Let’s learn about accounting fraud again this time. This article is written in the hope that, by examining fraud methods, management will provide sound oversight to prevent this kind of thing from happening.
Today, Iwaki Co., Ltd., a company listed on the First Section of the Tokyo Stock Exchange, disclosed a document entitled “Investigation Results Concerning Fraudulent Acts by a Former Officer of Our Subsidiary.”
As usual, let’s examine the methods and the issues involved.
Methods Used in the Cash-Embezzlement Fraud
There were mainly three methods. They were carried out by the person responsible for accounting.
- Embezzling part of the funds in cash or otherwise when transferring funds from a receiving bank account to a disbursing bank account (#1,2)
- Embezzling part of the petty cash (#3)
- Embezzling part of large accounts receivable that had been collected and kept in the safe (#4)
The embezzlement in each case was carried out as follows.
The losses appear to have totaled ¥126 million embezzled over 10 years.
To avoid detection, the accounting entries did not reflect the amounts embezzled, and discrepancies from the bank balances were dealt with by forging balance-confirmation letters.
Balance certificates and “Transaction Information” from Bank A were forged so that their contents matched the accounting books. Mr. X made these forgeries by copying the originals of the balance certificates and “Transaction Information,” cutting out and pasting the necessary figures, and then copying them again; the originals were destroyed in a shredder. This forgery work was carried out in the office at Hokuyaku’s head office. Although Bank A’s balance certificates could have been received by post at Hokuyaku’s head office, Mr. X personally went to Bank A’s counter to receive them directly, so no other officers or employees had an opportunity to handle the originals of Bank A’s balance certificates.
It would normally be detected in a financial statement audit, but was not because the subsidiary was not recognized as a significant component
With a method such as this, it would be detected 100% of the time if a financial statement audit were performed. The audit firm confirms bank balances directly with the bank, so company personnel cannot touch them; only bank personnel could make a forgery.
Iwaki is a listed company and is therefore required to undergo a financial statement audit, but it is stated that this subsidiary was not identified as a “significant component” in this instance.
In an audit, where materiality is generally almost nil, a company is treated as a “non-consolidated subsidiary” and is not made a component of the consolidated financial statements in the first place. In that case, it is effectively being “ignored.”
In this case, the subsidiary was not a “non-consolidated subsidiary” but a “consolidated subsidiary” (as can be seen from the securities report). For that reason, my honest impression is that the audit firm could at least have performed the procedure of confirming directly with the bank (through confirmation letters).
Incidentally, the audit firm was Azusa Audit Corporation, one of the major firms.
There may have been various factors, and perhaps they considered it to pose no risk because the company was very small and had a simple business, for example.
Organizing the Reasons the Fraud Occurred
The report summarizes them as follows.
A fixed organizational structure and personnel allocation
The same person had handled finance and accounting alone for as long as 30 years.
⇒ An inexcusable failure. When finance and accounting are handled by one person, they readily become fertile ground for fraud. If the amounts had become large, they should at least have put internal checks in place, such as outsourcing the accounting. This is a case in which internal controls were not working.
Internal procedures for accounting work had become a formality
The president’s approval was obtained, but no supporting documents were attached and nothing was checked.
⇒ The president was simply rubber-stamping. Even without checking every detail, a person who checks should at least ask for explanations or conduct detailed checks at random; the ordinary work expected of a supervisor was not being done.
Monitoring and supervision by the board of directors were not functioning effectively
There was no discussion of the balance sheet or cash flow.
⇒ Financial results are an important matter to report to the board. If they had properly checked why accounts payable had increased and changes in bank balances, that should have deterred the accounting staff member from committing fraud by making that person hesitate.
Audits by the corporate auditor were ad hoc and predictable
Because they were conducted on an ad hoc basis without an audit plan, effective audits could not be performed.
⇒ A subsidiary’s corporate auditor is not necessarily highly knowledgeable about accounting. I feel that they could at least have checked bank deposit balances, but in a sense it cannot be helped. It seems to me that the parent company’s internal audit team and the like should have responded properly.
The four reasons above are given, but fundamentally, if “accounting” and “finance” had been separated, this probably would not have happened in the first place. Accounting can prepare the bank-transfer data and the president can approve the transfers. This is a method I recommend for relatively small companies. Because transfers are basically made only on gotobi payment days (days falling on multiples of five or ten), it should not be that much of a burden. The allocation of work was too lax. I think that is what it comes down to.
The Heart-Pounding Course of Events That Uncovered the Embezzlement
Iwaki and its domestic and overseas subsidiaries (collectively, the “Iwaki Group”) set out in the “Iwaki Group Medium-Term Management Plan 2006–2008,” formulated in June 2006, to “achieve cost reductions and higher service levels by establishing a shared-service center for the Group’s indirect operations.” As part of that effort, it sought to introduce Iwaki’s management of subsidiary funds.
The timing for introducing Iwaki’s fund management differed by subsidiary, but because it was scheduled to begin at Hokuyaku from the fiscal year ending November 2016, preparations to transfer Hokuyaku’s accounting operations to Iwaki were under way at Iwaki and Hokuyaku in early November 2015.
In the course of that work, on the night of November 6, 2015, an employee of Iwaki’s Accounting Department checked, through internet banking, the balance of Hokuyaku’s current account at Branch B of Bank A (the “Bank A current account”) and found a discrepancy of ¥126 million between the deposit balance in the general ledger and the balance shown by internet banking. On the 9th of the same month, Mr. C, the head of Iwaki’s Accounting Department (the “Accounting Department Head”), and Mr. D, the head of Iwaki’s Operations Audit Department (the “Operations Audit Department Head”), were informed of the discrepancy.
Later, on the morning of the 11th of the same month, Iwaki’s Operations Audit Department (the “Operations Audit Department”) sent Mr. X an email and asked him to send materials including the deposit balance certificates. Mr. X replied that, because of a relative’s funeral, he would be taking leave from that afternoon through the 13th of the same month and would not be able to respond immediately.
In response, Iwaki immediately began an internal investigation. From the night of November 11 through the 13th, 2015, the Accounting Department Head and Operations Audit Department Head visited Hokuyaku and, in an investigation conducted in the presence of Mr. E, Hokuyaku’s representative director (the “current Hokuyaku representative”), found that the balance certificates and “Transaction Information” for the Bank A current account kept at Hokuyaku had been forged.
Further, on the night of November 13, 2015, when the Accounting Department Head and Operations Audit Department Head interviewed Mr. X, he admitted that he had been improperly embezzling money from Hokuyaku’s cash and deposits for more than 10 years, and that, to conceal it, he had forged balance certificates and other documents. This is how the fraudulent conduct came to light.
Iwaki’s head office handled this admirably. “Immediately began an investigation,” then “interviewed the person on November 13” after securing the evidence—this was quite a sound judgment.
Going forward, we plan to take appropriate legal action, including filing a criminal complaint against the former officer of the subsidiary and filing a creditor’s petition for bankruptcy.
That is stated, so I get the impression that they were thorough and handled it rather well. The criminal complaint pursues criminal responsibility; on the civil side, it says “filing a creditor’s petition for bankruptcy, etc.,” so the person who embezzled the money has probably spent it and has no assets on hand.
Incidentally, the report describes where the money went as follows.
It is considered that the funds embezzled in connection with this fraudulent conduct were spent on entertainment expenses such as pachinko, payments for credit-card purchases and cash advances, repayment of borrowings from consumer-finance companies, and the like.
Those in management should be careful if a person in accounting or finance appears to be gambling on pachinko or the like, or buying expensive items.