L

ast July the world again learned the hard truth that regardless of how smart we are, we can still be fooled a dozen times.

In what many believe to be one of the greatest accounting scandals in Japan, based on an investigation report by a panel of external lawyers and accountants, Toshiba was accused of conducting '€œinstitutional accounting malpractice'€.

Eight of its board members resigned presumably to take responsibility for the company'€™s artificially inflated profits in 2008 to 2014 by US$1.2 billion. The panel found that among the means employed by Toshiba to artificially inflate its profit was by delaying accounting for losses in various divisions such as its infrastructure, semiconductor, personal computer and television businesses.

The 82-page report highlights the possibility that Toshiba may have misused the complexity of its business accounting to create an image of financial strength.

Chapter 2 of the report questioned the application (or misapplication) of the percentage-of-completion method by the company and its subsidiaries on the accounting of various projects, which may have constituted the artificial inflation of profits (e.g. through understatement of cost of contract). The panel'€™s investigation was conducted from May 15 to July 20 based on information mainly obtained prior to July 17.

The report also explicitly mentions corporate culture as a causal factor behind the irregularities. Within the seemingly authoritarian culture, employees could not act contrary to the intent of their supervisors.

Yet every now and then a '€œchallenge'€ was issued in the form of targeted profits and losses. The '€œchallenge'€ got increasingly harder as Toshiba continued to generate losses.

This is where things got really bad as the supposedly ordinary '€œcreative'€ (but legal) accounting practices alone may not have been much of a help in achieving the financial statement targets.

Financial statements are essentially a '€œphotograph'€ of company operations based on which decisions will be made by both internal and external parties.

Therefore, especially for the external parties, the accuracy of the financial statements is important in decision-making processes such as whether investment into a company will be made (e.g. in the stock market). On the other hand, company executives'€™ performances, for example, are often tied to company performance as reflected by its financial statements.

This may create enormous pressure especially for executives with a '€œwheeler-dealer'€ attitude to do whatever it takes to achieve organizational and personal goals.

For the past two decades multiple corporate failures, such as Enron and WorldCom, demonstrated the power of accounting as a '€œweapon of mass distraction'€ when misused by large corporations. Since the release of the investigation report on Toshiba, antifraud experts have been comparing the scandal to the similarly orchestrated Olympus scandal in 2011.

An investigation found that through particular merger and acquisition transactions and their accounting, the company had managed to fraudulently hide around $1.7 billion in losses from its '€œunderwater'€ (unprofitable) investments. In December 2011, Olympus, represented by several of its executives, publicly apologized for the scandal.

Behind the complexity of corporate accounting scandals there are equally complex behavioral issues often taken for granted by decision makers prior to the revelation of the schemes.

Indications show that patrimonialism, narcissism, dictatorship and '€œwheeler dealer'€ attitudes have been common in corporate accounting scandals in the past two decades.

The investigation panel'€™s assessment on Toshiba'€™s corporate culture constitutes an important part in understanding the hidden '€œstories behind the numbers'€. Both the Olympus and Toshiba cases are characterized by similar if not the same behavioral problems including the ideology of maintaining organizational '€œpeace and harmony'€ which effectively bans internal criticism

In the Olympus case former president and chief operating officer (COO) Michael Woodford was willing to stand up against other company executives when he found out about the company'€™s practices in manipulating its financial statements. As a result, he was sacked only six months after his appointment as the COO.

Although the company executives'€™ knowledge and involvement in the accounting manipulation is not explicitly listed in the investigation report on Toshiba, evidence suggests that the quality of leadership directly or indirectly affects the propensity of fraud.

 Experts believe that Enron, WorldCom and many other companies from Wall Street'€™s '€œHall of Shame'€ had internalized fraud through '€œnormalization'€, to cite Blake E. Ashforth and Vikas Anand '€” a process which starts from making fraud part of organizational mindset and then embedding it within its individuals '€” followed by rationalization through denials.

One most common form of denial is the '€œappeal to higher loyalties'€ where employees place the highest loyalties with their peers and superiors.

According to the Toshiba investigation, when top management set financial targets, it was like an obligation for company presidents and their subordinates to achieve the targets and eventually resort to inappropriate accounting treatments.

On July 29 Toshiba released a written statement in response to the results of the independent investigation in which the company stated that it would establish a new corporate culture under the new management to regain the trust of shareholders, investors, stakeholders and the public.

Financial statement manipulation is a global phenomenon. In Indonesia, every now and then we hear allegations of financial statement fraud.

 In May 2015 a company in Indonesia whose primary businesses include distributing and retailing cell phones and accessories as well as provisioning cell phone repair services and contents was suspected of manipulating its financial statements due to its reported gross profit margin of 5.6 percent from its prepaid top-up card business.

Many believe that, compared to other contenders in the market, the highest margin from the business should be no more than 2 percent.

This and a number of other financial statement fraud allegations suggest an unhealthy corporate culture in Indonesia.

Numerous corruption cases are also believed to be caused in part by such organizational culture which include patrimonialism, rent-seeking and narcissism, to name a few.

Understanding interactions within an organization should be among the consideration of decision makers such as investors and regulators when assessing an entity'€™s overall performance.

Ignorance of behavioral issues and overreliance on financial figures has been proven by numerous corporate failures as a recipe for financial disaster.
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The writer is an Endeavour research fellow at the University of Wollongong, Australia. He is also director of the Center for Forensic Accounting Studies at the Islamic University of Indonesia, Yogyakarta.