ISA 600 Explained
The International Federation of Accountants has updated the International Standard on Auditing 600 (ISA 600), and the revised standard went into effect on December 15, 2023. What are the advantages and disadvantages of the revisions when it comes to group audits?
What are the pros and cons of the latest update to the International Standard on Auditing?
The International Federation of Accountants has updated the International Standard on Auditing 600 (ISA 600), and the revised standard went into effect on December 15, 2023. What are the advantages and disadvantages of the revisions when it comes to group audits?
Firstly, a group audit refers to an audit of consolidated financial statements where the parent company and its subsidiaries are viewed as a single economic entity or “group.” It is often conducted by the parent company’s auditor, known as the group auditor, and encompasses the financial information of the parent company and its subsidiaries. As the group auditor will provide an opinion on the consolidated financial statements, it is essential that they are satisfied with the work completed by component auditors or local audit teams.
The group audit is necessary because businesses often operate through different legal entities and across different geographical locations. For an accurate view of the group’s financial situation, auditors must assess financial statements at both the parent and subsidiary levels and follow the standards established by the relevant auditing bodies.
International Standard on Auditing 600 (ISA 600) (Revised), Special Considerations—Audits of Group Financial Statements (Including the Work of Component Auditors) deals with special considerations that apply to a group audit, including when component auditors are involved. The standard is effective for audits of group financial statements for periods beginning on or after December 15, 2023, and aligns with recently revised standards which emphasize the assessment of risk, including ISQM1 and ISA 220 (Revised) and ISA 315 (Revised 2019). There is increased emphasis on the responsibilities of auditors relating to professional skepticism, planning and performing a group audit, two-way communications between the group auditor and component auditors, and documentation.
The changes are intended to:
- Encourage proactive management of quality at the group engagement and the component levels
- Keep the standard fit for purpose in a wide range of circumstances and in a developing environment
- Reinforce the need for robust communication and interactions during the group audit
- Foster an appropriately independent, challenging, and skeptical mindset on the part of the auditor
ISA 600 (Revised) sets out the responsibilities of the group auditor for providing the audit opinion on the group financial statements, including components such as subsidiaries, associates, joint ventures, and non-controller entities.
Advantages
Viewed from the component auditor’s side, relying on a variety of useful information regarding management’s rationale from the group auditor can reduce the risk of material misstatement and detection risk when conducting audit components.
One significant change is the introduction of the risk-based approach as a framework for planning and performing a group audit engagement. This means more focus on identifying and assessing the risks of material misstatement and performing further audit procedures in response to the assessed risks. The group auditor develops initial expectations and, based on these, may involve component auditors in risk assessment procedures, as these individuals may have direct knowledge and experience with the entities or business units that could be helpful in understanding the activities and related risks.
According to the standard, the group engagement partner may take responsibility for directing and supervising component auditors in different ways, such as:
- Discussing identified and assessed risks, issues, findings, and conclusions
- Participating in the closing or other key meetings between the component auditors and component management
The discussion between the group auditors and component auditors provides the opportunity to understand how and where the entity’s financial statements may be susceptible to material misstatement due to fraud. This is done by considering external and internal factors affecting the group that may create an incentive or pressure for group management, component management, or others to commit fraud. The discussion between group engagement partners and other key management team members also provides a chance to identify risks of material misstatement relevant to components where there may be impediments to the exercise of professional skepticism. In other words, the involvement of the group auditor enhances the effectiveness of component auditors.
ISA 600 (Revised) strengthens and clarifies the importance of two-way communications between the group auditor and component auditors as well as various aspects of the group auditor’s interaction with component auditors. However, there are many types of restrictions that may exist, such as on access to people and information (e.g., component management, those charged with governance of component, component auditors) as well as audit documentation.
Viewed from the group auditor’s side, the revised standard provides guidance on ways to overcome restrictions. The group auditor may be able to visit the location of the component auditor or meet with the component auditor to review their audit documentation. They may also be able to review the relevant audit documentation remotely when not prohibited by law or regulation and request that the component auditor prepare and provide a memorandum that addresses the relevant information.
Disadvantages
The application of ISA 600 (Revised) may also bring some downsides.
According to the requirements, the role of group auditor increases, as does the workload of component auditors. The group auditor may involve component auditors to provide information or perform audit work to fulfill the requirements of the standard.
Component auditors can be—and often are—involved in all phases of the group audit. The group auditor shall take responsibility for the nature, timing, and extent of further audit procedures to be performed, including determining the components at which to perform further audit procedures. This responsibility is demonstrated through meeting the requirements of the consolidation process and considerations when component auditors are involved.
Communication
ISA 600 (Revised) includes enhanced documentation requirements and application material to emphasize the link to the requirements of ISA 230 and other relevant ISAs. The required documentation includes:
Basis for the group auditor’s determination of components
Basis for the group auditor’s determination of the competence and capabilities of component auditors
Documentation of the direction and supervision of component auditors and the review of the work
Additional considerations when access to audit documentation is restricted
The strength and clarity of the importance of two-way communications between the group auditor and component auditors in the standard are likely to result in more work for the group engagement team. This is particularly true regarding the enhanced responsibilities in evaluating the component auditor’s communication and the adequacy of their work, the sufficiency and appropriateness of audit evidence obtained, and communicating with group management and those charged with governance of the group. References in the standard to the definition of “engagement team” includes the group auditor and component auditors.
As mentioned, the group auditor will involve component auditors and clarify the instructions for the risk-assessment procedures. However, in practice, there are some instructions from the group auditor that may not be suitable for component auditors, and this can lead to some aspects of the instructions not being effective.
These changes to the standard will take time to implement, comply with, and complete for both the group auditor component auditor sides.
Generally, both sides should make sure that they understand the new requirements and that audit methodologies are updated accordingly and in a timely manner. They should also reassess the models being used for considering component materiality and aggregation risk to determine whether they are still appropriate.
For more information, please contact Grant Thornton Japan at info@jp.gt.com or visit www.grantthornton.jp/en
Internal Controls, Sustainability, and IFRS
With two new sustainability standards in effect for annual reporting as of January 1, 2024, companies may need to reassess their internal controls to ensure they are compliant with disclosure requirements.
How two new sustainability standards impact reporting and disclosure, and what companies should consider to ensure they are compliant.
On June 26, 2023, the International Sustainability Standards Board (ISSB) unveiled its first-ever standards for sustainability disclosure. Designated International Financial Reporting Standards (IFRS) S1 and S2, they focus on general sustainability- and climate-related disclosures.
As demand grows from investors, regulators, customers, and other stakeholders for companies to disclose their sustainability practices and impact on the environment and society, these standards could help with the assessment of a company’s long-term sustainability, its ability to manage risks and opportunities, and to compare companies across industries.
IFRS S1, General Requirements for Disclosures of Sustainability-related Financial Information, requires companies to disclose financial information about their sustainability-related risks and opportunities that is useful to primary users of general-purpose financial reports in making decisions related to providing resources to the company. IFRS S2, Climate-related Disclosures, requires companies to disclose the same related to climate.
As this information could affect the company’s cash flow, access to financing, or cost of capital, the requirement for reporting and transparency might influence strategy, objectives, and decision-making processes.
With these new sustainability standards taking effect for annual reporting periods beginning on or after January 1, 2024, companies should reassess their systems of internal controls to comply with the disclosure requirements.
The table below shows internal controls that companies may need to consider.
| Internal Control Areas | Points to Consider |
|---|---|
| Data collection, verification, and management | · Accuracy and reliability of sustainability data for reporting · Manage the increased volume of sustainability data |
| Risk assessment and management | · Controls and processes to identify, assess, and manage risks and opportunities · Consistency with its strategic decisions and operations |
| Technology infrastructure | · Invest in new technology and IT controls |
| Training and awareness | · Invest in employee training and awareness programs · Policies and procedures to evaluate competencies |
| Governance | · Establish authority and responsibility |
| Integration with financial reporting | · Communication and monitoring from management and those charged with governance · Facilitate external audit |
| Stakeholder engagement | · Inclusion of processes for engaging with stakeholders |
Data Collection, Verification, and Management
The IFRS standards and reporting promote transparency and accountability regarding sustainability- and climate-related risks and opportunities. By requiring the collection and validation of data, a company can ensure accuracy and reliability for reporting.
Doing so will require robust internal controls similar to those used in financial reporting, and internal controls may need to be updated to manage the storage, access, and protection of a larger volume of data. As sustainability reporting is often required by regulatory bodies or industry standards, integrating sustainability metrics into internal controls helps ensure compliance and reduces the risk of penalties and legal issues.
Risk Assessment and Management
As sustainability reporting involves identifying, assessing, prioritizing, and monitoring risks and opportunities related to sustainability and climate, internal controls must include processes to effectively assess, manage, and mitigate risks. It is also key to ensure that those charged with governance have considered trade-offs associated with the risks and opportunities.
Sustainability reporting also highlights long-term sustainability goals and opportunities. Therefore, aligning internal controls with these goals can ensure that strategic decisions and operations are consistent with sustainability objectives.
Technology Infrastructure
Companies may need to invest in new technology and IT controls to manage sustainability data, especially if they are transitioning to digital reporting platforms. Information systems should be able to capture internal and external sources of data related to sustainability and climate risks and opportunities.
Training and Awareness
Companies may need to invest in employee training and awareness programs to ensure that all personnel understand the sustainability goals and the importance of reporting, and can carry out their internal control responsibilities. Companies may need to monitor the contributions of employees to these objectives. Processes may include policies to determine whether appropriate skills and competencies are available or will be developed to oversee strategies designed to respond to risks and opportunities related to sustainability and climate.
Governance
Sustainability reporting may necessitate changes in corporate governance to ensure that sustainability considerations are integrated into strategy and decision-making processes. Internal controls should reflect shifts in governance by having a governance body (which may include a board, committee, or equivalent) or individuals responsible for oversight of risks and opportunities related to sustainability and climate. Companies should also consider updating policies and procedures to reflect the responsibilities of those charged with governance and management.
Integration with Financial Reporting
Aligning the processes for sustainability and financial reporting requires careful coordination and internal controls to ensure that both are accurate and consistent. Policies and processes should consider how, and how often, those charged with governance and management are informed about sustainability- and climate-related risks and opportunities and decisions on significant transactions. Companies may also need to establish controls and policies to facilitate external audits of their sustainability disclosures to ensure that the data, processes, metrics, and targets adhere to reporting standards.
Stakeholder Engagement
Internal controls may need adjusting to address the broader set of stakeholders associated with sustainability reporting compared with traditional financial reporting. Sustainability reporting can lead to increased stakeholder scrutiny and engagement, and effective internal controls can help manage these interactions and ensure that stakeholder concerns are addressed, and the company’s reputation maintained. Communication methods should take into considering the timing, audience, and nature of the engagement.
As the ISSB is currently developing these sustainability standards, we expect that additional standards might be promulgated to address the needs of the stakeholders. Regular reviews and updates of internal controls, policies, and procedures are necessary to adapt to changing sustainability reporting standards and evolving practices.
Companies focusing on sustainability could drive innovations and efficiencies in their processes that lead to cost reductions. Internal controls can monitor and optimize these changes to ensure that they are implemented effectively and align with the company’s strategies, objectives, and decision-making processes.
For more information, please contact Grant Thornton Japan at info@jp.gt.com or visit www.grantthornton.jp/en
2023 Tax Reform Proposals
On December 16, 2022, the Government of Japan released its 2023 tax reform proposals. The amendments contain changes to the rules related to gifts and inheritance tax. The proposals are usually promulgated into law by the end of March and enter into force on April 1. Here is an overview of what to expect.
How changes to gift tax rules and audits may impact you
On December 16, 2022, the Government of Japan released its 2023 tax reform proposals. The amendments contain changes to the rules related to gifts and inheritance tax. The proposals have been promulgated into law and entered into force on April 1. Here is an overview of the changes.
Seven Year Lookback for Gifts
Currently, gifts bestowed within three years of the giver’s death are added back to the estate of the deceased for Japan inheritance tax (IHT) purposes. The value of the assets is reduced by any gift tax paid at the time the gift was received, and this amount is then subject to IHT along with the other assets of the deceased.
To offset this, one aspect of long-term estate planning is to make small annual gifts which are taxed at gift-tax rates lower than the effective IHT rate that would be levied if the gifts had remained part of the estate.
The reforms increased the lookback period to seven years for gifts made on or after January 1, 2024. This brings Japan in line with countries such as the United Kingdom.
Unlike the UK, however, there is no gradual reduction in the value of the gift over the seven-year period. One hundred percent of the gift’s value is added back to the taxable estate, regardless of whether it was made seven years or one day prior to death. A ¥1 million deduction is allowed for gifts made between three and seven years prior to someone’s passing.
The chart below shows this in action:
This change has a significant impact on lifetime estate planning, as gifts made on or after January 1, 2024, will be subject to a seven-year lookback for inheritance tax purposes.
For expats, discussion about Japan IHT planning with overseas parents can be difficult—especially if being subject to the Japanese rules would impact overseas planning. However, these proposed changes will accelerate the need for gift planning during 2023.
Valuation Methods for High-Rise Apartments
Although there are no specific amendments, another issue that needs to be considered in the near future is the government’s discussion of amending the rules surrounding the IHT valuation of apartments in high-rises.
Currently, there can be a large disparity between the fair market value of an apartment and its tax basis for IHT purposes. This is due to the use of various tax valuations that reduce the IHT value. For apartments in certain parts of Tokyo, the IHT value can be significantly lower than the fair market value. This disparity can be used to reduce the value of an estate considerably for IHT purposes. The government has indicated that it will look to close this avenue for tax planning in the future.
Tax Audit Statistics
The government also released its tax audit statistics in December, covering audits conducted between July 2021 and June 2022. Direct comparisons to previous years are unreliable due to the impact of the Covid-19 pandemic on the tax authority’s ability to conduct audits. However, the number of audits involving overseas assets increased by 20 percent over the previous year and is approaching the level seen prior to the pandemic. About two-thirds of the cases involved undisclosed assets in North America or Asia.
Additionally, the number of simple inquiries where the tax office contacts a taxpayer by post or phone increased by eight percent over the previous year and is 40 percent higher than pre-pandemic levels. This indicates that the tax office has shifted to less formal inquiries as a means of identifying taxpayers who require a full audit.
Summary
The increase in the lookback period for gifts accelerates the need for planning before the end of the year. This will be necessary to ensure that gifts fall out of the scope of IHT sooner. Current planning utilizing high-rise apartments may also need to be revisited in light of the anticipated changes.
As always, with any informal contact from the tax office, it is wise to consult with your tax advisor before submitting a response.
For more information, please contact Grant Thornton Japan at info@jp.gt.com or visit www.grantthornton.jp/en
Tax and Trends
Yamada & Partners can help non-Japanese better understand how their assets are taxed and assist them in reducing their tax liability while accurately reporting income and assets.
Understanding Japan’s asset-related taxation system and shifts in audits
Understanding how income and assets are taxed in Japan can be a challenge for anyone, whether citizen or non-Japanese resident. And for those with significant wealth, investments, and real estate, a lack of understanding can lead to higher-than-expected taxes. Finding your way around the meshwork of regulations and calculations can be difficult, however, as most documents published by Japan’s National Tax Agency are only available in Japanese. Likewise, filings must be done in Japanese.
Yamada & Partners can help non-Japanese better understand how their assets are taxed and assist them in reducing their tax liability while accurately reporting income and assets.
“The tax system in Japan is one of the most complex in the world,” said Saori Koiso, an Osaka-based certified public accountant and senior tax manager with Yamada & Partners. The firm, founded in 1981, specializes in international tax consulting, inheritance and real estate, and tax compliance, among other services. Koiso hosts the webinar which covers:
- Individual income tax
- Inheritance tax
- Gift tax
- Audit trends
Individual Tax on Financial Investments and Real Estate
Individual income tax in Japan ranges from 15.105 to 55.945 percent. In the webinar, Koiso explains the brackets, deductions, and how capital gains, foreign assets, and real estate are taxed.
Capital gains derived from the sale of land and buildings are taxed separately from other income, and at different rates depending on whether they are considered short- or long-term. Various other factors, such as location of the property, residency status of the owner, and how the lessee uses the property also play a role.
Assets and liabilities—both domestic and foreign—must also be reported. The value of those assets at the time of taxation could be impacted by the international currency market, which has seen great turmoil with regard to Japan in 2022. On October 20, the Japanese yen slipped past ¥150 against the US dollar for the first time since August 1990, and there are warnings that it could slide to ¥170. This dramatic shift in currency value can have a significant impact on taxation for those who hold financial assets or own real estate overseas.
Understanding value thresholds and who must report what, and when, can make a big difference in minimizing the chance of an audit and avoiding penalties for misreporting. In the webinar, Koiso explains the key points of the system.
Inheritance Tax
Planning for the future is also important, but can be tricky when dealing with an unfamiliar system and language. If you live in Japan and continue living here, and one day pass away here, then your family members will be responsible for paying inheritance tax in Japan.
Japanese inheritance tax rates are among the highest in the world, Koiso said, in some cases reaching 53.2 percent. Understanding the rules that determine this amount is vital to minimize the impact, but can be difficult when most documents explaining the system are only available in Japanese.
Yamada & Partners’ on-demand English webinar will help you understand the rules contained in these documents.
An important thing to note is that individual heirs are taxed rather than the estate itself, as is done in the United States and many other countries. What’s more, the scope of the tax depends on a variety of factors, including:
- Whether or not the heir lives in Japan
- The heir’s visa status
- The nationality of both the heir and decedent
Another factor that has been used to determine inheritance tax liability is the period of residence, but changes were made to this in the 2021 tax reform. Under the new rules, those who have maintained a domicile in Japan for fewer than 10 of the past 15 years are only taxed on assets located in Japan rather than worldwide, as was the case before. This applies to particular types of visas, as defined by the Immigration Control and Refugee Recognition Act, but many categories are applicable to American Chamber of Commerce in Japan members, including investor/business manager, legal/accounting services, researcher, and intracompany transferee.
Also important to consider are ways to ease the process for a spouse or children left behind. Japan has rules which differ from those of the United States and other countries, and inheritance tax in Japan is calculated in accordance with the statutory inheritance ratio set forth in the Japanese Civil Code. And because there is no probate system in Japan, transferring money from a bank account can be complex for heirs if there is no will.
There are many more complexities to navigate when planning for the eventual inheritance tax, and this on-demand English webinar will help you better understand the rules and plan accordingly.
Tax Audit Trends
There have also been changes in how the National Tax Agency approaches audits. Due to the growing diversification and internationalization of asset management, the agency has increased active investigation of high-net-worth individuals with an eye towards overseas assets. Those with significant securities, real estate investments, and particularly high ordinary income have been on the radar.
The number of incorrect declaration cases grew each year from 2016 to 2019 before dropping in 2020 due to the coronavirus pandemic curtailing investigations. Of the 4,463 audits of personal income tax filings by wealthy individuals conducted in 2019, incorrect declarations were found in 3,837. The average amount of underreported income per case was ¥17.67 million and additional tax levied was ¥5.81 million. And while audits dropped to 2,158 in the first year of the pandemic, the average unreported income rose to ¥22.59 million, an increase of 127.8 percent year over year. Additional tax averaged ¥5.43 million.
As has been the trend in the past, cash and deposits are the most common underreported assets, and North America is the top region in which these assets are located.
The National Tax Agency is using the Standard for Automatic Exchange of Financial Account Information, better known as the Common Reporting Standard (CRS) to obtain data about individuals’ overseas transactions and assets by effectively utilizing the CRS system. And while the United States has not adopted the system, it does participant in the Global Forum on Transparency and Exchange of Information for Tax Purposes and has a tax treaty with Japan which allows the National Tax Agency to obtain information.
Be Prepared
Whether misreporting involves ordinary income, inheritance or gifts, capital gains, foreign assets, or real estate, understanding the system and rules—and working with professionals who know how to ensure that you are in compliance—is a must in today’s complex and interconnected world of global finance.
For more information, please visit Yamada & Partners at www.yamada-partners.jp/en/
Trusts and Audits
In December 2021, the Japanese government revealed its proposed changes to tax legislation. Some of these proposals affecting individual taxpayers are discussed in this column, together with an update on how Covid-19 has impacted the tax authority’s approach to inheritance and gift tax audits.
How changes to Japan’s tax rules may impact individuals
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In December 2021, the Japanese government revealed its proposed changes to tax legislation. Some of these proposals affecting individual taxpayers are discussed in this column, together with an update on how Covid-19 has impacted the tax authority’s approach to inheritance and gift tax audits.
Assets and Liabilities Statement
The rules surrounding this reporting obligation, which was introduced in 2015, have been amended to increase the scope of taxpayers subject to the requirements.
The additions are aimed at minority shareholders of large family corporations, such as an owner’s Japan-resident spouse or children. If the shareholder receives dividends and has no other source of income, the income tax can be settled through withholding and no return is due. Previously, they would not have met the requirement to file an assets and liabilities statement, regardless of the value of their shareholding and other assets, but the proposed changes would bring them within the scope of the report.
The changes are due to apply to income and assets beginning January 1, 2023 (January 1, 2024, for mitigating factors) with the first reports due in 2024.
Trust Reporting Requirements
Another proposed amendment is to the trust reporting requirements that apply to Japan-resident trustees and trust corporations of domestic and overseas trusts. Previously, if it was difficult to estimate the value of the assets within a trust, then the assets did not need to be included in the filing. The reports are required within one month of:
- Establishment or closure of a trust
- Changes in beneficiaries
- Changes in beneficial rights
Although there are no penalties for failure to file, individual trustees should pay attention to any filing requirements triggered by this amendment, which will apply to reports due beginning January 1, 2023.
Audit Focus
In December 2021, the National Tax Authority (NTA) released its annual audit statistics for 2020, showing the impact of Covid-19 on its approach to onsite audits. During 2020, the number of inheritance tax audits fell by 52 percent, from 10,635 to just 5,106. Of these, 551 related to overseas assets, with the NTA utilizing tax treaty information exchange provisions and Common Reporting Standards information to gather details of the assets. The average tax raised was ¥9.4 million per audit opened, a 47-percent increase in the average compared with the previous year’s ¥6.4 million.
The decrease in audits was countered by a 58-percent increase in the number of simple investigations, consisting of telephone inquiries and correspondence with taxpayers. There were 13,634 such instances in 2020, compared with 8,632 in 2019, while ¥650 million in additional tax and penalties were levied. The move from onsite audits to simple investigations shows that the pandemic has caused the NTA to focus personnel on audits with a higher chance of levying tax. The remainder are being handled with remote inquiries, seemingly a more efficient use of resources.
Takeaways
The tax reform proposals will affect individual taxpayers in different ways but, for most, the change to the filing deadline will reduce the administrative burden of filing asset and liabilities statements and overseas assets reports. Trustees of overseas trusts will have to pay attention to the changes in reporting requirements and be prepared to file reports containing estimated valuations. Finally, the increase in simple investigations is likely to mean that more taxpayers receive calls from their local tax office. In such cases, as always, seek professional advice on how to respond to such requests.
For more information, please contact Grant Thornton Japan at info@jp.gt.com or visit www.grantthornton.jp/en
Added Disclosures
The journal entries used to record the transactions of a typical trading company seem basic and are usually taught in introductory accounting classes. But while simple, when coupled with financial management concepts such as reverse factoring, supply chain finance, or supplier finance arrangement, these entries may require additional disclosures for financial reporting purposes. In November, the International Accounting Standards Board (IASB) proposed additional disclosure requirements to enhance the transparency of supplier finance arrangements.
Proposed reporting rules eye supplier finance arrangements
The journal entries used to record the transactions of a typical trading company seem basic and are usually taught in introductory accounting classes. But while simple, when coupled with financial management concepts such as reverse factoring, supply chain finance, or supplier finance arrangement, these entries may require additional disclosures for financial reporting purposes. In November, the International Accounting Standards Board (IASB) proposed additional disclosure requirements to enhance the transparency of supplier finance arrangements.
The Transaction
A trading company generally purchases on account from its suppliers, and is invoiced after the receipt of goods. This poses no issues if the company is in good financial condition, but it can be a challenge if the company has liquidity concerns. When a company cannot pay the invoiced amount, as a rule the supplier will decline further transactions with the company or will impose stringent credit measures. This may disrupt the company’s supply chain. To avoid this and secure the supply chain, the company may enter into a supplier finance arrangement with a financial institution.
Under such an arrangement, the financial institution pays the supplier at a discounted rate and the company later reimburses the financial institution. This may sound like factoring, but it differs in that factoring is normally initiated by the supplier, who sells its accounts receivable. Here, reverse factoring is initiated by the buyer obtaining a loan to defray payables.
A supplier finance arrangement is beneficial for both supplier and buyer. The former is assured of payment and can collect the amount due earlier than the due date of the invoice, while the buyer benefits from an extended due date.
Accounting Concerns
But there are things to consider. On the supplier’s side, such an arrangement is like selling accounts receivable to a financial institution, only it is buyer initiated. In other words, like a factoring of receivables, this can be viewed as off-balance-sheet financing that allows a company to increase its cash without reporting a corresponding increase in liability or equity.
On the buyer’s side, a supplier finance arrangement adds another layer to the purchase-to-pay cycle. Instead of the usual buy and pay, it becomes buy, loan, and pay. The issue here is whether accounts payable must be converted into loans payable and disclosed in financial statements.
International Financial Reporting Standards 7 Financial Instruments: Disclosures (IFRS 7) requires an entity to disclose information that enables users of its financial statements to evaluate the nature and extent of risks arising from financial instruments to which the entity is exposed at the end of the reporting period.
International Accounting Standards 1 Presentation of Financial Statements (IAS 1) requires companies to distinguish financing from working capital purposes.
A company that is protecting its current ratio would like the payable, arising from the supplier finance arrangement, to be classified as loans payable instead of trades payable. This is because loans payable can be reported as non-current when they are to be settled more than 12 months after the reporting period. This cannot be done for trades payable, which are always reported as current liabilities even if they are due to be settled more than 12 months after the reporting period. Thus, a disclosure requirement for supplier finance arrangements is necessary to understand the transaction and standardize the financial reporting requirements.
As IASB Chair Andreas Barckow explained: “Investors require more detailed disclosures about companies’ supply chain finance arrangements, as these funding practices are becoming increasingly common. The proposed requirements are designed to give investors the information they need to assess the effects of such finance arrangements on a company’s liabilities and cash flows.”
Proposed Solution
The IASB plans to amend IFRS 7 and IAS 7 Statement of Cash Flows, to require buyer companies to disclose information that enables investors to assess the effects of a company’s supplier finance arrangements on its liabilities and cash flows.
The proposed rule requires an entity to disclose, at the beginning and end of the reporting period, the line items in the statement of financial position in which the entity presents financial liabilities that are part of a supplier finance arrangement.
The proposed financial reporting requirements for supplier finance arrangements are still on the IASB’s exposure draft and are open for comment until March 28, 2022.
For more information, please contact Grant Thornton Japan at info@jp.gt.com or visit www.grantthornton.jp/en
It’s a New World for JCT
Beginning in October 2023, major changes to the laws governing Japan’s consumption tax system will likely impact a wide variety of businesses. Consumers need not worry—there is no rate hike included in these changes—but companies doing business in or with Japan will have more to consider. Companies will have to register, pay any output JCT collected to the tax authorities, and issue a qualified invoice (with certain required items stated correctly) in order for their customers to claim input JCT credits on their purchases.
How will changes to Japan’s consumption tax rules affect your business?
Presented in partnership with PwC
Beginning in October 2023, major changes to the laws governing Japan’s consumption tax system will likely impact a wide variety of businesses. Consumers need not worry—there is no rate hike included in these changes—but companies doing business in or with Japan will have more to consider.
Japanese consumption tax (JCT) is Japan’s version of a value-added tax (VAT) or sales tax. The current rate of 10 percent (up from eight percent as of October 2019) is generally applied to goods and services provided in Japan. There are some major differences between JCT and other VAT systems around the world, however, particularly concerning a company’s ability to claim input JCT credits on purchases or expenses.
In a nutshell, the current system:
- Allows purchasers to claim an input JCT credit even if the credit relates to goods or services from companies not registered for JCT purposes
- Permits companies, not registered for JCT purposes, technically not to be required to pay the output JCT they collect to the tax authorities
- Has no strict invoicing requirements, and businesses can rely on their accounting records in some circumstances
In 2023, all the above will change. Companies will have to register, pay any output JCT collected to the tax authorities, and issue a qualified invoice (with certain required items stated correctly) in order for their customers to claim input JCT credits on their purchases.
Real-world Impact
What does this mean for companies doing business in Japan? First, it is important to note that these changes will impact not only businesses with a physical presence in Japan but also those providing certain digital services to Japanese customers. (In some cases, digital services may be taxable for JCT purposes in Japan, even if the provider is located overseas.)
While at a high level many of the changes may be operational in nature, there are some more nuanced impacts that should be considered. As a first step, companies should begin to think about whether they are going to apply for the new registration.
While the application itself is not overly complex, the decision to register may be a difficult one for those businesses that are not otherwise obliged to remit the output JCT they collect to the tax authorities.
If businesses choose not to register, they will need to consider the resulting impact on their relationship with customers, who will lose the ability to claim an input JCT credit.
Next, companies may need to reexamine certain administrative processes to ensure that they can accommodate the changes. The new rules will bring additional bookkeeping and record-keeping requirements, so companies should make sure their enterprise resource planning systems are set up to handle them. The needs may include alignment of accounting systems with invoicing systems, alteration of electronic data interchange systems, and more. This may also be a good time for companies to consider whether their systems and processes are compliant with Japanese e-storage rules if accounting records are being maintained in soft, rather than hard, copy.
More Things to Consider
Apart from the need for registration and to make changes to the content of a qualified invoice, complying with the new invoicing system is likely to be easier for sellers than purchasers. More changes will be required on the purchase/expense side, as receiving and maintaining appropriate invoices will be mandatory to claim input JCT credits.
Under the new system, companies will need to reconsider the adequacy of their internal procedures—including those for employee expense reimbursements—as the system will require invoices to be maintained in cases where there was no such requirement previously.
In addition, businesses will also have to check the invoices actually received from vendors, registered or non-registered, to confirm all necessary content is included, e.g., the vendor’s registration number. This review process may already be a regular procedure in other VAT jurisdictions, but it is not currently so in Japan.
Further, the legal changes may impact the preparation of JCT returns, as the new system will require some decision-making around how the final JCT liability will be calculated.
While the qualified invoice system itself will go live in October 2023, the tax authorities began accepting applications for registration by vendors on October 1 of this year. As the tax authorities will also begin to publish information about registered companies on a dedicated website, the expectation is that many will opt for this early registration. For companies that wish to be compliant with the new system by October 2023, the application should be submitted by the end of March 2023 at the latest.
The new rules will have a pervasive influence over operations and systems. Given that businesses are likely to need professional support to prepare for all the changes, and with the application window for vendor registration having opened on October 1, now would be a good time to begin preparation.
