Accounting Auditors in Japanese Corporate Law: An In-Depth Explanation of Their Roles and Responsibilities

The Japanese Companies Act establishes various institutions to ensure the sound operation and transparency of businesses. Among these, the role of “Accounting Auditor” is a relatively new yet extremely important position introduced by the revision of the Companies Act in 2006 (Heisei 18). The Accounting Auditor occupies a unique status, being an internal officer of the company while also providing an external perspective as an accounting expert. The primary purpose of this role is to enhance the reliability and accuracy of financial documents, especially in small and medium-sized companies where the establishment of a Board of Corporate Auditors or accounting auditors is not mandated. By directly involving themselves in the process of preparing financial documents in collaboration with directors, Accounting Auditors internally assure the quality of financial reporting. This system is a crucial mechanism for increasing the credibility of a company’s financial information and strengthening the trust from stakeholders such as financial institutions and business partners. This article provides a detailed explanation of the legal framework for Accounting Auditors under Japanese Corporate Law, namely their significance and objectives, methods of appointment and qualification requirements, specific duties and authorities, as well as their legal obligations and responsibilities, based on the provisions of the law.  

The Significance and Purpose of the Accounting Auditor System Under Japanese Corporate Law

The Accounting Auditor System is an innovative mechanism introduced with the enforcement of the Japanese Companies Act in 2006 (Heisei 18) to enhance the reliability of corporate financial reporting. The background to the creation of this system includes the longstanding issue of ensuring the accuracy of accounting documents, especially in small and medium-sized enterprises. In the past, the introduction of systems such as “limited audits” or “simplified audits” by tax accountants was considered, but due to conflicting opinions regarding the framework of audits and their implementers, these ideas were never realized.

The Accounting Auditor System resolved this historical problem with a different approach. Instead of an external “audit,” it introduced a completely new concept where accounting professionals work as an “internal organ” of the company, jointly creating accounting documents with the directors. This “joint creation” mechanism aims to proactively ensure accuracy by involving experts from the creation stage, rather than checking the documents after completion, to prevent errors before they occur. This preventative approach can be said to be a more efficient and collaborative model for small and medium-sized enterprises than traditional external audits.

By adopting this system, companies can reap numerous practical benefits. Most importantly, the trust in accounting documents from external parties significantly improves. Financial information created with the involvement of accounting professionals sends a strong message to stakeholders such as financial institutions, business partners, and creditors that the company’s financial situation is being accurately reported. In fact, many financial institutions in Japan offer preferential lending terms and special loan products to companies that have an Accounting Auditor in place. This is evidence that the presence of an Accounting Auditor directly enhances a company’s creditworthiness. Additionally, collaboration with experts can strengthen the company’s financial management system and increase management discipline as a secondary effect.

Appointment and Qualifications of Accounting Auditors

In order to ensure the professionalism and independence of their duties, the appointment and qualifications of accounting auditors are subject to strict provisions under Japanese Corporate Law.

Accounting auditors are appointed by an ordinary resolution at the shareholders’ meeting, similar to other officers. Their term is generally set to end within the fiscal year that concludes within two years after their appointment, at the time of the last regular shareholders’ meeting. However, for certain types of companies, such as those with restrictions on the transfer of shares, the articles of incorporation may extend the term up to a maximum of ten years.

The most distinctive feature is the qualification requirements. Article 333, Paragraph 1 of the Japanese Corporate Law limits those who can become accounting auditors to professionals such as certified public accountants, audit corporations, tax accountants, or tax accountant corporations. This is an essential condition for performing the duties that require advanced expertise in the preparation of financial documents.

Furthermore, to guarantee the independence of accounting auditors, Paragraph 3 of the same article stipulates strict disqualifications. Consequently, the following individuals cannot become accounting auditors:

• Directors, corporate auditors, executive officers, managers, or other employees of the corporation or its subsidiaries.
• Individuals who have been suspended from practicing under the Certified Public Accountant Act or the Tax Accountant Act and the suspension period has not yet expired.
• Individuals who are prohibited from conducting tax accountant activities under the Tax Accountant Act.

These provisions legally ensure that accounting auditors perform their duties independently from the company’s management team. While accounting auditors hold an internal position as ‘officers’ of the company, the requirements for their qualifications and independence are based on the standards of external professionals. This ‘embedded independence’ is the core of the accounting auditor system. While they work closely with the board of directors, they are expected to maintain their objectivity and skepticism as professionals and, if necessary, express their opinions to the management team. This inherent tension is what makes the role of accounting auditors challenging and, at the same time, the source of their value.

The Duties and Authorities of Accounting Auditors Under Japanese Corporate Law

The duties and authorities of accounting auditors are clearly defined under Japanese Corporate Law, with a central focus on activities that ensure the reliability of financial documents.

One of the most important duties of an accounting auditor, based on Article 374, Paragraph 1 of the Japanese Corporate Law, is to jointly create the company’s financial documents (such as balance sheets and income statements) and their accompanying detailed statements with the directors. This “joint creation” means not merely reviewing documents prepared by the directors but deeply involving oneself in the creation process as an expert. During this process, the accounting auditor bears the responsibility of ensuring the validity of accounting treatments and the accuracy of presentations based on their professional expertise. Concurrently, the accounting auditor is also obligated to compile an “Accounting Auditor’s Report” summarizing the status of their duties.

To effectively perform these duties, accounting auditors are granted substantial rights to access information and conduct investigations. According to Article 374, Paragraph 2 of the Japanese Corporate Law, accounting auditors may inspect and transcribe the company’s accounting books and related materials at any time and request accounting reports from directors and employees. The scope of this authority includes the general ledger and subsidiary ledgers, but it is generally understood that the minutes of the board of directors’ meetings are not included.

Furthermore, if necessary for the performance of their duties, accounting auditors can request accounting reports from subsidiaries or investigate the status of a subsidiary’s operations and assets. However, subsidiaries can refuse such investigations if there are “legitimate reasons,” such as the protection of trade secrets (Article 374, Paragraphs 3 and 4 of the Japanese Corporate Law).

Accounting auditors are not merely creators of financial documents; they also play a crucial monitoring role in the company’s governance. According to Article 375 of the Japanese Corporate Law, if accounting auditors discover any fraudulent acts by directors or significant facts that violate laws or the articles of incorporation while performing their duties, they are obligated to report these without delay to the shareholders (or to the auditors in the case of companies with a board of corporate auditors). They are also required to attend the board of directors’ meetings where financial documents are approved and express their opinions as necessary (Article 376 of the Japanese Corporate Law). These authorities and obligations provide a legal foundation for accounting auditors to support the financial integrity of the company from multiple perspectives.

The Duties and Responsibilities of Accounting Auditors Under Japanese Corporate Law

Accounting auditors in Japan bear significant legal responsibilities due to their crucial roles and authorities. These responsibilities are broadly categorized into two types: those owed to the company itself and those owed to third parties such as shareholders and creditors.

Firstly, regarding the responsibilities to the company, Article 423, Paragraph 1 of the Japanese Companies Act stipulates that officers, including accounting auditors, are liable to compensate for damages caused to the company due to negligence in their duties. Examples of such negligence by accounting auditors include overlooking serious errors in financial documents, approving inappropriate accounting treatments that do not comply with accounting standards, or failing to report discovered fraudulent acts by directors. This liability can be partially exempted or limited only under specific conditions, such as with the consent of all shareholders or by special resolution at a shareholders’ meeting, as provided by the company’s articles of incorporation.

Next, the responsibility towards third parties is also extremely important. Article 429, Paragraph 1 of the Japanese Companies Act states that officers are liable to compensate for damages incurred by third parties due to malice or gross negligence in the performance of their duties. For instance, a financial institution that has extended credit to a company based on falsified financial statements involving the accounting auditor and suffers losses due to the company’s bankruptcy would fall under this category.

Furthermore, Paragraph 2 of the same article imposes a particularly stringent provision on accounting auditors. According to this provision, if the financial documents or the accounting auditor’s report that the accounting auditor was involved in creating contain false statements regarding material matters, the accounting auditor is liable for damages to third parties unless they can prove that they were not negligent in their actions. This shifts the burden of proof to the accounting auditor, making it easier for third parties to pursue liability. It indicates that a very high standard of care is expected of accounting auditors.

In addition to these civil liabilities, administrative sanctions such as a fine of up to one million yen may also be imposed for violations of the Companies Act, such as failing to comply with the obligation to keep financial documents or making false statements.

Judicial Decisions on the Duty of Care for Accounting Advisors Under Japanese Law

There exists a judicial decision that serves as a crucial guideline for understanding the standard of duty of care that should be borne by accounting advisors. This is the judgment handed down by the Supreme Court of Japan on July 19, 2021 (2021). Although the case directly concerned the responsibility of a “statutory auditor whose audit scope, as defined by the articles of incorporation, is limited to accounting matters” (accounting-specific statutory auditor), the legal rationale deeply relates to the duties of accounting advisors.  

In this case, the issue was that an accounting-specific statutory auditor failed to detect long-term embezzlement by a company’s accounting employee. The employee had forged bank balance certificates, and the auditor, unaware of the forgery, had prepared an audit report deeming the financial documents appropriate. The High Court, a lower court, ruled that “unless there are special circumstances where it is readily apparent that the company’s accounting books lack reliability, it suffices for the auditor to trust the contents of the accounting books prepared by the company and conduct the audit accordingly,” thus denying the auditor’s responsibility.  

However, the Supreme Court overturned this decision. The Supreme Court stated that in companies without an established accounting auditor, officers responsible for auditing accounting matters “should not assume that the contents of the accounting books are accurate and conduct audits of financial documents etc. based on that assumption.” The Court also pointed out that there are cases where it is necessary to request reports on the preparation of accounting books and verify the underlying documents to ensure that the financial documents accurately represent the company’s financial position.  

The impact of this Supreme Court decision on accounting advisors is immeasurable. If even an accounting-specific statutory auditor is not allowed to unconditionally trust the accounting books, it is logical to interpret that accounting advisors, who play a more proactive and essential role in “jointly creating” financial documents with the directors, are subject to a duty of care at the same or a higher level. This precedent clearly suggests that accounting advisors have a responsibility to not simply take the information provided by management at face value but to actively verify the validity of the underlying documents with professional skepticism as experts.

Comparison with Other Institutions

Under Japanese Corporate Law, in addition to the accounting auditor, there are institutions such as the “statutory auditor” and the “certified public accountant” involved in overseeing a company’s finances and management. These roles are often confused, but their authority, qualifications, and positioning within the company fundamentally differ. To understand the uniqueness of the accounting auditor, it is essential to compare it with these institutions.

The most distinctive feature of the accounting auditor is that, as an internal corporate body (executive), they work “jointly” with the directors to prepare financial documents. The purpose is to proactively ensure the accuracy of financial information by involving experts from the creation stage.

In contrast, the statutory auditor is also an internal corporate body (executive), but their primary duty is not the creation of financial documents, but rather to “audit (supervise)” the overall execution of duties by the directors. While the statutory auditor’s audit scope may be limited to accounting matters by the articles of incorporation, their fundamental role is to supervise management, not to be involved in the creation process. Unlike the accounting auditor, the statutory auditor is not generally required to have professional qualifications such as certified public accountant or tax accountant.

On the other hand, the certified public accountant is a completely independent “external” expert. They must be a certified public accountant or an audit corporation, and their duty is to “audit” the financial documents prepared by the company from an independent standpoint and express their opinion through an audit report. The appointment of a certified public accountant is mandatory for certain companies, such as large corporations. In contrast to the accounting auditor, who assists in the creation from within, the certified public accountant verifies the finished product from outside, clearly distinguishing their position and function.

Summarizing these differences, the following table is presented:

Thus, the accounting auditor plays a unique and significant role under Japanese Corporate Law, being an internal executive while possessing external expertise, and being involved in the pre-creation process rather than supervising or conducting post-hoc audits.

Conclusion

As detailed in this article, the role of the Accounting Auditor is an innovative system established by the Japanese Companies Act to enhance the reliability of corporate financial documents from within. Accounting Auditors, as experts in accounting, actively ensure the accuracy of financial reporting by jointly creating accounting documents with the company’s directors. This role brings significant practical benefits, such as improving corporate creditworthiness and facilitating smooth financing. However, with these important authorities come heavy legal responsibilities to the company and third parties. Recent Supreme Court decisions in Japan indicate that the level of due diligence required of Accounting Auditors is extremely high, necessitating a high degree of professionalism and ethical conduct in their duties.

Monolith Law Office has a proven track record of providing legal services related to corporate governance, including the establishment and operation of Accounting Auditors, to a diverse range of clients within Japan. Our firm employs several experts who are native English speakers with foreign legal qualifications, enabling us to offer specialized support for companies conducting international business to comply with the complex requirements of Japanese corporate law and to build an effective and compliance-oriented governance structure.