The true standing of Japanese firms in relation to their foreign rivals is slowly becoming clear.
After years of resistance, Japanese companies and their auditors are beginning to adopt accounting standards used by most of the industrialized world — starting with consolidated balance sheets in fiscal 1999 and mark-to-market value accounting for securities and sellable real estate in fiscal 2000.
“It’s not an issue about whose standards are better,” said Yuzo Takagi, executive director of the Japanese Institute of Certified Public Accountants. “If everyone is pointing at you and saying ‘unfair’ . . . that’s a sign you’re not doing good business.”
|Conversion to global accounting rules|
|The following is a chronology of Japan’s step-by-step changeover to the use of global accounting standards:|
|* Consolidated financial statements, which list the assets, liabilities and operating accounts of a parent company and its subsidiaries, become a mandatory item in the annual earnings results of listed firms.|
|* Cash flow statements, which analyze all changes affecting cash in operations, investments and financing, is included in corporate annual reports.|
|* The so-called tax effect accounting system is introduced to better reflect firms’ present and future tax liability.|
|* Consolidated financial statements are adopted in the midterm earnings reports of listed firms.|
|* The mark-to-market system, which reflects current market values of securities and other assets, is introduced for some financial products, such as marketable securities, derivatives and marketable real estate.|
|* The mark-to-market accounting system fully covers cross-held shares and all other securities.|
Foreign investors have long suspected that Japanese companies have more liabilities than they let on.
The collapse of the property and equity boom of the 1980s left enormous latent losses: The aggregate value of first-section issues on the Tokyo Stock Exchange plunged by 270 trillion yen — or 60 percent of the nominal gross domestic product at the time — in the nine months between Jan. 4 and Oct. 1, 1990, according to Asahi Bank.
And 10 years later, more accurate indications of the damage are surfacing, backing those suspicions and putting Japanese accountants in the spotlight.
In September, failed mid-tier insurer Chiyoda Mutual Life Insurance Co. announced that its liabilities were 34.3 billion yen. In February, that amount expanded 15 times to some 500 billion yen after a stricter assessment of its assets was conducted.
In May, general contractor Kumagai Gumi Co. reported final profits of 2.7 billion yen for fiscal 1999. Four months later it was asking creditors to forgive debts of 450 billion yen.
“Balance sheets don’t tell the full story,” said Masahiro Yamada, a former analyst at Goldman Sachs (Japan) Ltd. who is starting an Internet business consultancy. “They only show what companies want you to see.”
Since the demise of venerable Yamaichi Securities Co. in November 1997 and the revelation that it had kept massive debts off its books, the opacity of Japanese balance sheets has been a target of international criticism.
Until recently, the assets on Japanese balance sheets were usually calculated on the basis of their book value — the price they were bought at — making it difficult to gauge the true scale of unrealized profits and losses.
Many companies also reported their earnings on an unconsolidated basis, giving the parent firm room to shift
large, unsightly debts to the books of subsidiaries or affiliates, hiding them from investors’ eyes.
But several trends — the growing size of the global money market, the influence of foreign investors, crumbling alliances with banks as well as the escalating pace of mergers and acquisitions — are pressuring Japanese companies to prove they are abiding by global standards.
“If even corporate executives don’t know what the accurate numbers are, you can’t expect (the market and analysts) to be able to evaluate the company correctly,” Masayoshi Nakamura, managing director and head of Morgan Stanley’s M&A group in Tokyo, said, adding that grasping the true size of a firm’s assets and liabilities is essential to M&As.
Morgan Stanley recently completed the acquisition financing for consumer loan company Aiful Corp., which recently bought failed finance company Life Co. Ltd.
After wallowing in its “lost decade,” Tokyo has finally come to terms with the global business environment and begun accounting reforms designed to help Japan Inc. catch up with global standards.
As of fiscal 2000, Japanese companies were obligated to evaluate short-term assets in securities at mark-to-market value rather than purchase price. This rule will gradually expand to include cross-shareholdings at market value by March 2002 and may include nonsalable properties, pensions and golf course memberships by March 2003.
The TSE will further require around 30 companies listed on U.S. markets to release Japanese versions of their English reports submitted to the Securities and Exchange Commission for fiscal 2000. This is expected to speed up the adoption of accounting standards that are closer to U.S. standards in other Japanese companies.
While Japan is busy playing catchup, however, the rest of the market is forging ahead.
Investors worldwide are calling on the International Accounting Standards Committee to speed up the creation of a set of accounting rules that will enable direct comparisons of companies in different countries.
The first step was taken in January with the formation of the new International Accounting Standards Board, which will finalize the creation of an international base of accounting rules.
The switch to IASB standards will be painful, however, a fact that no one denies.
For example, disclosing latent losses for companies like Kumagai, which invested heavily in real estate during the bubble era, could be disastrous. In fiscal 1999, Kumagai revealed for the first time that its interest-bearing debts are worth a whopping 1.057 trillion yen.
Thinly stretched firms will also experience problems.
Kensho Yoshida, a researcher at the Hokuriku Economic Research Institute, polled 394 nonfinancial companies with capital of 100 million yen or more in the Hokuriku area in February. In the survey, 74.1 percent said they would not have sufficient reserves for pensions under the proposed accounting standards, while 25.9 percent said they would have to record unrealized losses to balance their books.
The greatest impact will be felt in the long term as companies struggle to break old management habits, such as shuffling latent gains and losses throughout the company network.
“Companies didn’t pay attention to cash flow — they didn’t need to,” Yoshida said. “This applies to companies nationwide. It’s just the way we used to do business.”
No longer. As of fiscal 2000, the Japanese Institute of Certified Public Accountants required publicly traded firms to include in their books any unrealized real estate losses where the market value has fallen below half the purchase price.
Combined with the protracted stock market slump, Japan Inc. is now desperately trying to dispose of these latent losses to present cleaner balance sheets.
Stock prices of general contractors with huge latent losses have fallen sharply, prompting major real estate and construction firms to finally begin taking actual losses through the sales of land and other assets purchased during the bubble era.
But change is still coming too slowly, according to Tatsumi Yamada, a former partner at Chuo Aoyama Audit Corp., a member firm of Pricewaterhouse Coopers.
“Japanese companies do not understand the magnitude of the changes occurring outside Japan,” said Yamada, the only Japanese member of the IASB.
Yamada points to a common practice by CEOs of leaving accounting to the accounting section. “Accounting is a core part of company strategy,” he said, because it is centered on attracting investors’ money.
IASB members will consider preliminary proposals submitted in December that include controversial items such as calculating depreciation on fixed assets like office buildings and factories, and evaluating all financial assets at market value, including long-term liabilities such as corporate bonds.
A team of representatives from 10 Japanese industrial organizations will meet in July to compile proposals for accelerating change in Japan’s accounting system and propose them to the IASB.
Opponents say it is difficult to measure the potential cash flow of assets essential for operations, such as headquarters buildings and factories. Some also question the market’s ability to assess financial products at fair value.
But Yamada said there is no fighting the general trend toward an international accounting system.
“The boat is ready to set sail,” he said. “If Japan has special concerns, it needs to speak up now and make its case in a logical manner.”
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