Similar to the United States, Japanese auditors have faced mounting criticism in recent years as a result of a series of high profile accounting and auditing failures. Much of this criticism stemmed from revelations that several of the large “mega banks” that have dominated Japan’s post-World War II economy were technically insolvent despite the fact that those banks had received unqualified audit opinions each year on their financial statements. As a result of the major financial crises within Japan’s banking industry, pervasive changes were made in the country’s regulatory infrastructure for its financial reporting system. Many of these changes directly impacted Japan’s accounting profession and independent audit function. The first major test of this new regulatory framework was posed by an accounting and auditing scandal involving a large cosmetics and apparel company, Kanebo Ltd. In fact, the Kanebo affair is often referred to by the Japanese press as “Japan’s Enron.”
Kansayaku—Key Facts
1. Similar to the United States, the public accounting profession and independent audit function in Japan are dominated by a small number of large accounting firms.
2. On a per capita basis, Japan has significantly fewer CPAs than any other industrialized country, including the United States; likewise, independent audit fees in Japan have historically been a small fraction of those in the United States.
3. A severe financial crisis that struck Japan’s banking industry during the late 1990s triggered a major credibility crisis for Japan’s accounting profession and independent audit function.
4. The criticism of Japan’s independent audit function focused on allegations that the close relationship between auditors and client management undermined the independence and objectivity of auditors.
5. Allegedly, independent auditors in Japan routinely subordinated their professional judgment to the wishes and demands of client executives.
6. In response to the widespread criticism of independent auditors, Japan’s federal government overhauled the regulatory structure for the nation’s financial reporting system.
7. The first major test of this new regulatory framework was posed by an accounting and auditing scandal involving Kanebo, Ltd., a large cosmetics and apparel company.
8. Kanebo’s top executives goaded the company’s accounting staff to misrepresent Kanebo’s financial statements throughout the late 1990s and beyond.
9. Kanebo’s independent auditors not only ignored the material misrepresentations in Kanebo’s financial statements but also suggested additional methods for improving the company’s apparent financial condition and operating results.
10. Despite the fact that Kanebo’s top executives and the company’s independent auditors either pled guilty or were convicted of various fraud charges, none of the individuals served any time in prison since each received suspended sentences.
11. Among the most significant results of the Kanebo scandal was the two-month suspension imposed on the company’s independent audit firm, ChuoAoyama.
12. The unprecedented suspension of ChuoAoyama signaled that Japan’s regulatory authorities were seriously committed to reforming the nation’s financial reporting system, including its independent audit function.
Question
Question and Answer
1. Research online news services to identify recent developments impacting the accounting and auditing profession in Japan. Briefly summarize these developments in a bullet format.
There have been recent developments in Japan that have impacted the accounting and auditing profession. Two of these developments are the Kanebo scandal of 2004 and the 2011 fraud scandal at Olympus Corp.
The Kanebo scandal of 2004 involved ChuoAoyama PricewaterhouseCoopers, a leading auditor in Japan. It was discovered that ChuoAoyama's monitoring systems failed to show that its employees had been cooking the books for Kanebo for five years. After this scandal was uncovered, the Japanese Financial Service Agency revised auditing standards, the CPA Law and the Financial Instruments and Exchange Law. The FSA also introduced the Internal Control Report and Audit and quarterly financial statement reviews. In addition, the CPAAOB was formed and was to become an independent regulator under the FSA. Further reforms include requiring auditors to rotate client teams every seven years, with a two year interval before they return.
Another development was the Olympus Corp. fraud of 2011. Olympus Corp. admitted to hiding large securities losses by using payments to merger advisers and venture capital funds. The two auditing firms that were under investigation were KPMG ASZA and Ernst & Young ShinNihon. With each firm, there was a failure to obtain sufficient, competent evidence to support the auditors' opinion on the financial statements. Based on this scandal, the PCAOB was given more international freedom. The PCAOB and Japanese regulators reached an agreement that allows the two countries to carry out joint inspections of auditing firms in Japan and the US. As a result, the PCAOB conducts inspections of international firms that audit public companies whose shares trade on US exchanges, which includes on-site visits and sharing of confidential information under certain circumstances.
2. As noted in this case, Japanese companies typically rely more heavily on debt capital than US Companies. Explain how this fact may cause the independent audit functions in the two countries to differ.
In any economy, the parties that are the principal source of capital for business organizations will obviously be among the principal stakeholders in that economy’s financial reporting process. Not surprisingly, individual audit firms, rule-making authorities, and professional organizations will likely feel some pressure or need to cater (or kowtow) to the information needs of those principal stakeholders. No doubt, this pressure will influence decisions made on individual audit engagements, influence the nature of accounting and auditing pronouncements, and influence the agendas and policy initiatives pursued by professional accounting and auditing organizations.
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