Japanese auditors lack sufficient powers to
pick up fraud, according to Yoshinao Matsumoto, a professor of
auditing at Kansai University.

Matsumoto told International Accounting
the Japanese audit profession is blighted by a
combination of relatively low audit fees and insufficient legal
powers to detect accounting irregularities.

Matsumoto’s comments come in the wake of one
of Japan’s largest corporate frauds in which the camera and medical
equipment manufacturer Olympus recently revealed it had hidden
large securities losses by using payments to merger advisers and
venture capital funds. Two of Japan’s largest firms, former Olympus
auditors KPMG ASZA and Ersnt & Young ShinNihon (E&Y), are
being investigated by authorities to determine whether they could
have done more to uncover accounting irregularities.

Matsumoto said it is difficult for audit firms
to play a stronger role in fraud detection due to the relatively
weak position they hold in their relationship with clients.

“The most typical Japanese audit environment
is that the power of business managements is much stronger than
CPAs. So CPAs, as auditors, cannot take a firmer attitude toward
these directors and managements,” Matsumoto said.

“The fact that auditor’s power is weak
compared to the management and that corporate governance, [such as] directors’ mutual monitoring, is not effective like in Japanese
traditional companies, makes fraud and irregularities easier.

“If the management did the fraud and
irregularities in the financial statements, in general, auditors
cannot detect them because the auditors do not have any legal power
like the tax collector”.

Low fees

Japanese audit firms are typically paid a
fraction of what US auditors receive, adding extra pressure.

Following the Kanebo scandal of 2004, the
Japanese Financial Service Agency revised auditing standards, the
CPA Law and the Financial Instruments and Exchange Law, while
introducing the Internal Control Report and Audit, and quarterly
financial statement reviews. This created a great deal more work
for auditors but fees have not risen at a high enough rate to cover
the additional man hours, which increases the likelihood that audit
work may not be as thorough.

“For example, since those reforms, audit fee
became 1.5 times as high as 2007. However, comparing it to the US
audit fee, the Japanese audit fee is only about 30% in average,”
Matsumoto said.

The Japanese Institute of Certified Public
Accountants and Japan’s Financial Services Agency are investigating
KPMG ASZA and E&Y ShinNihon over their audits of Olympus.

Regardless of the outcome, Matsumoto believes
the reputation of Japan’s Big Three is under threat.

The Kanebo scandal destroyed former auditor
PwC’s reputation in Japan to such a degree the network need to shut
down its former member PwC ChuoAoyama and rebuild from scratch.
This led to PwC being much smaller in size than its traditional
rivals, a position it still holds.

With only three large firms remaining, the
Japanese audit profession can ill afford another major