Case Presentation by Group 10

Mishika Gowswamy, Anurag Doshi, Neelabh Mayanad, Sreejit Ramakumar, Sankalp Nandanwar
Case Overview

• October 14, 2011, Olympus Corporation fired its President

and CEO, Michael Woodford.
• Mr. Woodford accused the company’s executives for
paying unrealistically high for dubious acquisition of Gyrus,
British medical equipment maker.
• He was questioning the payment of $687 million as
consulting and advisory fees to a little known financial
advisor for the above said acquisition.
• It was later discovered that the company was involved in
$1.7 billion of fraud that dated way back to 1990s.
 Story Time Line
FACTA published another article accusing
Olympus of its involvement in organized crime
and its links with YAKUZA.
Woodford sent an email to
the entire board of directors
involving external auditors
PwC and asked for meeting Finally Olympus agreed to the fraud of
to get the clarification dubious M&A.

FACTA published an article about questionable

financial practices. Woodford started
investigating and found out about dubious Sep 2011 Oct 2011 14 Oct 2011
M&A done in the past Woodford was make CEO Nov
and President(Expecting him
Michael Woodford, first non Japanese, was to calm down) and Kikukawa 2011
appointed as President and COO become the Chairman of Kikukawa fired Woodford in
Aug 2011 Board of Directors the same meeting by getting
1970s Early 2011 the consent of all the board
2001 He started questioning about this to members
Kikukawa, the then CEO and
President
Kikukawa became the
High growth period.
President and CEO and
Established as strong player
company “Flourished” under
in Microscope, Cameras and
his leadership till 2011
Medical Equipment Industry
Behind the scenes -
Dollar vs Yen Effect
• The dollar had been rising at a good clip and by
the end of 1984 was worth more than 250 yen.
• The Plaza Accord: By the end of the year, the
rate was down to 200 yen, and by the end of
1987 it was only 121 yen.
• No longer profitable to Export
 To compensate for an earnings shortfall, Olympus‟s top management
decided to implement what is known in the Japanese business culture as a
zaiteku strategy

This strategy involves liquidating underperforming corporate assets and

investing the proceeds in high-risk but potentially lucrative investments

Behind the scenes -

Initially, the zaiteku strategy proved successful.
Zaiketu
But then, in the early 1990s, the speculative “bubble” in Japan‟s securities
markets burst. Over the two-year period 1991-1992 alone, major Japanese
stock indices declined by more than 50 percent.

By the late 1990s, the zaiteku strategy had piled up cumulative losses
exceeding $1.5 billion

Hid those losses by simply maintaining the zaiteku investments at their

historical cost basis in the company‟s accounting records.
Behind the scenes – Changes in Japanese
Accounting Principles: Fair value
• In 1997, the accounting laws were modified
which forced Japan to adopt the fair value
accounting system, or “market-to-market
accounting,” as part of its implementation of
International Financial Reporting Standards.
(Mintz, 2012)

• The large investment losses would have to be

reported by Olympus—one way or another
Behind the scenes – Tobashi Scheme
• Many Japanese companies employed innovative tobashi schemes to make
those losses disappear
Loss separation:
• A tobashi scheme is a way for investment firms to conceal losses by
transferring assets and liabilities to companies so the losses are off of the
books
• The companies that purchase the failing assets are sometimes real and
sometimes shell companies
Loss disposition:
• Years later, the company re-acquires those assets at inflated prices from the
dummy entities holding them.
• Olympus used this strategy to “separate” and “dispose” of approximately two
thirds of the more than $1.5 billion of investment losses due its zaiteku
strategy.
 Shell Company
Journal Entries: Cash
Debit Credit
1000
b)
Olympus Corp. Payble 1000
Underwater Financial Investment 1000
Debit Credit c)
Cash 1000
Financial Investment 1000
a) Loss Cash 1000
Cash 1000 e)
Separation Underwater Financial Investment 1000
Cash 1000
b) Payble 1000
Collateral Certificate of Deposit 1000 f)
Cash 1000 Cash 1000
c) Impairment Losses
Underwater Financial Investment 1000 1000
Small Startup Acquisation 1000
d) Good Will
Credit
9000
10000
Good Will 1000
Collateral Certificate of Deposit 1000 Small Start Up
f) Loss
Cash 1000 Debit Credit
Disposition
Impairment Losses 1000 Cash 10000
g) d)
Good Will 1000 Common Stock 10000
Underwater Financial Investment 1000
e)
Cash 1000
Loss on Investment 1000
g)
Underwater Financial Investment 1000
 • When the asset bubble burst in the 1990s, Olympus incurred significant
losses on its investment portfolio and amount of losses amounted to billions
of yen .
• All of the incoming CEOs continued to resist disclosing the unrealized losses,
although the decision that led to those losses wasn’t theirs but that of a
predecessor
• Initially, the failure to disclose these losses wasn’t in violation of Japanese
Why was Generally Accepted Accounting Principles (GAAP), which allowed
investments to be valued at either historical cost or the lower of cost or
market at the company’s discretion.
the fraud not • Accounting rule makers changed the rules in 1997 – which no longer
allowed the financial investments to be reported at historical cost
detected well • A plan was developed to “sell” the losing investments, at original cost, to
shell companies set up by Olympus for that purpose. The sales were financed

over the with loans from banks, which received collaterals from Olympus to secure
the loans. Under lenient accounting rules, those shell companies would not
have to be consolidated with Olympus, so the losses could remain hidden.

Decade? • KPMG AZSA, the Japanese affiliate of the international accounting group,
failed to notice what was going on for years. Internal audit and audit
committee was not effective in monitoring of board .
 • In 2001, Enron went broke. One of the ways it had concocted phony profits
was to “sell” assets to off-balance-sheet entities it controlled, and to book
profits on those sales.
• But in 2007, the Japanese rules were changed. Those shell companies would
have to be consolidated. Olympus had until March 31, 2008, the end of its
fiscal year, to clean up its books. Some deals were quickly closed in March.
• Japanese magazine reported that the Olympus had overpaid spectacularly
for the acquisitions that it made to avoid the Enron-related accounting

How did it deadline, most notably a sum of $687 million apparently paid to advisers as
part of the Gyrus acquisition in 2007-08
• KPMG questioned the treatment for merger and acquisition fees for Gyrus
finally come to and huge impairment of good will assets , Olympus fired KPMG and hired
E&Y.

light? • E&Y allowed Olympus to book goodwill on this acquisition.

• Mr. Woodford, a British citizen who had run the company’s European
operations, became president in April and chief executive in September. He
was told to not worry about such history when the magazine article
appeared. But he did. With the assistance of PricewaterhouseCoopers, he
unraveled the transactions but not their purpose, and concluded that
company money was being stolen.
 • Board – Approved the loss separation scheme

• Japanese board – Company insiders and Long term

employees
• Chairman used to decide compensation - Lack of
independence of board members
Role of board • Board used to rubber stamp after Chairman approval

and audit • Audit Committee – A rarity in Japan but Olympus had audit
committee: committee , however was not successful in monitoring of the
top management
• Inside directors were long term employees
• External director deferred to insiders due to lack of
knowledge and were involved in the fraud
 Role of
External
audtiors:
 • E&Y:
• Violated IAS 300 13b: Communication with predecessor
auditor.
Role of • KPMG:
External • Violated IAS 240 29b & 240 A4: Application of auditing
principles to complex transactions and complex
audtiors: transactions as characteristics of fraud.
• E&Y and KPMG:
• Non-adherence to professional skepticism throughout
audit process.
Improvements in corporate governance
• The Olympus scandal strongly highlights the greatest problem in
Japanese corporate governance: the lack of an effective system for
monitoring management.

Problems in Organisation Solutions

Board is a managing body rather a monitoring one
Internal auditors lacked authority and no vote at board
meetings
Lack of supervision of board on CEO making him
accountable to none
Increasing the Monitoring power of board by following
a mixed or a hybrid structure
Company’s auditors to be replaced with one audit
committee of board having greater authority
Authority and number of independent directors to be
increased
Questions ?
Thank You!