Pressure to show a profit led to Toshiba’s accounting scandal
SEP 18, 2015
Manufacturing giant Toshiba Corp.’s president and seven other directors were forced to resign when an investigation revealed in July that the firm had doctored the books and had padded its profits over the past seven years to the tune of hundreds of billions of yen. The case is one of Japan’s biggest corporate scandals in years. The 140-year-old company is set to make a fresh start on Sept. 30 when it holds an emergency shareholder meeting to approve a new management team. But what was going on with Toshiba and why was it inflating its profits? Here are some questions and answers about Toshiba’s accounting problems.
How did Toshiba’s accounting scandal come to light?
Suspecting accounting irregularities at Toshiba, the Securities and Exchange Surveillance Commission under the financial watchdog Financial Service Agency launched a probe in February.
Realizing the seriousness of the issue, Toshiba decided to set up an in-house investigative committee in April, when the firm publicly announced its accounting troubles.
The irregularities apparently went deeper than the firm initially believed; thus it handed the investigation over to an independent outside committee in May and said that it would postpone reporting its fiscal 2014 earnings.
The committee compiled a nearly 300-page report and submitted it to Toshiba on July 20.
What did the investigation find?
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 President 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.
How did Toshiba manipulate the accounting?
There were several ways and methods, which differed in each division.
In one instance, Toshiba out-sourced the manufacturing of computers to a partner. Toshiba would sell computer parts to the partner, who would then assemble the computers, which it would then buy back.
The company’s computer division would sell more parts than necessary to the partners, which increased that company’s inventory, allowing Toshiba to inflate its profit figures.
In another example, the report said the infrastructure division purposely understated the costs of construction projects even though it knew, according to new estimates, the real costs had increased.
Were the pressures to make a profit that strong?
According to the report, the pressure the presidents placed on their subordinates to show a profit were immense.
For example, in September, 2012, the digital product and service division of Toshiba, which includes its computer business, told the then-President Sasaki that it would post a ¥24.8 billion operating loss for the first half of the fiscal year.
But Sasaki refused to accept the forecast and told the division to improve its profit by ¥12 billion in just three days.
In September, 2013, then-President Tanaka told a senior vice president that he wanted to have a “secret talk.” He asked the vice president to improve a loss at the digital product and service division by padding the numbers.
The vice president told Tanaka he was personally opposed to doing so, but if Tanaka decided, he would support it.
How did Toshiba react to the committee’s report?
At a news conference on July 21, then-President Tanaka apologized and resigned from the post. The company also announced that then-Vice Chairman Sasaki and Adviser Nishida were resigning, as were six other directors.
Tanaka refrained from commenting in detail on the report’s findings but did insist he did not directly order his employees to manipulate the company’s profits.
Toshiba said it will also increase the number of outside directors and strengthen its audit committee and internal audit systems.
How does the Toshiba’s scandal compare to similar cases?
In 2005, a probe found that Kanebo Ltd. committed accounting fraud that totaled about ¥200 billion, which resulted in the arrest of three executives.
Livedoor fabricated ¥5.3 billion in revenues for the business year through September 2004.
Former Livedoor President Takafumi Horie spent 21 months in jail over the incident.
In 2011, Olympus Corp.’s accounting scandal came to light. The firm covered up ¥110 billion in losses, leading to the arrest of seven people.
To date, prosecutors and the police have not publicly announced they are taking action over the Toshiba scandal, but some shareholders are expected to file a class-action lawsuit against the firm.
Some experts said that the case should be scrutinized further, otherwise, the Japanese market will lose the trust of overseas investors.
Will Toshiba be delisted from the Tokyo Stock Exchange?
Not for now. However, the TSE designated Toshiba a “security on alert” on Tuesday. The firm has been given a year to improve its internal control systems and will report its results to the TSE.
If the firm fails to strengthen its governance, it will be delisted. The TSE also fined Toshiba ¥91.2 million.
Ernst & Young ShinNihon LLC said the Financial Services Agency has been investigating staff involved with the audit of Toshiba. It said it was also undergoing a routine biennial inspection by regulators over its governance and overall operations.
The scandal ranks as one of Japan’s biggest corporate scandals alongside the fraud discovered in 2011 at medical equipment and camera maker Olympus Corp, which was also an Ernst & Young ShinNihon client.