Accounting Scandal Ripples Overseas

The accounting scandal in the U.S. is being felt in Asia, where Japanese accountants are reacting in shock and planning their own reforms, while in South Korea, five oil company executives are facing arrest.

South Korea's National Police Agency says it has requested warrants for the arrest of five S-Oil executives in a probe into share price manipulation and accounting irregularities.

S-Oil says in a statement that it is confident the investigation will ultimately find the company innocent of any wrongdoing.

Police, in their own statement, charge that "S-Oil executives made about 80.4 billion won of unfair profits through a total of 23,571 cases of stock price manipulation which lifted the price up to 56,000 won per share."

The police also accuse S-Oil executives of having inflated 2001 net profits to 19.1 billion won from a 7.7 billion won net loss.

In Tokyo, the head of a Japanese auditors' group is playing down the risk of Japan facing fraud scandals similar to the ones that have rocked corporate America, but warns at the same time that Japan still has much to do to ensure accounting transparency.

Akio Okuyama, president of the Japanese Institute of Certified Public Accountants (JICPA), which represents a total of 1,432 accountants across the country, described the wave of U.S. scandals as "unbelievable, truly a surprise."

"We had thought U.S. managers attached importance to disclosure and we had been told our auditing systems must learn more from that country. Quite the contrary," said Okuyama.

He notes that circumstances in Japan are different in one important way, in that U.S. firms have more often expanded through mergers and acquisitions, whereas Japanese companies have concentrated on organic growth through capital investment.

"Unlike expansion via capital investment, M&As allow a company to obtain hefty assets all at once. And when the assets start to turn sour, the pace is quite rapid," said Okuyama.

He says among the steps Japan must take, learning lessons from the U.S., are to strengthen the industry watchdog function of the financial regulator and to modify the current unlimited liability on all partners in auditing firms in the event of their firm losing a compensation suit.

At the same time, Okuyama acknowledges that Japanese balance sheets, long the object of foreign criticism for their lack of transparency, have yet to catch up with the United States, even in the light of recent U.S. events.

But he said that two big changes are on the way.

"We are to adopt 'going concern' auditing rules and asset impairment accounting, both of which will inevitably bring huge friction between auditors and companies," said Okuyama.

'Going concern' rules come into force for results reported for the current business year ending in March 2003, obliging certified public accountants to clearly state in reports the possibility of any risk of business failure in the year after.

The rules are designed to restore investor faith in Japanese corporate balance sheets, which have been hit by a series of business failures caused by massive losses that never showed up on earnings reports in past years.

JICPA is due to endorse guidelines for auditors by the end of this month. Japan, where accountants traditionally do not have much say and are reluctant to give such early warnings, is the only major country that has no such auditing rule.

Okuyama said wrangling is inevitable between auditors and company executives but he thought auditors were now more able to talk on an equal footing with top managers than before.

"The recent huge losses reported by Japanese firms for restructuring or tighter accounting rules could mean auditors tightened their checks and corporate managers accepted that," he said. "There must be a change in managements' mindset and we have created conditions under which the two sides can talk."

He said Japan should take a flexible, case-by-case approach on setting penalties if auditors failed to note potential risks at a client company that subsequently went under within a year of an audit.

New rules on asset impairment accounting will take effect in the year ending in March 2006. They aim to boost transparency on unrealized losses on property holdings, whose value has been hit by a slide in Japanese property prices over the past decade.

A major issue here is how to measure future cash flow from real estate asset holdings - a key yardstick for calculating the losses a company might incur. The rule requires a company to compare recoverable funds from the asset with their book value, not market value with book value.