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Summary of Olympus financial fraud – part 2

with 5 comments

Previous post described the investigative report of the Olympus financial fraud.

Now a discussion of the debits and credits. Final post will discuss the underlying causes identify by the investigative committee and some of their recommendations.

Update 2 – When accounting rules changed in 2000, the report says Olympus management decided to move the investments off the books instead of taking the write down. Thus phase 1 was launched.

How do you hide a $1.7B loss?

This is what I was most curious about and what prompted me to read the report.

Here is a one paragraph summary from the report:

The lost disposition scheme is featured in that Olympus sold the assets that incurred loss to the funds etc. set up by Olympus itself, and later provided the finance needed to settle the loss under the cover of the company acquisitions.  More specifically, Olympus circulated money either by flowing money into the funds etc. by acquiring the entrepreneurial ventures owned by the funds at the substantially higher price than the real values, or by paying a substantially high fees to the third-party who acted as the intermediate in the acquisition, resulting in recognition of large amount of goodwill, and subsequently amortized goodwill recognized impairment loss, which created substantial loss. (Page 5)

(I transcribed that paragraph since I could not copy it.  Grammar issues are in the original, which is understandable because this is the English translation from the Japanese report.)

Here’s my rudimentary understanding, which sufficiently satisfies the itch that I have:

The huge losses were transferred to an unconsolidated subsidiary. Money was loaned to the subsidiary and then the investments that had the huge loss were sold at historical cost, thus moving the impaired investments into an unconsolidated sub.

Journal entries

I’m going to walk through what I perceive the summary journal entries would be.  This will be in accounting shorthand, so only accountants will likely understand this. But that’s okay since the audience of this blog is accountants.

If you want more details, the last two pages of the report have diagrams showing the flows of money.  Be forewarned that there are 17 different entities on each graph with lots of arrows, so it’s a bit complicated. 

Here’s the Olympus entries in highly condensed form:

  • Note receivable Update 1 – certificate of deposit that was in turn loaned to unconsol sub
  •     Cash
  • transfer cash to new, unconsolidated sub

Update: This is a summary of a very complex manuever – it involved making a CD deposit in European bank, (update 2) three different banks, who were  who was asked to loan the money back to an apparently unrelated entity, with the CD as collateral, so the sub can buy back the investment. Banks were asked, and agreed, not to tell the auditors about the CDs being collateral.  Three different European banks were used.

  • Cash
  •      Financial assets that are seriously underwater (probably not the actual general ledger account they used!)
  • Selling underwater investments to new sub

When accounting rules changed and it looked likely that this unconsolidated subsidiary would have to be consolidated, another plan was needed. 

(Update 2) Eventually the CDs would have to be returned and a hit from the unrealized losses would have to taken eventually. Thus, management launched phase 2, according to the report.

Olympus bought some tiny companies.  They paid humongously more than they were worth and paid big dollars for consultants for their service as finders and intermediaries. This transferred money into the newest consolidated subsidiary, which used the money to buy the bad investments from the older unconsolidated subsidiary. The unconsolidated subsidiary then repaid the note payable to Olympus.  The investment in the consolidated subsidiary shows huge goodwill, which will be either written off over time or written down completely when it is determined to be impaired.

Here’s my understanding of the entries on Olympus’ books:

  • Investment in startup subsidiary
  •     Cash
  • Make investment in new subsidiary – note these have minimal revenue, assets or business plans
  • Cash
  •        Note receivable (update 1) certificate of deposit that was in turn loaned to unconsol sub
  • This is for the cash coming back from the unconsol sub repaying their loan, which was used to transfer out the underwater investments

Here’s the entries on the newly formed consolidated subsidiary:

  • Cash
  •     Common stock
  • Financial assets that are seriously underwater (bought from unconsol sub)
  •     Cash

Here’s the entries on the older, unconsolidated subsidiary, which now needs to be unwound before those cratered investments have to be consolidated and thus written down:

  • Cash (from consolidated sub)
  •      Financial assets that are seriously underwater
  • Note payable to Olympus update 1: n/p to the intermediary bank
  •     Cash

Therefore the net effect is the bad investments were moved into a new subsidiary, converted into goodwill, then written off as a goodwill impairment. You can guess what the press releases would then say: That investment in new technology or start-up or cutting edge idea or other-excuse-given-for-unsucessful-subsidiary just didn’t work out and those mean ol’ accounting rules required the goodwill to the written off. Oh well!

And thus the tanked investments would be off the books with the unrecognized loss written off slowly as goodwill amortization or impairment.

Update: All the off-book losses were cleared up by 2008 or 2010, apparently. See post 2a.

Full disclosure:  deletions from first edition identified by strikethrough. (Update 1 noted with bold intro) (update 2 on 12-19-11 noted with italic comments)

Final post: causes and recommendations. After a side trip to a few details from a WSJ article.

Written by Jim Ulvog

December 7, 2011, 9:25 am at 9:25 am

Posted in Accounting, Audits, Fraud

Tagged with , ,

5 Responses

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  1. […] Attestation Update – A&A for CPAs HomeAbout Ulvog CPASSARS #19 documentation requirements « Summary of Olympus financial fraud – part 2 […]

  2. […] posts discussed the outside report on the Olympus fraud. My wrapup […]

  3. […] post, the debits & credits.  Part3, the causes identified by the investigating committee and some of their recommendatins. […]

  4. Hi there

    First of all, thanks a bunch for the summary. I think you’ve done a good job and I share your personal notes.

    I was wondering about this step of your analysis: “This transferred money into the newest consolidated subsidiary, which used the money to buy the bad investments from the older unconsolidated subsidiary.”

    To be frank, I’m not an accountant but I’m trying hard to figure out how they converted Tobashi into Goodwill? I’ve read the investigation summary but I must have missed that point. Can you provide me with the reference in the report or name the entities involved (according to the scheme)?

    Thanks a bunch! Your helps is highly appreciated

    Mirko

    April 20, 2012, 9:22 am at 9:22 am

    • Thanks so much for your question.

      Don’t think I can boil it down to a simple description, but I’ll try – by dramatically overpaying for a small company, there is enough cash left over to buy the underwater securities at face value. The cash is returned to Olympus. That cash represents the difference between the cash put into the sub and the FMV of the tiny purchases made and is called goodwill. Thus, underwater securities converted to goodwill. That make not make sense unless you read my full articles.

      My posts have been combined and refined into one long post at re: The Auditors, which you can find here:
      http://retheauditors.com/2012/01/02/how-do-you-hide-a-multibillion-dollar-loss-accounting-for-the-olympus-fraud/

      If you really need to track the dollars, you can find two good illustrations at the back of the Olympus report, which can be found here.
      http://www.olympus-global.com/en/info/2011b/if111206corpe.pdf

      Try to find an accounting student at the college for some help explaining the journal entries. Also, you could try drawing a picture of the cash transfers I describe in my posts.

      Hope that helps!

      Jim Ulvog

      April 21, 2012, 14:18 pm at 2:18 pm


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