Findings

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Chapter 8: Findings and Future improvement

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4 The tendency of IFRS firms in Japan that reverse their impairment losses

・There is a unique trend in specific firms and industries in reversing impairment losses in Japanese IFRS firms.

・The types of assets with impaired losses that can be reversed are slightly more intangible fixed assets than tangible fixed assets.

・There is a difference in performance between the reversal firm and no-reversal firm, indicating a significant difference in both net income and OCF in the medical product and food industries, which have a high rate of reversing impairment losses on intangible assets

・The significant difference in business performance disappeared as the industry reversed more tangible fixed assets.

5 Classification shifting using discontinued operations and impact on core earnings

・Firms shift operating expenses of continuing operations to discontinued operations to increase core earnings

・Firms employ the classification shifting using negative non-core earnings (negative special items) of discontinued operations, invested by desegregating reported discontinued operations into core and non-core earnings.

・Income-increasing discontinued operations negatively influence both current and future core earnings, while income-decreasing discontinued operations do not.

6 Earnings Quality on Income Statements Under J-GAAP and IFRS

・J-GAAP earnings are superior to IFRS earnings in terms of persistence, predictability, smoothness, value relevance, and timeliness, while IFRS earnings are superior in conditional conservatism.

・Pseudo-ordinary income in the IFRS sample is better than GAAP-based IFRS earnings and equivalent to the J-GAAP earnings in persistence, predictability, smoothness, and value relevance

・The results do not support the adoption of IFRS in Japan to improve earning quality while support IFRS firms to disclose compulsorily “ordinary income (or core earnings)” as GAAP earnings.

7 Earnings management using OCI recycling under J-GAAP and IFRS

・A positive association between income-increasing OCIR and meeting or beating zero earnings, prior year’s earnings, and managers’ forecasts among J-GAAP firms while earnings management behaviors using OCIR disappear in the firms under

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IFRS except for meeting or beating management’s forecast of EPS.

・Firms with net income before OCIR (PRNI) below zero use OCIR to reduce current earnings and magnify losses under J-GAAP, consistent with the Big Bath hypothesis, while there is no supportive evidence under IFRS.

・Fail to obtain the evidence both under J-GAAP and IFRS for the income smoothing hypothesis that firms with PRNI above zero use OICR to reduce current earnings.

・Permitting OCIR entirely under J-GAAP encourages Japanese firms to engage in earnings management using OCIR while adopting IFRS can successfully prevent classification shifting.

This paper clarifies the pros and cons of J-GAAP and IFRS by highlighting a fundamental problem. Specifically, the results in chapter 6 indicate that “pseudo-ordinary” income in the IFRS sample is ultimately better than GAAP-based IFRS earnings and equivalent to the J-GAAP earnings in persistence, predictability, smoothness, and value relevance. The comparison of IFRS earnings attributes with pseudo-earnings that are the closest to J-GAAP ordinary income reflects the demand for value-relevant measures of financial performance beyond GAAP-based IFRS earnings. Therefore, this study is innovative in that it proposes a more desirable style by incorporating the positive aspects of both parties beyond the existing framework of Japanese standards and IFRS.

Firstly, goodwill impairment loss under IFRS has more predictive value for future operating cash flows than that under J-GAAP, suggesting it is more informative and timelier than those under J-GAAP, even in the case of voluntarily shifting to IFRS. The same result is obtained in the tangible long-lived assets, which are more negatively related to changes in future operating cash flows. Moreover, IFRS impairments relate more to macroeconomic factors to capture declines in profitability in a timelier manner. By contrast, J-GAAP impairments further relate to macroeconomic factors resulting in the delayed recognition.

These results also indicate that J-GAAP impairments are associated with reporting incentives more than IFRS impairments. This difference also is explained by the permitted impairment reversals under IFRS because the recognition of impairment is more related to fair value evaluation of assets. This study also reveals the usefulness of impairment reversals. Given these,

187 impairment losses under IFRS are advantageous to J-GAAP impairment losses. Assuming an impairment loss is the most significant item in the gains and losses, there is a possibility that the quality of the overall income statement is influenced by the difference in such losses.

Regarding earnings quality attributed to the treatment of gains and losses in the income statement, the consequence provides mixed messages indicating strengths and weaknesses in terms of earnings under both standards. By comparing subtotal incomes in the presentation, such as operating income, ordinary income, and income from continuing operations, the results reveal that the earnings quality on the income statement under J-GAAP is superior to IFRS in terms of persistence, predictability, smoothness, value relevance, and timeliness while IFRS earnings are superior in conditional conservatism. J-GAAP earnings are considered to be collectively better in terms of the superiority of earnings associations with the market due to the common objectives of accounting reports, as indicated in the Conceptual Framework in both J-GAAP and IFRS. Therefore, the results of this study do not support the adoption of IFRS in Japan to improve the earnings quality. Further, this study reveals the advantage of J-GAAP ordinary income even in the IFRS firms. Therefore, it could be better for firms that adopt IFRS to disclose compulsorily “ordinary income (or core earnings)” as GAAP earnings that require regulation and statutory auditing.

Regarding gains and losses of presentation in the income statement, discontinued operations is the specific regulation of IFRS. This study clarifies the classification shifting using discontinued operations, which impact on core earnings, suggesting their practical problems and usefulness. However, considering the permission of line separation in the income statement always comes with a potential risk of classification shifting, it is not available and depends on the audit quality or corporate governance. Because the merit of disclosing discontinued operations is more significant, it is possible for Japan to adopt a rule to classify discontinued operations.

Lastly, another classification shifting using OCI recycling is observed in the J-GAAP-based sample while not in the IFRS sample, suggesting permitting OCI recycling entirely under J-GAAP encourages Japanese firms to engage in earnings management using it while adopting IFRS can successfully prevent classification shifting using OCI recycling. This result fundamentally stems from the restriction of OCI recycling, but under-evaluation of net income under IFRS may also contribute to the prevention. As long as J-GAAP emphasizes net income, I assume classification shifting using OCI recycling is still an attractive tool of earnings management even though it accelerates the regulation.

188 In summary, this study underwrites the significance of the impairment accounting standard under IFRS for J-GAAP. Besides, the result supports disclosing discontinued operations separately to highlight continuing operations for J-GAAP. Meanwhile, this study sheds light on the superiority of J-GAAP over IFRS, proposing to disclose J-GAAP style ordinary income. It could be a better way for Japan to shift from emphasizing net income to income from continuing operations by separate disclosure of discontinued operations because such income is advantageous to net income while sustaining the concept of net income. Given this, I propose the ideal convergence for Japan to adopt the standard of gains and losses under IFRS and for IFRS to adopt J-GAAP style ordinary income as additional disclosure through footnote as a part of GAAP earnings.

2. Future improvement