Thursday, March 8, 2012

Olympus Scandal Points to the Limitations of Accounting

Japan’s SESC has filed a criminal complaint against Olympus and several of its directors and officers who it believes were involved in hiding $1.7 billion in losses. Prosecutors have filed charges in a few of the cases, with more indictments likely to follow. Other charges have previously been brought in the case, but the SESC complaint is the one that deals directly with the false accounting reports.

The scale of the case is sobering, not just in the amount of money involved, but also in the number of people who had to have been in on it, surely more than 100, the length of time the false accounting was kept under wraps, and the extent to which it distorted the company’s business decisions. It shows that public accounting is not the magic bullet that it was a quarter century ago.

Olympus’ false accounting statements were proper in form but not in intent. The intent to show a story of success overshadowed the intent to measure the company’s results. Yet this is a circumstance that could occur in any business, because every executive, by nature, shares the impulse to tell a story of success.

As long as accounting adapts itself to that impulse — and we appear to have run out of tricks to prevent that from happening — stockholders can no longer rely on a public company’s financial statements to indicate the financial condition of the company. This is a development that makes securities and financial investing inherently more risky than they were in the 1980s. As these accounting scandals become more frequent, they could threaten to unravel a substantial part of the financial system.