TOSHIBA ACCOUNTING SCANDAL

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: Abe, T. (2017, February 23). Where did Toshiba go wrong, and where
does it go now? Retrieved

from

https://asia.nikkei.com/Business/Where-did-Toshiba-go-wrong-and-