Financial Reporting Standards: Comparative Issues
Introduction
This paper describes about the International Accounting Standards Board (IASB) and
International Financial Reporting Standards (IFRS). It discusses the differences and similarities
in ownership and control of various business enterprises partly shaping financial reporting, and
how they are setup in the light of the United States and Japan, both which adhere to their
standards and the directional roadmaps to finally converge towards international standards. This
will be observed by analyzing the financial statements and annual reports of Walmart and Sony
selected from these two nations respectively, whereupon their accounting practices will be
highlighted according to the countries’ practices.
ISAB and IFRS
The International Accounting Standards Board (IASB), the independent standard-setting body of
the International Accounting Standards Committee Foundation. This has been employed by a
previous predecessor, the International Accounting Standards Committee (IASC), formed in
London and stipulations agreed by many countries. Such a process hopes to unify one standard
for first world economies (IASB, 2008). IASB reports similar references for the IFRS, it has
systems and regulations that are geared towards the financial industry and standards.
Ownership issues
The three forms of financial statements are i)balance sheet; 2)income statement; and 3)statement
of equity. For large corporations, a balance sheet refers to the statement of financial position or
condition and reports on a company's assets, liabilities and net equity as of a given point in time.
A balance sheet consists of three segments. One of them is asset, which includes fixed (longterm) and current (short-term) assets. Liquid assets include cash at hand or bank, prepaid
expenses, inventory and stocks. Fixed assets include property, equipment and machinery that are
not easily converted into liquid cash. A liability requires a debtor to make a payment, or
payments, to a creditor in circumstances specified in a contract between them (IMF, 2003). For
reporting purposes, registered corporations and the shareholders’ equity consists of capital stock
and retained earnings, however this differs for sole proprietor as only owner’s equity is included.
For partnership, it is similar except that there is a capital account for each partner. In a sole
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proprietor, the owner’s capital balance consists of the investments in the business, plus
cumulative net income since the beginning of the business, less any amounts withdrawn by the
owner. Thus, all the amounts in the various shareholders’ equity accounts for a corporation are in
the owner’s capital account in a single investor. In a partnership, each partner has a capital
account balance of that partner’s investment in the business, plus that partner’s cumulative share
of net income (Hermanson, Edwards and Maher, 1991).
Reh (2007) acknowledges an income statement as a standard financial document that
summarizes a company's revenue and expenses for a specific period of time. Corporations are
expected to indicate the revenue earnings made through selling a host of products and services.
The formula of cost of goods sold is,
“Cost of Goods Sold (COGS) = Beginning Merchandise Inventory + Net
Purchases of Merchandise - Ending Merchandise Inventory”
(source: Investorwords, 2007)
The result of this should deduct other COGS expenses related to the process of producing, selling
and distribution, which results in gross margin. Since it is to be expected that operating salaries,
expenses, depreciation, bad debts etc. will be tremendous during the first year, the net profit is a
negative sum (in brackets-loss) after accounting for taxes and interests. It is also known as the
‘bottom line’ since it is literally at the bottom and underlines the firm’s financial operating health.
Any profits can be paid off to the shareholders and increase their equity, known as earnings per
share (not given below). Sole proprietor reports his or her own financial condition that disclose
intangible assets and their live span, the maturities for receivable and debt, methods used to
compute income taxes on gains and losses and determine current values of assets. Keller (1992,
p.9) affirms that, “partnerships pay no income taxes in some instances, although it must file
annual tax returns. For most part of the reporting, personal expenses should not be reported as
business expense and should be paid for with partnership funds debited into partner’s drawing
accounts. The income statement should close out, moving the net profit or loss to the partners’
capital accounts accordingly.”
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Owner’s equity statement is an account of owner’s rights to the organization’s total assets. As the
investment increases, the rights to the assets increase. According to Doye & Haefner (n.d.), it is a
residual value of assets which the owner has claim to after satisfying other claims on the assets
(liabilities). Corporation reports its shareholder equity statements with a stock par value account,
for which the par value multiplies the par value per share by the number of shares issued.
Retained earnings account is required to track the business profits, and dividends paid account
for tracking amounts given to shareholders. However, for partnerships, accounts of partner’s
contributed capital, partner’s drawings, and distributed income are required. This allows tracking
when a partner withdraws to the draws account. When there are profits, it goes to the share
account (Nelson, 2008). He elaborates further that a single account each for contributed capital,
retained earnings and draws is required for reporting purposes in sole proprietor ownership.
US-Japan business and financial reporting systems
In the US, a single person can be a sole proprietor without needing to file documents for form
entity. American Incorporators Limited (2008) implies that the single owner is also the manager
and maintenance documents are not necessary for filing. Its report lists liability as unlimited and
the owner personally liable for all debts, but personal property can be attached by creditors to
settle business debts. The owner is taxed on business profits reported on personal income tax
return form 1040 Schedule "C". There are no corporate taxes. Partnership companies must file
certificate of limited partnership and maintain agreement, and all partners are liable for all debts.
As well, all partners are taxed on share of partnership income using the income tax return form
1065. As for US corporation, all articles of incorporation must be filed that include the
incorporation of board of directors and there is a need to maintain minutes of meetings. There is
unlimited liability limited to investors’ investment. US Corporations are taxed on profits and
shareholders have to pay taxes on dividends using return form 1120.
In certain respects, Japanese definition of sole proprietorships is essentially also a one person
partnership who has the sole right to manage, and is entitled to the profits and has unlimited
liability to creditors of the business. An article of Japanlaw (n.d.) states that partnerships take on
a different name under commercial partnership and all partners are jointly and severally liable.
The partners’ liability is unlimited, and creditors can go after each partner’s personal assets. The
article further elaborates that the Japanese law divides legal relations of the partnership into two
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categories: internal relations and external relations. Creditors of Japanese corporations can never
directly go after a shareholder individually. The business year of the Company shall commence
on January 1 and end on the following December 31, and accounts shall be settled as of the end
of the business year. It is not required for shareholders to pay tax on dividends.
Public companies in US and Japan have different structure of ownership and control that follow
different sets of financial and accounting reporting systems and standards. A look at the US
financial regulatory fragmented system is one of rules-based cum liberty, which is contradictory
and unpredictable. Much of the topic will revolve around the chapters as mentioned above.
According to Deloitte (2008), a report of financial and accounting standards by the US Financial
Accounting Standards Board (FASB) require specific presentation of certain line items that are
subject to Securities and Exchange Commission (SEC) rules and regulations, although for the
Accounting Standards Board of Japan (ASBJ), there are no known bodies that subject such
scrutiny, but are required to divide the balance sheet into sections on assets, liabilities, and net
assets, and the section on net assets is divided into owners’ equity and items other than owners’
equity (ASBJ, 2005).
In the US, land and building elements are generally accounted for as a single unit, unless land
represents more than 25% of the total fair value of the leased property. ASBJ accounts for in
accordance with a method that applies to ordinary selling and buying transactions as a general
rule, which is far less collective in nature. US inventories are permitted to measure at net
realizable value even if above cost, and where LIFO method is used. Since prices generally rise
over time because of inflation, the LIFO method records the sale of the most expensive inventory
first and thereby decreases profit and reduces taxes (Pricewaterhousecooper, 2008). However,
would this mean that the prices of the older items should be slashed against inflation as well, and
how would this be calculated? The Japanese use the FIFO at costs which indicate little
interference of global forces. The US construction contracts work on completed contract method
rather than in percentages of stage. However, this would result in difficulty with emergent and
breakdown costs of which the Japanese have avoided and attain both system of percentage and
completion contract.
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Brookes (1995: 59) explains that the FASB created “newly accepted accounting principles for
business combinations which, among other things, required that assets and liabilities of
purchased businesses be adjusted from their existing carrying values to current fair values. This
change was accompanied by an equally desirable requirement that any goodwill arising on a
business acquisition be amortized over a reasonable period of time, rather than allowing it to sit
indefinitely at original cost on the balance sheet. These changes, however, were undone by
allowing a reasonable amortization period of up to 40 years. The amortized period in Japan is up
to 20 years and allows lesser depreciation of the goodwill. Testing for impairment loss is
performed on a unit that is large enough to include both a group of assets that are associated with
the operation to which the goodwill is attributed (METI, 2004).
Deloitte continues to report that most costs are written off for research and development as less
significant in the US and deferred in Japan in some instances. Generally, the FASB and ASBJ
use the equity method for joint ventures (except in construction and oil and gas industries). This
requires further examination in the definition of joint ventures and overseas partnerships where
projects are not based on share allocation. As for segment reporting, components for which
information is reported internally to top management, which may or may not be based on lines of
business or geographical areas. This concludes a cultural feature of internal collusion and
nepotism, which results in the creation of Special Purpose Entities (SPEs) and mismanagement
of top companies in US. For Japan, both lines are considered and SPEs are deemed not to be
subsidiaries of the corporation (METI, 2004). The Tables A. and B. will provide a summary of
the reporting standards of both countries.
Table.A
Topic
US
Financial presentation
Certain standards require specific presentation of certain line items regulated
by SEC.
Leasing-financial lease
Land and building elements are generally accounted for as a single unit.
Inventories
At cost, and allow LIFO.
Construction contract
Can use completion contract method.
Goodwill
Can amortize up to 40 years till 2001. Must test for impairment from 2001.
Capitalization
Capitalisation is mandatory Generally only includes interest.
Extra ordinary items
Allowed.
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Deferred Tax
First reduce goodwill to zero, then any other non-current intangible assets to
zero. Any excess credited to net profit or loss.
Research and
All costs are written off.
development
Plants and Equipment
Revaluation above cost is not allowed. Generally the discounted present
value of expected proceeds on future disposal. Residual value may only
be adjusted downwards.
Joint Venture
Generally use the equity method (except in construction and oil and
gas industries).
Segmental Reporting
Components for which information is reported internally to top management,
which may or may not be based on lines of business or geographical areas.
Balance Sheet
More detailed requirements that may result in more share based
Classification
arrangements being classified as liabilities.
Consolidation of
For voting interests, entities generally look to majority voting rights. For
income
variable interest entities, look to a risks and rewards model.
Table.B
Topic
Japan
Financial presentation
Income statement
- Statement of retained earnings; Statement of cash flow
Leasing-financial lease
Accounted for in accordance with a method that applies to ordinary selling
and buying transactions as a general rule.
- Finance lease transactions without title transfer can be treated in accordance
with a method that applies to ordinary lease transactions.
* There are exceptions relating to finance lease transactions without title
transfer.
Inventories
At cost and allow FIFO
Construction contract
Either the percentage-of-completion or the completed-contract method is
selected for long-term construction contracts.
Goodwill
Amortised up to 20 years.
When there is an indication of impairment, testing for impairment loss is
performed on a unit that is large enough to include both a group of assets that
are associated with the operation.
Capitalization
Allowed for self-constructed fixed assets, and expenditures for real estate
development projects.
Extra ordinary items
Wide definition
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Deferred Tax
First reduce goodwill to zero, then any other non-current intangible assets to
zero. Any excess credited to net profit or loss. Allow liabilities and full
allocation methods.
Research and
However, cost expanded especially for the adoption of new technology or a
Development
new management organization, resource development, or development of a
new market can be recognized as deferred assets
Joint Venture
Generally use the equity method.
Presented in three segments, consisting of (i) operating activities, (ii)
investing activities, and (iii) financing activities.
Segmental Reporting
(By line of business)
Consideration is given to similarities of product types and characters,
manufacturing methods, sales markets, etc.
(By geographical location)
Consideration is given to geographical proximity, similarities of economic
activities, interrelationship of business activities, etc.
Balance Sheet
Presented in either the current or non-current sections, based on the
Classification
classification of the relevant assets and liabilities. Part of the deferred tax
assets relating to losses carried forward that are projected to be cleared in the
following period are presented as current assets.
Consolidation of
Outstanding balances of receivables and payables, and amounts of
income
transactions among consolidated corporations are eliminated.
Cash Flow
Indirect/direct
Walmart and Sony
Being the selected public companies that report to shareholders and the public, they are expected
to comply with the given set of regulation and standards within their countries. Financial
presentation is adequate. Lease is determined by whether a store lease is a capital or operating
lease which no further details about the land is mentioned. There are no construction clauses in
Walmart. Goodwill and indefinite-lived other acquired intangible assets are not amortized, which
does not reflect compliance, but they are evaluated for impairment annually. Capitalization
requirements are followed as interest costs capitalized on construction projects were reported as
$150 million, $182 million and $157 million in fiscal 2008, 2007 and 2006, respectively.
Goodwill and
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indefinite-lived other acquired intangible assets are not amortized; rather they are evaluated for
impairment annually. A venture/acquire was announced in February 2007 where Walmart
purchased 35% interest in BCL under the Trust-Mart banner. Segment reporting was primarily
based on the operations of the company which the chief operating decision maker regularly
reviews and analyze performances among business units of the company. Significant
intercompany transactions have been eliminated in income consolidation which signifies
compliance. See Fig.1 & 2 for financial documents.
(http://walmartstores.com/sites/AnnualReport/2008/financial_reporting.html)
The Japanese financial reports are reported in English. Presentation of consolidated incomes,
balance sheets, cash flows are in place. Goodwill was calculated in the sheets with a general
amortization statement with no specifics.Capital expenditure was recorded for research in
electronic semiconductors. Segments are reported by line of products such as electronics, games,
pictures, and not geographical.`For acquisition and ventures, Sony has reported using the equity
method for its 63 affliates such as Sony Ericsson. Consolidated income of other sites were
recorded but only for year 2008, and were not eliminated. The deferred tax assets related to
losses were indeed carried forward and presented as current assets in the balance sheet, although
goodwill and other non-current intangible assets were not reduced to zero.
(http://www.sony.net/SonyInfo/IR/financial/fr/07q4_sony.pdf)
Roadmaps
The roadmap of convergence to international standards differs for the 2 countries. In the US,
short term projects are focused on developing frameworks that touch on borrowing costs; joint
ventures with regards to removing proportionate consolidation and clarifying definition; fair
value option for financial instruments and investment properties. Longer term projects emphasize
business combinations, fair value measurement guidance, financial presentation, post-retirement
benefits, revenue recognition, liabilities and equity, financial instruments, consolidations and
special purpose entities. In Japan, Keidanren (2008) implies that the following issues must be
addressed that is more collective oriented; Training and education in Japan related to financial
reporting; Full-scale participation in the financial developing process, which includes
participating in the IASB discussion; Enhance the role of the Japanese accounting standards
board starting with translation.
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Conclusion
Generally, both have tried adopting IAS standards but improvements could be made. The US
FASB remains an organization vulnerable to factors, namely: the influences of political lobbyists
censor accounting requirements; the strong US/UK/EU influence on IAS; the misapplication of
principles of IAS. Specifically, Japan must construct a system that enables all relevant parties to
cooperate and continuously forward information to other nations in a communicable manner. As
many reports and papers on Japanese accounting standards and practices as possible should be
translated into English. It is also essential to promote international exchanges between people
and eradicate idiosyncratic and hidden practices where possible.
REFERENCES
Accounting Standards Board of Japan 2005, “ASBJ issues accounting standard for presentation
of net assets in the balance sheet and its implementation guidance”, ASBJ, viewed at December
5th 2008. http://www.asb.or.jp/html_e/technical_topics_reports/balance_sheet/bs_e.pdf
American Incorporators Limited 2008, “Most common forms of business”, American
Incorporators
Limited,
viewed
at
December
5th
2008.
http://www.ailcorp.com/comparisonchart.htm
Brooks, T 1995, “The goodwill game”, Ca Magazine. March, pp. 59-61, viewed at December 5th
2008. http://www.camagazine.com/multimedia/CAmagazine/Library/EN/1995/Mar//ss1.pdf
Deloitte 2008, “IFRSs and US GAAP-A pocket comparison” Deloitte- IAS Plus guide, viewed at
December 5th 2008. http://www.iasplus.com/dttpubs/0703ifrsusgaap.pdf
Doye, DG & Haefner, H n.d., "Owner equity section”, Oklahoma Cooperative Extension Service
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Hermanson, H, Edwards, JD & Maher, M 1991, Accounting Principles. Freeload Press, Inc
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IMF 2003, “External debt satistics: Guide for compilers and users – Appendix 3, Glossary”,
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APPENDICES
(Fig.1- Walmart Financial Reports)
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(Fig.2- Walmart Financial Reports)
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(Fig.3- Sony Financial Reports)
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(Fig.4- Sony Financial Reports)
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