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Discussion Summary of Forth Meeting
Advisory Council on the Systems of Accounting and Auditing

1. Date:

Tuesday, March 8, 2016, 13:00-14:00

2. Venue:

Common Special Conference Room No.1,

13th Floor, Common Government Office No. 7

3. Agenda:

Discussion on the Systems of Accounting and Auditing

4. Summary of Discussion:

The discussions is summarized below.

  • Facing various opinions, the content of the round-up is very informative. In reaction to recent cases of accounting fraud, the Japanese Institute of Certified Public Accountants (JICPA), is verifying the state of quality control reviews. So, we will earnestly take today’s recommendations and work through in a proper manner.

    While it is not the theme of this Advisory Council, in Japan, we have three disclosure systems under the Financial Instruments and Exchange Act, the Companies Act, and the Stock Exchange Rules. Especially, the fact that two sets of regulations exist related to the disclosure of settles figures, which are the Financial Instruments and Exchange Act and the Companies Act, is distinctive of our country. We need to align with international standards of disclosure systems after examining overseas systems.

    Furthermore, regarding disclosure schedules, normally there are timely disclosures made based on Stock Exchange Rules, from which companies thoroughly examine the figures and, the figures are finalized after audits by auditors. Then, based on the finalized figures, shareholders exercise their voting rights at shareholders meetings. This is the natural flow and it is similar in other countries. However, in Japan, 40% of auditor’s reports are submitted before Summary of Financial Results is disclosed, which is based on preliminary figures, so audit must be performed within a very short period of time.

    Needless to say that an organizational structure that facilitates the conduct of high-quality audit must be created by making audit firms to perform proper governance, and that engagement teams must conduct in-depth audits exercising professionalism. In addition, auditors must also insist on receiving enough time necessary to conduct audits.

  • It is a very good practice that auditors provide information related to audit to shareholders so that stakeholders can cooperate and monitor audits from their respective positions in order to prevent audit from becoming like a black box which one cannot see into from outside. However, currently, the reappointment and non-reappointment of auditors is decided by Kansayaku board, etc. While it is possible to some extent to evaluate the competence of engagement teams that perform on-site audits, the reality is that it is somewhat difficult to evaluate the quality control, governance, and audit quality of the audit firm as a whole.

    Although the inspection status, the existence and contents of issues identified by the Certified Public Accountants and Auditing Oversight Board (CPAAOB) are reported in the report from the engagement team, the report is usually abstract. If the audit for a certain company happens to be chosen as an inspection sample by the CPAAOB, relatively wide range of information could be obtained by the company. Otherwise, the information would be too general and, frankly speaking, it is not useful for evaluation. For companies which are not part of sample of the CPAAOB’s inspection, the problem of how audit firms should report issues based on audits of other companies is definitely difficult. So, it is important to use this opportunity for further discussion so that more concrete information which contributes to evaluations of audit firms can be provided for companies.

  • Recommendations are summarized in a very multi-faceted and conscientious manner. There are many recommendations made along with calls for action, as well as some that require time and some that cannot be undertaken simultaneously. However, the entire audit will improve precisely when we will implement all of these recommendations, so we should not give up and carry these out to the end.

    There are three points to mention. The first, within the recommendations, is that there are some places where the phrase, “value of audits,” comes up. For a company to pay audit fees, it is important to pinpoint the value of audits. To accomplish that, it is necessary for companies to recognize that it is positive to desire that kind of high-quality audit. Unless companies assume a cooperative stance so as to conduct higher quality audit, such as securing enough time, securing auditor access to management executives, then it is difficult to realize high-quality audit. So, the view of improving audit quality from the company side is important.

    The second, on page 5 of the recommendations, the item of “holding a forum, etc., for continuous dialog between regulatory authorities and major and second-tier audit firms” is very important. Specifically, as to why serious accounting fraud has occurred, it is important for an essential understanding of the situation to be shared between related parties, including the Financial Services Agency and the JICPA. Without this, if an Audit Firm Governance Code is formulated, that cannot work well. This forum should include the top or second management of major audit firms.

    The third, on page 10 of the recommendations, is “Ensuring Independence of Audit Firms”, where it says that the investigation of audit firm rotation system should be conducted, but when it is conducted, the time for audit should also be studied while keeping in mind how time for audit has changed as a result of audit firm rotation. Up until now, there has been opinion that since time for audit in our country is insufficient when compared to foreign countries, conducting high-quality audit is difficult. The reasons, why time for audit in foreign countries is different and where problems exist needs to be studied and analyzed.

  • Recommendations discuss creating a virtuous cycle by raising audit quality and providing proper information to shareholders. The content of these recommendations are very effective. The Audit Firm Governance Code of the United Kingdom references independent non-executives. Regarding this point, how does the Audit Firm Governance Code which will be formulated in our country view this?

  • While taking into consideration the functions of independent non-executives in the United Kingdom, an examination will be required about this issue, including whether the equivalent should be implemented in our country or not.

  • It was pointed out that the issues raised by the CPAAOB inspection and disclosed by the engagement team to Kansayaku, etc., are difficult to understand. The CPAAOB also carries the same recognition of the problem. In order for the engagement team to provide easy-to-understand information to the Kansayaku board of companies, etc., as well as for inspection result notice text given by the CPAAOB to audit firms, use of easier language should be considered.

  • In order to ensure the confidence in audit, there should be discussions on what information companies being audited should provide, and what attitudes company-related persons have on the disclosed information. It is said that most company scandals which occurred last year were disclosure fraud, including falsification of data. I think that many company-related persons in Japan may have a lack of understanding on the concept of accountability, which means reporting on how consigned work was fulfilled, and there is a lack of incentive to disclose correct information.

    If an unqualified opinion is declared in audit, in terms of shareholders meeting procedure, it is sufficient for the company to report its financial statements in the meeting, instead of voting. So, auditors substantially release company’s management from responsibility for accounting, or accountability. There are many points-of-view as to just what “value of audits” is, but for management, I think that the “value of audits” is that they are able to be released from their accountability with full trust. Auditors are evaluated and paid fees for performing thorough examinations and producing results that do not give someone cause to claim that the audit was not unqualified.

    While it might not be under the purview of this Advisory Council, looking at the situation in Japan, if one does not thoroughly probe matters on the company side and deliver a strong message, the focus will always be shifted to audit as the anchor. I think that it should be specified in the beginning of the recommendations or elsewhere that companies should realize the significance of their responsibility to disclose the information correctly, as a social responsibility of companies preparing and disclosing financial information.

  • It goes without saying that to ensure proper disclosure is the matter lying primarily with company management, and this is raised in “5. Improving Environment for High-Quality Audit” in the recommendations. However, while this recommendation assumes that this is a matter of course, the issue is how to ensure that confidence from the viewpoint of audit. So, I think that placing the problems of companies first in the recommendations differs from the main agenda of this Advisory Council.

    After that, there was mention that auditors release accountability of management. However, looking at recent accounting scandals, I have an impression that there may be cases in which auditors almost do not perform effective checks, and if this is the case, it could be said that accountability of management was released from the very beginning. Before considering the value resulting from releasing accountability of management, it could be said that this case did not meet pre-existing audit requirements.

    On the basis of these facts, it is likely not a good idea to place responsibility on the company side at the beginning of these recommendations.

  • While this recommendation comprehensively covers all the aspects in an extremely balanced manner, the possibility remains that the public might think that while the words are good, the actions which will be undertaken are not clear. So the answers detailing concrete actions need to be organized for these recommendations. Considering the recommendation of properly providing required knowledge and information to shareholders, it might be a good idea to release some form of message promoting heightened awareness of audit quality among shareholders.

    In regard to the two disclosure systems of the Companies Act and the Financial Instruments and Exchange Act, there is some room for discussion in terms of time and duration for audit. As a matter of social regimes, however, in contrast with regulations based on the Securities Exchange Act in America, in Europe, the regulation of company disclosure is traditionally a Companies Act issue. In Japan, up until the World War II, it was an issue of the Companies Act and the Commercial law. However, after the World War II, the Securities Exchange Act was introduced from America and grafted onto the existing laws. Therefore, two parallel disclosure systems are in place. However, from a global perspective, company disclosure systems are not necessarily based on just the Financial Instruments and Exchange Act or the Securities Exchange Act. In Europe, rather, the weight of the Companies Act has always been heavy. Due to the path dependency of systems, I think that it is difficult for each country to choose one from two systems uniformly. In Japan, I think that there is no choice other than to take this grafted systems as a given for the time being.

  • In regard to the recommendations, I believe a consensus on the original draft has been built among us, so do you agree to issue the recommendations with no modification today ? (Approved by all members of the Advisory Council)

  • I agree that it is important to put the recommendations into action, and to make such actions visible to the public. The Financial Services Agency will proceed as immediately as possible with measures that can be addressed. For example, we have received a recommendation that the Audit Firm Governance Code should be developed under the leadership of the Financial Services Agency. We will form an organization like the Council of Experts and develop the Code.

    For the audit firm rotation system, we have received a recommendation that we should properly conduct investigation and analysis of the system first. As the Financial Services Agency, we would like to conduct proper investigation and analysis that can raise issues to the world. We will ask for the advice of experts as needed, so we would like to request your cooperation then.

  • There are many actions contained within these recommendations, and I think that it is difficult for general investors and users to digest this. So, it is necessary to disclose a timetable or similar document at appropriate timing by the Financial Services Agency so that the progress status of initiative can be understood.

  • Although I think that it is extremely positive that the recommendations encompass all important items, there are some items discussed before. So I am concerned that someone who will read these recommendations will get the impression that these discussions are brought up every time when there is accounting fraud, and that there has been almost no progress.

    For example, I think that it is necessary to establish a project team to continuously study increasing in transparency of auditor’s reports toward a conclusion, no matter how many years it takes. To improve an environment for increasing in the transparency of an auditor’s report, for example, it may be useful to require auditors to report items, such as audit result, risk assessment, and implementation status of accounting policies, to the board of directors.

    While I understand that it is difficult to incorporate these kinds of points into the recommendations, I am anxious that there will be no progress on those issues if we do not encourage related persons in the industry, the Financial Services Agency, each audit firm, the JICPA, and other stakeholders to take concrete action on their own.

  • Among the recommendations, we should immediately take care of the items that the regulatory authorities and the JICPA should take action on. However, all of them are not necessarily enough for just the regulatory authorities and the JICPA to take action. For items related to audit firms and companies, or issues associated with the Companies Act and other such regulations, it is difficult to predict what kind of schedule can be progressed with. From this, for the initiatives as a whole, there are areas where it is unknown whether a work schedule can be formed. However, at least for items to be studied by the regulatory authorities and the JICPA, a proper work schedule should be prepared, made clear, and we will implement them with the full effort.

  • The discussions at this Advisory Council have come to an end for now. We appreciate the many diverse discussions.

    Among the recommendations, the related persons are expected to immediately take action on feasible items. In addition, as the Advisory Council, we will follow up on the progress status. Furthermore, among the recommendations, for items that require further investigation and analysis, such as audit firm rotation, as the Advisory Council, we will consider how each of those investigations will progress. As mentioned at the end of the recommendations, going forward, we would like to ask you all to maintain a close watch on the process of executing the recommendations of this Advisory Council.


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