Accounting for Business Combinations in Japan Is there any other Possibility but the Purchase Method?*

Transcription

1 25 Accounting for Business Combinations in Japan Is there any other Possibility but the Purchase Method?* J unji FUJIKI Taro YOSHINO Key words: Business Combinations Pooling Method Acquisitions Purchase Method Fresh-Start Method Mergers of Equals Contents I Introduction II Examinations of Business Combination Cases in Japan ill Comparison of Accounting Standards between Japanese Standard, SF AS 141 and IFRS 3 N Pros and Cons for Using any other Methods but Purchase in Japan V Conclusion I Introduction In October 2003, the Business Accounting Deliberation Council (BADC) issued its standard, Opinion on Setting Accounting Standards for the Business Combinations. 1 ) Currently, Japanese Accounting Standards are developed by the Accounting Standards Board of Japan (ASBJ) established in the private sector. 2 ) However, Japanese accounting standard for business * This paper is based on our presentation, "Accounting for Business Combinations in Japan: Is There Any Other Possibility but the Purchase Method?", at the 16th Asian-Pacific Conference on International Accounting Issues (Seoul, Korea, November 8, 2004). 1) This standard becomes effective for financial statements covering periods beginning on or after 1 April ) In July 2001, the Financial Accounting Standards Foundation (F ASF) was established by 10 private sector organizations - namely, Japan Federation Economic Organizations, the Japanese Institute of Certified Public Accountants, Tokyo Stock Exchanges, Japan Securities Dealers Association, Japanese Bankers Association, the Life Association of Japan, the Marine & Fire Association of Japan, the Japan Chamber of Commerce & Industry, the Security Analysts Association of Japan and Corporation Finance Research Institute, Japan. The F ASF is a supervisory foundation and the ASBJ is a core organization within the F ASF. The ASBJ is directly responsible for the development of Japanese accounting standards and until April 2004 it issued two accounting standards - namely, Accounting Standards for Treasury Stock and Reduction of Legal Reserves and Accounting Standards for Earnings per Share.

2 26 Vol. 44 No.4 combinations was developed by BADC which is an advisory body to the Prime Minister and the Commissioner of Financial Services Agency (F AS), because the accounting issues of business combinations had been deliberated before the establishment of the ASBJ. The BADC had deliberated the issues since September 2000 and in July 2001 published "Issues Paper on Accounting for Business Combinations", which summarized the points of issues related to accounting for business combinations. After revisited issues raised by the Issues Paper for approximately 3 years, the BADC issued the accounting standard for business combinations. Meanwhile, the Financial Accounting Standards Board (FASB) in June 2001 issued Statement of Financial Accounting Standards No. 141, Business Combinations. Additionally, the International Accounting Standards Board (IASB) in March 2004 issued International Financial Reporting Standards 3 (IFRS 3), Business Combinations. However, if we compare them in detail, we can find that there are some differences between Japanese standard and F ASB and IASB standards. One of the significant differences is the method of accounting for business combinations. Japanese standard requires that if business combination does not meets specific criteria for applying the pooling-of-interest method, the purchase method should be applied to that combination. In other words, this standard requires that mergers of equals should be accounted for by using any other methods but purchase. On the other hand, F ASB and IASB standards require the purchase method for all business combinations that these standards deal with. Using any other methods but purchase is prohibited under these standards. The purposes of this paper are (1) to examine the business combination cases in Japan, and (2) to provide a comparison between Japanese standard, F ASB standard and IASB standard, and (3) to indicate any other possibility not only the purchase method in Japan. II Examinations of Business Combination Cases in Japan In recent years, a lot of corporations in various business circles have been reorganized m Japan. According to Annual Report on Economic and Fiscal, statistical data from Cabinet Office, Government of Japan, business combinations among were less than 1,000 in each year. However, business combinations among were more than 2,000 in each year. It suggests that reorganization of corporations in various business circles has been accelerated in Japan. We can point out several factors as the reasons of this acceleration- namely, depression, economic globalization, deregulations, amendment of the Antimonopoly Act and amendment of Commercial Code. Table 1 shows main examples of business combination cases in recent years. Table 1 shows many business combinations of bank corporations, insurance corporations and securities corporations in Japan. In particular, non-life insurance corporations have furiously regrouped, because keen competition between each corporation of non-life insurance was caused by the amendment of insurance law and foreign exchange law. Moreover, foreign corporations which entered into non-life insurance market in Japan competed with Japanese corporations. For example, AIG group started its business in Japan and created new business styles such as direct sales for customers. Table 2 shows some combined corporations in the business circle of non-life msurance. All corporation listed in Table 2 could select the accounting method which they liked, because

3 March 2005 Accounting for Business Combinations in Japan 27 TABLE 1 Examples of Business Combination Cases in Recent Years Date Business Circle Combining Corporation 01-Apr-01 Construction Kyowa Exeo Syowa T ekunos Kyowa Exeo Corporation Name of Combined Corporation 01-Apr-01 Securities E-wing Securities Nihon on line Securities Kabu. com Securities 01-Apr Apr-01 The Dai Tokyo Fire and Marine Nippon Fire and Marine Chiyoda Fire and Marine Koa Fire and Marine Aioi Nipponkoa 01-Apr-01 Pulp & Paper Nihon Paper Dai-Syowa Paper Nippon Unipac Holding 01-Apr-01 Dowa Fire and Marine Nissay 01-Apr-01 Bank Sumitomo Mitsui Bank Sakura Bank 02-Apr-01 Bank Mitsubishi Tokyo Bank Mitsubishi Trust Bank Nippon Trust Bank Nissay Dowa General Sumitomo Mitsui Banking Corporation Mitsubishi Tokyo Financial Group Toukai Bank 02-Apr-01 Bank Sanwa Bank Toyo Trust Bank UFJ Holdings 30-Jun-01 Securities Monex Securities Saizon Securities Monex 01-0ct-01 Mitsui Fire and Marine 01-0ct-01 Bank Mitsubishi Trust Bank 21-Dec-01 Household Appliance Tostem Sumitomo Fire and Marine Nippon Trust Bank Tokyo Trust Bank 15-Jan-02 Bank Sanwa Bank Toukai Bank UFJ Bank 29-Mar-02 Sales Deodeo Eiden Edion 01-Apr-02 Nipponkoa 01-Jun-02 Securities Tsubasa Securities 01-Jul-02 Yasuda Fire and Marine In ax Taiyo Fire and Marine UFJ Capital Market Securities Nissan Fire and Marine Mitsui Sumitomo The Mitsubishi Trust and Banking Corporation Tostem lnax Holding Corporation Nipponkoa UFJ Tsubasa Securities Sompo Japan 27-Sep-02 Steel NKK Kawasaki Steel JFE Holdings 01-0ct-02 GE Edison Life Saizon Life GE Edison Life 01-0ct-02 Construction P. S. Corporation Mitsubishi Construction P. S. Mitsubishi Construction 02-0ct-02 Aviation Japan Air System Japan Air Lines Japan Airlines System 31-Jan-03 Oil Arabia oil Fuji oil AOC Holdings 10-Mar-03 Food & Bar Dais yo Eitaro Daisyo 17-Mar-03 Bank Mitsui Sumitomo Bank W akashio Bank Sumitomo Mitsui Banking Corporation 01-Apr-03 Construction Mitsui Construction Sumitomo Construction Sumitomo Mitsui Construction 01-Apr-03 TV Games Square Enix Square Enix

4 28 Vol. 44 No.4 TABLE 2 Combined Corporations of Non-Life. Combined Corporation Combining Corporations Accounting Method Relative Rate of the Voting Rights. Aioi The Dai Tokyo Fire and Marine Chiyoda Fire and Marine Pooling 54:46 Nipponkoa Nippon Fire and Marine Koa Fire and Marine Pooling 67: 33 Nissay Dowa General Dowa Fire and Marine Nissay Pooling 94: 6 Mitsui Sumitomo Mitsui Fire and Marine Sumitomo Fire and Marine Pooling 49: 51 Nipponkoa Nipponkoa Taiyo Fire and Marine Purchase 99: 1 Sompo Japan Yasuda Fire and Marine Nichido Fire and Marine Purchase 91: 9 TABLE 3 Constitution of Directors in Aioi, Nipponkoa and Mitsui Sumitomo Aioi Nipponkoa Mitsui Sumitomo The Dai Tokyo Chiyoda Fire and Nippon Fire and Koa Fire and Mitsui Fire and Sumitomo Fire Fire and Marine Marine Marine Marine Marine and Marine President Chairman President & Chairman & Chairman & President & Co, C.E.O. Co, C.E.O. Co, C.E.O. Co, C.E.O. there was no definite accounting standards for business combinations when these corporations combined. As Table 2 shows, some corporations selected the non-accepted accounting methods under the standard, Opinion on Setting Accounting Standards for the Business Combinations. However, other corporations selected the accepted accounting methods under the standard. As examples, the relative rate of the voting right between Mitsui Fire and Marine and Sumitomo Fire and Marine are roughly equal and combined corporation, Mitsui Sumitomo, selected the pooling method. Besides, Table 3 shows the constitution of directors in Aioi, Nipponkoa and Mitsui Sumitomo. As Table 3 shows, 8 directors of Aioi came from Dai Tokyo Fire and Marine and the same number of directors came from Chiyoda Fire and Marine. Moreover, the number of directors from each pre-merged corporation in Nipponkoa and Mitsui Sumitomo was same. And the number of CEO was also same in these corporations. In other word, there were two top of manager in one corporation. Furthermore, the constitution of posts of executives from Mitsui Fire and Marine and from Sumitomo Fire and Marine was equal in Mitsui Sumitomo. Table 4 shows the constitution of posts of executives in Mitsui Sumitomo.

5 March 2005 Accounting for Business Combinations in Japan 29 TABLE 4 Constitution of Posts of Executives in Mitsui Sumitomo. Chief Executive Senior Executive Vice president Officer Vice President Officer Sum From Mitsui Fire and Marine From Sumitomo Fire and Marine TABLE 5 Financial Information of Mitsui Fire and Marine and Sumitomo Fire and Marine before their Merger (Unit: mill Yen) (31-Mar-2001) Mitsui Fire and Marine Sumitomo Fire and Marine Earnings 989, ,079 Gross Profit 13,046 14,097 Total Asset 3,888,289 3,683,712 Liabilities 3,113,348 2,994,133 Owner's Equity 777, ,298 Additionally, Table 5 shows financial information of Mitsui Fire and Marine and Sumitomo Fire and Marine in March As Table 5 shows, the scales of sales, total asset and owner's equity of Mitsui Fire and Marine and Sumitomo Fire and Marine were almost same. Above-mentioned Table 3, Table 4 and Table 5 show positive facts that there are some cases which indicate the existence of mergers of equals in Japan. acquiring corporation in the case of Mitsui Sumitomo. Particularly, we could not identify the III Comparison of Accounting Standards between Japanese Standard, SFAS 141 and IFRS 3 As stated before, Japanese standard reqmres that if business combination does not meets specific criteria for applying the pooling method, the purchase method should be applied to that combination. Japanese Standard is based on a belief that it is appropriate to require the purchase method and the pooling method in accounting for business combinations, because both acquisitions and unitings of interests are actually existent as business combinations. 3 ) Under Japanese Standard, unless business combination meets the following criteria, the combination should be accounted for by applying the purchase method. 4 ) (a) The all of consideration tendered for the combination is voting stock. 3) Business Accounting Deliberation Council (BADC), Opinion on Setting Accounting Standards for the Business Combinations, BADC, 2003, Chapter 3 : Summary and Concepts. 4) BADC, Opinion on Setting Accounting Standards for the Business Combinations, op. cit., Chapter 3 : Summary and Concepts.

6 (b) (c) 30 Vol. 44 No.4 The relative percentage of voting rights to the combined entity which the shareholders of each combining entities retain as a whole is equal. Excepting the voting rights, none of the facts which indicate the relationship of control between combining entities exists. Above-mentioned criteria should be applied to business combinations on a step-by-step basis. In other words, the entity should examine whether business combination meets the criterion (a) in the first place. If the combination does not meet criterion (a), it should be accounted for by applying the purchase method in this stage. needed to prevent an arbitrary abuse of the pooling method. The BADC believes that this step-by-step basis is Meanwhile, SFAS 141 and IFRS 3 require the purchase method for all business combinations that these standards deal with. According to SFAS 141, the FASB concluded that all two-party business combinations but joint venture formations are acquisitions and that most business combinations involving three or more entities are acquisitions. 5 ) The FASB also concluded that identifying the acquiring entity is practicable in all cases, although doing so may be difficult in some instances. 6 ) Besides, the IASB concluded that the purchase method is the only appropriate method of accounting for business combinations in which one entity obtains control of one or more other entities or operations. 7 ) The IASB also noted that true mergers, assuming they exist, are likely to be relatively rare and that it does not follow that the pooling of interests method is appropriate method of accounting for true mergers. 8 ) As reasons for rejecting the pooling method, both the F ASB and the IASB argued that true mergers or mergers of equals are nonexistent or so rare. 9 ) Furthermore, they believe that if true mergers were to be accounted for using any other methods but purchase, a better method would be the fresh-start method. 10 ) They concluded that the pooling method does not provide superior information to that provided by the purchase method in any circumstance, because the pooling method fails to record the investment in the combination and fails to hold management accountable for that investment and its subsequent performance. 11 ) They believe that the pooling method is an exception to the general concept that exchange transactions are accounted for in terms of the fair value of the items exchanged. 12 ) decided not to adopt it at this time. fresh-start method might be applied to some combinations. 13 ) With respect to the fresh-start method, they However, they intend to consider in the future whether the 5) Financial Accounting Standards Board (F ASB), Statement of Financial Accounting Standards No. 141, Business Combinations, F ASB, 2001, paragraphs B31 and B32. 6) Ibid., paragraph B34. 7) Ibid., paragraph B24. 8) Ibid., paragraph B28. 9) Ibid., paragraph B42., and International Accounting Standards Board (IASB), International Financial Reporting Standards 3, Business Combinations, IASB, 2004, paragraph BC48. 10) Ibid. 11) F ASB, Statement of Financial Accounting Standards No. 141, op. sit., paragraph B57., and IASB, International Financial Reporting Standards 3, op. sit., paragraph BC53. 12) Ibid. 13) F ASB, Statement of Financial Accounting Standards No. 141, op. sit., paragraphs B81-85., and IASB, International Financial Reporting Standards 3, op. sit., paragraph BC43.

7 March 2005 Accounting for Business Combinations in Japan 31 IV Pros and Cons for Using any other Methods but Purchase in Japan When each combining entity regards itself as being equal to another combining entity and none of the facts to indicate the relationship of control to identify the acquiring entity exists, we should consider how to account for such business combinations. In order to consider how to account for such business combinations- namely, mergers of equals, this paper discusses the pros and cons for using any other methods but purchase. If substantially similar business combinations were accounted for by using different methods, the comparability of financial statements would be impaired. Therefore, substantially similar transactions should be accounted for by using a single method. The disadvantage of having alternative methods is that it may lead up to applying of accounting method to achieve a desired accounting results and it would result in an impairment of the comparability of financial statements. However, applying a single accounting method to substantially different business combinations also impairs the comparability of financial statements, because the users of financial statements can not compare the different substances between business combinations. As mentioned above, business combination where one of the combining entities did not obtain control over another entity actually existed in Japan. In the case of Mitsui Sumitomo, each combining entity regarded itself as being equal to another entity. In this case, it is very difficult to apply the purchase method, because we can not identify the acquiring corporation. Using any other methods but purchase for mergers of equals is an advantage for the users of financial statements, because the nature of business combination is reflected in financial statements. It is needed to improve the comparability of financial statements. It also accompanies the risk of causing abuse of accounting method to achieve desired accounting results. However, appropriate criteria which distinguish mergers of equals from acquisitions would prevent such abuse. Therefore, the criteria should be developed in order to improve the comparability of financial statements. Furthermore, the responsibility for preparing financial statements originally belongs the entity which prepare its financial statements. Sincerity of the entity is indispensable to the preparation of financial statements. V Conclusion The purposes of this paper are (1) to examine the business combination cases in Japan, and (2) to provide a comparison between Japanese standard, F ASB standard and IASB standard, and (3) to indicate any other possibility not only the purchase method in Japan. In the first place, this paper examines the business combination cases in Japan. Particularly, this paper focuses on the combination case of Mitsui Sumitomo. In this case, we can not identify the acquiring corporation. On the other hand, we can indicate the positive facts that the combination was a merger on equal terms. This paper also provides a comparison between Japanese standard, FASB standard and IASB standard for business combinations. Japanese Standard is based on a belief that it is appropriate to require the purchase method and the pooling method in accounting for business combinations,

8 32 Vol. 44 No.4 because both acquisitions and unitings of interests are actually existent as business combinations. Japanese standard requires that if business combination does not meets specific criteria for applying the pooling method, the purchase method should be applied to that combination. Meanwhile, the F ASB and the IASB argued that true mergers or mergers of equal are nonexistent or so rare and they require the purchase method for all business combinations that their standards deal with. Additionally, they also believe that if true mergers were to be accounted for using any other method but purchase, a better method would be the fresh-start method. Furthermore, this paper indicates any other possibility not only purchase method in Japan. In particular, this paper weighs up the pros and cons for using any other methods but purchase. When each combining entity regards itself as being equal to another entity and none of the facts to indicate the relationship of control to identify the acquiring entity exists, we should consider how to account for such business combinations. Using any other methods but purchase for such business combination improves the comparability of financial statements, because the nature of business combination is reflected m financial statements. If substantially similar business combinations were accounted for by using different methods, the comparability of financial statements would be impaired. However, applying a single accounting method to substantially different business combinations also impairs the comparability of financial statements. As this paper points out, business combination where one of the combining entities did not obtain control over another entity actually existed in Japan. In the case of Mitsui Sumitomo, applying the purchase method which views one of the combining entities as the acquiring entity can not improve the comparability of financial statements. In order to prepare financial statements which represent the economic substance of business combinations in Japan, we should consider the possibility of using any other methods, including the fresh-start method, but purchase for business combinations. REFERENCES Accounting Principles Board (APB), APB Opinion No. 16, Business Combinations, AICPA, Barry ]. Epstein, and Abbas Ali Mirza, Wiley las 2003 Interpretation and Application of International Accounting Standards, John Wiley & Sons, Business Accounting Deliberation Council (BADC), Issues Paper on Accounting for Business Combinations, BADC, , Opinion on Setting Accounting Standards for the Business Combinations, BADC, Cabinet office, Government of Japan, Annual Report ~n Economic and Fiscal, Cabinet Office, Government of Japan, Financial Accounting Standards Board (F ASB), Statement of Financial Accounting Standards No. 141, Business Combinations, FASB, International Accounting Standards Board (IASB), International Financial Reporting Standards 3, Business Combinations, IASB, International Accounting Standards Committee (IASC), International Accounting Standard las 22, Business Combinations, IASC, Patrick R. Delaney, Ralph Nach, Barry ]. Epstein, and Susan Weiss Budak, Wiley GAAP 2003 Interpretation and Application of Generally Accepted Accounting Principles, John Wiley & Sons, 2002.

9 March 2005 Accounting for Business Combinations in Japan 33 Richard G. Schroeder, Myrtle W. Clark, and Jack M. Cathey, Financial Accounting Theory and Analysis: Text Readings and Cases: John Wiley & Sons, (Received December 22, 2004)