Accounting Practices in Japanese K.K.s: What are "Generally Accepted Accounting Principles" (GAAP) in Japan?

Japanese Attorney at Law - Bengoshi L.L.

• 9 min read

For any Kabushiki Kaisha (K.K., or joint-stock company) operating in Japan, adherence to proper accounting practices is not merely a matter of good business management but a fundamental legal requirement under the Japanese Companies Act (Kaisha-hō). Corporate accounting serves multiple critical functions: it provides essential information to shareholders, creditors, and potential investors; it forms the basis for taxation and the calculation of distributable profits (dividends); and it supports the overall health and transparency of the economic system. The Companies Act itself does not lay down detailed accounting rules but mandates that companies follow "accounting practices that are generally accepted as fair and appropriate." This naturally leads to the question: What constitutes these "Generally Accepted Accounting Principles" (GAAP) in Japan, and how does the system work?

Why the Companies Act Regulates Corporate Accounting

The Companies Act places significant emphasis on proper corporate accounting for several key reasons, reflecting the diverse interests of those who rely on a company's financial information:

  1. Information Disclosure Function (Jōhō Teikyō Kinō):
    A primary purpose is to ensure that stakeholders have access to reliable information about the company's financial position (assets, liabilities, net assets) and its operational performance (revenues, expenses, profits). Shareholders need this information to assess the value of their investment and the performance of management. Creditors need it to evaluate the company's creditworthiness and its ability to meet its obligations. Potential investors rely on it to make informed investment decisions.
  2. Dividend Distribution Regulation Function (Haitō Kisei Kinō):
    Corporate accounting plays a crucial role in determining the amount of profit that a company can legally distribute to its shareholders as dividends. Japanese company law imposes restrictions on dividend payouts to protect creditors by ensuring that distributions do not impair the company's capital or its ability to pay its debts. Accurate accounting is essential for calculating this "distributable amount" (bumpai kanō gaku).
  3. Facilitating Corporate Activities and Economic Efficiency:
    Standardized and reliable accounting practices promote comparability between companies, facilitate smoother commercial transactions, and support the efficient allocation of resources within the economy. They provide a common language for business.

Instead of prescribing specific, detailed accounting rules within the Companies Act itself (which would make the Act unwieldy and difficult to update), Article 431 of the Act wisely mandates that "The accounting of a Stock Company shall be governed by accounting practices that are generally accepted as fair and appropriate." This flexible approach allows accounting standards to evolve independently while maintaining a legal underpinning for their observance.

The Accounting Process and Financial Statements in a Japanese K.K.

The Companies Act outlines the basic framework for the accounting process and the preparation of financial statements.

Accounting Books (Kaikei Chōbo) (Article 432)

Every K.K. is obligated to prepare and maintain accurate accounting books in a timely manner, in accordance with generally accepted accounting practices. These books must record all business transactions and financial activities that affect the company's assets, liabilities, and net assets. The accounting books form the underlying basis for the preparation of the financial statements and must be preserved for ten years from the closing of the books.

Financial Statements (Keisan Shorui) and Supporting Schedules (Article 435)

At the end of each business year (fiscal period), a K.K. must prepare its financial statements (keisan shorui) and supporting schedules (fusoku meisaisho). The core financial statements consist of:

  1. Balance Sheet (貸借対照表 - Taishaku Taishōhyō): Presents the company's financial position (assets, liabilities, and net assets) as of the end of the business year.
  2. Income Statement / Profit and Loss Statement (損益計算書 - Son-eki Keisansho): Reports the company's financial performance (revenues, expenses, and resulting profit or loss) for the business year.
  3. Statement of Changes in Net Assets (株主資本等変動計算書 - Kabunushi Shihon-tō Hendō Keisansho): Shows the changes in the components of the company's net assets (e.g., stated capital, capital surplus, retained earnings) during the business year.
  4. Individual Notes (個別注記表 - Kobetsu Chūkihyō): Provides supplementary information and disclosures necessary for a fair presentation of the financial statements, including significant accounting policies, details of certain accounts, and other relevant information.

These financial statements, along with their supporting schedules, must be kept at the company's head office for ten years from the time of their preparation.

Business Report (Jigyō Hōkoku) (Article 435, paragraph 2)

In addition to the financial statements, a K.K. must also prepare a Business Report for each business year. While not strictly a financial statement, it is prepared alongside them and provides crucial context. The Business Report typically describes the company's business activities, operational results, significant corporate events during the year, the status of its corporate group (if applicable), information about directors and other officers, and other matters concerning the company's situation. Its content is prescribed by Ministry of Justice Ordinance.

Audit of Financial Statements (Articles 381, 396, 436)

To ensure their reliability, financial statements (and the Business Report) are subject to audit:

  • Statutory Auditors (Kansayaku) or Audit Committee: In companies with statutory auditors or an audit committee (as part of a Company with Nominating Committee, etc., or a Company with Audit and Supervisory Committee), these internal audit organs audit the financial statements and the Business Report.
  • External Accounting Auditors (Kaikei Kansanin): As discussed in a previous article, "Large Companies," "Companies with a Nominating Committee, etc.," and "Companies with an Audit and Supervisory Committee" must appoint an external accounting auditor (a CPA or audit firm) to conduct an independent audit of the financial statements (and often consolidated financial statements).

The auditors prepare audit reports expressing their opinion on the fairness of the financial statements.

Approval of Financial Statements (Article 438)

After preparation and audit, the financial statements and Business Report must be approved:

  1. Board of Directors Approval: Initially, they must be approved by the board of directors (if the company has one).
  2. Shareholders' Meeting Approval: Subsequently, they are submitted to the annual general shareholders' meeting for approval (typically by an ordinary resolution).
    • An exception exists for companies with an external accounting auditor that issues an unqualified opinion and meets certain other conditions (e.g., proper internal controls, statutory auditor also finds no issues). In such cases, if the articles of incorporation permit, the financial statements can be deemed approved if their content is simply reported to the shareholders' meeting, rather than requiring a formal approval resolution (Article 439).

Public Notice of Financial Statements (Article 440)

K.K.s are required to give public notice of their balance sheet (and for Large Companies, also their income statement) after approval at the annual shareholders' meeting. The method of public notice (e.g., official gazette, daily newspaper, electronic public notice via a website) is usually stipulated in the articles of incorporation.

"Generally Accepted Accounting Principles" (GAAP) in Japan (Ippan ni Kōsei Datō to Mitomerareru Kigyō Kaikei no Kankō)

As mentioned, Article 431 of the Companies Act mandates that corporate accounting conform to "accounting practices that are generally accepted as fair and appropriate." This phrase refers to what is commonly known as Japanese GAAP.

What Constitutes Japanese GAAP?

Japanese GAAP is not a single, static, codified body of law like the Companies Act itself. Instead, it is a dynamic and hierarchical set of standards, rules, and interpretations. The primary sources and constituents of Japanese GAAP include:

  1. Accounting Standards issued by the Accounting Standards Board of Japan (ASBJ - 企業会計基準委員会 Kigyō Kaikei Kijun Iinkai): The ASBJ is a private-sector body responsible for developing and issuing accounting standards in Japan. Its pronouncements are the most authoritative source of Japanese GAAP for publicly traded companies and often for other companies as well.
  2. Implementation Guidance and Practical Guidelines issued by the ASBJ: These provide more detailed explanations and application guidance on the ASBJ standards.
  3. Practical Guidelines and Q&As issued by the Japanese Institute of Certified Public Accountants (JICPA - 日本公認会計士協会 Nihon Kōnin Kaikeishi Kyōkai): The JICPA also issues guidance that is considered an important part of GAAP, particularly on specialized industry practices or emerging issues.
  4. Past pronouncements of the Business Accounting Council (BAC - 企業会計審議会 Kigyō Kaikei Shingikai): The BAC, a governmental advisory body, historically played a central role in setting accounting standards. While its direct standard-setting function has largely been taken over by the ASBJ, its past opinions and statements continue to hold relevance where not superseded.
  5. Companies Act Calculation Rules (会社計算規則 - Kaisha Keisan Kisoku): This Ministry of Justice Ordinance provides detailed rules on the preparation of financial statements and related matters under the Companies Act, and these rules must align with GAAP.
  6. Prevailing Accounting Practices and Authoritative Literature: In areas not specifically covered by formal standards, well-established and widely accepted accounting practices, as well as respected academic and professional literature, can also inform the application of GAAP.

Dynamic Nature of GAAP

Japanese GAAP is not static. It continuously evolves to reflect changes in the economic environment, new business transaction types, and the ongoing international convergence of accounting standards. The ASBJ actively monitors international developments and issues new or revised standards and guidance as needed.

Key Principles Underpinning Japanese GAAP

While an exhaustive list is beyond this article's scope, some fundamental principles underlying Japanese GAAP include (similar to many other GAAP frameworks):

  • Accrual Basis of Accounting: Revenues and expenses are recognized when earned or incurred, not necessarily when cash is received or paid.
  • Matching Principle: Expenses are matched with the revenues they help generate.
  • Prudence (Conservatism): A degree of caution in making estimates under conditions of uncertainty, such_that assets or income are not overstated, and liabilities or expenses are not understated.
  • Going Concern Assumption: Financial statements are normally prepared on the assumption that the company will continue to operate for the foreseeable future.
  • True and Fair View / Proper Presentation: The ultimate objective is for financial statements to present a true and fair view (or proper presentation) of the company's financial position and performance.

Specific Valuation Principles (Illustrative Examples)

Japanese GAAP prescribes specific valuation methods for various assets and liabilities. For example:

  • Assets: Generally, assets are initially recorded at their acquisition cost (shutoku genka shugi).
    • Inventories: May be valued using methods like cost (e.g., FIFO, weighted-average) or the lower of cost or net realizable value.
    • Marketable Securities: Depending on their classification (e.g., trading securities, held-to-maturity, available-for-sale), they may be valued at acquisition cost or fair market value (jika hyōka), with unrealized gains or losses treated differently.
    • Fixed Assets (Tangible and Intangible): Valued at cost less accumulated depreciation or amortization. Impairment accounting rules require recognition of losses if the recoverable amount of an asset falls significantly below its carrying amount.
  • Liabilities: Generally recorded at the amount of the obligation.
  • Derivatives and Hedge Accounting: Specific rules govern the accounting for derivative financial instruments and hedge accounting.

Relationship with International Financial Reporting Standards (IFRS)

Japan has been actively involved in the international movement towards global convergence of accounting standards.

  • ASBJ's Efforts: The ASBJ has worked for many years to reduce differences between Japanese GAAP and International Financial Reporting Standards (IFRS). Many Japanese standards are now closely aligned with or based on IFRS principles.
  • Voluntary Adoption of IFRS: Since 2010, certain publicly listed Japanese companies have been permitted to voluntarily adopt IFRS for their consolidated financial statements, and a growing number of large, internationally active companies have done so.
  • Japan's Modified International Standards (JMIS): As another option, "Japan's Modified International Standards (Accounting Standards Comprising IFRS and ASBJ Modifications)" were developed, allowing companies to use IFRS with certain specific "deletions or modifications" endorsed by the ASBJ.
    Despite these convergence efforts and options, Japanese GAAP remains a distinct and comprehensive set of standards applicable to the vast majority of companies in Japan, especially unlisted ones and those preparing non-consolidated (parent company only) financial statements.

Consolidated Financial Statements (Renketsu Keisan Shorui) (Article 444)

For companies that are part of a corporate group, non-consolidated (parent-only) financial statements may not provide a complete picture of the group's overall economic performance and financial position.

Requirement for Certain Companies

The Companies Act (Article 444, paragraph 3) requires certain companies to prepare consolidated financial statements in addition to their non-consolidated ones. This typically applies to:

  • Large Companies that are also required to submit an Annual Securities Report (Yūka Shōken Hōkokusho) to financial authorities under the Financial Instruments and Exchange Act (this includes most listed companies and certain other large unlisted companies).
  • Certain other Large Companies that are not explicitly covered above but whose scale of operations necessitates a consolidated view.

Purpose

Consolidated financial statements present the financial position and results of operations of a parent company and its subsidiaries as if they were a single economic entity. They eliminate intercompany transactions and balances to provide a more meaningful understanding of the group's overall performance and risk. The preparation of consolidated financial statements is governed by specific consolidated accounting standards, which are an integral part of Japanese GAAP (or IFRS/JMIS if adopted).

Conclusion

The accounting practices of Japanese Kabushiki Kaisha are firmly rooted in the legal requirement to adhere to "accounting practices that are generally accepted as fair and appropriate" – effectively, Japanese GAAP. This system, primarily shaped by the standards issued by the Accounting Standards Board of Japan, provides the essential framework for reliable, consistent, and comparable financial reporting. Its objectives are manifold: to furnish crucial information to a diverse range of stakeholders, to underpin regulations on distributable profits thereby protecting creditors, and to contribute to the overall integrity and efficiency of the Japanese economy. For anyone involved in analyzing, investing in, or conducting legal or financial due diligence on Japanese companies, a foundational understanding of these accounting requirements, the nature of Japanese GAAP, and the process of financial statement preparation and approval is of paramount importance.