRS 9] The amount of change in the fair value that is attributable to change in the entity’s own credit is reclassified in other comprehensive income. Subsequent recycling is not allowed.

Similar to IAS 39. No requirements regarding fair value options.

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Derecognition of financial liabilities

Liabilities are derecognised when extinguished. Difference between carrying amount and amount paid is recognised in profit or loss.


Equity instruments

Capital instruments – purchase of own shares

Show as deduction from equity. Similar to IFRS. Similar to IFRS. 101

Derivatives and hedging

Derivatives Derivatives and embedded derivatives not qualifying for hedge accounting are measured at fair value with changes in fair value recognised in profit or loss.

Hedge accounting is permitted provided that certain stringent qualifying criteria are met.

Similar to IFRS. However, differences compared to IFRS can arise in the detailed application in determining the definition of derivatives, scope of derivatives, assessment of embedded derivatives and application of hedge accounting.

Similar to IFRS. 103



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Embedded derivatives [IAS 39] Separation of derivatives embedded in hybrid contracts when the economic characteristics and risks of the embedded derivatives are not closely related to that of the host contract, a separate instrument with the same terms as the embedded derivative would meet the definition of a derivative, and the hybrid instrument is not measured at fair value through profit or loss. In addition, IAS 39 provides an option to value certain hybrid instruments at fair value instead of bifurcating the embedded derivative.

[IFRS 9] If the host contract is a financial asset, the financial instrument should be treated as one unit and appropriate classification determined based on the business model and cash flow characteristics of the entire hybrid instrument. For financial liabilities and other non-financial contracts, IFRS 9 has retained the principles related to separation of derivatives.

Similar to IAS 39. However, no specific requirements regarding reclassification of financial assets.

In addition, under US GAAP, if an embedded derivative is not the criteria of being clearly and closely related to the host contract, continuous reassessment for bifurcation is required.

Derivatives embedded in hybrid instruments are bifurcated into financial assets and liabilities when certain requirements are met and are valued at fair value. The resulting valuation differences are accounted for as profit or loss of the current period. However, bifurcation is permitted when the embedded derivatives are bifurcated for managerial purposes.

104

Fair value hedges Hedging instruments are measured at fair value. The hedged item is adjusted for changes in fair value of the hedging instruments.

Gains and losses on fair value hedges, for both hedging instruments and the item being hedged, are recognised in profit or loss.

Similar to IFRS. In principle, hedging instruments are measured at fair value and gains and losses are accounted for using the deferral method, and for available for sale securities, fair value hedges similar to IFRS and US GAAP are also permitted.

111

Effectiveness testing and measurement of hedge ineffectiveness

The most common method used are the critical-terms comparison, the dollar-offset and regression analysis. Short-cut method is not allowed.

Short-cut method and critical-terms-match method are allowed.

Critical-terms-match method is not available for interest rate hedges.

Interest rate swaps with conditions virtually identical in terms of notional principal, condition of receipt and payment of the interest and the contract terms of the hedged asset or liability are not required to be fair valued. The net amount of actual receipt and payment is adjusted to the interest of the related hedged assets or liabilities (whish is an exceptional treatment for an interest rate swap).

111

Other accounting and reporting topics

Earnings per share – diluted

IAS 33 is prescriptive about the procedure and methods used to determine whether potential shares are dilutive.

‘Treasury share’ method is used for share options/warrants.

Similar in principle to IFRS, although differences may arise in the case of common shares arising from contingently convertible debt securities and when applying the treasury stock (share) method in year-to-date computations.


Functional currency definition Currency of primary economic environment in which entity operates.

Similar to IFRS. Functional currency is determined based on legal entity, i.e., foreign subsidiaries and foreign branches.

115

Functional currency – determination

If indicators are mixed and functional currency is not obvious, judgment is used to determine functional currency that most faithfully represents economic results of entity’s operations by giving priority to currency that mainly influences sales prices and currency that mainly influences direct costs of providing the goods and services before considering the other factors.

Similar to IFRS. However, no specific hierarchy of factors to consider. In practice, currency in which cash flows are settled is often key consideration.

Foreign subsidiaries use local currency and foreign branches use headquarters’ currency, as their functional currency. This is on the basis that operations of foreign subsidiaries are deemed to be independent of their parent company whereas operations of foreign branches are deemed to be dependent on their parent company.

115



Presentation currency When financial statements are presented in a currency other than the functional currency, assets and liabilities are translated at exchange rate at the reporting date. Statement of comprehensive income items are translated at exchange rate at dates of transactions, or average rates if rates do not fluctuate significantly.

Similar to IFRS, except equity is translated using historical rates.

Similar to IFRS. However income statement captions are translated using the average rate during the relevant time period in principle, and translation using the exchange rate as at closing date is also permitted.

117

Interim financial reporting Interim financial statements are prepared via the discrete-period approach, wherein the interim period is viewed as a separate and distinct period.

US GAAP views interim periods primarily as integral parts of an annual cycle. As such, it allows entities to allocate among the interim periods certain costs that benefit more than one of those periods.

Similar to IFRS. Discrete-period approach is adopted.

117

Discontinued operations – definition

Operations and cash flows that can be clearly distinguished operationally and for financial reporting and represent a separate major line of business or geographical area of operations, or a subsidiary acquired exclusively with a view to resale.

Wider definition than IFRS. Component that is clearly distinguishable operationally and for financial reporting can be a reportable segment, operating segment, reporting unit, subsidiary or asset group.

Discontinued operations are not defined or not presented separately.

117

Discontinued operations – presentation

At a minimum, a single amount is disclosed on face of statement of comprehensive income, and further analysis disclosed in notes, for current and prior periods.

Similar to IFRS. Discontinued operations are reported as separate line items on face of income statement before extraordinary items.

Discontinued operations are not reported on the face of the income statement. However, items related to discontinued operations are presented in the special gain or loss category in some cases.

118

Related-party transactions – disclosures

Related- party transactions are disclosed for each major category of related parties.

The compensation of key management personnel is disclosed within the financial statements in total and by category of compensation.

Related- party transactions are disclosed for each major category of related parties similar to IFRS.

Disclosure of the compensation of key management personnel is not required within the financial statements. However, SEC regulations require it to be disclosed.

Related- party transactions are disclosed not for each major category of related parties but for each related party.

The description for the remuneration of management personnel is not required in the Financial Statements. However, the guidance in the Financial Instruments and Exchange Act requires it to be disclosed.

119

Segment reporting – Matrix form of organisation

Entities that utilize a matrix form of organizational structure are required to determine their operating segments by reference to the core principle.

Entities that utilize a matrix form of organizational structure are required to determine their operating segments on the basis of products or services offered, rather than geography or other metrics


Segment reporting – Assets of reportable

segment

Required if regularly reported to CODM.

Similar to IFRS Required regardless of reporting to CODM.

120

Events after the reporting period

Events after the reporting period are those events, that occur between the end of the reporting period and the date when the financial statements are authorised for issue.

An entity shall disclose the matters of authorisation.

The scope is events or transactions that occur after the balance sheet date but before financial statements are issued or are available to be issued.

There is no requirement to disclose the matter of authorisation.

Audit Treatment for Subsequent Events defines subsequent events as events which occur after the balance sheet date and before reporting date. In addition, it sets the rules for the events which occur after the reporting date and before the submission date of the annual security report.


120



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Historical cost or valuation

IFRS Historical cost is the main accounting convention. However, IFRS permits the revaluation of intangible assets, property, plant and equipment (PPE) and investment property and inventories in certain industries. IFRS also requires certain categories of financial instruments and certain biological assets to be reported at fair value.

US GAAP Similar to IFRS but prohibits revaluations except for certain categories of financial instruments, which are carried at fair value.

JP GAAP Similar to IFRS, historical cost is the main accounting convention. JP GAAP does not permit revaluation. However, fair value measurement is required for certain financial instruments and inventories held for trading purpose.

First-time adoption of accounting framework

IFRS The IFRS framework includes a specific standard on how to apply IFRS for the first time. It introduces certain reliefs and imposes certain requirements and disclosures. First-time adoption of IFRS as the primary accounting basis requires full retrospective application of IFRS effective at the reporting date for an entity’s first IFRS financial statements, with optional exemptions primarily for PPE and other assets, business combinations, share-based payments and pension plan accounting and limited mandatory exceptions. Comparative information is prepared and presented on the basis of IFRS. Almost all adjustments arising from the first-time application of IFRS are adjusted against opening retained earnings of the first period presented on an IFRS basis. Some adjustments are made against goodwill or against other classes of equity. Further, in an entity’s first IFRS financial statements, it must present reconciliations of profit or loss in respect of the last period reported under previous GAAP, of equity at the end of that period and of equity at the start of the earliest period presented in comparatives in those first IFRS financial statements.

US GAAP Accounting principles should be consistent for financial information presented in comparative financial statements. US GAAP does not give specific guidance on first-time adoption of its accounting principles. However, first-time adoption of US GAAP requires full retrospective application. Some standards specify the transitional treatment upon first-time application of a standard. Specific rules apply for carve-out entities and first-time preparation of financial statements for the public. There is no requirement to present reconciliations of equity or profit or loss on first-time adoption of US GAAP.

JP GAAP JP GAAP does not give specific guidance on first-time adoption. There is no requirement to present reconciliations of equity or profit or loss on first-time adoption of JP GAAP.

Recent proposals – IFRS and US GAAP

Conceptual Framework

The conceptual framework project is being undertaken jointly by the IASB and the FASB as part of convergence. The project, conducted in 8 phases, Phases A – H, strives to create a sound foundation for future accounting standards that are principles-based, internally consistent and internationally converged. In March 2010, the IASB and FASB published an exposure draft on Phase D, the reporting entity concept. In September 2010, the IASB and FASB jointly announced the completion of the first phase of their joint project, Phase A, objectives and qualitative characteristics. Currently Phases B, C and D of the project are active.

Phase TopicA Objectives and qualitative characteristics. B Definitions of elements , recognition and derecognition C Measurement D Reporting entity conceptE Boundaries of financial reporting, and Presentation and Disclosure F Purpose and status of the framework G Application of the framework to not-for-profit entities H Remaining Issues, if any

REFERENCES: IFRS: Framework, IAS 1, IAS 8, IAS 16, IAS 38, IAS 39, IAS 40, IAS 41, IFRS 1US GAAP: ASC 220-10, ASC 250, ASC 320, ASC 323-10, ASC 815, CON 1, SAB Topic 4, SAB Topic 5JP GAAP: Business Accounting Principle, The Discussion Paper from Accounting Standards Board of Japan ‘Conceptual Framework of Financial Accounting’


Financial statements


Recent changes – JP GAAP

Accounting Standard for Accounting Changes and Error Corrections, Guidance on Accounting Standard for Accounting Changes and Error Corrections

In December 2009, the Accounting Standards Board of Japan (ASBJ) issued Standard for Accounting Changes and Error Corrections (ASBJ Statement No.24), Guidance on Accounting Standard for Accounting Changes and Error Corrections (ASBJ Guidance No.24) to converge with IFRS on accounting changes. An entity shall account for accounting changes and corrections of prior period errors retrospectively after the beginning of the fiscal year beginning on or after April 1, 2011. Thus, differences between JP GAAP and IFRS/US GAAP would be resolved with this standard.

The following are considered in this standard:

Depreciation method is treated not as an accounting estimation but as an accounting policy. However, it has been determined that a change of • depreciation method is not applied retrospectively. Thus, a GAAP difference does not exist.

The treatment of the ‘extra depreciation cost’ as a result of shortening of the useful life has been superseded.•

A third balance sheet is not required where restatement or reclassification occurs.•

Accounting Standard for Presentation of Comprehensive Income

In June 2010, ASBJ issued Accounting Standard for Presentation of Comprehensive Income (ASBJ Statement No.25) and an amendment to a related standard to converge with IFRS. This standard requires that comprehensive income shall be presented in either of:

(a) a format composed of the statement of income that presents net income and the statement of comprehensive income that presents net income and additions or deductions of components of other comprehensive income (two-statement format);

(b) a format using one statement (statement of income and comprehensive income) that presents net income and comprehensive income (one-statement format).

An entity shall apply this Accounted Standard to consolidated financial statements relating to the years-ending on or after March 31, 2011.


Each framework requires prominent presentation of a statement of financial position (balance sheet) as a primary statement.

Presentation items

IFRS IFRS requires presentation of the items on the face of the statement of financial position. Though, these items are just examples which should be separated and an entity may make the judgement about whether to present additional items separately.

US GAAP Items presented on the face of the balance sheet are similar to IFRS but should be sufficiently detail to enable identification of material components.

JP GAAP The financial statements regulations and the guidelines under the Financial Instruments and Exchange Act require items to be presented in more detail compared to IFRS and US GAAP.

Offsetting assets and liabilities

IFRS An entity shall generally not offset assets and liabilities unless required or permitted by a standard. Offsetting maybe appropriate when it reflects the substance of the transaction or other event or when a right of setoff exists.

Under the guidance, a right of setoff is a debtor’s legal right, by contract or otherwise, to settle or otherwise eliminate all or a portion of an amount due to a creditor by applying against that amount an amount due from the creditor. Two conditions must exist for an entity to offset a financial asset and a financial liability (and thus present the net amount on the balance sheet). The entity must:



18

• Currently have a legally enforceable right to set off the recognized amounts; and

• Intend either to settle on a net basis or to realize the asset and settle the liability simultaneously.

In unusual circumstances, a debtor may have a legal right to apply an amount due from a third party against the amount due to a creditor, provided that there is an agreement among the three parties that clearly establishes the debtor’s right of setoff.

Master netting arrangements do not provide a basis for offsetting unless both of the criteria described earlier have been satisfied.

US GAAP The guidance states that “it is a general principle of accounting that the offsetting of assets and liabilities in the balance sheet is improper except where a right of setoff exists.” A right of setoff is a debtor’s legal right, by contract or otherwise, to discharge all or a portion of the debt owed to another party by applying against the debt an amount that the other party owes to the debtor. A debtor having a valid right of setoff may offset the related asset and liability and report the net amount. A right of setoff exists when all of the following conditions are met:

• Each of two parties owes the other determinable amounts.

• The reporting party has the right to set off the amount owed with the amount owed by the other party.

• The reporting party intends to set off.

• The right of setoff is enforceable by law.

Repurchase agreements and reverse-repurchase agreements that meet certain conditions are permitted, but not required, to be offset in the balance sheet.

The guidance provides an exception to the previously described intent condition for derivative instruments executed with the same counterparty under a master netting arrangement. An entity may offset (1) fair value amounts recognized for derivative instruments and (2) fair value amounts (or amounts that approximate fair value) recognized for the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable) arising from derivative instruments recognized at fair value. Entities must adopt an accounting policy to offset fair value amounts under this guidance and apply that policy consistently.

JP GAAP Assets and liabilities are not allowed to be offset, in principle. However, financial assets and liabilities may be offset when the following three conditions are met: (i) they are receivables from / payables to the same party; (ii) a legally enforceable right to offset the recognised amounts exists and the entity is able to offset; and (iii) the entity intends to settle transactions on a net basis.

Financial assets and liabilities arising from derivative transactions between the same counterparty at fair value may be offset provided that a legally valid master netting agreement is in place.

Classification (current/non-current distinction-General)

IFRS The presentation of a classified balance sheet is required, except when a liquidity presentation is more relevant.

US GAAP The presentation of a classified balance sheet is required, with the exception of certain industries.

JP GAAP The presentation of a classified balance sheet is required. The financial statements regulations and the guidelines under the Financial Instruments and Exchange Act determines which items are current or non-current.

Classification—post-balance sheet refinancing agreements

IFRS If completed after the balance sheet date, neither an agreement to refinance or reschedule payments on a long-term basis nor the negotiation of a debt covenant waiver would result in noncurrent classification of debt, even if executed before the financial statements are issued.

US GAAP Entities may classify debt instruments due within the next 12 months as noncurrent at the balance sheet date, provided that agreements to refinance or to reschedule payments on a long-term basis (including waivers for certain debt covenants) get completed before the financial statements are issued.

JP GAAP There is no rule as provided under IFRS or US GAAP. Therefore, debt with a maturity date within the next 12 months should be classified as current regardless of an agreement to refinance and so on.


Classification—refinancing counterparty

IFRS If an entity expects and has the discretion to refinance or rollover an obligation for at least 12 months after the reporting period under an existing loan financing, it classifies the obligation as noncurrent, even if it would otherwise be due within a shorter period. In order for refinancing arrangements to be classified as noncurrent, the arrangement should be with the same counterparty.

US GAAP A short-term obligation may be excluded from current liabilities if the entity intends to refinance the obligation on a long-term basis and the intent to refinance on a long-term basis is supported by an ability to consummate the refinancing as demonstrated by meeting certain requirements. The refinancing does not necessarily need to be with the same counterparty.

JP GAAP There is no rule as provided under IFRS or US GAAP. Therefore, debt with a maturity date within next 12 months should be classified as current regardless of a management’s intension to refinance.

Statement of comprehensive income (Income statement)

Each framework requires prominent presentation of a statement of comprehensive income (Income statement) as a primary statement.

Format

IFRS Entities may present all items of income and expense in either a single statement of comprehensive income or two statements (an income statement and a statement of comprehensive income). Expenses may be presented either by function or by nature. Additional disclosure of expenses by nature is required if functional presentation is used.

While certain minimum line items are required, no prescribed statement of comprehensive income format exists.

Entities that disclose an operating result should include all items of an operating nature, including those that occur irregularly or infrequently or are unusual in amount within that caption.

Entities should not mix functional and nature classifications of expenses by excluding certain expenses from the functional classifications to which they relate.

US GAAP The income statement may be presented in (1) either a single-step format, whereby all expenses are classified by function and then deducted from total income to arrive at income before tax or (2) a multiple-step format separating operating and non-operating activities before presenting income before tax.

SEC regulations require all registrants to categorize expenses in the income statement by their function. However, depreciation expense may be presented as a separate income statement line item. In such instances, the caption cost of sales should be accompanied by the phrase exclusive of depreciation shown below and presentation of a gross margin subtotal is precluded.

Entities may utilize one of three formats in their presentation of comprehensive income:

• A single primary statement of income and comprehensive income

• A two-statement approach (a statement of income and a statement of comprehensive income)

• A separate category highlighted within the primary statement of changes in shareholders’ equity

JP GAAP The income statement must include the following items:

• Gross profit or loss

• Operating profit or loss

• Profit or loss from ordinary activities

• Pre-tax Profit or loss

• Net profit or loss

To show them, expenses are classified and presented by function such as cost of sales, selling, general and administrative expenses, non-operating expense and extraordinary loss. The financial statements regulations and the guidelines under the Financial Instruments and Exchange Act have more detailed rules for the presentation of income statements.

The statement of comprehensive income statement is not disclosed and each item in other comprehensive income is presented as items other than shareholders’ equity in the Statement of changes in net assets on a net basis. However, an entity will be required to show the



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comprehensive income in the consolidated financial statements for annual periods ending on or after March 31, 2011. It is yet to be determined whether this requirement would be applied to separate financial statements.

Exceptional (significant) items and extraordinary items

IFRS The term exceptional items is not used or defined. However, the separate disclosure is required (either on the face of the comprehensive/separate income statement or in the notes) of items of income and expense that are of such size, nature, or incidence that their separate disclosure is necessary to explain the performance of the entity for the period.

Extraordinary items are prohibited to be presented.

US GAAP Although US GAAP does not use the term exceptional items, significant unusual or infrequently occurring items are reported as components of income separate from continuing operations—either on the face of the income statement or in the notes to the financial statements.

Extraordinary items are defined as being both infrequent and unusual and are rare in practice.

JP GAAP Exceptional items are required to be presented in the ‘special gains and losses’ caption on the face of the income statement. The definition of ‘special’ is broader compared to IFRS and US GAAP, and includes some extraordinary items. The treatment of the extra depreciation cost as a result of a shortening of the useful life, which is categorized as an extraordinary loss, has been superseded for annual periods beginning on or after 1 April 2011.

Statement of equity

IFRS A statement of changes in equity is presented as a primary statement for all entities.

US GAAP Permits the statement of changes in shareholders’ equity to be presented either as a primary statement or within the notes to the financial statements.

JP GAAP Statement of changes in net assets is presented as a primary statement.

Statement of cash flows (Cash flow statement)

Definition of cash and cash equivalents (Treatment of bank over draft)

IFRS Cash may also include bank overdrafts repayable on demand. Short-term bank borrowings are not included in cash or cash equivalents and are considered to be financing cash flows.

US GAAP Bank overdrafts are not included in cash; changes in the balances of overdrafts are classified as financing cash flows, rather than being included within cash and cash equivalents.

JP GAAP Similar to IFRS. Bank overdraft is treated as negative cash.

Classification of specific items

IFRS, US GAAP and JP GAAP require the classification of interest, dividends and tax within specific categories of the cash flow statement.

ITEM IFRS US GAAP JP GAAP

Interest paid Operating or financing1 Operating2 Operating or financing4

Interest received Operating or investing1 Operating Operating or investing4

Dividends paid Operating or financing1 Financing Financing

Dividends received Operating or investing1 Operating Operating or investing4

Taxes paid Operating – unless specific identification with financing or investing

Operating2, 3 Operating

1 IFRS: Once an accounting policy election is made, it should be followed consistently.2 US GAAP: Additional disclosure rules exist regarding the supplemental disclosure of interest and taxes paid during the period.3 US GAAP: Specific rules exist regarding the classification of the tax benefit associated with share-based compensation arrangements.4 JP GAAP: An entity is permitted to choose either of the following;

Once an accounting policy is elected, it shall be applied consistently.


Disclosure of critical accounting policies and significant estimates

IFRS Within the notes to the financial statements, entities are required to disclose:

• The judgments that management has made in the process of applying its accounting policies that have the most significant effect on the amounts recognized in those financial statements; and

• Information about the key assumptions concerning the future—and other key sources of estimation uncertainty at the balance sheet date—that have significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year.

US GAAP For SEC registrants, disclosure of the application of critical accounting policies and significant estimates is normally made in the Management’s Discussion and Analysis section of Form 10-K.

Financial statements prepared under US GAAP include a summary of significant accounting policies used within the notes to the financial statements.

JP GAAP An entity discloses its critical accounting policy including significant estimates in accordance with the financial statements regulations and the guidelines under the Financial Instruments and Exchange Act. However, items, such as uncertainty in the future, which are required to be disclosed outside of the financial statements, exist.

Changes in accounting policy and other accounting changes

Changes in accounting policy

IFRS Changes in accounting policy upon initial application of a standard or an interpretation that does not include specific transitional provisions applying to that change, or changes an accounting policy voluntarily are accounted for retrospectively.

US GAAP Similar to IFRS.

JP GAAP There is no retrospective restatement in principle. The effect of changes in prior periods is included in net income for the period, and the nature and effect of the changes need to be disclosed in the notes to the financial statements. An entity shall account for changes in accounting policy retrospectively for annual periods beginning on or after 1 April 2011.

Correction of errors

IFRS The same method as for changes in accounting policy applies.

US GAAP Similar to IFRS, reported as a prior-period adjustment; restatement of comparatives is mandatory.

JP GAAP Generally included in net income for the period as an extraordinary item. Some entities which are regulated and disclose their financial statements in accordance with the Financial Instruments and Exchange Act restate errors by issuing a “revision of financial report”. An entity shall account for correction of errors retrospectively for annual periods beginning on or after 1 April 2011.

Changes in accounting estimates

IFRS Changes in accounting estimates are accounted for prospectively in profit or loss when identified. To the extent that a change in an accounting estimate gives rise to changes in assets and liabilities, or relates to an item of equity, it shall be recognised by adjusting the carrying amount of the related asset, liability or equity item in the period of the change.


JP GAAP Similar to IFRS. However, in terms of the accounting estimate for depreciation cost, an entity may correct it retrospectively and record the amount to adjust the carrying amount as an extra depreciation cost, which is categorised as an extraordinary loss. This treatment has been superseded for annual periods beginning on or after 1 April 2011.

Comparatives

IFRS One year of comparatives is required for all numerical information in the financial statements, with limited exceptions in disclosures. In limited note disclosures and the statement of equity (where a reconciliation of opening and closing positions are required), more than one year of comparative information is required.



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A third balance sheet also is required for first-time adopters of IFRS and in situations where a restatement or reclassification has occurred. Restatements or reclassifications in this context are in relation to a change in accounting policies, errors, or changes in presentation of previously issued financial statements.

US GAAP Comparative financial statements are not required; however, SEC requirements specify that most registrants provide two years of comparatives for all statements except for the balance sheet, which requires only one comparative year.

JP GAAP The financial statements regulations and the guidelines under the Financial Instruments and Exchange Act require to disclose one year (prior year) of comparatives for all information including notes to the financial statements.


Joint FASB/IASB: Staff Draft of Exposure Draft Financial Statement Presentation

In July 2010, the FASB and IASB published a staff draft of an exposure draft that will propose changes to the presentation of financial statements under IFRS and US GAAP. The staff draft reflects the boards’ collective tentative decisions. The proposed model would require companies to:

Classify assets, liabilities, income, expenses and cash flows as operating, investing, financing, taxes, or discontinued operations.•

Prepare a roll forward of significant Statement of Financial Position line items in the notes. •

Use the “direct method” for preparing the cash flow statement, with certain indirect information presented as supplemental cash flow • information.

Disaggregate information by function (e.g., cost of sales, selling, and marketing) on the face of the Statement of Comprehensive Income and by • nature (e.g., rent, payroll) in the notes.

Net debt reconciliation in a single note, showing the changes in each item of debt, cash, short-term investments, and finance leases.•

The boards’ tentative conclusions are expected to result in similar presentation of financial statements under IFRS and US GAAP, but there are three key differences between the proposals. (1) the FASB, but not IASB, will require the disaggregated information to be provided by segment; (2) the IASB’s proposal includes a separate note that reconciles changes in debt and related financial balances (a net debt reconciliation); (3) the IASB’s proposal requires certain additional disaggregated line items in the balance sheet.

The boards have not formally invited comment on the staff draft but would welcome input.

FASB Exposure Draft: Statement of Comprehensive Income, and IASB proposed amendment to IAS 1, Presentation of Financial Statements

In May 2010, the FASB issued a proposed ASU, Statement of Comprehensive Income, which would require most entities to provide a new primary financial statement, referred to as the statement of comprehensive income. At the same time, the IASB issued a similar proposed amendment to IAS 1, Presentation of Financial Statements. Under the proposals, all components of net income and other comprehensive income would be reflected with equal prominence in one continuous statement of comprehensive income (US GAAP) or a statement of profit or loss and other comprehensive income (IFRS). While the FASB and IASB jointly developed the proposals, the new guidance would not change those components that are recognized in net income and those components that are recognized in other comprehensive income under either accounting framework. As such, convergence is not achieved in that regard.

While the boards worked on the proposals jointly, there are certain terminology and other differences between the proposals, including:

Under the IASB proposal, items included in other comprehensive income that may be recycled into profit or loss in future periods (for example, • cash flow hedges and cumulative translation adjustment) will be presented separately from those that will not be recycled (for example, revaluations of property, plant and equipment, and actuarial gains and losses). This distinction does not exist under the FASB proposal, where all items included in other comprehensive income are subject to recycling.

The IASB proposal would require an entity that elects to show items in other comprehensive income before income tax to allocate the income • tax between the tax on items that might be reclassified subsequently to profit or loss and tax on items that will not be reclassified subsequently. The FASB proposal has no requirement like this because all the items of other comprehensive income are subject to recycling.

The IASB’s proposal retains the option to disclose reclassification adjustments in the notes to the financial statements. The FASB’s proposal • would eliminate that option.

Despite these differences, the proposals are intended to enhance comparability of entities’ reporting between US GAAP and IFRS and to provide a more consistent method of presenting non-owner transactions that affect an entity’s equity. The final standards are expected to be issued in the first quarter of 2011.


Recent proposals – JP GAAP

Discussion Paper on Financial Statement Presentation

ASBJ released Discussion Paper on Financial Statement Presentation in July 2009. In this discussion paper, the issues arising from the GAAP differences between JP GAAP and current international accounting standards such as the presentation of comprehensive income, the separated income statement presentation for discontinued operation, as well as those which treated on the joint discussion paper “Preliminary Views on Financial Statement Presentation” issued by IASB and FASB in October, 2008.

REFERENCES: IFRS: IAS 1, IAS 7, IAS 8, IAS 21, US GAAP: ASC 205, ASC 205-20, ASC 230, ASC 260, ASC 360-10, ASC 830, ASC 830-30-40-2 through 40-4JP GAAP: The Discussion Paper issued by Accounting Standards Board of Japan ‘Conceptual Framework of Financial Accounting’, Business Accounting Principle, Regulations on Financial Statements, Regulation on Accounting Standards for Consolidated Financial Statement, Accounting Standards for Preparing Consolidated Statement of Cash Flows, Accounting Standard for Presentation of Net Assets Section in the Balance Sheet, Guidance on Accounting Standard for Presentation of Net Assets Section in the Balance Sheet, Accounting Standard for Statement of Changes in Net Assets, Guidance on Accounting Standard for Statement of Changes in Net Assets, Accounting Standard for Accounting Changes and Error Corrections,Guidance on Accounting Standard for Accounting Changes and Error Corrections, Accounting Standard for Presentation of Comprehensive Income.


Consolidation

Consolidation

Recent changes – IFRS and US GAAP

IAS 27R (Revised in January 2008) and ASC810

The IASB issued IAS 27R, ‘Consolidated and separate financial statements’, in January 2008. This standard requires the effects of all transactions with non-controlling interests to be recorded in equity if there is no change in control. They will no longer result in goodwill or gains and losses. The standard also specifies the accounting when control is lost. Any remaining interest in the entity is re-measured to fair value and a gain or loss is recognised in profit or loss. This standard is effective for annual periods beginning on or after 1 July 2009.

The FASB issued guidance in December 2007 to establish accounting and reporting guidance for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. This guidance is effective for fiscal years and interim periods within those fiscal years, beginning on or after December 15, 2008.

IAS 27R and the new US guidance have converged in the broad principles, particularly related to the reporting of noncontrolling interests in subsidiaries.

Guidance on Consolidation of VIE (US GAAP)

The FASB issued guidance on the consolidation of variable interest entities (VIEs) in June 2009. This guidance will be effective as of the beginning of entity’s first annual reporting period beginning after November 15, 2009. The new guidance requires an entity with a variable interest in a VIE to qualitatively assess whether it has a financial interest in the entity and, if so, whether it is the primary beneficiary. This significantly changes previous guidance, moving to a qualitative analysis from a quantitative analysis. However, the application of the new guidance was deferred for certain investment companies such as mutual funds, hedge funds, private equity funds, venture capital funds, and certain mortgage REITs. If an entity meets the conditions for the deferral, the reporting entity should continue to apply the VIE model in ASC 810-10 or other applicable consolidation guidance, such as ASC810-20, when evaluating the entity for consolidation.

This guideline also requires enhanced disclosures to provide users of financial statements with more transparent information about an enterprise’s involvement in a VIE.

With the issuance of this guidance, US GAAP does not converge with IFRS. Therefore, differences will still exist between the two standards.

Investments in subsidiaries

Preparation of consolidated financial statements

IFRS Parent entities prepare consolidated financial statements that include all subsidiaries. An exemption applies to a parent:

• that is itself wholly owned and its other owners, including those not otherwise entitled to vote have been informed about and do not object to the parent not presenting consolidated financial statements;

• when the parent’s debt or equity securities are not publicly traded nor is it in the process of issuing securities in public securities markets; and

• when the ultimate or any intermediate parent of the parent produces consolidated financial statements that comply with IFRS.

The guidance applies to activities regardless of whether they are conducted by a legal entity. Subsidiaries are entities (including special purpose entities “SPE”) that are controlled by another entity. This can be taken the form of a corporation, trust, partnership or unincorporated entity.

US GAAP There are no exemptions for consolidating subsidiaries in general purpose financial statements. Consolidated financial statements are presumed to be more meaningful and are required for SEC registrants.

JP GAAP Public companies and companies that report under the Financial Instruments and Exchange Law are required to prepare consolidated financial statements that include all subsidiaries.

Please also refer to additional guidance on scope exceptions for subsidiaries under ‘Common issues (subsidiaries, associates and joint ventures)’.


Consolidation model and subsidiaries

The definition of a subsidiary, for the purpose of consolidation, is an important distinction between the three frameworks.

IFRS Focuses on the concept of control in determining whether a parent/subsidiary relationship exists. In the context of SPE, risks and rewards have greater emphasis in interpreting the concept of control.

Control: Control is the parent’s ability to govern the financial and operating policies of a subsidiary to obtain benefits from its activities. Control is presumed to exist when a parent owns, directly or indirectly through subsidiaries, more than one half of an entity’s voting power.

Potential voting rights: IFRS specifically requires potential voting rights to be assessed. Instruments that are currently exercisable or convertible are included in the assessment, together with all facts and circumstances that affect potential voting rights except the intention of management and the financial ability to exercise or convert).

De facto control: Control also exists when a parent owns half or less of the voting power of an entity but has legal or contractual rights with other investors to have the majority of the entity’s voting rights, to govern the entity’s financial and operating policies, to appoint or remove the majority of the members of the board of directors or equivalent bodies, or to cast majority votes at their meetings. A parent could have control over an entity in circumstances where it holds half or less of the voting rights of an entity and no legal or contractual rights by which to control the majority of the entity’s voting power or board of directors (de facto control).

Controlling party: The substance of the arrangement would be considered in order to decide the controlling party for IFRS purposes.

IFRS does not address the impact of related parties and de facto agents.

Silos: IFRS does not provide explicit guidance on silos. However, it does create an obligation to consider whether a corporation, trust, partnership or other unincorporated entity has been created to accomplish a narrow and well-defined objective. The governing document of such entities may impose strict and sometimes permanent limits on the decision-making power of their governing board, trustees, etc. IFRS requires the consideration of substance over form and discrete activities within a much larger operating entity to fall within its scope. When an SPE is identified within a larger entity (including a non-SPE), the SPE’s economic risks, rewards and design are assessed in the same manner as any legal entities.

SPE: Control may exist even in cases where an entity owns little or none of an SPE’s equity but retains a significant beneficial interest in the SPE’s activities. The application of the control concept requires, in each case, judgment in the context of all relevant factors.

When control of an SPE is not apparent, IFRS requires evaluation of every entity—based on the entity’s characteristics as a whole—to determine the controlling party. The concept of economic benefit or risk is just one part of the analysis. Other factors considered in the evaluation are the entity’s design (e.g., autopilot), the nature of the entity’s activities and the entity’s governance.

US GAAP US GAAP has a two-tiered consolidation model: the voting interest model and the variable interest model. The voting interest model focuses on the voting rights. The variable interest model is based on a party’s exposure to the risks and rewards on an entity’s activities.

Variable interest model: All consolidation decisions are evaluated first under the variable interest entity (VIE) model. US GAAP requires an entity with a variable interest in a VIE to qualitatively assess the determination of the primary beneficiary of a VIE.

In applying the qualitative model an entity is deemed to have a controlling financial interest if it meets both of the following criteria:

(1) Power to direct activities of the VIE that most significantly impact the VIEs economic performance (“power criterion”)

(2) Obligation to absorb losses from or right to receive benefits of the VIE that could potentially be significant to the VIE (“losses/benefits criterion”)

In assessing whether an enterprise has a controlling financial interest in an entity, it should consider the entity’s purpose and design, including the risks that the entity was designed to create and pass through to its variable interest holders.

Primary beneficiary: Only one enterprise, if any, is expected to be identified as the primary beneficiary of a VIE. Although more than one enterprise could meet the losses/benefits criterion, only one enterprise, if any, will have the power to direct the activities of a VIE that most significantly impact the entity’s economic performance.

Increased skepticism should be given to situations in which an enterprise’s economic interest in a VIE is disproportionately greater than its stated power to direct the activities of a VIE that most significantly impact the entity’s economic performance. As the level of disparity increases, the level of skepticism about an enterprise’s lack of power is expected to increase.

De facto control: US GAAP also includes specific guidance on interests held by related parties. A related-party group includes the reporting entity’s related parties and de facto agents (close business advisers, partners, employees, etc.) whose actions are likely to be influenced or controlled by the reporting entity.


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Individual parties within a related party group (including de facto agency relationships) are required to first separately consider whether they meet both the power and losses/benefits criteria. If one party within the related party group meets both criteria, it is the primary beneficiary of the VIE. If no party within the related party group on its own meets both criteria, the determination of the primary beneficiary within the related party group is based on an analysis of the facts and circumstances with the objective of determining which party is most closely associated with the VIE.

Silo: While US GAAP applies to legal structures, the FASB has included guidance to address circumstances in which entity with a variable interest shall treat a portion of the entity as a separate VIE if specific assets or activities (a silo) are essentially the only source of payment for specified liabilities or specified other interests. A party that holds a variable interest in the silo then assesses whether it is the silo’s primary beneficiary. The key distinction is that the US GAAP silo guidance applies only when the larger entity is a VIE.

SPE: If the entity is a VIE, management should follow the US GAAP guidance below, under ‘Special purpose entities’.

Reassessment: Determination of whether an entity is a VIE gets reconsidered either when a specific reconsideration event occurs or, in the case of a voting interest entity, when voting interests or rights change. However, the determination of a VIE’s primary beneficiary is an ongoing assessment.

Voting interest model: All other entities are evaluated under the voting interest model. Unlike IFRS, only actual voting rights are considered. Under the voting interest model, control can be direct or indirect. In certain unusual circumstances, control may exist with half or less ownership when contractually supported. The concept is referred to as effective control.

JP GAAP Under JP GAAP, an entity controlled by another entity (a controlling entity) is defined as a subsidiary of the controlling entity. ‘Control’ is defined as being ‘an entity controls the decision-making body of another entity’. Control is deemed effective in the following cases unless any rebuttable presumption exists. The decision making body of an entity is defined as a body which decides financial and operating policies of the entity.

(1) Parent substantially owns more than half of an entity’s voting power

(2) Parent holds between 40% or more and less than 50% of the voting rights of an entity, but holds more than 50% of the voting rights of an entity when combining those held by a party having a close relationship with the parent, or certain facts exist indicating that parent controls the decision-making body of the entity.

(3) Parent holds less than 40% of the voting rights of an entity, but holds more than 50% of the voting rights of an entity when combining those held by a party having a close relationship with the parent, and certain facts exist indicating that parent controls the decision-making body of the entity.

Special purpose entities

IFRS Special purpose entities (SPEs) are consolidated where the substance of the relationship indicates that an entity controls the SPE. Control may arise through the predetermination of the activities of the SPE (operating on ‘autopilot’) or otherwise. Indicators of control arise where:

• the SPE conducts its activities on behalf of the entity;

• the entity has the decision-making power to obtain the majority of the benefits of the SPE;

• the entity has other rights to obtain the majority of the benefits of the SPE and therefore expose to risks incident to the activities of the SPE; or

• the entity has the majority of the residual or ownership risks of the SPE or its assets.

This guidance is applied to all SPEs, with the exception of post-employment benefit plans or other long-term employee benefit plans. The guidance above applies to activities regardless of whether they are conducted by legal entity.

US GAAP Consolidation requirements focus on whether an entity is a VIE regardless of whether it would be considered an SPE.

Often, an SPE would be considered a VIE, since they are typically narrow in scope, often highly structured and thinly capitalized, but this is not always the case. For example, clear SPEs benefit from exceptions to the variable interest model such as pension, postretirement or postemployment plans.

The guidance above applies only to legal entities.

JP GAAP SPEs which are established by the SPE law and other entities operating similar business as SPEs in which the change of operations is restricted are presumed not to be subsidiaries, if the purpose of the establishment is to provide the owners of equity instruments issued by those entities with the returns from the assets transferred to them at fair value and their operations are conducted in accordance with that purpose.


Presentation of non-controlling interest

IFRS Non-controlling interests are presented as a separate component of equity in the statement of financial position. In the statement of comprehensive income, the non-controlling interests are presented on the face of the statement, but are not deducted from profit or loss in the determination of consolidated earnings. A separate disclosure on the face of the statement of comprehensive income attributing net earnings to the equity holders, i.e., owners of the parent and non-controlling interests, is required.


JP GAAP Minority interests (non-controlling interests) are presented as a component of net assets separate from equity in the balance sheet. In the income statement, net income is determined by adding/deducting minority interest income to/from net income before minority interest income.

Disclosures

IFRS IFRS does not have SPE specific disclosure requirements. IFRS has several consolidation disclosure requirements which include the following:

• Nature of relationship between parent and a subsidiary when parent does not own, directly or indirectly through subsidiaries, more than half of voting power;

• Reasons why ownership, directly or indirectly through subsidiaries, of more than half of voting or potential voting power of an investee does not constitute control;

• Date of financial statements of a subsidiary when such financial statements are used to prepare consolidated financial statements and are as of a date or for a period that is different from that of the parent’s financial statements, and the reason for using a different date or period;

• Nature and extent of any significant restrictions (e.g., resulting from borrowing arrangements or regulatory requirements) on ability of subsidiaries to transfer funds to parent in the form of cash dividends or to repay loans or advances;

• Schedule that shows effects of changes in a parent’s ownership interest in a subsidiary that do not result in a loss of control on equity attributable to owners of parent; and

• if control of a subsidiary is lost, the parent shall disclose the gain or loss, if any, and:

(1) Portion of that gain or loss attributable to recognising any investment retained in former subsidiary at its fair value at date when control is lost; and

(2) Line item(s) in the statement of comprehensive income in which gain or loss is recognised (if not presented separately in the statement of comprehensive income).

Additional disclosures are required in instances when separate financial statements are prepared for a parent that elects not to prepare consolidated financial statements, or when a parent, venturer with an interest in a jointly controlled entity or an investor in an associate prepares separate financial statements.

US GAAP US GAAP requires greater disclosure about an entity’s involvement in VIEs/SPEs and applies to both non-public and public enterprises. The principal objectives of disclosures are to provide financial statement users with an understanding of the following:

• Significant judgments and assumptions made by an enterprise in determining whether it must consolidate a VIE and/or disclose information about its involvement in a VIE

• The nature of restrictions on a consolidated VIE’s assets and on the settlement of its liabilities reported by an enterprise in its statement of financial position, including the carrying amounts of such assets and liabilities

• The nature of, and changes in, the risks associated with an enterprise’s involvement with the VIE

• How an enterprise’s involvement with the VIE affects the enterprise’s financial position, financial performance, and cash flows.

The level of disclosure to achieve these objectives may depend on the facts and circumstances surrounding the VIE and the enterprise’s interest in that entity.

US GAAP provides additional detailed disclosure guidance in order to meet the objectives described above.

Guidance also calls for certain specific disclosures to be made by (1) a primary beneficiary of a VIE, and (2) an enterprise that holds a variable interest in a VIE (but is not the primary beneficiary).


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JP GAAP For entities that are presumed not to be a subsidiary (so-called ‘disclosing SPEs’), disclosures are required, including a general description of the transactions involving the SPE and the amount of transactions with the SPE.

Employee share trusts (including employee share ownership plans)

Employee share-based payments are often combined with separate trusts that buy shares to be given or sold to employees.

IFRS The assets and liabilities of an employee share trust are consolidated by the sponsor if the employee share trust is an SPE of the sponsor in accordance with SIC 12. An entity accounts for its own shares held by such a trust as treasury shares under IAS 32, Financial Instruments: Presentation.

US GAAP For employee share trusts other than Employee Stock Ownership Plans (ESOPs), the treatment is generally consistent with IFRS. Specific guidance applies for ESOPs, under ASC 718-40.

JP GAAP No specific guidance exists as employee share trusts are not common.

Investments in associates

Definition

IFRS An associate is an entity, including an unincorporated entity such as partnership, over which the investor has significant influence – that is, the power to participate in, but not control, an associate’s financial and operating policies. Participation by an investor in the entity’s financial and operating policies via representation on the entity’s board demonstrates significant influence. A 20% or more interest by an investor in an entity’s voting rights leads to a presumption of significant influence unless it can be clearly demonstrated that this is not the case.

US GAAP Similar to IFRS, although the term ‘equity investment’ rather than ‘associate’ is used. US GAAP does not include unincorporated entities, although these would generally be accounted for in a similar way.

JP GAAP Similar to IFRS. An ‘associate’ is defined as a non subsidiary entity over which the parent company or its subsidiaries can exert significant influence on financial and operational or business policy decisions through investment, personnel, financial, technological, or trade relationships. When a company holds at least 20% of another entity’s voting rights, the company is presumed to have significant influence over the entity.

Equity method

IFRS An investor accounts for an investment in an associate using the equity method. The investor presents its share of the associate’s post-tax profits and losses after the date of acquisition in the statement of comprehensive income. The investor recognises its proportionate interest in the associate arising from changes in the associate’s other comprehensive income. The investor, on acquisition of the investment, accounts for the difference between the cost of the acquisition and investor’s share of fair value of the net identifiable assets as goodwill. The goodwill is included in the carrying amount of the investment.

The investor’s investment in the associate is stated at cost, plus its share of post-acquisition profits or losses, plus its share of post-acquisition movements in investee’s other comprehensive income, less dividends received. Losses that reduce the investment to below zero are applied against any long-term interests that, in substance, form part of the investor’s net investment in the associate – for example, preference shares and long-term receivables or loans. Losses recognised in excess of the investor’s investment in ordinary shares are applied to the other components of the investor’s interest in an associate in the reverse order of priority in a winding up. Further losses are provided for as a liability only to the extent that the investor has incurred legal or constructive obligations or made payments on behalf of the associate.

Disclosure of information is required about the revenues, profits or losses, assets and liabilities of associates.

Investments in associates held by venture capital organisations, mutual funds, unit trusts and similar entities including investment-linked insurance funds can be designated as at fair value through profit or loss or are classified as held for trading.

US GAAP Similar to IFRS if the equity method is applied. In addition, an entity can elect to adopt the fair value option for any of its equity method investments. If elected, equity method investments are presented at fair value at each reporting period, with changes in fair value being reflected in the income statement.

JP GAAP Similar to IFRS if the equity method is applied. Fair value option can not be applied.


Disclosure information is required under the related party disclosure, for the names of significant associates, and their summarized financial information. The summarized financial information may be aggregated.

Investments in joint ventures

Definition

IFRS A joint venture is defined as a contractual arrangement whereby two or more parties undertake an economic activity that is subject to joint control. Joint control is the contractually agreed sharing of control over an economic activity. Unanimous consent of the parties sharing control, but not necessarily all parties in the venture, is required.

US GAAP The term joint venture refers only to jointly controlled entities, where the arrangement is carried on through a separate entity. A corporate joint venture is defined as a corporation owned and operated by a small group of businesses as a separate and specific business or project for the mutual benefit of the members of the group.

JP GAAP A joint venture is included in the definition of ‘jointly controlled entities’. ‘Joint control’ is the contractually agreed sharing of control by multiple independent entities. A ‘jointly controlled entity’ is an entity jointly controlled by multiple independent entities. Certain requirements need to be satisfied for the formation of a ‘jointly controlled entity’. Joint ventures that do not satisfy these requirements should apply standards for subsidiaries or affiliates.

Types

IFRS Distinguishes between three types of joint venture:

• jointly controlled entities – the arrangement is carried on through a separate entity (company or partnership);

• jointly controlled operations – each venturer uses its own assets for a specific project and the joint venture activities may be carried out by the venturer’s employees alongside the venturer’s similar activities. The joint venture agreement usually provides a means by which the revenue from the sale of the joint product and any expenses incurred in common are shared among the venturers; and

• jointly controlled assets – a project carried on with assets that are jointly owned in order to obtain benefits for the venturers. Each venturer may take a share of the output from the assets and each bears an agreed share of the expenses incurred.

US GAAP Only refers to jointly controlled entities, where the arrangement is carried on through a separate corporate entity.

Most joint venture arrangement give each venturer (investor) participating rights over the joint venture (with no single venturer having unilateral control) and each party sharing control must consent to the venture’s operating, investing and financing decisions.

JP GAAP Similar to US GAAP. Only refers to jointly controlled entities, where the arrangement is carried on through a separate corporate entity.

Jointly controlled entities

IFRS Either the proportionate consolidation method or the equity method is allowed to account for a jointly controlled entity (a policy decision that must be applied consistently). Proportionate consolidation requires the venturer’s share of the assets, liabilities, income and expenses to be either combined on a line-by-line basis with similar items in the venturer’s financial statements, or reported as separate line items in the venturer’s financial statements. A full understanding of the rights and responsibilities conveyed in management agreements is necessary.

US GAAP Prior to determining the accounting model, an entity first assesses whether the joint venture is a VIE. If the joint venture is a VIE, the accounting model discussed in the above section, ‘Special purpose entities’, is applied. Joint ventures often have a variety of service, purchase and/or sales agreements as well as funding and other arrangements that may affect the entity’s status as a VIE. Equity interests are often split 50-50 or near 50-50, making non equity interests (i.e., any variable interests) highly relevant in consolidation decisions. Careful consideration of all relevant contracts and governing documents is critical in the determination of whether a joint venture is within the scope of the variable interest model and, if so, whether consolidation is required.

If the joint venture is not a VIE, venturers apply the equity method to recognise the investment in a jointly controlled entity. Proportionate consolidation is generally not permitted except for unincorporated entities operating in certain industries.

JP GAAP Equity method is applied to jointly controlled entities.


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Contributions to a jointly controlled entity

IFRS A venturer that contributes non-monetary assets, such as shares, property, plant and equipment or intangible assets to a jointly controlled entity in exchange for an equity interest in the jointly controlled entity recognises in its consolidated statement of comprehensive income the portion of the gain or loss attributable to the equity interests of the other venturers, except when:

• the significant risks and rewards of the contributed assets have not been transferred to the jointly controlled entity;

• the gain or loss on the assets contributed cannot be measured reliably; or

• the contribution transaction lacks commercial substance.

US GAAP As a general rule, an investor (venturer) records its contributions to a joint venture at cost (i.e., the amount of cash contributed and the book value of other nonmonetary assets contributed). When a venturer contributes appreciated noncash assets and others have invested cash or other hard assets, it may be appropriate to recognise a gain for a portion of that appreciation. Practice and existing literature vary in this area. As a result, the specific facts and circumstances affect gain recognition and require careful analysis.

JP GAAP Similar to US GAAP. As a general rule, an investor (venturer) records its contributions to a joint venture at cost.

Jointly controlled operations

IFRS A venturer recognises in its financial statements:

• the assets that it controls;

• the liabilities it incurs;

• the expenses it incurs; and

• its share of income from the sale of goods or services by the joint venture.

US GAAP Equity accounting is appropriate for investments in unincorporated joint ventures. The investor’s pro-rata share of assets, liabilities, revenues and expenses are included in their financial statements in specific cases where the investor owns an undivided interest in each asset of a non-corporate joint venture.

JP GAAP There is no specific standard for investments in unincorporated joint ventures.

Jointly controlled assets

IFRS A venturer accounts for its share of the jointly controlled assets, liabilities, income and expenses incurred by the joint venture, and any liabilities and expenses it has incurred.

US GAAP Not specified. However, proportionate consolidation is used in certain industries to recognise investments in jointly controlled assets.

JP GAAP There is no specific standard for investments in jointly controlled assets.

Common issues (subsidiaries, associates and joint ventures)

Scope exclusion : for subsidiaries, associates and joint ventures

IFRS Investments in a subsidiary, associate or joint venture that meets, on acquisition, the criteria to be classified as held for sale in accordance with IFRS 5, applies the presentation for assets held for sale (i.e., separate presentation of assets and liabilities to be disposed), rather than normal presentation (consolidation, equity method or proportionate consolidation).

A subsidiary is not excluded from consolidation simply because the investor is a venture capital organisation, mutual fund, unit trust or similar entity.

US GAAP Investment in subsidiary, associate or joint venture held-for-sale may not be precluded from consolidation or equity method of accounting. Unconsolidated subsidiaries are generally accounted for using the equity method unless the presumption of significant influence can be overcome.

Industry-specific guidance precludes consolidation of controlled entities and equity method investees by certain types of organisations, such as registered investment companies or broker/dealers.


JP GAAP Subsidiaries over which control is deemed temporary or subsidiaries that may significantly mislead stakeholders’ decision-making by the consolidation of those entities are not consolidated.

Standards specify circumstances that presume that certain special purpose entities are not subsidiaries of an investor or circumstances for which investees for venture capital are not considered as subsidiaries.

Less significant subsidiaries are permitted to be excluded from consolidation and are accounted for under the equity method.

Uniform accounting policies

IFRS Consolidated financial statements are prepared by using uniform accounting policies for like transactions and events in similar circumstances for all of the entities in a group

US GAAP Similar to IFRS, with certain exceptions. Consolidated financial statements are prepared by using uniform accounting policies for all of the entities in a group except when a subsidiary has specialised industry accounting principles. Retention of the specialised accounting policy in consolidation is permitted in such cases. Equity method investee’s accounting policies do not have to conform to the investor’s accounting policies, if the investee follows an acceptable alternative US GAAP treatment.

JP GAAP Similar to IFRS. However, when accounting policies applied by foreign subsidiaries are either IFRS or US GAAP, entities may use them for the preparation of consolidated financial statements. However, reconciliations to JP GAAP are required for significant items such as amortization of goodwill and others. Basically, associates are also required to use uniform accounting policies. However, as for foreign associates, the same treatment as foreign subsidiaries are permitted.

Reporting periods

IFRS The consolidated financial statements of the parent and the subsidiary are usually drawn up at the same reporting date. However, the subsidiary accounts as of a different reporting date can be consolidated, provided the difference between the reporting dates is no more than three months. The length of the reporting periods and any difference between the ends of the reporting periods shall be the same from period to period. Adjustments are made for significant transactions that occur in the gap period.

US GAAP Similar to IFRS, except that adjustments are generally not made for transactions that occur in the gap period. Disclosure of significant events is required.

JP GAAP Similar to IFRS. The consolidated financial statements of the parent and the subsidiary are usually drawn up at the same reporting date. However, the subsidiary accounts as of a different reporting date can be consolidated, provided the difference between the reporting dates is no more than three months. In such circumstances, significant differences in transactions between consolidated entities, which occurred during the different reporting periods, are adjusted.

Impairment

IFRS Investments in subsidiaries, associates and joint ventures that are carried at cost are tested for impairment under IAS 36, Impairment of Assets, whenever there is an indication that the carrying amount of the investment may not be recoverable.

For investments in associates and joint ventures accounted for under the equity method, if the investor has objective evidence of one of the indicators of impairment set out in IAS 39, for example, significant financial difficulty of the associate or joint venture, the entire carrying amount of the investment is tested for impairment as prescribed under IAS 36, Impairment of Assets. Goodwill on the initial acquisition of the investment is not tested for impairment separately, as it is not separately recognised.

When testing for impairment under IAS 36, the carrying amount of the investment is tested by comparing its recoverable amount (higher of value in use and fair value less costs to sell) with its carrying amount as a single asset. In the estimation of future cash flows for value in use, the investor may use either: its share of future net cash flows expected to be generated by the investment (including the cash flows from its operations) together with the proceeds on ultimate disposal of the investment; or the cash flows expected to arise from dividends to be received from the subsidiary, associate or joint venture together with the proceeds on ultimate disposal of the investment. Under appropriate assumptions, both methods give the same result.

US GAAP The impairment test under US GAAP is different from that of IFRS. Equity investments are considered impaired if the decline in value is considered to be other than temporary. As such, it is possible for the fair value of the equity method investment to be below its carrying amount, as long as that decline is temporary. If other-than-temporary impairment is determined to exist, the investment is written down to fair value.

JP GAAP Investments in subsidiaries, associates and joint ventures are carried at cost in the separate financial statements and such securities are tested for impairment as securities. Investments with a quoted market price are valued at market value when their market value declined significantly, unless market value is expected to recover. Investments without a quoted market price are impaired when there is a significant decline in the actual price of the investment due to a deterioration of financial position of the issuing entity. In both cases, the valuation differences are accounted for as current period losses.


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Recent proposals – IFRS

Exposure Draft 9, Joint Arrangements

In September 2007 the IASB issued Exposure Draft 9, Joint Arrangements, which would amend existing provisions of IAS 31 (ED 9). The exposure draft’s core principle is that parties to a joint arrangement recognise their contractual rights and obligations arising from the arrangement. The exposure draft therefore focuses on the recognition of assets and liabilities by the parties to the joint arrangement. The scope of the exposure draft is broadly the same as that of IAS 31. That is, unanimous agreement is required between the key parties that have the power to make financial and operating policy decisions for the joint arrangement.

ED 9 proposes two key changes. The first is the elimination of proportionate consolidation for a jointly controlled entity. This is expected to bring improved comparability between entities by removing the policy choice. The elimination of proportionate consolidation would have a fundamental impact on the statement of comprehensive income and statement of financial position for some entities, but it should be straightforward to apply.

The second change is the introduction of a dual approach to the accounting for joint arrangements. Exposure Draft 9 carries forward—with modification from IAS 31—the three types of joint arrangement, each type having specific accounting requirements. The first two types are Joint Operations and Joint Assets. The description and the accounting for them are consistent with Jointly Controlled Operations and Jointly Controlled Assets in IAS 31. In May 2009, the board reached a tentative decision to merge Joint Operations and Joint Assets into a single type of joint arramgement called Joint Operations. The remaining type of joint arrangement is a Joint Venture, which is accounted for by using equity accounting. A Joint Venture is identified by the party having rights to only a share of the outcome of the joint arrangement. The key change is that a single joint arrangement may contain more than one type.

The Board currently expects to publish a final standard in the first quarter of 2011. As drafted, the exposure draft broadly achieves convergence in principle with US GAAP, which generally requires the use of the equity method to account for jointly controlled entities.

Recent proposals – IASB/FASB Joint project

Exposure Draft 10, Consolidation

The IASB initiated its project on consolidated financial statements with the objective of publishing a single IFRS on consolidation to replace the consolidation requirements in IAS 27, Consolidated and Separate Financial Statements and SIC-12 Consolidation—Special Purpose Entities. The main objectives of the project are to improve the definition of control and related application guidance so that a control model can be applied to all entities, and to improve the disclosure requirements about consolidated and unconsolidated entities. The IASB issued an exposure draft at the end of 2008, and a final standard is expected in the first quarter of 2011.

The FASB completed, in 2009, its own project to improve the consolidation guidance and disclosures related to variable interest entities. The boards intend that once the IASB standard is finalized, their respective guidance relating to the consolidation of structured vehicles and other special purpose entities will be substantially converged. However, while the boards’ respective guidance will be based on generally consistent definitions of control, some differences will exist in how those principles are required to be applied. In certain circumstances this would result in different consolidation conclusions under each accounting framework.

The boards are working together to address the consolidation of investment companies and intend on issuing their respective proposals in the second quarter of 2011. The boards have tentatively agreed to define investment companies similarly and to require that investment companies not consolidate investments in entities that they control but instead measure those investments at fair value with changes in fair value recognized in profit or loss. However, the boards tentatively decided that the parent of an investment company (if the parent is not an investment company itself) would not retain the fair value accounting that is applied by the investment company to its controlled investments.

In September 2010, IASB published a staff draft of the final standard which includes the followings.

Control

The revised definition of control will focus on the need to have both power and variable returns before control is present. Power is the current ability to direct the activities that significantly influence returns. Returns must vary and can be positive, negative or both.

The determination of power is based on current facts and circumstances and is continuously assessed. The fact that control is intended to be temporary does not obviate the requirement to consolidate any investee under the control of the investor. Voting rights or contractual rights may be evidence of power, or a combination of the two may give an investor power. Power does not have to have to be exercised. An investor with more than half the voting would meet the power criteria in the absence of restrictions or other circumstances.

The application guidance includes examples of when an investor may have control with less than half of the voting rights. When assessing if it controls the investee, it should consider potential voting rights, economic dependency and the size of its shareholding in comparison to other holdings, together with voting patterns at shareholder meetings. This last consideration will bring the notion of ‘de facto’ firmly within the consolidation standard.


Principal-agency relationships

The staff draft also includes guidance on participating and protective rights and agent/principal relationships. Participating rights give an investor the ability to direct the activities of an investee that significantly affect the returns. Protective rights (often known as veto rights) may restrict an investor’s ability to control if the right applies to decisions in the ordinary course of business.

An investor (the agent) may be engaged to act on behalf of a single party or a group of parties (the principals). Certain power is delegated to the agent − for example, to manage investments. The investor may or may not have control over the pooled investment funds. The staff draft includes a number of factors to consider when determining whether or not the investor has control or is acting as an agent.


Discussion Paper on Treatment of Special Purpose Entities and Related Matters in Consolidated Financial Statements

In February 2009, the ASBJ published “Discussion Paper on Treatment of Special Purpose Entities and Related Matters in Consolidated Financial Statements” that includes issues on treatment of special purpose entities and related disclosures in consolidated financial statements, definition of control, application of effective control, entities subject to consolidation and issues on subsidiaries over which control is temporary.

In September 2010, an exposure draft was released which proposed that the treatment not to presume special purpose entities to be subsidiaries should be applied only to entities which transferred assets to the special purpose entities.

REFERENCES: IFRS: IAS 1(Revised in 2007), IAS 27(Revised), IAS 28(Revised), IAS 32, IAS 36, IAS 39, IFRS 5, SIC 12, SIC 13US GAAP: ASC 205-20, ASC 323, ASC 323-10-15-8 through 15-11, ASC 325-20, ASC 360-10, ASC 718-40, ASC 810, ASC 810-10-25-1 through 25-14, ASC 810-10-60-4, ASC 825, ASC 840-10-45-4, SAB Topic 5HJP GAAP: Practical Treatment on Changing the Scope of Subsidiaries and Associated Companies Included in Consolidated Financial Statements, Accounting Standard for Equity Method, Practical Solution on Accounting in Associates Accounted for Using Equity Method, Practical Guidelines on Accounting Under the Equity Method, Accounting Standard for Financial Instruments, Accounting Standards for Business Combinations, Guidance on Accounting Standard for Business Combinations and Accounting Standard for Business Divestitures, Accounting Standard for Consolidated Financial Statements, Announcement of Guidance on Determining a Subsidiaries and an Affiliate


Business combinations



IFRS 3 (revised January 2008) and ASC 805

The IASB and FASB issued new standards on business combinations in January 2008 and December 2007 respectively to replace the previous standards. The release of the revised standards resulted in significant changes to the accounting for business combinations under both IFRS and US GAAP and with greater impact on US GAAP. Many historical differences were eliminated, although certain important differences remain There are significant recognition differences, at the acquisition date, with respect to contingent assets and contingent liabilities. In subsequent accounting, there are also significant differences in the requirements for impairment testing and accounting for deferred taxes.

The IASB’s new standard IFRS 3R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after July 1 2009. The new US standard applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after Dec. 15, 2008.


An amended standard for business combinations

In December 2008, the Accounting Standards Board of Japan (ASBJ) issued an amended accounting standard for business combinations. The amendment removed a number of differences between IFRS; however several significant differences including goodwill amortization still remain.

The amended standard applies to business combinations entered into on and after April 1, 2010 and this chapter is prepared under the revised JP standard.

Definition

Both IFRS and US GAAP define business combinations as a transaction or other event in which an acquirer obtains control of one or more businesses. Under JP GAAP, a business combination is defined as an integration of an entity, or a business constituting an entity with another entity or businesses constituting another entity, so as to constitute a single reporting unit.

IFRS Business combinations within the scope of IFRS 3R are accounted for as acquisitions. The acquisition(purchase) method of accounting applies.

A business is defined in IFRS 3R as an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs or other economic benefits directly to investors or other owners, members or participants. A business generally consists of inputs, and processes applied to those inputs that have the ability to create outputs. Although businesses usually have outputs, outputs are not required for an integrated set to qualify as a business. If goodwill is present in a transferred set of activities and assets, the transferred set shall be presumed to be a business in the absence of evidence to the contrary.

US GAAP Similar to IFRS in the definition of a business. The use of purchase method of accounting is required for most business combinations if the acquired entity meets the definition of a business.

JP GAAP The purchase method is applied for business combinations. A business is where operating resources are organized and functioning for the purpose of an entity’s activities. Business combinations besides organization of common control entities and common control transactions are accounted for as acquisitions and purchase method of accounting is applied.

Acquisitions

Date of acquisition

IFRS The date on which the acquirer obtains control over the acquiree.


JP GAAP Similar to IFRS.


Identifying the acquirer

IFRS The acquirer is determined by reference to IAS 27R, under which the general guidance is the party that holds greater than 50% of the voting power has control. In addition, there are several instances where control may exist if less than 50% of the voting power is held by an entity, IFRS 3R nor IAS 27R contains guidance related to primary beneficiaries.

US GAAP The acquirer is determined by reference to ASC 810-10, under which the general guidance is that the party that holds directly or indirectly greater than 50% of the voting shares has control, unless the acquirer is the primary beneficiary of a VIE

JP GAAP Similar to IFRS. The controlling party is identified by the proportion of voting rights, the rights to appoint and dismiss board members, the structure of the board, and the terms for the exchange of shares.

Consideration transferred

The consideration transferred in a business combination shall be measured at fair value, which shall be calculated as the sum of the acquisition-date fair values of the assets transferred by the acquirer, the liabilities incurred by the acquirer to former owners of the acquiree, and the equity interests issued by the acquirer.

Share-based consideration

IFRS Shares issued as consideration are recorded at their fair value as at the acquisition date. Where control is achieved in a single transaction the acquisition date will be the date on which the acquirer obtains control over the acquiree’s net assets and operations.

US GAAP Similar to IFRS. Shares issued as consideration are measured at their fair values as at the date the acquirer achieves control.

JP GAAP Similar to IFRS. Shares issued as consideration are calculated based on the market price as at the date of the business combination, when the acquirer’s shares issued has a quoted market price as at that date.

Restructuring provisions

IFRS The acquirer may recognise restructuring provisions as part of the acquired liabilities only if the acquiree has an existing liability at the acquisition date for a restructuring recognised in accordance with IAS 37, Provisions, Contingent Liabilities and Contingent Assets.

A restructuring plan that is conditional on the completion of the business combination is not recognised in the accounting for the acquisition. It is recognised post-acquisition and the expenses flow through post-acquisition earnings.

US GAAP Similar to IFRS. Recognised as part of the acquisition only if the acquiree has an existing liability at the acquisition date.

JP GAAP ‘Restructuring provision’ or other related terms are not used in JP GAAP. Expenses or losses corresponding to certain events expected to occur after acquisition are recognised as liability, if the likelihood of such occurrence is reflected in the calculation of the consideration for acquisition. Unlike IFRS, such a liability can be recognised as part of a business combination even where the restructure does not meet the criteria for recognising a provision in the acquiree’s accounts.

Contingent consideration

IFRS If part of the purchase consideration is contingent on a future event, such as achieving certain profit levels, IFRS 3R requires the contingent consideration be recognised initially at fair value. A right to the return of previously transferred consideration is recognised as an asset. An obligation to pay contingent consideration is recognised as either a liability or equity. Financial liabilities are remeasured to fair value at each reporting date. Any changes in estimates of the expected cash flows outside the measurement period are recognised as profit or loss. Other liabilities should be accounted for in accordance with IAS 37 or other IFRSs as appropriate. Equity-classified contingent consideration is not remeasured at each reporting date. Settlement is accounted for within equity.

US GAAP US GAAP requires contingent consideration be measured initially at fair value. In subsequent periods outside the measurement period, changes in the fair value of contingencies classified as assets or liabilities will be recognised in earnings. Equity-classified contingent consideration is not remeasured at each reporting date; settlement is accounted for within equity.

JP GAAP Contingent consideration shall be accounted for when it becomes transferable or deliverable, and its market price becomes reasonably determinable. Where contingent consideration is contingent on future performance, additional consideration payable shall be recognised as an acquisition cost and additional goodwill shall be recognised accordingly. Where contingent consideration is contingent on the market price of specific equity shares or corporate bonds, it shall be additionally recognised at the fair value as at additional delivery of equity shares or bonds, and shares and bonds delivered as at business combination are remeasured at fair value and the resulting premiums and discounts for bonds are amortized prospectively.



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Transaction costs

IFRS Transaction costs (e.g., professional fees) are expensed and are not included in the business combination accounting.


JP GAAP Transaction costs regarded as consideration for acquisition are included in the acquisition cost, with the remaining transaction costs recognised as period expenses.

Recognition and measurement of identifiable assets and liabilities acquired

IFRS, US GAAP and JP GAAP require separate recognition, by the acquirer, of the acquiree’s identifiable assets acquired and liabilities assumed and contingent liabilities that existed at the date of acquisition.

These assets and liabilities are generally recognised at fair value at the date of acquisition with certain exceptions, including deferred tax assets and liabilities, liabilities related to the acquiree’s employee benefit arrangements, indemnification assets, reacquired rights, share-based payment awards and non-current assets held for sale.

Intangible assets

IFRS An intangible asset is recognised separately from goodwill if it represents contractual or legal rights or is capable of being separated or divided and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, identifiable asset or liability.

Acquired in-process research and development (IPR&D) is recognised as a separate intangible asset if it is identifiable. In subsequent periods, the intangible assets would be subject to amortization upon completion or impairment testing. Non-identifiable intangible assets are subsumed within goodwill.


JP GAAP An intangible asset is recognised if it represents legal rights or is capable of being separately transferred for which an independent value can be reasonably allocated. Costs for acquired R&D in process are recognised as intangibles similar to IFRS.

Acquired contingencies

IFRS The acquiree’s contingent liabilities are recognised separately at the acquisition date as part of allocation of the cost, provided they arise from past event and their fair values can be measured reliably.

The contingent liability is measured subsequently at the higher of the amount initially recognised or, if qualifying for recognition as a provision, the best estimate of the amount required to settle (under the provisions guidance).

Contingent assets are not recognised.

US GAAP Acquired liabilities and assets subject to contractual contingencies are recognised at fair value if fair value can be determined during the measurement period. If fair value can not be determined, companies should typically account for the acquired contingencies using existing guidance.

An acquirer shall develop a systematic and rational basis for subsequently measuring and accounting for assets and liabilities arising from contingencies depending on their nature.

JP GAAP Generally, contingent liabilities are recognised for the portion satisfying the general accounting standard for provisions. There is no requirement for recognising contingent assets.

Goodwill

IFRS Goodwill is not amortised but reviewed for impairment annually and when indicators of impairment arise, at the cash-generating-unit (CGU) level, or group of CGUs, as applicable. CGUs may be aggregated for purposes of allocating goodwill and testing for impairment. Groupings of CGUs for goodwill impairment testing cannot be larger than an operating segment.

US GAAP Similar to IFRS. Goodwill is not amortised but reviewed for impairment at least annually at the reporting unit level. Goodwill is assigned to one or more of an entity’s reporting units (i.e., an operating segment) or one level below (i.e., a component). The level of testing may be more different than under IFRS.

JP GAAP Goodwill is amortised regularly, on a straight-line basis, or other reasonable basis, over the period up to 20 years. Impairment of goodwill is assessed when an indicator of impairment is identified.


Goodwill impairment

IFRS Goodwill is allocated to a cash-generating unit (CGU) or group of CGUs, as defined within the guidance.

A one-step impairment test is performed. The recoverable amount of the CGU (i.e., the higher of its fair value less costs to sell and its value in use) is compared to its carrying amount. The impairment loss is recognised in operating results as the excess of the carrying amount over the recoverable amount. Impairment is allocated first to goodwill. Allocation is made on a pro rata basis to the CGU’s other assets to the extent that the impairment loss exceeds the book value of goodwill.

US GAAP Goodwill is assigned to an entity’s reporting units, as defined within the guidance.

A two-step impairment test is required:

(1) The fair value and the carrying amount of the reporting unit including goodwill are compared. Goodwill is considered to be impaired if the fair value of the reporting unit is less than the carrying amount; and

(2) Goodwill impairment is measured as the excess of the carrying amount of goodwill over its implied fair value. The implied fair value of goodwill—calculated in the same manner that goodwill is determined in a business combination—is the difference between the fair value of the reporting unit (or one level below) and the fair value of the various assets and liabilities included in the reporting unit (or one level below). The impairment charge is included in operating income. The loss recognised cannot exceed the carrying amount of goodwill.

JP GAAP Impairment test is performed by either of the following two methods since goodwill does not by itself generate cash-flows:

(1) In principle, test by a larger group unit, by adding the goodwill to multiple asset groups related to business to which the goodwill is attributed.

(2) Test by each asset group, when goodwill can be reasonably allocated to each asset group.

Similar to IFRS, impairment is first allocated to goodwill. Allocation is made on a reasonable basis to the asset group’s other assets to the extent that the impairment loss exceeds the book value of goodwill.

Bargain purchase (“negative goodwill”)

IFRS If the amount of goodwill determined is negative, the acquirer reassesses the identification and measurement of the acquiree’s identifiable assets, liabilities and contingent liabilities, the non-controlling interests (if any), the acquirer’s previously held interest (if any) and the consideration transferred. If there is any excess remaining after reassessment, the resulting gain shall be recognised in profit or loss on the acquisition date. The gain is attributed to the acquirer.



Subsequent adjustments to assets and liabilities (measurement period)

IFRS Adjustments against goodwill to the provisional fair values recognised at acquisition are permitted provided those adjustments are made within 12 months of the acquisition date to reflect new information obtained about facts and circumstances that existed as of the acquisition date. Adjustments made after 12 months are recognised in profit or loss. Measurement-period adjustments to the provisional amounts are recognised as if the accounting for the business combination had been completed at the acquisition date. Thus, the acquirer should revise comparative information for prior periods presented in financial statements as needed, including making any change in depreciation, amortisation or other income effects recognised in completing the initial accounting.


JP GAAP Similar to IFRS and US GAAP, adjustments should be made against goodwill within 12 months from the date of the business combination. When adjustments are made in a fiscal year following the first fiscal year of the business combination, adjustments related to prior years should be charged to profit and loss.

Noncontrolling interests (minority interests)

IFRS Where an investor acquires less than 100% of a subsidiary, the noncontrolling interests are stated on the investor’s statement of financial position either at the fair value of their proportion of identifiable net assets or at full fair value, at the option of the entity on a business combination by business combination basis. This option applies only to instruments that represent present ownership interests and entitle their holders to a proportionate share of the net assets in the event of liquidation. All other components of noncontrolling interest are measured at fair value unless other measurement basis is required by IFRS.



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In addition, no gains or losses will be recognised in earnings for further transactions between the parent company and the noncontrolling interests—unless control is lost.

US GAAP Noncontrolling interest is measured at fair value. In addition, no gains or losses are recognised in earnings for transactions between the parent company and the noncontrolling interests—unless control is lost.

JP GAAP When an investor acquires less than 100% of a subsidiary, the minority interests (noncontrolling interests) are stated on the investor’s balance sheet (statement of financial position) at the fair value of their proportion of identifiable net assets. If control is not lost, transactions between parent and minority interests (non-controlling interests) are recognised as goodwill for additional acquisitions and as gain or loss on sales for partial divestitures.

Fair Value

IFRS Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction. IFRS does not specifically refer to either an entry or exit price.

IFRS does not contain guidance about which market should be used as a basis for measuring fair value when more than one market exists; however, under both IFRS and US GAAP, observable markets typically do not exist for many assets acquired in a business combination. As a result, for many nonfinancial assets, the principal or most advantageous market will be represented by a hypothetical market which likely will be the same under both frameworks.

IFRS does not include an equivalent premise to “highest and best use” under US GAAP in measuring fair value.

The fair value definition of a liability uses a settlement concept. The fair value of financial instruments should reflect the credit quality of the instrument, and generally the entity’s own credit risk. However, the fair value of nonfinancial liabilities may not necessarily consider the entity’s own credit risk.

US GAAP Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

The exchange price represents an exit price under US GAAP, while IFRS does not specifically refer to either an entry or exit price.

A fair value measurement assumes that the transaction occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market.

Fair value measurements include concept of “highest and best use”, which refers to how market participants would use an asset to maximize the value of the asset or group of assets. The highest and best use is determined based on the use of the asset by market participants, even if the intended use of the asset by the reporting entity is different.

The fair value definition of a liability is based on a transfer concept and reflects nonperformance risk, which generally considers the entity’s own credit risk.

JP GAAP Similar to IFRS. However, the fair value of a debt instrument should not reflect the entity’s own credit risk.

Business combinations involving entities under common control

IFRS Does not specifically address such transactions. Entities should develop and apply consistently an accounting policy; management can elect to apply acquisition accounting or merger accounting (otherwise known as ‘predecessor accounting’ method) to a business combination involving entities under common control. The accounting policy can be changed only when the criteria in IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors, are met. Related-party disclosures are used to explain the impact of transactions with related parties on the financial statements.

US GAAP Specific rules exist for accounting for combinations of entities under common control. Such transactions are generally recorded at predecessor cost, reflecting the transferor’s carrying amount of the assets and liabilities transferred.

JP GAAP Similar to US GAAP. In principle, transactions under common control are required to be recorded based on book values measured prior to the transfer.


Step acquisitions (investor obtaining control through more than one purchase)

IFRS When entities obtain control through a series of acquisitions (step acquisitions) the entity will remeasure any previously held equity interests to fair value, and recognise any gain or loss in profit or loss or other comprehensive income, as appropriate.



Employee benefit arrangements, including share-based payments and income tax

Accounting for share-based payments and income taxes in accordance with IFRS and US GAAP, not at fair value, may result in different results being recorded as part of acquisition accounting.

Under JP GAAP, when an acquirer’s stock warrants are issued in exchange for the acquiree’s stock warrants, the stock warrants are measured at fair value. Unlike IFRS and US GAAP, deferred taxes are not measured at fair value and are required to be accounted for separately under JP GAAP.


An amended standard for business combination

In July 2009, the ASBJ issued Discussion Paper on Accounting for Business Combinations; toward the second-step amendment of the accounting for business combinations. This discussion paper addresses issues which were not discussed in the first-step amendment finalized in December 2008, such as amortization of goodwill and accounting for non-controlling interests.

REFERENCES: IFRS: IAS 12, IAS 27 (Revised), IFRS 3 (Revised), SIC 12, SIC 9US GAAP: ASC 205-20, ASC 350-10, ASC 350-20, ASC 350-30, ASC 360-10, ASC 805, ASC 810, ASC 810-10JP GAAP: Accounting Standards for Business Combination, Guidance on Accounting Standard for Business Combinations and Accounting Standard for Business Divestitures. Practical Guidelines on Accounting Standards for Capital Consolidation Procedures in Preparing Consolidated Financial Statements, Accounting Standards for Impairment of Fixed Assets, Guidance on Accounting Standards for Impairment of Fixed Assets


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Revenue recognition

Revenue

Recent changes – US GAAP

FASB Accounting Standards Update 2009-13: Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements—a consensus of the FASB Emerging Issues Task Force

In October 2009, the FASB amended Accounting Standards Codification Subtopic 605-25, Revenue Recognition—Multiple-Element Arrangements with Accounting Standards Update (ASU or Update) 2009-13 (EITF 08-1). This ASU will supersede current US GAAP guidance in this area and will become the standard guidance under US GAAP for many multiple-element arrangements.

This Update amends existing guidance for separating deliverables and allocating consideration in multiple-deliverable arrangements. It ultimately will result in a greater separation of deliverables. The amended guidance includes a hierarchy for determining the selling price of a deliverable. Such hierarchy requires selling price to be based on VSOE if available, third-party evidence (TPE) if VSOE is not available, or estimated selling price if neither VSOE nor TPE is available. The term “fair value” also is replaced with “selling price” to clarify that the allocation of revenue is based on entity-specific assumptions rather than assumptions of a marketplace participant.

As the amended guidance requires the use of a best estimated selling price if neither VSOE nor TPE is available, arrangement consideration will be allocated at the inception of the arrangement to all deliverables using the relative selling price method. The residual method of allocating arrangement consideration will be eliminated.

The Update is effective for arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Early adoption is permitted for years in which financial statements have not yet been issued. The guidance may be applied either prospectively from the beginning of the fiscal year for new or materially modified arrangements or retrospectively.

FASB Accounting Standards Update 2009-14: Software (Topic 985): Certain Revenue Arrangements That Include Software Elements—a consensus of the FASB Emerging Issues Task Force

In October 2009, the FASB amended Accounting Standards Codification Topic 985, Software, with Accounting Standards Update 2009-14 (EITF 09-3). This Update amends the scope of the software revenue recognition guidance to exclude (a) non-software components of tangible products and (b) software components of tangible products that are sold, licensed, or leased with tangible products when the software components and non-software components of the tangible product function together to deliver the tangible product’s essential functionality. Existing software revenue recognition guidance still requires the use of VSOE of fair value to separate deliverables and the use of the residual method to allocate the arrangement consideration when VSOE of fair value exists for all of the undelivered items but is not known for all of the delivered items.

The Update is effective for arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Early adoption is permitted for years in which financial statements have not yet been issued. The guidance may be applied either prospectively from the beginning of the fiscal year for new or materially modified arrangements or retrospectively. However, a company must adopt this Update in the same period that it adopts Update 2009-13.

FASB Accounting Standards Update 2010-17: Revenue Recognition—Milestone Method (Topic 605): Milestone Method of Revenue Recognition—a consensus of the FASB Emerging Issues Task Force

In April 2010, the FASB amended Accounting Standards Codification Topic 605, Revenue Recognition with Accounting Standards Update 2010-17 (EITF 08-9). This Update codifies a method that has been used in practice to recognize revenue related to contingent consideration (milestone payments). The Update generally applies to research or development deliverables under which a vendor satisfies its obligations over time, and arrangement consideration is contingent upon uncertain future events. Prior to this Update, authoritative guidance on the use of the milestone method did not exist.

In certain revenue arrangements, such as a collaboration agreement between a large pharmaceutical company and a smaller biotechnology company, early fixed payments from one party to the other for services are supplemented by additional payments that are contingent on the achievement of goals or milestones. Under the milestone method, an entity can recognize consideration that is contingent on achievement of a milestone as revenue in its entirety in the period in which the milestone is achieved only if the milestone meets all criteria to be considered substantive. Determination of whether a milestone is substantive will require significant judgment. For a milestone to be considered substantive, consideration earned from the achievement of a milestone must:

Be indicative of the value provided to the customer through either the vendor’s performance or a specific outcome resulting from the vendor’s • performance to achieve the milestone (for example, performance of research and development services by a biotechnology company that leads to US Food and Drug Administration approval);


Relate solely to past performance; and •

Be reasonable relative to all deliverables and payment terms in the arrangement.•

This Update defines a milestone and specifies that the use of the milestone method is a policy election; other proportional recognition methods may be used as long as the result does not cause the recognition of contingent consideration in its entirety in the period the milestone was achieved.

The new guidance is effective on a prospective basis for milestones achieved in fiscal years (and interim periods within those years) beginning on or after June 15, 2010. Early adoption is permitted. A vendor may elect to adopt the amendments in this Update retrospectively for all prior periods.

Definition

IFRS Income is defined in the IASB’s Framework as including revenues and gains. The standard IAS 18, Revenue, defines revenue as the gross inflow of economic benefits during the period arising from the ordinary activities of an entity when the inflows result in an increase in equity, other than increases relating to contributions from equity participants.

US GAAP Revenue is defined by the Concept Statement to represent actual or expected cash inflows (or the equivalent) that have occurred or will result from the entity’s major ongoing operations.

JP GAAP There is no currently-effective accounting standard which defines “revenue” explicitly. The Discussion Paper ‘Conceptual Framework of Financial Accounting’ defines revenue as an item which increases net income or minority interest income and expenses and is, in principle created along with the increase of assets or the decrease of liabilities.

Measurement

IFRS and US GAAP require measurement of revenues at the fair value of the consideration received or receivable. This is usually the amount of cash or cash equivalents received or receivable. Discounting to present value is required under IFRS where the inflow of cash or cash equivalents is deferred, and in limited situations under US GAAP.

Under JP GAAP, there is no written standard which specifies measurement of revenues. Generally, the amount of cash or cash equivalents received or receivable is used to measure revenue; and the amount receivable is not discounted to the present value in accounting practice.

Revenue recognition

IFRS Specific criteria for the sale of goods, the rendering of services, and interest, royalties, dividends and construction contracts need to be met in order to recognise revenue. The revenue recognition criteria common to each of these are the probability that the economic benefits associated with the transaction will flow to the entity and that the revenue and costs can be measured reliably.

Additional recognition criteria applies to revenue arising from the sale of goods as shown in the table next page. Interest is recognised on a basis that takes into account the asset’s effective yield. Royalties are recognised on an accrual basis. Dividends are recognised when the shareholder’s right to receive payment is established.

The principles laid out within each of the categories are generally to be applied without significant further rules and/or exceptions.

US GAAP The guidance is extensive and this may lead to significant differences in practice. Historically, there were a number of different sources of revenue recognition guidance, such as FASs, SABs, SOPs, and EITFs. While the FASB’s codification project has put authoritative US GAAP in one place, it has not impacted the volume and/or nature of the guidance. US GAAP focuses more on revenues being realised (either converted into cash or cash equivalents, or the likelihood of its receipt being reasonably certain) and earned (no material transaction pending and the related performance has occurred). Revenue recognition involves an exchange transaction – i.e., there should be no revenue recognition unless and until an exchange has taken place. Additional guidance for SEC registrants sets out criteria that an entity should meet before revenue is realised and earned (compared to IFRS in the table next page). SEC pronouncements also provide guidance related to specific revenue recognition situations.

JP GAAP Realisation principles’ for revenue recognition are indicated in accounting standards. However there is no comprehensive guideline that specifies the concept. It is often interpreted that “completion of transfer of goods or rendering of services” and “receipt for corresponding consideration (e.g., in the form of cash or receivables)” are the conditions to meet the concept.


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Revenue recognition criteria for the sale of goods

IFRS US GAAP JP GAAP

The entity has transferred to the buyer the significant risks and rewards of ownership of the goods.

Persuasive evidence of an arrangement exists. Goods are transferred.

The entity retains neither continuing managerial involvement nor effective control over the goods.

Delivery has occurred. Goods are transferred.

The amount of revenue can be measured reliably. Vendor’s price to the buyer is fixed or determinable. Consideration is received or receivable.

It is probable that economic benefits will flow to the entity.

Collectibility is reasonably assured. Consideration is received or receivable.

The costs incurred or to be incurred in respect of the transaction can be measured reliably.

– –

Specific revenue recognition issues

Contingent consideration

IFRS For the sale of a good, one looks to the general recognition criteria as follows:

• The entity has transferred to the buyer the significant risks and rewards of ownership;

• The entity retains neither continuing managerial involvement to the degree usually asociated with ownership nor effective control over the goods sold;

• The amount of revenue can be measured reliably;

• It is probable that the economic beneifts associated with the transaction will flow to the entity; and

• The costs incurred or to be incurred in respect of the transaction can be measured reliably.

As such, assuming that the other revenue recognition criteria are met, IFRS specifically calls for consideration of the probability of the benefits flowing to the entity as well as the ability to reliably measure the associated revenue. If it were not probable that the economic benefits would flow to the entity or if the amount of revenue could not be reliably measured, recognition of the contingent portion would be postponed until such time as all of the criteria are met.

US GAAP General guidance associated with contingencies around consideration is addressed within SAB Topic 13 and the concept of the seller’s price to the buyer being fixed or determinable.

Even when delivery has clearly occurred (or services have clearly been rendered) the SEC has emphasized that revenue related to contingent consideration should not be recognised until the contingency is resolved. It would not be appropriate to recognise revenue based upon the probability of a factor being achieved.

As further discussed in the Recent Changes section, the US GAAP guidance in this area is in a state of transition. The milestone method of revenue recognition guidance is effective on a prospective basis for milestones achieved in fiscal years (and interim periods within those years) beginning on or after June 15, 2010. Under the milestone method, an entity can recognize consideration that is contingent on achievement of a milestone as revenue in its entirety in the period in which the milestone is achieved only if the milestone meets all criteria to be considered substantive.

JP GAAP No specific guidance. However, its treatment is similar to IFRS in practice.

Sale of goods – continuous transfer

IFRS When an agreement is for the sale of goods and is outside the scope of construction accounting, an entity considers whether or not all of the sale of goods revenue recognition criteria are met continuously as the contract progresses. When all of the continuous transfer criteria are achieved, an entity recognises revenue by reference to the stage of completion using the percentage of completion method. The requirements of the construction contracts guidance are generally applicable to the recognition of revenue and the associated expenses for such continuous transfer transactions. Achieving the continuous transfer requirements is expected to be relatively rare in practice.

US GAAP Other than construction accounting, US GAAP does not have a separate model equivalent to the continuous transfer notion for sale of goods.

JP GAAP Similar to US GAAP.


Rendering services

IFRS IFRS requires that service transactions be accounted for by reference to the stage of completion of the transaction. This method is often referred to as the percentage-of-completion method. The stage of completion may be determined by a variety of methods (including the cost-to-cost method). Revenue may be recognised on a straight-line basis if the services are performed by an indeterminate number of acts over a specified period of time and no other method better represents the stage of completion. Revenue may have to be deferred in instances where a specific act is much more significant than the other acts specified in an arrangement.

Revenue may be recognised only to the extent of expenses incurred that are recoverable when the outcome of a service transaction cannot be measured reliably. That is, a zero-profit model would be utilized, as opposed to a completed-performance model. If the outcome of the transaction is so uncertain that recovery of costs is not probable, revenue would need to be deferred until a more accurate estimate could be made.

US GAAP US GAAP prohibits the use of the cost-to-cost percentage-of-completion method to recognise revenue under service arrangements unless the contract is within the scope of specific guidance for construction or certain production-type contracts.

Generally, companies would have to apply the proportional-performance (based on output measures) model or the completed-performance model. In limited circumstances where output measures do not exist, input measures, which approximate progression toward completion, may be used. Revenue is recognised based on a discernible pattern and if none exists, then the straight-line approach may be appropriate.

Revenue is deferred where the outcome of a service transaction cannot be measured reliably.

JP GAAP There is no standard which explicitly specifies the accounting for service transactions. However, it is a common practice that revenue is recognised based on passage of time, for services rendered over time pursuant to written arrangements, otherwise upon completion of the service. In general, the percentage-of-completion method is not applied to those other than construction contracts or made-to-order software development.

Rendering services – right of refund

IFRS Service arrangements that contain a right of refund must be considered in order to determine whether the outcome of the contract can be estimated reliably and whether it is probable that the company would receive the economic benefit related to the services provided.

When reliable estimation is not possible, revenue is recognised only to the extent of the costs incurred that are probable of recovery.

US GAAP A right of refund may preclude recognition of revenues from a service arrangement until the right of refund expires.

In certain circumstances, companies may be able to recognise revenues over the service period—net of an allowance—if certain criteria within the guidance are met.

JP GAAP There is no guidance for service arrangements that contain a right of refund. It is generally interpreted that revenues cannot be recognised where receipt of consideration for rendered services has not been obtained.

Multiple-element arrangements

General

IFRS The revenue recognition criteria are usually applied separately to each transaction. In certain circumstances, however, it is necessary to separate a transaction into identifiable components in order to reflect the substance of the transaction. When identifiable components have stand alone value and their fair value can be measured reliably, separation is appropriate. At the same time, two or more transactions may need to be grouped together when they are linked in such a way that the whole commercial effect cannot be understood without reference to the series of transactions as a whole.

The price that is regularly charged when an item is sold separately is the best evidence of the item’s fair value. At the same time, under certain circumstances, a cost-plus-reasonable-margin approach to estimating fair value would be appropriate under IFRS. Under rare circumstances, a reverse residual methodology may be acceptable.

The use of either the cost-plus or the reverse residual method under IFRS may allow for the separation of more components/elements than would be achieved under US GAAP.

US GAAP Revenue arrangements with multiple deliverables are separated into different units of accounting if the deliverables in the arrangement meet all of the specified criteria outlined in the guidance. Revenue recognition is then evaluated for each separate unit of accounting.


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The US GAAP concept of separating potential units of accounting and identifying/measuring the fair value of a potential unit of accounting looks to market indicators of fair value and generally does not allow, for example, an estimated internal calculation of fair value based on costs and an assumed or reasonable margin.

When there is objective and reliable evidence of fair value for all units of accounting in an arrangement, the arrangement consideration should be allocated to the separate units of accounting based on their relative fair values.

When fair value is known for the undelivered items, but not for the delivered item, a residual approach can be used.

The reverse-residual method—when objective and reliable evidence of the fair value of an undelivered item or items does not exist—is precluded unless other US GAAP guidance specifically requires the delivered unit of accounting to be recorded at fair value and marked to market each reporting period thereafter.

As further discussed in the Recent Changes section, the US GAAP non-software guidance in this area is in a state of transition. Effective for years beginning on or after June 15, 2010, companies will be required to estimate a selling price for those deliverables in which VSOE or third-party evidence is not available. Accordingly, the residual method will be eliminated and estimation methods such as cost plus a reasonable margin will become acceptable.

JP GAAP There is no guidance for revenue recognition of multiple-element arrangements except for software transactions and construction contracts.

Multiple-element arrangements – software revenue recognition

IFRS No specific software revenue recognition guidance exists. Fees from the development of customised software are recognised as revenue by reference to the stage of completion of the development, including completion of services provided for post-delivery customer support service.

US GAAP Unlike IFRS, US GAAP provides specific guidance on software revenue recognition for software vendors, in particular for multiple-element arrangements. A value is established for each element of a multiple-element arrangement, based on vendor-specific objective evidence (VSOE) or other evidence of fair value. VSOE is generally limited to the price charged when elements are sold separately. Consideration is allocated to separate units based on their relative fair values; revenue is recognised as each unit is delivered.

As further discussed in the Recent Changes section, the US GAAP software guidance in this area is updated to amend the scope of the software revenue recognition guidance to exclude certain items.

JP GAAP In software transactions, when the contents and the amounts of each component of a contract (e.g., goods to sell, services to render) are agreed with customers (users), entities should appropriately separate the contractual consideration, and recognise revenues for goods (e.g., hardware or software) upon delivery, and recognise revenues for services as rendered. For multiple-deliverable arrangements when one component is to another primary component of the arrangement, revenues for that supplemental component can be recognised upon the revenue recognition of the primary component.

Multiple-element arrangements – customer loyalty programmes

IFRS IFRS requires that award, loyalty or similar programs whereby a customer earns credits based on the purchase of goods or services be accounted for as multiple-element arrangements. As such, IFRS requires that the fair value of the award credits (otherwise attributed in accordance with the multiple-element guidance) be deferred and recognised separately upon achieving all applicable criteria for revenue recognition.

The above-outlined guidance applies whether the credits can be redeemed for goods or services supplied by the entity or whether the credits can be redeemed for goods or services supplied by a different entity. In situations where the credits can be redeemed through a different entity, a company should also consider the timing of recognition and appropriate presentation of each portion of the consideration received given the entity’s potential role as an agent versus as a principal in each aspect of the transaction.

US GAAP Currently, divergence exists under US GAAP in the accounting for customer loyalty programs. There are two very different models that are generally employed.

Some companies utilize a multiple-element accounting model wherein revenue is allocated to the award credits based on relative fair value. Other companies utilize an incremental cost model wherein the cost of fulfilment is treated as an expense and accrued for as a “cost to fulfil,” as opposed to deferred based on relative fair value.

The two models can drive significantly different results.



JP GAAP There is no specific guidance on the accounting for customer loyalty programmes. However, it is common to apply the provision method by recognising the full amount of revenue at initial recognition including the awards credit and the estimated future expense for goods and services.

Multiple-element arrangements – contingencies

IFRS IFRS maintains its general principles and would look to key concepts including, but not limited to, the following:

• Revenue should not be recognised before it is probable that economic benefits would flow to the entity.

• The amount of revenue can be measured reliably.

When a portion of the amount allocable to a delivered item is contingent on the delivery of additional items, IFRS might not impose a limitation on the amount allocated to the first item. A thorough consideration of all factors would be necessary so as to draw an appropriate conclusion. Factors to consider would include the extent to which fulfillment of the undelivered item is within the control of and is a normal/customary deliverable for the selling party as well as the ability and intent of the selling party to enforce the terms of the arrangement. In practice, the potential limitation is often overcome.

US GAAP US GAAP generally looks to contingencies around pricing to be resolved such that price to the buyer is fixed or determinable. The guidance on multiple-element arrangements includes a strict limitation on the amount of revenue otherwise allocable to the delivered element in such an arrangement.

Specifically, the amount allocable to a delivered item is limited to the amount that is not contingent on the delivery of additional items. That is, the amount allocable to the delivered item or items is the lesser of the amount otherwise allocable in accordance with the standard or the noncontingent amount.


JP GAAP There is no guidance on treatment of contingent consideration in multiple-deliverable arrangements.

Construction contracts

Scope

IFRS The guidance applies to the fixed-price and cost-plus-construction contracts of contractors for the construction of a single asset or a combination of assets that are interrelated or interdependent in terms of their design, technology and function or their ultimate purpose or use. The guidance is not limited to certain industries. Assessing whether a contract is within the scope of the construction contract standard or revenue standard has been an area of recent focus. A buyer’s ability to specify the major structural elements of the design (either before and/or during construction) is a key factor (although not, in and of itself, determinative) of construction contract accounting. At the same time, with the aforementioned scope focus on the construction of a single asset or a combination of interrelated or interdependent assets to a buyer’s specifications, the construction accounting guidance is generally not applied to the recurring production of goods.

US GAAP The guidance applies to accounting for performance of contracts for which specifications are provided by the customer for the construction of facilities or the production of goods or the provision of related services. The scope of the guidance has generally been limited to certain specific industries and types of contracts.

JP GAAP Similar to IFRS. Among contract agreements, guidance is applied to construction contracts such as civil engineering, architecture, shipbuilding, manufacturing of certain machinery, in which basic specification and operation are based on customers’ requirements.


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Recognition method

Percentage-of-completion method

IFRS When the outcome of the contract can be measured reliably, revenue and costs are recognised by reference to the stage of completion of the contract activity at the end of the reporting period. The criteria necessary for a cost-plus contract to be reliably measurable are less restrictive than for a fixed-price contract. The zero-profit method is used when the final outcome cannot be estimated reliably. This recognises revenue only to the extent of contract costs incurred that are expected to be recovered. When it is probable that total contract costs will exceed total contract revenue, the expected loss is recognised as an expense immediately. IFRS provides limited guidance on the use of estimates.

US GAAP Two different approaches are allowed:

• the revenue approach (similar to IFRS) multiplies the estimated percentage of completion by the estimated total revenues to determine earned revenues; and multiplies the estimated percentage of completion by the estimated total contract costs to determine the cost of earned revenue; and

• the gross-profit approach (different from IFRS) multiplies the estimated percentage of completion by the estimated gross profit to determine the estimated gross profit earned to date.

Losses are recognised when incurred or when the expected contract costs exceed the expected contract revenue, regardless of which accounting method is used. US GAAP provides detailed guidance on the use of estimates.

JP GAAP Similar to IFRS, if the certainty of outcome for the portion progressed can be confirmed, revenue and costs are recognised with reference to the stage of completion of the contract activity at the balance sheet date. However, if the certainty of outcome cannot be confirmed, the completed contract method is applied.

Completed contract method

IFRS The completed-contract method is prohibited.

US GAAP While the percentage-of-completion method is preferred, the completed-contract method is also required in certain situations (e.g., inability to make reliable estimates).

For circumstances in which reliable estimates can not be made, but there is an assurance that no loss will be incurred on a contract (e.g., when the scope of the contract is ill defined, but the contractor is protected from an overall loss), the percentage-of-completion method based on a zero-profit margin, rather than the completed-contract method, is recommended until more-precise estimates can be made.

JP GAAP If the total amount of construction revenue, the total amount of construction costs, and the percentage of completion at closing date can not be reliably and reasonably estimated, the completed contract method is applied.

Combining contracts and segmenting a contract

IFRS A group of contracts is combined and treated as a single contract when they are negotiated as part of a package and other specified conditions are met. Where a contract relates to the construction of more than one asset, the construction of each asset is treated as a separate construction contract if it is part of a separate proposal that could be accepted or rejected separately and revenues and costs for that asset can be clearly identified.

US GAAP Combining and segmenting contracts is permitted provided certain criteria are met, but is not required, so long as the underlying economics of the transaction are fairly reflected.

JP GAAP If a contract document doesn’t properly reflect the substantial transaction unit agreed between transacting parties, the contract should be combined or segmented. A characteristic for the substantial transaction unit is that construction contractors obtain definitive claim rights for the consideration from customers by performing their construction obligation.

Barter transactions

Non-advertising-barter transactions

IFRS IFRS requires companies to look first to the fair value of items received to measure the value of a barter transaction. When that value is not reliably determinable, the fair value of goods or services surrendered can be used to measure the transaction.


US GAAP US GAAP generally requires companies to use the fair value of goods or services surrendered as the starting point for measuring a barter transaction.

The fair value of goods or services received can be used if the value surrendered is not clearly evident.

JP GAAP There is no separate guidance on measuring barter trading.

Accounting for advertising-barter transactions

IFRS Revenue from a barter transaction involving advertising cannot be measured reliably at the fair value of advertising services received. However, a seller can reliably measure revenue at the fair value of the advertising services it provides if certain criteria are met.

US GAAP If the fair value of assets surrendered in an advertising-barter transaction is not determinable, the transaction should be recorded based on the carrying amount of advertising surrendered, which likely will be zero.

JP GAAP There is no guidance on measuring barter trading with advertising services.

Accounting for barter-credit transactions

IFRS There is no further/specific guidance for barter-credit transactions. The broader principles outlined/referred to above should be applied.

US GAAP It should be presumed that the fair value of the nonmonetary asset exchanged is more clearly evident than the fair value of the barter credits received.

However, it is also presumed that the fair value of the nonmonetary asset does not exceed its carrying amount unless there is persuasive evidence supporting a higher value. In rare instances, the fair value of the barter credits may be utilized (e.g., if the entity can convert the barter credits into cash in the near term, as evidenced by historical practice).

JP GAAP There is no guidance on measuring barter-credit transactions.

Extended warranties

IFRS If an entity sells an extended warranty, the revenue from the sale of the extended warranty should be deferred and recognised over the period covered by the warranty.

In instances where the extended warranty is an integral component of the sale (i.e., bundled into a single transaction), an entity should attribute relative fair value to each component of the bundle.

US GAAP Revenue associated with separately priced extended warranty or product maintenance contracts should generally be deferred and recognised as income on a straight-line basis over the contract life. An exception exists where historical experience indicates that the cost of performing services is incurred on an other-than-straight-line basis.

The revenue related to separately priced extended warranties is determined by reference to the selling price for maintenance contracts that are sold separately from the product. There is no relative fair market value allocation in this instance.

JP GAAP There is no guidance on sales of extended warranties. General income recognition principles for service provision are applied.


Joint FASB/IASB Revenue Recognition Project

In June 2010 the FASB and IASB released an exposure draft, Revenue From Contracts with Customers, proposing a model that will have a significant impact on current revenue recognition under both US-GAAP and IFRS.

The proposed model employs an asset and liability approach, the cornerstone of the FASB’s and IASB’s conceptual frameworks. Current revenue guidance focuses on an “earnings process,” but difficulties often arise in determining when revenue is earned. The boards believe a more consistent application can be achieved by using a single, contract-based model where revenue recognition is based on changes in contract assets (rights to receive consideration) and liabilities (obligations to provide a good or perform a service). Under the proposed model, revenue is recognized based on the satisfaction of performance obligations. In applying the proposed model, entities would follow the below five-step process:

Identify the contract with a customer;•

Identify the separate performance obligations in the contract;•

Determine the transaction price;•


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Allocate the transaction price to the separate performance obligations; and•

Recognize revenue when each performance obligation is satisfied.•

Identify the contract with a customer

The model starts with identifying the contract with the customer and whether an entity should combine, for accounting purposes, two or more contracts (including contract modifications), or segment one contract into two or more contracts, to properly reflect the economics of the underlying transaction. The proposed guidance is based on a price interdependency principle. That is, two or more contracts (including contract modifications) should be combined when prices are interdependent. Conversely, an entity should segment one contract into two or more contracts if goods or services within the contract are priced independently. While aspects of this proposal are similar to existing literature, careful consideration will be needed to ensure the model is applied to the appropriate unit of account.

Identify the separate performance obligations in the contract

An entity will be required to identify all performance obligations in a contract. Performance obligations are promises to transfer an asset (either goods or services) to a customer and are similar to what we know today as “elements” or “deliverables.” The proposal broadens the existing definition. Performance obligations may be explicitly stated in the contract but may also arise in other ways. Legal or statutory requirements to deliver a good or perform a service may create performance obligations even though such obligations are not explicit in the contract. A performance obligation may also be created through customary business practices, such as an entity’s practice of providing customer support. The result is an increased identification of obligations within an arrangement, possibly changing the timing of revenue recognition. Sales-type incentives such as free products or customer loyalty programs, for example, are currently recognized as marketing expense under US GAAP in some circumstances. These incentives are performance obligations under the proposed model, thus revenue will be deferred until such obligations are satisfied, such as when a customer redeems loyalty points. Other potential changes in this area include accounting for certain warranties, return rights, licenses, and options.

Determine the transaction price

Once an entity identifies all the performance obligations in a contract, the obligations will be measured using a “transaction price approach.” The transaction price is the amount of expected consideration to be received for delivering a good or performing a service. The amount of expected consideration captures: (a) variable consideration, if reasonably estimable; (b) an assessment of collectibility; (c) an assessment of time value of money, if material; (d) noncash consideration, generally at fair value; and (e) consideration paid to customers. Inclusion of variable consideration may represent a significant change in the timing of revenue recognition. Revenue may be recognized earlier than under existing guidance if an entity can reasonably estimate the amount of variable consideration. This could result in increased volatility as estimates change, including a reduction of revenue for estimates adjusted downward. Collectibility refers to the customer’s ability to pay the contractual consideration. The amount of expected consideration (and therefore revenue) should be adjusted to reflect the customer’s credit risk, with subsequent upward or downward adjustments recorded in other income or expense. Existing literature requires that payment be reasonably assured (or probable under IFRS) for revenue to be recognized. Under the proposed model, collectibility impacts initial measurement of revenue as opposed to the recognition of revenue and, as such, both the amount and timing of revenue recognition may change.

Allocate the transaction price to the separate performance obligations

For contracts with multiple performance obligations (deliverables), the obligations should be separately accounted for to the extent that they are (a) transferred at different times and (b) distinct from other goods or services promised in the contract. A good or service is distinct and should be accounted for separately if the entity or another entity sells (or could sell) an identical or similar good or service separately. This determination will require a significant amount of judgment and likely will increase the number of obligations that require separation as compared to today. For example, those that currently account for deliverables at the contract level (such as many long-term construction or service contracts) are likely to be significantly impacted by this proposed separation principle.

Once an entity identifies and determines whether to separately account for all the performance obligations in a contract, the transaction price is allocated to these separate performance obligations based on relative standalone selling prices. The best evidence of standalone selling price is the observable price of a good or service when the entity sells that good or service separately. The selling price is estimated if a standalone selling price is not available. Some possible estimation methods include (a) cost plus a reasonable margin or (b) evaluation of standalone sales prices of the same or similar products, if available. This guidance is similar to the new US GAAP non-software multiple-element arrangement guidance as well as current IFRS guidance. The proposed model, however, will significantly affect entities that currently use the residual method to allocate arrangement consideration, as the residual method no longer will be permitted.


Recognize revenue when each performance obligation is satisfied

Revenue should be recognized when a promised good or service is transferred to the customer, which occurs when the customer obtains control of that good or service. Control can transfer at a point in time or continuously over time. Determining when control transfers will require a significant amount of judgment. Indicators that may be considered in determining whether the customer has obtained control of the good or service include: (a) the customer has an unconditional obligation to pay; (b) the customer has legal title; (c) the customer has physical possession; and (d) the customer specifies the design or function of the good or service. These indicators are not a checklist nor are they all-inclusive. All relevant facts and circumstances should be considered to determine whether the customer has obtained control of the good or service. If control is transferred continuously over time, an entity may use output methods (e.g., units delivered), input methods (e.g., costs incurred) or the passage of time to measure the amount of revenue to be recognized. The method that best depicts the transfer of goods or services to the customer should be applied consistently throughout the contract and to similar contracts with customers. The notion of an earnings process is no longer applicable.

Select other considerations

Contract cost guidance

The proposed model also includes guidance related to contract costs. First, all costs of obtaining a contract, costs relating to satisfied performance obligations, and costs related to inefficiencies should be expensed as incurred. This may represent a significant change for some entities, particularly those that currently capitalize customer acquisition costs. Entities should then evaluate whether direct costs incurred in fulfilling a contract are in the scope of other standards (i.e., inventory, intangibles, or fixed assets). If so, the entity should account for such costs in accordance with those standards. If not, the entity should capitalize those costs only if the costs relate directly to a contract, relate to future performance, and are probable of recovery under a contract. An example of such costs may be certain mobilization, design, or testing costs. These costs would then be amortized as control of the goods or services to which the asset relates is transferred to the customer.

Onerous performance obligations

Performance obligations should be assessed at contract inception and each reporting period thereafter to determine whether those obligations have become onerous. A performance obligation is onerous when the present value of the probability-weighted direct costs to satisfy a performance obligation exceeds the consideration allocated to it. The excess should be recognized as a contract loss with a corresponding liability that is remeasured at each reporting period. This proposal may represent a significant change for US GAAP and IFRS preparers. The recognition of onerous provisions for executory contracts generally is not currently permitted in US GAAP outside of certain specific guidance (e.g., construction contract guidance), and IFRS guidance generally requires an assessment of onerous provisions at the contract level, not the performance obligation level.

Summary observations

The above commentary is not all inclusive. The effect of the new revenue recognition guidance will be extensive. Every industry may be affected, and some will see pervasive changes as the proposed model will replace all existing US GAAP and IFRS revenue recognition guidance, including industry-specific guidance. Comments on the exposure draft are due on October 22, 2010. A final standard is expected in 2011, with an effective date likely no earlier than 2014. Entities should continue to evaluate how the model might change current business activities, including contract negotiations, key metrics (including debt covenants), budgeting, controls and processes, information technology requirements, and accounting. The proposed standard requires full retrospective application, including application to those contracts that do not affect current or future periods but affect reported historical periods. Although the proposed standard does not address early adoption, the FASB prefers to prohibit early adoption; the IASB proposes to allow first-time adopters of IFRS to adopt early.

REFERENCES: IFRS: IAS 11, IAS 18, IFRIC 13, IFRIC 15, IFRIC 18, SIC 31US GAAP: ASC 605-20-25-1 through 25-6, ASC 605-20-25-14 through 25-18, ASC 605-25, ASC 605-35, ASC 605-50, ASC 985-605, CON 5, SAB Topic 13JP GAAP: Business Accounting Principles, Accounting Standards for Research and Development Costs, Practical Solution on Revenue Recognition of Software Transactions, Accounting Standard for Construction Contracts, Research Report on Revenue Recognition in Japan (Interim Report) – Discussion in light of IAS 18, Revenue.


Expense recognition

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Expense recognition

Expense recognition—share-based payments


IFRS 2 amendment: Group cash-settled share-based payment transactions

In June 2009, the IASB published an amendment to IFRS 2 to provide a clear basis to determine the classification of share-based payment awards in both consolidated and separate financial statements. The amendments to IFRS 2, ‘Share-based payment - Group cash-settled share-based payment transactions’, incorporates IFRIC 8 and IFRIC 11 into the standard, expands on the guidance given in IFRIC 11 to address plans that were not considered in the interpretation and provides some useful tidying up to a number of the IFRS 2 definitions. The amended definitions remove inconsistencies between appendix A, defined terms, and the main body of the standard. The original IFRS 2 wording was inconsistent regarding the treatment of other group entities’ equity instruments. The amendments are effective for annual periods beginning on or after 1 January 2010 and must be applied retrospectively.

FASB Accounting Standards Update 2010-13: Compensation—Stock Compensation (Topic 718): Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades—a consensus of the FASB Emerging Issues Task Force

In April 2010, the FASB issued ASU 2010-13, Compensation—Stock Compensation: Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades (EITF 09-J). This Update amends ASC 718, Compensation—Stock Compensation, to specify that an employee share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity’s equity securities trades should be considered an equity award, assuming all other criteria for equity classification are met. The currency in which the underlying equity trades could be different from the currency in which the employee is paid or the functional currency of the subsidiary. The amendment is effective retrospectively for fiscal years beginning on or after December 15, 2010, with early adoption permitted.

Scope

IFRS IFRS focuses on the nature of the services provided and treats awards to employees and others providing employee-type services similarly. Awards for goods from vendors or nonemployee-type services are treated differently.

IFRS 2, Share-based payments, includes accounting for all employee and nonemployee arrangements. Furthermore, under IFRS, the definition of an employee is broader than the US GAAP definition.

US GAAP The guidance is focused on/driven by the legal definition of an employee with certain specific exceptions/exemptions.

ASC 718, Compensation—Stock Compensation, applies to awards granted to employees and Employee Stock Ownership Plans. ASC 505-50 applies to grants to nonemployees.

JP GAAP Applies to the accounting for employee and nonemployee share-based payment transactions.

Measurement of awards granted by nonpublic companies

IFRS IFRS does not include such alternatives of equity-classified and liability-classified for nonpublic companies and requires the use of the fair-value method in all circumstances.

US GAAP Equity-classified: The guidance allows nonpublic companies to measure stock-based-compensation awards by using the fair-value (preferred) method or the calculated-value method.

Liability-classified: The guidance allows nonpublic companies to make an accounting-policy decision on how to measure stock-based-compensation awards that are classified as liabilities. Such companies may use the fair-value method, calculated-value method, or intrinsic-value method.

JP GAAP JP GAAP allows nonpublic companies to measure stock-based-compensation awards by using the intrinsic value based method instead of the fair value method.

Classification of certain instruments

IFRS Puttable shares are always classified as liabilities.


Share-settled awards are classified as equity awards even if there is variability in the number of shares due to a fixed monetary value to be achieved.

Under IFRS2, equity/liability classification for share-based awards is determined wholly on whether the awards are ultimately settled in equity or cash, respectively.

US GAAP In certain situations, puttable shares may be classified as equity awards.

Liability classification is required when an award is based on a fixed monetary amount settled in a variable number of shares.

ASC 718 contains guidance on determining whether to classify an award as equity or a liability. ASC 718 also references the guidance in ASC 480, Distinguishing Liabilities from Equity, when assessing classification of an award.

JP GAAP Accounting standards specify only equity-settled share based payment transactions. Cash-settled share based payment transactions are not common in practice, the general requirement for provision is applied to the transaction. Puttable shares (shares with claim right for acquisition) are also not common, and they are classified in equity or liability by legal form. There is no guidance on share-settled awards that offer employees the choice of settlement in stock or cash. They are accounted for based on their business practices.

Awards with conditions other than service, performance, or market conditions

IFRS If an award of equity instruments contains conditions other than service, performance, or market vesting conditions, it is still classified as an equity-settled award. Such conditions may be nonvesting conditions. Nonvesting conditions are taken into account when determining the grant date fair value of the award.

US GAAP If an award contains conditions other than service, performance, or market conditions (referred to as “other” conditions), it is classified as a liability award.

JP GAAP Accounting standards specify only equity-settled share based payment transactions.

Service-inception date, grant date, and requisite service

IFRS IFRS does not include the same detailed definitions as US GAAP. The difference in the grant date definition is that IFRS does not have the requirement that the employee begins to be affected by the risks and rewards of equity ownership.

US GAAP The guidance provides specific definitions of service-inception date, grant date, and requisite service, which, when applied, will determine the beginning and end of the period over which compensation cost will be recognised. Additionally, the grant date definition includes a requirement that the employee begins to be affected by the risks and rewards of equity ownership.

JP GAAP The corporate law requires the grant date to be specified in the provisions of the subscription warrant and to be approved at the general shareholders’ (or board of directors’) meeting.

There is no requirement that an employee either begin to benefit from, or be adversely affected by, subsequent changes in the price of the employer’s equity shares in order to establish a grant date.

Attribution—awards with service conditions and graded-vesting features

IFRS Companies are not permitted to choose how the valuation or attribution method is applied to awards with graded-vesting features. Companies should treat each installment of the award as a separate grant. This means that each installment would be separately measured and attributed to expense over the related vesting period.

US GAAP Companies are permitted to make an accounting policy election regarding the attribution method for awards with service conditions and graded-vesting features. The choice in attribution method is not linked to the valuation method that the company uses. For awards with graded vesting and performance or market conditions, the graded-vesting attribution approach is required.

JP GAAP Similar to IFRS, in principle JP GAAP requires each instalment of a graded vesting award to be treated as a separate grant. There is also an option to value the award in total as a single award.

Tax withholding arrangements—impact to classification

IFRS IFRS does not contain a similar exception as US GAAP. Under IFRS, for an award to be wholly classified as equity-settled, the entity should settle the transaction by issuing the gross number of shares under option upon exercise. Conversely, where an employer settles an employee’s tax withholding liability using its own cash, the payment is treated as a cash-settled award. The classification of the net balance of the award settled in shares is not affected.

US GAAP An award containing a net settled tax withholding clause could be equity-classified so long as the arrangement limits tax withholding to the company’s minimum statutory rate. If tax withholding is permitted at some higher rate, then the whole award would be classified as a liability.


Expense recognition

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JP GAAP JP GAAP does not contain guidance to this aspect.

Recognition of social charges (e.g., payroll taxes)

IFRS Social charges, such as payroll taxes levied on the employer in connection with stock-based-compensation plans, are expensed in the income statement when the related compensation expense is recognised. The guidance in IFRS for cash-settled share-based payments would be followed in recognizing an expense for such charges.

US GAAP A liability for employee payroll taxes on employee stock-based-compensation should be recognised on the date of the event triggering the measurement and payment of the tax (generally the exercise date for a nonqualified option).

JP GAAP Not applicable, as employer payroll taxes for share options are not generally imposed.

Valuation—SAB Topic 14 guidance on expected volatility and expected term

IFRS IFRS does not include guidance comparable to SAB Topic 14.

US GAAP SAB Topic 14 includes guidance on expected volatility and expected term, which includes (1) guidelines for reliance on implied volatility and (2) the “simplified method” for calculating expected term for qualifying awards.


Certain aspects of modification accounting

IFRS Under IFRS, if the vesting conditions of an award are modified in a manner that is beneficial to the employee, this would be accounted for as a change in only the number of options that are expected to vest (from zero to a new amount of shares), and the award’s full original grant-date fair value would be recognised over the remainder of the service period. That result is the same as if the modified performance condition had been in effect on the grant date.

US GAAP An “improbable-to-probable” Type III modification can result in recognition of compensation cost that is less than the estimated fair value of the award on the original grant date. When a modification makes it probable that a vesting condition will be achieved, and the company does not expect the original vesting conditions to be achieved, the grant-date fair value of the award would not be a floor for the amount of compensation cost recognised.


Employee stock purchase plan (ESPP)

IFRS ESPPs are compensatory and treated like any other equity-settled share-based payment arrangement. IFRS does not allow any safe-harbor discount for ESPPs.

US GAAP ESPPs are compensatory if terms of the plan:

• Either: (a) are more favorable than those available to all shareholders or (b) if the discount from the market price exceeds the percentage of stock issuance costs avoided (discount of 5 percent or less is a safe harbor);

• Do not allow all eligible employees to participate on an equitable basis; or

• Include any option features (e.g., look backs).

JP GAAP Similar to IFRS. There is no compensation cost exemption for employee stock purchase plans.

Alternative vesting triggers

IFRS An award that becomes exercisable based on the achievement of either a service condition or a market condition is treated as two awards with different service periods, fair values, etc. Any compensation cost associated with the service condition would be reversed if the service was not provided. The compensation cost associated with the market condition would not be reversed.

US GAAP An award that becomes exercisable based on the achievement of either a service condition or a market condition is treated as a single award. Because such an award contained a market condition, compensation cost associated with the award would not be reversed if the requisite service period is met.

JP GAAP An award that is vested based on the achievement of either a service condition or a stock price condition should be treated as a single award. Even if an award is vested when a stock price condition is achieved without waiting for the achievement of service condition, only the service condition is considered as a vesting condition when entities do not consider the expectation of vesting date for a stock price condition. Compensation costs associated with the award may not be reversed.


Cash-settled awards with a performance condition

IFRS For cash settled awards even where the performance condition is not probable (i.e., greater than zero but less than 50 percent probability), a liability is recognised under IFRS based upon the fair value of the instrument (considering the likelihood of earning the award).

US GAAP For cash-settled awards with a performance condition, where the performance condition is not probable, there may be no liability recognised under US GAAP.

JP GAAP Accounting standards specify only equity-settled share based payment transactions. Cash-settled share based payment transactions are not common in practice, the general requirement for provision is applied to the transaction.

Group share-based payment transactions

IFRS For the separate financial statements of the subsidiary, equity or liability classification is determined based on the nature of the obligation each entity has in settling the awards.

The accounting for a group cash-settled share-based payment transaction in the separate financial statements of the entity receiving the related goods or services when that entity has no obligation to settle the transaction would be as an equity-settled share-based payment. The group entity settling the transaction would account for the share-based payment as cash-settled.

The accounting for a group equity-settled share-based payment transaction is dependent on which entity has the obligation to settle the award.

For the entity that settles the obligation, a requirement to deliver anything other than its own equity instruments (equity instruments of a subsidiary would be “own equity”) would result in cash-settled (liability) treatment. Therefore, a subsidiary that is obligated to issue its parent’s equity would treat the arrangement as a liability, even though in the consolidated financial statements the arrangement would be accounted for as an equity-settled share-based payment. Conversely, if the parent is obligated to issue the shares directly to employees of the subsidiary, then the arrangement should be accounted for as equity-settled in both the consolidated financial statements and the separate standalone financial statements of the subsidiary.

Hence, measurement could vary between the two sets of accounts.

US GAAP Generally, push-down accounting of the expense recognised at the parent level would apply to the separate financial statements of the subsidiary.

For liability-classified awards at the parent company, the mark to market expense impact of these awards should be pushed down to the subsidiary’s books each period, generally as a capital contribution from parent. However, liability accounting at the subsidiary may be appropriate, depending on the facts and circumstances.

JP GAAP Push-down accounting of the expense recognised at the parent level would apply to the separate financial statements of the subsidiary. At the same time, income is recognised as the awards are not charged to the parent company.

No accounting treatment is required in the case that the share-based payment is not awards at the subsidiary.

Derived service period

IFRS IFRS does not define a derived service period for fully vested, deep-out-of-the-money awards. Therefore, the related expense for such an award would be recognised in full at the grant date because the award is fully vested at that date.

US GAAP US GAAP contains the concept of a derived service period for awards that contain market conditions. Where an award containing a market condition is fully vested and deep-out-of-the-money at grant date but allows employees only a limited amount of time to exercise their awards in the event of termination, US GAAP presumes that employees must provide some period of service to earn the award. Because there is no explicit service period stated in the award, a derived service period must be determined by reference to a valuation technique. The expense for the award would be recognised over the derived service period and reversed if the employee does not complete the requisite service period.


REFERENCE: IFRS: IFRS 2, IFRIC 8, IFRIC 11US GAAP: ASC 480, ASC 505-50, ASC 718, ASC 815-40, SAB Topic 14-DJP GAAP: Accounting Standard for Share-based Payment, Guidance on Accounting Standard for Share-based Payment


Expense recognition

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Expense recognition—employee benefits

Recent changes – IFRS

IFRIC 14: IAS 19—The Limit on a Defined Benefit Asset, Minimum Funding Requirements and Their Interaction

In November 2009, the IASB issued an amendment to IFRIC 14, IAS19—The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction. The amendment removes an unintended consequence of IFRIC 14. Under the current guidance, some entities are not permitted to recognize certain prepayments for minimum funding contributions as an asset. The amendment remedies this by requiring prepayments to be recognised as assets in certain circumstances. The amendment is effective for annual periods beginning on or after January 1, 2011, and will apply from the beginning of the earliest comparative period presented. Early adoption is permitted. Differences to US GAAP and JP GAAP with respect to asset limitations will remain, as IFRS will retain certain limitations on defined benefit assets, and US GAAP and JP GAAP has no such limitations.

Determination of pension and other post-retirement obligation

IFRS Projected unit credit method used.


JP GAAP Similar to IFRS. However small companies (with 300 or fewer employees) are allowed to apply the simplified method, which is based on the amount of retirement benefits that would be payable assuming all the employees voluntarily retired at the end of the period.

Expense recognition—actuarial gains/losses

IFRS In addition to the choices available under US GAAP, IFRS allows companies to recognize all gains/losses immediately in other comprehensive income. Once recognised in other comprehensive income, gains/losses are not subsequently recorded within profit or loss.

US GAAP The literature permits companies to either (1) record expense for gains/losses in the period incurred within the statement of operations or (2) defer gains/losses through the use of the corridor approach (or any systematic method that results in faster recognition than the corridor approach).

Whether gains/losses are recognised immediately or are amortized in a systematic fashion, they are ultimately recorded within the statement of operations as components of net periodic pension expense.

JP GAAP Recognised immediately or allocated over a certain number of years within the average remaining service period starting from the period in which they were incurred or a period after.

In principle, straight-line method is applied. The declining-balance method is also permitted.

Although there is no corridor approach, in the event that no significant change in the discount rate nor other assumptions are identified, the assumptions need not be revised.

Income statement classification

IFRS There is no requirement to present the various components of net pension cost as a single item or a set of items all presented on a net basis within the income statement as US GAAP. Rather, the guidance allows for the potential disaggregation of the component pieces of pension/OPEB cost.

US GAAP All components of net pension/OPEB cost must be aggregated and presented as a net amount in the income statement.

While it is appropriate to allocate a portion of net pension expense to different line items (such as cost of goods sold if other employee costs are included in this caption), the disaggregation and separate reporting of different components of net pension expense are precluded.

JP GAAP Service cost and interest cost are expensed as pension cost, and expected return on plan assets is deducted from the cost. The allocation of past service cost and actuarial gains/losses are included in the pension cost.

Expense recognition—prior-service costs and credits

IFRS For active employees not yet vested, prior-service cost should be recognised, in income, on a straight-line basis over the average period from the date of the amendment until the benefits become vested.

To the extent that the incremental benefits are vested as of the date of the plan amendment, the cost of those benefits should be recognised immediately in the income statement.

Negative prior-service cost is accounted for the same as positive prior service costs.


US GAAP Prior-service cost should be recognised in other comprehensive income at the date of the adoption of the plan amendment and then amortized into income over one of the following:

• The participant’s remaining years of service (for pension plans except where all or almost all plan participants are inactive)

• The participant’s service to full eligibility date (for other postretirement benefit plans except where all or almost all plan participants are inactive)

• The participant’s life expectancy (for plans that have all or almost all inactive employees)

Negative prior-service cost should be recognised as a prior-service credit to other comprehensive income and used first to reduce any remaining positive prior-service cost included in accumulated other comprehensive income. Any remaining prior-service credits should then be amortized over the remaining service period of the active employees unless all or almost all plan participants are inactive, in which case the amortization period would be the plan participants’ life expectancies.

JP GAAP Past-service cost is the portion of increase or decrease of retirement benefit obligation due to amendment of retirement benefit levels, and is amortized over a certain number of years within the average remaining service period starting from the year incurred.

Expected return on plan assets

IFRS Plan assets should always be measured at fair value, and fair value should be used to determine the expected return on plan assets.

US GAAP Plan assets should be measured at fair value for balance sheet recognition and for disclosure purposes. However, for purposes of determining the expected return on plan assets and the related accounting for asset gains and losses, plan assets can be measured by using either fair value or a calculated value that recognizes changes in fair value over a period of not more than five years.


Balance sheet recognition

IFRS Companies are required to recognize on the balance sheet the difference between the defined benefit obligation (as defined) and the fair value of plan assets, plus or minus any unrecognised actuarial gains/losses or prior-service costs. This amount would be subject to the asset ceiling test (refer to the asset ceiling discussion below).

US GAAP Companies are required to record on the balance sheet the full funded status (i.e., the differences between the fair value of the plan assets and the benefit obligation/accumulated postretirement benefit obligation) of pension / postretirement plans with the offset to other comprehensive income. This guidance does not have an impact on the recognition of net periodic pension costs.


Substantive commitment to provide pension or other postretirement benefits

IFRS In certain circumstances, a history of regular increases may indicate:

• a present commitment to make future plan amendments, and

• that additional benefits will accrue to prior service periods.

In such cases, a constructive obligation (to increase benefits) is the basis for determining the obligation.

US GAAP The determination of whether a substantive commitment exists to provide pension benefits beyond the written terms of a given plan’s formula requires careful consideration. Although actions taken by an employer can demonstrate the existence of a substantive commitment, a history of retroactive plan amendments is not sufficient on its own. However, in postretirement benefit plans other than pensions, the substantive plan should be the basis for determining the obligation. This may consider a company’s past practice or communication of intended changes, for example in the area of setting caps on cost-sharing levels.

JP GAAP Generally, clearly presented written terms of the pension plan is the basis for the determination of the obligation, and substantive commitment is not included in the consideration. A temporary pension whose payment could not be presumed beforehand and pension payments exceeding recognised pension liability are expensed when paid.

Defined benefit versus defined contribution plan classification

IFRS An arrangement qualifies as a defined contribution plan if a company’s legal or constructive obligation is limited to the amount it contributes to a separate entity (generally, a fund or an insurance company). There is no requirement for individual participant accounts.


Expense recognition

56

For multiemployer plans, the accounting treatment used is based on the substance of the terms of the plan. If the plan is a defined benefit plan in substance, it should be accounted for as such, and the participating employer should record its proportionate share of all relevant amounts in the plan. However, defined benefit accounting may not be required if the company cannot obtain sufficient information.

US GAAP A defined contribution plan is any arrangement that provides benefits in return for services rendered, establishes an individual account for each participant, and is based on contributions by the employer or employee to the individual’s account and the related investment experience. Multiemployer plans are treated similarly to defined contribution plans.


For multiemployer plans, the pension assets attributable to an entity are allocated to the entity by a reasonable basis such as the proportion of the retirement benefit obligation of the entity. When the pension assets cannot be allocated on a reasonable basis, the contribution payable for the period is expensed. The latest full fund status, the proportion of each entity to the whole plan and supplementary information is disclosed in the notes.

Curtailments

IFRS A curtailment is defined as an event that an entity either (1) is demonstrably committed to make a material reduction in the number of employees covered by a plan, or (2) amends a defined benefit plan’s terms such that a material element of future service by current employees will no longer qualify for benefits, or will qualify only for reduced benefit.

Curtailment gains should be recorded when the company is demonstrably committed to making a material reduction (as opposed to once the terminations have occurred).

IFRS requires the curtailment gain/loss to include a pro rata share of related unamortized gains/losses (relevant if the Company applies the corridor method) and prior service costs previously not recognised (relevant for all plans).

US GAAP A curtailment is defined as an event that significantly reduces the expected years of future service of present employees or eliminates for a significant number of employees the accrual of defined benefits for some or all of their future service.

Curtailment gains are recognised when realized (i.e., once the terminations have occurred or the plan amendment is adopted).

The guidance permits certain offsets of unamortized gains/losses but does not permit pro rata recognition of the remaining unamortized gains/losses in a curtailment.

JP GAAP Curtailment is not explicitly defined; however, similar treatment of curtailment under IFRS is applied for the significant reduction of post-retirement benefit plans or significant reduction of number of employees implemented due to a large-scale restructuring plan.

Settlements

IFRS A settlement gain or loss is recognised when the settlement occurs. If the settlements are due to lump sum elections by employees as part of the normal operating procedures of the plan, settlement accounting does not apply.

A partial settlement occurs if a transaction eliminates all further legal or constructive obligations for part of the benefits provided under a defined benefit plan.

Settlement accounting requires complex calculations unique to IFRS to determine how much is recognised in current period earnings as compared to other comprehensive income.

US GAAP A settlement gain or loss normally is recognised in earnings when the settlement occurs. However, an employer may elect an accounting policy whereby settlement gain or loss recognition is not required if the cost of all settlements within a plan year does not exceed the sum of the service cost and interest cost components of net periodic pension cost for that period.

A partial settlement does not occur if a portion of the obligation for vested benefits to all plan participants is satisfied and the employer remains liable for the balance of the participants’ vested benefits.

Settlement accounting requires complex calculations unique to US GAAP to determine how much is recognised in current period earnings as compared to other comprehensive income.

JP GAAP In JP GAAP, on ‘termination’ of retirement benefit plan, when retirement benefit plan termination occurs, the difference between the retirement benefit obligations pertaining to the terminated portion and the corresponding payment actually made is accounted for as gains or losses. Unrecognised past service cost and unrecognised gains or losses are to be allocated to the terminated portion in the same proportion as the terminated portion bears to the whole retirement benefit obligations prior to the termination, or on some other rational basis and are to be accounted for as gains or losses.


Asset ceiling

IFRS Under the guidance, an asset ceiling test limits the amount of the net pension asset that can be recognised to the lower of (1) the amount of the net pension asset or (2) the sum of any cumulative unrecognised net losses, unrecognised prior-service cost, and the present value of any economic benefits available in the form of refunds or reductions in future contributions to the plan. The guidance also governs the treatment and disclosure of amounts, if any, in excess of the asset ceiling. In addition, the limitation on the asset often will create an additional liability because contributions may be required that would lead to or increase an unrecoverable surplus.

US GAAP There is no limitation on the size of the net pension asset that can be recorded on the balance sheet.

JP GAAP No similar requirement to IFRS.

Deferred compensation arrangements—employment benefits

IFRS IFRS does not distinguish between individual senior executive employment arrangements and a “plan” in the way that US GAAP does. Whether a postemployment benefit is provided for one employee or all employees the accounting is the same under IFRS. Deferred compensation accounting relates to benefits that are normally paid while in service but more than 12 months after the end of the accounting period in which they are earned.

The liability associated with deferred compensation contracts classified as other long-term benefits under IAS 19 is measured by the projected-unit-credit method (equivalent to postemployment-defined benefits), with the exception that all prior-service costs and gains and losses are recognised immediately in the income statement.

US GAAP Deferred compensation liabilities are measured at the present value of the benefits expected to be provided in exchange for an employee’s service to date. If expected benefits are attributed to more than an individual year of service, the costs should be accrued in a systematic and rational manner over the relevant years of service in which the employee earns the right to the benefit (to the full eligibility date).

A number of acceptable attribution models are used in practice, including the sinking-fund model and the straight-line model. Gains and losses are recognised immediately in the income statement.

JP GAAP There is no guidance for deferred compensation liabilities associated with deferred compensation arrangements. When requirements for provisions are met, corresponding expenses and provisions are recognised.

Plan asset valuation

IFRS Plan assets should be measured at fair value, which is defined as the amount for which an asset could be exchanged in an arm’s-length transaction between knowledgeable and willing parties.

For securities quoted in an active market, the bid price should be used.

Under IFRS, the fair value of insurance policies should be estimated using, for example, a discounted cash flow model with a discount rate that reflects the associated risk and the expected maturity date or expected disposal date of the assets. Qualifying insurance policies that exactly match the amount and timing of some or all of the benefits payable under the plan are measured at the present value of the related obligations. Under IFRS, the use of the cash surrender value is generally inappropriate.

US GAAP Plan assets should be measured at fair value less cost to sell. Fair value should reflect an exit price at which the asset could be sold to another party.

For markets in which dealer-based pricing exists, the price that is most representative of fair value—regardless of where it falls on the fair value hierarchy—should be used. As a practical expedient, the use of midmarket pricing is permitted.

Under US GAAP, contracts with insurance companies (other than purchases of annuity contracts) should be accounted for as investments and measured at fair value. In some cases, the contract value may be the best available evidence of fair value unless the contract has a determinable cash surrender value or conversion value, which would provide better evidence of the fair value.

JP GAAP Plan assets are measured at fair value at the end of the period. Fair value is the amount agreed on in sales transactions negotiated voluntarily between sellers and buyers who have sufficient knowledge and information.

Discount rates

IFRS The discount rate should be determined by reference to market yields on high-quality corporate bonds in the same currency as the benefits to be paid with durations that are similar to those of the benefit obligation.

Where a deep market of high-quality corporate bonds does not exist, companies are required to look to the yield on government bonds when selecting the discount rate.


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A synthetically constructed bond yield designed to mimic a high-quality corporate bond may not be used to determine the discount rate.

US GAAP The discount rate is based on the rate at which the pension obligation could be effectively settled. Companies may look to the rate of return on high-quality, fixed-income investments with similar durations to those of the benefit obligation to establish the discount rate. The SEC has stated that the term high-quality means that a bond has received one of the two highest ratings given by a recognised ratings agency (e.g., Aa or higher by Moody’s).

The guidance does not specifically address circumstances in which a deep market in high-quality corporate bonds does not exist (such as in certain foreign jurisdictions). However, in practice, a hypothetical high-quality bond yield is determined based on a spread added to representative government bond yields.

JP GAAP The discount rate is based on market yields of high-quality long-term debt securities, such as long-term government bonds, debt securities issued by government agencies or high-grade corporate bonds.

Accounting for termination indemnities

IFRS Defined benefit accounting is required for termination indemnities. Gains and losses are recognised following the company’s accounting policy for its other defined benefit plans.

US GAAP When accounting for termination indemnities, there are two acceptable alternatives to account for the obligation: (1) full defined benefit plan accounting; or (2) mark-to-market accounting (i.e., basing the liability on the amount that the company would pay out if the employee left the company as of the balance sheet date).

JP GAAP Additional payments (premiums) for voluntary retirement are expensed when such early retirement programs are implemented to the employees and when the amount can be reasonably estimated. Other termination benefits are treated under the general accounting rule for provisions.

REFERENCES: IFRS: IAS 19, IAS 37, IAS 39, IFRIC 14US GAAP: ASC 710, ASC 712, ASC 715, ASC 820, ASC 835-30JP GAAP: Accounting Standards for Retirement Benefits, Practical Guidelines on Accounting Standards for Retirement Benefits, Q&A on Accounting for Retirement Benefits, Accounting Standards for Transfer between Retirement Benefit Plans, Practical Solution on Accounting for Transfer between Retirement Benefit Plans


IASB Exposure Draft: Defined Benefit Plans

In April 2010, the IASB issued an exposure draft proposing significant changes to the recognition, presentation, and disclosure of long-term employee benefit plans. The key proposals are as follows:

Recognition of gains and losses

Gains and losses would be recognised immediately in other comprehensive income (OCI). The corridor and spreading option in IAS 19, which allows delayed recognition of gains and losses for postemployment benefits, would be prohibited. Immediate recognition of gains and losses in profit and loss, which is currently permitted for postemployment benefits and required for other long-term benefits, also would be prohibited. Gains and losses recognised in OCI would not be recycled through profit or loss in subsequent periods.

Recognition of past-service cost (referred to as prior-service cost under US GAAP)

All past-service costs (positive or negative) would be recognised in profit or loss when the employee benefit plan is amended. Past-service cost arises when the terms of a defined benefit plan are amended to provide additional benefits for service the employee has already delivered. These additional benefits are sometimes conditional on the employee providing future service (i.e., over a vesting period). IAS 19 currently requires past-service cost to be recognised on a straight-line basis until the future service has been delivered, or recognised immediately if no future service is required. This proposal no longer would allow past-service cost to be spread over the future-service period, which would increase volatility in profit or loss.

Measurement of pension expense

The expected return on plan assets and the interest cost on the pension obligation would be replaced by a new method of calculating the finance cost associated with a funded defined benefit obligation. The ED proposes that net interest expense or income would be calculated by applying the discount rate to the net surplus or deficit of the plan (the plan assets less the defined benefit obligation). The discount rate would be a high-quality corporate bond rate in markets where there is a deep market in such bonds, and a government bond rate in other markets. The effect of this proposal is that the expected earnings on plan assets would be determined using the same discount rate that is used to calculate the obligation. Currently, the expected return on plan assets is generally higher than the discount rate, so the proposed change would increase the pension cost recognised in profit or loss for most entities with funded plans. The measurement of the interest cost for an unfunded plan would remain unchanged.


Presentation of pension expense

IAS 19 would be amended to remove the flexibility around where in profit and loss the components of pension expense would be recognised. The cost of benefits accrued from service in the current period, benefit changes from plan amendments, and the effect of curtailments would be recognised as an operating expense. Net interest expense or income would be recognised as a financing item. Remeasurements (gains and losses on the obligation and plan assets, the effects of the asset limitation, and any gain or loss from settlements) would be recognised net of tax in OCI.

Disclosure requirements

Additional disclosures would be required with regard to the characteristics of the company’s benefit plans, the amounts recognised in the financial statements, and the risks arising from defined benefit plans and multiemployer plans. The proposed disclosures will cover long-term benefits payable in service, as well as post-employment benefits and likely would increase the volume of disclosure for many companies.

Timing

Comments on the ED are due by September 6, 2010. A final standard is expected in the first quarter of 2011. The FASB’s project in this area is not active, but the board is monitoring the work of the IASB as it contemplates next steps. The IASB plans to perform a comprehensive review of defined benefit accounting including measurement issues. The review will be performed in the future as part of a next phase for which a timetable has not yet been set. The IASB would consider conducting such a review with the FASB.

IASB expected amendments to IAS 19, Termination Benefits

While not yet issued, the IASB is expected to amend the guidance for termination benefits in IAS 19 in a manner that would align the treatment of termination benefits with US GAAP guidance for one-time termination benefits. See further discussion in the Recent/proposed guidance section of the Liabilities—other chapter.

Recent proposals – US GAAP

FASB Exposure Draft: Statement of Comprehensive Income and IASB proposed amendment to IAS 1, Presentation of Financial Statements

In May 2010, the FASB issued a proposed Accounting Standards Update, Statement of Comprehensive Income, which would require most entities to provide a new primary financial statement, referred to as the statement of comprehensive income. At the same time, the IASB issued a similar proposed amendment to IAS 1, Presentation of Financial Statements. With the proposed changes to what is recognised in OCI under IAS 19, as discussed above, the projects are seen as linked. See further discussion of the statement of profit or loss and other comprehensive income in the Other accounting and reporting topics section.


ASBJ Exposure Draft: Accounting Standard for Retirement Benefits and its Implementation Guidance

In March 2010, ASBJ released the Exposure Draft of Accounting Standard for Retirement Benefits (Exposure Draft of Statement No.39) and the Exposure Draft of Implementation Guidance on Accounting Standard for Retirement Benefits (Exposure Draft of Guidance No.35). The Exposure Drafts are based on the Standard for Presentation of Comprehensive Income (Statement No.25) which was issued in June 2010 and proposed to replace the standards and guidelines issued in the past. The Exposure Drafts also represent Step 1 of two separate steps for the Retirement Benefits project which ASBJ is working towards and the following revisions are proposed.

In the Exposure Drafts of the Accounting Standard and Implementation Guidance on Accounting Standard, unrecognised gains/losses and past-service cost should be recognised in other comprehensive income on a net of tax basis and companies are required to record on the balance sheet the full funded status as asset/liability. There is no change in expense recognition of unrecognised gains/losses and past-service cost.

The Exposure Drafts of the Accounting Standard and Implementation Guidance on Accounting Standard allow companies to attribute projected retirement benefits either on the basis of the promotion of the total service period which has elapsed or on the basis of projected unit credit method. The discount rate for calculation of the retirement benefit obligation should be several rates which are set based on each expected payment period, in principle. However, a single weighted average discount rate which reflects expected benefit periods and the related payment amounts is permitted in practice.

The majorities of disclosures required under the current international accounting standards, for example detail schedule of fluctuation of the retirement benefit obligations and the plan assets are outlined in the Exposure Drafts.


Assets

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Assets

Historical cost or valuation

IFRS Historical cost is the primary basis of accounting. However, IFRS permits the revaluation of intangible assets; property, plant and equipment; and investment property and inventories in certain industries. IFRS also requires that certain categories of financial instruments and biological assets be reported at fair value.

US GAAP US GAAP generally utilizes historical cost and prohibits revaluations except for certain categories of financial instruments, which are carried at fair value.

JP GAAP Similar to IFRS, historical cost is the accounting convention. Basically, JP GAAP does not permit revaluation of assets. However, fair value measurement is required for certain financial instruments and inventories for trading purpose.

Intangible assets

Recognition

IFRS General IFRS definition of assets applies, i.e., it is controlled by the entity and probable that future economic benefits are expected to flow to the entity. In addition, an intangible asset must be identifiable, which is either separable or arises from contractual or other legal rights. An acquired intangible is recognised if future economic benefits attributable to the asset are probable and the cost of the asset can be measured reliably.

US GAAP Similar to IFRS. Intangible assets may be recognised even though they do not meet the contractual-legal criterion or the separability criterion (for example, specifically-trained employees or a unique manufacturing process). Such transactions commonly are bargained exchange transactions conducted at arm’s length, which provides reliable evidence about the existence and fair value of those assets.

JP GAAP There is no specific accounting standard.

Recognition – additional criteria for internally generated intangibles

IFRS Costs associated with the creation of intangible assets are classified into research phase costs and development phase costs. Costs in the research phase are always expensed as the entity cannot demonstrate that it is probable to generate future economic benefits. Costs in the development phase are capitalized if all of the following six criteria are demonstrated:

• The technical feasibility of completing the intangible asset.

• The intention to complete the intangible asset.

• The ability to use or sell the intangible asset.

• How the intangible asset will generate future economic benefits (the entity should demonstrate the existence of a market or, if for internal use, the usefulness of the intangible asset).

• The availability of adequate technical, financial and other resources to complete the development.

• The ability to measure reliably the expenditure attributable to the intangible asset during its development.

Expenditures on internally generated brands, mastheads, publishing titles, customer lists and items similar in substance cannot be distinguished from the cost of developing the business as a whole. Therefore, such items are not recognised as intangible assets.

Development costs initially recognised as expenses cannot be capitalized in a subsequent period.

US GAAP In general, both research costs and development costs are expensed as incurred, making the recognition of internally generated intangible assets rare.

However, separate, specific rules apply in certain areas. For example, there is distinct guidance governing the treatment of costs associated with the development of software for sale to third parties. Separate guidance governs the treatment of costs associated with the development of software for internal use.


The guidance for the two types of software varies in a number of significant ways. There are, for example, different thresholds for when capitalization commences, and there are also different parameters for what types of costs are permitted to be capitalized.

JP GAAP Both research and development costs are expensed as incurred, making the recognition of internally generated intangible assets rare. However, as for software developed for the purpose to sell at market, the costs incurred to improve or strengthen the function of purchased software and product masters, where an intention for sales becomes clear by means of numbering product codes, shall be capitalized, as long as the improvement is not significant. Software developed for internal use shall be capitalized when earning of revenue or cost saving by utilizing the software is certain. Capitalization of software developed for internal use ceases when the production of software is substantially completed and there is evidence supporting the completion.

Recognition – website development costs

IFRS Costs incurred during the planning stage are expensed. Costs incurred for activities during the website’s application and infrastructure development stages are capitalised, and costs incurred during the operation stage are expensed as incurred.


JP GAAP There is no specific accounting standard. In practice, costs incurred during the planning stage are expensed. Similar to IFRS, costs incurred for activities during the website’s application and infrastructure development stages are capitalised, and costs incurred during the operation stage are expensed as incurred.

Recognition – advertising costs

IFRS Costs of advertising are expensed as incurred. The guidance does not provide for deferrals until the first time the advertising takes place, nor is there an exception related to the capitalization of direct response advertising costs or programs.

Prepayment for advertising may be recorded as an asset only when payment for the goods or services is made in advance of the entity’s having the right to access the goods or receive the services.

The cost of materials, such as sales brochures and catalogues, is recognised as an expense when the entity has the right to access those goods.

US GAAP The costs of other than direct response advertising should be either expensed as incurred or deferred and then expensed the first time the advertising takes place. This is an accounting policy decision and should be applied consistently to similar types of advertising activities.

Certain direct response advertising costs are eligible for capitalization if, among other requirements, probable future economic benefits exist. Direct response advertising costs that have been capitalized are then amortized over the period of future benefits (subject to impairment considerations).

Aside from direct response advertising related costs, sales materials, such as brochures and catalogues, may be accounted for as prepaid supplies until they no longer are owned or expected to be used, in which case their cost would be a cost of advertising.

JP GAAP There is no guidance for advertising costs. Generally, costs incurred for advertising are expensed based on the term of advertising or the distribution of catalogue and others.

Initial measurement – acquired intangibles

IFRS Recognised initially at cost. The cost of a separately acquired intangible asset at the date of acquisition is usually self-evident, being the fair value of the consideration paid. The cost of a separately acquired intangible asset comprises its purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates; and any directly attributable cost of preparing the asset for its intended use.



Initial measurement – internally generated intangibles

IFRS The cost comprises all expenditures that can be directly attributed or allocated to creating, producing and preparing the asset from the date when the recognition criteria are met.

US GAAP Costs of internally developing, maintaining or restoring intangible assets that are not specifically identifiable and that have indeterminable lives, or that are inherent in a continuing business and related to an entity as a whole, are recognised as an expense when incurred.

JP GAAP There is no recognition criteria for internally generated intangibles (except for software) and generally they are not recognised in practice.


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Subsequent measurement – acquired and internally generated intangibles

IFRS Intangible assets subject to amortisation are carried at historical cost less accumulated amortisation / impairment losses. Intangible assets not subject to amortisation are carried at historical cost unless impaired. Where the revaluation model is chosen, subsequent revaluation of intangible assets to their fair value is based on prices in an active market. Revaluations are performed regularly and at the same time for all assets in the same class if an entity adopts this treatment. The use of the revaluation model is extremely rare in practice.

US GAAP Similar to the cost method under IFRS, intangible assets subject to amortisation are carried at amortised cost less impairment. Intangible assets not subject to amortisation are carried at historical cost less impairment. Revaluation of intangible assets is not allowed under US GAAP.

JP GAAP Revaluation is not allowed. Intangible assets subject to amortisation are carried at amortised cost less impairment.

Amortisation – acquired and internally generated intangibles

IFRS Amortised if the asset has a finite life; not amortised if the asset has an indefinite life but should be tested at least annually for impairment. There is no presumed maximum life.


JP GAAP In general, assets are amortised over the period stipulated by corporate tax law on a straight line basis.

Impairment – acquired and internally generated intangibles

IFRS Impairment reviews are required whenever changes in events or circumstances indicate that an intangible asset’s carrying amount may not be recoverable. Annual reviews are required for intangible assets with indefinite useful lives and for assets not yet ready for use. Reversals of impairment losses are allowed under specific circumstances (excluding goodwill).

US GAAP Similar to IFRS, except reversals of impairment losses are prohibited.

JP GAAP Similar to IFRS. However, there is no requirement for an annual review of intangible assets. Reversals of impairment losses are prohibited.


An amended standard for Intangible assets

In December 2009, the ASBJ issued Discussion Paper on Accounting for Intangible assets. This discussion paper is issued for the purpose of establishing a standard which covers overall guidance on intangible assets, including definition, recognition criteria, accounting for internally generated intangible assets and intangible assets not subject to amortisation.

REFERENCES: IFRS: IAS 36, IAS 38, SIC 32US GAAP: ASC 350-10, ASC 350-20, ASC 350-30, ASC 350-40, ASC 985JP GAAP: Business Accounting Principle, the Corporate Calculation Regulations, Regulations on Financial Statements. Accounting Standards for Business Combination, Guidance on Accounting Standard for Business Combinations and Accounting Standard for Business Divestitures


Recognition

IFRS General IFRS asset recognition criteria apply. PPE is recognised if future economic benefits attributable to the asset are probable and the cost of the asset can be measured reliably.


JP GAAP There is no specific requirement.

Initial measurement

IFRS PPE, at initial measurement, comprises the purchase price plus costs directly attributable to bringing the asset to the location and working condition necessary for it to be capable of operating in the way management intends. It also includes the initial estimate of the costs of dismantling and removing the item and restoring the site on which PPE is located. Start-up and pre-production costs are not capitalised unless they are a necessary part of bringing the asset to its working condition. The following costs are also included in the initial measurement of the asset:

• the costs of site preparation;


• initial delivery and handling costs;

• installation and assembly costs;

• costs of employee benefits arising from construction or acquisition of the asset;

• costs of testing whether the asset is functioning properly;

• professional fees; and

• fair value gains/losses on qualifying cash flow hedges relating to the purchase of PPE in a foreign currency.

Further, an entity must include borrowing costs incurred during the period of acquiring, constructing or producing a qualifying asset for its intended use or sale (see p.69).

Government grants received in connection with acquisition of PPE may be offset against the cost (see p.91).

US GAAP Similar to IFRS, except that hedge gains/losses on qualifying cash flow hedges are not included. Relevant borrowing costs are included if certain criteria are met. Consistent with IFRS, the fair value of a liability for an asset retirement obligation is recognised in the period incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalised as part of the asset’s carrying amount.

JP GAAP Similar to IFRS. PPE is initially measured at cost (including set up costs). Gains/losses on qualifying cash flow hedges are included in the initial measurement of the asset. Borrowing costs satisfying certain criteria may be included in the initial measurement. Similar to IFRS, the fair value of a liability for asset retirement obligation is included in the initial measurement when a reasonable estimate of the fair value can be made. The related asset retirement costs are capitalized as part of the asset’s carrying amount.

Subsequent expenditure

IFRS Subsequent maintenance expenditure is expensed as incurred. Replacement of parts may be capitalised when general recognition criteria are met. The cost of a major inspection or overhaul occurring at regular intervals is capitalised where the recognition criteria are satisfied. The net book value of any replaced component would be expensed at the time of overhaul.


JP GAAP There is no standard for subsequent expenditure. In practice, costs attributable to extending the useful life or to improving the performance capability of PPE are capitalised as ‘capital expenditure’.

Asset retirement obligations

IFRS IFRS requires that management’s best estimate of the costs of dismantling and removing the item or restoring the site on which it is located be recorded when an obligation exists. The estimate is to be based on a present obligation (legal or constructive) that arises as a result of the acquisition, construction or development of a long-lived asset. If it is not clear whether a present obligation exists, the entity may evaluate the evidence under a more-likely-than-not threshold. This threshold is evaluated in relation to the likelihood of settling the obligation.

The guidance uses a pretax discount rate that reflects current market assessments of the time value of money and the risks specific to the liability.

Changes in the measurement of an existing decommissioning, restoration or similar liability that result from changes in the estimated timing or amount of the cash outflow or other resources or a change in the discount rate adjust the carrying value of the related asset under the cost model. Adjustments may not increase the carrying amount of an asset beyond its recoverable amount or reduce it to a negative value. The periodic unwinding of the discount is recognised in profit or loss as a finance cost as it occurs.

US GAAP Asset retirement obligations are recorded at fair value and are based upon the legal obligation that arises as a result of an acquisition, construction or development of a long-lived asset

The use of a credit-adjusted, risk-free rate is required for discounting purposes when an expected present-value technique is used for estimating the fair value of the liability.

The guidance also requires an entity to measure changes in the liability for an asset retirement obligation due to passage of time by applying an interest method of allocation to the amount of the liability at the beginning of the period. The interest rate used for measuring that change would be the credit-adjusted, risk-free rate that existed when the liability, or portion thereof, was initially measured.

In addition, changes to the undiscounted cash flows are recognised as an increase or a decrease in both the liability for an asset retirement obligation and the related asset retirement cost. Upward revisions are discounted by using the current credit-adjusted, risk-free rate.


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Downward revisions are discounted by using the credit-adjusted, risk-free rate that existed when the original liability was recognised. If an entity cannot identify the prior period to which the downward revision relates, it may use a weighted-average, credit-adjusted, risk-free rate to discount the downward revision to estimated future cash flows.

JP GAAP An asset retirement obligation is recongnised when incurred, and a liability is recognised at the amount of discounted value based on the estimated undiscounted future cash flows for dismantling properties. Discount rate should be risk free rate before tax that reflects time value of money.

If the estimate for undiscounted future cash flows is significantly changed, the adjustment for this change is provided to the carrying amounts of asset retirement obligations and related properties.

The cost for asset retirement, such as the depreciation expense of the cost for asset retirement included in the acquisition cost of the PPE, the change of amount due to the time value of money and the difference between the actual cost incurred and the liability recognized, are expensed in the same category of the underlying asset.

Depreciation

IFRS The depreciable amount of an item of PPE (cost or valuation less residual value) is allocated on a systematic basis over its useful life, reflecting the pattern in which the entity consumes the asset’s benefits. Additionally, an entity is required to depreciate separately the significant components of PPE if they have different useful lives (component approach). For example, it may be appropriate to depreciate separately the airframe and engines of an aircraft. Any change in the depreciation method used is treated as a change in accounting estimate, reflected in the depreciation charge for the current and prospective periods. Consistent with the component approach, guidance requires that the carrying amounts of parts or components that are replaced be derecognized.

The depreciation methods are reviewed periodically; residual values and useful lives are reviewed at each reporting date.

US GAAP Similar to IFRS, however, US GAAP generally does not require a component approach for depreciation. Like IFRS, US GAAP requires that a change in depreciation method is accounted for as a change in accounting estimate effected by a change in accounting principle.

While it would generally be expected that the appropriateness of significant assumptions within the financial statements would be reassessed each reporting period, there is no requirement for an annual review of residual values.

JP GAAP The cost of PPE is depreciated over its useful life using the straight line method, or the declining method, etc. Similar to US GAAP, a change in depreciation method is a change in accounting policy, however, treated similarly to a change in accounting estimate, since it is difficult to differentiate from a change in accounting estimate. A change in useful life is also treated as a change in accounting estimate, similar to IFRS The accounting standard which clarifies the above treatment will be applied for annual periods beginning on or after 1 April 2011.

A component approach of depreciation is not required under JP GAAP.

Subsequent measurement

IFRS PPE is accounted for under either the cost model or the revaluation model. Under the cost model, PPE is carried at cost less accumulated depreciation and impairment losses.

Under the revaluation model, PPE is carried at fair value at the date of revaluation less depreciation and impairment losses. The revaluation model should be applied to an entire class of assets. Revaluations have to be kept sufficiently up-to-date to ensure that the carrying amount does not differ materially from fair value.

The increase of an asset’s carrying amount as a result of a revaluation is credited directly to equity under the heading ‘revaluation surplus’, unless it reverses a revaluation decrease for the same asset previously recognised as an expense. In this case it is recognised in the income statement. A revaluation decrease is charged directly against any related revaluation surplus for the same asset; any excess is recognised as an expense.

US GAAP PPE is carried at cost less accumulated depreciation and impairment losses. Revaluations are not permitted. Consistent with IFRS, impairment testing is performed whenever events or changes in circumstances suggest the carrying value of an asset is not recoverable.

JP GAAP PPE is carried at cost less accumulated depreciation and impairment losses. Revaluations are not permitted. Consistent with IFRS, impairment testing is performed whenever changes in facts and circumstances suggest that the carrying value of an asset may not be recoverable.

REFERENCES: IFRS: IAS 16, IAS 23, IAS 36, IAS 37, IFRIC 1,SIC 32US GAAP: ASC 205-20, ASC 250, ASC 330, ASC 360-10, ASC 410-20, ASC 410-20-25, ASC 835-20JP GAAP: Business Accounting Principle, Accounting Opinion Series No.3 Depreciation of Fixed Assets, Accounting Standards for Impairment of Fixed Assets, Guidance on Accounting Standards for Impairment of Fixed Assets


Non-current assets held for sale

IFRS A non-current asset is classified as held for sale if its carrying amount will be recovered principally through a sale transaction rather than through continuing use. The asset should be available for immediate sale in its present condition, and its sale should be highly probable. Specific criteria must be met to demonstrate that the sale is highly probable. Once classified as held for sale, the asset is measured at the lower of its carrying amount and fair value less costs to sell with any loss being recognised in the income statement. These assets are not depreciated or amortised during the selling period. They are presented separately from other assets in the statement of financial position.


JP GAAP There is no accounting standard for non-current assets held for sale or disposal group. Non-current assets held for sale are measured by general accounting guidance such as impairment accounting standard and presented in the appropriate account.

REFERENCES: IFRS: IFRS 5US GAAP: ASC 205-20, ASC 360-10 JP GAAP: There is no standard

Leases

Lease classification—general

The lease classification concepts are similar in all three frameworks, IFRS, US GAAP and JP GAAP. Substance rather than legal form, however, is applied under IFRS, while extensive form-driven requirements are present in US GAAP. Under JP GAAP, two requirements are specifically required, i.e., non-cancellable and practically receiving economic benefits and costs of the arrangement.

A finance (capital) lease exists if the agreement transfers substantially all the risks and rewards associated with ownership of the asset to the lessee. IFRS and US GAAP provide guidance on determining when an arrangement contains a lease. All three frameworks provide indicators for determining the classification of a lease; these are presented in the table below.

INDICATOR IFRS US GAAP JP GAAP

Normally leads to a finance lease

Ownership is transferred to the lessee at the end of the lease term

Indicator of a finance lease. Finance lease accounting required. Finance lease accounting required.

A bargain purchase option exists Indicator of a finance lease. Finance lease accounting required. Finance lease accounting required.

The lease term is for the majority of the leased asset’s economic life

Indicator of a finance lease. Specified as equal to or greater than 75% of the asset’s life; finance lease accounting required.

Specified as approximately equal to or greater than 75% of the asset’s life; finance lease accounting required.

The present value of minimum lease payments is equal to substantially all the fair value of the leased asset

Indicator of a finance lease. Specified as 90% of the fair value of the property less any investment tax credit retained by the lessor; finance lease accounting required.

When the present value of the gross lease income exceeds approximately 90% of the estimated cash purchase price; finance lease accounting required.

The leased assets are of a specialised nature such that only the lessee can use them without major modification

Indicator of a finance lease. Not specified. Indicator of a finance lease.

Could lead to a finance lease

On cancellation, the lessor’s losses are borne by the lessee

Indicator of a finance lease. Not specified. Not specified.

Gains and losses from the fluctuation in the fair value of the residual fall to the lessee


The lessee has the ability to continue the lease for a secondary period at below market rental



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Lease classification—other

IFRS The initial lease term is the non-cancellable period for which the lessee has contracted to lease the asset together with any further terms for which the lessee has the option to continue to lease the asset, with or without further payment, when at inception of the lease it is reasonably certain that the lessee will exercise the option. If the period covered by the renewal option was not considered to be part of the initial lease term, but the option is ultimately exercised based on the contractually stated terms of the lease, the original lease classification under the guidance continues into the extended term of the lease; it is not revisited.

The guidance does not permit leveraged lease accounting. Leases that would qualify as leveraged leases under US GAAP would typically be classified as finance leases under IFRS. Any nonrecourse debt would be reflected gross on the statement of financial position.

The guidance does not have a similar provision as US GAAP for immediate income recognition by lessor on leases of real estate. Accordingly, a lessor of real estate (e.g., a dealer) will recognise income immediately if a lease is classified as a finance lease (i.e., if it transfers substantially all the risks and rewards of ownership to the lessee).

US GAAP The renewal or extension of a lease beyond the original lease term, including those based on existing provisions of the lease arrangement, normally triggers a fresh lease classification.

The lessor can classify leases that would otherwise be classified as direct-financing leases as leveraged leases if certain additional criteria are met. Financial lessors sometimes prefer leveraged lease accounting, because it often results in faster income recognition. It also permits the lessor to net the related nonrecourse debt against the leveraged lease investment in the balance sheet.

Under the guidance, income recognition for an outright sale of real estate is appropriate only if certain requirements are met. By extension, such requirements also apply to a lease of real estate. Accordingly, a lessor is not permitted to classify a lease of real estate as a sales-type lease unless ownership of the underlying property automatically transfers to the lessee at the end of the lease term, in which case the lessor must apply the guidance appropriate for an outright sale.

JP GAAP The renewal of a lease is generally within a year and the lease payment is normally a small amount. Therefore, except for cases when there is an explicit intention to extend the lease term at the initial of the lease contract, lease payment for the extended term is recorded as lease income when incurred, in principle.

Similar to IFRS in terms of leveraged leases. However, leveraged lease arrangements are not common for legal entities as there are no tax advantages.

Similar to IFRS in terms of lessor on real estate (i.e., dealer).

Recognition of the investment in the lease

All three frameworks, IFRS, US GAAP and JP GAAP, require the amount due from a lessee under a finance lease to be recognised as a receivable at the amount of the net investment in the lease. This will comprise, at any point in time, the total of the future minimum lease payments and the unguaranteed residual value less earnings allocated to future periods. Minimum lease payments for a lessor under IFRS and JP GAAP include guarantees from the lessee or a party related to the lessee or a third-party unrelated to the lessor. US GAAP excludes third-party residual value guarantees that provide residual value guarantees on a portfolio basis. The interest rate implicit in the lease would, under IFRS, US GAAP and JP GAAP, generally be used to calculate the present value of minimum lease payments.

The rentals are allocated between receipt of the capital amount and receipt of finance income to provide a constant rate of return. Initial direct costs are amortised over the lease term. All three frameworks require the use of the net investment method to allocate earnings; this excludes the effect of cash flows arising from taxes and financing relating to a lease transaction. An exception to this is for leveraged leases under US GAAP where tax cash flows are included.

Operating lease

All three frameworks require an asset leased under an operating lease to be recognised by a lessor according to its nature − for example, as PPE − and depreciated over its useful life. Rental income is generally recognised on a straight-line basis over the lease term.

IFRS and US GAAP require the lessor to recognise the aggregate cost of incentives given as a reduction of rental income over the lease term on a straight-line basis.

Under JP GAAP, there is no guidance for incentives.


Sale-leaseback arrangements

IFRS When a sale-leaseback transaction results in a lease classified as an operating lease, the full gain on the sale would normally be recognised if the sale was executed at the fair value of the asset. It is not necessary for the leaseback to be minor.

If the sale price is below fair value, any profit or loss should be recognised immediately, except that if the favorable price is compensated for by future lease payments at below-market rates, the impact thereof should be deferred and amortized in proportion to the lease payments over the lease period. If the sale price is above fair value, the excess over fair value should be deferred and amortized over the period for which the asset is expected to be used.

When a sale-leaseback transaction results in a finance lease, the gain is amortized over the lease term irrespective of whether the lessee will reacquire the leased property.

There are no real estate-specific rules equivalent to the US guidance. Accordingly, almost all sale-leaseback transactions result in sale-leaseback accounting. The property sold would be removed from the statement of financial position and if the leaseback is classified as an operating lease, the property would not come back onto the seller-lessee’s statement of financial position.

US GAAP The gain on a sale-leaseback transaction is generally deferred and amortized over the lease term. Immediate recognition of the full gain is normally appropriate only when the leaseback is minor, as defined.

If the leaseback is more than minor, but less than substantially all of the asset life, a gain is recognised immediately to the extent that the gain exceeds the present value of the minimum lease payments.

If the lessee provides a residual value guarantee, the gain corresponding to the gross amount of the guarantee is deferred until the end of the lease; such amount is not amortized during the lease term.

When a sale-leaseback transaction results in a capital lease, the gain is amortized in proportion to the amortization of the leased asset.

There are onerous rules for determining when sale-leaseback accounting is appropriate for transactions involving real estate. If the rules are not met, the sale leaseback will be accounted for as a financing. As such, the real estate will remain on the seller-lessee’s balance sheet and the sales proceeds will be reflected as debt. Thereafter, the property will continue to be depreciated and the rent payments will be recharacterised as debt service.

JP GAAP The gain on a sale-leaseback transaction, when the lease contract is a finance lease, is generally deferred and amortized over the lease term. There is no accounting standard for sale-leaseback transactions that are operating leases.

Leases involving land and buildings

IFRS Land and building elements must be considered separately, unless the land element is not material. This means that nearly all leases involving land and buildings should be bifurcated into two components, with separate classification considerations and accounting for each component.

In 2009 lease accounting was amended to provide guidance for classifying the land element of a lease. Previously, the land element of a lease was required to be classified as an operating lease unless title to the land was expected to pass to the lessee by the end of the lease term. That rule has been eliminated. Going forward, the lease of the land element should be classified based on a consideration of all of the risks and rewards indicators that apply to leases of other assets. Accordingly, a land lease would normally be classified as a finance lease if the lease term were long enough to cause the present value of the minimum lease payments to be at least substantially all of the fair value of the land. The new lease classification should be applied retrospectively at the effective date if the entity has the information to do so. If not, the new lease classification shall be applied for annual periods beginning on or after 1 January 2010.

In determining whether the land element is an operating or a finance lease, an important consideration is that land normally has an indefinite economic life. A lessee is required to reassess the classification of land elements of unexpired leases at the date it adopts the amendment noted above on the basis of information existing at the inception of those leases.

US GAAP Land and building elements are generally accounted for as a single unit, unless the land represents 25% or more of the total fair value of the leased property.

JP GAAP Land and building elements are, in principle, accounted for separately based on a reasonable method. The land element of a lease is considered to be an operating lease, except for cases when land ownership will pass to the lessee before the end of the lease term or a bargain purchase option is reliably expected to be exercised.


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Recent proposals – IFRS/US GAAP

Joint IASB/ FASB Leasing Project

The IASB and FASB are carrying out a joint project with the objective of ensuring that assets and liabilities arising from leasing transactions are recorded on the balance sheet. This project comprehensively reconsiders IAS 17, Leases and the guidance in ASC 840 on accounting for leases along with subsequent amendments and interpretations. The boards issued exposure drafts on leases in August 2010.

Lessee accounting

The exposure draft includes the following:

Lease accounting will significantly change, including the elimination of operating lease accounting by all lessees. Lessees record the rights and • obligations of all leases on the balance sheet, including those in effect as well as short-term leases.

The lease asset and obligation recorded on the balance sheet include estimates of expected term (renewal options) and contingent payments • (contingent rents, residual value guarantees, etc.).

The asset and lease obligation is initially calculated as the present value of the lease payments discounted using the company’s incremental • borrowing rate. Alternatively, the rate the lessor is charging in the lease can be used if known. The proposal requires lessees to reassess the lease term, contingent rentals, residual value guarantees, and the corresponding lease obligation as facts and circumstances change.

Straight-line rent expense generally is replaced by amortization of the leased asset and interest expense on the lease obligation. Interest expense • is front-loaded similar to mortgage amortization.

Leases embedded in other arrangements such as service or supply contracts also follow the new lease accounting model. For leases that contain • lease and service components, the lessee must separate distinct services from the lease. The leased asset and obligation only represent payments for use of the asset.

Lessor accounting

The boards decided to use a hybrid approach for lessor accounting. For leases where the lessor has exposure to significant risks or benefits of the leased asset, the performance obligation approach is followed. All other leases follow the partial derecognition approach.

Under the performance obligation approach, the underlying leased asset remains on the lessor’s balance sheet. The lessor recognizes a lease • receivable representing the right to receive rental payments and a corresponding performance obligation, representing the obligation to permit the lessee to use the leased asset.

Under the partial derecognition approach, the lessor derecognizes an allocated portion of the carrying amount of the leased asset (and record • cost of sale) and record a lease receivable (and sale) equal to the present value of the lease payments to be received over the lease term.

Symmetrical with lessee accounting, lessor is required to estimate the lease term and contingent rents in developing the initial lease receivable • amount.

Arrangements that pass control and all but a trivial amount of the risks and benefits of the leased asset to the lessee at the end of the lease are considered a sale/or purchase rather than a lease and are excluded from applying the leasing standard.

Sale-leaseback transactions qualify as a sale rather than a financing if the leased asset is considered sold in accordance with the criteria mentioned in the paragraph above. Gains and losses on the sale are not deferred.

The exposure draft is open for comment until mid December 2010. The boards will consider responses to the exposure draft as they work toward issuing the final standard. The final standard is expected in the second guarter of 2011.

REFERENCES: IFRS: IAS 17, IFRIC 4US GAAP: ASC 360-20, ASC 840, ASC 840-40, ASC 976JP GAAP: Accounting Standards for Lease Transaction, Guidance on Accounting Standards for Lease Transactions


Recognition and measurement

IFRS An entity should assess at each reporting date whether there are any indications that an asset may be impaired. The asset is tested for impairment if there is any such indication based on internal and/or external sources of information. Goodwill, intangible assets with indefinite useful life and intangibles not yet ready for use are required to be tested annually even if there are no indications of impairment. In practice, individual assets do not usually meet the definition of a cash generating unit. As a result assets are rarely tested for impairment individually but are tested within a group of assets. Goodwill impairment testing is performed at the lowest level at which it is monitored for internal management purposes and may not be larger than an operating segment before aggregation.


IFRS uses a one-step impairment test. The carrying amount of an asset is compared with the recoverable amount. The recoverable amount is the higher of (1) the asset’s fair value less costs to sell or (2) the asset’s value in use. Value in use represents the future cash flows to be derived from the particular asset or group of assets, discounted to present value using a pre-tax market rate that reflects the current assessment of the time value of money and the risks specific to the asset or group of assets for which the cash flow estimates have not been adjusted. Fair value less cost to sell represents the amount obtainable from the sale of an asset or cash-generating unit in an arm’s length transaction between knowledgeable, willing parties, less the costs of disposal.

An impairment loss is recognised in profit or loss when a non-revalued asset’s carrying amount exceeds its recoverable amount. Where the asset is carried in accordance with the principles of the revaluation model, the impairment loss is recognised directly against any revaluation surplus for the asset to the extent that the impairment loss does not exceed the amount of the revaluation surplus for that same asset and any excess is recognised in profit or loss.

US GAAP Like IFRS, long-lived assets are tested for recoverability whenever events or changes in circumstances indicate that their carrying amount may not be recoverable.

US GAAP requires a two-step impairment test and measurement model as follows:

1. The carrying amount is first compared with the undiscounted cash flows. If the carrying amount is lower than the undiscounted cash flows, no impairment loss is recognised, although it may be necessary to review depreciation (or amortization) estimates and methods for the related asset.

2. If the carrying amount is higher than the undiscounted cash flows, an impairment loss is measured as the difference between the carrying amount and fair value. Fair value is defined as the price that would be received to sell an asset or that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date. The IFRS reference to knowledgeable, willing parties is generally viewed as being consistent with the market participant assumption noted under US GAAP.

Use of market participant assumptions: US GAAP emphasizes that a fair value measurement should be based on the assumptions of market participants and not those of the reporting entity. Therefore, entity-specific intentions should note impact the measurement of fair value unless those assumptions are consistent with market participant’s views.

If the asset is recoverable based on undiscounted cash flows, the discounting or fair value type determinations are not applicable. Changes in market interest rates are not considered impairment indicators.

JP GAAP Similar to US GAAP, assets are assessed for impairment by first comparing the carrying amount with the undiscounted cash flows that are expected to result from the use and eventual disposal of the asset. The impairment loss is recognised in the income statement when an asset’s carrying amount exceeds its recoverable amount (the higher of net selling value or value in use).

Reversal of impairment loss

IFRS Impairment losses are reversed when there has been a change in economic conditions or in the expected use of the asset. Reversal of impairment losses is prohibited as long as it relates to goodwill.

US GAAP Impairment losses cannot be reversed for assets to be held and used.

JP GAAP Similar to US GAAP. Impairment losses cannot be reversed.

REFERENCES: IFRS: IAS 16, IAS 36US GAAP: ASC 205-20, ASC 360-10, ASC 410-20JP GAAP: Accounting Standards for Impairment of Fixed Assets, Guidance on Accounting Standards for Impairment of Fixed Assets

Capitalisation of borrowing costs

Recognition

IFRS Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset are required to be capitalized as part of the cost of that asset.

The guidance acknowledges that determining the amount of borrowing costs that are directly attributable to an otherwise qualifying asset may require professional judgment. Having said that, the guidance first requires the consideration of any specific borrowings and then requires consideration of all general borrowings outstanding.

In broad terms, a qualifying asset is one that necessarily takes a substantial period of time to get ready for its intended use or sale. Investments accounted for under the equity method would not meet the criteria for a qualifying asset.

US GAAP Capitalization of interest costs is required while a qualifying asset is being prepared for its intended use. The guidance does not require that


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all borrowings be included in the determination of a weighted-average capitalization rate. Instead, the requirement is to capitalize a reasonable measure of cost for financing the asset’s acquisition in terms of the interest cost incurred that otherwise could have been avoided.

An investment accounted for by using the equity method meets the criteria for a qualifying asset while the investee has activities in progress necessary to commence its planned principal operations, provided that the investee’s activities include the use of funds to acquire qualifying assets for its operations.

JP GAAP Borrowing costs are required to be expensed. However, interest paid on borrowings to finance self-constructed fixed assets and work in process for real estate development business may be capitalised.

REFERENCES: IFRS: IAS 23RUS GAAP: ASC 835-20JP GAAP: Accounting Opinion Series for Coordination between Business Accounting Principles and its Related Regulations No.3 Depreciation of Tangible Fixed Assets, Accounting Opinion Series for Coordination between Business Accounting Principles and its Related Regulations No.4 Evaluation of Inventories, and Audit Treatment for Interest Paid for Real Estate Development Business

Investment property

Definition

IFRS Property (land and/or buildings – or part of a building) held (by the owner or by the lessee under a finance lease) to earn rentals and/or for capital appreciation The definition does not include owner -occupied property, property held for sale in the ordinary course of business or property being constructed or developed on behalf of third parties. Properties under construction or development for future use as investment properties are within the scope of investment properties.

US GAAP There is no specific definition of investment property.

JP GAAP Properties are classified by its form (existence of contractual agreement etc. ). Properties not classified as inventories and which are held to earn rentals and capital gains are defined as “Investment and rental property”.

Initial measurement

IFRS An investment property is measured initially at its cost. The cost of a purchased investment property comprises its purchase price and any directly attributable costs, such as professional fees for legal services, property transfer taxes and other transaction costs. Over the period of construction, the costs of construction of a self-constructed investment property are capitalised as part of its cost. Costs that may be capitalised are similar to those permitted for PPE.

The initial cost of a property interest held under a lease and classified as an investment property is as prescribed for a finance lease under IAS 17.

US GAAP The historical cost model is used for most real-estate companies and operating companies holding investment-type property. Investor entities − such as many investment companies, insurance companies separate accounts, bank-sponsored real-estate trusts and employee benefit plans that invest in real estate − carry their investments at fair value.



IFRS The entity can choose between the fair value and depreciated cost models for all investment property. When fair value is applied, the gain or loss arising from a change in the fair value is recognised in profit or loss. The carrying amount is not depreciated. Where the fair value model is applied, investment property in the course of construction is measured at fair value, unless its fair value is not reliably measurable. In this case, the property is measured at cost until the earlier of the date construction is completed or the date at which fair value becomes reliably measurable.

An investment property held under an operating lease must be measured under the fair value model.

US GAAP The depreciated cost model is applied for real estate companies and operating companies holding investment-type property. Investor entities measure their investments at fair value.

The fair value alternative for leased property does not exist.

JP GAAP Only depreciated cost model is allowed.

REFERENCES: IFRS: IAS 40US GAAP: ASC 360JP GAAP: Business Accounting Principles, Accounting Opinion Series for Coordination between Business Accounting Principles and its Related Regulations No.3 Depreciation of Tangible Fixed Assets


Inventories

Definition

All three frameworks, IFRS, US GAAP and JP GAAP, define inventories as assets that are: held for sale in the ordinary course of business; in the process of production or for sale in the form of materials; or supplies to be consumed in the production process or in rendering services. However, there are several differences in the categorization of certain assets between IFRS and JP GAAP. Under JP GAAP, supplies used for selling and administrative activities which are planned to be used within a short term are included in inventories.

Measurement

IFRS Inventories are carried at the lower of cost or net realisable value (sale proceeds less all further costs to bring the inventories to completion). Reversal (limited to the amount of the original write-down) is required for a subsequent increase in value of inventory previously written down.

US GAAP Broadly consistent with IFRS, in that the lower of cost and market value is used to value inventories. Market value is defined as being current replacement cost subject to an upper limit of net realisable value (i.e., estimated selling price in the ordinary course of business less reasonably predictable costs of completion and disposal) and a lower limit of net realisable value less a normal profit margin. Reversal of a write-down is prohibited, as a write-down creates a new cost basis.

JP GAAP Similar to IFRS. For write downs, the entity can choose to apply either the reversal method or the non-reversal method, provided the method is consistently applied. An election can be made for each asset class. Reversal of a write-down is limited to the amount written down in previous period.

Formula for determining cost

METHOD IFRS US GAAP JP GAAP

LIFO Prohibited Permitted Prohibited

FIFO Permitted Permitted Permitted

Weighted average cost Permitted Permitted Permitted

REFERENCES: IFRS: IAS 2US GAAP: ASC 330JP GAAP: Business Accounting Principles, Accounting Opinion Series for Coordination between Business Accounting Principles and its Related Regulations No.4 Evaluation of Inventories, Accounting Standard for Measurement of Inventories

Biological assets

IFRS The accounting treatment for biological assets requires measurement at fair value less estimated costs to sell at initial recognition of biological assets and at each subsequent reporting date, unless fair value cannot be measured reliably (in which case it should be measured at cost less accumulated depreciation and impairment losses if any).

All changes in fair value are recognised in profit or loss in the period in which they arise.

US GAAP Historical cost is generally used for biological assets. These assets are tested for impairment in the same manner as other long-lived assets.

JP GAAP Not specified - historical cost is generally used.

REFERENCES: IFRS: IAS 41

Nonmonetary assets

IFRS Accounting for the distribution of nonmonetary assets to owners of an entity should be based on the fair value of the nonmonetary assets to be distributed. A dividend payable is measured at the fair value of the nonmonetary assets to be distributed. Upon settlement of a dividend payable, an entity will recognise the difference, if any, between the carrying amount of the assets to be distributed and the carrying amount of the dividend payable in profit or loss.

US GAAP Accounting for the distribution of nonmonetary assets to owners of an enterprise should be based on the recorded amount (after reduction, if appropriate, for an indicated impairment of value) of the nonmonetary assets distributed. Upon distribution those amounts are reflected as a reduction of owner’s equity.


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J GAAP The accounting for distribution of nonmonetary assets is based on the fair value of the nonmonetary assets; and deducted from other capital surplus or other retained earnings (retained earnings carries forward). The difference between the fair value and the appropriate carrying value of the nonmonetary assets as of the effective date of distribution (i.e., actual distribution date) is recognised in net income for the period of that date and presented appropriately in accordance with the type of nonmonetary assets.

Financial assets


IFRS 9: Financial Instruments

In November 2009, IASB issued new accounting standard on classification and measurement of financial instruments (IFRS 9, Financial Instruments). IFRS 9 replaces the multiple classification and measurements bases in IAS 39 with a single model that has two classification categories: amortized cost and fair value. Classification under IFRS 9 is driven by the entity’s business model for managing the financial assets and the contractual cash flow characteristics of the financial assets. A financial asset is measured at amortized cost if the objective of the business model is to hold the financial asset for the collection of the contractual cash flows and such contractual cash flows solely represent payments of principal and interest, interest being the consideration for the time value of money and the credit risk of the principal amount outstanding; otherwise the financial asset is measured at fair value.

The new standard further indicates that all equity investments should be measured at fair value. IFRS 9 removes the cost exemption for unquoted equities and derivatives on unquoted equities but provides guidance on when cost may be an appropriate estimate of fair value. Fair value changes of equity investments are recognized in profit and loss unless management has elected the option to present unrealized and realized fair value gains and losses on equity investments that are not held for trading in other comprehensive income. Such designation is available on initial recognition on an instrument-by-instrument basis and is irrevocable. There is no subsequent recycling of fair value gains and losses to profit or loss; however, dividends from such investments will continue to be recognized in profit or loss.

Under the new model, management may still designate a financial asset as at fair value through profit or loss on initial recognition but only if this significantly reduces an accounting mismatch. The designation at fair value through profit or loss will continue to be irrevocable. The new standard removes the requirement to separate embedded derivatives from financial asset hosts. It requires a hybrid contract to be classified in its entirety at either amortized cost or fair value. As many embedded derivatives introduce variability to cash flows, which is not consistent with the notion that the instrument’s contractual cash flows solely represent the payment of principal and interest, most hybrid contracts with financial asset hosts will be measured at fair value in their entirety. The reclassification between categories is prohibited except in circumstances where the entity’s business model changes.

IFRS 9 is effective for annual periods beginning on or after January 1, 2013, with early application permitted. The European Commission has decided to defer the endorsement of this standard until it has carried out an in-depth analysis. As a result, European companies were unable to adopt the new standard for their 2009 financial statements while companies in more than 80 countries outside the European Union were able to early adopt the new standard. As only the classification and measurement aspects of IFRS 9 have been issued as a final standard, if a company early adopts this standard, it will need to apply it in conjunction with IAS 39 for impairment, EIR, derecognition and hedge accounting.

In addition, IASB issued the requirements for financial liabilities to IFRS 9. Refer to the “Recent changes—IFRS” section of the Financial liabilities and eguity chapter for discussion for details.

IFRS outlines the recognition and measurement criteria for all financial assets defined to include derivatives. The guidance in IFRS is broadly consistent with US GAAP and JP GAAP.

Definition

IFRS, US GAAP and JP GAAP define a financial asset in a similar way, to include:

cash; •

a contractual right to receive cash or another financial asset from another entity or to exchange financial instruments with another entity under • conditions that are potentially favourable; and

an equity instrument of another entity. •

Recognition and initial measurement

IFRS, US GAAP and JP GAAP require an entity to recognise a financial asset only when the entity becomes a party to the contractual provisions of the instrument. A financial asset is typically recognised initially at its fair value (which is normally the transaction price), plus, in the case of a financial asset that is not recognised at fair value with changes in fair value recognised in the income statement, transaction costs that are directly attributable to the acquisition of that asset.


The following table outlines the classification requirements for various financial assets.

IAS 39 IFRS 9 (*comparison to IAS39) US GAAP JP GAAP

Financial assets at fair value through profit or loss Two sub-categories: financial assets designated to the category at inception and those held-for-trading (see below).

Financial assets designated as at fair value through profit or loss at inception

An irrevocable decision at inception to classify a financial asset at fair value, with changes in fair value recognised in profit or loss, provided it results in more relevant information because either:

it eliminates or significantly reduces •a measurement or recognition inconsistency;

a group of financial assets, financial •liabilities or both is managed and performance is evaluated on a fair value basis; or

the contract contains one or more •‘substantive’ embedded derivatives.

An irrevocable fair value election at initial recognition can be made for financial assets if measuring them at fair value through profit or loss eliminates or significantly reduces an accounting mismatch.

Irrevocable decision to designate financial assets at fair value with changes in fair value recognised in the income statement.

Unlike IAS 39, this decision is not restricted to specific circumstances.

The concept of the fair value option has not been introduced. Therefore, a group of financial instruments cannot be designated as ‘financial assets at fair value through profit or loss’.

Held-for-trading financial assets

Debt and equity instruments (securities) held for sale in the short term. Includes non-qualifying hedging derivatives.

The intention should be to hold the financial asset for a relatively short period, or as part of a portfolio for the purpose of short-term profit-taking.

Subsequent measurement at fair value. Changes in fair value are recognised in profit or loss.

Debt instruments are categorised as “financial assets measured at fair value through profit or loss” unless both of the following conditions are met:

The asset is held within a business •model whose objective is to hold assets in order to collect contractual cash flows.

The contractual terms of the •financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding. Interest is consideration for the time value of money and for the credit risk associated with the principal amount outstanding during a particular period of time.

Equity instruments are categorised as “financial assets measured at fair value through profit or loss” unless they are designated as measured at fair value through OCI.

Frequent buying and selling usually indicates a trading instrument. However, the category is not limited to those securities held for short-term profit taking.

Subsequent measurement at fair value. Changes in fair value are recognised in profit or loss.

Similar to IAS 39. Financial assets held for the purposes of short-term profit-taking from changes in market prices are measured at fair value, with the changes in fair value recognised in profit or loss.

Subsequent measurement is at fair value. Changes in fair value are recognised in profit or loss.

Held-to-maturity financial assets Financial assets held with a positive intent and ability to hold to maturity. Includes assets with fixed or determinable payments and maturities. Does not

include equity instruments (securities), as they have an indefinite life.

An entity should have the ‘positive intent and ability’ to hold a financial asset to maturity, not simply a present intention.

When an entity sells more than an insignificant amount of assets (other than in limited circumstances), classified as held to maturity, it is prohibited from using the held-to-maturity classification for two full annual reporting periods (known as tainting). The entity should also reclassify all its held-to-maturity assets as available-for-sale assets.

Measured at amortised cost using the effective interest rate method.

IFRS 9 eliminates the held-to-maturity category. Financial assets that would be classified into this category under IAS 39 and are held within a portfolio whose business model is to hold financial assets for the collection of contractual cash flows are likely (unless they fail the contractual cash flow characteristics criteria) to be classified as at amortised cost.

Similar to IAS 39, although US GAAP is silent about when assets cease to be tainted. For listed companies, the SEC states that the tainting period for sales or transfers of held-to-maturity securities should be two years.

Similar to IAS 39, although only debt securities are included in this classification.


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IAS 39 IFRS 9 (*comparison to IAS39) US GAAP JP GAAP

Loans and receivablesThe scope of financial assets classified in this category is different between IFRS, US GAAP and JP GAAP.

IAS 39 defines loans and receivables as nonderivative financial assets with fixed or determinable payments not quoted in an active market other than:

Those that the entity intends to sell •immediately or in the near term, which are classified as held for trading and those that the entity upon initial recognition designates as at fair value through profit or loss

Those that the entity upon initial •recognition designates as available-for-sale

Those for which the holder may not •recover substantially all of its initial investment (other than because of credit deterioration) and that shall be classified as available-for-sale

An interest acquired in a pool of assets that are not loans or receivables (i.e., an interest in a mutual fund or a similar fund) is not a loan or receivable.

Instruments that meet the definition of loans and receivables (regardless of whether they are legal form securities) are carried at amortized cost in the loan and receivable category unless designated into either the fair value through profit-or-loss category or the available-for-sale category. In either of the latter two cases, they are carried at fair value.

IAS 39 does not have a category of loans and receivables that is carried at the lower of cost or market.

IFRS 9 eliminates the loans and receivables category. Financial assets that would be classified into this category under IAS 39 and are held within a portfolio whose business model is to hold financial assets for the collection of contractual cash flows are likely (unless they fail the contractual cash flow characteristics criteria) to be classified as at amortised cost.

The classification and accounting treatment of nonderivative financial assets such as loans and receivables generally depends on whether the asset in question meets the definition of a debt security under ASC 320. If the asset meets that definition, it is generally classified as trading, available-for-sale, or held-to-maturity.

If classified as trading or available-for-sale, the debt security is carried at fair value. To meet the definition of a debt security under ASC 320, the asset is required to be of a type commonly available on securities exchanges or in markets or, when represented by an instrument, is commonly recognized in any area in which it is issued or dealt in as a medium for investment.

Loans and receivables that are not within the scope of ASC 320 fall within the scope of other guidance. As an example, mortgage loans are either:

Classified as loans held for •investment, in which case they are measured at amortized cost;

Classified as loans held for sale, in •which case they are measured at the lower of cost or fair value (market); or

Carried at fair value if the fair value •option is elected.

Similar to IAS 39 for the classification of receivables. Financial assets are classified by their legal form.

Measured at acquisition cost or amortized cost after deducting allowances for bad debts.

Available-for-sale financial assets Includes debt and equity instruments designated as available-for-sale, or that are not classified into any of the above categories.

Measured at fair value.

Changes in fair value are recognised net of tax effects in other comprehensive income (i.e., presented in a statement of changes in shareholder’s equity) and recycled to profit or loss when sold, impaired or collected.

IFRS 9 eliminates the available-for-sale category. However, changes in fair value of equity instruments designated as measured at fair value through other comprehensive income at their acquisition will be recognised in other comprehensive income. Impairment accounting will not apply to the designated equity instruments, nor realised gains or losses be recycled in profit or loss. Although dividends, that are not a return of capital, are recognised in profit or loss.

Similar to IAS 39, except unlisted equity securities are generally carried at cost. Exceptions apply for specific industries.

Changes in fair value are reported in other comprehensive income, though impairment recognition is different compared to IAS 39.

Similar to IAS 39.

Available-for-sale financial assets: fair value versus cost of unlisted equity instruments (securities)

IFRS [IAS 39] There are no industry-specific differences in the treatment of investments in equity instruments that do not have quoted market prices in an active market. Rather, all available-for-sale assets, including investments in unlisted equity instruments, are measured at fair value (with rare exceptions only for instances where fair value cannot be reasonably estimated).

Fair value is not reliably measurable when the range of reasonable fair value estimates is significant and the probability of the various estimates within the range cannot be reasonably assessed.


In those instances where an entity demonstrates that fair value cannot be reasonably estimated, extensive disclosures are required, including (1) the fact that the instruments are not reflected at fair value, (2) reasons that the fair value could not be measured, (3) information about the market for the instruments and (4) whether and how the entity plans to dispose of the instruments.

[IFRS 9] Equity instruments should be measured at fair value. However, IFRS 9 illustrates limited circumstances in which cost may be the best estimate of fair value; when insufficient more recent information is available to determine fair value, or if there is a wide range of possible fair values and cost represents the best estimate of fair value within that range.

US GAAP Unlisted equity investments are generally carried at cost (unless either impaired or the fair value option is elected).

Certain exceptions requiring that investments in unlisted equity securities be carried at fair value do exist for specific industries (e.g., broker/dealers, investment companies, insurance companies, defined benefit plans).

JP GAAP Investments in unlisted equity instruments are recorded at cost because they are extremely difficult to measure at fair value (except when there is an impairment).

Available-for-sale debt financial assets: foreign exchange gains/losses on debt instruments

IFRS [IAS 39] For available-for-sale debt instruments, the total change in fair value is bifurcated, with the portion associated with foreign exchange gains/losses on the amortised cost basis separately recognised in profit or loss. The remaining portion of the total change in fair value is recognised in other comprehensive income, net of tax effect.

[IFRS 9] IFRS 9 eliminates the available-for-sale category. Foreign exchange gains or losses on debt instruments are recognised in profit or loss, regardless of whether they are categorised as measured at fair value or amortised cost unless designated as a hedging instrument in a cash flow hedge or net investment hedge.

US GAAP The total change in fair value of available-for-sale debt securities—net of associated tax effects—is recorded within other comprehensive income.

Any component of the overall change in fair market value that may be associated with foreign exchange gains and losses on an available-for-sale debt security is treated in a manner consistent with the remaining overall change in the instrument’s fair value.

JP GAAP The total changes in fair value of available-for-sale debt instruments net of associated tax effects are recognised in “net assets”. However, foreign exchanges gains or losses associated with debt securities may be recognised in the income statement.

Effective interest rates: expected versus contractual cash flows

IFRS For financial assets carried at amortised cost, the calculation of the effective interest rate is generally based on the estimated cash flows over the expected life of the asset.

Contractual cash flows over the full contractual term of the financial asset are used only in those rare cases when it is not possible to reliably estimate the expected cash flows over the expected life of a financial asset.

US GAAP For financial assets where amortized cost is required, the calculation of the effective interest rate is generally based on contractual cash flows over the asset’s contractual life.

The expected life, under US GAAP, is typically used only for (1) loans if the entity holds a large number of similar loans and the prepayments can be reasonably estimated, (2) certain structured notes, (3) certain beneficial interests in securitized financial assets and (4) certain loans or debt securities acquired in a transfer.

JP GAAP For financial assets where amortized cost is required, the calculation of the effective interest rate is generally based on contractual cash flows over the asset’s contractual life.

Effective interest rates: changes in expectations

IFRS If an entity revises its estimates of payments or receipts, the entity adjusts the carrying amount of the financial asset (or group of financial assets) to reflect both actual and revised estimated cash flows.


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Revisions of the expected life or of the estimated future cash flows may exist, for example, in connection with debt instruments that contain a put or call option that doesn’t need to be bifurcated or whose coupon payments vary because of an embedded feature that does not meet the definition of a derivative because its underlying is a nonfinancial variable specific to a party to the contract (e.g., cash flows that are linked to earnings before interest, taxes, depreciation and amortization; sales volume; or the earnings of one party to the contract).

The entity recalculates the carrying amount by computing the present value of estimated future cash flows at the financial asset’s original effective interest rate. The adjustment is recognised as income or expense in profit or loss (i.e., by the cumulative-catch-up approach).

Estimates of cash flow projections beyond the period covered by the most recent budgets/forecasts should extrapolate the projections based on the budgets/forecasts using a steady or declining growth rate for subsequent years, unless an increasing rate can be justified. This growth rate shall not exceed the long-term average growth rate for the products, industries, or country in which the entity operates, or for the market in which the asset is used.

Cash flows are from the perspective of the entity itself. Expected future cash flows should be based on reasonable and supportable assumptions consistent with other assumptions made in the preparation of the financial statements and other information used by the entity for comparable periods.

US GAAP Different models apply to the ways revised estimates are treated depending on the type of financial asset involved (e.g., structured notes, beneficial interests, loans or debt acquired in a transfer).

Depending on the nature of the asset, changes may be reflected prospectively or retrospectively. None of the US GAAP models are the equivalent of the IFRS cumulative-catch-up-based approach.

JP GAAP The effective interest rate calculation is based on contractual cash flows and expected cash flows are not usually reflected in the calculation.

Fair value option for equity-method investments

IFRS IFRS permits venture capital organizations, mutual funds and unit trusts (as well as similar entities, including investment-linked insurance funds) that have investments in associates (entities over which they have significant influence) to carry their investments at fair value, with changes in fair value reported in earnings (provided certain criteria are met) in lieu of applying equity method of accounting.

US GAAP The fair value option exists for US GAAP entities under ASC 825, Financial Instruments, wherein the option is unrestricted. Therefore, any investor’s equity method investments are eligible for the fair value option.

JP GAAP There is no accounting standard for the fair value option.

Fair value measurement: bid-ask spreads

IFRS The appropriate quoted market price for an asset held or a liability to be issued is the current bid price and, for an asset to be acquired or a liability held, is the ask price. However, when the entity has assets and liabilities with offsetting market risks, the entity may use the midpoint for the offsetting positions and apply the bid or ask price to the net open position.

US GAAP If an input used for measuring fair value is based on bid and ask prices, the price within the bid-ask spread that is most representative of fair value in the circumstances is used. At the same time, US GAAP does not preclude the use of midmarket pricing or other pricing conventions as practical expedients for fair value measurements within a bid-ask spread. As a result, financial assets may, in certain situations, be valued at a bid or ask price, at the last price, at the mean between bid and ask prices or at a valuation within the range of bid and ask prices.

JP GAAP Accounting standards do not specify the bid/ask spread. However, for unlisted derivatives, an entity may use the mean between bid and ask prices if the range of bid and ask prices is small. If the range is large, it is preferable to use the bid price for assets and the ask price for liabilities.

Reclassification

IFRS [IAS 39] Financial assets may be reclassified between categories, albeit with conditions.

More significantly, debt instruments may be reclassified from held for trading or available-for-sale into loans and receivables, if the debt instrument meets the definition of loans and receivables and the entity has the intent and ability to hold for the foreseeable future.

Also, a financial asset can be transferred from trading to available-for-sale in rare circumstances.

Reclassification is prohibited for instruments where the fair value option is elected.


[IFRS 9] When there is a change in the business model for managing financial assets, an entity must reclassify all affected financial assets. The date of reclassification is the first day of the first period after the change in business model that requires reclassification of financial assets.

US GAAP Changes in classification between trading, available-for-sale and held-to-maturity categories occur only when justified by the facts and circumstances within the concepts of ASC 320. Given the nature of a trading security, transfers into or from the trading category should be rare, though they do occur.

JP GAAP Reclassification of assets between categories is prohibited in principle.

Similar to IAS 39 in terms of reclassification of debt securities from held-to-maturity and the “tainted” concept.

Only in rare cases, transfer from available-for-sale to trading is allowed for debt securities.

Impairment

The IASB has released an exposure draft, Amortized cost and impairment, which would significantly change the impairment model under IAS 39. Please refer to the Recent proposals section at the end of this chapter for details on the exposure draft. There would be no impairment for equity instruments designated as measured at fair value through other comprehensive income.

Impairment principles: available-for-sale debt instruments (securities)

IFRS [IAS 39] A financial asset is impaired and impairment losses are incurred only if there is objective evidence of impairment as the result of one or more events that occurred after initial recognition of the asset (a loss event) and if that loss event has an impact on the estimated future cash flows of the financial asset that can be estimated reliably. In assessing the objective evidence of impairment, an entity considers the following factors:

• Significant financial difficulty of the issuer.

• High probability of bankruptcy.

• Granting of a concession to the issuer.

• Disappearance of an active market, because of financial difficulties.

• Breach of contract, such as default or delinquency in interest or principal.

• Observable data indicating there is a measurable decrease in the estimated future cash flows since initial recognition.

The disappearance of an active market, because an entity’s securities are no longer publicly traded or the downgrade of an entity’s credit rating is not, by itself, evidence of impairment, although it may be evidence of impairment when considered with other information.

At the same time, a decline in the fair value of a debt instrument below its amortized cost is not necessarily evidence of impairment. For example, a decline in the fair value of an investment in a corporate bond that results solely from an increase in market interest rates is not an impairment indicator and would not require an impairment evaluation under IFRS.

An impairment analysis under IFRS focuses only on the triggering credit events that negatively affect the cash flows from the asset itself and does not consider the holder’s intent.

Once impairment of a debt instrument is determined to be triggered, the cumulative loss recognized in other comprehensive income due to changes in fair value is released into profit or loss.

[IFRS 9] IFRS 9 eliminates the available-for-sale category. It requires debt instruments to be categorised as measured at fair value or amortised cost, according to the entity’s business model and the contractual cash flow characteristics of the instrument. The impairment requirements in IAS 39 are applied to debt instruments categorised as measured at amortised cost.

US GAAP An investment in debt securities classified as available-for-sale is assessed for impairment if the fair value is less than cost. An analysis is performed to determine whether the shortfall in fair value is temporary or other than temporary.

In a determination of whether impairment is other than temporary, the following factors are assessed for available for sale securities:

Step 1 - Can management assert (a) it does not have the intent to sell and (b) it is more likely than not that it will not have to sell before recovery of cost? If no, then impairment is triggered. If yes, then move to Step 2.

Step 2 - Does management expect recovery of the entire cost basis of the security? If yes, then impairment is not triggered. If no, then impairment is triggered.


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Once it is determined that impairment is other than temporary, the impairment loss recognised in the income statement depends on the impairment trigger:

• If impairment is triggered as a result of Step 1, the cumulative loss deferred in equity is released into the income statement.

• If impairment is triggered in Step 2, impairment loss is measured by calculating the present value of cash flows expected to be collected from the impaired security. The determination of such expected credit loss is not explicitly defined; one method could be to discount the best estimate of cash flows by the original effective interest rate. The difference between the fair value and the post impairment amortized cost is recorded within other comprehensive income.

JP GAAP Securities with a fair value are impaired when their fair value has significantly declined and there is no possibility of recovery. For debt instruments where it is extremely difficult to determine the fair value, the expected unrecoverable amount is based on the calculation of the bad debt allowance taking into account credit risk.

Impairment principles: held-to-maturity debt instruments

IFRS [IAS 39] Impairment is triggered for held-to-maturity investments based on objective evidence of impairment described above for available-for-sale debt instruments.

Once impairment is triggered, the loss is measured by discounting the estimated future cash flows (adjusted for incurred loss) by the original effective interest rate. As a practical expedient, impairment may be measured based on the instrument’s observable fair value.

[IFRS 9] IFRS 9 eliminates the held-to-maturity category. It requires debt instruments to be categorised as measured at fair value or amortised cost, according to the entity’s business model and the contractual cash flow characteristics of the instrument. If an entity elects to early adopt IFRS 9, the impairment requirements in existing IAS 39 would apply to financial assets categorised as measured at amortised cost.

US GAAP The two step impairment test mentioned above is also applicable to certain investments classified as held-to-maturity. However, as this would result in tainting, it would be expected that held-to-maturity investments would not trigger Step 1. Rather, evaluation of Step 2 may trigger impairment.

Once triggered, impairment is measured with reference to expected credit losses as described for available-for-sale debt securities. The difference between the fair value and the post impairment amortized cost is recorded within other comprehensive income (OCI) and accreted from OCI to the amortized cost of the debt security over its remaining life prospectively.

JP GAAP Debt instruments with a fair value are impaired when their fair value has significantly declined and there no possibility of recovery. For debt instruments where it is extremely difficult to determine the fair value, the expected unrecoverable amount is based on the calculation of the bad debt allowance taking into account credit risk.

Impairment of available-for-sale equity instruments

IFRS [IAS 39] Similar to debt investments, impairment of available for sale equity investments is triggered by objective evidence of impairment. In addition to examples of events discussed above, objective evidence of impairment of AFS equity includes:

• Significant or prolonged decline in fair value below cost; or

• Significant adverse changes in technological, market, economic or legal environment.

Each factor on its own could trigger impairment (i.e., the decline in fair value below cost does not need to be both significant and prolonged). For example, if a decline has persisted for more than twelve consecutive months, then the decline is likely to be considered “prolonged”.

Whether a decline in fair value below cost is considered as significant must be assessed on an instrument-by-instrument basis and should be based on both qualitative and quantitative factors.

[IFRS 9] Under IFRS 9, all equity instruments are measured at fair value. Impairment accounting will not apply to equity instruments designated as measured at fair value through profit or loss nor those categorised as measured at fair value through other comprehensive income.

US GAAP US GAAP looks to whether the decline in fair value below cost is other-than-temporary. The factors to consider include:

• The length of the time and the extent to which the market value has been less than cost;

• The financial condition and near-term prospects of the issuer, including any specific events that may influence the operations of the issuer, such as changes in technology that may impair the earnings potential of the investment or the discontinuance of a segment of the business that may affect the future earnings potential; and


• The intent and ability of the holder to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in market value.

The evaluation of the OTTI trigger requires significant judgment in assessing the recoverability of decline in fair value below cost. Generally, the longer the decline and the greater the decline, the more difficult it is to overcome the presumption that the AFS equity is other than temporarily impaired.

JP GAAP An impairment loss is recognised when there is a significant decline in the fair value. “Significant decline” is determined by the level of decline in the fair value below the cost. If the decline rate is 50% and above, the decline is presumed not to be recoverable unless there are reasonable rebuttals and an impairment loss must be recognised. If the decline rate is less than 30%, the decline is considered not significant and the recognition of an impairment loss is not required. If the decline rate is between 30% and 50%, entities should establish a reasonable basis for the determination of impairment and judge whether the recognition of an impairment loss is necessary or not. For equity securities where it is difficult to determine the fair value, an impairment is recognised when the determinable value of the investment has declined significantly.

Losses on available-for-sale instruments subsequent to initial impairment recognition

IFRS [IAS 39] Impairment charges do not establish a new cost basis. As such, further reductions in value below the original impairment amount are recorded within profit or loss for the current-period.

[IFRS 9] All equity instruments are measured at fair value. Impairment accounting will not apply to equity instruments. Debt instruments classified as at amortised cost should follow the requirements under IAS 39.

US GAAP Impairment charges establish a new cost basis. As such, further reductions in value below the new cost basis may be considered temporary (when compared with the new cost basis).

JP GAAP Similar to US GAAP.

Impairments: measurement and reversal of losses

IFRS [IAS 39] For financial assets carried at amortized cost, if in a subsequent period the amount of impairment loss decreases and the decrease can be objectively associated with an event occurring after the impairment was recognised, the previously recognised impairment loss is reversed. The increased carrying amount attributable to the reversal of an impairment loss, however, does not exceed what the amortized cost would have been had the impairment not been recognised.

For available-for-sale debt instruments, if in a subsequent period the fair value of the debt instrument increases and the increase can be objectively related to an event occurring after the loss was recognised, the loss may be reversed through profit or loss.

[IFRS 9] All equity instruments are measured at fair value. Impairment accounting will not apply to equity instruments.

Reversals of impairments on equity investments are prohibited.

US GAAP Impairments of loans held for investment measured under ASC 310-10-35 and ASC 450 are permitted to be reversed; however, the carrying amount of the loan can at no time exceed the recorded investment in the loan.

One-time reversals of impairment losses for debt securities classified as available-for-sale or held-to-maturity securities, however, are prohibited. Rather, any expected recoveries in future cash flows are reflected as a prospective yield adjustment.

Reversals of impairments on equity investments are prohibited.

JP GAAP Impairment losses on equity instruments and debt instruments are not reversed.

As for receivables, the allowances for bad debt recognised in prior periods can be reversed based on a change in estimates. However, impairment losses directly deducted from specific loans are not reversed regardless of the increase of possibility for recoverability.

Derecognition

IFRS The guidance focuses on evaluation of whether a qualifying transfer has taken place, whether risks and rewards have been transferred and, in some cases, whether control over the asset(s) in question has been transferred.

The transferor first applies the consolidation guidance and consolidates any and all subsidiaries or special purpose entities (SPEs) it controls.

The next step is to determine whether the analysis should be applied to part of a financial asset (or part of a group of similar financial assets) or to the financial asset in its entirety (or a group of similar financial assets in the entirety).

Under IAS 39, full derecognition is appropriate once both of the following conditions have been met:


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• The financial asset has been transferred outside the consolidated group.

• The entity has transferred substantially all of the risks and rewards of ownership of the financial asset.

The first condition is achieved in one of two ways:

• When an entity transfers the contractual rights to receive the cash flows of the financial asset; or

• When an entity retains the contractual rights to the cash flows, but assumes a contractual obligation to pass the cash flows on to one or more recipients (referred to as a pass-through arrangement).

Many securitizations do not meet the strict pass-through criteria to recognise a transfer of the asset outside of the consolidated group and as a result fail the first condition for derecognition.

If there is a qualifying transfer, an entity must determine the extent to which it retains the risks and rewards of ownership of the financial asset. IAS 39 requires the entity to evaluate the extent of the transfer of risks and rewards by comparing its exposure to the variability in the amounts and timing of the transferred financial assets’ net cash flows, both before and after the transfer.

If the entity’s exposure does not change substantially, derecognition would not be appropriate. Rather, a liability equal to the consideration received would be recorded (financing transaction). If, however, substantially all risks and rewards are transferred, the entity would derecognize the financial asset transferred and recognize separately any asset or liability created through any rights and obligations retained in the transfer (e.g., servicing assets).

Many securitization transactions include some ongoing involvement by the transferor that causes the transferor to retain substantial risks and rewards, thereby failing the second condition for derecognition, even if the pass through test is met.

When an asset transfer has been accomplished, but the entity has neither retained nor transferred substantially all risks and rewards, an assessment as to control becomes necessary. The transferor assesses whether the transferee has the practical ability to sell the financial asset transferred to a third party. The emphasis is on what the transferee can do in practice and whether it is able, unilaterally, to sell the transferred financial asset without exposing any restrictions on the transfer. If the transferee does not have the ability to sell the transferred financial asset, control is deemed to be retained by the transferor and the transferred financial asset may require a form of partial derecognition called continuing involvement. Under continuing involvement, the transferred financial asset continues to be recognised with an associated liability.

When the entity has continuing involvement in the transferred financial asset, the entity must continue to recognise the transferred financial asset to the extent of its exposure to changes in the value of the transferred financial asset. Continuing involvement is measured as either the maximum amount of consideration received that the entity could be required to repay (in the case of guarantees) or the amount of the transferred financial asset that the entity may repurchase (in the case of a repurchase option).

US GAAP The guidance focuses on an evaluation of the transfer of control. The evaluation is governed by three key considerations:

• Legal isolation of the transferred asset from the transferor.

• The ability of the transferee (or if the transferee is a securitization vehicle, the beneficial interest holder) to pledge or exchange the asset (or the beneficial interest).

• No right or obligation of the transferor to repurchase.

As such, derecognition can be achieved even if the transferor has significant ongoing involvement with the assets, such as the retention of significant exposure to credit risk.

ASC 860 must be considered with the consolidation guidance.

Therefore, even if the transfer criteria are met, the transferor may not achieve derecognition as the assets may be, in effect, transferred to the consolidated entity.

There is no concept of continuing involvement / partial derecognition under US GAAP.

When accounting for a transfer of an individual financial asset or a group of financial assets that qualifies as a sale, the assets transferred in the sale must be derecognised from the transferor’s balance sheet. The total carrying amount of the asset is derecognised and any assets and liabilities retained are recognised at fair value. The transferor should separately recognise any servicing assets or servicing liabilities retained in the transfer at their fair values. A gain or loss on the transfer is calculated as the difference between the net proceeds received and the carrying value of the assets sold.

JP GAAP Financial assets must be derecognised when the contractual rights of the financial assets are exercised, when those rights are lost or when the control of those rights has passed to other parties.


Control is deemed to have transferred when all three categories below are met, and the financial assets must be derecognised.

1) The contractual rights of the transferee over the transferred financial assets are secured legally from transferors and their creditors.

2) The transferee can enjoy contractual rights on financial assets directly and indirectly in the normal way,

3) The transferor does not have the right or the obligation to repurchase the transferred financial assets before their maturity date.


Joint FASB/IASB Financial Instruments Project

Overview

The FASB and IASB’s joint project on financial instruments is intended to address the recognition and measurement of financial instruments, including impairment and hedge accounting. Once finalized, the new guidance will replace the FASB’s and IASB’s respective financial instruments guidance. While the project is a joint project, the FASB and IASB have been working on different timetables. The IASB has been conducting its work in separate phases: (1) classification and measurement of financial assets; (2) classification and measurement of financial liabilities; (3) impairment; and (4) hedge accounting, while the FASB elected to issue one comprehensive exposure draft on financial instruments.

In November 2009, the IASB issued IFRS 9, Financial Instruments, which reflects the decisions it reached in the classification and measurement phase for financial assets. The IASB also issued an exposure draft on impairment of financial assets carried at amortized cost. The board also plans to release its exposure draft on hedge accounting in the fourth quarter of 2010.

In May 2010, the FASB released its financial instrument accounting exposure draft, Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities.

Although the FASB and IASB are coordinating efforts in their projects to reduce complexity in reporting financial instruments, the final standards may not be fully converged.

IASB Exposure Draft, Financial Instruments: Amortized cost and impairment

In November 2009, the IASB issued ED 2009/12, which proposes fundamental changes to the current impairment guidance for financial assets accounted for at amortized cost. The proposed model is built upon the premise that interest charged on financial instruments includes a premium for expected losses, which should not be included as part of interest revenue/income. This results in an allocation of the initial estimate of expected credit losses over the expected life of the financial asset. At the inception of an instrument, the lender will be required to identify the effective interest rate (EIR) component, which represents compensation for the expected losses. Interest income is recognized over the life of the instrument at the EIR net of the expected loss component identified at inception. The premium associated with the expected losses is reflected each period as a reduction in the basis of the receivable (effectively an allowance for bad debts).

Unlike the incurred loss model currently required under IAS 39, the expected cash flow model does not wait for evidence that impairment has occurred but instead requires a continuous assessment of the expected cash flows over the life of the instrument. No impairment losses will be recognized if the original expected loss projection proves accurate. However, if more losses are expected than originally estimated, an impairment charge will be recognized for the decrease in the expected cash flows in the period in which the estimate changes. If favorable changes to loss expectations occur, a credit to income will be recognized for the increase in expected cash flows in the period in which the estimate changes. The model requires the use of an allowance account for credit losses. Direct write-offs are prohibited.

Recognizing the operational challenges in implementing and applying the expected cash flow model, the IASB created an Expert Advisory Panel to advise the board on the operational issues surrounding application of the proposed model and possible practical expedients.

IASB Exposure Draft, Derecognition: Proposed Amendments to IAS 39 and IFRS 7

In March 2009, the IASB issued ED 2009/3, Derecognition, which would amend the existing derecognition provisions of IAS 39. The main purpose of the exposure draft was to address the perceived complexities within IAS 39 and the resulting difficulty of application in practice. The draft included two approaches to derecognition of financial assets: the “proposed model” and the “alternative view.”

The alternative approach required that if the entity has given up control over any of the cash flows of the asset, the entity no longer controls that asset and hence the asset is derecognized in its entirety and a new asset/liability is recognized for any continuing involvement in the asset retained.


FASB proposed ASU: Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities

In May 2010, the FASB issued a proposal to amend the accounting for financial instruments. The FASB’s proposal addresses all aspects of financial instrument accounting, including classification and measurement, impairment, and hedge accounting. The proposal would significantly change the current accounting for many financial instruments by expanding the use of fair value and limiting amortized cost measurements to certain issuances of an entity’s own debt. For example, financial instruments currently measured at amortized cost (such as held-for-investment loans, held-to-maturity securities, and debt instruments) would be measured at fair value.


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The FASB has proposed that all financial instruments be measured at fair value with changes in fair value recognized in net income. However, changes in fair value of certain financial instruments may be recognized in OCI if the instrument is held for the collection or payment of contractual cash flows, meets certain cash flow characteristics, and does not contain embedded derivatives that require bifurcation. Gains and losses in OCI are reclassified into the income statement upon sale or settlement of the instrument. For financial liabilities, an entity could irrevocably elect at inception to measure certain types of its own liabilities at amortized cost provided: (a) such financial liabilities are eligible for fair value through OCI accounting and (b) measuring the liabilities at fair value would create or exacerbate a measurement mismatch. All equity securities will be measured at fair value with changes in fair value recognized in income. Core deposits (without a stated maturity and considered by management as a stable source of funds) would be recorded at remeasurement value through net income or OCI. Noncore/time deposits would be carried at fair value. Further, loan commitments and standby letters of credit would be measured at fair value and classified in a manner consistent with how the loan would be classified if and when it is funded.

The FASB has proposed a single model for recognizing and measuring impairment of financial assets recorded at fair value with changes in fair value recognized in OCI. For these financial assets, credit impairment would be recognized in net income when an entity does not expect to collect all of the contractually promised cash flows (which include both principal and interest). An entity no longer would wait for a probable event to recognize a loss; instead, it would need to consider the impact of past events and existing conditions on the collectability of contractual cash flows. Moreover, the interest income would be recognized based on the asset balance less allowance, which will reduce interest income as compared with the existing guidance.

The final standard is expected by the second quarter of 2011. However, these changes are unlikely to be effective before 2013. The board also has proposed, subject to certain conditions being met, to provide nonpublic entities with less than $1 billion in total assets, a four-year deferral from recognizing certain loans and core deposit liabilities at fair value on the balance sheet.

FASB Exposure Draft, Proposed ASU: Amendments for Common Fair Value Measurement and Disclosure Requirements in US GAAP and IFRSs-Fair Value Measurements and Disclosures (Topic 820) and IASB Exposure Draft, Measurement Uncertainty Analysis Disclosure for Fair Value Measurements

In May 2009, the IASB issued Exposure Draft 2009/5 containing provisions similar to those in ASC 820, Fair Value Measurements and Disclosures. This joint project forms part of the MoU between the FASB and IASB. The objective of the project is to bring together, as closely as possible, the fair value measurement guidance. The proposals in the exposure draft eliminate some but not all of the current US GAAP and IFRS differences in this area.

The FASB and IASB have been jointly redeliberating the proposals in the IASB ED and, as a result, in June 2010, have issued the exposure drafts noted in the title above to further converge US GAAP and IFRS. Both boards plan to issue their new and updated standards by the first quarter of 2011.

Many of the proposed changes would result in conformed terminology and will drive consistent application of the principles of fair value measurements and disclosures between US GAAP and IFRS. Although many of these changes are not expected to have any significant effect on practice, some of the principles and disclosures stand to have an impact under US GAAP as described below:

The FASB is proposing that the “in use” premise can only be applied to measurement of nonfinancial assets. As a result, financial assets will be • valued only based on the unit of account being measured. For example, financial assets (such as an equity security) no longer would be able to be aggregated to arrive at a valuation based on the “in use” premise but rather would be valued based on the individual security. This may change practice where reporting entities have aggregated equity securities that are not actively traded and recorded premiums or discounts on the block position. Those premiums and discounts may no longer be acceptable.

The proposal includes a practical expedient for fair value measurement in situations in which an entity manages a group of financial assets and • financial liabilities that have offsetting market risks or counterparty credit risks based on the net open risk position. Four criteria must be present to be able to use the practical expedient: (1) the entity must manage the portfolio based on the net open risk position as part of its documented risk management or investment strategy; (2) such information must be presented in that manner to management of the entity; (3) the management of the portfolio on a net open risk position basis must be consistently applied from period to period; and (4) the financial assets and financial liabilities must be measured at fair value on a recurring basis.

The proposed ASU would extend the prohibition of the recognition of a blockage factor to all fair value measurements. Despite the change, • certain premiums or discounts may apply but may be limited to instances such as control premiums when the unit of account is a reporting unit (e.g., for goodwill impairment testing and minority interest discounts).

Additional disclosures will be required under the ASU. The most significant additional requirement will be a measurement uncertainty analysis • (otherwise known as a sensitivity analysis) for Level 3 fair value measurements.

The IASB’s exposure draft includes a similar disclosure requirement for measurement of uncertainties taking into account the impact of • correlation between inputs.


Proposed Accounting Standards Update, Transfers and Servicing (Topic 860) Reconsideration of Effective Control for Repurchase Agreements

In November 2010, the FASB issued an exposure draft, Reconsideration of Effective Control for Repurchase Agreements. The proposed guidance in the exposure draft is intended to simplify and improve the accounting for repurchase agreements (“repos”) and other similar agreements. Specifically, the proposed guidance modifies the criteria for when these transactions would be accounted for as financings (secured borrowings/lending agreements) as opposed to sales (purchases) with commitments to repurchase (resell).

Repo agreements are utilized principally as mechanisms for obtaining financing, generally on a short-term (frequently overnight) basis. In a repurchase agreement, one party (the “transferor”) transfers a security to another party (the “transferee”) for cash (or other liquid instruments) and is obligated to repurchase the transferred asset for a fixed price on a stated date. Most repo agreements have ongoing collateral maintenance provisions. For example, if the transferred asset increases in fair value, typically the transferor receives additional cash from the transferee. Conversely, if the transferred asset declines in value, cash is returned to the transferee. Such provisions minimize the credit exposure in the transaction to both parties.

In determining the proper accounting treatment for repo transactions one must determine whether or not the transfer of the financial asset should be treated as a sale. If a repo transaction is accounted for as a sale, the transferred asset is removed from the transferor’s balance sheet and the transferor accounts for the cash received and an obligation to repurchase the security. When a repo does not qualify for sale accounting, it is accounted for as a secured financing. In this case, the transferred asset remains on the transferor’s balance sheet and the transferor recognizes a liability (borrowing) for the cash received. Sale accounting is only achieved if certain criteria are met, including demonstrating that the transferor has surrendered effective control over the transferred asset. The transferee generally follows a symmetrical accounting model to the transferor.

Currently, when assessing effective control, one of the conditions a transferor has to meet is the ability to repurchase or redeem the financial assets even in the event of default of the transferee. This ability is demonstrated through obtaining cash or other collateral sufficient to fund substantially all of the cost to purchase replacement assets should the transferee fail to return the transferred asset.

In the exposure draft, the FASB is proposing to remove from the assessment of effective control the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in default by the transferee. The Board’s proposed action makes the level of cash collateral received by the transferor in a repo or other similar agreement irrelevant in determining if it should be accounted for as a sale. As a result, more agreements will be accounted for as financings. The Board believes that contractual rights and obligations determine effective control and there does not need to be a requirement to assess the ability to exercise those rights.

If issued as a final Accounting Standards Update (ASU), the new guidance is expected to be effective prospectively for new transfers and existing transactions that are modified as of the beginning of the first interim or annual period after the final ASU is issued. A final ASU is expected to be issued during the first quarter of 2011. Therefore, for example, a calendar year-end public company would apply the guidance to new transfers and existing transactions that are modified as of the second quarter of 2011.


ASBJ Discussion Paper on Revision of Accounting Standards for Financial Instruments (Classification and Measurement for Financial Assets)

In August 2010, the ASBJ issued Discussion Paper on Revision of Accounting Standards for Financial Instruments (Classification and Measurement of Financial Assets). The discussion paper is on the project for a comprehensive review of ASBJ Statement No. 10 “Accounting for Financial Instruments” that constitutes a part of the convergence project based on the Tokyo Agreement between the IASB and the ASBJ. The ASBJ had in mind the convergence with IFRS 9, and seeks comments from interested parties on the scope of financial instruments regarding the definition of financial instruments, and classification and measurement of financial assets (except impairment (allowance for doubtful accounts or credit losses)). Primary topics discussed are as follows:

Define financial instruments and derivatives according to the characteristics of the instruments, same as under IFRS. Eliminate the net • settlement criteria and only require to be settled in the future,

2 primary categories of “measured at amortised cost” and “measured at fair value” to be provided according to a mixed measurement attribute • model, same as under IFRS, regarding the classification and measurement of financial assets,

Introduce the fair value option, and•

Reclassify all of the affected financial assets’ categories if an entity changes its business model for managing its financial assets. In this case, the • date of reclassification will be the first day of the first fiscal year after the business model change.

In addition, the following are examples of requirements that are different from IFRS 9 and unique to Japan that are being discussed:

Whether to classify investments in unquoted equity instruments as measured at fair value and set application guidelines for when cost may be • an appropriate estimate of fair value, same as under IFRS 9, or to classify as measured at cost if fair value cannot be measured reliably.


Assets

84

The Discussion Paper allows entities to recognise valuation differences of certain equity instruments not in profit or loss but in other • comprehensive income if they are designated at inception, and the ASBJ discusses whether not to permit reclassification of the valuation difference of those instruments recorded in other comprehensive to profit or loss (i.e. recycling) even after the sale of the instrument as specified in IFRS 9, or to allow recycling following the traditional practice in Japan.

ASBJ Exposure Draft, Accounting standards for Fair Value Measurement and Disclosures.

In July 2010, the ASBJ issued Exposure Draft, Accounting Standards for Measurement and Disclosure of Fair Value” (the ED). This is also a project that is underway and constitutes a part of the convergence project based on the Tokyo Agreement between the IASB and the ASBJ.

The exposure draft is on the project for a comprehensive review of the ASBJ Statement No. 10 “Accounting for Financial Instruments” that constitutes a part of the convergence project based on the Tokyo Agreement between the IASB and the ASBJ. The ED defines fair value, in conformity with IFRS and U.S. GAAP, as the price that market participants would receive by selling assets or the price they would pay for transferring liabilities in an orderly transaction between them, and clarifies that fair values are exit prices. Therefore, the same assumptions that the market participant would use when they set prices for assets or liabilities need to be used for the calculation of fair value. For example, the ED proposes to consider limitations on the sale of assets that the market participants would consider, but not to permit adjustment for transaction costs and liquidity costs due to blockage factors because they are specific to the entity.

A valuation technique should be selected that is appropriate for the situation and where sufficient data can be obtained. In this regard, the entity should make the best use of observable inputs and the use of unobservable inputs should be kept to a minimum. Additionally, inputs are categorised into 3 levels and the order of preference is prescribed as from Level 1 to Level 3. These 3 levels are defined below:

Level 1 indicates quoted prices of identical assets or liabilities as at the measurement date that can be obtained by the entity. Quoted prices in • an active market is the most reliable evidence of fair value, and are used in the calculation of fair value if available. A Level 1 fair value means that the fair value uses Level 1 inputs in its calculation.

Level 2 indicates that the inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either • directly or indirectly. Level 2 fair values are fair values where Level 2 inputs are significant in the calculation.

Level 3 indicates unobservable inputs for assets or liabilities, and may be used only when observable Level 1 or Level 2 inputs are not available. • Level 3 fair values are fair values where Level 3 inputs are significant in the calculation.

The ED clearly indicates points to consider in the calculation of fair value when it is determined that the volume and frequency of transactions for the asset or liability has decreased or when the transaction is not orderly. It also provides guidance on determining whether the volume and frequency of transactions for the asset or liability has decreased.

With regard to entities using prices provided by brokers or information vendors in calculating fair value, the proposed application guidance clarifies that it is necessary to understand how the prices are calculated and evaluate whether the prices meet the definition of fair value.

Also, the ED proposes to enhance footnotes regarding fair value. Key disclosures in the footnotes as to assets and liabilities that are recorded at fair value on the balance sheet continuously every period are:

The calculation method of fair value: valuation technique used for calculating fair value; inputs and information used to set the inputs; any • changes in valuation techniques and the effect on fair value at the measurement date.

Breakdown of fair value by fair value levels: measured fair value by individual levels; accounting policy as to when to allow reclassification • between the levels; significant amount of reclassification between the levels and its basis.

Level 3 fair value: reconciliation from the beginning balance to the ending balance of Level 3 fair value; this reconciliation includes a • description of where the amounts recorded in the profit or loss for the current period are presented in the income statement/ profit or loss and in the statement of comprehensive income; the reconciliation also includes a description of where the amounts that are included in the profit or loss for the current period and related to the assets and liability held at the reporting date are presented in the income statement/ profit or loss and in the statement of comprehensive income; the basis for reclassification into/from Level 3; the amount and reason for any significant reclassification into Level 3. Also, it proposes that when a Level 3 fair value will significantly change if one or more inputs are changed to reasonably replaceable inputs, to include the fact, the effect of the change and the calculation method.

It proposes to disclose the fair values measured by the levels described above as to assets and liabilities, in the footnotes every period.

The ASBJ proposes to apply the ED for fiscal years beginning on and after April 1, 2012, and plans to issue a finalised standard in the first half of 2011. Early application is also permitted.

REFERENCES: IFRS: IFRS 9, IAS 39, SIC 12US GAAP: ASC 310, ASC 310-10-35, ASC 310-20, ASC 310-30, ASC 320, ASC 325-40, ASC 815, ASC 815-15-25-4, ASC 820, ASC 825, ASC 860JP GAAP: Accounting Standards for Financial Instruments, Guidance on Accounting for Other Compound Financial Instruments (Compound Financial Instruments Other than Those with an Option to increase Paid-in Capital), Practical Guidelines on Accounting Standards for Financial Instruments, and Q&A on Financial Instruments Accounting


Liabilities

Liabilities

Provisions

IFRS has a specific standard on accounting for various types of provisions. US GAAP has several different aspects to the authoritative literature addressing specific types of provisions – for example, environmental liabilities and restructuring costs. IFRS and US GAAP prohibit recognition of provisions for future costs, including costs associated with proposed but not yet effective legislation. Under JP GAAP, there is no specific standard, whereas only general rules are specified.

Recognition

IFRS A provision is recognised when:

• An entity has a present obligation to transfer economic benefits as a result of past events;

• it is probable (more likely than not) that such a transfer will be required to settle the obligation; and

• a reliable estimate of the amount of the obligation can be made.

A present obligation arises from an obligating event. It may take the form of either a legal obligation or a constructive obligation. An obligating event leaves the entity no realistic alternative to settle the obligation created by the event.

The term probable is used for describing a situation in which the outcome is more likely than not to occur. Generally, the phrase more likely than not denotes any chance greater than 50%.

US GAAP Similar to IFRS, although ‘probable’ is a higher threshold than ‘more likely than not’. Guidance uses the term probable to describe a situation in which the outcome is likely to occur. While a numeric standard for probable does not exist, practice generally considers an event that has a 75% or greater likelihood of occurrence to be probable.

JP GAAP Similar to IFRS. A provision shall be recognised when expense or loss will be probably incurred as a result of past events, and a reliable estimate can be reasonably made. However, no common practice or definition exists in terms of any specific quantitative threshold for the likelihood of occurrence of losses.

Measurement

IFRS The amount recognised should be the best estimate of the expenditure required (the amount an entity would rationally pay to settle the obligation at the end of the reporting period).

Where there is a continuous range of possible outcomes and each point in that range is as likely as any other, the midpoint of the range is used.

US GAAP A single standard does not exist to determine the measurement of obligations. Instead, entities must refer to guidance established for specific obligations (e.g., environmental or restructuring) to determine the appropriate measurement methodology.

Pronouncements related to provisions do not necessarily have settlement price or even fair value as an objective in the measurement of liabilities and the guidance often describes an accumulation of the entity’s cost estimates.

When no amount within a range is a better estimate than any other amount, the low end of the range is accrued.

JP GAAP There are no detailed guidelines concerning the measurement of provisions. In practice, the amount recognised as a provision is the best estimate of the expenditure required to settle the present obligation at the end of the reporting period.

Discounting

IFRS IFRS requires that the amount of a provision be the present value of the expenditure expected to be required to settle the obligation. The anticipated cash flows are discounted using a pre-tax discount rate (or rates) that reflect(s) current market assessments of the time value of money and the risks specific to the liability (for which the cash flow estimates have not been adjusted) if the effect is material.

Provisions shall be reviewed at the end of each reporting period and adjusted to reflect the current best estimate. The carrying amount of a provision increases in each period to reflect the passage of time with said increase recognized as a borrowing cost.


Liabilities

86

US GAAP For losses that meet the accrual criteria of ASC 450, an entity will generally record them at the amount that will be paid to settle the contingency, without considering the time that may pass before the liability is paid. Discounting these liabilities is acceptable when the aggregate amount of the liability and the timing of cash payments for the liability are fixed or determinable. Entities with these liabilities that are eligible for discounting are not, however, required to discount those liabilities; the decision to discount is an accounting policy choice.

The classification in the statement of operations of the accretion of the liability to its settlement amount is an accounting policy decision that should be consistently applied and disclosed.

When discounting is applied, the discount rate applied to a liability should not change from period to period if the liability is not recorded at fair value.

There are certain instances outside of ASC 450 (e.g., in the accounting for asset retirement obligations) where discounting is required.

JP GAAP The liabilities are generally not discounted, however discounting is required for asset retirement obligations.

Restructuring provisions

IFRS A provision for restructuring costs is recognised when, among other things, an entity has a present obligation.

A present obligation exists when, among other conditions, the company is demonstrably committed to the restructuring. An entity is usually demonstrably committed when there is a legal or a constructive obligation. A constructive obligation exists when the entity has a detailed formal plan for the restructuring and it has announced the plan’s main features to those affected or is unable to withdraw the plan because it has started to implement the plan. A current provision is unlikely to be justified if there will be a delay before the restructuring begins or if the restructuring will take an unreasonably long time to complete. As long as an entity is “demonstrably committed” to a plan—for example one which requires future service—a liability would be recognized.

Liabilities related to offers for voluntary terminations are recorded when the offer is made to employees and are measured based on the number of employees expected to accept the offer.

US GAAP The guidance prohibits the recognition of a liability based solely on an entity’s commitment to an approved plan.

Recognition of a provision for onetime termination benefits requires communication of the details of the plan to employees who could be affected. The communication is to contain sufficient details about the types of benefits so that employees have information for determining the types and amounts of benefits they will receive.

Further guidance exists for different types of termination benefits (i.e., special termination benefits, contractual termination benefits, severance benefits and onetime benefit arrangements). For example, one-time termination benefits provided in exchange for an employees’ future service are considered a ‘stay bonus’ and are recognised over the employees’ future service period.

Inducements for voluntary terminations are to be recognised when (1) employees accept offers and (2) the amounts can be estimated.

JP GAAP There are no detailed guidelines concerning restructuring provisions. Such provisions are recognised in accordance with general principles for provisions.

Onerous contracts

IFRS Provisions are recognized when a contract becomes onerous regardless of whether the entity has ceased using the rights under the contract.

When an entity commits to a plan to exit a lease property, sublease rentals are considered in the measurement of an onerous lease provision only if management has the right to sublease and such sublease income is probable.

IFRS generally requires recognition of an onerous loss for executory contracts if the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it.

US GAAP Provisions are not recognised for unfavourable contracts unless the entity has ceased using the rights under the contract (i.e., the cease-use date). One of the most common examples of an unfavourable contract has to do with leased property that is no longer in use. With respect to such leased property, estimated sublease rentals are to be considered in a measurement of the provision to the extent such rentals could reasonably be obtained for the property, even if it is not management’s intent to sublease or if the lease terms prohibit subleasing. Incremental expense in either instance is recognised as incurred. US GAAP generally does not allow the recognition of losses on executory contracts prior to such costs being incurred.

JP GAAP There are no detailed guidelines concerning onerous contracts. Such provisions are recognised in accordance with general principles for provisions.


REFERENCES: IFRS: IAS 37US GAAP: ASC 410-20, ASC 410-30, ASC 420, ASC 450-10, ASC 450-20, ASC 460-10, ASC 944-40JP GAAP: Business Accounting Principles

Contingencies

Reimbursements and contingent asset

IFRS Reimbursements—where some or all of the expenditure required to settle a provision is expected to be reimbursed by another party, the reimbursement shall be recognized when, and only when, it is virtually certain that reimbursement will be received if the entity settles the obligation. The amount recognized for the reimbursement shall be treated as a separate asset and shall not exceed the amount of the provision.

The virtually certain threshold may, in certain situations, be achieved in advance of the receipt of cash.

Contingent assets—contingent assets are not recognized in financial statements because this may result in the recognition of income that may never be realized. If the inflow of economic benefits is probable, the entity should disclose a description of the contingent asset. However, when the realization of income is virtually certain, then the related asset is not a contingent asset, and its recognition is appropriate.

US GAAP Recovery of recognized losses—an asset relating to the recovery of a recognized loss shall be recognized when realization of the claim for recovery is deemed probable.

Recoveries representing gain contingencies—gain contingencies should not be recognized prior to their realization. In certain situations a gain contingency may be considered realized or realizable prior to the receipt of cash.

JP GAAP There are no detailed guidelines concerning contingent assets. However, in practice similar to IFRS.

Contingent liability

IFRS A contingent liability is defined as a possible obligation whose outcome will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events outside the entity’s control. It can also be a present obligation that is not recognised because it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or the amount of the obligation cannot be measured with sufficient reliability.

A contingent liability becomes a provision and is recorded when three criteria are met: (1) that a present obligation from a past event exists, (2) that the obligation is probable and (3) that a reliable estimate can be made. The term probable is used for describing a situation in which the outcome is more likely than not to occur. Generally, the phrase more likely than not denotes any chance greater than 50 percent.

US GAAP A loss contingency is an existing condition, situation, or set of circumstances involving uncertainty as to possible loss to an entity that will ultimately be resolved when one or more future events occur or fail to occur.

An accrual for a loss contingency is required if it is probable that there is a present obligation resulting from a past event and that an outflow of economic resources is reasonably estimable.

Implicit in the first condition above is that it is probable that one or more future events will occur confirming the fact of the loss.

The guidance uses the term probable to describe a situation in which the outcome is likely to occur. While a numeric standard for probable does not exist, practice generally considers an event that has a 75 percent or greater likelihood of occurrence to be probable.

JP GAAP Contingent liability is an obligation that is not currently incurred but is possible to be incurred by an entity in the future. The provision cannot be provided if the probability of the contingent liability is low.


Liabilities

88


IASB Exposure Draft: Measurement of Liabilities in IAS 37 and Working Draft: IFRS X, Liabilities

In January 2010, the IASB issued an exposure draft titled Measurement of Liabilities in IAS 37. In February, 2010, the IASB published a working draft of a proposed new IFRS titled Liabilities. The working draft incorporated the measurement changes discussed within the January 2010 exposure draft as well as recognition and disclosure changes from a 2005 exposure draft (and related subsequent deliberations). The working draft proposals would affect the recognition and/or measurement of most provisions and would be relevant to almost every entity reporting under IFRS.

Recognition

Currently, a provision is recognized under IFRS when:

An entity has a present obligation as a result of a past event;•

It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and •

A reliable estimate can be made of the amount of the obligation. •

Under the IASB’s proposal, the second criteria of probability of outflow of economic benefits would be eliminated. Hence, liabilities would be recorded when there is a present obligation and a reliable estimate can be made even if the probability of economic outflow is low. Probability of outflow would be factored into measurement but would no longer factor into recognition. This proposal does not align with US GAAP, so convergence in this area would not be achieved.

Measurement

Under the proposal, provisions would be measured at the amount that an entity would rationally pay at the end of the reporting period to be relieved of the present obligation. This is a measure of value and not of the expected cost to the entity. It is expressed in the exposure draft as the lowest of:

The present value of the resources required to fulfill the obligation;•

The amount the entity would have to pay the counterparty to cancel the obligation; and•

The amount the entity would have to pay a third party to transfer the obligation to that third party.•

When the amount of resources required to fulfill the obligation is uncertain, the measurement guidance within the proposal indicates that the provision would be measured using the weighted average of possible outcomes (an “expected value” approach). This will rarely be the amount eventually paid but will reflect the uncertainty inherent in the estimate. The provision will be discounted using a rate that reflects the time value of money and any risks specific to the obligation that are not reflected in the expected value calculation.

When the obligation is to make payments to the counterparty, for example to settle litigation, the provision would be measured at the expected cash payment plus any associated costs.

When the obligation is to deliver a service, for example in connection with a warranty or an asset decommissioning obligation, the provision would be measured at the amount that would be paid to a contractor to undertake the service, based on the market price for the relevant service. If there is no market price for the service, an entity estimates the amount it would charge another party to undertake the service. The estimates would include the costs an entity expects to incur and the margin it would require to undertake the service for the other party.

The proposed guidance is different from the way provisions are often measured today. For example, many provisions under current guidance are measured using management’s best estimate of the amount that will be paid. The best estimate approach no longer would be acceptable. At the same time, provisions for an obligation to deliver a service are often measured, under the existing IFRS guidance, at the expected cost of fulfilling the obligation. A movement to a value-based model including a profit margin would represent a significant change. Neither of these changes would align with the US GAAP requirements in this area. Other differences also would be created.

REFERENCES: IFRS: IAS 19, IAS 37.US GAAP: ASC 410-30, ASC 450-10, ASC 450-20, ASC 460-10, ASC 944-40JP GAAP: Regulation on the Terminology, Format and Preparation of Financial Statements, Audit Treatment for Accounting and Presentation of Debt Guarantee and Similar Guarantee Obligations


Income taxes

All three frameworks require a provision for income taxes, but there are differences in the methodologies, as set out in the table below.

ISSUE IFRS US GAAP JP GAAP

Recognition exemption

Exemptions from accounting for temporary differences

An exemption exists in the accounting for deferred taxes from the initial recognition of an asset or liability in a transaction that neither is a business combination nor affects accounting profit/loss or taxable profit at the time of the transaction.

No special treatment of leveraged leases exists under IFRS.

An exemption exists from the initial recognition of temporary differences in connection with transactions that qualify as leveraged leases under lease accounting guidance.

Generally, no exemption exists for the initial recognition of temporary differences other than goodwill.

No special treatment of leveraged leases exists under JP GAAP.

Measurement of deferred tax

Tax rates applied to current and deferred taxes

Current and deferred tax is calculated using enacted or substantively enacted rates.

Rate used is the applicable rate for expected manner of recovery.

US GAAP requires the use of enacted rates when calculating current and deferred taxes.

The applicable tax rate, which is used to measure deferred tax assets and liabilities, is the enacted tax rate that is expected to apply when temporary differences are expected to be settled or realized.

Calculate based on the tax rate applicable in the period in which the tax refund or payment is expected.

Must use future applicable tax rate according to the tax law effective as of the end of the reporting period. When the tax law is revised and enacted prior to the end of the reporting period and the revised future tax rate is determined, the revised tax rate must be used.

Recognition of deferred tax assets

Deferred tax assets are recognised when it is considered probable (defined as more likely than not) that sufficient taxable profits will be available to utilize the temporary difference or unused tax losses.

Valuation allowances are not allowed to be recorded.

Deferred taxes are recognised in full, but are then reduced by a valuation allowance if it is considered more likely than not that some portion of the deferred taxes will not be realized.

A deferred tax asset is recognised to the extent that it is expected to be recoverable based on the following considerations:

(1) Sufficiency of taxable income based on profitability

(2) Existence of tax planning

(3) Sufficiency of future taxable differences

Presentation of deferred tax

Current/non-current Generally, deferred tax assets and deferred tax liabilities are classified net (within individual tax jurisdictions and if there is a legally enforceable right to offset) as noncurrent on the statement of financial position. Supplemental note disclosures are included to describe the components of temporary differences as well as the recoverable amount bifurcated between amounts recoverable less than or greater than one year from the end of the reporting period.

Interest and penalties related to taxation (e.g. uncertain tax positions) may be classified either:

as finance or other operating •expenses when they can be clearly identified and separated from the related tax liability; or

included in the tax line if they cannot •be separated from the taxes, or as matter of accounting policy.

The accounting policy decision should be consistently applied and disclosed.

The classification of deferred tax assets and deferred tax liabilities follows the classification of the related, nontax asset or liability for financial reporting (as either current or noncurrent). If a deferred tax asset is not associated with an underlying asset or liability, it is classified based on the anticipated reversal periods. Any valuation allowances are allocated between current and noncurrent deferred tax assets for a tax jurisdiction on a pro rata basis.

The classification of interest and penalties related to uncertain tax positions (either in income tax expense or as a pretax item) represents an accounting policy decision that is to be consistently applied and disclosed.

Deferred tax assets and liabilities are classified as current or non-current based on the classification of the related assets and liabilities. A deferred tax asset related to tax loss carry forwards, which is not related to specific assets and liabilities, is classified as current or non-current depending on the timeframe of the expected recovery.

Specific applications

Unrealised intragroup profits Any tax impacts to the seller as a result of the intercompany transaction are recognised as incurred.

Deferred taxes resulting from the intragroup sale are recognised at the buyer’s tax rate.

Any tax impacts to the seller as a result of the intercompany sale are deferred and are realized upon the ultimate third-party sale.

The buyer is prohibited from recognising deferred taxes resulting from the intragroup sale.

Similar to US GAAP. The amount of temporary difference is limited to the seller’s taxable income for the year when the assets were sold to the buyer.


Liabilities

90


Intraperiod tax allocation Subsequent changes in deferred tax balances are recognised in the statement of comprehensive income—except to the extent that the tax arises from a transaction or event that is recognised, in the same or a different period, directly in equity.

Subsequent changes in deferred tax balances due to enacted tax rate and tax law changes are taken through the income statement regardless of whether the deferred tax was initially created through the income statement, through equity or in purchase accounting.

Changes in amount of valuation allowance due to changes in assessment about realization in future periods are generally taken through the income statement, with limited exceptions for certain equity-related items.

Subsequent changes in deferred tax balances are recognised in the corporate income tax adjustment account in profit or loss. However, when the valuation difference resulting from the revaluation of assets is charged directly in net assets and their corresponding amount of deferred tax related to the valuation differences is adjusted, the adjusted tax differences are recognised in the valuation differences of the asset in net assets.

Deferred taxes on investments in subsidiaries, joint ventures and equity investees – treatment of undistributed profit

With respect to undistributed profits and other outside basis differences related to investments in subsidiaries, branches and associates, and joint ventures, deferred taxes are recognised except when a parent company (investor or venturer) is able to control the timing of the reversal of the temporary difference and it is probable that the temporary difference will not reverse in the foreseeable future.

With respect to undistributed profits and other outside basis differences, different requirements exist depending on whether they involve investments in subsidiaries, in joint ventures or in equity investees.

As it relates to investments in domestic subsidiaries, deferred tax liabilities are required on undistributed profits arising after 1992 unless the amounts can be recovered on a tax-free basis and unless the entity anticipates utilizing that method.

As it relates to investments in domestic corporate joint ventures, deferred tax liabilities are required on undistributed profits that arose after 1992.

Deferred taxes are generally recognised on temporary differences related to investments in equity investees.

Deferred tax assets for investments in subsidiaries and corporate joint ventures may be recorded only to the extent they will reverse in the foreseeable future.

With respect to profits and other outside basis differences related to investments in subsidiaries, deferred taxes are not recognised unless a parent company has a clear intention to sell the investment in the subsidiary or it satisfies all requirements to be treated as tax deductible expense in the foreseeable future. Deferred tax liability on undistributed profit is generally recognised when the parent company plans to recover it by dividend income.

Uncertain tax positions Accounting for uncertain tax positions is not specifically addressed within IFRS. The tax consequences of events should follow the manner in which an entity expects the tax position to be resolved (through either payment or receipt of cash) with the taxation authorities at the end of the reporting period.

Practice has developed such that uncertain tax positions may be evaluated at the level of the individual uncertainty or group of related uncertainties. Alternatively, they may be considered at the level of the total tax liability to each taxing authority.

Acceptable methods by which to measure tax positions include (1) the expected-value/probability-weighted-average approach and (2) the single-best-outcome/most-likely-outcome method. Use of the cumulative probability model required by US GAAP is not supported by IFRS.

Uncertain tax positions are recognised and measured using a two-step process, first determining whether a benefit may be recognised and subsequently measuring the amount of the benefit. Tax benefits from uncertain tax positions may be recognised only if it is more likely than not that the tax position is sustainable based on its technical merits.

Uncertain tax positions are evaluated at the individual tax position level.

The tax position is measured by using a cumulative probability model: the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement.

There is no specific guidance for uncertain tax positions. Generally, recorded as liability when requirements for provisions are met.



Share-based payments The measurement of the deferred tax asset in each period is based on an estimate of the future tax deduction, if any, for the award measured at the end of each reporting period (based upon the current stock price if the tax deduction is based on the future stock price).

When the expected tax benefits from equity awards exceed the recorded cumulative recognized expense multiplied by the tax rate, the tax benefit up to the amount of the tax effect of the cumulative book compensation expense is recorded in the income statement; the excess is recorded in equity.

When the expected tax benefit is less than the tax effect of the cumulative amount of recognized expense, the entire tax benefit is recorded in the income statement. IFRS 2 does not include the concept of a pool of windfall tax benefits to offset shortfalls.

In addition, all tax benefits or shortfalls upon settlement of an award generally are reported as operating cash flows.

The US GAAP model for accounting for income taxes requires companies to record deferred taxes as compensation cost is recognized. The measurement of the deferred tax asset is based on an estimate of the future tax deduction, if any, based on the amount of compensation cost recognized for book purposes. Changes in the stock price do not impact the deferred tax asset or result in any adjustments prior to settlement or expiration. Although they do not impact deferred tax assets, future changes in the stock price will nonetheless affect the actual future tax deduction (if any).

Excess tax benefits (“windfalls”) upon settlement of an award are recorded in equity. “Shortfalls” are recorded as a reduction of equity to the extent the company has accumulated windfalls in its pool of windfall tax benefits. If the company does not have accumulated windfalls, shortfalls are recorded to income tax expense.

In addition, the excess tax benefits upon settlement of an award would be reported as cash inflows from financing activities.

For tax non-qualified stock options in which the salary income for individuals including employees is taxed, the expense related to the service is deductible from taxable income on the date a taxable event on the salary occurred (execution date) if the salary for individuals is taxed. As the timing difference between the recognition of the expense for accounting purposes and the deduction for tax purposes results in a future deductible difference, deferred tax is recognised.

No excess tax benefit is accounted for, as the tax deduction is allowed only to the extent of the expense recognised for accounting purposes and there is no difference between the recognition of the expense for accounting purposes and the deduction for tax purposes.


Deferred Tax

In March 2009, the IASB released an exposure draft that proposes changes to its income tax accounting standard. After reviewing comments received on the exposure draft, and giving further consideration to income tax guidance as a whole, the IASB indicated that a fundamental review of the scope of the current project on accounting for income taxes should occur after 2011. In the meantime, the IASB is developing proposals for more limited amendments. The revised project scope—which will address areas such as uncertain tax positions, deferred tax on property remeasurement at fair value, valuation allowances, and allocation of taxes within a group filing a consolidated tax return, among others—has the potential to eliminate certain differences with US GAAP. However, deliberations around some of these topics are in the early stages, and depending on the path taken, may simply change the nature of the differences with US GAAP rather than eliminate them.

REFERENCES: IFRS: IFRS 2, IAS 1, IAS 12, IAS 37US GAAP: ASC 740JP GAAP: Accounting Standards for Tax Effect Accounting, Practical Guidelines on Accounting Standards for Tax Effect Accounting in Consolidated Financial Statements, Practical Guidelines on Accounting Standards for Tax Effect Accounting in Non-Consolidated Financial Statements, Audit Treatment related to Judgement for Recoverability of Deferred Assets, Q&A on Tax Effect Accounting, Guidance on Accounting Standard for Business Combinations and Accounting Standard for Business Divestitures

Government grants

IFRS Government grants are recognised once there is reasonable assurance that both (1) the conditions for their receipt will be met and (2) the grant will be received. Revenue-based grants are deferred in the statement of financial position and released to the statement of comprehensive income to match the related expenditure that they are intended to compensate. Capital-based grants are deferred and matched with the depreciation on the asset for which the grant arises.

Grants that involve recognised assets are presented in the statement of financial position either as deferred income or by deducting the grant in arriving at the asset’s carrying amount, in which case the grant is recognised as a reduction of depreciation.

US GAAP If conditions are attached to the grant, recognition of the grant is delayed until such conditions have been fulfilled. Contributions of long-lived assets or for the purchase of long-lived assets are to be credited to income over the expected useful life of the asset for which the grant was received.

JP GAAP Government grants are not directly recognised in the capital surplus of net assets. Both capital-based grants and revenue-based grants should be recognised as income when they are received. However, there is also a shortcut compressed entry (‘Asshukukicyou’) method system provided by income tax law and special taxation measures law, whereby government grants are offset against acquired assets. This treatment is also acceptable for accounting purposes.


Liabilities

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REFERENCES: IFRS: IAS 20US GAAP: ASC 958-605JP GAAP: Business Accounting Principles, Audit Treatment for Compressed Entry


Classification

See ‘Classification’ section under ‘Assets Leases – lessor accounting’.

Finance leases

IFRS Requires recognition of an asset held under a finance lease (see classification criteria on p.65) with a corresponding obligation for future rentals, at an amount equal to the lower of the fair value of the asset and the present value of the future minimum lease payments (MLPs) at the inception of the lease. The asset is depreciated over its useful life or the lease term if shorter, unless there is reasonable certainty that the lessee will obtain ownership of the asset at the end of the lease term in which case depreciation should be over its useful life. The interest rate implicit in the lease is normally used to calculate the present value of the MLPs. The lessee’s incremental borrowing rate may be used if the implicit rate is unknown. Rental payments are allocated between repayment of capital and interest expense. Interest is calculated to give a constant periodic rate of interest on the remaining balance of the liability. The guidance acknowledges that in allocating the finance charge, a lessee may use some form of approximation to simplify the calculation.

US GAAP Similar to IFRS, except that the lessee’s incremental borrowing rate is used to calculate the present value of the MLPs, excluding the portion of payments representing executory costs, unless it is practicable to determine the rate implicit in the lease and the implicit rate is lower than the incremental borrowing rate. If the incremental borrowing rate is used, the amount recorded as the asset and obligation is limited to the fair value of the leased asset. Asset amortisation is consistent with IFRS.

JP GAAP Similar to IFRS. However, in the case of finance leases, the asset and lease obligation are primarily recorded at the amount of the purchase price paid by the lessor. An alternative treatment of recording at the lesser of (i) the present value of the gross lease payments discounted by the appropriate discount rate or (ii) the estimated cash purchase price is also acceptable if the lessee has no information on the purchase price paid by the lessor. In principle, leased assets are depreciated over their estimated economic useful life. The discount rate used to determine the present value of total minimum lease payments should principally be the implied interest rate used by the lesser, however, using the additional borrowing rate is an acceptable method when the lessee has no information on the implied interest rate used by the lesser.

Operating leases

The rental expense (net of any incentives received) under an operating lease is generally recognised on a straight-line basis over the lease term under IFRS and US GAAP. Under JP GAAP, incentives received is not adjusted for rental expense.

Sale and leaseback transactions

The seller-lessee sells an asset to the buyer-lessor and leases the asset back in a sale and leaseback transaction. There are differences among three frameworks in the accounting for profits and losses arising on sale and leaseback transactions. These are highlighted in the table below.


Finance lease

Profit or loss on sale Deferred and amortised over the lease term.

Timing of profit or loss recognition depends on whether the seller relinquishes substantially all or a minor part of the use of the asset. If substantially all, profit/loss is generally recognised at date of sale. If seller retains more than a minor part, but not substantially all of the use of the asset, any profit in excess of either the present value of MLPs (for operating leases) or the recorded amount of the leased asset (for finance leases) is recognised at date of sale. A loss on a sale-leaseback is recognised immediately by the seller-lessee to the extent that net book value exceeds fair value. Specific rules apply for sale-leasebacks relating to continuing involvement and transfer of risks and rewards of ownership.

Similar to IFRS. The lessee defers the gain or loss on the sale of the asset subject to the lease as either a long-term prepaid expense or long-term deferred income and records it in profit or loss by adjusting to the depreciation expenses according to the proportion of the recognition for the leased asset’s depreciation expense. If it is evident that the loss on the sale arose from the decrease in the reasonably estimated market price of the assets over the carrying amount, that loss should not be deferred but recorded as a loss on sale.



Operating lease

Sale at fair value Immediate recognition. See above. No specific guidance. However, similar to IFRS in practice.

Sale at less than fair value Immediate recognition, unless the difference is compensated by lower future rentals. In such cases, the difference is deferred over the period over which the asset is expected to be used.

See above. No specific guidance. However, similar to IFRS in practice.

Sale at more than fair value The difference is deferred over the period for which the asset is expected to be used.

See above. No specific guidance. However, similar to IFRS in practice.


Leases

See ‘Assets-lease’ section for details of recent proposals on Leases.

REFERENCES: IFRS: IAS 17, SIC 15US GAAP: ASC 840, ASC 976JP GAAP: Accounting Standard for Lease Transaction, Guidance on Accounting Standard for Lease Transaction



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In October 2010, IASB added the requirements for financial liabilities to IFRS 9 and completed the classification and measurement phase to replace the IAS 39. The additional requirements for the classification and measurement of the financial liabilities carry forward the existing guidance within IAS 39, except for the treatment of the portion of the change in its fair value due to changes in the entity’s own credit risk of the financial liabilities designated as at fair value through profit or loss.

For financial liabilities designated as at fair value through profit or loss, this additional requirements to the existing IFRS9 require an entity to recognize the amount of change in the fair value of the financial liability that is attributable to changes in the credit risk of that liability in other comprehensive income (OCI) and the remaining amount of change in the fair value of the liability in profit or loss unless the recognition of the changes in the liability’s credit risk in OCI would create or enlarge an accounting mismatch in profit or loss. On the other hand, if the treatment would create or enlarge an accounting mismatch in profit or loss, an entity shall present all gains or losses on that liability in profit or loss.

These requirements apply to financial statements for annual periods beginning on or after 1 January 2013. Entities are permitted to apply the new requirements in earlier periods, however, if they do, they must also apply the requirements in IFRS 9 that relate to financial assets.

The classification and measurement of financial liabilities forms part of the overall joint project on the Accounting for Financial Instruments by the FASB and the IASB. The FASB addresses financial liabilities within its comprehensive exposure draft, which was released on May 26, 2010. Refer to the “Recent proposal – US GAAP” section of the Assets—financial assets chapter for discussion of the FASB’s comprehensive exposure draft.

Amendment to IAS 32: Classification of Rights Issues

In October 2009, the IASB issued an amendment that addressed the accounting for rights issues (rights, options, or warrants) denominated in a currency other than the functional currency of the issuer. Prior to this amendment, such rights issues were accounted for as derivative liabilities, as such rights normally would fail the “fixed for fixed” requirement in IAS 32 to qualify for equity treatment. This amendment created an exception to the “fixed for fixed” requirements, whereby such rights issues are classified as equity if they are issued pro rata to an entity’s existing shareholders within the same class for a fixed amount of any currency, regardless of the currency in which the exercise price is denominated.

This amendment creates a new US GAAP and IFRS difference. For details, refer to the discussion under Derivatives on own shares—“fixed for fixed” versus indexed to issuer’s own shares.

IFRIC 19: Extinguishing Financial Liabilities with Equity Instruments

In November 2009, IFRIC 19, Extinguishing Financial Liabilities with Equity Instruments, was issued. The IFRIC clarifies the accounting when an entity renegotiates the terms of its debt resulting in the financial liability being extinguished through the debtor issuing its own equity instruments to the creditor (referred to as a “debt for equity swap”). A gain or loss is recognized in profit or loss based on the fair value of the equity instruments compared to the carrying amount of the debt. Before IFRIC 19, some entities recognized the equity instrument at the carrying amount of the financial liability and did not recognize any gain or loss in profit or loss on the transaction. Others recognized the equity instruments at the fair value of equity instruments issued and recognized any difference between that amount and the carrying amount of the financial liability in profit or loss. As a result, there was diversity in practice in accounting for such transactions, and the issue became more pervasive in light of the current economic environment.

IFRIC 19 requires a gain or loss be recognized in profit or loss when a financial liability is settled through the issuance of the entity’s own equity instruments. The amount of the gain or loss recognized in profit or loss will be the difference between the carrying value of the financial liability and the fair value of the equity instruments issued. If the fair value of the equity instruments cannot be reliably measured, then the fair value of the existing financial liability is used to measure the gain or loss. Entities no longer will be permitted to reclassify the carrying value of the existing financial liability into equity (with no gain or loss being recognized in profit or loss).

The publication of IFRIC 19 results in greater convergence between the guidance provided under US GAAP and IFRS.

Definition

IFRS, US GAAP and JP GAAP define a financial liability in a similar way, to include a contractual obligation to deliver cash or a financial asset to another entity, or to exchange financial instruments with another entity under conditions that are potentially unfavourable. Generally, the narrower definition US GAAP definitions result in more instruments being treated as equity /mezannine equity under US GAAP while more instruments are treated as financial liabilities under IFRS. Also, derivatives that may be settled in an issuer’s own shares are evaluated differently under IFRS and US GAAP as explained below.


Classification of non-derivative contracts

IFRS Where there is a contractual obligation (either explicit or indirectly through its terms and conditions) on the issuer of an instrument whereby the issuer may be required to deliver either cash or another financial asset to the holder, that instrument meets the definition of a financial liability.

The issuer also classifies the financial instrument as a liability if the settlement is contingent on uncertain future events beyond the control of both the issuer and the holder. An instrument that is settled using an entity’s own equity shares is also classified as a liability if the number of shares varies in such a way that the fair value of the shares issued equals the obligation.

Financial instruments with characteristics of both liabilities and equity are classified as either liabilities or equity. When an evaluation of the terms of an instrument determines that it contains both a liability and an equity component it is bifurcated between liabilities and equity.

Puttable instruments (financial instruments that give the holder the right to put the instrument back to the issuer for cash or another asset) are liabilities, except when the class of puttable instruments is the residual interest in the entity and meet certain characteristics prescribed in the Standard. Specific guidance exists when the holder’s right to redemption is subject to specific limits.

US GAAP Under US GAAP, the following types of instrument are classified as liabilities under ASC 480:

• a financial instrument issued in the form of shares that is mandatorily redeemable – i.e., that embodies an unconditional obligation requiring the issuer to redeem it by transferring its assets at a specified or determinable date (or dates) or upon the occurrence of an event that is certain to occur;

• a financial instrument (other than an outstanding share) that, at inception, embodies an obligation to repurchase the issuer’s equity shares, or is indexed to such an obligation, and that requires or may require the issuer to settle the obligation by transferring assets (for example, a forward purchase contract or written put option on the issuer’s equity shares that is to be physically settled or net cash settled); and

• a financial instrument that embodies an unconditional obligation or a financial instrument other than an outstanding share that embodies a conditional obligation that the issuer should or may settle by issuing a variable number of its equity shares, also, provided the contract meets certain conditions.

Specific SEC guidance provides for the classification of certain redeemable instruments that are outside the scope of ASC 480 as mezzanine equity (i.e., outside of permanent equity). Examples of items requiring mezzanine classifications are instruments with contingent settlement provisions or puttable shares. However, IFRS does not provide for the classification of an instrument as mezzanine equity.

JP GAAP There is no detailed guidance for the classification of a financial liability and equity. However, the classification follows the legal form under the corporate law.

Contingent settlement provisions

IFRS IAS 32 notes that a financial instrument may require an entity to deliver cash or another financial asset in the event of the occurrence or nonoccurrence of uncertain future events beyond the control of both the issuer and the holder of the instrument. Contingencies may include linkages to such events as a change in control or to other matters such as a change in a stock market index, consumer price index, interest rates, or net income.

If the contingency is outside of the issuer’s control, the issuer of such an instrument does not have the unconditional right to avoid delivering cash or another financial asset. Therefore, except in limited circumstances (such as if the contingency were not genuine or if it is triggered only in the event of a liquidation of the issuer), instruments with contingent settlement provisions represent financial liabilities.

As referenced previously, the guidance focuses on the issuer’s unconditional ability to avoid settlement no matter whether the contingencies may or may not be triggered.

There is no concept of mezzanine classification under IFRS.

US GAAP A contingently redeemable financial instrument (e.g., one redeemable only if there is a change in control) is outside the scope of ASC 480 because its redemption is not unconditional. Any conditional provisions must be assessed to ensure that the contingency is substantive.

For SEC-listed companies applying US GAAP, certain types of securities require classification in the mezzanine equity category of the balance sheet. Examples of items requiring mezzanine classification are instruments with contingent settlement provisions or puttable shares as discussed in the Puttable shares section.

Mezzanine classification is a US public company concept that is also preferred (but not required) for private companies.

JP GAAP There is no specific guidance on contingently redeemable financial instruments. In practice, they are classified as a liability or equity according to their legal form.



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Compound instruments that are not convertible instruments (that do not contain equity conversion features)

IFRS If an instrument has both a liability component and an equity component—known as a compound instrument (e.g., redeemable preferred stock with dividends paid solely at the discretion of the issuer)—IFRS requires separate accounting for each component of the compound instrument.

The liability component is recognised at fair value calculated by discounting the cash flows associated with the liability component at a market rate for a similar debt host instrument and the equity component is measured as the residual amount and is not subsequently remeasured.

The accretion calculated in the application of the effective interest rate method on the liability component is classified as interest expense.

US GAAP The guidance does not have the concept of compound financial instruments outside of instruments with equity conversion features. As such, under US GAAP the instrument would be classified wholly within liabilities or equity.

JP GAAP Compound instruments which have both a liability and an equity component are bifurcated into a liability or equity component following the legal form under the corporate law.

Convertible Instruments (compound instruments that contain equity conversion features)

IFRS For convertible instruments with a conversion feature characterized by a fixed amount of cash for a fixed number of shares (fixed-for-fixed), IFRS requires bifurcation and split accounting between the liability and equity components of the instrument.

The liability component is recognised at fair value calculated by discounting the cash flows associated with the liability component —at a market rate for nonconvertible debt —and the equity conversion features are measured as the residual amount and recognised in equity with no subsequent remeasurement.

Equity conversion features within liability host instruments that fail the fixed-for-fixed requirement (i.e., a fixed number of shares for a fixed amount of cash) are considered to be embedded derivatives. Such embedded derivatives are bifurcated from the host debt contract and measured at fair value, with changes in fair value recognised in profit or loss.

IFRS does not have a concept of a beneficial conversion feature (BCF), as the compound instruments are already accounted for based on their components.

US GAAP Equity conversion features should be separated from the liability component and recorded separately as embedded derivatives only if they meet certain criteria (e.g., fail to meet the scope exception of ASC 815).

• For convertible debt instruments that may be settled in cash, the liability and equity components of the instrument should be separately accounted for by allocating the proceeds from the issuance of the instrument between the liability component and the embedded conversion option (i.e., the equity component). This allocation is done by first determining the carrying amount of the liability component based on the fair value of a similar liability excluding the embedded conversion option and then allocating to the embedded conversion option the excess of the initial proceeds ascribed to the convertible debt instrument over the amount allocated to the liability component.

• A convertible debt may contain a beneficial conversion feature (BCF) when the strike price on the conversion option is “in the money.” The BCF is generally recognized and measured by allocating a portion of the proceeds received, equal to the intrinsic value of the conversion feature, to equity.

JP GAAP For convertible instruments, either bifurcating into equity and liabilities or treating as a single instrument is acceptable. In practice, they are generally treated as a single instrument.

Puttable shares / Shares redeemable upon liquidation

IFRS Puttable shares Puttable instruments are generally classified as financial liabilities because the issuer does not have the unconditional right to avoid

delivering cash or other financial assets. Under IFRS, the legal form of an instrument (i.e., debt or equity) does not necessarily influence the classification of a particular instrument.

Under this principle, IFRS may require certain interests in open-ended mutual funds, unit trusts, partnerships and the like to be classified as liabilities (because holders can require cash settlement). This could lead to situations where some entities have no equity capital in their financial statements.

An entity classifies certain puttable instruments as equity provided they have particular features and meet certain specific conditions.

Shares redeemable upon liquidation For instruments issued out of finite-lived entities that are redeemable upon liquidation, equity classification is appropriate if certain

conditions are met.


However, when classifying redeemable financial instruments issued by a subsidiary (either puttable or redeemable upon liquidation) for a parent’s consolidated accounts, equity classification at the subsidiary level is not extended to the parent’s classification of the redeemable noncontrolling interests in the consolidated financial statements, as the same instrument would not meet the specific criteria from the parent’s perspective.

US GAAP Puttable shares The redemption of puttable shares is conditional upon the holder exercising the put option. This contingency removes puttable shares from

the scope of instruments that ASC 480 requires be classified as a liability.

As discussed for contingently redeemable instruments, SEC registrants would classify these instruments as “mezzanine.” Such classification is encouraged but not required for private companies.

Shares redeemable upon liquidation ASC 480 scopes out instruments that are only redeemable upon liquidation. Therefore, such instruments may achieve equity classification

for finite-lived entities.

In classifying these financial instruments issued by a subsidiary in a parent’s consolidated financial statements, U.S. GAAP permits an entity to defer the application of ASC 480; the result is that the redeemable noncontrolling interests issued by a subsidiary are not a liability in the parent’s consolidated financial statements.

JP GAAP Puttable shares and shares redeemable upon liquidation There is no detailed guidance for puttable shares and shares redeemable upon liquidation. In practice, they are classified in equity

following the legal form under the corporate law.

Derivates on own shares-“fixed for fixed” versus indexed to issuer’s own share

IFRS Only contracts that provide for gross physical settlement meet the fixed-for-fixed criteria and are classified as equity. Variability in the amount of cash or the number of shares to be delivered results in financial liability classification.

For example, a warrant issued by Company X has a strike price adjustment based on the movements in Company X’s stock price. This feature would fail the fixed-for-fixed criteria under IFRS - the same adjustment would meet the fixed-for-fixed criteria under U.S. GAAP. As such, for Company X’s accounting for the warrant, IFRS would result in liability classification whereas US GAAP would result in equity classification.

However, there is a recent exception to the “fixed for fixed” criteria in IAS 32 for rights issues. Under this exception, rights issues are classified as equity if they are issued for a fixed amount of cash regardless of the currency in which the exercise price is denominated, provided they are offered on a pro rata basis to all owners of the same class of equity.

US GAAP Equity derivatives need to be indexed to the issuer’s own shares to be classified as equity. The assessment follows a two step approach under ASC 815-40-15.

Step 1 considers whether there are any contingent exercise provisions and, if so, they cannot be based on an observable market or index other than those referenced to the issuer’s own shares or operations

Step 2 considers the settlement amount. Only settlement amounts equal to the difference between the fair value of a fixed number of the entity’s equity shares and a fixed monetary amount or a fixed amount of a debt instrument issued by the entity, will qualify for equity classification.

If the instrument’s strike price (or the number of shares used to calculate the settlement amount) is not fixed as outlined above, the instrument may still meet the equity classification criteria when the variables that might effect settlement include inputs to the fair value of a “fixed for fixed” forward or option on equity shares and the instrument does not contain a leverage factor.

In case of rights issues, if the strike price is denominated in a currency other than the issuer’s functional currency, it shall not be considered as indexed to the entity’s own stock as the issuer is exposed to changes in foreign currency exchange rates. Therefore, rights issues of this nature would be classified as liabilities at fair value through profit or loss.

JP GAAP Warrants are classified as equity because it is not appropriate to be classified as liabilities because entities do not have obligations to redeem those warrants. There is no specific guidance for derivatives on an issuer’s own shares other than warrants since such derivatives are not common in the Japanese market.



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Derivates on own shares-settlement models

IFRS Contracts that are net settled (net cash or net shares) are classified as liabilities or assets. This is also the case even if the settlement method is at the issuer’s discretion.

Gross physical settlement is required to achieve equity classification.

Unlike US GAAP, under IFRS a derivative contract that gives one party (either the holder or the issuer) a choice over how it is settled (net in cash, net in shares or by gross delivery) is a derivative asset/liability unless all of the settlement alternatives would result in its being an equity instrument.

US GAAP Derivative contracts that are in the scope of ASC 815-40 and that:

(1) require physical settlement or net share settlement; and

(2) give the issuer a choice of net cash settlement or settlement in its own shares

are considered equity instruments, provided they meet the criteria set forth within the literature.

Analysis of a contract’s terms is necessary to determine whether the contract meets the qualifying criteria, some of which can be difficult to meet in practice.

Similar to IFRS, derivative contracts that require net cash settlement are assets or liabilities.

Contracts that give the counterparty a choice of net cash settlement or settlement in shares (physical or net settlement) result in derivative classification.

JP GAAP There is no specific guidance for derivatives on own shares since such derivatives are not common in the Japanese market.

Written put option on the issuer’s own shares

IFRS If the contract itself meets the definition of an equity instrument (because it requires the entity to purchase a fixed amount of its own shares for a fixed amount of cash), any premium received or paid must be recorded in equity. Therefore, the premium received on such a written put is classified as equity, which is contrary to US GAAP where the fair value of the written put is recorded as a financial liability.

In addition, when an entity has an obligation to purchase its own shares for cash (under a written put), the issuer records a financial liability for the discounted value of the amount of cash that the entity may be required to pay. The financial liability is recorded against equity.

US GAAP A financial instrument—other than an outstanding share—that at inception (1) embodies an obligation to repurchase the issuer’s equity shares or is indexed to such an obligation and (2) requires or may require the issuer to settle the obligation by transferring assets shall be classified as a liability (or an asset in some circumstances). Examples include forward purchase contracts or written put options on the issuer’s equity shares that are to be physically settled or net cash settled.

ASC 480 requires written put options be measured at fair value, with changes in fair value recognised in current earnings.

JP GAAP There is no specific guidance for derivatives on an issuer’s own shares since such derivatives are not common in the Japanese market.

Initial measurement of a liability with related party

IFRS When an instrument is issued to a related party, the financial liability initially should be recorded at fair value, which may not be the value of the consideration received.

The difference between fair value and the consideration received (i.e., any additional amount lent or borrowed) is accounted for as a current-period expense, income, or as a capital transaction based on its substance.

US GAAP When an instrument is issued to a related party at off-market terms, one should consider which model the instrument falls within the scope of as well as the facts and circumstances of the transaction (i.e., the existence of unstated rights and privileges) in determining how the transaction should be recorded. There is, however, no requirement to initially record the transaction at fair value.

The ASC 850 presumption that related party transactions are not at arm’s length and the associated disclosure requirements should also be considered.

JP GAAP Initial measurement of liabilities between related parties is accounted for under the general measurement guidance because there is no specific guidance.


Effective-interest-rate calculation

IFRS The effective interest rate used for calculating amortization under the effective interest method discounts estimated cash flows through the expected—not the contractual—life of the instrument.

Generally, if the entity revises its estimate after initial recognition, the carrying amount of the financial liability should be revised to reflect actual and revised estimated cash flows at the original effective interest rate, with a cumulative-catch-up adjustment being recorded in profit and loss. Revisions of the estimated life or of the estimated future cash flows may exist, for example, in connection with debt instruments that contain a put or call option that does not need to be bifurcated or whose coupon payments vary. Payments may vary because of an embedded feature that does not meet the definition of a derivative because its underlying is a nonfinancial variable specific to a party to the contract (e.g., cash flows that are linked to earnings before interest, taxes, depreciation and amortization; sales volume; or the earnings of one party to the contract).

Generally, floating rate instruments (e.g., LIBOR plus spread) issued at par is not subject to the cumulative catch-up approach; rather, the effective interest rate is revised as market rates change.

US GAAP The effective interest rate used for calculating amortization under the effective interest method generally discounts contractual cash flows through the contractual life of the instrument. However, expected life may be used in some circumstances.

JP GAAP Financial liabilities are initially measured at cost. However, issuance of a debt at discount and similar transactions are calculated using the effective interest rate method, which is similar to IFRS.

Modification or exchange of debt instruments and convertible debt instruments

IFRS A substantial modification of the terms of an existing financial liability or part of the financial liability should be accounted for as an extinguishment of the original financial liability and the recognition of a new financial liability. In this regard, the terms are substantially different if the discounted present value of the cash flows under the new terms is at least 10 percent different from the discounted present value of the remaining cash flows of the original financial liability. If this test is met, the exchange is considered as an extinguishment.

It is clear that if the discounted cash flows change by at least 10 percent, the original debt should be accounted for as extinguishment, It is not clear, however, in IAS 39 whether the quantitative analysis is an example or is the definition of substantially different. Accordingly, there is an accounting policy choice where entities can either perform:

(1) an additional qualitative analysis of any modification of terms when the change in discounted cash flows is less than 10 percent or

(2) only the 10 percent test (quantitative test) as discussed above.

For debt instruments with embedded derivative features, the modification of the host contract and the embedded derivative should be assessed together when applying the 10 percent test as the host debt and the embedded derivative are interdependent. However, a conversion option that is accounted for as an equity component would not be considered in the 10 percent test. In such cases, an entity may also consider whether there is a partial extinguishment of the liability through the issuance of equity before applying the 10 percent test.

A liability is also considered extinguished if there is a substantial modification in the terms of the instrument – for example, where the discounted present value of new cash flows differs from the remaining cash flows of the original financial liability by at least 10%

US GAAP An exchange or modification of debt instruments with substantially different terms is accounted for as a debt extinguishment. In order to determine whether the debt is substantively different, a quantitative assessment must be performed.

If the present value of the cash flows under the new terms of the new debt instrument differs by at least 10 percent from the present value of the remaining cash flows under the original debt, the exchange is considered an extinguishment. The discount rate for determining the present value is the effective rate on the old debt.

If the debt modifications involve changes in non-cash embedded features, the following test comprising of a two-step approach is required:

Step 1: If the change in cash flows as described above is greater than 10 percent of the carrying value of the original debt instrument, the exchange or modification should be accounted for as an extinguishment. This test would not include any changes in fair value of the embedded conversion option.

Step 2: If the test in Step 1 is not met, the following should be assessed:

• Whether the modification or exchange affects the terms of an embedded conversion option, where the difference between the fair value of the option before and after the modification or exchange is at least 10 percent of the carrying value of the original debt instrument prior to the modification or exchange.

• Whether a substantive conversion option is added or a conversion option that was substantive at the date of modification is eliminated.



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If either of these criteria is met, the exchange or modification would be accounted for as an extinguishment.

JP GAAP There is no guidance which states that a financial liability is considered extinguished if there is a substantial modification in the terms and conditions of the financial instrument.

Transaction costs (also known as debt issue cost)

IFRS When the financial liability is not carried at fair value through profit or loss, transaction costs are deducted from the carrying value of the financial liability and are not recorded as separate assets. Rather, they are accounted for as a debt discount and amortized using the effective interest rate method,

Transaction costs are expensed immediately when the financial liability is carried at fair value, with changes recognised in profit and loss.

US GAAP When the financial liability is not carried at fair value through income, transaction costs are deferred as an asset.

Transaction costs are expensed immediately, when the financial liability is carried at fair value, with changes recognised in profit and loss.

JP GAAP In principle, debt issue costs are expensed when incurred. However, it is also permitted to recognise the debt issue costs as a deferred asset which is amortized over the debt maturity period using the effective interest method.

Derecognition of financial liabilities

IFRS A financial liability is derecognised when: the obligation specified in the contract is discharged, cancelled or expires; or the primary responsibility for the liability is legally transferred to another party.

The difference between the carrying amount of a liability (or a portion thereof) extinguished or transferred and the amount paid for it should be recognised in net profit or loss for the period.

US GAAP Similar to IFRS, a financial liability is derecognised only if it has been extinguished. Extinguishment means paying the creditor and being relieved of the obligation or being legally released from the liability either judicially or by the creditor.

JP GAAP Similar to IFRS. A financial liability must be derecognised when the contractual obligation for the financial liability is discharged, extinguished or when the primary debtor has been released from its position as a primary debtor.

Financial liabilities designated as at fair value through profit or loss (Fair Value Option)

IFRS [IAS 39] The amount of change in the fair value is recognised in profit or loss.

[IFRS 9] The amount of change in the fair value of the financial liability that is attributable to changes in the credit risk of that liability is recognised in other comprehensive income and the remaining amount of change in the fair value of the liability is recognised in profit or loss unless the recognition of the changes in the liability’s credit risk in OCI would create or enlarge an accounting mismatch in profit or loss. On the other hand, if the treatment would create or enlarge an accounting mismatch in profit or loss, an entity shall present all gains or losses on that liability in profit or loss.

US GAAP Similar to IAS39.

JP GAAP The concept of the fair value options has not introduced.


Joint FASB/IASB Financial Instruments with Characteristics of Equity Project

The project on financial instruments with characteristics of equity is facing challenges in developing an improved classification model. Substantial concerns had been raised by constituents on the draft proposals in May 2010. Since that time, the boards have evaluated a range of alternatives. Given the concerns raised with the existing proposals and the significant effort necessary to deliberate the issues, the boards agreed to postpone the project until July 2011.

REFERENCES: IFRS: IAS 32, IAS 39, IFRIC 2US GAAP: ASC 470-20, ASC 470-20-25-12, ASC 480, ASC 480-10-65-1, ASC 815, ASC 815-15-25-4 through 25-5, ASC 815-40, ASC 815-40-25, ASC 825, ASC 850, ASC 860, ASR 268, CON 6JP GAAP: Accounting Standard for Financial Instruments, Practical Guidelines on Accounting Standards for Financial Instruments, Q&A on Financial Instruments Accounting


Equity

Equity

Equity instruments

Recognition and classification

IFRS An instrument is classified as equity when it does not contain an obligation to transfer economic resources. Preference shares that are not redeemable, or that are redeemable solely at the option of the issuer, and for which distributions are at the issuer’s discretion, are classified as equity. Only derivative contracts that result in the delivery of a fixed amount of cash, or other financial asset for a fixed number of an entity’s own equity instruments, equity components of compound instruments, puttable instruments that can now be classified as equity under the amendment to IAS 32 are classified as equity instruments. All other derivatives on the entity’s own equity are accounted for as derivatives.

US GAAP Generally, an instrument qualifies as equity from the issuer’s perspective if it does not meet the criteria for liability classification. However, for SEC registrants, certain redeemable instruments need to be classified as “mezzanine” equity. See “Financial Liabilities and equity” chapter for further discussion.

JP GAAP It follows the legal form under the corporate law. Financial instruments such as preferred shares are classified as equity. Mandatorily redeemable financial instruments are not common in Japan.

Purchase of own shares

IFRS When an entity’s own equity shares or other equity instruments are repurchased, they are shown as a deduction from shareholders’ equity at cost. Any profit or loss on the subsequent sale of the shares or equity instruments is shown as a change in equity.

When an entity has an obligation or a conditional obligation to purchase its own shares for cash (e.g., such as under a forward contract to purchase its own shares or under a written put) and the contract itself meets the definition of an equity instrument (because it requires the entity to purchase a fixed amount of its own shares for a fixed amount of cash), any premium received or paid must be recorded in equity.

US GAAP When treasury stock is acquired with the intention of retiring the stock, an entity has the option to: charge the excess of the cost of treasury stock over its par value entirely to retained earnings; allocate the excess between retained earnings and additional paid-in-capital (APIC); or charge the excess entirely to APIC.

However, a contract to purchase an entity’s own shares is considered a liability and accordingly, any premium received or paid should be amortized to income.

JP GAAP Similar to IFRS. However, there is no guidance for the treatment for any premium received or paid when an entity has an obligation or a conditional obligation to purchase its own shares for cash and the contract itself meets the definition of an equity instrument.

Dividends on ordinary equity shares

IFRS Presented as a deduction in the statement of changes in equity in the period when authorised by shareholders.



Transaction cost for disposal and purchase of own shares

IFRS Transaction costs of an equity transaction shall be accounted for as a deduction from equity, net of any related income tax benefit, to the extent they are incremental costs directly attributable to the eguity transaction that otherwise would have been avoided. The costs of an equity transaction that is abandoned are recognised as an expense.

US GAAP Specific incremental costs directly attributable to a proposed or actual offering of securities may properly be deferred and charged against the gross proceeds of the offering. However, management salaries or other general and administrative expenses may not be allocated as costs of the offering and deferred costs of an aborted offering may not be deferred and charged against proceeds of a subsequent offering. A short postponement (up to 90 days) does not represent an aborted offering.

JP GAAP Stock issue cost shall be expensed as incurred. Where the stock issuance is for financial activities such as funding for business expansion, the stock issue cost may be capitalised as a deferred asset and amortised on straight-line basis over its effective period (maximum 3 years).


Equity

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REFERENCES: IFRS: IAS 32, IAS 39US GAAP: ASC 470-20, ASC 480, CON 6, ASC 340-10-S99-1JP GAAP: Accounting Standard for Financial Instruments, Guidance on Accounting for Other Compound Financial Instruments (Compound Financial Instruments Other than Those with an Option to increase Paid-in Capital), Practical Guidelines on Accounting Standard for Financial Instruments, Q&A on Financial Instruments Accounting, Guidance on Accounting Standards for Treasury Shares and Reversal of Legal Reserve, Practical Issue Task Force No. 19 “Practical Solution on Accounting for Deferred Assets”






Refer to “Recent changes – IFRS” section in the Assets – Financial asset chapter for details.


FASB Accounting Standards Update 2010-11: Derivatives and Hedging (Topic 815): Scope Exception Related to Embedded Credit Derivatives

In March 2010, the FASB issued ASU 2010-11 to clarify and amend the accounting for credit derivatives embedded in beneficial interests in securitized financial assets. Currently, certain credit derivative features embedded in beneficial interests in securitized financial assets are not accounted for as derivatives. The new guidance will eliminate the scope exception for embedded credit derivatives (except for those that are created solely by subordination) and provides new guidance on the evaluation to be performed. Bifurcation and separate recognition may be required for certain beneficial interests that are currently not accounted for at fair value through earnings, including some unfunded securitized instruments, synthetic collateralized debt obligations, and other similar securitization structures. This guidance is effective the first day of the first fiscal quarter beginning after June 15, 2010, with early adoption permitted. At adoption, a company may make a one-time election to apply the fair value option on an instrument-by-instrument basis for any beneficial interest in securitized financial assets.

The publication of this ASU eliminates the US GAAP and IFRS difference with respect to the treatment of credit derivatives in synthetic CDOs, as IFRS does not contain a scope exception for credit derivatives embedded in beneficial interests in securitized financial assets. IFRS considers credit derivatives held by an SPE that issues synthetic CDO tranches to be an embedded derivative that is not closely related to the host contract because the issuer (SPE) transfers the credit risk of an asset it does not own. Therefore, the embedded credit derivative held in the issuing SPE is not considered closely related to the host contract.

Derivatives

IFRS, US GAAP and JP GAAP specify requirements for the recognition and measurement of derivatives.

Definition and net settlement provision

IFRS A derivative is a financial instrument:

• whose value changes in response to a specified variable or underlying rate (for example, interest rate);

• that requires no or little net investment; and

• that is settled at a future date.

IFRS does not include a requirement for net settlement within the definition of a derivative.

There is an exception under IAS 39 for derivatives whose fair value cannot be measured reliably (i.e., instruments linked to equity instruments that are not reliably measurable), which could result in not having to account for such instruments at fair value. In practice, however, this exemption is very narrow in scope, because in most situations it is expected that fair value can be measured reliably even for unlisted securities. In addition, this exception is removed in IFRS 9.

Effective January 1, 2010, an option contract between an acquirer and a seller to buy or sell stock of an acquiree at a future date that results in a business combination likely would be considered a derivative under IAS 39 for the acquirer, however, the option may be classified as equity from the seller’s perspective.

US GAAP To meet the definition of a derivative, a financial instrument or other contact must require or permit net settlement.

US GAAP generally excludes from the scope of ASC 815 certain instruments linked to unlisted equity securities when such instruments fail the net settlement requirement and are therefore not accounted for as derivatives.

An option contract between an acquirer and a seller to buy or sell stock of an acquiree at a future date that results in a business combination may not meet the definition of a derivative as it may fail the net settlement requirement (i.e., the acquiree’s shares are not listed so the shares may not be readily convertible to cash).



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JP GAAP Similar to IFRS. However, to meet the definition of a derivative, a financial instrument or other contact must require or permit net settlement, similar to US GAAP.

Own use versus normal purchase normal sale

When a contract related to non-financial items qualifies for the “own use”(IFRS)/“normal purchase normal sale (NPNS)” (US GAAP) exception and meets the requirement of a derivative; such contract may not be accounted for as a derivative.

IFRS [IAS 39] “Own use” are contracts that were entered into and continue to be held for the purpose of the receipt or delivery of a non-financial item in accordance with the entity’s expected purchase, sale or usage requirement.

While US GAAP requires documentation to apply the NPNS exception (i.e. it is elective), IFRS requires such contract to be accounted for as own use (i.e., not accounted for as a derivative) if the own use criteria are satisfied.

[IFRS 9] Similar to IAS 39, because IFRS 9 follows the IAS 39 definition of derivatives.

US GAAP There are many factors to consider in determining whether a contract related to nonfinancial items qualifies for the NPNS exception.

“NPNS” are contracts that provide for the purchase or sale of something other than a financial instrument or derivative instrument that will be delivered in quantities expected to be used or sold by the reporting entity over a reasonable period in the normal course of business. If a contract meets the requirement of the NPNS exception, then the reporting entity must document that it qualifies in order to apply the NPNS exception - otherwise, it will be considered a derivative.

JP GAAP Contracts related to future purchase, future sale or commodity transactions, for which the delivery of the commodity is apparent at inception and where the objective of such transaction is not for trading purposes, are not considered to be derivatives.

Initial measurement

All derivatives are recognised on the statement of financial position as either financial assets or liabilities under IFRS, US GAAP and JP GAAP. They are initially measured at fair value on the day when an entity becomes party to the contractual provisions of the instrument.


IFRS and US GAAP require subsequent measurement of all derivatives at their fair values with changes recognised in profit or loss except for derivatives used in cash flow or net investment hedges. However, under IAS 39, a derivative that is linked to and should be settled by delivery of an unquoted equity instrument whose fair value cannot be reliably measured is carried at cost less impairment until settlement. In addition, this requirement is removed in IFRS 9. JP GAAP requires to defer the change in fair value of hedging instruments in net assets until the profit or loss of hedged item is recognised. However, fair value hedge is also permitted in certain cases.

Embedded derivatives

IFRS [IAS 39] IAS 39 requires separation of derivatives embedded in hybrid contracts when the economic characteristics and risks of the embedded derivatives are not closely related to the economic characteristics and risks of the host contract, a separate instrument with the same terms as the embedded derivative would meet the definition of a derivative, and the hybrid instrument is not measured at fair value through profit or loss. In addition, IAS 39 provides an option to value certain hybrid instruments at fair value instead of bifurcating the embedded derivative.

There are some detailed differences between IFRS and US GAAP for certain types of embedded derivatives on what is meant by ‘closely related’. Under IFRS, after the amendment of IFRIC 9 and IAS 39 in March 2009, on reclassification of a financial asset out of the “at fair value through profit or loss” category, all embedded derivatives should be reassessed and, if necessary, separately accounted for. If an entity is unable to measure the embedded derivative that would have to be separated on reclassification, the financial asset is prohibited from being reclassified and has to remain in the “at fair value through profit or loss” category. This amendment only affects those entities that reclassified financial assets using the October 2008 reclassification amendment. It may mean that some reclassifications will have to be reversed if the embedded derivative that is required to be separated is unable to be measured.

[IFRS 9] For the accounting for embedded derivatives, IFRS 9 sets forth specific requirements only for the case when a host contract is a financial asset. If the host contract is a financial asset, the financial instrument should be treated as one unit and appropriate classification determined based on the business model and cash flow characteristics of the entire hybrid instrument. For financial liabilities and other non-financial contracts, IFRS 9 has retained the principles related to separation of derivatives.


US GAAP Similar to IAS 39. However, no specific requirements regarding to reclassification of financial assets. In addition, under US GAAP, if a hybrid instrument contains an embedded derivative that is not clearly and closely related to the host contract at inception, but is not required to be bifurcated, the embedded derivative is continuously reassessed for bifurcation.

JP GAAP Derivatives embedded in hybrid instruments are bifurcated into financial assets and financial liabilities when the following requirements are met and are fair valued. The resulting valuation differences are accounted for as a profit or loss in the current period. (1) There is a possibility that the risks of the embedded derivatives may impact the actual financial asset or financial liability, (2) a separate derivative with the same terms as the embedded derivative would meet the characteristics of a derivative, (3) the valuation differences of the hybrid instrument due to changes in the fair value will not be recognised in the profit or loss of the current period. However, when the embedded derivative is bifurcated for managerial purposes, despite not meeting the requirement of (1) or (3), bifurcation is permitted.

Reassessment of embedded derivatives

IFRS IFRS precludes reassessment of embedded derivatives after inception of the contract unless there is a change in the terms of the contract that significantly modifies the expected future cash flows that would otherwise be required under the contract.

Having said that, if an entity reclassifies a financial asset out of the held for trading category, embedded derivatives must be assessed and, if necessary, bifurcated.

US GAAP If a hybrid instrument contains an embedded derivative that is not clearly and closely related at inception, and it is not bifurcated (since it does not meet the definition of a derivative), it must be continually reassessed to determine whether bifurcation is required at a later date. Once it meets the definition of a derivative, the embedded derivative is bifurcated and measured at fair value with changes in fair value recognised in earnings.

Similarly, the embedded derivative in a hybrid instrument that is not clearly and closely related at inception and is bifurcated must also be continually reassessed to determine whether it subsequently fails to meet the definition of a derivative. Such embedded derivative should cease to be bifurcated at the point at which it fails to meet the requirements for bifurcation. An embedded derivative that is clearly and closely related is not reassessed subsequent to inception for the “clearly and closely related” feature. However, for non-financial host contracts, the assessment of whether an embedded foreign currency derivative is clearly and closely related to the host contract should only be performed at inception of the contract.

JP GAAP Embedded derivatives are bifurcated when their risk increases and may impact the actual financial asset or financial liability.

Calls and puts in debt instruments

IFRS [IAS 39] Calls, puts or prepayment options embedded in a hybrid instrument are closely related to the debt host instrument if either: a) the exercise price approximates the amortized cost on each exercise date or b) the exercise price of a prepayment option reimburses the lender for an amount up to the approximate present value of the lost interest for the remaining term of the host contract. Once determined to be closely related as outlined above, these items do not require bifurcation.

[IFRS 9] If the host contract is a financial asset, embedded derivatives should not be bifurcated and the financial instrument should be accounted for in its entirety. Existence of certain call and put features do not necessarily result in the hybrid instrument being classified at fair value through profit or loss. If the host contract is a financial liability, calls and puts would need to be assessed for potential separation, unless the entity elects the fair value option for the entire hybrid instrument. IFRS 9 has retained the current tests prescribed under IAS 39 for purposes of evaluating such embedded derivatives.

US GAAP Multiple tests are required in evaluating whether an embedded call or put is clearly and closely related to the debt host. The failure of one or both of the below outlined tests is common and typically results in the need for bifurcation.

Test #1 - If a debt instrument is issued at a substantial premium or discount and a contingent call or put can accelerate prepayment of principal, then the call or put is not clearly and closely related.

Test #2 - If there is no contingent call or put that can accelerate principal or if the debt instrument is not issued at a substantial premium or discount, then it must be assessed whether the debt instrument can be settled in a such a way that the holder would not recover substantially all of its recorded investment or the embedded derivative would at least double the holder’s initial return and the resulting rate would be double the current market rate of return. However, this rule is subject to certain exceptions.

JP GAAP There is no guidance for the evaluation of the relationship between the prepayment option and the host contract. The evaluation of the prepayment option to be closely related to the host contract is judged by whether the risk impacts the host contract or not.



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Non-financial host contracts – currencies commonly used

IFRS IFRS requires bifurcation of an embedded foreign currency derivative from a non-financial host unless the payment is (a) denominated in the local currency or functional currency of a substantial party to the contract, (b) represents the price which is routinely denominated in that foreign currency in international commerce (e.g., US Dollar for crude oil transactions), or (c) denominated in a currency that is commonly used to purchase or sell such items in the economic environment in which the transaction takes place.

For example, Company X, in Russia (functional currency and local currency is Russian ruble) sells timber to another Russian Company with a ruble functional currency in Euros. Since the Euro is a currency commonly used in Russia, bifurcation of an embedded foreign currency derivative from the non-financial host contract would not be required under IFRS.

US GAAP US GAAP requires bifurcation of an embedded foreign currency derivative from a non-financial host unless the payment meets the criteria (a) or (b) cited above for IFRS or the payment is in a foreign currency because a party operates in a hyperinflationary environment.

JP GAAP There is no guidance for currencies commonly used for non-financial host contracts. However, similar accounting treatment to IFRS is applied in practice.

Day one gains and losses

In some circumstances, the transaction price is not equal to fair value, usually when the market in which the transaction occurs differs from the market where the reporting entity could transact. For example, banks can access wholesale and retail markets—the wholesale price may result in a day one gain compared to the transaction price in the retail market.

IFRS Day one gains and losses are recognized only when the fair value is evidenced by comparison with other observable current market transactions in the same instrument or is based on a valuation technique whose variables include only data from observable markets.

US GAAP Entities must recognize day one gains and losses even if some inputs to the measurement model are not observable.

JP GAAP No specific guidance.

Hedge accounting

Detailed guidance is set out in the respective standards under IFRS, US GAAP and JP GAAP dealing with hedge accounting.

Criteria for hedge accounting

Hedge accounting is permitted under IFRS, US GAAP and JP GAAP provided that an entity meets stringent qualifying criteria in relation to documentation and hedge effectiveness. All three frameworks require documentation of the entity’s risk management objectives and how the effectiveness of the hedge will be assessed. Hedge instruments should be highly effective in offsetting the exposure of the hedged item to changes in the fair value or cash flows, and the effectiveness of the hedge is measured reliably on a continuing basis under three frameworks.

A hedging relationship qualifies for hedge accounting under IFRS, US GAAP and JP GAAP if changes in fair values or cash flows of the hedged item are expected to be highly effective in offsetting changes in the fair value or cash flows of the hedging instrument (‘prospective’ test) and ‘actual’ results are within a range of 80% to 125% (‘retrospective’ test). Under JP GAAP, if, at inception, hedge instruments and hedged assets or liabilities are the same, or critical terms related to forecasted transaction are the same, it is permissible to omit effectiveness testing thereafter.

When to assess effectiveness

IFRS IFRS requires that hedges be assessed for effectiveness on an ongoing basis and that effectiveness be measured, at a minimum, at the time an entity prepares its annual or interim financial reports.

Therefore, if an entity is required to produce only annual financial statements, IFRS requires that effectiveness be tested only once a year. An entity may, of course, choose to test effectiveness more frequently.

US GAAP US GAAP requires that hedge effectiveness be assessed whenever financial statements or earnings are reported and at least every three months (regardless of how often financial statements are prepared).

JP GAAP The hedge effectiveness should always be evaluated at each closing date and at least once semiannually.


Hedged items

IFRS, US GAAP and JP GAAP contain additional requirements for the designation of specific financial assets and liabilities as hedged items as shown below. Additional detailed application differences may arise.

Eligibility of held-to-maturity investments as hedged item

IFRS [IAS 39] Held-to-maturity investments cannot be designated as a hedged item with respect to interest-rate risk or prepayment risk.

[IFRS 9] Not applicable because the held-to-maturity category is eliminated in IFRS 9.

US GAAP Similar to IAS 39.

JP GAAP Similar to IAS 39. However, held-to-maturity securities can be designated as a hedged item if the held-to-maturity security is hedged by an interest rate swap from the acquisition date, and the conditions of the interest rate swap and the hedged securities are virtually identical in terms of notional principal, condition of receipt and payment for the interest, and the contractual term.

Designated risks for financial assets or liabilities

IFRS The guidance allows a portion of a specific risk to qualify as a hedged risk (so long as effectiveness can be reliably measured). Designating a portion of a specific risk may reduce the amount of ineffectiveness that needs to be recorded in profit or loss under IFRS.

Under IFRS, portions of risks can be viewed as portions of the cash flows (e.g., excluding the credit spread from a fixed-rate bond in a fair value hedge of interest rate risk) or different types of financial risks, provided the types of risk are separately identifiable and effectiveness can be measured reliably.

US GAAP The guidance does not allow a portion of a specific risk to qualify as a hedged risk in a hedge of financial assets or financial liabilities. US GAAP specifies that the designated risk be in the form of changes in one of the following:

• Overall fair value or cash flows.

• Benchmark interest rates.

• Foreign currency exchange rates.

• Creditworthiness and credit risk.

The interest rate risk that can be hedged is explicitly limited to specified benchmark interest rates.

JP GAAP Similar to IFRS. A portion of the total amounts or holding period of a hedged item can be designated as a hedged item.

Non-financial items

IFRS If the hedged item is a non-financial asset or liability, it may be designated as a hedged item only for foreign currency risk, or in its entirety for all risks because of the difficulty of isolating other risks.


JP GAAP Assets and liabilities which are expected to be impaired due to changes in market price can be designated as a hedged item.

Groups of similar assets and liabilities

IFRS For similar assets or similar liabilities to be aggregated and hedged as a group, the change in fair value attributable to the hedged risk for individual items should be expected to be generally proportionate to the change in fair value for the group.


JP GAAP Similar to IFRS. If a hedged item consists of a number of assets or liabilities, each asset or liability should be exposed to potential losses arising from common market fluctuation and anticipated to respond in the same way to the market fluctuations.



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Firm commitment to acquire a business

IFRS An entity is permitted to hedge foreign exchange risk to a firm commitment to acquire a business in a business combination only for foreign exchange risk.

US GAAP US GAAP specifically prohibits a firm commitment to enter into a business combination or acquire or dispose of a subsidiary, minority interest or equity method investee from qualifying as a hedged item for hedge accounting purposes (even if it is with respect to foreign currency risk).

JP GAAP There is no specific guidance.

Fair value hedge of interest rate risk in a portfolio of dissimilar items

IFRS IFRS allows a fair value hedge of interest rate risk in a portfolio of dissimilar items whereby the hedged portion may be designated as an amount of a currency, rather than as individual assets (or liabilities). Furthermore, an entity is able to incorporate changes in prepayment risk by using a simplified method set out in the guidance, rather than specifically calculating the fair value of the prepayment option on a (prepayable) item by item basis.

In such strategy, the change in fair value of the hedged item is presented in a separate line in the statement of financial position and does not have to be allocated to individual assets or liabilities.

US GAAP US GAAP does not allow a fair value hedge of interest rate risk in a portfolio of dissimilar items.

JP GAAP It is permitted for financial institutions only if they apply a highly established hedging method for reflecting the effectiveness of offsetting risk in the financial statements.

Hedges of a portion of the time period to maturity

IFRS IFRS permits designation of a derivative as hedging only a portion of the time period to maturity of a hedged item if effectiveness can be measured and the other hedge accounting criteria are met. For example, an entity with a 10% fixed bond with remaining maturity of 10 years can acquire a 5-year pay-fixed, receive-floating swap and designate the swap as hedging the fair value exposure of the interest rate payments on the bond until the fifth year and the change in value of the principal payment due at maturity to the extent affected by changes in the yield curve relating to the 5 years of the swap. That is, a 5-year bond is the imputed hedged item in the actual 10-year bond; the interest rate risk hedged is the 5-year interest rate implicit in the 10-year bond.

US GAAP US GAAP does not permit the hedged risk to be defined as a portion of the time period to maturity of a hedged item.

JP GAAP Similar to IFRS, JP GAAP permits the hedged risk to be defined as a portion of the time period to maturity of a hedged item.

Servicing rights

IFRS Under IFRS, servicing rights are considered non-financial items. Accordingly, they can only be hedged for foreign currency risk or hedged in their entirety for all risks (i.e., not only for interest rate risk).

Furthermore, IFRS precludes measurement of servicing rights at fair value through profit or loss because the fair value option is applicable only to financial items and therefore cannot be applied to servicing rights.

US GAAP US GAAP specifically permits servicing rights to be hedged for the benchmark interest rate or for overall changes in fair value in a fair value hedge.

An entity may, however, avoid the need to apply hedge accounting by electing to measure servicing rights at fair value through profit or loss as both the hedging instrument and the hedged item would be measured at fair value through profit or loss.

JP GAAP There is no specific guidance on servicing rights as hedging servicing rights are not common.

Cash flow hedges with purchased options

IFRS Under IFRS, when hedging one-sided risk via a purchased option in a cash flow hedge of a forecasted transaction, only the intrinsic value of the option is deemed to be reflective of the one-sided risk of the hedged item. Therefore, in order to achieve hedge accounting with purchased options, an entity will be required to separate the intrinsic value and time value of the purchased option and designate as the hedging instrument only the changes in the intrinsic value of the option.

As a result, for hedge relationships where the critical terms of the purchased option match the hedged risk, generally, the change in intrinsic value will be deferred in equity while the change in time value will be recorded in profit or loss.


US GAAP US GAAP permits an entity to assess effectiveness based on total changes in the purchased option’s cash flows (that is, the assessment will include the hedging instrument’s entire change in fair value). As a result, the entire change in the option’s fair value (including time value) may be deferred in equity based on the level of effectiveness.

Alternatively, the hedge relationship can exclude time value from the hedging instrument such that effectiveness is assessed based on intrinsic value.

JP GAAP Changes in the market price or cash flows of a hedged item are generally due to the fluctuations in the spot price of underlying instruments, and those changes are construed to correspond to the changes in the fair value of the derivative used as a hedging instrument less the changes in the time value or other related values (i.e., changes in the intrinsic value). As such, the intrinsic value and the time value are basically separated and only the changes of the option’s intrinsic value are designated as a hedging instrument and the changes in the time value or other related values are recorded in profit or loss. However, the time value and other related values are permitted to be designated as a hedged item in the aggregate.

Hedging instruments

Typically, only a derivative instrument can qualify as a hedging instrument in most cases.

Foreign currency risk and the combination of derivatives and nonderivatives

IFRS Under the guidance, for foreign currency risk only, two or more nonderivatives or proportions of them or a combination of derivatives and nonderivatives or proportions of them can be viewed in combination and jointly designated as the hedging instrument.

As an illustrative example, consider a fact pattern in which a US parent’s functional currency is the US dollar. Say the US parent has a net investment in a French subsidiary whose functional currency is the Euro. US parent also has fixed-rate external debt issued in yen and a receive-fixed-yen, pay-floating-Euro currency swap for all principal and interest payments. The combination of the fixed-rate yen debt and a receive-yen, pay-Euro currency swap resembles the economics of floating-rate Euro debt. Under IFRS, the combination of the debt and the swap may be designated as a hedging instrument in a net investment in the French subsidiary.

US GAAP US GAAP prohibits using a combination of a separate derivative and a nonderivative as hedging instrument.

In the illustrative example above, US GAAP would preclude the combination of the derivative and nonderivative to be designated as a single hedging instrument in a hedging relationship.

JP GAAP There is no guidance for the combination of a derivative and a non-derivative to be designated as the hedging instrument.

Foreign currency risk and internal derivatives

IFRS Under IFRS, internal derivatives do not qualify for hedge accounting in the consolidated financial statements (because they are eliminated in consolidation). However, a treasury center’s net position that is laid off to an external party may be designated as a hedge of a gross position in the consolidated financial statements. Careful consideration of the positions to be designated as hedged items may be necessary so as to minimize the effect of this difference. Entities may use internal derivatives as an audit trail or a tracking mechanism to relate external derivatives to the hedged item.

The internal derivatives would qualify as hedging instruments in the separate financial statements of the subsidiaries entering into internal derivatives with a group treasury center.

US GAAP US GAAP permits hedge accounting for foreign currency risk with internal derivatives, provided specified criteria are met and, thus, accommodates the hedging of foreign currency risk on a net basis by a treasury center. The treasury center enters into derivatives contracts with unrelated third parties that would offset, on a net basis for each foreign currency, the foreign exchange risk arising from multiple internal derivative contracts.

JP GAAP For internal derivatives, when a derivative transaction between one company of a group of companies and an external party can individually correspond to an internal derivative transaction, such a transaction may be designated as a hedging instrument on consolidation. However, there is no guidance in JP GAAP referring to a treasury centre of the group.

A written option in a separate contract

IFRS Under the guidance, two or more instruments may be designated as the hedging instrument only if none of them is a written option or a net written option. Assessment of whether a contract is a net written option includes assessment of whether a written option and a purchased option can be combined and viewed as one contract. If the contracts can be combined and do not result in a netwritten option, then the combined contract would be the eligible hedging instrument.



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For a written option and a purchased option to be combined and viewed as one contract, the separate contracts must meet a series of indicators, including that they (1) were entered into contemporaneously and in contemplation of one another, (2) have the same counterparty and (3) relate to the same risk and that there is no apparent economic need or substantive business purpose for structuring the transactions separately that could not also have been accomplished in a single transaction.

US GAAP The guidance does not require contracts to be entered into contemporaneously with the same counterparty in a determination of when separate contracts can be combined and designated as a hedging instrument.

In instances where a net premium is received, US GAAP requires that the quantitative tests in ASC 815 be met in order to qualify as a hedging instrument.

JP GAAP Similar to IFRS in terms of not being available for designating a written option or a net written option as a hedging instrument.

Hedging more than one risk

IFRS IFRS permits designation of a single hedging instrument to hedge more than one risk in two or more hedged items by separating a single swap into two hedging instruments if certain conditions are met.

A single hedging instrument may be designated as a hedge of more than one type of risk if the risks hedged can be identified clearly, the effectiveness of the hedge can be demonstrated and it is possible to ensure that there is specific designation of the hedging instrument and different risk positions. In the application of this guidance, a single swap may be separated by inserting an additional (hypothetical) leg, provided that each portion of the contract is designated as a hedging instrument in a qualifying and effective hedge relationship.

US GAAP US GAAP does not allow a single hedging instrument to hedge more than one risk in two or more hedged items. US GAAP does not permit creation of a hypothetical component in a hedging relationship to demonstrate hedge effectiveness in the hedging of more than one risk with a single hedging instrument.

JP GAAP Interest rate currency swap can be separated into two hedging instruments (interest rate risk and foreign currency risk).

Foreign currency risk and location of hedging instruments

IFRS For foreign currency hedges of forecasted transactions, IFRS does not require the entity with the hedging instrument to have the same functional currency as the entity with the hedged item. At the same time, IFRS does not require that the operating unit exposed to the risk being hedged within the consolidated accounts be a party to the hedging instrument. As such, IFRS allows a parent company with a functional currency different from that of a subsidiary to hedge the subsidiary’s transactional foreign currency exposure. The same flexibility regarding the location of the hedging instrument applies to net investment hedges.

US GAAP Under the guidance, either the operating unit that has the foreign currency exposure is a party to the hedging instrument or another member of the consolidated group that has the same functional currency as that operating unit is a party to the hedging instrument. However, for another member of the consolidated group to enter into the hedging instrument, there may be no intervening subsidiary with a different functional currency.

JP GAAP Hedge accounting can be applied to hedging instruments held for the foreign currency risk in the qualifying forecasted transactions between consolidated entities.

Hedge relationships

Exposure to risk can arise from: changes in the fair value of an existing asset or liability; changes in the future cash flows arising from an existing asset or liability; or changes in future cash flows from a transaction that is not yet recognised.

IFRS Recognises the following types of hedge relationships:

• a fair value hedge where the risk being hedged is a change in the fair value of a recognised asset or liability or an unrecognised firm commitment;

• a cash flow hedge where the risk being hedged is the variability in cash flows forecasted for a future date or period. A forecasted transaction should be highly probable to qualify as a hedged item.; and

• a hedge of a net investment in a foreign entity, where a hedging instrument is used to hedge the foreign currency exposure to changes in the reporting entity’s share in the net assets of that operation.

US GAAP Similar to IFRS. However, there are differences in the detailed application.



Fair value hedges

IFRS Hedging instruments are measured at fair value. The hedged item is adjusted for changes in its fair value but only due to the risks being hedged. Gains and losses on fair value hedges, for both the hedging instrument and the item being hedged, are recognised in profit or loss.


JP GAAP In principle, hedge accounting is applied using the deferral method whereby gains and losses or valuation differences generated from a hedging instrument measured at fair value in net assets are deferred until the gain or loss related to a hedged item is recognised. In addition, fair value hedges similar to those of IFRS and US GAAP are permitted. However, this method is applied for hedging securities available for sale as it is permitted only for hedging an item which is valued at fair value at the balance sheet date.

Cash flow hedges and basis adjustments on acquisition of nonfinancial items

IFRS Under IFRS, basis adjustment commonly refers to an adjustment of the initial carrying value of a nonfinancial asset or nonfinancial liability subject to a cash flow hedge. That is, the initial carrying amount of the hedged item recognised on the statement of financial position (i.e., the basis of the hedged item) is adjusted by the cumulative amount of the hedging instrument’s fair value changes that were recorded in equity.

IFRS gives entities an accounting policy choice to either basis adjust the hedged item (if it is a nonfinancial asset or liability) or release amounts from equity to profit or loss as the hedged item affects earnings.

US GAAP In the context of a cash flow hedge, US GAAP does not permit basis adjustments. That is, under US GAAP, an entity is not permitted to adjust the initial carrying amount of the hedged item by the cumulative amount of the hedging instruments’ fair value changes that were recorded in equity.

US GAAP does refer to basis adjustments in a different context wherein the term is used to refer to the method by which, in a fair value hedge, the hedged item is adjusted for changes in its fair value attributable to the hedged risk.

JP GAAP When the forecasted transactions represent acquisitions of an asset, the resulting gains and losses do not incur immediately, but will incur as the cost of sale or depreciation of the acquired asset. As such, a basis adjustment, which reflects the gains and losses to the cost of the acquired asset, is applied. However, when the acquired assets are interest bearing financial assets such as a loan, they are deferred as hedging gains and losses in net assets and transferred into profit and loss when the interest cash flows are received.

Hedges of net investments in foreign operations

IFRS Similar treatment to cash flow hedges. The hedging instrument is measured at fair value with gains/losses deferred in equity, to the extent that the hedge is effective, together with exchange differences arising on the entity’s investment in the foreign operation. These gains/losses are released from equity to profit or loss on disposal or partial disposal of the foreign operation.

US GAAP Similar to IFRS. Gains and losses are transferred to the income statement upon sale or complete or substantially complete liquidation of the investment.


Effectiveness testing and measurement of hedge ineffectiveness

IFRS IFRS does not specify a single method for assessing hedge effectiveness prospectively or retrospectively. The method an entity adopts depends on the entity’s risk management strategy and is included in the documentation prepared at the inception of the hedge. The most common methods used are the critical-terms comparison, the dollar-offset method and regression analysis.

Short-cut method IFRS does not allow a shortcut method by which an entity may assume no ineffectiveness.

IFRS permits portions of risk to be designated as the hedged risk for financial instruments in a hedging relationship such as selected contractual cash flows or a portion of the fair value of the hedged item, which can improve the effectiveness of a hedging relationship. Nevertheless, entities are still required to test effectiveness and measure the amount of any ineffectiveness.

Critical terms match IFRS does not specifically discuss the methodology of applying a matched-terms approach in the level of detail included within US GAAP.

However, if an entity can prove for hedges in which the principal terms of the hedging instrument and the hedged items are the same that the relationship will always be 100% effective based on an appropriately designed test, a similar qualitative analysis may be sufficient for prospective testing. Even if the principal terms are the same, retrospective effectiveness is still measured in all cases, since IFRS precludes the assumption of perfect effectiveness.



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US GAAP US GAAP does not specify a single method for assessing hedge effectiveness prospectively or retrospectively. The method an entity adopts depends on the entity’s risk management strategy and is included in the documentation prepared at the inception of the hedge.

Short-cut method US GAAP provides for a shortcut method that allows an entity to assume no ineffectiveness (and, hence, bypass an effectiveness test) for

certain fair value or cash flow hedges of interest rate risk using interest rate swaps (when certain stringent criteria are met).

Critical terms match Under US GAAP, for hedges that do not qualify for the shortcut method, if the critical terms of the hedging instrument and the entire

hedged item are the same, the entity can conclude that changes in fair value or cash flows attributable to the risk being hedged are expected to completely offset. An entity is not allowed to assume (1) no ineffectiveness when it exists or (2) that testing can be avoided. Rather, matched terms provide a simplified approach to effectiveness testing in certain situations.

The SEC has clarified that the critical terms have to be perfectly matched to assume no ineffectiveness. Additionally, the critical-term-match method is not available for interest rate hedges.

JP GAAP As a general rule, if the critical terms between a hedging instrument and hedging assets or liabilities or a forecast transaction are the same, the hedging instrument is generally presumed to fully net-settle market fluctuations or cash flow changes at the inception of the hedge and after. In those cases, hedge effectiveness testing can be omitted.

Furthermore, interest rate swaps with conditions virtually identical in terms of notional principal, condition of receipt and payment of the interest and the contractual term of the hedged asset or liability are not required to be fair valued. The net amount of actual receipt and payment is adjusted to the interest of the related hedged assets or liabilities (which is an exceptional treatment for an interest rate swap).

Credit risk and hypothetical derivatives

IFRS Under IFRS, hypothetical derivative perfectly matches the hedged risk of the hedged item. Because the hedged item would not contain the derivative counterparty’s (or an entity’s own) credit risk, the hypothetical derivative would not reflect that credit risk. The actual derivative, however, would reflect credit risk. The resulting mismatch between changes in the fair value of the hypothetical derivative and the hedging instrument would result in ineffectiveness.

The extent of ineffectiveness depends on whether the hedging derivative instrument is in an asset or liability position and the method used for measuring derivative liabilities. This is because counterparty credit risk always affects the valuation of a derivative asset. If the derivative instrument is in a liability position, the ineffectiveness will depend on the method used to measure the liability.

US GAAP Under US GAAP, a hypothetical derivative will reflect an adjustment for the counterparty’s (or an entity’s own) credit risk. This adjustment will be based upon the credit risk in the actual derivative. As such, no ineffectiveness will arise due to credit risk, as the same risk is reflected in both the actual and hypothetical derivative.

If, however, the likelihood that the counterparty will perform ceases to be probable, an entity would be unable to conclude that the hedging relationship in a cash flow hedge is expected to be highly effective in achieving offsetting cash flows. In those instances, the hedging relationship is discontinued.

JP GAAP No specific guidance.


FASB proposed ASU: Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities

The FASB and IASB are jointly reconsidering the accounting for financial instruments, including hedge accounting. Among other things, the boards expect the project to result in simplification of the accounting requirements for hedging activities, resolve hedge accounting practice issues that have arisen under the current guidance, and make the hedge accounting model and associated disclosures more useful and understandable to financial statement users.

In this regard, in May 2010, the FASB issued its exposure draft on financial instruments. Comments are due by September 30, 2010. The FASB proposes to carry forward many of its ideas contained in the 2008 exposure draft on hedge accounting. However, in contrast with the 2008 ED, the FASB proposes to continue with the bifurcation-by-risk approach as contained in Topic 815 for financial instruments classified at fair value with changes in fair value recognized in OCI.

The 2010 exposure draft:


Lowers the threshold to qualify for hedge accounting. The hedging relationship must be “reasonably effective” instead of “highly effective.” A • company would need to demonstrate and document at inception that: (1) an economic relationship exists between the derivative and the hedged item, and (2) the changes in fair value of the hedging instrument would be reasonably effective in offsetting changes in the hedged item’s fair value or variability in cash flows of the hedged transaction. While this assessment would need to be performed only qualitatively, the proposal notes that a quantitative assessment might be necessary in certain situations.

Replaces the current requirement to quantitatively assess hedge effectiveness each quarter with a qualitative assessment at inception and • limited reassessments in subsequent periods. The proposal also would eliminate the shortcut and critical-terms match method. Under the proposal, a subsequent hedge effectiveness assessment would be required only if circumstances suggest that the hedging relationship may no longer be effective. Companies would need to remain alert for circumstances that indicate that their hedging relationships are no longer effective. Under current guidance, it is not unusual for companies to determine that a hedging relationship is highly effective in one period but not highly effective in the next period. In those circumstances, companies are unable to consistently apply hedge accounting from period to period. The board believes that by lowering the effectiveness threshold to reasonably effective, the frequency of these occurrences should diminish.

Prohibits the discretionary de-designation of hedging relationships. The proposed model no longer would allow an entity to discontinue fair • value or cash flow hedge accounting by simply removing the designation. A company would only be able to discontinue hedge accounting by entering into an offsetting derivative instrument or by selling, exercising, or terminating the derivative instrument. As a result, once a company elects to apply hedge accounting, it would be required to keep the hedge relationship in place throughout its term, unless the required criteria for hedge accounting no longer are met (e.g., the hedge is no longer reasonably effective) or the hedging instrument expires, is sold, terminated, or exercised.

Requires recognition of the ineffectiveness associated with both over- and under-hedges for all cash flow hedging relationships (i.e., the • accumulated OCI balance should represent a “perfect” hedge). This represents a significant change since under current US GAAP, only the effect of over-hedging is recorded as ineffectiveness during the term of the hedge.

Requires hybrid instruments (with financial hosts) containing embedded derivatives requiring bifurcation (i.e., do not meet the clearly and • closely related criterion) to be measured at fair value with changes in fair value recognized in net income. Hybrids containing embedded derivatives that do not require bifurcation are eligible for fair value with changes in fair value recognized in other comprehensive income if they meet the business strategy classification criterion.

The FASB’s proposal will simplify certain key aspects of hedge accounting that many companies have found challenging. However, it also will limit or eliminate other aspects of the current model that some companies found beneficial. The proposed hedge accounting has the potential to create significant differences when compared with that proposed by IFRS. Despite the overall difference in approach to the project, the FASB and IASB have been jointly discussing hedge accounting.


ASBJ Discussion Paper on Revision of Accounting Standards for Financial Instruments (Classification and Measurement of Financial Assets)

In August 2010, the ASBJ issued Discussion Paper on Revision of Accounting Standards for Financial Instruments (Classification and Measurement of Financial Assets). The discussion paper is on the project for a comprehensive review of ASBJ Statement No. 10 “Accounting for Financial Instruments” that constitutes a part of the convergence project based on the Tokyo Agreement between the IASB and the ASBJ. The board is proposing to delete net settlement provision for derivatives.

REFERENCES: IFRS: IAS 39, IFRS 7, IFRIC 9, and IFRIC 16US GAAP: ASC 815, ASC 815-20-25-3, ASC 815-15-25-4 through 25-5, ASC 810-20-25-94 through 25-97, ASC 830-30-4-2 through 40-4JP GAAP: Accounting Standard for Financial Instruments, Guidance on Accounting for Other Compound Financial Instruments (Compound Financial Instruments Other than Those with an Option to increase Paid-in Capital), Practical Guidelines on Accounting Standards for Financial Instruments, Q&A on Financial Instruments Accounting



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In June 2010, Accounting Standards Board of Japan amended its accounting standard for earnings per share and related application guidance. The existing differences in the calculation of the earnings per share from that of IFRS are eliminated by the amendments. These amendments are applied for annual periods beginning on or after April 1, 2011. Earlier application is prohibited.

Earnings per share

Earnings per share (EPS) is disclosed by entities whose ordinary shares or potential ordinary shares are publicly traded, and by entities in the process of issuing such securities under the three frameworks. IFRS, US GAAP and JP GAAP use similar methods of calculating EPS, although there are detailed application differences.

Basic EPS

IFRS Basic EPS is calculated as profit available to common shareholders, divided by the weighted average number of outstanding shares during the period. Shares issued as a result of a bonus issue are treated as outstanding for the whole year. Bonus issues occurring after the year-end are also incorporated into the calculation. For rights issues, a theoretical ex-rights formula is used to calculate the bonus element. Comparative EPS is adjusted for bonus issues and rights issues.



Diluted EPS calculation

IFRS The ‘treasury share’ method is used to determine the effect of share options and warrants. The assumed proceeds from the issue of the dilutive options and warrants are regarded as having been received from issuing shares at fair value. The difference between the number of shares to be issued on exercise of options and the number of shares that would have been issued at fair value is treated as an issue of ordinary shares for no consideration (i.e., a bonus issue) and is factored into the denominator used to calculate diluted EPS. The earnings figure is not adjusted for the effect of share options/warrants.

The guidance states that dilutive potential common shares shall be determined independently for each period presented, not a weighted average of the dilutive potential common shares included in each interim computation.

Contracts that can be settled in either common shares or cash at the election of the issuer are always presumed to be settled in common shares and included in diluted EPS; that presumption may not be rebutted.

The potential common shares arising from contingently convertible debt securities would be included in the dilutive EPS computation only if the contingency price was met as of the reporting date.

US GAAP In computing diluted EPS, the treasury stock method is applied to instruments such as options and warrants. This requires that the number of incremental shares applicable under the contract be included in the EPS denominator where a year-to-date weighted average number of incremental shares is computed by using the incremental shares from each quarterly diluted EPS computation.

Certain convertible debt securities give the issuer a choice of either cash or share settlement. These contracts would typically follow the if-converted method, as US GAAP contains the presumption that contracts that may be settled in common shares or in cash at the election of the entity will be settled in common shares. However, that presumption may be overcome if past experience or a stated policy provides a reasonable basis to believe it is probable that the contract will be paid in cash.

Contingently convertible debt securities with a market price trigger (e.g., debt instruments that contain a conversion feature that is triggered upon an entity’s stock price reaching a predetermined price) should always be included in diluted EPS computations if dilutive—regardless of whether the market price trigger has been met. That is, the contingency feature should be ignored.

JP GAAP Similar to IFRS. When the treasury stock method is applied, the entity’s stock price is the average stock price of the period.


Diluted EPS calculation – application of treasury stock method to share-based payments – windfall tax benefits

IFRS Tax benefits for vested options are already recorded in the financial statements because IAS 12, Income taxes, requires the deductible temporary differences to be based on the entity’s share price at the end of the period. As a result, no adjustment to the proceeds is needed under the treasury stock method for EPS purposes.

However, it is not clear whether the amount of tax benefit attributable to unvested stock options (which has not yet been recognized in the financial statements) should be added to the proceeds. As part of the IASB’s deliberations on amending IAS 33 in May 2008, the IASB stated that it did not intend for IAS 33 to exclude those tax benefits and, therefore, this would be clarified when IAS 33 is amended. Either treatment would currently be acceptable.

US GAAP Some ASC 260 requires the amount of windfall tax benefits to be received by an entity upon exercise of stock options to be included in the theoretical proceeds from the exercise for purposes of computing diluted EPS under the treasury stock method. This is calculated as the amount of tax benefits (both current and deferred), if any, that will be credited to additional paid-in-capital.

The treatment is the same as for vested options (i.e., windfall tax benefits included in the theoretical proceeds).

JP GAAP There is no specific guidance regarding windfall tax benefits.


Joint IASB/ FASB Exposure Draft: Simplifying Earnings per share

In August 2008, a joint exposure draft was issued to reduce differences between IFRS and US GAAP. The objective of this exposure draft is to clarify and simplify the computation of EPS and converge requirements of IAS 33 with those of ASC 260. The proposed amendments would improve the comparability of EPS since it will eliminate differences in the denominator of the earnings per share calculation. In April 2009, the IASB considered comments received in relation to the exposure draft. In the light of other priorities, the project was removed from the IASB and FASB’s agenda and is currently inactive.

REFERENCES: IFRS: IAS 33US GAAP: ASC 260JP GAAP: Accounting Standards for Earnings per Share, Guidance on Accounting Standards for Earnings per Share

Foreign currency translation

Functional currency – definition and determination

IFRS Primary and secondary indicators should be considered in the determination of the functional currency of an entity. If the indicators for the determination of the functional currency are mixed and the functional currency is not obvious, management should use its judgment to determine the functional currency that most faithfully represents the economic results of the entity’s operations by focusing on the currency of the economy that determines the pricing of transactions (not the currency in which transactions are denominated).

Additional evidence (secondary in priority) may be provided from the currency in which funds from financing activities are generated, or receipts from operating activities are usually retained, as well as the nature of activities and extent of transactions between the foreign operation and the reporting entity. In the case of a foreign operation e.g., a subsidiary or a branch, it is necessary to assess whether its activities are carried out as an extension of the reporting entity rather than being carried out with a significant degree of autonomy.

US GAAP There is no hierarchy of indicators to determine the functional currency of an entity. In those instances in which the indicators are mixed and the functional currency is not obvious, management’s judgment is required so as to determine the currency that most faithfully portrays the primary economic environment of the entity’s operations.

JP GAAP The functional currency is determined based on the legal entity, i.e., foreign subsidiaries and foreign branches. Foreign subsidiaries use their local currency and foreign branches use headquarters’ currency, as their functional currency. This is on the basis that operations of foreign subsidiaries are deemed to be independent of their parent company whereas operations of foreign branches are deemed to be dependent on their parent company.

Translations – the individual entity

IFRS, US GAAP and JP GAAP have similar requirements regarding the translation of transactions by an individual entity, as follows:

• Translation of transactions denominated in a foreign currency is at the exchange rate in operation on the date of the transaction;

• Monetary assets and liabilities denominated in a foreign currency are re-translated at the closing (year-end) rate;



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• Non-monetary foreign currency assets and liabilities are translated at the appropriate historical rate;

• Non-monetary items denominated in a foreign currency and carried at fair value are reported using the exchange rate that existed when the fair value was determined (IFRS and JP GAAP);

• Amounts in profit or loss are translated using historical rates of exchange at the date of transaction or an average rate as a practical alternative, provided the exchange rate does not fluctuate significantly; and

• Exchange gains and losses arising from an entity’s own foreign currency transactions are reported as part of the profit or loss for the year. This includes foreign currency gains and losses on available-for-sale debt securities (IFRS and JP GAAP) as well as long-term loans, which in substance form part of an entity’s net investment in a foreign operation.

Translation – consolidated financial statements

When translating financial statements into a different presentation currency (for example, for consolidation purposes into the functional currency of the parent), IFRS, US GAAP and JP GAAP require the assets and liabilities to be translated using the closing (year-end) rate. Amounts in profit or loss are translated using the average rate for the accounting period if the exchange rates do not fluctuate significantly. However, under JP GAAP, the exchange rate as of the closing date is also permitted only for the translation of expenses and revenue for foreign subsidiaries. IFRS is silent on the translation of equity accounts; historical rates are used under US GAAP and JP GAAP. The translation differences arising are reported in equity.

Tracking of translation differences in equity

IFRS Translation differences in equity are separately tracked and the cumulative amounts disclosed. The appropriate amount of cumulative translation difference relating to an entity is transferred to profit or loss on disposal of that foreign operation, and included in the gain or loss on sale. For partial disposals where control or significant influence is lost, the entire cumulative translation adjustment (CTA) is recognised in profit or loss. For a partial disposal where control is retained, CTA is allocated to the additional non-controlling interest. For a partial disposal where significant influence is retained, CTA is recycled into profit or loss on a proportionate basis.

US GAAP Similar to IFRS; there may be some differences in the detailed application of the model depending on the type of disposal.

JP GAAP Similar to IFRS. If the percentage of interest held declines due to changes in ownership interest, the portion of the CTA balance in the consolidated balance sheet that corresponds to the declined percentage in ownership interest is realised. The realised amount should be recorded in the consolidated income statement as gains/losses on sales of equity instruments.

Trigger to release amounts recorded in the currency translation account

IFRS The triggers for sale and dilution noted in the US GAAP column apply for IFRS, except when significant influence is lost, the entire CTA balance is released into the income statement.

Also, the sale of a second-tier subsidiary may trigger the release of the CTA associated with that second-tier subsidiary even though ownership in the first-tier subsidiary has not been affected.

US GAAP Some or all of the CTA balance is released into the income statement in the following situations where a parent sells its interest or its interest is diluted via the foreign operation’s share issuance:

• When control of a foreign subsidiary is lost, the entire CTA balance is released.

• Complete liquidation of a foreign operation triggers the full release of the CTA.

• When an interest is sold but significant influence is retained, a proportion of the CTA is released.

• When significant influence is lost, a proportion of the CTA is released into the income statement and the remaining CTA balance affects the cost basis of the investment retained.

Amounts in the CTA generally should not be released into earnings when a first-tier foreign subsidiary sells or liquidates a second-tier subsidiary because the first-tier subsidiary still contains investments in foreign assets. This principle may be overcome in certain cases.

JP GAAP Similar to IFRS. If the percentage of interest held declines due to changes in ownership interest, the portion of the CTA balance in the consolidated balance sheet that corresponds to the declined percentage in ownership interest is realised. The realised amount should be recorded in the consolidated income statement as gains/losses on sales of equity instruments.

Translation of goodwill and fair value adjustments on acquisition of a foreign entity

IFRS Translated at closing rates.




Presentation currency

IFRS Presentation currency is the currency in which the financial statements are presented. An individual entity and a group have a free choice as to its presentation currency (if the presentation currency is not the functional currency, the reason for selecting a different presentation currency must be disclosed.

Assets and liabilities are translated at the closing rate at the date of the statement of financial position when financial statements are presented in a currency other than the functional currency. Items in the statement of comprehensive income are translated at the exchange rate at the date of the transaction or, if the exchange rates do not fluctuate significantly, at average rates. Equity accounts may be translated at either historical or closing rates - such policy choice must be applied consistently.

US GAAP Historical rates are used for equity with the translation of other items being similar to IFRS.

JP GAAP Similar to IFRS. Income statement captions are translated using the average rate during the relevant time period in principle, and translation using the exchange rate as at closing date is also permitted. The rate as at the transaction date is used in the equity caption. The presentation currency is the functional currency of the parent company, i.e., Japanese yen.

REFERENCES: IFRS: IAS 21US GAAP: ASC 830, ASC 830-30JP GAAP: Accounting Standards for Foreign Currency Transactions, Practical Guidelines on Accounting Standards for Foreign Currency Transactions

Interim financial reporting

Recent change – IFRS

In May 2010, the IASB amended IAS 34 as a part of the Annual Improvement to IFRS. With this amendment, selected explanatory notes would be divided to 1) Significant events and transactions and 2) Other disclosures.

An entity shall apply this amendment for annual periods beginning on or after 1 January 2011.

Allocation of costs in interim periods

IFRS Interim financial statements are prepared via the discrete-period approach, wherein the interim period is viewed as a separate and distinct accounting period, rather than as part of an annual cycle.

US GAAP US GAAP views interim periods primarily as integral parts of an annual cycle. As such, it allows entities to allocate among the interim periods certain costs that benefit more than one of those periods.

JP GAAP Similar to IFRS. Discrete-period approach is adopted.

REFERENCES: IFRS: IAS 34US GAAP: ASC 270, ASC 280JP GAAP: Format and Preparation Methods of Interim Financial Statements, Accounting Standards for Preparing Interim Consolidated Financial Statements, Accounting Standard for Quarterly Financial Reporting, Guidance on Accounting for Quarterly Financial Reporting

Discontinued operations

IFRS and US GAAP have requirements for the measurement and disclosures of ‘discontinued’ operations. Under JP GAAP, a discontinued operation is not defined and not reported on the face of the income statement.

Definition of discontinued operations

IFRS A discontinued operation is a component of an entity (operations and cash flows that can be clearly distinguished, operationally and for financial reporting, from the rest of the entity) that has either been disposed of or is classified as held for sale and represents a separate major line of business or geographical area of operations, or is a subsidiary acquired exclusively with a view to resale.The definitions of discontinued operations are different under IFRS compared to US GAAP. Therefore disposal transactions may be accounted for differently. Partial disposals characterized by movement from a controlling to a noncontrolling interest could qualify as discontinued operations.

US GAAP The results of operations of a component of an entity that either has been disposed of or is classified as held for sale are reported as



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discontinued operations if:

• the operations and cash flows have been or will be eliminated from the ongoing operations of the entity; and

• there will be no significant continuing involvement in the operations of the component after the disposal transaction.

A component presented as a discontinued operation under US GAAP may be a reportable segment, operating segment, reporting unit, subsidiary or an asset group.

Generally, partial disposals characterized by movement from a controlling to a noncontrolling interest would not qualify as discontinued operations due to continuing involvement.

Envisaged timescale

IFRS Completed within a year, with limited exceptions.


Starting date for disclosure

IFRS From the date on which a component has been disposed of or, if earlier, classified as held for sale.


Measurement

IFRS Lower of carrying value or fair value less costs to sell.


Presentation

IFRS A single amount is presented on the face of the statement of comprehensive income comprising the post-tax profit or loss of discontinued operations and the post-tax profit or loss recognised in the measurement to fair value less costs to sell or on the disposal of the assets or disposal group(s) constituting the discontinued operation. An analysis of this amount is required either on the face of the statement of comprehensive income or in the notes for both current and prior periods.

US GAAP Similar to IFRS. From measurement date, results of operations of the discontinued component (and gain or loss on disposal) are presented as separate line items in the income statement, net of tax, after income from continuing operations.

Ending date of disclosure

IFRS Until completion of the discontinuance.


Comparatives

IFRS Statement of comprehensive income and cash flow statement re-presented for effects of discontinued operations but not statement of financial position.

US GAAP Similar to IFRS except that separate disclosure of cash flows from discontinued operations is not required. If a company elects to disclose cash flows from discontinued operations separately, it must disclose such cash flows consistently and must do so for any comparative periods presented.


In September 2008, the IASB published an exposure draft on IFRS 5 that proposes a change to the definition of a discontinued operation and additional disclosure about components of an entity that have been disposed of or are classified as held for sale (regardless of whether they meet the discontinued operation definition). The objective of this project is to develop a common definition of discontinued operations and require common disclosures related to disposals of components of an entity between IFRS and US GAAP. The IASB decided to consider the issue on discontinued operations in the annual improvement project and expects to finalise in the second half of 2011.

REFERENCES: IFRS: IFRS 5US GAAP: ASC 205, ASC 205-20, ASC 230, ASC 360-10


Related-party disclosures


In November 2009, the IASB amended IAS 24. This amendment includes the following:

(1) Removes the requirement for government-related entities to disclose details of all transactions with the government and other government-related entities; and

(2) Clarifies and simplifies the definition of a related party.

An entity shall apply this amendment for annual periods beginning on or after 1 January 2011.

Disclosures of related-party transaction

IFRS Related- party transactions are disclosed for each major category of related parties.


JP GAAP Related- party transactions are disclosed not for each major category of related parties but for each related party.

Compensation of key management personnel

IFRS The compensation of key management personnel is disclosed within the financial statements in total and by category of compensation.

US GAAP Disclosure of the compensation of key management personnel is not required within the financial statements.

SEC regulations require key management compensation to be disclosed outside the primary financial statements.

JP GAAP The description for the remuneration of management personnel is not required in the Financial Statements. However, the guidance in the Financial Instruments and Exchange Law requires that the information should be disclosed in the non-financial information section of the annual security report.

REFERENCES: IFRS: IAS 1, IAS 24US GAAP: ASC 850JP GAAP: Regulation on the Terminology, Format and Preparation of Financial Statements, Accounting Standard for Related Party Disclosures, Guidance on Accounting Standard for Related Party Disclosures

Segment reporting


In the annual improvements to IFRS 2009, disclosure of gross assets for each reporting segment had not been required unless it is reported to the CODM.

An entity shall apply this amendment for annual periods beginning on or after 1 January 2010. The difference between IFRS and US GAAP is resolved with this amendment.

Matrix form of organisation (when managers are held responsible for two or more overlapping sets of components)

IFRS Entities that utilize a matrix form of organizational structure are required to determine their operating segments by reference to the core principle (i.e., an entity shall disclose information to enable users of its financial statements to evaluate the nature and financial effects of the business activities in which it engages and the economic environments in which it operates).

US GAAP Entities that utilize a matrix form of organizational structure are required to determine their operating segments on the basis of products or services offered, rather than geography or other metrics.




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Assets of reportable segment

IFRS Required if regularly reported to the chief operating decision-maker.


JP GAAP Required regardless of reporting to the CODM.

REFERENCES: IFRS: IFRS 8US GAAP: ASC 280JP GAAP: Accounting Standard for Disclosures about Segments of an Enterprise and Related information, Guidance on Accounting Standard for Disclosures about Segments of an Enterprise and Related information



In May 2009, the FASB issued a final standard regarding Subsequent Events that establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before the financial statements are issued or are available to be issued. This standard is effective for interim or annual periods ending after June 15, 2009.

Scope of terms for the events and disclosure

IFRS Events after the reporting period are those events, that occur between the end of the reporting period and the date when the financial statements are authorised for issue.

An entity shall disclose the date when the financial statements were authorised for issue and who gave that authorisation. If the entity’s owners or others have the power to amend the financial statements after issue, the entity shall disclose that fact.

US GAAP The scope is events or transactions that occur after the balance sheet date but before financial statements are issued or are available to be issued. Financial statements are considered available to be issued when they are complete in a form and format that complies with GAAP and all approvals necessary for issuance have been obtained.


JP GAAP There is no accounting standard for events after the reporting period. However “Audit Treatment for Subsequent Events” defines subsequent events, which are within the scope of the financial statements audit, as events which occur after the balance sheet date and before the reporting date. This treatment is the guidelines to specify the audit procedures for auditors. Because it includes the definition, scope and treatment of subsequent events, it is also used as a practical guide for accounting. In addition, it sets the rules for the events which occur after the reporting date and before the submission date of the annual security report.


REFERENCES: IFRS: IAS 10US GAAP: ASC 855JP GAAP: Audit Treatment for Subsequent Events

IFRS for small and medium-sized entities

IFRS In July 2009, the IASB issued IFRS for Small and Medium-sized Entities (SMEs), which provides an alternative accounting framework for entities meeting certain eligibility criteria. IFRS for SMEs is a self-contained, comprehensive set of standards specifically designed for entities that do not have public accountability.

One aim of the IFRS for SMEs is to provide a standard for entities in countries that have no national GAAP. IFRS for SMEs will provide an accounting framework in such countries for entities that are not of the size nor have the resources to adopt full IFRS.

The volume of accounting guidance has been reduced by more than 85 per cent compared with the full IFRS. Much of the implementation guidance in full IFRS has been omitted, together with the detailed explanation and requirements relating to the more complex circumstances not usually applicable to SMEs. The IFRS for SMEs does not just reduce disclosure requirements; it also simplifies the recognition and measurement requirements – for example, in connection with financial instruments. When there is a policy choice, the IFRS for SMEs generally adopts the simpler option. IFRS for SMEs is written so that it is complete in itself and contains all the mandatory requirements for SME financial statements.


The term ‘small and medium-sized entities’ has different meanings in different territories. The definition in the context of the IFRS for SMEs is entities that do not have public accountability and publish general purpose financial statements. Every entity has some form of accountability, if only to its owners and the local tax authorities. Public accountability is defined to cover entities with or seeking to have securities traded in a public market or that hold assets in a fiduciary capacity as their main business activity. The definition is therefore based on the nature of an entity rather than on its size.

US GAAP During 2010, a blue ribbon panel was formed to advise the Financial Accounting Foundation (the parent organization of the FASB) on how US GAAP can best meet the needs of US users of private company financial statements. Though the FASB has held the view that there should be only one US GAAP used by both public and private companies, the recommendations of the blue ribbon panel, which is composed of a cross-section of private company financial reporting constituencies, may cause the FASB to reconsider its position.

JP GAAP In April 2010, “Guidance on accounting treatment for Small and Medium-sized entities” was issued. Under this guidance, small and medium sized entities are allowed to account for under simplified methods and limited disclosures are required.



Historical cost or valuation ....................................................... 16

First-time adoption of accounting framework ........................... 16



Presentation items ............................................................. 17

Offsetting assets and liabilities ........................................... 17

Classification (current/non-current distinction-General) ........................ 18

Classification—post-balance sheet refinancing agreements ....................................................................... 18

Classification—refinancing counterparty ........................... 19

Statement of comprehensive income (Income statement)

Format .............................................................................. 19

Exceptional (significant) items and extraordinary items ........................................................... 20

Statement of equity .................................................................. 20

Statement of cash flows (Cash flow statement)

Definition of cash and cash equivalents (Treatment of bank over draft) .......................................... 20

Classification of specific items ............................................ 20

Disclosure of critical accounting policies and significant estimates ................................................................................. 21

Changes in accounting policy and other accounting changes

Changes in accounting policy............................................. 21

Correction of errors ........................................................... 21

Changes in accounting estimates ....................................... 21

Comparatives ........................................................................... 21

Consolidation

Investments in subsidiaries

Preparation of consolidated financial statements ............... 24

Consolidation model and subsidiaries ................................ 25

Special purpose entities ..................................................... 26

Presentation of non-controlling interest ............................. 27

Disclosures ........................................................................ 27

Employee share trusts (including employee share ownership plans)............................ 28

Investments in associates

Definition .......................................................................... 28

Equity method ................................................................... 28

Investments in joint ventures

Definition .......................................................................... 29

Types ................................................................................. 29

Jointly controlled entities .................................................. 29

Contributions to a jointly controlled entity ........................ 30

Jointly controlled operations ............................................. 30

Jointly controlled assets..................................................... 30

Common issues (subsidiaries, associates and joint ventures)

Scope exclusion : for subsidiaries, associates and joint ventures ............................................. 30

Uniform accounting policies .............................................. 31

Reporting periods .............................................................. 31

Impairment ....................................................................... 31


Definition................................................................................. 34

Acquisitions

Date of Acquisitions ........................................................... 34

Identifying the acquirer ..................................................... 35

Consideration transferred .................................................. 35

Share-based consideration................................................. 35

Restructuring provisions .................................................... 35

Contingent consideration .................................................. 35

Transaction costs ............................................................... 36

Recognition and measurement of identifiable assets and liabilities acquired ............................................................. 36

Intangible assets ................................................................ 36

Acquired contingencies ...................................................... 36

Goodwill ........................................................................... 36

Goodwill impairment ........................................................ 37

Bargain purchase (“negative goodwill”)............................. 37

Subsequent adjustments to assets and liabilities (measurement period) ...................................................... 37

Noncontrolling interests (minority interests) ..................... 37

Fair Value .......................................................................... 38

Business combinations involving entities under common control ..................................................................................... 38

Step acquisitions (investor obtaining control through more than one purchase) .................................................................. 39

Employee benefit arrangements, including share-based payments and income tax ......................................................... 39

Revenue recognition

Revenue

Definition .......................................................................... 41

Measurement .................................................................... 41

Revenue recognition .......................................................... 41

Revenue recognition criteria for the sale of goods .............. 42

Specific revenue recognition issues

Contingent consideration .................................................. 42

Sale of goods – continuous transfer .................................... 42

Rendering services ............................................................ 43

Rendering services – right of refund .................................. 43

Multiple-element arrangements

General ............................................................................. 43

Index


Multiple-element arrangements – software revenue recognition ........................................................................ 44

Multiple-element arrangements – customer loyalty programmes ...................................................................... 44

Multiple-element arrangements – contingencies ................ 45

Construction contracts

Scope ................................................................................ 45

Recognition method

Percentage-of-completion method ..................................... 46

Completed contract method .............................................. 46

Combining contracts and segmenting a contract ................ 46

Barter transactions

Non-advertising-barter transactions .................................. 46

Accounting for advertising-barter transactions .................. 47

Accounting for barter-credit transactions ........................... 47

Extended warranties ................................................................ 47

Expense recognition

Expense recognition—share-based payments

Scope ................................................................................ 50

Measurement of awards granted by nonpublic companies ......................................................................... 50

Classification of certain instruments .................................. 50

Awards with conditions other than service, performance, or market conditions .................................... 51

Service-inception date, grant date, and requisite service .......................................................... 51

Attribution—awards with service conditions and graded-vesting features ..................................................... 51

Tax withholding arrangements—impact to classification ...................................................................... 51

Recognition of social charges (e.g., payroll taxes) .............. 52

Valuation—SAB Topic 14 guidance on expected volatility and expected term .............................................. 52

Certain aspects of modification accounting ........................ 52

Employee stock purchase plan (ESPP) ............................... 52

Alternative vesting triggers ................................................ 52

Cash-settled awards with a performance condition ............ 53

Group share-based payment transactions .......................... 53

Derived service period ....................................................... 53

Expense recognition—employee benefits

Determination of pension and other post-retirement obligation .......................................................................... 54

Expense recognition—actuarial gains/losses ..................... 54

Income statement classification ......................................... 54

Expense recognition—prior-service costs and credits ........................................................................ 54

Expected return on plan assets ........................................... 55

Balance sheet recognition .................................................. 55

Substantive commitment to provide pension or other postretirement benefits ...................................................... 55

Defined benefit versus defined contribution plan classification ...................................................................... 55

Curtailments ..................................................................... 56

Settlements ....................................................................... 56

Asset ceiling ...................................................................... 57

Deferred compensation arrangements—employment benefits ............................................................................. 57

Plan asset valuation ........................................................... 57

Discount rates ................................................................... 57

Accounting for termination indemnities ............................ 58

Assets

Historical cost or valuation ....................................................... 60

Intangible assets

Recognition ....................................................................... 60

Recognition – additional criteria for internally generated intangibles ........................................................ 60

Recognition – website development costs .......................... 61

Recognition – advertising costs .......................................... 61

Initial measurement – acquired intangibles........................ 61

Initial measurement – internally generated intangibles ........................................................................ 61

Subsequent measurement – acquired and internally generated intangibles ........................................................ 62

Amortisation – acquired and internally generated intangibles ........................................................................ 62

Impairment – acquired and internally generated intangibles ........................................................................ 62


Recognition ....................................................................... 62

Initial measurement .......................................................... 62

Subsequent expenditure .................................................... 63

Asset retirement obligations .............................................. 63

Depreciation ...................................................................... 64

Subsequent measurement ................................................. 64

Non-current assets held for sale................................................ 65

Leases

Lease classification—general ............................................. 65

Normally leads to a finance lease ....................................... 65

Could lead to a finance lease .............................................. 65

Lease classification—other ................................................ 66

Recognition of the investment in the lease ......................... 66

Operating lease ................................................................. 66

Sale-leaseback arrangements ............................................ 67

Leases involving land and buildings ................................... 67


Recognition and measurement .......................................... 68

Reversal of impairment loss ............................................... 69

Capitalisation of borrowing costs

Recognition ....................................................................... 69


Investment property

Definition .......................................................................... 70

Initial measurement .......................................................... 70

Subsequent measurement ................................................. 70

Inventories

Definition .......................................................................... 71

Measurement .................................................................... 71

Formula for determining cost ............................................ 71

Biological assets ....................................................................... 71

Nonmonetary assets ................................................................. 71

Financial assets

Definition .......................................................................... 72

Recognition and initial measurement ................................ 72

Financial assets at fair value through profit or loss ............. 73

Held-to-maturity financial assets ....................................... 73

Loans and receivables ........................................................ 74

Available-for-sale financial assets ....................................... 74

Available-for-sale financial assets: fair value versus cost of unlisted equity instruments (securities) .................. 74

Available-for-sale debt financial assets: foreign exchange gains/losses on debt instruments ....................... 75

Effective interest rates: expected versus contractual cash flows .......................................................................... 75

Effective interest rates: changes in expectations ................. 75

Fair value option for equity-method investments ............... 76

Fair value measurement: bid-ask spreads ........................... 76

Reclassification.................................................................. 76

Impairment ....................................................................... 77

Impairment principles: available-for-sale debt instruments (securities) .................................................... 77

Impairment principles: held-to-maturity debt instruments ....................................................................... 78

Impairment of available-for-sale equity instruments .......... 78

Losses on available-for-sale instruments subsequent to initial impairment recognition ........................................... 79

Impairments: measurement and reversal of losses ............. 79

Derecognition.................................................................... 79

Liabilities

Provisions

Recognition ....................................................................... 85

Measurement .................................................................... 85

Discounting ....................................................................... 85

Restructuring provisions .................................................... 86

Onerous contracts ............................................................. 86

Contingencies

Reimbursements and contingent asset ............................... 87

Contingent liability ............................................................ 87

Income taxes

Exemptions from accounting for temporary differences ........................................................................ 89

Tax rates applied to current and deferred taxes .................. 89

Recognition of deferred tax assets ..................................... 89

Current/non-current ......................................................... 89

Unrealised intragroup profits ............................................. 89

Intraperiod tax allocation .................................................. 90

Deferred taxes on investments in subsidiaries, joint ventures and equity investees – treatment of undistributed profit ........................................................... 90

Uncertain tax positions ...................................................... 90

Share-based payments ....................................................... 91

Government grants .................................................................. 91


Classification ..................................................................... 92

Finance leases ................................................................... 92

Operating leases ................................................................ 92

Sale and leaseback transactions ......................................... 92


Definition .......................................................................... 94

Classification of non-derivative contracts ........................... 95

Contingent settlement provisions ...................................... 95

Compound instruments that are not convertible instruments (that do not contain equity conversion features)............................................................................ 96

Convertible Instruments (compound instruments that contain equity conversion features) ................................... 96

Puttable shares / Shares redeemable upon liquidation ....... 96

Derivates on own shares-“fixed for fixed” versus indexed to issuer’s own share .......................................................... 97

Derivates on own shares-settlement models ....................... 98

Written put option on the issuer’s own shares .................... 98

Initial measurement of a liability with related party ........... 98

Effective-interest-rate calculation ...................................... 99

Modification or exchange of debt instruments and convertible debt instruments ............................................. 99

Transaction costs (also known as debt issue cost) ............ 100

Derecognition of financial liabilities................................. 100

Financial liabilities designated as at fair value through profit or loss (Fair Value Option) ...................................... 100

Equity

Equity instruments

Recognition and classification ......................................... 101

Purchase of own shares.................................................... 101

Dividends on ordinary equity shares ................................ 101

Transaction cost for disposal and purchase of own shares ...................................................................... 101



Derivatives

Definition and net settlement provision ........................... 103

Own use versus normal purchase normal sale .................. 104

Initial measurement ........................................................ 104

Subsequent measurement ............................................... 104

Embedded derivatives ..................................................... 104

Reassessment of embedded derivatives ........................... 105

Calls and puts in debt instruments ................................... 105

Non-financial host contracts – currencies commonly used ............................................................... 106

Day one gains and losses .................................................. 106

Hedge accounting

Criteria for hedge accounting .......................................... 106

When to assess effectiveness ............................................ 106

Hedged items .................................................................. 107

Eligibility of held-to-maturity investments as hedged item .................................................................... 107

Designated risks for financial assets or liabilities .............. 107

Non-financial items ......................................................... 107

Groups of similar assets and liabilities ............................. 107

Firm commitment to acquire a business ........................... 108

Fair value hedge of interest rate risk in a portfolio of dissimilar items ............................................................... 108

Hedges of a portion of the time period to maturity ........... 108

Servicing rights ............................................................... 108

Cash flow hedges with purchased options ........................ 108

Hedging instruments ....................................................... 109

Foreign currency risk and the combination of derivatives and nonderivatives ........................................ 109

Foreign currency risk and internal derivatives ................. 109

A written option in a separate contract ............................ 109

Hedging more than one risk .............................................110

Foreign currency risk and location of hedging instruments ......................................................................110

Hedge relationships ..........................................................110

Fair value hedges ..............................................................111

Cash flow hedges and basis adjustments on acquisition of nonfinancial items ......................................111

Hedges of net investments in foreign operations ...............111

Effectiveness testing and measurement of hedge ineffectiveness ..................................................................111

Credit risk and hypothetical derivatives ........................... 112


Earnings per share

Basic EPS ..........................................................................114

Diluted EPS calculation ....................................................114

Diluted EPS calculation – application of treasury stock method to share-based payments – windfall tax benefits ...................................................................... 115

Foreign currency translation

Functional currency – definition and determination......... 115

Translations – the individual entity .................................. 115

Translation – consolidated financial statements ................116

Tracking of translation differences in equity .....................116

Trigger to release amounts recorded in the currency translation account ...........................................................116

Translation of goodwill and fair value adjustments on acquisition of a foreign entity ...........................................116

Presentation currency .......................................................117

Interim financial reporting

Allocation of costs in interim periods ................................117

Discontinued operations

Definition of discontinued operations ...............................117

Envisaged timescale ........................................................ 118

Starting date for disclosure .............................................. 118

Measurement .................................................................. 118

Presentation .................................................................... 118

Ending date of disclosure ................................................. 118

Comparatives .................................................................. 118

Related-party disclosures

Disclosures of related-party transaction ............................119

Compensation of key management personnel ...................119

Segment reporting

Matrix form of organisation (when managers are held responsible for two or more overlapping sets of components) ....................................................................119

Assets of reportable segment ........................................... 120


Scope of terms for the events and disclosure .................... 120

IFRS for small and medium-sized entities ............................... 120

PwC Japan Accounting Consulting Services

In addition to audit related services, PwC Japan provides advice to clients wishing to transition to IFRS as well as advisory services on the implementation of new or amended Japanese accounting standards as they converge with IFRS. IFRS technical team has been established within Accounting Consulting Services group to technically support high quality IFRS services to our clients leveraging the PwC network.

● For more information on IFRS, please visit website below:　 www.pwc.com/jp/ifrs

● Contact: 　 Email : [email protected]

©2010 PricewaterhouseCoopers Aarata. All rights reserved. In this document, “PwC” refers to PricewaterhouseCoopers Aarata, which is a member firm of PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity.

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