2003 JAPAN LAW: ACCOUNTING PROFESSION
Keywords: Corporate Law, Financial Services Agency, Accounting, Accountant, Certified Public Accountant, Disclosure, Asset Valuation, Consulting Services, Deferred Tax Assets, Resona
Copyright 2004. All rights reserved Attorney Roderick H. Seeman
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“In Japan,  any auditor would admit in private that majority of firms cook their books. Because the books are full of lies, banks can not evaluate the financial standings of borrowers. That’s why they demand collateral and guarantees.”
Junichiro Koshi, former banker with the Industrial Bank of Japan

For those in the know, the Industrial Bank of Japan no longer exists any more, having been involved in one of the many mega-bank mergers that transformed the Japanese banking industry in the 1990s. But for decades the Industrial Bank of Japan was the elite bank, the preferred tool of government and business leaders of Japan in transforming the Japanese economy during the post-war and high growth period in Japan. Its bankers were the elite of the elite in the Japanese banking industry. This writer learned much of his analysis training about Japanese companies when he worked for five years at Wako Securities Company from a director who had “floated from heaven” from the Industrial Bank of Japan, Wako’s main bank and major shareholder.

A likely revision to the Commercial Code would empower shareholders of a corporation which had suffered losses due to the negligence of an accounting firm to file a lawsuit for damages against that law firm.

In line with the trend around the world, particularly in the USA,  the credibility of the accounting profession in serious question. This Japan as well joined the pack in crack downs.  The Financial Services Agency has been seeking the revision of the Certified Public Accountant Law which would include inspections of the accounting firms by the Certified Accountant Examination Committee. Based on the results of those inspections the Financial Services Agency would decide whether to issue orders for correction to the auditing firms. This is in contrast to the voluntary checks by the profession’s Institute of Certified Public Accountants. The Financial Services Agency is losing faith in the voluntary system by the Institute of Certified Public Accountants. The FSA suspended Mizuho Auditing for a year due to the falsification of the financial data of one of its clients.

Under the present provisions of the Certified Public Accountant Law, the maximum penalty that can be imposed for falsely certifying financial statements is a one year suspension. The FSA would like to increase this to two years in the revision, but the ruling Liberal Democratic Party would like to make it into a criminal penalty.

The amendment would require firms to change their accounting firms doing their audits every seven years. But this would apply primarily for firms listed on the stock exchanges and financial institutions.  Private companies with paid up capital of 10 billion yen or more or liabilities of 100 billion yen or more would also have to meet the same requirements.

The amendment would also include a clear provision that the role of the certified public accountant is for investor protection. In this relation information that would have a material effect on the company’s financial statements will be required to be disclosed. For companies publicly traded on Japanese stock exchanges events or transactions that may cause the auditors to have doubts about the ability of the company to continue to function on a going concern will have to disclosed.

How such concern over investor clarity and clarity in disclosure can be squared with the ruling party filing a distortive bill with the Diet whereby company’s would be able to suspend the valuation of shares held long term at market value is difficult to comprehend. In the spring of 2003, with the Japanese stock markets sinking to levels not seen in decades this change  would involve an amendment to the Securities Exchange Law. Companies would be given the option of valuing these shareholdings at book value. This was blamed on the war with Iraq causing excessive losses in the market.

In contrast, the Japan Corporate Accounting Standards Commission, which decides on Japanese accounting standards has announced that from fiscal year 2006, corporate fixed assets which have a market value less than 50% of book value will become candidates for treatment with such losses shown through the income statement. In addition, when the earnings from such assets produces  losses for three consecutive terms they may also be given similar treatment. The difference from the cash flow from such property and the book value of the asset may be shown through the income statement as an extraordinary loss.

The Ministry of Justice will be requiring firms that file financial statements with regulatory bodies (certainly all companies traded on stock exchanges) to publicly reveal how much the company pays to its accounting firm for auditing and non-auditing services.  The revision of the Certified Public Accountant Law sought by the government will also prohibit the accounting firms from simultaneously providing auditing and management consulting services such as actuarial services, investment consulting and  financial system designs. It is estimated that on average Japanese corporations pay  20 million per year for auditing services to the accounting firms, about one-tenth the level  in the USA. On the other hand, most experts do not regard the audits made by the Japanese accounting firms to be as rigorous as their US counterparts. This is in part due to the system of corporate finance in each country. In the USA banks want thoroughly audited financial statements before they make loans. The securities markets depend heavily on investment ratings given by ratings firms which likewise need such rigorous audits. In Japan however corporate financings have long been made by borrowings secured by collateral and intricate systems of guarantees. Banks often second their own personnel to their client borrowers staff. When I worked for many years at Wako Securities Company in Tokyo virtually every department in the company had at least one worker from the company’s two main banks, the Industrial Bank of Japan and Mitsui Trust. Such  a spy network, common throughout Japan, can get more of the low down on what is really going on inside a company compared to any outsiders making statistical analysis. Certainly outside accountants seeking auditing fees from their corporate clients do not have the clout with a customer compared to a bank which provides much of the firm’s financing.

As is the case with the legal profession, a major change in the accounting profession is also being brought about by this amendment. The government seeks to increase the number of CPAs in Japan to 50,000 in the near future from the present 15,000 (compared to 334,000 in the USA). Providing a relaxed licensing exam is one the means to be used to achieve such a result. The new exam is expected to happen in 2006. Many wonder however whether there is enough demand for such numbers of CPAs. As noted, Japanese companies do not pay that much for their auditing services and many CPAs are reportedly looking for jobs even at these reduced levels. Exemption from certain parts of the exam may be provided for applicants with several years of experience in preparing financial statements or internal audits. As is the case with the new graduate law schools for attorneys the government is also seeking graduate schools for accountants. Graduates from such schools may also be exempted from some parts of the licensing exam.

In one ironic case however, the CPAs may have had their revenge on the FSA, to the tune of hundreds of billions of yen. In June 2003 the accounting firm Shin Nihon & Company, a major accounting firm made a decision that forced the hand of the FSA resulting in the government be forced to come up with massive funds once again to rescue another Japanese bank. In this case the auditors called a spade and spade and looked into the magic mirror of deferred tax assets in Japanese banks that were becoming the main source of capital at Japanese banks. The deferred tax assets were basically nothing more than assumed accumulated tax refunds coming from the government to be used some day when the banks actually once again made profits. However, the banks have been in such dire straits for so many years with their mountains of bad debt that produced rivers of red ink, it was becoming increasingly unrealistic to believe that those banks would be making profits making such “deferred tax assets” have some kind of value before they expired. So the head of Shin Nihon consulted with the chairman of the Japanese Institute of Certified Public Accountants about the problem of deferred tax assets at Japanese banks. That chairman of the CPAs organization then advised senior officials of the FSA that such deferred tax assets should be “assessed strictly.” So when Shin Nihon refused to recognized the deferred tax assets as part of capital, the bank immediately fell into a capital deficient category and the government was forced to rescue it with massive fund injections of government money. So the CPAs removed the emperors cloths on the biggest financial disclosure deficiency in Japan, the status of Japanese banks.