Internationalization of Accounting Standards for Consolidation - Japan: A Case
The purpose of this paper will be to examine problems with internationalization
of accounting standards for consolidations on methods from an international
perspective - specifically, in the US and Japan. This is an especially timely
topic as standardization of financial markets is a prerequisite to international
free trade. Given the trends toward greater globalization, the motivations of
companies for seeking a uniform accounting system are strong. If companies have
to prepare their accounts according to several different sets of rules, in order
to communicate with investors in the various capital markets in which they
operate or for other national purposes, they incur a considerable cost penalty
and feel that money is wasted. This significantly limits global opportunities
for multinational businesses. Thus, it is important to understand what the
differences are between accounting standards, why they exist, and what problems
It is worth noting that no one nation has a set of accounting rules which
appears to have such clear merits that they deserve adoption by the whole world.
No one country can claim to have a uniquely correct set of rules. The United
States has the longest history of standard setting. It has the largest standard
setting organization which is characterized by high standards of professionalism.
But, even the rules of the United States exhibit compromises between different
interests of a kind which could have reasonably been decided otherwise.
Furthermore, no unanimity exists among U.S. accountants about the merits of the
precise details of the compromises that have been struck. For example, the
recent discussion memorandum on consolidation outlines three different methods
which are GAAP in the US (Beckman, 1995). No one nation has a clear right, on
the basis of existing achievements, to be regarded as predominant in accounting.
A great deal more work is needed by accountants from different countries before
we can reach the point of having a well founded basis for uniformity.
People who study differences among systems of accounting rules are inclined to
group countries into two categories. On the one hand, there are countries where
business finance is provided more by loans than by equity capital, where
accounting rules are dominated by taxation considerations and where legal
systems customarily incorporate codes with detailed rules for matters such as
accounting. The effect of taxation systems can be particularly pervasive. Often,
the taxation system effectively offers tax breaks for businesses by allowing
generous measurement of expenses and modest measurement of revenues on condition
that these measurements are used for general reporting purposes. Companies have
strong incentives to take advantage of these taxation concessions as real cash
is involved. But the penalty is a jack of full transparency for investors. Major
countries in this category include France, Germany and Japan( AAA, 1995).
The other group of countries is one in which equity sources of finance are more
important, accounting measurements are not dominated by taxation considerations
as tax breaks can be enjoyed independent of the way result are reported to
shareholders, and common law systems prevail. These countries generally have
some private sector system for setting accounting standards, often with a
general statutory framework. The role of equity finance is important because
capital market pressures are then brought to bear most strongly to improve the
quality of information available. The absence of detailed codes leaves
flexibility to respond to pressures. The United States, the United Kingdom,
Australia and the Netherlands are examples of countries in this category (AAA,
US consolidation policy begins with a definition of control. It is based on the
simple legal concept that the majority shareholder controls a company and that
even without a majority, a stockholder can exert significant influence. Thus,
consolidated financial statements reflect the financial position and results of
the firm as well as all subsidiaries upon which the firm may exert this
influence. Furthermore, the entity about which the consolidated financial
statements are prepared is not an entity in legal form. It is an abstraction
created solely for the purpose of these statements and does not have an ongoing
set of books as a normal corporation would (Beams, 1992). The details of
consolidation in the US are based on one of two theories as outlined in the
Discussion Memorandum. The economic unit theory considers the consolidated
group to be one economic entity for financial accounting purposes. Thus, the
full fair market value of the subsidiary's net assets at the date of acquisition
as well as the minority interest in those assets are included in the
consolidated financial statements. The parent company theory holds that only
the parent company's shareholders' ownership interest should be reflected.
There are many more detailed controversies in US accounting for consolidations,
but this illustrates how even the US, with the most developed set of accounting
standards in the world can have disputes about the most fundamental aspects of
consolidation (Beckman, 1995). However, because the US has been the first to
conceptualize accounting for consolidations, our form has come to be accepted by
the international financial community (Lowe, 1990). While this may be good for
us because our method of consolidation is consistent with our culture, it does
have some negative effects on the substance of reporting in other countries with
Japan is an excellent example of how the international acceptance of accounting
standards can actually lower the value of the information provided if the
standard is incompatible with the culture of the country. The Japanese began to
use consolidated financial statements at least half a century later than many of
the other industrialized countries of the world. Responding to external pressure
they reluctantly adopted the accounting practices applicable to consolidated
reporting employed in the United States and have made a determined effort to
adapt them to their own business environment (McKinnon, 1984). The results,
however, have been terrible. While US GAAP for preparing consolidated financial
statements recognizes groups based upon the legal relationships arising from the
majority ownership of voting shares, Japanese corporate groups tend to form from
substantive relationships of a non-legal nature. The nature of Japan's corporate
group associations reflect that nation's cultural and historical interpersonal
and intergroup relationships (Lamb, 1993). These corporate related entities deal
with each other much in the same manner as we in the United States expect of
parent and subsidiary company groups. It is because of this kind of special
relationship that we in the U.S. insist upon consolidated reporting. But because
Japanese groups are often not connected through legal ownership they are not
consolidated. Instead entities with weak relationships are consolidated because
they are tied together legally (Lowe, 1990). Consequently, American users of
Japanese consolidated statements assume they are analyzing the financial
position and results of operations of a group of companies operating as an
economic entity. Actually they may be analyzing something quite irrelevant
because the statements do not represent the substance of the actual business
relationships. This obviously impairs the ability of readers to make appropriate
judgments from these statements.
The Japanese form of business grouping is called the keiretsu. This term
indicates a grouping or alignment when stockholder control is formally lacking.
It enables companies to share risk and allocate investment to strategic
industries (Lamb, 1993). Lowe outlines the characteristics of a keiretsu:
(1) Members are all "independent" major firms in their own oligopolists
industries. (2) The keiretsu is a confederation of firms excluding competition
but aiming at representing all lines within the confederation
(3) Service firms such as banking, trading, insurance and shipping
companies from within the keiretsu perform special functions for industrial
member firms to the complete exclusion of outsiders.
(4) Between the firms there are many cross ties. Examples are borrowing
from the same bank, mutual shareholdings, interlocking directors, using the same
trademark, or selling their products through the same trading company.
(5) The presidents of each member firm meet together once a month and
discuss matters of mutual interest to the member corporations. These are backed
up with meeting of directors and of upper level managers.
(6) Interfirm business within the group has a high priority.
(7) Holding companies at the top are prohibited so the relationship
between the firms in these groups is based on cooperation not control as would
be the case in the U.S.
Each of these groups is centered around a bank and includes a trading company, a
real estate company, an insurance company, and numerous other companies each
performing a special function useful to the group. For example, the Mitsui Group
includes the Mitsui Bank, Mitsui and Co. (Trading Co.), The Mitsui Real Estate
Company, The Tashio Marine Insurance Company, The Mitsui Life Insurance Co., the
Mitsui Chemical Co., et al. Each of these major companies has from a few to
hundreds of affiliated firms many with small and others with large intercompany
stockholdings. Each also holds a small fraction of the outstanding voting shares
of the other "parent-like" firms in the group. This is not done for control
purposes but to create good relationships and stimulate the feeling of
interdependence. It is difficult to determine the size of these corporate
groups. They exist as a matter of fact but not as a matter of record. Sales, net
income, or asset information is not published on a group basis (McKinnon, 1984).
Each company may own up to 10 percent of each other's voting shares but none has
voting control over any of the others. Human ties within the group insure the
cohesiveness through intercompany meetings, interlocking directorates, and
transfers of personnel. It is difficult for the typical American to understand
the forces which bind together on a stable and permanent basis a group of
corporations of the type described (Lowe, 1990). If legal control by a parent is
not present an American would say a stable group does net exist. However, this
is perfectly rational for a person reared in the Japanese culture and tradition.
The vital factors in the maintenance of the keiretsu are the generally
recognized characteristics of group consciousness and interdependence.
Japanese consolidated statements patterned after American standards have
survived only because foreign users have been largely unaware of their
inappropriate focus and innocent misrepresentation. No financial statements yet
developed are capable of dealing with the typical Japanese sphere of influence
concept of economic interdependence (McKinnon, 1984). Parent-company only
financial statements do alert readers to the fact that they are seeing only a
segment of the financial position and results of operations of the total
economic entity. Consolidated statements prepared in such circumstances have the
serious weakness of tending to mislead users into believing they are getting a
full picture of the group when obviously they are not. Many of the most
important firms affecting the future fortunes of the group are not even
represented in these statements.
Cultural and historical influences provide significant contrasts between
corporate group associations and corporate behavior in Japan and the United
States. Evidence of these contrasts in Japan are found in the stable ownership
of a majority of the shares, the decentralized cross-holding pattern of share
ownership, the predominance of small shareholdings, and the importance of non-
share ownership criteria as a basis for forming corporate groups. The corporate
group associations tend to be maintained by the cultural characteristic of group
consciousness with a strong orientation toward interdependence. The notion of
control through direct or indirect majority share ownership and the presence of
a holding company or a dominant parent company are foreign concepts to the
typical Japanese executive. Share ownership is generally regarded as of minor
significance in the forming and maintaining of corporate groups. Consequently,
American practices of consolidation tend to group Japanese corporations in a
manner co ntrary to their normal functioning. Such practices tend to break up
the complex and dynamic reality of the natural groups into American-type
corporate groups attempting to portray an American perspective to something
Japan's experience with consolidated statements pinpoints an unexpected problem
associated with the process of harmonizing accounting standard. All nations have
their own peculiar cultural features. It is expected that each country will make
an effort to harmonize its own financial reporting methods with international
reporting standards in order to make its reports more useful to foreign users.
But it will do so only as fast as it is able to reconcile these standards with
its culture. In contrast to this, Japan adopted harmonizing consolidated
reporting standards without reconciling them with its culture and it attempts to
apply these standards meticulously. Consequently, its unique business
organizational structure often makes its consolidated financial report less
rather than more useful to readers.
American Accounting Association. "German Accounting Principles: An
Framework" Accounting Horizons. September, 1995. Pp. 92-99
Beams, Floyd A. Advanced Accounting. Englewood Cliffs, NJ: Prentice-Hall 1992
Beckman, Judy K. "Economic Unit Approach to Consolidated Financial Statements".
Journal of Accounting Literature. Vol.14, 1995. Pp. 1-23
Lamb, Charles W. Principles of Marketing. Cincinnati: South-Western Publishing.
Lowe, Howard. "Shortcomings of Japanese Consolidated Financial Statements".
Accounting Horizons. September, 1990. Pp. 1-9.
McKinnon, Jill. "Application of Anglo-American Principles of Consolidation to
Financial Disclosure in Japan". Abacus. Vol.20, No. 1, 1984, pp. 18-19