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Internationalization of accounting standards for consolidation

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

they pose.

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

incompatible cultures.

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

uniquely Japanese.

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

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