Frequently Asked Questions - Others

Business Accounting Standards

Q2

What is mark-to-market accounting of securities holdings?

A2

The so-called ''mark-to-market accounting of securities holdings'' includes both ''market price valuation of securities holdings'' and ''compulsory devaluation of securities holdings (valuation losses)''. These two are often confused but they are separate accounting treatments.

''Market price valuation of securities holdings'' means to value at market ''securities holdings for trading'' (from FY2000) and ''other securities holdings'' including cross-holding stocks (from FY2001) based on the ''Accounting Standards for Financial Instruments'' published by the Business Accounting Council in 1999. On the other hand, ''Compulsory devaluation of securities holdings (valuation losses)'', which is prescribed in the Commercial Code (now the Commercial Code Enforcement Regulations) since 1962, requires valuation at market when the current market value has fallen significantly, except for the cases where recovery is expected. This compulsory devaluation is also included in the ''Accounting Standards for Financial Instruments''.

For example, cross-holding stocks are recorded at the current market value in the assets section of the balance sheet, but the variance in valuation (latent profit and loss) is not recorded in the income statement but the increase or decrease is presented in the shareholders' equity section in the balance sheet. In valuing at market, the difference is recorded in the shareholders' equity section when the current market value rises or falls, and it is not reflected in the income. However, when the current market value has fallen significantly, the compulsory devaluation method applies and the devaluation loss is recorded in the income statement.

The Commercial Code Enforcement Regulations allows the application of the cost method, lower-of-cost-or-market method (which shows either the cost or market value, whichever is lower) or the market price valuation method for the valuation of the stock. However, listed companies and other companies subject to the Securities and Exchange Law as well as large enterprises defined in the Commercial Code for Special Regulations Concerning Auditing (enterprises with a capital of 500 million yen or more, or those with a liability of 20 billion yen or more) must be audited by a Certified Public Accountant, and if they fail to comply with the Accounting Standard, a clean audit opinion will not be issued on their financial statements in the audit. On the other hand, market valuation is not compulsory for companies that are not listed or that do not belong in the category of ''large companies''.

(Reference) Valuation methods for securities holdings in ''Accounting Standards for Financial Instruments''

Securities holdings are classified by purpose of holding, and each classification has a specified valuation method. ''Market price valuation of securities holdings'' generally means carrying out a market price valuation of the securities holdings described in Items (1) and (4).

• (1) Securities holdings for trading

  ''Securities holdings for trading'' are held with the purpose of gaining profit through the fluctuation of market values, as seen in trading in financial institutions, and are recorded in the balance sheet at current market values. At the same time, the difference between the book value and current market value (profit and loss) is recorded in the income statement. Therefore, both the rise and fall of current market values are recorded in the income statement.

• (2) Held-to-maturity bonds (bonds and debentures to be held until maturity)

  When bonds are held until maturity, they are redeemed at face value, and the changes in market value during the holding period do not apply. Therefore, ''held-to-maturity bonds'' are to be recorded in the balance sheet at the acquisition cost. Concerning discounts, the difference between the face value and the issue price is to be distributed as yield until maturity (amortized cost method).

• (3) Subsidiaries and affiliates

  Since ''subsidiaries' stock'' and ''affiliates' stock'' are considered to be business investments through subsidiaries and affiliates without the intention for selling, they should be recorded in the balance sheet at their acquisition costs. However, net assets and performance of subsidiaries and affiliates will be included in the consolidated financial statements.

• (4) Other securities holdings

  Since securities holdings with diverse holding purposes and selling possibilities, such as the so-called cross-holding stocks and securities holdings that are held for a long time for business purposes, do not fall in the categories (1) to (3) above, they are comprehensively classified as ''other securities holdings''. ''Other securities holdings'' are valued at market at the end of the period and recorded in the balance sheet at the current market price. However, unlike ''securities holdings for trading'', the difference between the book value and the market price (profit and loss) is not recorded in the income statement but in the shareholders' equity section on the balance sheet under an item named ''balance of revaluation of other securities holdings''. The amount of latent profit and loss to be recorded (the amount to which the amount of taxes that would result from an assumed sale of the securities holdings is added or subtracted) must have the accounting for income taxes applied to it.

Note: The compulsory devaluation method (valuation losses) applies to (2) and (3) above.

Q3

What is ''impairment accounting'' of fixed assets (devaluation of fixed assets)?

A3

It is an accounting treatment in which the book values of assets or asset groups are written down to recoverable values in order to reflect the possibility of recovery under certain conditions when recovery of investment is not expected due to the fall of profitability of lands, buildings, and other fixed assets belonging to the enterprise.
In other words, impairment accountingon fixed assets means devaluing excessive book prices of business assets to prevent deferred of losses into the future.

Q4

What is the procedure for impairment accounting?

A4

First, group land, buildings and other fixed assets for business purpose of an enterprise into the smallest units that create independent cash flow.

Next, check whether the following events (signs of devaluation) are occurring in each asset group.

• Profits and cash flow generated by operating activities are decreasing in succession
• Discontinuance or reorganization of business
• Significant deterioration of operating environment
• Significant fall of market price

When there is a sign that any of the above events is to occur, compare the total (before discounting) of the cash flow expected to be generated in the future from fixed assets with the book value and judge whether to recognize a loss on devaluation.

If a devaluation loss is to be recognized based on the judgment, devalue the book value to a recoverable amount. The recoverable amount is the higher of the following values.

• Value in use (present value of the future cash flow estimated to be generated by continuous usage of asset groups and its disposal after usage)
• Net sale value (the amount calculated by deducting the anticipated cost of disposal from the market price of the asset groups)

Record the reduced amount (devaluation loss) in the income statement as the loss for the period.