Toshiba's lack of auditor options exposes global problem
Checks and balances jeopardized by overconcentration in the accounting industry
RYUSHIRO KODAIRA, Nikkei senior staff writer
TOKYO -- When Toshiba holds its annual shareholders' meeting on June 28, the company's fiscal 2016 financial results will not be ready because its auditor, PricewaterhouseCoopers Aarata, has not approved them. This ongoing mess at the troubled Japanese electronics company shows how concentrated the global audit industry has become and the danger it poses to global capital markets.
Until fiscal 2015, Toshiba had its books audited by Ernst & Young ShinNihon. Toshiba switched to auditors in fiscal 2016 partly because of the accounting fraud that came to light in 2015 at the conglomerate. The change was made to avoid a repeat of such malpractice. PwC Aarata then raised questions about internal controls at Toshiba's nuclear unit in the U.S. and refused to approve the nine-month financial results to December 2016.
Toshiba was unhappy with that decision and considered hiring a different accounting firm to audit its full-year results to March, but it could not find any. So it stayed with PwC Aarata at least for that fiscal year. Who is going to audit Toshiba's books this year is anyone's guess.
Wanted: new partner
Why is it so difficult for Toshiba to find another auditor? There are two reasons.
First, auditing Toshiba's books is a huge risk for any accounting firm. Agreeing to do so now could be seen as giving tacit approval of Toshiba's accounts. In other words, that auditing firm could be criticized for aiding Toshiba in opinion shopping -- the practice of soliciting a favorable opinion from a third party -- and end up tarnishing its reputation in the process.
The other reason is that because the auditing industry has become increasingly concentrated, there are few major accounting firms left that can handle big companies' books. Auditing Toshiba entails checking a number of relevant accounts spread across the world. It also requires highly specialized skills for extremely complex industries, namely semiconductors and nuclear power.
The choice, therefore, would have to be a major global player. In Japan, that means one of the auditors that is affiliated with one of the four multinational accounting firms known as the big four -- Deloitte Touche Tohmatsu, Ernst & Young, Pricewaterhouse Coopers and KPMG.
Of those, who can take over as Toshiba's auditor this year?
Ernst & Young ShinNihon has just been ditched. The choice of Tohmatsu raises concerns about impartiality because Toshiba's audit committee chairman, Ryoji Sato, used to be the accounting firm's CEO. KPMG Azsa is believed to have been providing nonaccounting services to Toshiba, which could mean there is a conflict of interest. Toshiba appears to be stuck with PwC Aarata.
There is such a scarcity of choice because the field has seen restructuring in recent years.
In the past, global accounting was dominated by eight major auditing firms. In 1998, after several reorganizations, the eight became five. Then the prestigious Arthur Andersen collapsed due to an accounting scandal at Enron, a U.S. energy trader.
Around that time, regulators and antitrust authorities began to start worrying about the downside of an oligopoly in the industry.
According to a 2009 report by the International Organization of Securities Commissions, 98% of 1,500 large corporations in the U.S. are audited by the big four. And there is a growing gap between the big four's annual revenues -- 15 billion to 20 billion euros ($16.82 billion to $22.43 billion) per firm -- and those of second-tier auditors, which stand at about 2 billion to 3.7 billion euros. As the big four invest heavily in information technology to expand their operations worldwide, which attracts even more companies, the gap seems to widen.
The picture is similar in Japan. In terms of the number of partners, the difference between the top accounting firms and the rest is apparent. This shows how risky and unnatural it is for Toshiba to choose a new auditor from outside the major players.
Reform on the horizon?
In terms of market value, over 90% of listed companies in Japan are audited by the big four affiliates, according to data by the Financial Services Agency. If a large company wants to choose a truly independent auditor -- one that does not provide nonaccounting services to the company, such as sending an outside director or providing consulting -- the company would have very little choice.
Too much concentration in the industry could undermine the quality of work being done. If big companies get cozy with their auditors, accountants may turn a blind eye to fraud, such as cooking the books.
Measures have been taken to prevent negative consequences from occurring. In Japan and the U.S., partner accountants -- those responsible for auditing specific companies' accounts -- must change after a certain period of time, although the accounting firms themselves do not have to change. The European Union has gone one step further and introduced a rotation system under which companies, in principle, must not use the same accounting firms for more than 10 years.
In the U.K., accountants now add an extended auditor's report to cite specific risks such as the possibility of accounts being rigged. This system is gradually spreading to other European countries and is expected to reach the U.S. soon. Japan recently began talks on introducing it.
The accounting industry tends to evolve after explosive scandals occur at big companies. The Enron case is a prime example. Toshiba's predicament should serve as a weather vane pointing to the need for reforms in Japan's audit industry.