Tobashi - how to make losses fly away

Monday, 17 December 2012

In November 2012, British born Michael Woodford published a book about his experiences as the whistle-blower in the scandal which became known as the "Japanese Enron".  Woodford’s book outlines his experience as CEO and the lessons to be taken from the episode in which Olympus avoided booking around US$1.5 billion of losses.
 
What has emerged from the ashes is that Olympus had been utilising a method of accounting manipulation known in Japan as a Tobashi scheme (Tobashi is Japanese for ‘fly away’).  The scheme involves shifting unrealised losses away from the investment firm to special purpose entities which are not consolidated into the group. The unrealised losses are held off the balance sheet in the hope that improving market conditions will allow realised losses to be avoided.

The losses that Olympus had sought to make “fly away” related to heavy investment losses the company had suffered during the early 1990s when the Japanese investment bubble burst.  A Japanese panel established to investigate found that Olympus had made large overpayments to acquire entrepreneurial ventures from related funds. Olympus also paid substantial consulting fees to advisers for merger and acquisition fees.

But how exactly would overpaying for acquisitions make prior investment loses go away?  The answer is complex, but by way of illustration a simplified version of this type of scheme might operate as follows:

1. Establish external funds which, while related, were not consolidated so that the financial position of the funds was not reflected in Olympus’ financial position.

2. Obtain finance for the funds, with repayment guaranteed by Olympus.

3. Sell the investments containing the unrealised losses to the funds at book value (which is greater than their current market value).

4. Compensate the funds for accepting the loss making investments by acquiring entrepreneurial ventures owned by the funds at inflated prices or pay them excessive merger and acquisition consulting fees.  

5. Under Japanese accounting standards, the excess of the amount paid by Olympus for the ventures and the large fees could be capitalised by Olympus as goodwill.  Further the Japanese accounting standards allowed goodwill to be amortised over 20 years, thus avoiding the recognition of a large loss immediately. Both of these accounting treatments are contrary to Australian Accounting Standards which expense consulting fees incurred on the acquisition of an entity and do not allow the amortisation of goodwill.

This type of accounting standards manipulation via the use of special purpose entities is similar to that undertaken in other high profile corporate frauds, including Enron. It highlights the problems that accounting standard setters face in developing consolidation regimes which meet the needs of all users.