PROJECT ON AUDITING

A study of the
Toshiba Accounting Scandal, 2015

Prepared by:
Suvam Das
MCI16004
Department of Commerce
 ACKNOWLEDGEMENT

I would like to express my special thanks of gratitude to my teacher Dr. Reshma Tiwari, who
gave me the golden opportunity to do this wonderful project of AUDITING on
“TOSHIBA CORPORATION”, who also helped me in completing my project. I came to know
about so many new things I am thankful to her. Secondly, I would also like to thank my parents
and friends who helped me a lot in finalizing this project within the limited time frame.

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 CONTENTS

 Introduction
 Company background
 The fraud
 The revelation of fraud
 The three eras of fraud
 Audit failures
 Aftermath
 Consequences in respect to the auditors.
 Conclusion

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Introduction

Toshiba Corporation is one of the most famous firms in Japan. This study addresses the case
of Toshiba’s fraudulent accounting in 2015. On July 21, 2015, Toshiba CEO Hisao
Tanaka declared his resignation within the face of an accounting scandal tied
to about $1.2 billion in exaggerated operating profits.
Details of the scandal emerged the day before when an independent investigative panel
released a report describing the accounting improprieties in detail.
Improper accounting was found to have taken place over the course of seven years,
embroiling two former CEOs in the scandal alongside Tanaka.
The investigatory report discovered that the CEOs did not directly instruct anyone to cook
the books but rather placed immense pressure on subordinates and waited for the
corporate culture to turn out the results they wanted.

Company Background

The Toshiba Corporation has been a mainstay of Japanese business since its inception in 1875.
It was once ranked the second largest technology company in Japan in terms of revenue
generation and appeared to be the epitome of good corporate governance. A factory was built
in Tokyo in 1875 that later became Shibaura Seisakusho. Meanwhile, Tokyo Denki was
founded as Hakunetsusha in 1890. Toshiba was founded in 1939 by the merger of these two
firms. Shibaura Seisakusyo’s strength lay in its being a major manufacturer of heavy electrical
machinery, whereas Tokyo Denki’s strength lay in the manufacture of incandescent electric
lamps and other consumer products. Therefore, they could make use of each other’s strengths
to leverage the synergies. The company rode the post-war Japanese boom in the late 1950s to
high growth and an expanding catalogue of unique and innovative products. Toshiba began
selling products in foreign markets during this period and continued to expand its businesses
across the globe during the following decades.
As of 2015, the conglomerate operates business units on a worldwide scale in a variety of
diverse industries, including semiconductors, personal electronics, infrastructure, home
appliances and medical equipment. Toshiba reported net worldwide sales of more than $63
billion for the fiscal year ending March 31, 2015. It employs more than 200,000 people
worldwide.

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The Fraud

At a press conference on 21 July, Toshiba President Hisao Tanaka, along with two of his
predecessors, Atsutoshi Nishida and Norio Sasaki, entered a press conference at the company’s
headquarters in Tokyo to announce they were stepping down in the wake of a scandal which
suggested the company had falsified its earnings by at least $1.2bn since the onset of the global
financial crisis in 2008. The figure by which Toshiba misrepresented its profits during that
period is equal to about a third of the pre-tax profits that the company reported during that
period.
In 2008, there was a global financial crisis that reduced the profitability of Toshiba this led
Toshiba’s employees finding ways to overstate profits. They used techniques such as booking
future profits early and pushing back of losses and charges. They originally were reported to
have overstated profits from fiscal year 2008 to the first quarters of fiscal year 2014 by 151.8
billion yen which is equivalent to close to 1.2 billion dollars, a later mentioned report mentions
that the profits may have been overstated by 2 billion dollars. The infrastructure division also
purposefully understated costs of construction of projects, internal control system was not
functional, and the corporate governance was weak.

The Revelation of Fraud

On February 12, 2015, the Securities and Exchange Surveillance Commission in Japan, based
on the Financial Instruments and Exchange Act (Article 26), gave Toshiba an order to report.
To deal with the order, Toshiba set up an internal special investigation committee in April,
which was followed by Independent Investigation Committee in May. The committee compiled
a nearly 300-page report and submitted it to Toshiba on July 20.
The four-member committee looked into Toshiba’s accounting practices from fiscal 2009 to
2014 and found a series of “inappropriate” accounting entries that showed a staggering ¥152
billion ($1.2 billion) net profit.
The report said the firm’s top executives, including Toshiba CEO Hisao Tanaka and his
predecessors Atsutoshi Nishida and Norio Sasaki, were involved in the manipulation and there
were no internal systems in place to stop them.
The report said the priority for the presidents was to secure profits for each quarter, and thus
they set high targets, demanding their subordinates improve the company’s results. The
business culture at Toshiba did not allow lower-level managers “to go against the bosses,” it
said.

The Three Eras of Fraud

There were three different eras of fraud with three different CEOs from 2005 to 2009, Atsutoshi
Nishida was CEO since the fraud started in 2008 this means he was the CEO when the fraud
started, he also played a vital role after giving up being CEO since he stayed in the company

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as an advisor. The CEO after him was Norio Sasaki and he was CEO from 209 to 2013, he then
became the vice chairman of the board of directors. The next CEO is Hisao Tanaka who was
CEO from 2013-15. He was the CEO when Toshiba was caught being fraudulent by the
Independent Investigation Committee. All three of the CEOs were accused of pressuring
managers to reach high set targets which were difficult or rather impossible to accomplish
without fraud. On July 21, 2015 Mr. Tanaka announced his resignation along with Mr Nishida
and Mr. Sasaki also resigning from their respective posts. It is mentioned that they never
instructed anyone to actually cook the book but applied enough pressure to encourage a
corporate culture that accepted and promoted fraud, nonetheless these three men lost their
integrity and placed Toshiba in a very negative situation and view from the public

Audit Failures

Auditors do not simply follow the directives of regulators, professional associations or the
various laws. Ideally, auditors appreciate their obligations to equity holders, debt holders as
well as their broader responsibilities to third parties. Auditors can act on their own professional
authority. They can limit their liabilities and warn stake holders by qualifying their opinion of
a firm’s financial reports. “Qualified” means that in the auditor’s expert opinion, the firm’s
financial information has material misstatements, or that the auditor cannot obtain sufficient
evidence on which to base an opinion but concludes that the undetected evidence is potentially
material. “Material” simply means that the amount in question is large enough to matter in the
decisions of managers and stakeholders. Auditors could also express an “adverse” opinion
about a financial report meaning that the firm’s financial reports have material and pervasive
misstatements. Auditors can also express a “disclaimer of opinion” regarding a firm’s financial
statements. This would be appropriate when the auditor realizes that there may be undetected
material and pervasive misstatements. Auditors can also explain the degree to which the
statements deviate from accounting principles. The Toshiba scandal offers a clear example of
how an auditor can fail. Toshiba’s financial reports have unambiguous deviations from
accounting standards. These deviations are material and pervasive. Ernst & Young ShinNihon
should not have given an unqualified opinion of Toshiba’s financial statements.
Accounting irregularities leading to window-dressing of financial statements mostly occur due
to collusion between management and accountants as well as negligence by accountants in
carrying out their audits with due diligence and professional. Although Ernst & Young
ShinNihon LLC is the biggest auditing corporation in Japan and oversaw Toshiba’s accounts
for sixty consecutive years, it failed to carry out its duties. Its audit staff failed to detect
irregularities for eight consecutive years dating back to 2008 and did not give any guidance to
management for improvement and prevention. Nor did it deliberate on the matter internally. It
has utterly failed in its professional auditing responsibilities and destroyed public confidence
in CPAs.
The improper accounting practices were persistence, pervasive and material; they should not
have been difficult for Ernst & Young ShinNihon to detect.

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Toshiba observed that for the PC Business, the Auditor, in the course of its fiscal year-end audit
for fiscal year 2012, was required to conduct additional auditing procedures that would have
been reasonably necessary in order to clarify the factors behind the operating profit exceeding
sales in the last month of the quarter. Although the Company found that the Auditor conducted
audit procedures regarding receivables from the Company’s consolidated subsidiary, Taiwan
Toshiba International Procurement Corp. (TTIP), it cannot be found that the Auditor obtained
sufficient and appropriate audit evidence, from the perspective of performing an audit of
receivables recorded on the consolidated financial statements of the Company. In this respect,
it is highly possible to find that the Auditor is responsible for negligence of duties. For
percentage-of-completion method projects (the electronic toll collection facilities renewal
project), the auditing procedures by the Auditor to check the reasonableness of the NET (total
estimated cost of contract work, etc.) in the course of its fiscal year-end audit for fiscal year
2012 were limited to matching the NET figures against the order item numbering list, and since
it cannot be denied the possibility that the Auditor neglected to perform adequate auditing
procedures to check the reasonableness of the order item numbering list figures themselves,
there is a possibility of finding that there was negligence of duties. Thus, it is clear that Toshiba
itself could identify negligence in the audits performed by Ernst & Young ShinNihon.
Also, later, the Independent investigating committee discovered that the internal audit
committee was not knowledgeable enough in finance or Accounting procedures and to add on
to the causes, the company, by then did not had a whistle blower policy.

Aftermath

The shareholders were affected, after the revelation of the fraud they had a lack of trust in the
company on which they had invested their hard-earned money in. This issue not only affected
the investors in Toshiba but in the entire Japanese system. At the time of the fraud the Japanese
Finance Minister became worried that the Toshiba Accounting scandal will scare away
investors from investing in Japanese companies since Japan was already recovering from a
corporate governance scandal regarding Olympus Corporation in 2011, furthermore the stock
prices decreased by 40% after the fraud became of public knowledge. Toshiba was then
removed from the stock index of the best Japanese companies and even worse Toshiba’
shareholders sue the company 2.45 bn dollars in damages from the decreased stock prices. The
TSE also fined Toshiba ¥91.2 million.
Whereas, shareholders were only one piece of the stakeholder puzzle. Employees as expected
were negatively affected, almost 34,000 employees were let to restructure their business. It was
observed that the company had reduced its workforce from 217000 to 183000(approx.) by
March 2017. In December 2015 it was reported that Toshiba would be cutting 7800 jobs
specifically in the consumer electronics business, this represents 30% of the consumer
electronics business at Toshiba and almost 3% of the total organisation.
Toshiba lost their reputation to consumers and therefore the consumers were less likely to buy
from them.

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Consequences in respect to the auditors.

The Financial Services Authority has issued two punitive actions against Ernst & Young
ShinNihon for falsifying financial statements: firstly, suspension of taking new business
contracts for three months starting from January 2016, and secondly, the imposition of a fine
in the amount of ¥2.1 billion or about US$17.4 million, which was equivalent to two years of
auditing fees received from Toshiba. Soon after the fine was imposed, the firm announced the
resignation of its chief executive, Koichi Hanabusa, and imposed a pay cut of 20-50 percent on
the 19 employees involved. Perhaps the most meaningful punishment to Ernst & Young
ShinNihon came from Toshiba. Toshiba terminated its audit contract and entered into a new
contract with PricewaterhouseCoopers (PwC) from April 2016.
Company Resolutions
All of this leads to what Toshiba did in order to regain integrity after the scandal. There was a
major change in improving internal controls. The implementation of budgetary control was one
way that Toshiba tried to re-establish their business, the control to make sure that excessive
demands to get target profits were no longer happening. Employee awareness has also
improved, the were made aware of appropriate accounting reporting regarding financial
reporting. New internal controls were also placed over disclosure in connection with the
financial closing and reporting process. Also, a new internal audit division and audit committee
were formed and consisted of outside directors.
the biggest response to the fraud was in the change of CEO, Satoshi Tsunakawa became the
new CEO. He put out a public statement shortly after gaining the office and mentioned that he
is dedicated in regaining the trust of the people in the company.

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 CONCLUSION

In response to Toshiba’s fraud there are may takeaways. Frauds can happen for a long time
without getting caught, this is not an encouragement to the companies since once they are
caught the consequences, they face are even worse since often the amount of fraud is higher.
Often many people are involved in fraud when it is in large-scale, it took three CEOs before
the fraud was caught and not one of the admitted to it or became a whistle blower before they
were caught likely they were offering or told each other in confidence to keep the fraud going.
Toshiba had to learn the difficult way that the company keeps better business by keeping
integrity. The money that the company was losing from the global financial crisis is nothing in
comparison to loss of reputation as a company face. Instead of having to deal with lower profits
the old management instead have left the new CEO having to gain the respect of the Toshiba
stakeholders all over again. What also can be learned is that shareholders take a lot of the
damage when such fraud occurs, they have invested in a company that they truly believe is
good and then they were hit in the face with a company’s fraud. Basically, the moral of the
story and all the fraud cases is don’t be fraudulent the risks far outweigh the benefits.

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 References

http://www.toshiba.co.jp/worldwide/about/history.html
https://www.investopedia.com/articles/investing/081315/toshibas-accounting-scandal-how-it-
happened.asp
https://www.financierworldwide.com/toshiba-behind-the-numbers#.XKCWU_kzbIV
https://prezi.com/oe-02jdfx-c1/toshiba-accounting-scandal/
https://www.japantimes.co.jp/news/2015/09/18/business/corporate-business/pressure-to-
show-a-profit-led-to-toshibas-accounting-scandal/#.XKCaivkzbIV
http://www.ic.nanzan-u.ac.jp/MCENTER/pdf/wp1704_.pdf
https://www.youtube.com/watch?v=noqxJbCRsrk