Toshiba Accounting Scandal: Should Auditor Ernst & Young ShinNihon Get a Mulligan?

Mulligan: a free shot sometimes given a golfer in informal play when the previous shot was poorly played. Merriam–Webster Dictionary

Recently Toshiba Corporation reported that due to accounting irregularities, its profits were inflated by $1.2 billion for the period of 2008 through the third quarter of 2014. This overstatement represents approximately one-third of Toshiba’s pre-tax profits during this period, as reported by the New York Times. Of course this is a material misstatement, and understandably it caused a corporate governance shake-up at Toshiba leading to the resignation of its president and CEO, in addition to a number of its board members.

So where was the auditor? It has been reported that the improper accounting dating back to 2008 was intentional, that it would have been difficult for Toshiba auditor Ernst & Young ShinNihon LLC to detect. It is hard to understand the nature of the difficulties that the auditor would have encountered, but given the sheer size of the misstatement, it begs the question: Why was the auditor blind to the accounting irregularities? More about this will probably come out in the future.

It is also curious that, according to Toshiba’s action plan to correct these past accounting irregularities, the amounts identified for correction by Toshiba’s independent investigation committee will first be verified by the company and then audited by Ernst & Young ShinNihon LLC — the very auditor under whose watch the irregularities occurred. Having another audit firm review the corrections seems a more reasonable strategy given what Ernst & Young ShinNihon missed, for whatever reason, over the span of six years. Doing so would provide another set of eyes on the circumstances that led to the accounting inaccuracies and independently verify the accuracy of the restated amounts. This independent look would help restore confidence in Toshiba’s financial results and possibly identify further improvements to the audit process.

Should Ernst & Young ShinNihon be given a “mulligan” to try to get it right the second time around? We don’t think so.

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