Fraudulent financial reporting: an application of fraud diamond to Toshiba’s accounting scandal

Published date20 August 2021
Date20 August 2021
Subject MatterAccounting & finance,Financial risk/company failure,Financial crime
AuthorPolydoros Demetriades,Samuel Owusu-Agyei
Fraudulent f‌inancial reporting: an
application of fraud diamond to
Toshibas accounting scandal
Polydoros Demetriades and Samuel Owusu-Agyei
Department of Accounting and Finance, De Montfort University, Leicester, UK
Purpose The purpose of this paper is to examine Toshibas fraudulent f‌inancial reporting in relation to
the fraud diamond(pressure, opportunity, rationalisationand capability).
Design/methodology/approach A quantitative empirical research, analysing secondary data from
Toshibas published annual reports before restatement, from 20082014 has been used. A simultaneous
equations approach was used to test the hypothesis.Excel software was used to analyse secondary data and
to carry out correlationanalysis and descriptive statistics analysis.
Findings This study uncoversevidence that pressure proxied by return on assets(ROA), the opportunity
proxied by ineffective monitoring (BDOUT), rationalisation proxied by audit opinion (AO) and capability
proxied by board member changes (BCHANGE)had moderate to strong relationship to f‌inancial statement
fraud (FSF) (proxied by Beneish M-score model). However, ROA has a negative and signif‌icant effect on
Toshibas FSF. BDOUT, AO and BCHANGE have positive and signif‌icant effect on Toshibas FSF.
Furthermore, there is no multicollinearity problem within the four variables. Overall, this study has
statistically proven that all dimensions of fraud diamond are required for the explanation of Toshibas
Originality/value Although a few studies discuss the four dimensions (fraud diamond), none, to our
surprise, exists which explain the circumstances led Toshibas high-level executives to commit fraud. This
study is the f‌irst thorough investigation of Toshibas accounting scandal that uses all four dimensions to
explain ToshibasFSF.
Keywords White collar crime, Financial statement fraud, Fraud diamond, Accounting fraud,
Paper type Research paper
1. Introduction
Statements of f‌inancial position are used as means of communication between the
companys parties, including internal and external parties, with regards to the companys
economic activities and to show accountability to the users. Financial statements provide
both qualitative and quantitative information to assist users to make f‌inancial decisions
(Diansari and Wijaya, 2019). To guide good decision-making, f‌inancial information needsto
be precise, relevantand free from errors and fraud (Fahmi and Weningtyas, 2018).However,
as a consequence of competition, individuals might commit fraud by intentionally
manipulating f‌inancial statements in an effort to mislead the users (Li, 2010;Sorensen and
Miller, 2017;Diansariand Wijaya, 2019).
Besides f‌inancial losses, fraud results in loss of productivity, increased employment
uncertainty, and lack of trust in the stock-market and audit profession. These make fraud a
serious issue for shareholders and professionals (Kassem, 2014). While a variety of fraud
classif‌ications have been suggested, Association of Certif‌ied Fraud Examiners (ACFE)
(2020a,2020b) and PwC (2020) have categorised fraud as either internally or externally.
Journalof Financial Crime
Vol.29 No. 2, 2022
pp. 729-763
© Emerald Publishing Limited
DOI 10.1108/JFC-05-2021-0108
The current issue and full text archive of this journal is available on Emerald Insight at:
In this study, the term fraudrefers to internally committed fraud, and more particularly
occupational fraud with a focus on f‌inancial statement fraud (FSF). Various incidents of
crime have caused total losses of $42bn worldwide,occupational fraud being within the f‌irst
top-f‌ive most costly frauds (PwC,2020).
Occupational fraud is committed by internal perpetrators and more detrimental than
externally committed fraud (PwC, 2020). FSF generates the highest median losses over the
years in global capital market (Appendix 1). After the release of fraudulently misrepresented
publications, many large companies collapsed (e.g. Enron, WorldCom). This affects the
conf‌idence of investors and questions the credibility of f‌inancial information (Mohamed and
Handley-Schachler, 2015). Manipulation of f‌inancial statement practices have remained
undetected due to the lax implementation of regulatory and security systems in practice
(Khondaker and Bremer, 2017). Japan, which is the third-largest economy in the world, has
experienced numerous accounting scandals despite excellent accounting systems, accounting
and auditing bodies and standards. The accounting scandal of Toshiba is particularly of
interest to this research due to Toshibas massive FSF, which surprised Japan and the business
world, questioning the internal control systems of Japanese f‌irms, causing damagesto Japanese
companies and marketstrust(TheGuardian, 2015).
Despite the attention paid to the failings of auditors in previous studies on accounting
standards (Kizil and Kasbası, 2018), little attention has been paid to the conditions which must
exist for fraud to occur in practical fraud cases. This motivates our study aimed at disc ussing
the circumstances that led to Toshibas high-level executives manipulating the companys
earnings. We explain accounting fraud using the fraud diamond model (FDM) and use the
Beneish M-score model to evaluate and identify earnings manipulation. The main research
problem is what is the level of signif‌icance of the four dimensions of FDM to ToshibasFSF?
While some research has been carried out on Toshibas FSF, no studies have been found to
explain the circumstances led Toshibas high-level executives to commit fraud.To resolve this
research problem, this study answers thefollowing research questions:
RQ1. How is fraud diamondrelated to f‌inancial statement fraud of Toshiba?
RQ2. Which issues inf‌luencedfraud in the case of Toshiba?
Using a case study and quantitative approach on data from Toshibasf‌inancial statements
between 2008 and 2014, we answer these questions. We contribute to the application of
fraud diamond theory by f‌inding that there is a positive association between return on
assets (ROA), the opportunity proxied by ineffective monitoring (BDOUT), rationalisation
proxied by audit opinion (AO) and capability proxied by board member changes
(BCHANGE). ROA, on the other hand, has negative and signif‌icant effect on Toshibas
f‌inancial statement frauds.BDOUT, AO and BCHANGE have positive and signif‌icant effect
on Toshibasf‌inancialstatement fraud.
The rest of this study proceedsas follows: Section 2 discusses relevant theoriesand prior
researches and also develops the hypotheses. Section 3 discusses Toshibas accounting
scandal. Section 4 explains theresearch methodology and data collection method. Section 5
analyses data and illustrates the mainoutcomes. Section 6 discusses the results, conclusion,
limitations and suggestionsfor future research.
2. Literature review
2.1 Theoretical literature
We use agency and fraud diamond theories as the basis for our study. Agency theory
encompasses the contractual relationship in which principals bind agents to carry out
services on their behalf including decision-making and control (Jensen and Meckling, 1976).
However, the f‌inancial interest of those parties may differ, causing a conf‌lict of interest
termed the agency problem. Jensen and Meckling (1976) argued that the agency theory is
grounded on two key assumptions.Firstly, it is expected that risk-averse executiveswill not
perform to the benef‌it of the risk-neutral shareholders, as it might not be in the executives
personal-interest to maximise the shareholdersvalue, raising the motives for moral hazard
and opportunistic behaviours (Demsetz and Lehn, 1985;Lan and Heracleous, 2010).
Secondly, the information asymmetry between principals and executives due to the day-to-
day operation of the f‌irm by executives, leading executivesto have a lot more data than the
principals do (Adams,1994). Competing interests sometimes result in white-collarcrime.
White-collar crime is committed by members of privileged socioeconomic statuses and
respected f‌irms for f‌inancial gain and are facilitated by opportunity, pressure and rational
(Sutherland, 1940). White-collar crime encompasses occupational crime and tend to be
deceitful, intentional, breach trust, involves losses, concealed and committed by high-level
professionals (Gottschalk, 2011). Accounting fraud is part of white-collar crime as it is an
intentional act by [...] management, those charged with governance, employees or third
parties, involving the use of deception to obtain [...] illegal advantage(IFRS, 2009, p. 159).
Accounting fraud does not engage in physicalabuse but purposely exploits trust for illegal
activities against the company or earnings manipulation to increase the companys
Managers may manage earnings by applying accounting policies that bypassthe
accounting standardsto achieve the expected earnings, without committing fraud. Earnings
management arises when executives,although following the law, may deceive the interested
parties about the economic indicators of the company or may affect the outcome-based
contracts that rely on accounting numbers (Healy andWahlen, 1999;Wu, 2014). ACFE
(2014a,2014b) thoroughly determines the accounting fraud as an extreme form of earnings
The ACFE (2020a,2020b,p. 86) def‌ined occupational fraud as the use of ones occupation
for personal enrichment through the deliberate misuse or misapplication of the using
organisations resources or assets. Occupational fraud can be classif‌ied into three key
categories which are: FSF, asset misappropriation and corruption (Dilla et al., 2013;PWC,
2020; ACFE,2020a, 2020b). Occupational fraud is usually committed by high, medium and/
or low-level fraudsters. The study focusess on misstatements resulting from deliberate
misstatements or omissions of amounts, disclosures or transactions to mislead the users of
f‌inancial statements(Wells, 2017;ACFE,2020a, 2020b). In line with Wells (2017), we classify
FSF schemes using the nature of the different methods for executing an accounting fraud-
the timing differences; concealed overheads and liabilities; improper disclosures; and
improper asset valuationmethods.
Timing differences referto the recording of sales and/or overheads with improper timing
and often performed to move revenues or overheads between different accounting periods,
increasing or decrease prof‌its as desired (Zack, 2012). Concerning Toshibas FSF, the most
relevant ways are the percentage-of-completion and recording expenses in the wrong period.
The percentage-of-completion method is the proposed technique for long-term contracts
which involves estimating and recognising sales and overheads as quantif‌iable
advancement on a project made and therefore it makes the method vulnerable to
manipulation (PwC, 2017). Concealing overheads and liabilities fraud schemes occur if the
total value of the overhead or liability is not accounted within the f‌inancial statements
(Wells, 2017). Considering Toshibas FSF, the key method used by the company to conceal

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