Accounting Standards Advisory Forum meeting
Equity Method of Accounting
December 2014

Feedback to the Survey on
Equity Method of Accounting

The Accounting Standards Board of Japan

I. Overview
1.

The IASB initiated a research project on the equity method of accounting in
response to the feedback received to the Agenda Consultation 2011. Having
acknowledged the critical importance of the issue, the ASBJ carried out a survey toJapanese constituents to seek their views on the usefulness and practical challenges
relating to the information using equity method of accounting. The ASBJ shared
the summary of responses received to the questionnaire with EFRAG as it issued
the Discussion Paper, EFRAG Short Discussion Series - The Equity Method: ameasurement basis or one-line consolidation?

2.

In designing the survey, the ASBJ focused on basic issues rather than technicaldetails, because it believed that setting the right scope is of utmost importance at
the initial phase of the research project. In addition, the ASBJ believed that
focusing on basic issues would be an effective way to receive the highest rate of
responses. Accordingly, the ASBJ asked the following matters in its questionnaire(a list of questions are reproduced in Appendix-I of this paper.) :(a) Whether information resulting from the application of the equity method of

accounting is found to be useful;(b) Whether the scope of the equity method of accounting under the existingaccounting standards is considered to be appropriate; and(c) What matters are found to be major implementation challenges whencomplying with accounting requirements relevant to the equity method of
accounting.
3.

The ASBJ sent a questionnaire to financial statement users, preparers and auditors,
assisted by relevant organisations1. Even with a very short comment period (from15 April 2014 to 12 May 2014), the ASBJ received 28 responses in total, of which
the details are as follows:

Financial statement users: 4 individuals;



Financial statement preparers: 23 corporations2; and

Auditors: 1 organisation3.

1

The ASBJ expresses special appreciation to the Securities Analysts Association of Japan (SAAJ),
Keidanren and the Japanese Institute of Certified Public Accountants (JICPA), as they provided assistancewith the survey.
2
All responses are from listed companies, and most of them are multi-national global companies.
Industries in which these corporations operate include manufacturing, financial services (banking,insurance services), shipping, chemical, railways and trading companies. These respondents include
users of IFRSs, Japanese GAAP and US GAAP and all these standards provide generally consistentaccounting requirements with regard to the equity method of accounting.

2II. Summary of responses
4.

Responses the ASBJ has received to the survey are summarised in the following
paragraphs.

(a) Whether Information Resulting from the Application of the Equity Method is Useful
5. The ASBJ sought views as to whether information resulting from the application of
the equity method (especially an investor’s profit or loss relative to its share of aninvestee’s profit or loss) to investments in associates provides useful information.
6.

In seeking feedback, the ASBJ asked respondents to presume that the ‘group’concept under existing IFRSs is unchanged (that is, to presume that the group
comprises a parent and its subsidiaries), because changing the group concept ismore fundamental and would require a different set of questions. In addition, the
ASBJ limited the question to investments in associates rather than trying to ask
about the relevance of the equity method of accounting to investments in joint
ventures. The ASBJ believed that the scope of applying the equity method of
accounting would be much larger for investments in associates and it would be
efficient to give consideration to investments in joint ventures after considering thebasic questions for investments in associates.

7.

Summary of responses to this question is as follows:8.

All users stated that they found the information resulting from the applicationof the equity method of accounting to be useful.

Most preparers (87% or 20 out of 23) stated that the information resulting fromthe application of the equity method of accounting is generally considered to be
useful.



Many auditors stated that the equity method of accounting is considered to be
useful, while others questioned the usefulness of the information.

Respondents who stated that the equity method of accounting contributes toproviding useful information shared the following comments:(Responses from users)3

Measurement at FV-PL being irrelevant: Measuring all equity instruments
including investments in associates at FV-PL would fail to provide useful
information to users of financial statements, especially when these investments
are not held for the purpose of capital appreciation through sales, or when areliable fair value measurement is found to be difficult (this would beThis response represents the collective views of 15 senior public accountants from large audit firms,
who are interested in this topic.

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particularly the case for equity investments in unlisted entities.)Lateness of dividend income: Recognising dividend income alone would notproperly reflect the financial performance of investments in associates in thegroup’s consolidated financial statements, because dividend income often
comes with a time lag.

Consistency with an entity’s business activities: The equity method of
accounting is relevant for investments in associates, because they are often held
as part of their business activities aiming to earn returns on the investees’
business outcome, and an investor participates in business decisions ofinvestees as a major shareholder. Yet it may be worthwhile to consider fairvalue measurement for investments in associates, when associates are listed
entities or when investments in associates are found to be frequently sold.



Inapplicability of gross presentation: If assets and liabilities of associates arerecognised in the group’s consolidated financial statements, such information
would fail to represent the group’s financial condition and would be misleading.
Thus, net presentation through the use of the equity method of accounting is awell-balanced way of communicating useful information.
(Responses from preparers)



Responsibility of group management: The equity method of accounting
provides useful information for investments in associates, because groupmanagement is usually responsible for profitability of the investees as part of
the group’s business management. The focus of group management is usually
to increase profitability from the investments by exercising power (in this case,significant influence) over them. In other words, such investments are notusually held to gain cash flows through sales of investments in the market.

Timely recognition of profits or losses: The equity method of accounting is
considered to provide useful information on profits or losses in the
consolidated financial statements, because it contributes to providing more
timely information about the investments than when measuring suchinvestments at cost.



Challenges for reliable fair value measurement: It would be significantly
challenging to reliably measure the fair value of investments in associates, andsuch measurement is inappropriate. On the other hand, the equity method of
accounting is evidenced by the investees’ financial statements which have ahigher degree of objectivity. In addition, measurement at cost would fail torepresent the existence of significant influence on the face of financial
4statements.



Cost-benefit: Costs associated with the equity method of accounting isrelatively smaller than the costs required for fair value measurement or
proportionate consolidation.
(Responses from auditors)Prevention of earnings management: Compared with measurement at cost, theequity method of accounting provides better information, because
measurement at historical cost entails risks of earnings management throughmanaging or negotiating the timing of dividend payments.

Responsibility of group management: The equity method of accounting
provides useful information for investments in associates, because groupmanagement is considered to be responsible for the performance of associates
over which it has significant influence.

Timely recognition of profits or losses: The equity method of accounting
enables the group to report the effect of changes in net assets and theperformance of investees in a timely manner.



Irrelevance of fair value measurement: Measurement at FV-PL does not reflect
the economic substance of investments in associates, as they are not held togain returns on appreciation of market prices of the investments.

9.

Some constituents stated that the equity method of accounting does notcontribute to providing useful information for users of financial information
primarily for the following reasons:(Responses from preparers)

Similarity of nature to other investments: The scope of investments to which
the equity method of accounting is applied is significantly broad, and thenature of investees differs significantly among them. The equity method of
accounting is not considered to be useful when the nature of investments issimilar to those measured at cost or FV-OCI or when there is a controllingshareholder for the investee. In addition, it would be important to note thatthe effect on profit or loss from the equity method of accounting is sometimes
so significant that the impact of the loss from the use of equity method of
accounting offsets the total profit from the group’s operation.

Function of associates under the group’s strategy: Usefulness of the equity
method of accounting is questionable, because associates are expected tofunction as part of the value-chain of the group under the group’s strategy and5capital gain is not the purpose of such investments. In addition, an investor is
not able to control the dividend policy of associates, and it is not certain
whether such dividends will be distributed to an investor. Thus, suchinvestments should rather be measured at FV-OCI or cost.
(Responses from auditors)Diversity of application in practice: There is diversity in practice for theapplication of the equity method of accounting, due to a lack of guidance in
IAS 28.

(b) Whether the scope of the equity method of accounting is appropriate
10. For respondents who stated that the equity method of accounting generally provides
useful information, the ASBJ questioned whether there are instances where theequity method does not provide useful information.
11. Summary of responses to this question is as follows:All users stated that the there are some cases when using the equity method of
accounting is not found to be useful.

Many preparers (45% or 9 out of 20) stated that the information resulting fromapplication of the equity method of accounting is not considered to be useful insome circumstances.



Some auditors stated that the equity method of accounting is not considered to
be useful in some circumstances.

12. Respondents who pointed out circumstances where information resulting from theequity method of accounting is not useful shared the following comments:(Responses from users)

Some investments being held solely for financial purposes: The equity methodof accounting may not be relevant, when an entity holds more thantwenty-percent of investees’ shares solely for financial assistance rather than aspart of its business investments.



Difficulties in understanding risk exposures from investments: Risks associatedwith investments in associates differ depending on cases. For example, forsome investments, an investor may have risk exposure beyond the nominal
amount of the investment, but in other cases the risk exposures are limited to
the nominal amount of investments. Such risk exposure is not necessarily
clear under the existing disclosure requirements.
(Responses from preparers)
6

Circumstances where the equity method of accounting would not be relevant:
The equity method of accounting may fail to provide useful information tousers in the following circumstances when: A dividend policy of an associate is controlled by another entity. Thismight be the case where an associate is a subsidiary of another entity.
 A group intends to sell off its investment in an associate in the near future.
 An associate is a listed entity.
(Responses from auditors)Lack of information relevant to sub-totals in the statement of profit or loss andOCI: The impact on profit or loss using the equity method of accounting isshown in one-line in the statement of profit or loss and OCI. Thus, it may bedifficult to understand significant events that occur in associates, such asrecognition of impairment losses.

(c) Major implementation challenges relating to the equity method of accounting
13. The ASBJ also questioned whether constituents have faced significant
implementation challenges, when applying the equity method of accounting.
14. Summary of responses to this question is as follows:

Half of users stated that the there are some challenges in using information
resulting from the use of the equity method of accounting.



Approximately two third of preparers (70% or 16 out of 23) stated that they
have faced practical challenges when applying the equity method of
accounting.



Auditors stated that they have faced practical challenges when performing anaudit of information prepared using the equity method of accounting.

15. Respondents who pointed out practical challenges relating to the equity method of
accounting provided the following comments:(Responses from users)

Risks of recognising impairment losses: It is sometimes difficult to anticipate
risks of recognising impairment losses for investments in associates, due to alack of sufficient disclosures regarding the current status of each associate.



Relationship with cash flows: It is difficult to understand whether profits fromthe equity method of accounting have actually contributed to cash inflows of
the investor.
(Responses from preparers)
7

Availability of data: It is significantly challenging to obtain financial
information that is necessary for the equity method of accounting (including
the data necessary for elimination of unrealised gains or losses fromtransactions between the investor and its associates) in a timely manner, given
the recent trend of an accelerated financial reporting period.



Unification of reporting periods: It is significantly challenging to unify
reporting periods between an investor and associates, especially given that afinancial reporting period is often the end of March in Japan, while thefinancial reporting period is often the calendar year in many other jurisdictions.



Unification of accounting policies: It is significantly challenging to unify
accounting policies among an investor and associates, given that an investor
has only a significant influence over the associates. Such challenges areparamount when the associate is a listed entity or a subsidiary of another listed
entity.
(Responses from auditors)



Difficulties in auditing judgment: Judgement of accounting treatments is often
challenging for the following areas: Whether to measure a previously held interest at far value when investments
in associates are obtained in stages;
 Whether to capitalise acquisition costs for investments in associates; and How to account for the share of other net asset changes for investments inassociates.

(d) Other comments
16. Other than those stated in paragraphs 5 to 15 of this paper, the ASBJ received thefollowing comments:(Responses from users)

Consideration of business model: When considering the equity method of
accounting, it is important to identify the business model where an investor
does not control its investee and it does not aim to realise the return on theinvestment through movement of market prices.
(Responses from preparers)Discussion about ‘one-line consolidation’ vs. ‘measurement’: It is important toconsider whether the equity method of accounting is ‘one-line consolidation’ ora form of ‘measurement’, but the equity method of accounting should not be
considered as either a ‘pure-one line consolidation’ or a ‘measurement basis.’8

Rather, it should be considered as a ‘mezzanine-type method’ that falls
in-between consolidation and FV-PL.



Notion of significant influence: It is important to clarify the conceptual
grounds of why a twenty-percent share holdings is supposed to give rise to‘significant influence’, where investments of less than twenty-percent ofshareholdings is presumed to be otherwise, especially when both investments
are held for strategic purposes.

Impairment testing for investments in associates: Accounting requirements
relating to impairment testing for investments accounted for using the equity
method of accounting are unclear. This lack of clarity is attributable to thefact that IAS 28 requires many procedures as if an investment in an associate is
not a single asset, while it requires that the impairment test should be
performed as if the investment as a whole is a single asset.
(Responses from auditors)Elimination of unrealised gains or losses: It is important to maintain that therelevant share of unrealised gains or losses from transactions between an
investor and associates be eliminated, while there is an argument thatelimination of unrealised gains or losses would be unnecessary when the equity
method of accounting is regarded as part of the measurement.

Question to the ASAF members
1.

Do you have any questions or comments on the ASBJ’s survey?

2.

Have you heard of other views that you believe would help the IASB to set thedirection for carrying out the research project on this subject?

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Appendix-I

A list of questions in the ASBJ’s survey
Question 1: Do you think that the information resulting from the application of theequity method for the investee over which the investor has ‘significant influence’(especially investor’s profits or losses relative to its share of the investee’s profits orlosses) provides useful information? In answering the question, please presume thatthe ‘group’ concept under existing IFRSs is maintained.
Question 2: For respondents who answer ‘yes’ to Question 1, do you believe that there
are any instances where the equity method of accounting does not provide useful
information? In answering the question, please presume that the scope of
consolidation and the equity method of accounting specified in existing Standards aremaintained.
Question 3: Have you faced significant implementation challenges (such as difficulties
in obtaining sufficient information), when applying the equity method of accounting?
Question 4: Please provide additional comments, if any.

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