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Case 8-6
Olympus
Summary of the Case
On September 25, 2012, Japanese camera and medical equipment maker Olympus Corporation and three of its
former executives pleaded guilty to charges related to a $1.7 billion accounting cover-up in one of Japan’s biggest
corporate scandals. Olympus admitted it tried to conceal investment losses by using improper accounting under a
scheme that began in the 1990s.
The scandal was exposed in 2011 by Olympus’s then-chief executive officer, Michael C. Woodford, who was fired
by the company’s board after asking about deals that were later found to have been used to conceal the losses.
“The full responsibility lies with me and I feel deeply sorry for causing trouble to our business partners,
shareholders and the wider public,” the former chairman, Tsuyoshi Kikukawa, told the Tokyo district court. “I take
full responsibility for what happened.”
Prosecutors charged Kikukawa; a former executive vice president, Hisashi Mori; and a former internal auditor,
Hideo Yamada, with inflating the company’s net worth in financial statements for five fiscal years to March 2011
due to accounting for risky investments made in the late-1980s bubble economy. The three former executives had
been identified by an investigative panel, commissioned by Olympus, as the main suspects in the fraud.
An Olympus spokesman said the company would cooperate fully with the investigative authorities. It is under
investigation by law enforcement agencies in Japan, Britain and the United States.
In December 2011, Olympus filed five years' worth of corrected financial statements plus overdue first-half results,
revealing a $1.1 billion hole in its balance sheet leading to speculation it would need to merge or forge a business
tie-up to raise capital.
Olympus Spent Huge Sums on Inflated Acquisitions, Advisory Fees to Conceal Investments
Losses
Olympus’ cover-up of massive losses has shed light on murky methods employed to clean up the mess left after
Japan’s economic bubble burst. Many companies turned to speculative investments as they suffered sluggish sales
and stagnant operating profits. The company used "loss-deferring practices" to make losses look smaller on the
books by selling bad assets to related companies.
To take investment losses off its books, Olympus spent large sums of money to purchase British medical equipment
maker Gyrus Group PLC and three Japanese companies and paid huge consulting fees. According to their records,
Olympus paid about ¥66 billion (yen) (about $660 million) mainly in advisory fees for their purchase of Gyrus, an
apparent manipulation to conceal losses.
Olympus is suspected of having deliberately acquired Gyrus at an inflated price; and in the year following the
purchases, it booked impairment losses as a result of decreases in the companies' value.
To avert a rapid deterioration of its financial standing, Olympus continued corporate acquisitions and other measures
for many years, booking impairment losses to improve its balance sheet. Losses on the purchases of the three
Japanese companies amounted to ¥55.7 billion. With money paid on the Gyrus deal included, Olympus may have
used more than ¥100 billion in funds for past acquisitions to conceal losses on securities investments.
Olympus Reported Only ¥17 Billion of ¥100 Billion in Losses
Olympus reported only about ¥17 billion in losses in its annual securities report for the year ending March 2000,
despite the fact its losses totaled nearly ¥100 billion at that time. Japanese accounting standards were revised in 2000
to require latent losses of financial products to be specified in annual securities reports. Olympus should have
reported the actual latent losses in its report for the year ending March 2001.
The previous method that recorded stocks and other financial products by book value – the price when they were
purchased – was abolished. The new method listed them by market value (mark-to-market accounting). Under this
change, Olympus had to report all the losses in its March 2001 report. However, Olympus anticipated this change a
year in advance and posted only about ¥17 billion of the nearly 100 billion yen as an extraordinary loss for the
March 2000 settlement term. The company did not post the remainder as a deficit, but deferred it using questionable
measures.
Olympus’s Tobashi Scheme
At the heart of Olympus’s action, was a once-common technique to hide losses called tobashi, which Japanese
financial regulators tolerated before clamping down on the practice in the late 1990s. Tobashi, translated loosely as
“to blow away,” enables companies to hide losses on bad assets by selling those assets to other companies, only to
buy them back later through payments, often disguised as advisory fees or other transactions, when market
conditions or earnings improve.
Tobashi allows a company with the bad assets to mask losses temporarily, a practice banned in the early 2000s. The
idea is that you pay off the losses later, when company finances are better.
Olympus appears to have pushed to settle its tobashi amounts from 2006 to 2008, when the local economy was
picking up and corporate profits rebounding, in an effort to “clean up its act.” Business was finally strong enough to
be able to withstand a write-down. It was during those years that the company engineered the payouts that came
under scrutiny: $687 million in fees to an obscure financial adviser over Olympus’s acquisition of Gyrus in 2008, a
fee that was roughly a third of the $2 billion acquisition price, more than 30 times the norm. Olympus also acquired
three small Japanese companies from 2006 to 2008 with little in common with its core business for a total of $773
million, only to write down most of their value within the same fiscal year.
Olympus Scandal Raises Questions about the ‘Japan Way’ of Doing Business
The scandal rocked corporate Japan, not least because of the company’s succession of firings, denials, admissions,
and whistle-blowing. It also exposed weaknesses in Japan’s financial regulatory system and corporate governance.
“This is a case where Japan’s outmoded practice of corporate governance remained and reared its ugly head,”
according to Shuhei Abe, president of Tokyo-based Sparx Group Company. “With Olympus’s case, it will no longer
be justifiable for Japan Inc. to continue practicing under the excuse of the ‘Japan way of doing things.’” “The
Japanese market is already looking unattractive to foreign investors,” said Hideaki Tsukuda, managing partner at
Egon Zehnder International’s Tokyo office. “Japanese companies really have to get their acts together, taking this
opportunity to strengthen their corporate-governance practices.”
On the surface, Olympus seemed to have checks on its management. For example, it hired directors and auditors
from outside the company, as well as a British president who was not tied to corporate insiders. In reality, however,
the company's management was ruled by former Chairman Tsuyoshi Kikukawa and a few other executives who
came from its financial sections.
The company's management is believed to have been effectively controlled by several executives who had a
background in financial affairs, including Kikukawa and former vice president Hisashi Mori, both of whom were
involved in the cover-up of past losses. Olympus's board of auditors, which is supposed to supervise the board of
directors, includes full-time auditor Hideo Yamada, who also had financial expertise.
In some ways, the Olympus episode harks back to an older — and more freewheeling — era of Japanese deal-
making, before the bursting of the country’s economic bubble in the 1990s and subsequent regulatory reform efforts.
Back then, small Japanese shareholders would threaten to cause problems at corporate annual meetings unless they
were paid to be silent. In other cases, companies would pay politicians to secure government business. Culturally,
you trust intermediaries and relationships so due diligence often is shortchanged.
How Woodford Rocked the Boat at Olympus
Olympus initially said it fired Woodford, one of a handful of foreign executives at top Japanese companies, over
what it called his aggressive Western management style. Woodford disclosed internal documents to show he was
dismissed after he raised questions about irregular payouts related to mergers and acquisitions. Woodford later made
a bid to return to the company with a fresh slate of directors, but he abandoned that effort after Japanese institutional
investors continued to back Olympus’s current management.
Woodford had officially raised his concerns in a series of letters to the Olympus vice chairman, Hisashi Mori,
beginning in mid-September 2011. The letters painted a picture of an increasingly frustrated Woodward as he
demanded more disclosure over the acquisitions. In his fifth letter, dated September 27, he set the first of his
ultimatums: Mori must, he insisted, produce documents before his return to Tokyo from London the next day, and
agree to a three-way summit with chairman Kikukawa.
But Kikukawa and Mori then made what seemed at the time as a puzzling move: they offered Woodford the position
of CEO, to add to his post as president. The promotion was announced in a news release filled with glowing praise
for Woodford, championing his cost-cutting drive and presenting him as the new global face of Olympus.
If the promotion was meant to give Woodford a greater stake in the company’s future, and a greater sense of loyalty
to the board, Woodford interpreted it as giving him even more ability to investigate the deals. Without the board’s
knowledge, he commissioned a report by PricewaterhouseCoopers (PwC) into the Gyrus deal, including the
unusually high advisory fee and apparent lack of due diligence. On October 11, 2011, he circulated the report to the
board, and called on Kikukawa and Mori to resign. Three days later, the board fired him.
Losses for Financial Year 2011-2012
Olympus said it posted a bigger-than-expected Group (consolidated) net loss for the fiscal year to March 2012. The
consolidated net loss stood at ¥48.985 billion, compared with its projected loss of ¥32 billion and the ¥3.866 billion
profit it logged the previous year. The weaker result stemmed from additional special losses that the optical
equipment maker booked to liquidate three companies it used to conceal massive investment losses from the bubble
economy.
In December 2011, Olympus filed five years’ worth of corrected earnings statements to restate its accounts. It said
that as of the end of September, net assets were ¥46 billion, down from a restated ¥225 billion in March 2007. It also
withdrew its forecast for a ¥18 billion net profit in the current business year.
Accounting Explanations
Olympus hid a $1.7 billion loss through an intricate array of transactions.
A one paragraph summary of what it did appears in the investigation report:
“The lost disposition scheme is featured in that Olympus sold the assets that incurred loss to the funds set up by
Olympus itself, and later provided the finance needed to settle the loss under the cover of the company acquisitions.
More specifically, Olympus circulated money either by flowing money into the funds by acquiring the
entrepreneurial ventures owned by the funds at the substantially higher price than the real values, or by paying a
substantially high fees to the third party who acted as the intermediate in the acquisition, resulting in recognition of
large amount of goodwill, and subsequently amortized goodwill recognized impairment loss, which created
substantial loss.”
Here is a more understandable version of the event:
Olympus indirectly loaned money to an off-the-books subsidiary and then sold the investments that had the huge
losses to the subsidiary at historical cost, eventually paying a huge premium to buy some other small companies and
writing off the underwater investments as if they were goodwill impairments.
A more detailed bookkeeping analysis of the complicated transactions appears in Exhibit 1
Exhibit 1
Detailed Bookkeeping Analysis of Olympus’s Accounting Fraud
Phase 1
Transaction 1:
This is a summary of a complex move – it involved making a CD deposit at several banks that were asked to loan
the money back to an unrelated entity, with the CD as collateral, so the subsidiary can buy investments from
Olympus.
Note: According to the investigative committee’s report, three banks were involved through the course of
the whole project: Commerzbank, LGT, and Société Générale. The committee’s report indicates that all three
banks agreed to Olympus’s request to not tell the auditors about the CDs being collateral for a loan.
(Olympus books)
DR Certificate of deposit
CR Cash
(CD purchase at banks; banks loan it to unconsolidated subsidiary)
(Unconsolidated subsidiary books)
DR Cash
CR Note payable to banks
(Cash from banks; collateralized by Olympus)
Transaction 2:
(Olympus books)
DR Cash
CR Financial assets (Investments)
(Proceeds from selling underwater investments to unconsolidated subsidiary; may have triggered gain on
sale)
(Unconsolidated subsidiary books)
DR Financial assets (Investments)
CR Cash
(To buy underwater investments from Olympus)
Phase 2
Eventually the CDs would have to be rolled over and brought back. In addition, the unrealized losses would have to
be written down eventually, so the second phase was launched.
Transaction 3:
Olympus bought some tiny (startup) companies. They paid significantly more than they were worth and paid large
amounts for consultants for their service as finders and intermediaries.
(Olympus books)
DR Investments (startup subsidiary)
DR Goodwill – (cash paid less fair market value of subsidiary net assets)
CR Cash
(Investments in new subsidiaries)
Note: The investment in the consolidated subsidiary shows a large amount of goodwill, which could then be written
down for impairment)
(Entries by the newly formed consolidated subsidiary)
DR Cash
CR Common stock
(Cash investment from Olympus)
Transaction 4:
The effect of these transactions was to transfer money into the newest consolidated subsidiary, which used the
money to buy the bad investments from the older, unconsolidated subsidiary. The unconsolidated subsidiary then
repaid the note payable to the bank and Olympus liquidated its CD.
(Entries by the newly formed consolidated subsidiary)
DR Financial assets (Investments)
CR Cash
(Buy underwater investments from unconsolidated subsidiary at book value)
(Unconsolidated subsidiary books)
DR Cash (from consolidated sub)
CR Financial assets (Investments)
(Proceeds received from consolidated subsidiary from sale of underwater investments)
DR Note payable to banks
CR Cash
(Repay loan to banks)
Entries by Olympus
DR Cash
CR Certificate of deposit
(CD liquidated)
Auditor Responsibilities
Arthur Andersen was the external auditor through March 31, 2002, after which Andersen was forced out of business
by a U.S. DOJ investigation due to its role at Enron. Then KPMG AZSA LLC was the auditor through March 31,
2009. The 2010 and 2011 fiscal years were audited by Ernst & Young ShinNihon LLC.
The investigative report noted that the fraud was hidden quite well. Three banks were also involved by hiding
information from the auditors. The summary report said all three of them agreed not to tell auditors the information
that would normally be provided on an audit confirmation.
KPMG did come across one of the tobashi schemes carried out through one of the three different routes that had
been set up. According to the investigative report:
“Not everything was going smoothly. The report said that in 1999, Olympus’s then-auditor, KPMG
AZSA LLC, came across information that indicated the company was engaged in tobashi, which
recently had become illegal in Japan. Mori and Yamada initially denied KPMG’s assertion, but the
auditor pushed them that same year to admit to the presence of one fund and unwind it, booking a
loss of ¥16.8 billion. The executives assured KPMG that was the only such deal, the report said.”
Questions about the auditor’s role include: How do you perform an audit for a global investor audience in a local
economy where intentionally hiding losses is legal? How do you function in a business environment where that is
acceptable and normative?
On the other hand, notice how one audit team, from KPMG in 1999, did find one part of the scheme. Management
lied by denying it even existed. After agreeing to write it off, Olympus senior management lied again and said it was
the only one. But the scheme expanded, without detection, for another six years or so and was in place, without
detection, until the last component was unwound at the end of fiscal year 2010.
Olympus Finally Had Enough of the Deception
The last part of the bad investments was finally written off in March 2010. That was the last month of the fiscal year
when Ernst & Young took over the audit from KPMG. Mori and Yamada had finally decided to unwind and write-
off the underwater financial assets and repay the loans it had made through its unconsolidated subsidiary. Of course,
by then the financial press had gotten wind of what was going on at Olympus.
Questions
1. In the Olympus case, Michael Woodford was abruptly fired on October 14, 2011, by the company’s
executive board because of what the board cited as “management culture clash.” Explain what you
think this statement means in the context of the facts of the case and our discussion about the role of
culture in business operations.
In April 2011, British-born Michael Woodford, an Olympus veteran of 30 years, was promoted to the post of
president and chief operating officer and became the first ever non-Japanese chairman of Olympus. Six months later,
Olympus elevated him to its chief executive officer; at that time, he was regarded as an unlikely choice. There were
rumors that he only got the job because he would be "easy to control." Woodford, who spoke no Japanese, had been
There was a cultural difference in Woodford’s managing style and the normal Olympus managing style.
2. Do you think the practice of “tobashi” is a form of earnings management? Why or why not?
Tobashi is form of earnings management. Prior to 2000 it was a common technique to hide losses; it enabled the
3. Explain the ethical issues and corporate governance failings that contributed to the fraud at
Olympus, including the role of the auditors.
The ethical issues include untruthful and inaccurate financial statements and disclosures. The board was not
independent, but was controlled by Kikukawa, former chair, and a few other executives. Olympus’s board of
auditors was supposed to supervise the board of directors, but seemed to do the bidding of Kikukawa also. Olympus
Postscript
In an interesting twist after the facts of the case as presented, is that Olympus faulted five internal auditors for the
fraud and said KPMG Azsa LLC and Ernst & Young ShinNihon LLC weren’t responsible.
A panel the company set up to investigate the fraud determined that five internal auditors are culpable for 8.4 billion
Optional Question
4. What are similarities between the actions taken in the Olympus case and those of Enron with respect
to its special-purpose-entities (SPEs)?
Enron set up SPEs to borrow money and keep those liabilities off of Enron’s balance sheet. Olympus developed a
plan to “sell” the losing investments, at original cost, to shell companies (off-balance-sheet-entities) set up by
The ethics lesson to be learned from the Olympus affair is that a lack of underlying ethical values trumps full
disclosure even in the post-Enron era of transparency. In fact, underlying cultural values such as secrecy may
