Westinghouse, the U.S. nuclear power company acquired by Toshiba in 2006, booked write-downs totaling over $1.3 billion in fiscal 2012 and 2013. The write-downs were first discovered by Nikkei Business in Toshiba internal e-mails and documents, and Toshiba did not disclose them until questioned by Nikkei Business reporters. In response to the newly revealed accounting issues, the Tokyo Stock Exchange is launching a probe.
Faced with sluggish demand for new nuclear plants, Westinghouse booked write-downs of $926 million in 2012 and $400 million in 2013, Nikkei Business found. Westinghouse ended fiscal 2012 (the year ending March 2013) and fiscal 2013 in the red as a result of the devaluation of its assets. Toshiba said the write-downs would not affect its consolidated earnings, and that it has not violated any accounting rules.
Toshiba has been consistently upbeat regarding its nuclear power business until now. But it has become clear that there is a gap between the company's public statements and its actual state of affairs.
An official at the Tokyo Stock Exchange suspects “a systematic cover-up,” pointing out that “a huge write-down at the Westinghouse unit completely contradicts what they have said up until now.”
Toshiba is already ensnared in a separate accounting scandal, and the TSE on Sept. 15 put the company “on alert,” stating it had serious problems with its internal controls.
Toshiba first disclosed accounting irregularities in April, and since then has conducted investigations by two committees, an internal one and an independent one composed of lawyers and other outside experts. The company admitted it had inflated profits by 224.8 billion yen over seven years, and revised past figures accordingly. The scandal caused the resignations of the company's past three CEOs, who were president, vice chairman, and adviser, respectively, at the time of their resignations.
Toshiba hoped to convince investors that it had put its problems behind. But a TSE official says that given its continued cover-up of write-downs at an important subsidiary, “it hasn't fulfilled its accountability obligations as a publicly traded company.”
TSE has given Toshiba a year to improve its corporate governance, and its shares continue to be traded on the exchange. But if TSE finds the reforms lacking when it screens Toshiba again next September, it could go so far as to delist the company.
Toshiba’s nuclear business has struggled in the wake of the 2011 disaster at the Fukushima Daiichi nuclear power plant. When Toshiba invested 540 billion yen in Westinghouse in 2006 (later increased to 660 billion yen), then-CEO Atsutoshi Nishida and then―vice president Norio Sasaki said the company planned to secure contracts to build over 30 new reactors and increase revenue from its nuclear division to one trillion yen by 2015. But the 2011 disaster made those goals all but impossible. As of 2015, Toshiba has won only 10 contracts for new nuclear plants.
Nonetheless, at the end of September Toshiba still had on its books 515.6 billion yen in assets and goodwill related to its nuclear business, including Westinghouse. But it has not disclosed Westinghouse's revenue, profits, or current assets.
Toshiba has continued to state that Westinghouse is doing brisk business. At Toshiba’s April-September earnings briefing on Nov. 7, CFO Masayoshi Hirata said, “The services and fuel businesses are holding steady, and since the Fukushima Daiichi nuclear disaster, we have seen growth in the plant safety business.” But he did not offer any figures, such as recent earnings, to back those claims.
Internal documents reveal the gap between Toshiba’s claims and the actual state of affairs at Westinghouse. As the nuclear unit fell into a prolonged slump, Toshiba’s management tried a number of methods to prevent it from affecting the parent’s bottom line. An internal document clearly states that if Toshiba had had to write down its goodwill related to Westinghouse, there might have been “insufficient funds for cash dividends.” Executives appear to have been concerned about this and other possibilities.
●Statements from top officials, quoted from internal documents (titles as of date of quote)
It’s completely inappropriate for an auditor. . . . We'll be soliciting bids, and we hope EY will put its best foot forward with a new team. (July 2013)
Through our fiscal 2012 audit, we became aware of the need for a massive write-down totaling $926 million. I deeply apologize. We had a particularly serious shortage of funds in the second quarter. (July 2013)
Regarding the explanation to P[resident Hisao] Tanaka of third-quarter results, the situation reports on cost overruns at Westinghouse and the write-down have been scheduled as below. (December 2013)
Ernst & Young's main points were that Westinghouse has "failed to secure new contracts in the previous several years, causing a decline in cash flow," and that the company faced "project delays every year." So they claimed Westinghouse "couldn't still be worth the fair value of $5.4 billion calculated at the time of its acquisition." (March 2014)
We need to make an argument that will convince [Ernst & Young] ShinNihon to evaluate our consolidated results using slightly different methods than Ernst & Young proper, that is, using methods that the Japan side takes the initiative in applying. (April 2014)
The Westinghouse impairment test is extremely important for Toshiba. Even when on the premises, be careful not to needlessly share information with people who are not directly involved, and do not discuss company matters outside the office (during lunch, in taxis, etc.). (April 2014)
Vice president puts pressure on auditor
On July 28, 2013, Makoto Kubo, Toshiba vice president and CFO, sent the following e-mail to Westinghouse executives: “EY [Ernst and Young] has tried to cut off debate. It’s completely inappropriate for an auditor to say they can't change their conclusion. I brought this up with H, partner at [Ernst and Young] ShinNihon. I told him we'll be soliciting bids, and we hope EY will put its best foot forward with a new team.”
Ernst & Young ShinNihon, Toshiba’s auditor, is the Japanese affiliate of U.S.-based Ernst & Young, which audited Westinghouse. On July 23, 2013, Ernst & Young signed its report, which had Westinghouse book a write-down of $926 million in fiscal 2012. Kubo was unsatisfied with what he termed EY’s “auditing process.”
Ernst & Young had clear reasons for recommending a write-down in view of the difficulties Westinghouse was experiencing. An internal e-mail from Westinghouse from the time stated that it “had a particularly serious shortage of funds in the second quarter. This fiscal year, the failure to meet sales targets for uranium and the drop in revenue due to deferred plant construction [could] have a large impact on the bottom line.”
If Westinghouse's troubles became publicly known, Toshiba would have been pressured to write down the unit's value on its consolidated statement. Given the size of the write-down－over 100 billion yen－Toshiba no doubt wanted to contain the damage to its subsidiary.
That's why Kubo sought to change Ernst & Young's opinion. When Ernst & Young ShinNihon pushed back, he referred to a new bid, implying that Toshiba would terminate their contract. Toshiba pays Ernst & Young ShinNihon about one billion yen a year for auditing, so the pressure would have been enormous.
According to Kubo's e-mails, Toshiba's liaison at Ernst & Young ShinNihon replied, “I promise you that Ernst & Young will bring in a new team. Please wait and see the outcome before launching the bidding process.” Subsequently, Ernst & Young put a different employee, who was Japanese, in charge of the Westinghouse audit. The new team leader, referred to in Toshiba’s internal communications as “K,” came to be in frequent contact with Toshiba.
When asked about the matter, ShinNihon Ernst & Young confirmed the personnel change at Ernst & Young at the time, but denied that pressure from Toshiba had been the cause.
●How Toshiba contained the damage from huge write-downs on its nuclear unit
Don't talk in taxis
As Westinghouse remained in a slump, tense e-mails were exchanged among Toshiba executives. Ernst & Young auditors increasingly believed an asset write-down was inevitable. A high-level executive at Toshiba's energy division wrote in an email that their auditor “will have to recommend a write-down in Toshiba’s consolidated results unless some very positive outcomes appear [in fiscal 2013].”
The email goes on to state that Ernst & Young had noted Westinghouse had “failed to secure new contracts in the previous several years, causing a decline in cash flow,” and that the company faced “project delays every year.” Therefore, the auditor’s opinion was that Westinghouse “couldn't still be worth the fair value of $5.4 billion calculated at the time of its acquisition.”
Toshiba internal documents from the time state that “it would be very hard for even K to alter Ernst & Young's position.” Consequently, in March 2014, Toshiba's finance division began efforts that another internal memo calls “minimizing the impact of a write-down on consolidated performance.” Kubo’s communications reflect the new stance: he sent an e-mail to subordinates telling them to “handle matters in crisis mode.”
Toshiba officials began to work hard at finding “an argument acceptable to Ernst & Young ShinNihon,” as another energy division executive put it in an e-mail. The head of the division responsible for Westinghouse sent out an e-mail on April 28, 2014, whose tone is both urgent and grim: “The Westinghouse impairment test is extremely important for Toshiba. Even when on the premises, be careful not to needlessly share information with people who are not directly involved, and do not discuss company matters outside the office (during lunch, in taxis, etc.).”
Westinghouse's troubles were essentially an open secret at Toshiba. In addition to e-mails, other internal documents obtained by Nikkei Business show management struggling to deal with the company's ailing finances.
Toshiba executives' greatest fear was that a huge write-down at Westinghouse would spill over to Toshiba itself. Even when Westinghouse booked write-downs of more than $1.3 billion, Toshiba did not include them in its consolidated earnings report. Of course, Toshiba claims that Westinghouse's overall earnings forecast is not so bad that Toshiba itself should book a write-down. Also, Westinghouse did not book write-downs in all four of its main business divisions, only on the goodwill in the divisions with losses.
Erest & Young ShinNihon also maintains it acted “appropriately” as Toshiba’s auditor. However, a detailed look into the accounting process leaves doubts.
In June of 2014, a high-ranking executive at Toshiba's Westinghouse division warned Toshiba executives of the risk of a write-down, stating in an internal document that “[in the worst-case scenario,] Toshiba could take impairment charges of 150 billion yen. That would exceed Toshiba's retained earnings at the close of fiscal 2013, meaning there would be no funds for cash dividends.”
At the time, Westinghouse faced the possibility of a write-down of several hundred million dollars, as its nuclear plant construction business continued to struggle in fiscal 2013 after booking a large write-down the previous year. If the write-down in fiscal 2013 exceeded $500 million (about 60 billion yen), Toshiba itself would have had to book a write-down of around 150 billion yen.
Toshiba's retained earnings at the end of fiscal 2012 totaled about 101.7 billion yen (before correction for accounting irregularities). Even adding on the company's profits from fiscal 2013, there was a high probability these funds would be swallowed up by a write-down, rather than going toward dividends. Toshiba surely wanted to avoid such an outcome. The size of the write-down booked by Westinghouse for fiscal 2013 turned out to be some $400 million, an amount Toshiba had calculated would not be reflected in its own earnings report.
Toshiba had another reason to want to avoid a write-down besides cash dividends. After the 2008 financial crisis, banks placed tighter restrictions on corporate debt levels. Financial covenants were introduced that typically required borrowers to pay back their loan when certain benchmarks, such as the company's capital adequacy ratio, fell below a specified level. Toshiba was among those borrowers bound by such a restriction.
At the end of fiscal 2013, Toshiba's long-term debt totaled 600 billion yen. The company would have wanted to avoid breaching its financial covenants as a result of a large write-down.
Toshiba tried two eleventh-hour strategies. The first was to change its method of judging whether to book a write-down, which is done when the business value of goodwill in the current fiscal year is less than its value in the previous fiscal year.
When calculating the values of its consolidated business and of Westinghouse alone, Toshiba used two methods: projected future cash flow and projected value based on the stock prices of competitors. But after Westinghouse booked large write-downs, Toshiba switched to using only projected future cash flow for its consolidated calculations. An accountant at a top auditing firm suggests Toshiba did so because “using future cash flow makes it easier to inflate a firm's value.”
Ernst & Young ShinNihon bends to pressure
●Toshiba's profits in each sector in the first half of fiscal 2015
|Energy and infrastructure||－6.3 billion yen||－34.4 billion yen|
|Community solutions||－68.5 billion yen||－82.2 billion yen|
|Healthcare||3 billion yen||－3.5 billion yen|
|Electronic devices||38.8 billion yen||－80.4 billion yen|
|Lifestyle||－42.5 billion yen||－27.9 billion yen|
|Total||－90.5 billion yen||－228.4 billion yen|
Toshiba's other strategy was to merge its US and Japan earnings reports. In fiscal 2014, the company integrated Westinghouse and its own nuclear power division. This allowed Toshiba to produce future cash flow projections for the combined business, rather than for Westinghouse alone. The new cash flow projections were larger, of course, reducing the risk of a write-down. But these strategies to improve outward appearances did not help Westinghouse escape its slump.
In Toshiba's April-September earnings report, the company posted lower year on year profits in each of five divisions, including energy, infrastructure, and electronic devices. For Westinghouse's troubles to come to light at this time, nine years after Toshiba bet its future on the company, would be a huge blow to Toshiba.
Ernst & Young ShinNihon claims the accounting methods relating to Westinghouse were “appropriate,” but the final figures are clearly favorable to Toshiba. Internal documents reveal intense efforts by Toshiba to contain the damage from Westinghouse, and Ernst & Young ShinNihon bending to the pressure.
The revelations raise the question of whether Ernst & Young ShinNihon also bent to pressure from Toshiba regarding profits that were inflated by 224.8 billion yen. The Financial Services Agency has begun an investigation of the auditor.
“The Financial Services Agency ordered ChuoAoyama Audit Corporation to suspend their business for involvement in the accounting frauds at Kanebo Cosmetics and Livedoor Marketing. That led to ChuoAyama's dissolution. Ernst & Young ShinNihon could receive a stiff punishment, too,” says a legal expert.
Analysts agree that Ernst & Young ShinNihon is unlikely to continue to serve as Toshiba's auditor. The question is whether its successor also bends to pressure from Toshiba or takes a firmer stance. The new auditor will have to tread carefully, as regulatory authorities, investors, and market experts will be watching.