As William Edwards Deming famously demonstrated, no system can understand itself, and why it does what it does, including the American social system. ...
System to prevent flawed financial results not working
BY HIRONORI KATO STAFF WRITER
Under a system introduced in fiscal 2008, listed companies in Japan are obliged to vouch for the veracity of their financial results.
The aim is to gain greater transparency and trust in financial markets.
But even after many companies announced they had issued "valid" results, critics say the system is not working because a number of companies revised their initial assessments.
Some were forced to do so after being hit by scandal.
Under the system, listed companies are obliged to report to the Financial Services Agency each year to say whether steps they had taken to ensure the veracity of their financial results are "valid" or "seriously flawed."
The system was introduced under the Financial Instruments and Exchange Law and took effect in the year ended March 2009.
Even if a company reports a flaw with its internal controls, it is not liable for punishment by the FSA.
According to a research by The Asahi Shimbun, at least 17 companies have revised their evaluation of internal controls after having earlier pronounced them as "valid."
Of these, four corrected their assessment for two years running.
Many of the companies were forced to change their assessment of their internal controls and to correct asset securities reports after fictitious transactions and front-loading of sales surfaced.
Mercian Corp., a leading winery, corrected its assessment in August after it emerged in late May that the company was involved in fictitious deals in marine feed business and falsifying expense sheets.
The correction came after Mercian said in March that its internal controls worked effectively when it evaluated transactions, including potentially risky ones.
A third-party investigation concluded the assessment was erroneous because personnel in charge of internal controls knew next to nothing about the marine feed business.
Yoshihiro Machida, a professor of auditing at Aoyama Gakuin University, said Mercian's initial assessment may not have been appropriate in the first place.
"The purpose of introducing the system was to allow an accurate understanding of actual conditions of an organization," he said. "(The company) should not have jumped to the conclusion that its internal controls were valid."
Some analysts question the trustworthiness of auditing by auditing firms.
An auditing firm usually endorses a self-appraisal of a company in its audit report on the company's internal controls.
Kintetsu Corp., a railway company, reversed its assessment of internal controls on financial results for fiscal 2008 and 2009 to "seriously flawed" after improper accounting by a subsidiary emerged.
KPMG Azsa, which audited Kintetsu's subsidiary, approved both initial and revised assessments, which contradicted each other.
Yoshinao Matsumoto, a professor of auditing at Kansai University, said that an auditing firm should be held responsible if its fails to detect irregularities.
"If companies habitually revise their assessments, people will no longer trust the system," he said. "An auditing firm should provide more in-depth explanation to investors."
The ratio of companies that assessed their internal controls as "seriously flawed" was 1.8 percent by September since the system began.
After March this year, it was only 0.9 percent.
The figure in the United States, which introduced a similar system about four years ahead of Japan, was more than 10 percent for the first two years.
The FSA plans to moderate an expression to "important inadequacy that should be disclosed" from "seriously flawed" for fiscal 2011 financial results to get the system to take root.
It said the change will be made because companies have a strong tendency to resist the term "seriously flawed."