The articles looks at which accounting standards apply, the different categories of enterprise combinations defined in those standards and finally how purchase accounting is dealt with in Japan including how goodwill and reserves required for future costs are recognised.
Accounting treatment of Japanese enterprise combinations
There are three principle sets of Japanese accounting regulations applicable to enterprise combinations (all links below in Japanese).
- The Accounting Standards Relating to Enterprise Combinations (企業結合に関する会計基準・below the ‘Combination Standard’) which addresses the accounting treatment at the time of the enterprise combination.
- The Accounting Standards Relating to Business Splits (事業分離等に関する会計基準・below the ‘Split Standard’). This standard focuses on the accounting treatment for the party that originated the transfer, corporate split or similar reorganization transaction and the treatment for shareholders in enterprise combinations.
- The Practice Guidelines relating to Accounting Standards for Enterprise Combinations and Business Splits (企業結合会計基準及び事業分離会計基準に関する適用指針・below the ‘Combination Guidelines’). The Combination Guidelines give more detailed regulation on the application of the two standards above.
As discussed in this article, recent IFRS convergence changes to Japanese accounting standards have prohibited merger accounting. The above set of regulations define three different accounting treatments which can apply to an enterprise combination including purchase accounting, the treatment of transactions under common control and a treatment with some of the features of merger accounting intended to be applied to limited classes of joint venture-like co-operative enterprise combinations. These three methods are summarized in the table below.
|Purchase (取得)||Formation of Enterprise Under Co-operative Control (共同支配企業の形成、below ‘JV Formation’)||Transaction under Common Control (共通支配下の取引等, below ‘Group Transaction’)|
|Definition||The acquisition by one enterprise of control over another enterprise or of a business that comprises an enterprise. This is also the default category for any enterprise combination that is not treated as a JV Formation or Group Transaction.||A enterprise combination resulting in the formation of a co-operatively controlled enterprise (i.e. a joint venture or similar) from two or more formerly independent enterprises based on contract or similar||A enterprise combination where both before and after the combination an identical set of shareholders have final control of the enterprise or business concerned and such control is not transitory or temporary|
|Valuation of assets and liabilities acquired||In principle the value of assets and liabilities that are capable of separate recognition is based on market value at the time of the enterprise combination and any difference between such valuation and the consideration paid is treated as goodwill||In principle at an book value.||In principle at an book value. See note 1|
|Example||The straightforward purchase of one company by another.||Establishing a new joint venture company||An internal group reorganization between parent and subsidiary or brother and sister companies.|
Note1 In relation to a enterprise combination involving a parent company and its subsidiary, when the assets and liabilities of the subsidiary company are being adjusted on consolidation then, in relation to the individual financial statements prepared by the parent, the amount that is booked on the enterprise combination is the book value after adjustment for reporting on the consolidated financial statements.
Purchase transaction treatment is the default treatment for an enterprise combination that does not meet the criteria to apply JV Formation or Group Transaction treatment. The criteria for these transactions will be explained in later articles but below we first look at the four steps in a purchase transaction:
- Identification of the acquired enterprise
- Calculation of acquisition cost
- Allocation of acquisition cost
- Determination of the residual amount of goodwill
Identification of the acquired enterprise
The acquiror and the acquiree in the enterprise combination first have to be identified. This in turn means determining which enterprise (the acquiring enterprise) has obtained control over the other enterprise. In principle the same tests are used in this respect as are applied for determining whether one enterprise should consolidate another enterprise for Japanese accounting purposes, so reference is made to the same consolidation guidelines (all links in Japanese – these are the Accounting Standard Concerning Consolidated Financial Statements or 「連結財務諸表に関する会計基準」the Practice Guidelines Concerning the Scope of Subsidiary and Related Companies in Consolidated Financial Statements or 「連結財務諸表における子会社及び関連会社の範囲の決定に関する適用指針」and the Practical Treatment Related to Review of the Scope of Subsidiary and Related Companies in Consolidated Financial Statements or「連結財務諸表における子会社及び関連会社の範囲の見直しに係る具体的な取り扱い」).
In order to help clarify the application of the above consolidation standards to enterprise combinations the Combination Standard lists four factors to consider when identifying the acquiror in a enterprise combination. These are:
- In general, the company paying across cash or other assets or which is succeeding to liabilities is the acquiror.
- In enterprise combinations involving the transfer of shares, the enterprise transferring the shares would normally be the acquiror.
- Relative scale – the enterprise that is clearly larger in terms of total assets, revenues or similar would normally be the acquiror.
- Where a combination involves three or more enterprises, consider which of the enterprises first proposed the combination concerned.
Although the above factors may often be important they are not always decisive. For example, it may not always be true that the company issuing the shares is the acquiror and factors such as the composition of the shareholders post combination, make up of boards of directors, conditions relating to the issue of shares and similar matters relating to the control of the enterprises concerned should also be considered.
Calculation of acquisition cost
In principle the cost of the acquisition should be based on the market value of the consideration at the time of the acquisition. Where the consideration is in cash only then determination of the acquisition cost is of course straightforward. However, when consideration for the acquisition is in assets other than cash, consideration should be given to which is the most reliable acquisition basis out of either a valuation of the consideration paid or alternatively a valuation of the enterprise or business acquired.
Note that the direct costs of specified fees or commissions paid to external advisors or similar can be included in acquisition cost but that other costs should be expensed in the year that they arose.
Allocation of acquisition cost
Costs of acquisition should be allocated to the assets purchased or liabilities succeeded to that are capable of separate recognition and based on their market value at the time of the enterprise combination. This will include allocating acquisition cost to legal rights or other separable intangible assets that had not previously been recognized on the balance sheet of the acquired enterprise. Intangible assets here can also include costs of incomplete but ongoing research and development or also customer lists where such assets are capable of separate recognition. This article discusses this process in more detail.
Where costs and losses of restructuring are foreseen to arise post the enterprise combination and the possibility of such costs arising is reflected in the calculation of consideration for the enterprise combination, then such future expenses should be recognized as a liability in the Special Account for Enterprise Combination (企業結合に係る特別勘定). Given goodwill is the residual amount of consideration after allocation, the recognition of such a liability will correspondingly increase the overall amount of goodwill arising in the enterprise combination.
Goodwill – the residual amount left over after the above allocation of acquisition cost – should be recognized as an asset and amortized in a straight line over twenty years or according to some other logical method. Where negative goodwill arises however the amount should be recognized in the financial period end of the reorganization as an exceptional gain.
The amount remaining after allocation of the acquisition cost to assets and liabilities capable of separate differentiation is allocated to goodwill.
JV Formation and Group Transactions
When specified criteria aimed at differentiating co-operatively run joint venture enterprises are met then the JV Formation accounting treatment can apply. These criteria are explained in the flowchart in this article.
A Group Transaction would typically be an internal merger, share exchange or similar transaction where there was no change in the composition of the shareholders (which may include minority shareholders) before and after the transaction.
Note that the tax treatment of a transaction is independent from the accounting treatment for a transaction so it would be quite possible for a transaction that is a Group Transaction for accounting purposes to be treated as non-qualified for tax purposes which would involve rebasing assets to their market value for tax purposes while they retained their original market value for accounting purposes.