The Toshiba Accounting Scandal Case Study

Introduction about The Toshiba Accounting Scandal

● The case began in 2015 with the initiative of Prime Minister Abe's Government to
encourage greater transparency in Japanese companies to attract more foreign
investment. On the advice of the government, Toshiba hired an independent panel of
accountants and lawyers to investigate transparency issues in the company. How
surprising, the report that published by the independent panel said that three directors
had played an active role in inflating Toshiba's operating profit of $1.2 billion since
2008. Furthermore, it was revealed that over 7 years, the firm was in a state of improper
accounting.
● CEO, Hisao Tanaka, resigned. The CEO put a lot of pressure on the juniors (employees)
so that the corporate culture yield the results that they needed.
● Toshiba inflated its pre-tax income by approximately 30% from the period of 2008 to
2014. The accounting areas that were deliberately affected include: the percentage of
completion method, parts transactions of the visual products business and PC business,
recording of operating expenses of the visual products business and pc business, and
the valuation of inventory of the semiconductor business.
● Accounting practices that are not in accordance with accounting principles at Toshiba
were so neat and smart (were hard to detect and ongoing for a long time because the
accounting methods used seemed to be appropriate on the surface) that the external
auditor team (Ernst & Young ShinNihon) did not discovered the fraud from Toshiba's
financial statements.
The Toshiba Accounting Scandal Case Study (Answer)

1. Toshiba Business Strategy at that time that may lead to the scandal was company
management set unrealistic profit targets, so that when the target is not reached, the
division leader is forced to manipulate the financial reporting data. In detail, company
executives have pressured the company's business units, from personal computer units
to semiconductor units and nuclear reactors to achieve unrealistic profit targets. Others
accounting issues in this Toshiba scandal were the intentional delay for reporting the
operating expenses, intentionally increase the price of products that were sold to
overseas distributors, and improper recording inventory losses when disposing the
goods. Toshiba has a corporate culture that demands compliance with superiors, and
 this is an important factor that results in the practice of manipulating financial
statements.
2. In my point of view, Toshiba’s critical performance variables were profit and diluted
earnings per share seen in Financial Highlights page 12. The profit became one of
Toshiba’s critical performance variables because as we can see, even though the
subordinates were struggling to achieve the target that had been set in the beginning of
the business period, at the end, they were doing accounting manipulation in order to get
incentive and avoid the pressure from the management. Moreover, profit will be one of
the indicator whether good or bad a company is in public’s view. Thus, this variable
affect subordinates to achieve which means that they put “profit over everything”. Profit
over everything became an implicit culture in the company where the everything itself
means moral value. Second, earnings per share is the most important thing in
fundamental analysis to measure the performance of a company. Diluted earnings per
share were affected significantly when the company expressing a loss. A loss (or
income) from Toshiba can be analyzed from the diluted earnings per share. It appears
that Toshiba’s highest diluted EPS was in 2011. Between 2012 and 2014, the diluted
EPS have decreased by $2.09. Then, in 2015, the diluted EPS decreased until -$8.93
due to manipulation into the book’s company. A negative diluted EPS value indicates
that a company is experiencing a loss. Many shareholders or stakeholders will neglect
a company with a negative diluted EPS. Thus, it would be a serious problem for the
continuance and existence of Toshiba.
3. Toshiba failed because several improper ethics in this accounting scandal such as:
a. Corporate culture
Issues occuring from 2008 to 2014 with last three presidents reign; Atsutoshi
Nishida (2005 - 2009), Norio Sasaki (2009 - 2013) and Hisao Tanaka (2013 -
2015). The operation of Toshiba is an in-House company system which each
division is treated as its own company (at the time of scandal, there were 7
companies and 2 divisions). Allusion of autonomy, but company presidents
heavily incentived to show profit. And also, the culture enforced by presidents
focused on profits. For instance: one division fraudulently adjusted profit by 12
billion yen instead of showing a 24.8 billion yen loss.
Shockingly, President Tanaka instructed a senior Vice President to improve a
loss on digital product and service by padding numbers in 2013. Then, in the
 next year, Tanaka warned the power system head to not accept a $396 million
dollar loss.
b. Lack of accountability: Auditing & Policies failures
The audit committee did not review policies despite repeated to do so. The
auditing failure was not stopped even though in 2009, 2011 and 2013, the
channel stuffing was raised to the Corporate Audit Division.
At Toshiba, we could see that the audit committees were not independent and
not capable. The two members of the audit committee were not knowledgeable
enough in management and accounting practices. The former Chief Financial
Officer was the only member of the audit committee during accounting
irregularities. Earnings management gets the tacit approval from top
management. Therefore, it is not surprising that audit accounting is not included
in the internal audit scope.
In 2009-2013, Sasaki was president and the correction of the profit was only
allowed when profit in the individual division was high and therefore General
Managers were forced to tolerate situation.
The company did not have a whistleblower policy and corporate culture kept
employees quiet.
In conclusion, all the levels in the company did not act ethically, the CEO of the
company expressed egoism (created a culture of incentives profits), the failure to have
the deontology ethics applied, the workplace culture in the company was misleading,
the senior managers expect total obedience from the workers, no system for
whistleblowing, and Toshiba also had poor corporate governance.
4. In my opinion, Toshiba’s board played a critical role in this accounting scandal since
they put pressure that were affected coworkers and subordinates. I could say that
Toshiba’s board quality along with Toshiba’s corporate governance was poor. I will
explain it by analyzing the case using fraud triangle (pressure, opportunity and
rationalization) which are:
a. Pressure to achieve targets
The target was set too high and the pressure on achieving the target was a factor
of why this scandal occur. This practice is actually normal, but there were
pressure and punishment from top management and also, the company culture
was slightly not good which the subordinates were not able to correct top
 management mistakes in making decisions. Subordinates could not correct
CEO’s targets that were not realistic with business and company conditions.
In addition, the employee compensation system that were calculated from
financial performance also contributes to this scandal. When the target was not
achieved, then came the creative ideas to achieve the targets set. Unfortunately,
this creativity was not in research development or marketing but in terms of
accounting treatment. Thus, high-profit financial statements were made which
not reflect the real situation.
b. Opportunity
The opportunity to commit fraud occurs because all parties within the company
did not disclose the practice. Diversion was done in congregation, systematic
and intelligent. Many layers of the control system from the accounting,
financial, internal audit divisions did not function at all.
This Toshiba accounting case would not possibly known by public if the
Toshiba commissioner (Chairman) did not take the initiative to form an
independent investigation committee.
c. Rationalization
In this case, the top managements or even the employees seeks justification for
their actions by assuming the following: that their actions are to make his family
and the people they loves happy, their work period was quite long and they feels
why should be entitled to more than they had now (position, salary, promotion,
etc.), and the company had made huge profits and it did not matter if they take
a small part of the profits.
Thus, based on this analyzation, Toshiba’s board should be blamed since they are the
‘main brain’ of this accounting scandal. In my opinion, there is a need for corporate
structural reforms aimed to bring back public trust to the company. Then, describe the
steps to reform the culture that has negative effect to the company realistically, as well
as strengthen the audit committee's oversight function in mitigating corporate risk.
5. One general lesson about Toshiba’s accounting scandal related to corporate
management is an obsession about profits and incentives that can affect a company so
that the company overstretched earnings beyond its capability. The external party
investigation revealed that there was the pressure from the top management to the
divisions managers to escalate the profits in order to meet the targets that had been set
in the beginning of the business term. In other cases, the managers who are trying to
 achieve the annual target moved up the profits in the report. The way to move up the
profits is by deferring (postponing) the posting of expenses (costs) and losses. As we
discussed before, Toshiba’s priority was placed on how maximize their quarter or
annual profits instead of long-term profitability, as indicated by the report.
In this business world, profits are considered as a crucial factor to the continuity and
development of a company. Thus, some companies in order to achieve its near-term
profits often doing income smoothing; however, there was an obsession to achieve the
target that can lead to an accounting manipulation, based on Toshiba accounting
scandal.
6. In my opinion, the external auditor can not be blamed at all yet they were still a part of
this scandal. Actually, this scandal would not occur if the external auditor from Toshiba,
Ernst & Young, could detect fraud in Toshiba. The first thing that can be concluded
immediately from this case is the lack of accuracy of the E&Y auditors in checking
Toshiba's internal control system. If E&Y really tests Toshiba's internal control, surely
E&Y could find inflated funds made by Toshiba, especially considering that the amount
of income inflated by Toshiba was significantly high, 151.8 billion Yen (U$1.22
billion) since 2008 or last six years.
The next possible mistake that E&Y might made was E&Y set a high material level
because Toshiba was one of the companies that had a very good reputation before this
scandal. Because of this, errors that might have been categorized as material errors were
instead classified as immaterial errors, not to mention that 151.8 billion Yen was
distributed for 6 years, thereby reducing E&Y's suspicion of fraud in Toshiba's
management.
The next flaw that might have been made by E&Y (and also by JICPA) was that there
was no prohibition on a public accounting firm to audit the same company as long as
the audit partner of the public accounting firm was rotated for 5 years. This can trigger
the independency state of mind condition, which certainly influences the opinion of the
relevant public accounting firm because of the familiarity between the company (in this
case Toshiba) and the public accounting firm which is E&Y. It was found that E&Y
has been an auditor in Toshiba for 12 years, starting from 2002. This could have been
make E&Y believe in the results of Toshiba financial statements, while as auditors,
E&Y must maintain professional skepticism. Familiarity might happen in the case of
Toshiba and E&Y. There is a little chance that E&Y who has audited the company's
financial statements for 12 years has not carried out a risk assessment procedure and is
 aware of the risks that could occur in Toshiba's financial statements. This is a strong
factor that E&Y did wrong opinion on Toshiba financial statements.
7. Through these explanations, it is proven that Toshiba made mistakes and these mistakes
include fatal mistakes and have been running since 2008. Take a note that Toshiba
should has a stronger internal control. As we know, the existence of internal control
aims to achieve a company's goals and to avoid any improper action, for instance an
accounting fraud. Internal control itself is regulated by the COSO (Committee of
Sponsoring Organizations of The Treadway Commission). According to COSO,
internal control aims to ensure that financial reporting is properly presented, operations
within the company run effectively and efficiently, and that all parts of the company
comply with applicable laws and regulations. Emphasizing the objectives of internal
control according to COSO in financial reporting, if financial reporting is not presented
correctly, then internal control within the company is weak or poor. In addition, internal
control itself is intended to everyone in the company so that everyone in the company
can comply (obey) with applicable regulations. In this case, Toshiba clearly violated
applicable regulations. For this reason, the power of internal control is needed to
prevent things that are not desirable as in the case of Toshiba. A new way of monitoring
to prevent this from happening again is a kind of inspection from the company
commissioner or from the regulator (if the company is public). Special inspection or
inspection can be done at any time with uncertain times. This special inspection
(inspection) must be set forth in official regulations (OJK regulations or government
regulations) so that all companies do it together, including who is responsible for this
inspection. With the application of multi-layered supervision, a more accountable
financial report, good corporate governance, and of course the trust of stakeholders
(including investors) will be created.
8. Corporate Governance is a concept that defines the rights and responsibilities of each
role in the company, could be shareholders, management, or external parties. In
implementing this concept, each country has shown diversity to one another. But, it is
undeniable that there are differences in each country, for example in Indonesia and
Japan. The first model of Japanese corporate governance applies the concept of a board
independence that is tighter than Indonesian corporate governance within the scope of
registered companies. Indonesia uses a dual board system where the division of the
board is divided into two divisions. First, the Supervisory board (Board of
Commissioners) which acts as an agent of shareholders and has the responsibility to
appoint, supervise and give advice to members of the management board, and also
develop fundamental corporate strategies. Second, the Management board who are
responsible for carrying out the day-to-day functions of business management,
divisions or performing control functions in Indonesia. Meanwhile in Japan, a company
is not required to adopt the structure of three committees that have a majority from
outside directors on the board. It is required to all firms to have a majority of external
directors on every audit, nomination and compensation committee.
References:

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