This post reviews principles behind allocating cost to intangible assets under Japanese purchase accounting for business combinations.
As part of Japan’s convergence with International Financial Reporting Standards (IFRS) Japanese merger accounting (持分プーリング in Japanese, best translated as “pooling of interests”) is no longer available from 1 April 2010. Also the Japanese Accounting Standards Board (‘JASB’) intends examining in Step 2 of its IFRS convergence process whether Japan’s current approach – amortisation of goodwill over a set period – should be brought closer to the IFRS approach (namely separately identifying intangible assets and goodwill and then periodically reviewing the value of such goodwill). The JASBs request for public comment on accounting for business combinations is here and the related paper here.
Against the above background on 18 December 2009 the Japanese Accounting Standards Board issued an invitation for public comment on the accounting for intangible assets – 無形資産に関する論点の整理/mukei shisan nikansuru ronten no seiri “Summary and Analysis of Debate Related to Intangible Assets”.
It is important to note that the tax treatment and accounting treatment relating to the recognition of intangible assets in a corporate reorganisation can be significantly different. Differences can arise both with respect to the scope of transactions in respect of which intangibles are recognised (for example, you may have a transaction to which purchase accounting applies but which is also a qualified transaction for tax purposes with no revaluation of assets to market value for tax purposes and no recognition of taxable gain) and with respect to the balance sheet valuation of “tax goodwill” and “accounting goodwill”.
Furthermore the Japanese tax practice around the recognition of intangible assets for tax purposes on a business combination is not well developed, with the default treatment historically being to have lumped together most intangibles as goodwill for tax purposes without their differentiation into different types of separable intangibles. These issues are discussed further below.
Basic treatment of accounting for intangible assets under Japanese purchase accounting
Under current Japanese purchase accounting rules purchase consideration should be allocated to the market value at the time of the business combination concerned of rights that arise under the law that can be separately identified. The related intangible asset should then be recognised on the balance sheet. Intangible assets typically falling into this category would include copyrights, trademarks, patent rights and similar. Furthermore intangible assets that do not have such a defined legal nature (although they may still arise from contract law) but which can be separately identified and are capable of sale should also be valued and the purchase consideration allocated accordingly. Examples of such assets might include customer lists, databases, the results of research activities that are not yet complete (i.e. have not yet resulted in the registration of a patent right or similar but which can be valued and are transferable). The Japanese accounting term for these classes of intangible assets is 分離して譲渡可能な無形資産・bunri shite jyouto kanouna mukei shisan or “assets capable of differentiation and transfer”. The discussion document mentioned above – the “Summary and Analysis of Debate Related to Intangible Assets” – goes into more detail around potential accounting treatment for different classes of asset. Note that prior to 1 April 2010 allocation of purchase cost in a business combination to intangible assets was optional, but from this date such allocation is compulsory.
Any residual purchase price after allocation to the above separately identifiable assets would normally be treated as goodwill. Conceptually the value of goodwill is attributable to factors that are not capable of differentiation such as excess earning power arising from market position, synergies from the existing organistion such as teamwork and leadership of the existing management team. Note that marketing intagibles such as brands follow the general rule for intangibles that if capable of differentiation and separate sale then they should be valued as intangible assets. Note however it is generally thought difficult to separate out the “corporate brand” (e.g. Toyota) from the product brand (e.g. Lexus) for separate valuation.
Period and method for depreciating intangible assets for accounting purposes
Once intangible assets have been recognized on the balance sheet the period and method of amortisation has to be determined. For intangible assets arising from an underlying legal right (such as a patent) or based on contract then the period of amortisation should be either the period over which the legal right extends or an appropriate period over which the benefits of the intangible can be realised. Where it can be reasonably determined that, based on past business rank or business custom, the value of the intangible can be continuously maintained and renewed without undue cost and effort then the asset can be amortised over the years that can reasonably be estimated that the asset can be maintained. However given the original assumptions around the period of amortisation may change with the passage of time, it would be necessary to periodically reconsider the amortisation policy. Although straight line amortisation is common, an appropriate method reflecting the use of the intangible is also possible.
Where negative accounting goodwill arises the amount is credited directly to the profit and loss account in the year concerned under the revised rules adopted as part of IFRS convergence from 1 April 2010.
Tax treatment of “Goodwill”
“Goodwill” for Japanese tax purposes is defined and treated under the Japanese tax law differently from accounting goodwill. In particular the tax law recognises the creation of a so called “資産調整勘定” or “Asset Adjustment Account” for tax purposes which, is calculated from the value of the consideration in a taxable business combination concerned less the market value of the net assets acquired. (Note that an adjustment can also be made to the Asset Adjustment Account under some circumstances when excessive consideration is paid for a company. This is a tax anti-avoidance measure intended to prevent overpaying for businesses amd claiming correspondingly excessive tax depreciation – the adjustment being called the 資産等超過差額 or “Asset Excess Amount”). The amount in the Asset Adjustment Account is then amortised as tax deductible over five years (if negative, amortised into taxable profits over five years).
Tax practice in the past in Japan has tended not to separately identify separable intangible assets and depreciate them for tax purposes but instead to include them as part of the above overall Asset Adjustment Account amount. However given with the above accounting changes it is now mandatory to account for seperable identifiable intangible assets it seems likely that this practice will change.
Deferred tax accounting for goodwill
The above JASB paper on accounting for business combinations includes proposals that distinguish clearly between “accounting goodwill” and “tax goodwill” (i.e. the amount in the Asset Adjustment Account).
In sections 117 to 131 proposals for deferred tax accounting for goodwill are discussed. These paragraphs note that the Japanese accounting goodwill (based on accounting principles) is different from tax goodwill (based on the tax law) and also identifies problems from treating tax and accounting goodwill as identical (e.g. the impact on tax accounting of revaluations of accounting goodwill). The draft considers as one possibility for deferred tax accounting for goodwill, being to not recognise a deferred tax asset or liability on account of goodwill at the time of a tax qualified transaction (where tax goodwill will not arise) but to recognize a deferred tax asset in full in respect of the timing difference represented by the tax goodwill on a non-tax qualified transaction (Section 127 and 128). However the report also notes that given the differences between tax and accounting goodwill another approach is not to change existing Japanese accounting practice (Section 128) so the point remains open at the present time.