T

he year 2012 has just started, bringing with it new hopes and dreams for a better future, but not for the Olympus Corporation. In December 2011, the Third Party Committee released its investigative report on the alleged financial fraud by the Japanese-based optics and reprography manufacturer.

The scandal has been said to be the largest inappropriate loss-hiding scheme in Japanese corporate history. It is quite surprising to see that fraud of such a scale occurred in a country which scored 8.0 on the recent Transparency International’s Corruption Perception Index (CPI) study. This suggests that no country is completely immune to fraud.

The report from the Third Party Committee revealed that, through particular merger and acquisition transactions and their accounting, the company had managed to fraudulently hide around US$1.7 billion (Rp 15.6 trillion) in losses from its “underwater” (unprofitable) investments by moving around $2.8 billion of such investments.

The practice of hiding investment losses itself (known also as tobashi or to make fly away) was reported to be common among Japanese corporations in the 1990s. Tobashi was used by security brokerages of the time to help companies to hide losses from their previous investments by using temporary off-balance-sheet havens.

By 1999, tobashi was illegal in Japan. Additionally, the accounting standard in the country dictates that a company’s investment must be marked to market value, which results in investment losses (or gains), to be recorded in a company’s financial statements.

In the Olympus case, although the way the scheme was perpetrated may not be entirely the same as that of the 1990s, the term tobashi is often used by financial experts in explaining what happened in the company.

According to the report, Olympus’ investment losses were hidden by shifting them among several subsidiaries so as to be able to write them down as goodwill impairments. Doing so created the impression on its financial statements that Olympus had been able to maintain its profitability throughout the years.

The Olympus case is just one of many financial fraud cases that aimed at presenting “handsome” financial statements, especially to external parties such as shareholders and potential investors. Other notable cases include Enron, WorldCom, Adelphia Communications, Bristol-Myers Squibb, and many more. Just as in other fraud cases, motivation or pressure is believed to be a major driving factor behind every accounting related fraud.

These pressures on motivations stem from the fact that good accounting figures translate into a lot of good things for the company such as a positive public image, higher stock prices, higher ability to compensate employees with stock options, more incentives for executives, personal status (for executives) just to name a few.

Normally, to achieve such figures a company must perform well in their business, which will then be reflected in its financial statements. Unfortunately, the existence of the stock market often creates pressures for companies to perform well in their financial statements through whatever means necessary.

In Indonesia, although cases of financial statement fraud are less intensely covered by mass media than those of corruption, evidence suggests that such practices are commonplace in Indonesia, just as they are in other countries. Over the years there have been allegations that some large corporations have engaged in some fraudulent financial reporting schemes.

For example, recently a group named Indonesia Audit Watch (IAW) urged the House of Representative (DPR) to examine alleged irregularities involving PT Krakatau Steel’s initial public offering (IPO) before approving the IPOs of other state-owned companies.

The IAW suggested the House to look into Krakatau Steel’s financial statements to see whether or not there the company’s net income had been manipulated. The IAW’s founder and secretary, Iskandar Sitorus, argued that such an enquiry was necessary since, according to him, the company had not been performing well for years. This has created pressure to manipulate financial statements in order to attract investors from the stock market.

There are a wide range of methods that can be used to manipulate a company’s financial statements. Common methods include, but are not limited to, asset or revenue overstatements or understatements, timing differences, fictitious revenues, concealed liabilities, expenses and losses, improper disclosures and improper asset valuations. The Olympus case is an example of a concealed losses scheme whereas Enron was that of concealed liabilities.

An important theme underlying all these schemes is to show or exaggerate figures that look good on the report and hide or omit those that do not. Simply put, all the complexities within financial statement fraud aim primarily at distracting external parties’ attention from the real issue (company’s bad performance) and thus earning it a nickname of “weapon of mass distraction”.

In most if not all cases, executives play a central role in deciding whether or not under a difficult financial situation the company will resort to unlawful means such as accounting fraud.

KPMG’s 2011 global study on fraud offenders revealed that most fraud offenders held senior management positions. This, according to KPMG, was due to the fact that they are often entrusted with sensitive information which gave them, among other things, the ability to override controls within their organizations.

KPMG’s study highlighted that access to and responsibility for corporate assets, financial reporting, and credit lines often provided the most significant temptation, as well as the opportunity, to commit fraud.

In the Olympus case, for example, a number of executives were allegedly involved in the company’s decision to engage in its loss-hiding scheme. In December 2011, Olympus, represented by several of its executives publicly apologized for the scandal.

Within a company, generally there is a principle known as the “management accounting” function, which serves as a means for the decision-making process.

Principally, this part of the organization gathers information about the results of a company’s operations in a given period of time and then conducts evaluations regarding the achievability of the predetermined objectives, by which unfavorable variances can then be identified and evaluated to devise the most appropriate means or strategy to solve the problems.

This process can result in new products, better services, more innovative marketing strateges, etc. Unfortunately many large corporations were too “lazy” to go through all of the trouble completing these complex processes and instead went straight to their accounting departments to request “unfavorable figures” be removed or at least “polished”.

It is important for company executives to realize that although in the short run accounting fraud may seem to be able to help their companies get back on their feet again after a crisis (e.g. declining market share and profitability), in reality, it actually marks the beginning of their end.

In the aftermath of many notable accounting scandals, most companies suffer huge losses. Ironically, the people most hurt most by the events are often they who had the least involvement in the frauds, such as shareholders employees.

The writer is director of the Centre for Forensic Accounting Studies at the Department of Accounting of the Islamic University of Indonesia. He obtained his Masters and PhD in Forensic Accounting from the University of Wollongong Australia.