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of a Japanese unit of the PricewaterhouseCoopers Group were arrested last month on suspicion of falsifying accounting reports of Kanebo Ltd., a maker of sundries, food products and pharmaceuticals. If these CPAs are found guilty of violating the Securities and Exchange Law, the credibility of the nation’s auditing services will be undermined, and the Japanese economy could suffer as a result.

The four CPAs — three of whom were indicted on charges Monday — worked for ChuoAoyama PricewaterhouseCoopers. They were arrested by the special investigation department of the Tokyo District Public Prosecutor’s Office on charges of collaborating with former Kanebo executives to falsify the company’s financial records. Mr. Takashi Hoashi, a former Kanebo president, and Mr. Takashi Miyahara, a former vice president, have already been indicted.

Public prosecutors suspect that the accountants not only were aware that the financial statements they approved had been falsified but actively offered suggestions on how to cook the company’s books. Whereas liabilities exceeded Kanebo’s assets by 81.9 billion yen and 80.6 billion yen in fiscal 2001 and 2002, respectively, the consolidated financial statements, submitted to the Kanto Local Finance Bureau of the Finance Ministry, reported that the company’s assets exceeded liabilities.

Set up in 1968, ChuoAoyama is one of the nation’s four largest audit corporations. It employs about 1,800 CPAs, has more than 20 offices in Japan and nearly 30 offices abroad, and serves more than 5,000 clients. The present management of Ashikaga Bank — which is now temporarily under state ownership after going bankrupt — has sued ChuoAoyama for its alleged lax auditing work, which it blames for its financial woes.

The Kanebo accounting scandal has surfaced at a time when the world is working toward the creation of a unified accounting standard. The European Union, for example, is calling on enterprises from outside the EU, including Japanese companies, to adopt an international accounting standard from 2007. Problems arising from the Kanebo case can tarnish the international reputation of Japanese accounting practices.

Kanebo’s accounting discrepancies came to light during an in-house investigation following the company’s filing of a request with the Industrial Revitalization Corp. of Japan, a government-backed bailout organization, for rehabilitation assistance in March 2004. The company announced in April 2005 that, from fiscal 1999 to fiscal 2003, its financial statements falsely recorded a total of 215.6 billion yen in consolidated profits to make the company appear in the black. In fact, the company’s liabilities were in excess of assets for consecutive nine years on a consolidated basis from fiscal 1995 to fiscal 2003. The falsified amount is believed to be a record amount for nonfinancial companies.

One of three accountants indicted Monday had been in charge of auditing Kanebo since the 1970s. Such long ties may have led to the formation of a collusive relationship between the ChuoAoyama accountants and Kanebo executives, causing the accountants to “forget” their duty to correct any irregular practices discovered in the client company. Similar irregularities in the past led to a revised Certified Public Accountant Law in 2003, which made it mandatory that the head of an auditing unit assigned to a company step down after seven years.

The Certified Public Accountants and Auditing Oversight Board, established under the revision, is empowered to recommend disciplinary measures against CPAs whose behavior is deemed questionable and to carry out on-the-spot investigations of an company’s auditing practices. The Japanese Institute of Certified Public Accountants, the sole organization for the CPA profession in Japan, plans to publicize instances of improper auditing.

Given the vital watchdog role performed by the nation’s certified public accountants, it is not an understatement to say that the healthy development of the Japanese economy depends in part on their trustworthiness. Suspicious accounting reports can undermine both the stock market and daily transactions between businesses. Accountants may need to improve their skills to detect the more subtle window-dressing techniques that come into vogue since electronic technology was introduced into accounting practices.

Various steps taken by the oversight board and the CPA organization may help reduce incidences of accounting irregularities. Ultimately, however, the only way that the accounting profession can regain the public’s trust is for all CPAs to heighten their awareness of their profession’s ethical standards.

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