IASB Chairman discusses Japanese modified international standards and the dangers of ignoring unrealised income
03 Sep 2014
IASB Chairman Hans Hoogervorst gave a speech today at an IFRS Conference in Tokyo titled 'The dangers of ignoring unrealised income'. He discussed an overview of the current use of IFRS around the world and Japan especially focusing on the recently issued Japanese Exposure Draft 'Japan’s Modified International Standards (JMIS): Accounting Standards Comprising IFRSs and the ASBJ Modifications' and connected the modifications made to the IASB's project to update its Conceptual Framework and the dangers of ignoring unrealised gains and losses.
Mr Hoogervorst commented that the increase of the voluntary use of IFRSs in Japan was especially encouraging as Japanese companies have the choice of several sets of standards and would only choose to adopt IFRS if they thought it was a strong business case. He explained that IFRSs are a cost effective alternative for companies with subsidiaries as they can apply one single financial reporting language for both internal and external reporting. In addition, the use of IFRS would make it more attractive to foreign investors to invest in Japanese shares if the financial statements were prepared in a reporting language they understand.
Yet Mr Hoogervorst pointed out that following a recommendation by Japan's Business Accounting Council (BAC) regarding the use of IFRSs in Japan, a set of 'endorsed IFRSs' called JMIS that would offer an additional choice of accounting framework to Japanese companies has been developed and published as an Exposure Draft (ED) in July 2014. As JMIS in essence consist of most IFRSs as issued by the IASB combined with two major modifications relating to the treatment of Goodwill and recycling of some OCI-items, he connected the modifications to the IASB's project on the Conceptual Framework and especially the meaning of Profit or Loss and Other Comprehensive Income (OCI).
Mr Hoogervorst admitted that the IASB has so far not been able to draw a binary distinction between Profit or Loss and OCI and yet he also struggled with the ASBJ's definition in the JMIS ED that 'Profit or Loss represents an all-inclusive measure of irreversible outcomes of an entity's business activities in a certain period.' Although the IASB agrees that Profit or Loss should be as comprehensive as possible and has made tentative decisions supporting that understanding, the irreversibility criterion seemed to be "fraught with difficulties" to Mr Hoogervorst. He explained that a systematic relegation of unrealised income items to OCI could result in a lack of faithful presentation, especially as unrealised income does not only consist of gains, but also of losses. Mr Hoogervorst also added that this approach could be detrimental from a stewardship perspective as many problems would be confronted much earlier on if they are presented in Profit or Loss - he argued that postponement of recognition of losses until they have become irreversible has the big disadvantage that they become irreversible. He therefore concluded:
I would conclude that a systematic relegation of unrealised profits or losses to OCI is extremely problematical. Moreover, where OCI is used to capture short-term 'market volatility' of long-term assets or liabilities, the information it contains should not be ignored. While income in OCI may be of a less certain nature than income captured in Profit or Loss, OCI may contain indicators of risk that may materialise sooner than you think. Clearly, ignoring unrealised elements of income may be hazardous to your financial health.
Please click for access to the full text of Mr Hoogervorst's speech on the IASB website.