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Oversight and Independence of CPA Auditing in Japan Amendment Project of the CPA Law Structure of the CPA Profession in Japan Public Practice of CPAs and Audit Corporations Standard
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Oversight and Independence of CPA Auditing in Japan Amendment Project of the CPA Law Structure of the CPA Profession in Japan Public Practice of CPAs and Audit Corporations Standard Setting Independence Requirements for CPAs Oversight of Statutory Audits in Japan Corporate Governance and Oversight of CPAs Disciplinary Actions and Sanctions of CPAs...32 Supplement: Illustration of Auditor Oversight in Japan Copyright (C) 2004 The Japanese Institute of Certified Public Accountants 1 Amendment Project of the CPA Law The bill for amendment of the Certified Public Accountants Law (Law No.103, 1948) (the CPA Law) passed the Diet on May 30, Amendment of the CPA law, which is the biggest change since the 1970s, has been called for in several years after the bubble economy crashed in the early 1990s and was finally concluded under strong influences of the U.S. Sarbanes-Oxley Act of The following points are included in the amendment to the CPA Law: 1. Auditor independence rules 1-1 Non-audit services The prior CPA Law allowed CPAs to provide compiling financial statements, researching or planning financial matters, or responding to consultation on financial matters, to the extent that it did not impede the audit service. The amended CPA Law, put into effect in April 2004, prohibits an Audit Corporation from providing certain non-audit services to any audit client in addition to tax services which had been prohibited by the prior law. The list of non-audit services prohibited, which are provided in the supplemental cabinet ordinance, are as follows: 1 Services related to bookkeeping, financial documents, and accounting books, 2 Design of financial or accounting information systems, 3 Services related to appraisal of the contribution-in-kind reports, 4 Actuary services, 5 Internal audit outsourcing services, 6 Securities brokerage services, 7 Investment advisory services, 8 Other services that are equivalent to the above listed services, which may involve management decisions or lead to self-audit of the financial documents the auditor examines. It is prohibited to provide these non-audit services to any clients that are required to be audited in accordance with the Securities and Exchange Law and certain large companies that are statutorily audited in accordance with the Commercial Code. 1-2 Audit partner rotation Prior to the amendment, engagement partner rotation was required in the JICPA s Audit Standards Committee Statement as seven years term with two years time-out period. Under the amended CPA Law, all engagement partners are legally required to rotate every certain period within seven years with time-out period which are prescribed in a cabinet order. Partner rotation is also required with regard to statutory audit engagements that are based on the Securities and Exchange Law and the Commercial Code for the certain large companies. In this respect, the audit engagements to which the partner rotation rule is applied are the same as those for the prohibition of certain non-audit services. 1-3 Cooling off The prior CPA Law had no clause that prohibits Audit Corporations from having an audited client that employs a retired partner of the Audit Corporation as management. 2 Under the amended CPA Law, an engagement partner who performs audit services to a client shall not be in the management of such a client as a director or some other important position until at least one year elapses after the end of the accounting period during which this partner was involved in auditing this client. 2. Strengthening auditor oversight Prior to the amendment FSA, as the regulator in Japan, oversaw auditors and JICPA to protect the public interest. FSA had a Board named the CPA Investigation and Examination Board, and this Board oversaw CPA examination and disciplinary action for CPAs. The amended CPA Law also stipulates that a new CPA and Auditing Oversight Board (CPAAOB) be established by reorganization of the present CPA Investigation and Examination Board in order to enhance monitoring and oversight of CPAs and JICPA quality control review. The CPAAOB consists of ten members who are to be nominated by the Prime Minister with consent by the Diet, and at least a chairperson and one member of the new Board serve full-time. Also, the amendment introduces the legal authority for JICPA to conduct quality control reviews. The quality control review is currently a legally required measure. 3. Reform of CPA Examination The amendment of the CPA Law contains the reform of the CPA examination system and this amendment regarding the CPA examination will be effective as of January The new CPA examination will be simplified to a single step examination (currently three steps). All candidates who have passed CPA examination are required to take two years practice training, which can be taken before sitting for the examination, one year schooling and the final assessment to be provided by JICPA in order to be acknowledged as CPAs. 4. Introduction of limited liabilities of partners Prior to the amendment, every partner of an Audit Corporation was jointly and un-limitedly liable for liabilities. Under the amended CPA Law, a new concept named designated partner was created to alleviate burdens of partners who are not designated as engagement partners. Only the partners who perform audits (designated partner) are jointly and severally liable for misconduct and negligence, and other partners who are not involved in the audits in question are liable to their equities, at maximum, in the audit corporation with regard to the liabilities claimed by audit clients. However, this designated partner system is different from limited liability partnership. Non-engagement partners are still liable for third party claims. In this respect, non-engagement partners are jointly and severally liable for third party claims together with the engagement partner(s). 3 1. Structure of the CPA Profession in Japan 1-1 Introduction Historically, the audit profession in Japan developed under strong government leadership over the last fifty years in order to promote sound development of the Japanese capital market. The first group of professional accountants in Japan is said to have emerged around 1907, but it was not until 1927, when the Accountants Law was enacted, that a fledgling institute of professional accountants came into existence. However, the formal institutionalization of the profession had to wait for the enactment of the CPA Law (as amended) in July 1948, following the enactment of the Securities and Exchange Law Law No. 25, 1948 in April The CPA Law was designed to ensure the quality of professionals compared with those in the U.S. mainly, and to establish socially recognized status for CPAs. The Japanese Institute of Certified Public Accountants (JICPA) started in Many such measures were introduced under the supervision of the General Headquarters (GHQ) during the Allied Forces occupation period after World War II. These measures helped to respond to the growing post-war demand for the democratization of business, the disclosure of corporate information following the dissolution of zaibatsu (conglomerate), and the introduction of foreign capital. Since that time, the audit profession in Japan has been highly regulated by the regulatory authorities. 1-2 The CPA Law The CPA Law provides the basic structure of the audit profession in Japan. It includes the scope of services to be provided by CPAs, mechanisms of the national CPA examination, requisitions of the CPA qualification, establishment of audit firms (Audit Corporation: kansa hojin), duties and responsibilities of CPAs, roles and organization of JICPA, roles of regulatory authority and the disciplinary and criminal sanctions against CPAs. The Financial Services Agency (FSA) is given authoritative power to oversee CPAs, Audit Corporations and JICPA by the CPA Law. 1-3 Financial Services Agency (FSA) The FSA has oversight responsibilities over the accounting profession in Japan. The CPA examination is conducted by the CPA and Auditing Oversight Board (CPAAOB) established in FSA (Article 15 of the CPA Law). Recent amendments to CPA Law changed the legal procedures for incorporation, dissolution, mergers and the amendment to the articles of incorporation of an Audit Corporation from approval basis to filing basis to FSA (Article , 34-10, and 34-19). Audit Corporations and CPAs are subject to FSA s requirements of reporting and submission of the necessary materials (Article 49-3) and are subject to disciplinary sanctions including suspension of practice or revocation of qualification registrations (Articles 29 through 31, and 34-21). Audit Corporations and CPAs are subject to examinations and inspections by FSA (Articles 32, 4 33 and 34-21). FSA also oversees JICPA, the description of which follows. 1-4 The Japanese Institute of Certified Public Accountants (JICPA) The establishment of JICPA is compulsory under the CPA Law (Article 43, (1) of the CPA Law). JICPA is the only professional accounting body in Japan. It was originally formed in 1949 as a voluntary body, and was reorganized in1966 into its present form requiring every CPA in practice to become a member of the Institute. The most important role of JICPA is to keep a register of CPAs. All qualified CPAs should be registered under his or her own name and address in the Register of the Institute (Articles 17 and 18). Inclusion in the register denotes qualification as a CPA in Japan. JICPA can revoke registration of members who are disciplinary sanctioned as such. In this regard, JICPA may perform the role of the State Accountancy Board in the USA. The Institute s other roles under the CPA Law are to effectively exercise guidance to, communicate with, and supervise the members in order to uphold professional standards and to improve and advance the profession (Article 43, (2)). Members are legally required to comply with the JICPA Constitution (Article 46-3). The Constitution includes provisions on members' obligations to observe the Code of Ethics and other resolutions of various committees including the Audit Standards, the Quality Control Review, the Audit Practice and the Review Committees. Changes in the JICPA Constitution must be approved by FSA (Article 44, (2)). Pursuant to the JICPA Constitution, members are subject to reporting requirements, direction and disciplinary action by JICPA (Article 46-3). In addition, CPAs and Audit Corporations who perform audits for publicly held corporations should be reviewed periodically by the Quality Control Reviewers from JICPA (Article 87, (3) of the JICPA Constitution). 5 2. Public Practice of CPAs and Audit Corporations 2-1 Qualifications (The CPA Examination System in Japan) Instituted in 1948 upon the promulgation of the CPA Law, the CPA examination is considered one of the most difficult examinations conducted by the Japanese Government. The examination has been adopted in order to assure that those who have adequate professional ability and practical experience, together with a high level of professional ethics, perform audits. Some amendments have been made according to the demands of the changing times with the aim of improving the quality of Japanese CPAs. All examinations are prepared by knowledgeable experts, such as experienced CPAs and university professors under the oversight of the CPA Investigation and Examination Board established in FSA (Articles 15, 35 and 38 of the CPA Law). The subjects included in the first examination are Japanese, English, Mathematics, and an Essay. Its aim is to measure a candidate s general literacy (Article 6). University graduates and their equivalents are exempt from the first examination. The subjects of the second examination are Accounting Theory, Accounting Practice (bookkeeping), Cost Accounting, Auditing Theory, the Commercial Code (Law No.48, 1899), Economics, Business Administration, and the Civil Code (candidates select two from among the last three subjects). The second examination aims to measure whether a candidate holds a university graduate s level of competency (Article 8). Successful candidates of the second examination are qualified as junior CPAs. Before taking the third examination, junior CPAs are required to go through the minimum of three years of professional training, including two years of internship, and one year of schooling (Article 11). The third examination measures the level of professional competency in the subjects of Auditing Practices, Financial Analysis Practices, Taxation Practices and an Essay (Article 10). After passing the third examination, candidates are given the title CPA. The following chart shows the number of candidates and the number of successful candidates from among them. The amendment of the CPA Law reforms the CPA examination system and this amendment regarding the CPA examination will be effective as of January The new CPA examination will be simplified to a single examination. People who satisfy certain requirements, successful candidates of certain other professional examinations and people who are qualified professionals are exempt from taking certain subjects in the CPA examination. However, all candidates who have passed CPA examination are required to take two years practice training, which can be taken before sitting for the examination, one year schooling and the final assessment to be provided by JICPA in order to be awarded a CPA qualification. 6 Historical Trends of Candidates/Successful Candidates of the CPA Examination First Level Second Level Third Level Apply Pass % Apply Pass % Apply Pass % ,389 1, n.a n.a n.a , , , , , , , , Cumulative Total since inception 29,040 4, ,970 20, ,203 15, Audit Corporations and CPAs As of March 31, 2002, there were 13,721 CPAs, 4,301 junior CPAs and 147 Audit Corporations in Japan. An Audit Corporation is a corporation that consists of only CPAs who are all unlimited liability contributors and are also expected to participate in management (Article 34-4). These CPAs are not legally regarded as partners since Japanese law does not provide for this form of partnership common in the United States and Europe for professional services (but partner is used hereafter for the readers of this paper). An Audit Corporation is a legal entity performing an audit. The Audit Corporation system was introduced by the CPA Law amendment of 1966 in order to take advantage of a larger business base that would justify the establishment of large professional firms to have organized audit services and acceptable competence of CPAs that can be comparable to world best practices. It was hoped that Audit Corporations would assist CPAs in better maintaining their independence and integrity as professionals and increase the public trust in the profession. Prior to the amendment, every partner of an audit corporation is jointly and un-limitedly liable for liabilities. Under the amended CPA Law, a new concept named designated partner was created to alleviate burdens of partners who are not engagement partners. The only partners who perform audits (designated partner) are jointly and severally liable for misconduct and negligence, and other partners who are not involved in the audits in question are liable, at maximum, to their equities in the audit corporation with regard to the liabilities claimed by audit clients. However, this designated partner system is different from limited liability partnership. Non-engagement partners are still liable for third party claims. That is, if their equities in the audit corporation are not enough to pay off all the third party claims, they have to pay for the third party claims with their personal properties. In this respect, non-engagement partners are jointly and severally liable for third party claims together with the engagement partner. One of the future agenda for the CPA profession is the introduction of limited liability system which is not permitted in Japan. Therefore, limited liability partnership system for the audit 7 corporation shall continue to be considered in the future amendment of the CPA Law. 147 Audit Corporations account for 50.5% of CPAs and 60.7% of junior CPAs. Even though there are many Audit Corporations, most of them are very small while four Audit Corporations are very large as shown below. Number of CPAs at the four large Audit Corporations Audit Corp. Number of CPAs A 1,361 B 1,255 C 1,242 D 1,126 Total 4,984 There are almost 4,500 companies subject to the statutory audits required by the Securities and Exchange Law of Japan (both listed and non-listed) The largest four Audit Corporations in Japan provide audit services to almost 3,400 companies in accordance with the Securities and Exchange Law, accounting for 76.4% of all companies. The breakdown of auditors for companies subject to statutory audits based on the Securities and Exchange Law are as follows: No. of audit clients Share Large four Audit Corp. 3, % Small Audit Corp Sole practitioners Total 4, % The practice of the Audit Corporation is limited to audits and other services including 1) compilation of financial statements, research, advice and consulting services relating to financial matters for clients and 2) schooling of junior CPAs; as long as such work does not impede the audit service (Article 34-5). Any Audit Corporation is not permitted to provide tax services; however, an individual CPA is permitted to provide tax services (Article 3 of the Licensed Tax Accountant Law). 8 Accordingly, all large Audit Corporations concentrate on providing audit services. Consulting and tax services are provided by legally separated entities of each group. The revenue of consulting and tax services is relatively small compared with similar groups in the U.S. and other countries. The following table shows the fee split of these groups. Fee split of the four large Audit Corporation groups (in billions of yen) Audit Corp. A B C D Groups Revenue % Revenue % Revenue % Revenue % Audit Corporation Consulting entity Tax entity Total (Source: Nihon Keizai Shimbun, August 21, 2002) 2-3 Professional Competency The Japanese CPA examination does not require a candidate to have a university degree in accounting or management. However, the second CPA examination tests whether a candidate has a thorough knowledge (equivalent to an undergraduate level) of accounting, auditing and related business subjects and the third examination tests professional knowledge obtained through three years of professional training. In this sense, de facto pre-qualification education is required for Japanese CPAs. The mechanism for the maintenance of post-qualified professional competency is provided by Continuing Professional Education (CPE). CPE has been mandatory since April 2002 for CPAs, who are full members of JICPA (Article 83, (2) of the JICPA Constitution). Junior CPAs are not required to satisfy CPE requirements because the majority of junior CPAs are enrolled in the three-year practice training courses. Furthermore, junior CPAs have to take the third examination in order to be qualified as CPAs. In April 1997, the CPE program was recommended by the CPA Investigation and Examination Board under, Recommendations to Strengthen CPA Audits. In April 1998, CPE was first introduced to JICPA members as a voluntary program that each member was recommended to follow. JICPA sets forty hours of training as an annual target for CPE. JICPA classifies CPE training as self-study and seminar. Self-study is a broad category that includes not only reading but also watching videos, listening to audio tapes, taking distance educational programs, and attending small study-group meetings. A member can earn required credits by applying one or more self-study methods. For example, a 9 member can earn certain credits by reading books and articles. Up to forty credits a year can be earned by self-study of reading the articles in the J
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