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Japan to Revise Merger Accounting Rules

Nagano Yuriko | April 15, 2008

Japan is planning a major overhaul of its accounting rules, starting with how to account for mergers and acquisitions. The move is part of a broader effort to stay in step with the United States and Europe as they converge accounting rules worldwide.

An exposure draft of the merger accounting reforms is slated to be introduced in June by the Accounting Standards Board of Japan. It will be one of some short-term convergence projects, tackling issues such as eliminating the pooling-of-interests method of accounting for mergers. A wider overhaul of less-pressing accounting issues will follow, which the ASBJ hopes to complete by 2011.

The short-term convergence projects are to be finished by the end of December, based on an agreement the ASBJ and the International Accounting Standards Board reached last August. The two boards agreed to accelerate the convergence of Japanese Generally Accepted Accounting Principles and International Financial Reporting Standards, a process that has been in the works since 2005. The short-term changes were first proposed in 2005 by the Committee of European Securities Regulators to bridge major differences between Japan and the European Union (which has been using IFRS since that time).

The merger accounting reforms are currently in the form of six discussion points. Most notably is the plan to abolish the pooling-of-interests method—a rule that had been widely accepted and employed in developed nations until recent years, when both IFRS and U.S. Generally Accepted Accounting Principles abolished it.

The other five discussion points are:

  • using the acquisition date in the purchase method of accounting, instead of the current practice of using the date of the merger agreement;

  • handling negative goodwill as profit on the date of acquisition. Negative goodwill is being regularly depreciated in Japan under current standards;

  • eliminating the choice to measure only part of the fair value of affiliate companies for non-controlling interest;

  • using the final acquisition date to re-evaluate and calculate the profit and loss of step acquisitions;

  • calculating goodwill based on foreign currency by using the exchange rate on the day the acquisition closes, rather than the current practice of the day the acquisition is approved.



Nomura

The ASBJ posted the discussion points in December and asked for public comment back in February. “The most apparent and symbolic change will be abolishing the pooling-of-interests method,” says Kazuhide Kobori of the ASBJ, who is the technical staff in charge of business combination projects. “The feedback we received from various entities was of general support for the arguments we made.”

The ASBJ has consulted with the Japanese business community along the way, to smooth the road for the accounting reforms. Yoshihiro Nomura, a senior strategist at Financial & Economic Research Center of Nomura Securities Co. in Tokyo, says that of all the changes proposed, “I think the pooling-of-interests method being abolished and negative goodwill profits being recorded in one lump can be called relatively ‘epoch-making’ revisions.”

Unlike the United States—where M&A crazes regularly sweep the landscape every few years—Japan has rarely seen mergers as a popular business strategy, Nomura says. Rather, he contends, mergers were generally used as rescue measures or in cases where corporations needed to reorganize themselves. “Japan is still warming up to the idea of hostile takeovers and M&As by funds,” Nomura says.


“Japan is still warming up to the idea of hostile takeovers and M&As by funds.”


— Yoshihiro Nomura,

Senior Strategist,

Nomura Securities Co.



Conceptually, the idea behind the pooling of interests method is still something not denied in Japan, Nomura says. “But even if it becomes no longer available, there’s no real damage,” he says. “That’s the general feeling within the business community here, and people understand why the change is needed.”

Nomura, who supports abolishing the pooling-of-interests method, doesn’t believe its end will have any affect on future buyout deals. “I’m not sure if there will be a lot of M&As going forward that would make it clear who’s buying who because this change is made,” he says.

Wider Support Seen

Even Japan’s most powerful economic organization, Nippon Keidanren, is backing the proposed changes, according to Takashi Inoue, group manager of tax and accounting affairs for the Keidanren. He sees the reforms as inevitable.

“In the age of converging international accounting standards, unfortunately, the pooling-of-interests method has been characterized as symbolic of something Japanese that is internationally not up to standard,” Inoue says. “There’s been little use of the method in actuality, and not getting rid of it may have negative implications internationally. As a result, there’s not much choice but to abolish it, and that’s Keidanren’s position.”

Sei-ichi Kaneko, executive vice president of the Security Analysts Association of Japan, calls ASBJ’s short-term revisions “appropriate.”

“In Japan, there are instances where employees or labor unions insist on a 50-50 merger, and that’s why we left the method intact,” Kaneko says. “In reality, even if an M&A was arranged as a 50-50 merger, employees would know and [would also be] clear to them who the acquirer was. As a result, I think there is less and less of a resistance to a change.”

If there’s no real harm, bringing Japan’s accounting methods up to international standards is important and “change is necessary for a convergence to work,” Kaneko adds.



Kobori

How to revise the handling of goodwill has been another point of contention. Kobori says there was discussion on how to include the idea of negative goodwill, such as defining it as a bargain purchase. “There’s been some strong opposition from the business community on this idea,” he admits. “We received comments asking to review positive goodwill and negative goodwill together.”

Keidanren was one such group; it asked the ASBJ that accounting standards pertaining to positive and negative goodwill be reviewed simultaneously.

“There is this discussion on how goodwill should be amortized, but that’s still something to be decided even in the United States,” Inoue says. “We are in the position of supporting regular depreciation of goodwill.”

Kobori says the ASBJ is listening and considering Keidanren’s feedback. “We haven’t changed our proposal due to their comment, though,” he adds.

One issue not yet being discussed in Japan is whether to make advisers’ fees appear as an expense on the income statement, rather than capitalize them and bury them on the balance sheet in the total cost of the deal. Recent merger accounting reforms in IFRS and U.S. accounting principles both do precisely that, which has left lawyers, accountants, bankers, and other advisers none too pleased that their fees are much more visible.

“I haven’t heard much opposition to making commissions such as lawyer’s fees [more] visible … it’s not a major issue,” says Nomura. “That’s something to be reviewed in the phase-two process.”

The implementation date for the first set of accounting changes proposed by the ASBJ, assuming they proceed as planned, is yet to be determined, Nomura adds.