The adoption of IAS in Japan affected various levels of income. A summary of the accounting changes and their effects on the different levels of income is presented inTable 1. As shown inTable 1, having consolidated financial statements as the primary financial statements, consistent with IAS 27 (see appendixfor IAS list), will increase itemized assets, liabilities, revenues, and expenses. This change will increase aggregated assets and liabilities on the balance sheet. Total revenues and total expenses will increase. The major change is the introduction and use of fair market values being used to replace or supplement historical cost. This furthers the goal of providing useful information. A few examples are presented next to illustrate the changes that IAS have when moving from traditional Japanese GAAP.
Consistent with IAS 12, Japanese accounting standards now require the adoption of asset liability in inter-period tax allocation. This change may facilitate the forecast of income tax expense.
Adoption of IAS 39 requires reporting financial instruments at fair value. This is a change from the lower of cost or market method for marketable securities and cost method for other investments. The change in fair value under the trading securities classification is reported as unrealized gains or losses in the income statement. The unrealized gain or loss of the available-for-sale securities is shown as a separate component of stockholders’ equity, net of taxes. This change is expected to give rise to higher forecasting error on current profit because of the volatile securities markets.
Adoption of IAS 19 requires the application of the accrual basis of accounting in recording pension costs and liabilities. The pension benefits are based on future salary levels discounted to the present based on actuarial calculations and estimates. Plan assets are required to be reported at fair value. Despite the requirement of the actuarial estimations of several factors of pension cost computation and fair value adjustments, an income smoothing method is applied to amortize the significant prior service cost.
Hence, the forecast errors under this accrual method are expected to be relatively lower than the cash basis.
Table 1. Summary of Accounting Standards and Effects on the Level of Income.
Effective Date Accounting Standard Effect on Level of Income April 1, 1999 Consolidated financial statements
as primary financial statements
Operating income, current profit April 1, 1999 Income tax allocation Net income
April 1, 2000 Mark to market: Current profit
Trading securities Operating income
Pension assets Current profit
Derivatives Accrual basis:
Pension costs and liability Operating income Current exchange rate on Current profit Long-term receivables and
payables
Cumulative translation gains/
losses from current rate method
No impact on income
April 1, 2001 Mark to market: No impact on income
Available-for-sale securities
Adoption of IAS 21 requires long-term receivables and payables denominated in foreign currencies to be translated at the current exchange rates at the balance sheet date. They were translated at the exchange rate prevailing at the transaction dates under the old standard. The impact is on the income statement under other income/expense. Given the existing volatile foreign exchange markets, forecasting errors on current profit would tend to be higher than those in the past.
A revision is required on the current rate method in which the currency of the overseas subsidiary is the local currency. Any translation exchange gain or loss resulting from the translation of the foreign currency into yen was formerly accounted for as a component of assets or liabilities in the previous years. It now must be recorded as a component of shareholders’ equity and minority interest in the consolidated balance sheet. Such modification is consistent with IAS 21.
Consistent with IAS 39, companies are required to state the derivatives position at fair value. The changes in fair value of derivatives designated as hedging instruments is deferred until the loss or gain on the underlying hedging instrument item is recognized. Formerly, gains or losses on derivative positions were deferred without the assessment of hedge effectiveness. This change will impact the current-profit forecasting errors and stockholders’ equity (for cash-flow hedge). The derivative markets are volatile. Perfect hedging is relatively expensive in practice.
The changes in accounting principles effective April 1, 2000 appear to complicate the forecasting of the current income. Changes in accounting principle on accounting for pensions will impact the operating income. The application of fair value accounting on marketable securities and derivatives will affect current profit. Revision of accounting for foreign currency translation will also impact current profit.
The increased disclosure and transparency income measurement is expected to decrease earnings forecast errors. The 2003 earnings forecast error should be less than that of 1999 in these three different levels of income: operating income, current income, and net income. The forecast error at the net income level should be the least, since management has a high incentive not to miss their net income forecasts by more than 30% to avoid the potential insider trading investigations. Hence, the first null hypothesis is
H01. There is no significant difference between analysts’ forecast errors on operating income, current profit, and net profit before and after the adoption of IAS.