Explanation of Accounting Books and Financial Documents in Japanese Corporate Law

For joint-stock companies operating in Japan, adhering to the accounting-related provisions set forth by the Japanese Companies Act is not merely an accounting task. It is a legal obligation that forms the backbone of corporate governance, ensuring corporate transparency, maintaining stakeholder trust, and enabling management to fulfill their legal responsibilities. Central to understanding this obligation are the three pillars: ‘accounting books,’ ‘financial statements,’ and the ‘business report.’ While each has a distinct role, they are closely interrelated and form a comprehensive framework for presenting a company’s financial condition and management status both internally and externally.

The obligations regarding the creation, content, and preservation of these documents are specifically stipulated under Japanese Company Law. In particular, Article 432 of the Japanese Companies Act provides the basis for ‘accounting books’ that record daily transactions, while Article 435 of the same act underpins the ‘financial statements’ that summarize the financial condition for each fiscal year and the ‘business report’ that describes the overview of the business. Violations of these provisions can lead to legal liability for individual directors, with potentially significant consequences.

However, practical compliance involves more than just understanding the articles of the Companies Act. For example, while the Japanese Companies Act mandates a 10-year retention period for documents, the Japanese Corporate Tax Law generally stipulates a 7-year period. Moreover, with the recent advancements in digitalization, the Japanese Electronic Bookkeeping Law has imposed strict requirements on the preservation methods for data related to electronic transactions, which will become fully mandatory from 2024. Therefore, for companies navigating these intersecting laws, adopting the most stringent standards (in this case, a 10-year retention and compliance with electronic preservation requirements) becomes the only safe strategy. This article will unravel these complex legal requirements and comprehensively explain the specific processes from the creation of accounting books to the disclosure of financial statements, as well as the associated rights of shareholders and the responsibilities of directors, including relevant case law.

Accounting Books: The Foundation of All Corporate Accounting in Japan

Accounting books are the foundational documents that record all economic activities of a company. Under Japanese Corporate Law, the creation and preservation of these books are strictly mandated for all joint-stock companies.

Legal Obligations and Types of Accounting Books

Article 432, Paragraph 1 of the Japanese Companies Act stipulates that “a joint-stock company must create accurate accounting books in a timely manner as prescribed by the Ministry of Justice ordinance.” This timely and accurate recording is the source of reliability for financial statements prepared later. Failure to fulfill this obligation may result in an administrative fine of up to one million yen under Article 976 of the Japanese Companies Act.

While the Japanese Companies Act does not specify the exact format of accounting books, in practice, they are broadly categorized into “general ledgers” and “subsidiary ledgers.”

General ledgers are the basic books that comprehensively record all transactions and are legally essential to create.

• Journal: A book that records all transactions in chronological order of occurrence.
• General Ledger: A book that classifies and posts transactions recorded in the journal by account, summarizing them.

Subsidiary ledgers supplement the content of the general ledger and record details of specific transactions. For example, the “Accounts Receivable Ledger” manages the balance of receivables for each customer, and the “Cash Receipts and Disbursements Book” records daily cash transactions. Although their creation is not uniformly mandated by law, they are practically essential for accurate accounting and internal control.

Thus, the “accurate accounting books” required by the Japanese Companies Act must simultaneously meet the detail necessary for tax audits (as demanded by the Japanese Corporate Tax Law) and the clarity that contributes to efficient management (as required in practice).

Retention Period and Mandatory Electronic Storage

Article 432, Paragraph 2 of the Japanese Companies Act requires joint-stock companies to “preserve their accounting books and important documents related to their business for ten years from the time of closing the books.” This “important documents related to their business” is interpreted to include contracts, and the ten-year retention period is longer than the seven years prescribed by the Japanese Corporate Tax Law, making it important to comply with the Companies Act’s provisions.

Moreover, of critical importance in today’s business environment is compliance with Japan’s Electronic Bookkeeping Law. From January 1, 2024, data received through “electronic transactions,” such as invoices received via email or receipts downloaded from websites, must be stored in electronic form rather than printed on paper.

There are strict requirements for this electronic storage. For example, during a tax audit, the ability to promptly present requested data by searching for transaction dates, amounts, and counterparties (ensuring searchability), and ensuring that the data can be clearly viewed on a display (ensuring visibility) is required. To meet these requirements, it is essential to implement not just file storage but an appropriate accounting or document management system and organize internal business workflows. Compliance with this law is no longer just an accounting department issue but a significant management challenge that demands the establishment of a company-wide information management system.

Financial Statements: A Summary of a Company’s Financial Position and Performance

If accounting books are the ‘raw data’ of daily transactions, financial statements are the ‘official report cards’ that aggregate and process this data for each fiscal year, reporting the financial position and performance of a company to stakeholders.

Legal Obligations and Components

Article 435, Paragraph 2 of the Japanese Companies Act obligates stock companies to prepare financial statements and their accompanying detailed schedules for each fiscal year. According to Article 59, Paragraph 1 of the Japanese Corporate Accounting Regulations, ‘financial statements’ consist of the following four documents:

1. Balance Sheet: A document that shows the state of a company’s assets, liabilities, and net assets at the end of the fiscal year, clarifying the financial position.
2. Income Statement: A document that contrasts a company’s revenues and expenses over a fiscal year to show profit or loss, clarifying the performance of management.
3. Statement of Changes in Equity: A document that details how the net assets section of the balance sheet has changed over the fiscal year and the reasons for each change.
4. Notes to Financial Statements: A document that includes important accounting policies and explanatory notes that supplement the content of the balance sheet and other documents, which cannot be fully conveyed by the first three documents alone.

These financial statements are created based on the vast amount of data recorded in the accounting books. Understanding the relationship between accounting books and financial statements is crucial for grasping the accounting rules under Japanese corporate law.

Retention Period and Format of Preparation

The retention period for financial statements is subject to the same rules as accounting books. Article 435, Paragraph 4 of the Japanese Companies Act stipulates that ‘financial statements and their accompanying detailed schedules must be retained for ten years from the time of their creation.’ As for the format of preparation, Paragraph 3 of the same article allows for the creation of financial statements not only on paper but also as ‘electromagnetic records,’ legally recognizing the option for paperless documentation.

Business Report: The Untold Story Behind the Numbers

Under Japanese Corporate Law, companies are required not only to present quantitative financial information in their financial statements but also to create a business report that provides qualitative information.

Purpose and Legal Positioning

The business report, mandated by Article 435, Paragraph 2 of the Japanese Companies Act, differs significantly in nature from financial statements. It is essentially the ‘narrative of the business,’ explaining the progress and results of the business for the fiscal year, as well as significant matters related to the company’s situation, using text and diagrams. This enables shareholders and creditors to understand the management environment, business strategies, and future challenges behind the numbers in the financial statements.

An important legal distinction is that the business report is clearly differentiated from the ‘financial statements.’ This distinction has a significant impact on the auditing process. While financial statements are subject to accounting audits by certified public accountants or audit corporations, the business report is not. Instead, it is audited by the ‘statutory auditors’ who oversee the legality and validity of the directors’ execution of their duties. This dual auditing system is a notable feature of Japanese corporate governance, and managers must pay attention not only to the accuracy of financial figures but also to the appropriateness of qualitative descriptions in the business report.

Main Items to be Included

The contents that should be included in the business report are detailed in the Enforcement Regulations of the Japanese Companies Act (especially Articles 118 to 127). The main items common to all companies include:

• Matters related to the company’s current situation: Progress and results of the business, main business activities, major offices, employee status, main borrowing sources, significant capital investments, and financing conditions, etc.
• Matters related to company officers: Names, positions, responsibilities, and remuneration of directors and statutory auditors, etc.
• Matters related to shares: Total number of issued shares, status of major shareholders, etc.
• Matters related to the system for ensuring the appropriateness of business (internal control system): Summary of decisions regarding its establishment and operational status.

Companies are required to accurately describe these items in a way that does not lead to misunderstandings.

Supplementary Schedules: Enhancing Transparency with Detailed Information

Supplementary schedules, as the name suggests, are documents that provide more detailed information to complement financial statements and business reports. Article 435, Paragraph 2 of the Japanese Companies Act requires the creation of supplementary schedules for both financial statements and business reports.

The supplementary schedules for financial statements present essential details for understanding the financial content, which would be too cumbersome to include in the main body of the financial statements. According to the Japanese Corporate Accounting Regulations, these schedules typically include items such as:

• Details of tangible and intangible fixed assets
• Breakdown of allowance accounts
• Details of selling, general, and administrative expenses

On the other hand, the supplementary schedules for business reports contain important matters that supplement the content of the business reports. Based on regulations such as Article 128 of the Enforcement Regulations of the Japanese Companies Act, they include information like:

• The status of officers holding significant positions in other companies (significant concurrent positions)
• Details concerning significant transactions with the parent company

While there is an obligation to prepare these supplementary schedules and keep them at the company’s principal office, they are not typically required to be sent to all shareholders with the notice of the annual general meeting or reported at the meeting. Shareholders and creditors can access more detailed information by reviewing these documents at the principal office.

From Creation to Disclosure: The Lifecycle of Financial Documents in Japan

In Japan, financial documents created by a corporation are not confined to internal use but undergo a series of legal procedures including auditing, approval, and disclosure, ensuring their legitimacy. The specifics of this process vary depending on the company’s organizational structure, such as whether it has a Board of Corporate Auditors or Accounting Auditors in place.

1. Creation and Audit: First, the director(s) (or the Board of Directors) prepare the financial documents, business reports, and their accompanying detailed statements for each fiscal year. These documents are then submitted to the Corporate Auditors (in companies with a Board of Corporate Auditors) and Accounting Auditors (in companies with Accounting Auditors) for auditing. Corporate Auditors primarily audit the legality of the business reports, while Accounting Auditors audit the appropriateness of the financial documents.
2. Board of Directors’ Approval: After receiving the audit reports from the Corporate Auditors and Accounting Auditors, companies with a Board of Directors approve these financial documents etc. (as per Article 436, Paragraph 3 of the Japanese Companies Act).
3. Submission and Approval at the Shareholders’ Meeting: As a general rule, directors must submit the Board-approved financial documents etc. to the annual shareholders’ meeting for approval (according to Article 438 of the Japanese Companies Act). Shareholders are briefed on the company’s performance at this meeting and provide their final approval, thereby assessing the management’s performance.
4. Exceptions to the Approval Process: There is a very important exception to note here. Article 439 of the Japanese Companies Act simplifies the approval process for financial documents for Accounting Auditor-appointed companies that meet certain criteria. Specifically, if the Accounting Auditor’s audit report expresses an unqualified opinion and the Corporate Auditor(s) (or the Board of Corporate Auditors) do not find the Accounting Auditor’s auditing methods and results to be inappropriate, then the financial documents do not require a resolution of “approval” by the shareholders’ meeting; it is sufficient to “report” the contents. This is based on the idea that rigorous audits by independent external experts provide a level of reliability equivalent to shareholder approval. This system is particularly applicable to many large companies, including listed companies, and contributes to the efficient operation of shareholders’ meetings.
5. Storage and Disclosure: Financial documents etc. that have been approved or reported at the shareholders’ meeting must be kept at the company’s head office for five years, starting one week before the annual shareholders’ meeting (two weeks in advance for companies with a Board of Directors), for inspection by shareholders and creditors (as per Article 442 of the Japanese Companies Act). Furthermore, corporations must promptly publish the balance sheet (and the income statement for large companies) after the conclusion of the annual shareholders’ meeting (according to Article 440 of the Japanese Companies Act). This publication, known as the “financial statements announcement,” is carried out through methods such as posting in the Official Gazette, daily newspapers, or on the company’s website.

Rights and Responsibilities: Shareholder Access and Director’s Legal Liability Under Japanese Corporate Law

The system for the creation and disclosure of accounting books and financial documents forms the foundation for the exercise of shareholder rights and the pursuit of director responsibilities. Japanese Corporate Law grants shareholders powerful rights to obtain information while simultaneously imposing significant responsibilities on directors.

Shareholder Rights: Requesting Inspection and Copies of Accounting Books

Shareholders have the right to oversee the management of a company. One crucial means to ensure the effectiveness of this right is the ‘right to request inspection and copying of accounting books’ as stipulated in Article 433 of the Japanese Companies Act. Shareholders who meet certain criteria, such as holding at least one-third of the total voting rights, can request to inspect or copy the accounting books and related documents at any time during the company’s business hours.

In exercising this right, the extent to which ‘the reason for the request’ must be specified often becomes a point of contention. On this matter, the Supreme Court of Japan made an important decision on July 1, 2004 (Heisei 16). This ruling established two key criteria:

1. Shareholders must specify the reason for their request in detail. This allows the company to determine whether the request is a legitimate exercise of rights or if it is intended to interfere with the company’s operations or abuse shareholder rights.
2. However, shareholders are not required to prove at the time of the request that the facts supporting their stated reason (such as ‘suspicion of misconduct by directors’) objectively exist.

The Supreme Court ruled that the purpose of this right is precisely to discover and collect evidence of misconduct, and requiring evidence at the time of the request would render the right ineffective. This precedent is a very important decision that balances the stability of company management with the shareholders’ right to oversee management.

Director’s Responsibility: The Consequences of False Statements

Directors have a duty of care as prudent managers to the company, which includes ensuring that the content of financial documents accurately reflects the company’s financial position and performance in accordance with laws and the articles of incorporation.

If there are false statements regarding significant matters in the financial documents, directors may be liable for damages to the company due to dereliction of duty. Furthermore, they may also be liable for compensation to third parties such as shareholders and creditors who have suffered damage due to the false statements.

This responsibility is not merely theoretical. In recent years, there have been a series of strict judicial decisions recognizing such liabilities. For example, in the case of Toshiba, a major electronics manufacturer, the Tokyo District Court ordered former directors to pay over 300 million yen in damages on March 28, 2023 (Reiwa 5), for failing to take corrective measures despite being aware of inappropriate accounting practices. In past cases like the Livedoor and Olympus scandals, management faced severe criminal penalties, including hefty fines and prison sentences, due to fraudulent financial reporting. These cases clearly demonstrate the heavy duty of directors to ensure the accuracy of financial documents.

Summary

As outlined in this article, the discipline regarding accounting books and financial documents under Japanese Corporate Law is not merely a set of administrative procedures. It is a consistent system designed to ensure corporate transparency and accountability, from the accurate recording of daily transactions to auditing, approval, and disclosure. In particular, the overlapping retention obligations of multiple laws and the recent adaptation to the Electronic Bookkeeping Law present modern challenges that all companies face. Furthermore, the rights of shareholders to inspect records and the stringent legal responsibilities of directors for false statements form the backbone of Japanese corporate governance. Understanding and adhering to these rules is an essential foundation for sustainably growing a business in Japan.

Monolith Law Office has a wealth of experience in providing advice on the accounting-related legal matters discussed in this article to numerous clients within Japan. Our firm is staffed with legal experts who are not only qualified as Japanese attorneys but also hold foreign legal qualifications and are English speakers. This unique strength allows us to offer truly valuable legal support that goes beyond merely translating and explaining Japanese regulations. We deeply understand the legal norms and backgrounds of foreign parent companies and management, enabling us to provide practical, value-added legal assistance. For assistance in establishing compliance systems for accounting books and financial documents, shareholder relations, or any other matters related to Japanese Corporate Law, please do not hesitate to contact our office.