Japan's Fair Value Measurement Standard

A company preparing financial statements measures the fair value of financial instruments, including derivative transactions, and discloses it by level, following the requirements of Japanese standards.

Publication and timing of application

The names of the standards, issued by the Accounting Standards Board of Japan (ASBJ) unless noted otherwise, are as follows.

Before the standard, Japan's financial instruments accounting standard required fair value measurement, but there was no detailed guidance on how to measure it¹. As part of an effort to improve comparability with international accounting standards, the ASBJ published the fair value standard and the implementation guidance on July 4, 2019². On the same day, the financial instruments standard and other standards were amended². The main later developments are in the table below.

The application date is as shown in the table, and early application was permitted from the beginning of fiscal years beginning on or after April 1, 2020⁵. The amended implementation guidance applies from the beginning of fiscal years beginning on or after April 1, 2022⁶.

Fair value is an exit price

The fair value standard defines fair value in the following wording, as given in PwC's commentary⁷.

"The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date" (our translation)

This price is not the price paid to acquire an asset or the price received to assume a liability (an entry price). It is the price at which the asset is sold or the liability is transferred (an exit price). Fair value is measured as an exit price, whether or not it can be observed directly, and the measurement is based on the market. The entity's intention to hold an asset or to settle a liability is not reflected in fair value⁸.

Under the Financial Statements Regulation, a market participant is a party that trades in one of three markets and meets four requirements. The markets are the one with the greatest volume and frequency of transactions, the one that maximizes the amount received, and the one that minimizes the amount paid. The party is independent of the other parties and not a related party. It has a sufficient understanding of the asset or liability, has the ability to enter into the transaction, and is willing to enter into it voluntarily⁹.

Before the amendment, the financial instruments standard defined fair value as the "fair appraised amount" and used a reasonably calculated price when there was no market price⁸. Because the definition changed, the treatment that allowed the average market price for the month before the end of the period to be used as the year-end value of available-for-sale securities was deleted¹⁰.

International Financial Reporting Standard (IFRS) 13, "Fair Value Measurement," uses the term "fair value," but the fair value standard uses a different Japanese term, literally "current price," partly because that term is widely used in other Japanese laws and regulations¹⁰. In this English version, both are rendered as "fair value."

Scope of fair value measurement

The fair value standard covers financial instruments and inventories held for trading purposes. Financial instruments are included because aligning with international standards offers a high benefit in improving comparability between companies. Inventories held for trading are treated together with financial instruments because, like securities held for trading, they are carried on the balance sheet at fair value every period, with the valuation difference recognized in profit or loss for the period. Other assets and liabilities are in principle not included, after weighing the cost and benefit of aligning them¹⁰.

Under the Financial Statements Regulation, financial instruments are financial assets and financial liabilities. Financial assets are monetary claims, securities, and claims arising from derivative transactions, and financial liabilities are monetary obligations and obligations arising from derivative transactions. Both also include similar items¹¹. Under this definition, the claims and obligations arising from derivative transactions are financial instruments.

Whether an item is within the scope is checked in order in the following figure.

Figure description

The figure checks, in order, whether an item is within the scope of the fair value standard, with two questions. If the answer to the first question is no, the item is in principle not included. If yes, go to the next question; if the answer is no, the item is not treated as fair value and is carried on the balance sheet at acquisition cost. If yes, it is included in the scope.

"In principle" means that assets and liabilities other than financial instruments and inventories held for trading are not included, after weighing cost and benefit. The unit of account for measuring fair value, for items that are in the scope, is covered in the paragraph beginning "The unit of account for measuring fair value" below.

Shares and similar items without a market price are not treated as fair value. They are carried on the balance sheet at acquisition cost, and no fair value note is required. This carries over the earlier approach: even if a value can be calculated by some method, it is not treated as fair value. The category of securities whose fair value is recognized as extremely difficult to determine was deleted, because it did not fit the idea of measuring fair value even with unobservable inputs¹².

The unit of account for measuring fair value is determined by the accounting treatment and disclosure that apply to the asset or liability, and for financial instruments it is normally the individual financial instrument⁸. When fair value is measured for a group of financial assets and financial liabilities on the basis of the net amount offset for a particular market risk or credit risk, this is stated in the note on significant accounting policies¹³.

Valuation techniques and the levels of inputs

Fair value is measured with valuation techniques for which sufficient data are available. Examples are the market approach, the income approach, and the cost approach. Because it is hard to judge in general which technique is appropriate, no hierarchy is set among the techniques, and the technique chosen is used consistently from period to period⁸. Within a technique, however, relevant observable inputs are used to the maximum extent and the use of unobservable inputs is minimized¹⁰. Option valuation is covered in The Black-Scholes Model.

Under the fair value hierarchy, inputs are divided into three levels, in the order in which they are given priority. The Financial Statements Regulation defines them as follows¹⁴.

A Level 1 quoted price means a price used without adjustment, and when it is available it is in principle used as is to measure fair value⁸.

The fair value itself is also classified as a Level 1, 2, or 3 fair value, according to the level to which the inputs that have a significant effect on the measurement belong. When inputs of different levels have a significant effect, the fair value is classified in the lowest-priority level among them¹⁰. For example, if even one significant input is Level 3, the fair value is a Level 3 fair value.

Fair value of derivative transactions and third-party quoted prices

A quoted price obtained from a third party such as the counterparty financial institution, a broker, or an information vendor can be used to measure fair value if it can be judged to have been measured in accordance with the fair value standard¹⁶.

The implementation guidance also sets out the following treatment for derivative transactions. However, a corporate group or company whose total assets are mostly financial assets and whose total liabilities are mostly financial liabilities and liabilities arising from insurance contracts cannot use this treatment. Other corporate groups and companies can treat a third-party quoted price as fair value for the transactions below when all three of the following conditions are met¹²¹⁷.

• The third party is objectively reliable and independent of the company.
• There is no clear inconsistency between the movement, since inception of the contract, of the published inputs and the quoted price obtained.
• The fair value is judged to belong to Level 2.

The covered transactions are as follows.

• An interest rate swap that exchanges fixed and floating interest rates in the same currency, where the interest rates that are inputs are published and observable over the whole term (a so-called plain vanilla swap)
• An FX forward or a cross-currency swap, where the forward exchange rates that are inputs are published and observable over the whole term

Transactions that include an option are outside this treatment. PwC's commentary explains that, depending on the type of volatility used, such transactions are likely to be classified in Level 3 (the author's view)¹⁶.

Examples of the determination

Consider a fictional example in which the counterparty financial institution provides a quoted price. Assume that the third party is objectively reliable and independent, and that there is no clear inconsistency with the movement of the published inputs. Assume also that the fair value is judged to belong to Level 2. The interest rate swaps in Examples 1 and 3 exchange fixed and floating interest rates in the same currency, and the interest rates that are inputs are published over the whole term.

Examples 1 and 3 involve the same interest rate swap, but the companies differ in the condition on the company, so whether the price can be treated as fair value differs. Examples 1 and 2 involve the same company, but the result differs depending on whether the transaction is covered. In Examples 2 and 3, even when the price cannot be treated as fair value in this way, a third party's quoted price can be used to measure fair value if it can be judged to have been measured in accordance with the fair value standard.

Fair value levels and notes

With the application of the fair value standard, the Financial Services Agency amended the Financial Statements Regulation and other rules and introduced disclosure of the fair value of financial instruments by level³. In financial statements under the Financial Statements Regulation, except for immaterial items, the total fair value for each of Level 1, 2, and 3 is disclosed in the notes, broken down into appropriate items. For Level 2 and Level 3 financial instruments, an explanation of the valuation technique and inputs is also disclosed. For Level 3 financial instruments carried on the balance sheet at fair value, quantitative information about significant unobservable inputs and a reconciliation from the opening balance to the closing balance are also required¹⁵.

Relationship with IFRS 13

The fair value standard was developed by adopting, in principle, all of the requirements of IFRS 13, in order to improve the comparability of financial statements of Japanese and foreign companies. However, in consideration of past Japanese practice, it sets different treatments for individual items, to the extent that comparability is not significantly impaired¹⁰.

Following the headings in the source, the items given different treatments are the scope (assets and liabilities other than financial instruments are in principle not included), third-party quoted prices for certain derivative transactions, shares and similar items without a market price, and disclosure. In disclosure, of the items IFRS 13 requires, the amounts transferred between Level 1 and Level 2 and the reasons for them, and the effect of changing Level 3 inputs to alternative assumptions, are not required by the disclosures in the implementation guidance¹².

The content of IFRS 13 and ASC 820 in the United States, and the way the fair value levels are viewed, are covered in Fair Value Measurement: IFRS 13, ASC 820 and the Fair Value Hierarchy.

Notes

Notes

1. PwC Arata LLC, "ファンドニュース 不動産シリーズ －「時価の算定に関する会計基準」について" (Fund News, Real Estate Series: On the "Accounting Standard for Fair Value Measurement", in Japanese; our translation) (August 2022), p.1, "「時価の算定に関する会計基準」および関連する会計基準等の改正" (the Accounting Standard for Fair Value Measurement and amendments to related standards). Commentary from an audit firm. ↩ ↩²

2. PwC Arata LLC, "日本基準トピックス 第378号" (Japanese GAAP Topics No. 378, in Japanese; our translation) (July 4, 2019), p.1, "主旨" (purpose) and "経緯" (background). The amended standards are those listed in this source. Commentary from an audit firm. ↩ ↩²

3. PwC Arata LLC, "日本基準トピックス 第389号" (Japanese GAAP Topics No. 389, in Japanese; our translation) (March 19, 2020), p.1, "主旨" (purpose). The Financial Services Agency published the Cabinet Office Order on March 6, 2020. ↩ ↩²

4. PwC Arata LLC, "日本基準トピックス 第395号" (Japanese GAAP Topics No. 395, in Japanese; our translation) (April 6, 2020), p.1, "主旨" (purpose). The Ministry of Justice's ministerial order was published on March 31, 2020, and joint-stock companies other than large companies obliged to file securities reports are permitted to omit disclosure by level. ↩ ↩²

5. Same, "日本基準トピックス 第378号," p.4, "適用時期" (timing of application). ↩

6. PwC Arata LLC, "ファンドニュース 不動産シリーズ" (Fund News, Real Estate Series, in Japanese), p.6, "適用時期" (timing of application). Early application of the amended implementation guidance is also permitted from the beginning of fiscal years beginning on or after April 1, 2021. ↩

7. The quotation is the definition in the fair value standard as shown in PwC Arata LLC, "日本基準トピックス 第378号" (Japanese GAAP Topics No. 378, in Japanese), p.2, "時価の定義" (definition of fair value). ↩

8. PwC Arata LLC, "ファンドニュース 不動産シリーズ" (Fund News, Real Estate Series, in Japanese), p.2, "時価の算定" (measurement of fair value; 1. definition of fair value, 2. unit of account, 3. measurement method). The source gives the earlier definition as "公正な評価額" (fair appraised amount). The source gives paragraph 31 of the fair value standard as the basis for the basic approach. ↩ ↩² ↩³ ↩⁴ ↩⁵

9. Financial Statements Regulation (in Japanese; see the English translation at Japanese Law Translation), Article 8, paragraph 64. ↩

10. PwC Arata LLC, "日本基準トピックス 第378号" (Japanese GAAP Topics No. 378, in Japanese), p.2, "開発にあたっての基本的な方針" (basic policy for development), "時価の定義" (definition of fair value), "期末前 1 か月の平均価額の削除" (deletion of the average price for the month before period end), and "時価の算定方法" (fair value measurement method). The source gives the IFRS 13 term as "公正価値" and the term in the fair value standard as "時価". ↩ ↩² ↩³ ↩⁴ ↩⁵ ↩⁶

11. Financial Statements Regulation (in Japanese; see the English translation at Japanese Law Translation), Article 8, paragraph 41 (definition of "financial instruments"). ↩

12. PwC Arata LLC, "日本基準トピックス 第378号" (Japanese GAAP Topics No. 378, in Japanese), p.3, "その他の取扱い" (other treatments), "市場価格のない株式等の取扱い" (treatment of shares and similar items without a market price), and "開示" (disclosure). ↩ ↩² ↩³

13. PwC Arata LLC, "日本基準トピックス 第389号" (Japanese GAAP Topics No. 389, in Japanese), p.3. The treatment of non-consolidated financial statements is in Article 8-6-2, paragraph 10 of the Financial Statements Regulation (the current paragraph number; the source shows the numbering as of 2020). The note on significant accounting policies when the net amount is used as the unit is in Guideline 8-2-10 of the Financial Statements Regulation. ↩ ↩²

14. Financial Statements Regulation (in Japanese; see the English translation at Japanese Law Translation), Article 8, paragraphs 65 to 68 (inputs used in measuring fair value, observable inputs, unobservable inputs, and the level to which inputs belong). The parenthetical on "active market" in the table is from Article 8, paragraph 68, item 1. ↩

15. Financial Statements Regulation (in Japanese; see the English translation at Japanese Law Translation), Article 8-6-2, paragraph 1, item 3 (sub-items (a) and (b) are the totals by level, (c) is the explanation of valuation techniques and inputs, and (d) is the Level 3 notes). ↩ ↩²

16. PwC Arata LLC, "ファンドニュース 不動産シリーズ" (Fund News, Real Estate Series, in Japanese), p.4, "第三者から入手した相場価格の利用" (use of quoted prices obtained from third parties). The statement that transactions including options are considered likely to be classified in Level 3 is written in the source as the author's view. ↩ ↩²

17. Deloitte Tohmatsu Group, "時価算定会計基準に関連する開示の事例分析（第2回）" (Analysis of Disclosure Examples Related to the Fair Value Standard, Part 2, in Japanese; our translation) (monthly Accounting Information, April 2023), "（4）デリバティブ取引について第三者から入手した相場価格を時価とみなす容認規定" (4. The permitted treatment of regarding a quoted price obtained from a third party for a derivative transaction as fair value). Paragraph 24 of the implementation guidance. ↩

18. PwC Arata LLC, "日本基準トピックス 第395号" (Japanese GAAP Topics No. 395, in Japanese), p.2, notes (*1) (results of the Ministry of Justice's call for comments on the Regulation on Corporate Accounting) and (*2) (Article 444, paragraph 3 of the Companies Act). ↩