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IFRS Principles-Based Standards

List of news

1. Introduction
IFRS is now being adopted as official accounting standards in many parts of the world except Japan and the US. In Japan, the introduction of IFRS is still voluntary, but more than one hundred Japanese companies have adopted it this year. We will update IFRS from this News, and we would like to start from the topic of principles-based standards as one of the characteristics of IFRS.

2. What is IFRS?  - Accounting standards from the viewpoint of protecting investors 
The IFRS standards are called international accounting standards (Kokusai kaikei kijyun in Japanese), but IFRS officially stands for “International Financial Reporting Standards (Kokusai zaimuhokoku kijyun in Japanese). IFRS was established for the purpose of making a single set of global accounting standards, which enables investors easily to compare financial statements of companies located in different countries.
Investors had difficulties in comparing financial statements based on the original accounting standards of each country, and it could be at the risk of misjudging their investment decisions. In order to solve such problems, the organization called the International Accounting Standards Board (IASB) was established by CPAs and other professionals around the world. ISAB has set IFRS as globalized accounting standards.

3. Characteristics of IFRS
Compared with Japanese GAAP, IFRS has the following characteristics: ① principles-based accounting standards, ② more detailed explanations in notes. We will mention principles-based standards in 4.

4. Principles-based standards

(1) Principles-based standards: Broad rules
IFRS does not show detailed numerical standards or regulations; instead, it only describes broad accounting rules. Such descriptions in IFRS are hence called “principles-based” standards.

(2) Contrasting ideas: Rules-based standards
Rules-based standards are contrasting ideas of principles-based. Rules-based standards have detailed descriptions of numerical standards or regulations. The purposes of rules-based include the following.
① No professional judgement required because of the detailed accounting rules and no distinct differences of consequences in accountants’ decisions
② Minimizing the risk of misuse of accounting rules and prevent manipulation caused by the broad range of interpretation
The US and Japanese GAAP are considered a set of rules-based standards.

(3) Reasons for applying principles-based
① The reason for applying principles-based is that IFRS is aimed at being used worldwide. In rules-based, hard-set regulations in one country could not be acceptable in another county because of differences of business custom or legal system. IFRS, on the contrary, by applying principles-based, could minimize the accounting gaps between different counties.
② Additionally, on-the-edge transactions under the rules-based could cause a chance of profit manipulations. For example, a country’s consolidated accounting standards stipulate that “in cases of being held more than 50% of voting rights (shares), the company concerned will be subject to consolidation.” In this case, the parent company could intentionally manipulate the range of its consolidated subsidiaries by selling or purchasing 1% of the subsidiary’s shares as needed with the condition of holding the very limit of 50% of the subsidiary’s voting rights. The detailed set of standard could hence give the company a thought of profit manipulation.
In order to eliminate such problems, IFRS has adopted principles-based standards, in which only general guidelines are set and accountants are required to use their own discretion and make professional judgement when preparing financial statements.

(4) Examples of Principles-based
Concepts of principles-based standards are seen in the following sections:

Sections / Characteristics of Principles-based
Consolidated accounting:No numerical voting standards in the scope of consolidation
Depreciation:No detailed useful life table for each asset
Tax effect accounting:No detailed guidelines for measuring collectability of deferred tax assets based on company types under Japanese GAAP

・Consolidated accounting
Under Japanese GAAP, there are detailed descriptions of consolidation such as “an entity which holds more than half of the voting rights “or “an entity which holds 40% or more of the voting rights under a certain condition.” IFRS, on the other hand, only stipulates that “a parent has the power of control over a subsidiary” and does not show numerical standards of voting rights.

In Japanese GAPP, useful lives of assets under tax law are applied. In IFRS, it is only stipulated as “the expected period of use for operation”, and there is no detailed description of useful life for each asset.

・Tax effect accounting
Under Japanese GAAP, collectability of deferred tax assets is assessed by classifying companies into five types, which are based on the likelihood of future taxable income. (e.g.: Type 1 - Deferred tax assets are fully collectable. Type 4 - Deferred tax assets are collectable only within the range of taxable income expected for the next fiscal year.  Type 5 - Deferred tax assets are not collectable.) IFRS, on the other hand, has no such guidelines; collectability is judged based on whether the likelihood of future taxable income is high or not.

5. Conclusion
In this News, we have mentioned “IFRS Principles-Based Standards”. Please note that this News only introduces general outlines and does not include professional advice. So please make sure not to make any decisions without taking professional advice individually. If you have any questions, please feel free to contact us.