Japan Accounting
Embarrassing accounting debacles at Olympus and Toshiba haven’t been enough to
shake up Japan’s cozy audit world.
Japan saw 60 accounting discrepancies, including inflated numbers in reports, in 2020
—more than double its 24 cases in 2010, according to Tokyo Shoko Research data.
Just last month, Japan Display Inc., parts supplier for Apple Inc., was hit with 2.16 billion
yen ($19.8 million) in administrative fines for overstating profits from 2015 to
2019. Nissan Motor Co. Ltd. last year faced 2.42 billion yen in administrative fines for
falsifying executive compensation in its disclosures.
From April 1, partners at audit firms will no longer be able to work with the same
company for more than 10 years. Time worked on an audit prior to becoming partner
will be counted. At the time of the 2015 Toshiba Corp. scandal, the multinational had
retained the same auditor for more than 40 years.
The revised corporate law in March mandates corporations to carry at least
one independent outside director. “In Japan, people think that if you bring in
an outside independent director, you have good corporate governance,”
Takaaki Wakasugi, co-director of Tokyo-based Japan Corporate Governance
Research Institute, said in a video interview. It’s more important to enforce
corporate governance codes and rules, he said.
The regulator has been feeling the heat from the 2011 Olympus Corp.
accounting scandal, which resulted in minor administrative fines of 191 million
yen. When Toshiba’s case followed, the agency slapped 7.37 billion yen in
administrative fines. Toshiba’s auditor Ernst & Young ShinNihon
LLC faced more than 2.1 billion yen in administrative fines and suspension of
its partners up to six months.
Such regulatory actions have yet to catch the attention of the entirety of Japan
Inc. The financial regulator introduced a voluntary governance code with
auditors publishing detailed annual quality reviews after Toshiba in 2017. But
less than 20% of audit firms for listed companies had introduced them by July
2019, according to government data.
The Public Company Accounting Oversight Board introduced audit quality indicators for
auditors to explain to investors and others actions by companies. The Japanese
regulator has felt indicators help “boost competition among auditing firms,” the senior
agency official said.
“We think that there are advantages and disadvantages” to introducing EU-
like mandatory firm rotations, Kanako Ogura, JICPA’s deputy president, said
in a recent virtual interview. Requiring companies to change auditors regularly
hike costs, she said.
Audit fees in Japan are only a quarter of the level compared to the U.S. and
also below averages in Europe, according to a 2020 association survey.
“If you don’t pay an appropriate amount, the auditor won’t do an adequate
audit,”
Yoshihiro Machida, an accounting professor at Aoyama Gakuin University in
Tokyo, said in a video call. Machida has been serving as an adviser to
financial agency committees looking at audit policies.
Big Four firms dismissed arguments on Japan’s audit fees being too low.
“The U.S. requires a large volume of information disclosure while Japan’s is
much smaller,” Takaaki Ino, CEO of PricewaterhouseCoopers Aarata LLC,
said in a virtual interview.
Comparing audit fees between Japan and the U.S. and Europe would not be
appropriate, Taisei Kunii, CEO of Deloitte Touche Tohmatsu LLC, said in an
email. “The fee depends on differing situations of each company,” he said.
Machida rejects that kind of assessment. If listed companies paid double the
fees, the auditing quality would double and so would the standards, he said.
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Toshiba problems: Says
looking into whether it adequately spread costs of
multi-year projects in its accounts.
Says internal investigation found further instances of improper
accounting amounting to 3.6 billion yen. Says that investigation, running
parallel to third-party probe, found 12 instances of irregularities,
including not making provisions for a canceled contract, postponing
recording of expenses, underestimating material costs.
Firm expects to book charges of 300 billion yen to 400 billion yen
related to improper accounting, sources say. Charges include six years of
overstated profit and various writedowns
Tanaka and his predecessor, Vice Chairman Norio Sasaki, were aware of
the overstatements of profits and delays in reporting losses in a corporate
culture that “avoided going against superiors’ wishes”.
Toshiba inflated profits by $1.2
billion with top execs' knowledge:
investigation
By Ritsuko Ando
4 MIN READ
TOKYO (Reuters) - Japan’s Toshiba Corp overstated its operating profit
by 151.8 billion yen ($1.22 billion) over several years in accounting
irregularities involving top management, an independent investigation
said in a report on Monday.
In the country’s biggest corporate scandal in years, the findings could
lead to the restatement of earnings, a board overhaul and potentially
hefty fines at the computers-to-nuclear conglomerate.
Toshiba President and Chief Executive Hisao Tanaka and his
predecessor, Vice Chairman Norio Sasaki, were aware of the
overstatement of profits and delay in reporting losses in a corporate
culture that “avoided going against superiors’ wishes,” the investigating
committee said in a report filed by Toshiba to the Tokyo Stock
Exchange.
The overstatement was roughly triple Toshiba’s initial estimate. Sources
have said Tanaka and Sasaki would resign in the coming months and
most of the board would be replaced to take responsibility for the
shortcomings.
The report said Tanaka and Sasaki had set operating profit targets that
the heads of divisions were required to meet, applying pressure by
hinting at withdrawing from areas that underperformed.
“Within Toshiba, there was a corporate culture in which one could not
go against the wishes of superiors,” the report said.
“Therefore, when top management presented ‘challenges’, division
presidents, line managers and employees below them continually carried
out inappropriate accounting practices to meet targets in line with the
wishes of their superiors.”
Sources said previously that one of the investigators’ theories was that
top executives, worried about the impact of the 2011 Fukushima disaster
on nuclear business, set unrealistic targets for new operations such as
smart meters and electronic toll booths.
The report did not mention Fukushima, but said such pressure was
particularly strong in fiscal years 2011 and 2012.
Improper accounting included overstatements and booking profits early
or pushing back the recording of losses or charges, and such steps often
led to even higher targets being set for divisions in the following period.
“This led to a need to carry out improper accounting of an even bigger
scale, and as this was repeated, the scale of the inappropriate book-
keeping also expanded,” it said.
GOVERNANCE PUSH
The investigation comes as Prime Minister Shinzo Abe is trying to
improve the country’s corporate governance in order to attract more
foreign investors.
This is Japan’s biggest business scandal since camera and medical
equipment maker Olympus Corp’s 13-year cover-up of $1.7 billion in
losses blew up in late 2011.
The revelations shake one of the stalwarts of Japanese industry. Toshiba
remains Japan’s 10th-biggest company by assets and market value
despite its stock price falling 26 percent since the scandal surfaced in
early April.
The report said much of the improper accounting, stretching back to
fiscal 2008, was intentional and would have been difficult for auditors to
detect.
Toshiba has not been able to close its books for the latest year because
of the probe, which also forced the company to cancel its annual
dividend.
Toshiba’s shares are “almost certain” to be placed under special
monitoring, according to a stock exchange source, who added that he
doubted it would be delisted.
The source also said the bourse was considering a penalty for breach of
contract, which would be around 91 million yen based on Toshiba’s
market capitalization.
Last week, other sources said the company was expecting 300-400
billion yen ($2.4-3.2 billion) in charges include the overstated profits as
well as various writedowns.
In a positive sign for Toshiba, however, its main lender Sumitomo
Mitsui Banking Corp announced that it would continue supporting the
company.
Toshiba is due to hold a news conference at 5 p.m. (0800 GMT) on
Tuesday, shortly before the investigating committee is to hold a separate
news conference at 7 p.m. (1000 GMT).
Toshiba's accounting probe
By Reuters Staff
4 MIN READ
(Reuters) - Toshiba Corp on Monday announced a summary of an
independent investigation into accounting irregularities.
People familiar with the matter said it could result in up to 400 billion
yen ($3.2 billion) in charges and the resignation of Chief Executive
Hisao Tanaka.
Following are key moments in the saga since Toshiba first announced
the accounting probe in April.
April 3 - Toshiba says probing possible improper accounting, may have
under-reported costs of infrastructure projects in the business year
through March 2014. Says looking into whether it adequately spread
costs of multi-year projects in its accounts.
May 8 - Expands investigation, plans to set up third-party committee.
Cancels dividend payment, withdraws earnings outlook.
May 13 - Says likely to mark down operating profit for the three years
through March 2014 by at least 50 billion yen.
May 15 - Launches independent committee headed by a former
prosecutor to broaden probe.
May 22 - Extends probe to three more business units.
May 26 - Firm likely to seek extension to annual securities filing
deadline to avoid being placed under supervision by the Tokyo stock
exchange, sources say.
May 27 - Considers special dividend to compensate investors after
skipping year-end payment due to probe, sources say.
May 29 - Toshiba says accounting probe to end mid-July, gained
approval to release annual report by August-end, first-quarter results by
Sept. 14 - one month later than usual bourse deadline.
June 12 - Says internal investigation found further instances of improper
accounting amounting to 3.6 billion yen. Says that investigation, running
parallel to third-party probe, found 12 instances of irregularities,
including not making provisions for a canceled contract, postponing
recording of expenses, underestimating material costs.
June 25 - CEO says may appoint more outside board members to
improve accounts oversight.
July 8 - Firm talks with banks about up to $4.9 billion credit line to
secure funding in case probe hurts creditworthiness, sources say.
July 9 - Considers selling assets including a stake in Westinghouse
Electric, sources say.
Independent investigation looks into roles top management played in
accounting practices, sources say.
July 15 - Firm expects to book charges of 300 billion yen to 400 billion
yen related to improper accounting, sources say. Charges include six
years of overstated profit and various writedowns, they say.
CEO, other board members including Vice Chairman Norio Sasaki to
step down in September to take responsibility, sources say.
July 16 - Independent panel finds top executives involved in improper
accounting practices, source says.
July 17 - Toshiba says third-party committee to submit report to the firm
on July 20. Says to release entire report, hold news conference at 5 p.m.
(0800 GMT) on July 21.
July 20 - Independent panel concludes Toshiba overstated its operating
profit by 151.8 billion yen over several years.
The report says Tanaka and his predecessor, Vice Chairman Norio
Sasaki, were aware of the overstatements of profits and delays in
reporting losses in a corporate culture that “avoided going against
superiors’ wishes”.
The inappropriate accounting techniques employed at Toshiba varied somewhat
between the different business units. Investigators found evidence of booking future
profits early, pushing back losses, pushing back charges, and other similar techniques
that resulted in overstated profits. Although the techniques varied, the investigative
panel identified a single set of direct and indirect causes to explain how the
inappropriate practices took hold across the conglomerate. 4
Investigators describe how Toshiba's corporate leadership handed down strict profit
targets, known as Challenges, to business unit presidents, often with the implication
that failure would not be accepted. In some cases, quarterly Challenges were handed
down near the end of the quarter when there was no time left to materially affect unit
performance. It soon became clear within individual business units that the only way to
achieve these Challenges was to do so through the use of irregular accounting
techniques.4
According to investigators, the firm’s top executives set unrealistic profit targets which
systematically led to flawed accounting practices. Mr Nishida and his successors appear
to have applied unreasonable pressure to divisional heads, setting them unattainable
targets. It was this pressure which caused a number of divisions to adopt questionable
accounting tactics, then ‘skilfully’ hide the irregularities from outside observers. A
whistleblower in early 2015 was the first to highlight the issue, bringing to an end a
seven year deception by the company’s senior management, described by the panel as
both “systematic” and “deliberate”.
This impropriety appears to have been considerable, endemic and longstanding. Much
of the false accounting is believed to have begun under Mr Nishida during his tenure as
chief executive between 2005 and 2009. The investigative panel noted that in 2008 Mr
Nishida got word that the company was heading for a loss of around ¥18.4bn, and
declared that the scale of the loss was “so embarrassing that we cannot announce it”.
Accordingly, Toshiba’s staff falsified the records and expunged the loss. The company
instead recorded a profit of around ¥500m. For his part, Mr Tanaka has denied any
wrongdoing, noting that he did not instruct people to falsify accounts and was wholly
unaware that the practice was going on.
Four years after the Olympus scandal in which the Japanese camera maker was accused of
concealing nearly $1.7bn in losses, Toshiba – a leading industrial conglomerate - has become the
new bad boy of corporate misgovernance in Japan. An independent investigation has confirmed that
Toshiba inflated profits by $1.2bn over a period of seven years, using accounting malpractices. The
probe was launched by Japan’s Securities and Exchange Surveillance Commission after the agency
was tipped off by an unidentified whistleblower. A more perverse aspect of the saga is that Toshiba
was recognised as a leader in corporate governance before the fraud came to light.
Nine Toshiba executives, including half of the 16-member board, among them three former chief
executives and incumbent chief executive Hisao Tanaka, have resigned in shame, leaving a large
hole in the top management. There was the usual guilt-laden Japanese bow ritual at the press
conference where they announced their departures. The board chairman has been appointed as
interim chief executive with a 90% cut in remuneration. By mid-July, Toshiba shares had dived 30%
in value.
So what went wrong? Everything, it seems. The fraud was systematic and several top executives
were complicit. Profit figures were inflated under pressure from top management to meet ambitious
targets. The scam spanned three successive chief executives. Out of these, two joined the board after
stepping down. The auditors Ernst & Young ShinNihon failed to notice anything amiss.
Toshiba inflated profits
The timing of the Toshiba scandal could not have been worse. Barely two months before the scandal,
Japan had introduced a new corporate governance code championed by prime minister Shinzo Abe,
who sees corporate governance reforms as necessary to restart the sluggish economy.
The scandal has cast doubts about the effectiveness of the new code, which is not legally binding. A
key measure in the new code requires nearly 2,400 companies listed on stock exchange to appoint at
least two independent directors. Toshiba pioneered the practice of appointing independent directors a
decade ago and had four independent directors on its board when the fraud came to light.
The new corporate governance code does include a whistleblower policy but as the code is voluntary,
companies are not required to follow it. Other principles of the code include gender diversity,
stakeholder engagement and social and environmental responsibility.
Japan's problem is not limited to Toshiba. The country has had a dismal record in corporate
governance. It ranked 36th in corporate governance quality out of 39 developed and emerging
economies in a survey by the research firm GMI Ratings in 2010.
Clubby atmosphere
Japan’s poor corporate governance is rooted in the way Japanese companies are run. It’s common
knowledge that most companies have clubby boards. Boards generally have a significant number of
senior company executives and former executives who have worked together for years and are bound
by cultural norms of loyalty to seniors. Then there is a widespread practice of appointing former
bureaucrats to the board who once regulated the industry or the company. Former diplomats are also
a popular board choice among the companies. Toshiba had two diplomats on its board who were also
on the audit committee without having a relevant qualification or experience. Add to this the popular
practice of cross-holdings in which companies hold each other’s shares and protect mutual interests.
Appearances can be deceiving
Chummy boards face little challenge. In Japanese culture, it’s unthinkable for employees to question
their bosses or express any disagreement, let alone protest. Lifelong employment in exchange for
complete loyalty is the social contract Japanese society has respected in the post-war era. So whistle
blowing does not figure in the scheme of things. In the case of the 2011 Olympus scandal, the whistle
blower was the company’s British chief executive Michael Woodford, the first westerner to head a
Japanese conglomerate. He was later fired by the board for seeking answers to $2 billion of dubious
payments.
The Toshiba scandal has also brought attention to the quality of accountants and auditors in Japan.
Auditors in Japan are among the worst paid, by international standards. Companies in Japan pay their
auditors an average of 0.032% of turnover, compared with 0.053% in the UK and 0.118% in the US,
while the international average is 0.056%, according to a study by Hong Kong-based GMT Research.
Toshiba paid Ernst & Young ShinNihon 0.015% of turnover for the year ending March 2014. The
quality and rigour of low paid and overworked auditors in Japan is being debated.
Japan needs to act tough to win international investors’ confidence. Tougher disclosure requirements
should be imposed on companies. These should include disclosing the number and names of ex-
government officials as board members and in company employment. An increased external
oversight into company affairs as well as effective internal controls should be required. A board
membership should carry stringent qualification criteria. Comprehensive director training should be
introduced. Independence of independent directors should be subjected to rigorous tests.
Employees should be trained in the benefits of whistle blowing including the larger interests of the
company. Japan should also think of introducing rewards and real protection for whistleblowers. The
biggest change however, and the most difficult one, is to create an environment of openness and
transparency and a establishing a culture in which diversity of ideas, including feedback from
underlings, is encouraged.
The latest corporate crisis could be a potential opportunity to start an open debate in the country to
find effective ways to fix corporate misbehaviour by the boardroom boys.
The response of Japan’s legal system will also be significant. There have been some
calls for Mr Tanaka and the company’s other disgraced former executives to face
criminal charges and even custodial sentences for their part in the scandal. But the
chances of arrests being made in the Toshiba case appear unlikely.
If the government is serious about truly revolutionising corporate governance in
Japanese organisations, full and serious accountability among top level executives
must be a key consideration. Furthermore, the undoing of cross-shareholding
structures should also be prioritised. If corporate governance is to be improved, a
move away from the ‘old boys club’ shareholding structure is a must.
Toshiba, which went to great lengths to hide its corporate losses, has been forced to
divulge the financial impact of the scandal. It was announced on 18 August that the
company would likely record a $1bn net loss for last year in impairment charges for its
nuclear and semiconductor businesses, incurred following an investigation into
accounting malpractice. According to the company, it will record an asset devaluation
loss of $1bn and costs of $386m.
In an accounting scandal almost unparalleled in its magnitude over the course of six
years, Toshiba appears to have practised widespread, institutionalised fraud. If the
company is to clear some of its tarnished reputation, its reorganised board must focus
on reinvigorating its corporate governance program. Establishing a robust and ethical
culture requires setting the right tone from the top. The deep bow of contrition
performed by Mr Tanaka and his former colleagues on 21 July was the first gesture on
a long road back.
