February 22, 2016

If Japan wins future submarine competition - Role of Japanese Board of Audit?

[Pete's introduction] In Japan’s pricing of its submarines for the purposes of Australia’s future submarine Competitive Evaluation Process (CEP) an Australian understanding of Japanese audit procedures, assumptions and thinking is important. Part of the reason is that Japan is new to the business of arms selling on a large scale so it would be still fully developing accounting procedures to justify the pricing to prospective major customers (beginning with Australia).

It is unclear whether the Japanese Board of Audit's powers and responsibilities over submarines sold domestically to the Japanese Navy are the same as for large foreign sales (starting with Australia). Overarching political justification for arms sales includes Japan's:




Pete is reliant on the greater knowledge of Australian Department of Defence and Department of Finance financial analysts and accountants to understand the importance or significance of the following:

BACKGROUND ON JAPAN'S BOARD OF AUDIT

In Comments of mid February 2016 S indicates "In Japan, the predetermined price of procurement goods is calculated based on the law, i.e., “Instruction on calculation standards of predetermined price of procurement goods” and the Board of Audit strictly checks its adequacy on regular basis.

[Pete’s Note: Japan’s domestic procurement audit, formulas, standards and laws have evolved over more than a century. Japan’s Board of Audit was established in 1880 The Board of Audit is a “constitutionally independent organization to audit the final accounts of the State, accounts of government affiliated institutions and independent administrative agencies, and those of bodies which receive financial assistance from the State such as State subsidies.” So the Board’s oversight extends much further than Japan’s Ministry of Defense (JMoD) or Japan's Ministry of Finance (MoF).

The Board of Audit's oversight may cover JMoD while JMoD is bidding alongside MHI and KHI in the future submarine contest. As reported in the Fairfax media in early February 2016 the Australian Government CEP assessors had asked for information from the Japanese bidders in “a different form” as there was a "government-to-government arrangement as opposed to a commercial arrangement".

INFORMATION PROVIDED BY "S"

In Comments of mid February 2016 "Sis introducing calculation item and its definition & scope in this law. The predetermined price is summation of calculated values of following items ((1)-(10)). Calculation is conducted according to specific "equations" [items].

(1) Direct material cost (material/raw material cost, parts cost)
(2) Direct labor cost (wages including overtime pay, allowance)
(3) Direct cost (design cost, inspection cost, specialized jig & tool cos,
 machinery & equipment cost, construction cost, experimental research cost, development cost, technical collaboration fee, royalty usage fee, various expense)
(4) Manufacturing overhead ([1] is indirect material cost [2] is indirect labor cost [3] is indirect cost)
(5) General administrative and selling expenses (all of the costs incurred in common with respect to management of the entire business and sale of goods [4] )
(6) Selling direct expenses
(7) Interest (cost of capital necessary for the accomplishment of manufacturing & selling of procurement goods and benefits of the contract)
(8) Profit (reward for the accomplishment of manufacturing & selling of procurement goods and benefits of the contract, and expense profit of compensation for the risk bearing)
(9) Packing cost
(10) Transportation cost

[1]
(a) Expense of consumable tool, equipment, fixtures and equipment expenses,
(b) auxiliary management material costs (such as fuel for the power),
(c) factory supplies cost (such cost of chemicals and nails), and
(d) office supplies cost

[2]
(a) Indirect wage (wage for indirect workers, wage for indirect works of direct workers),
(b) wage for waiting time wage,
(c) salary (salary for supervisor), and
(d) indirect allowance (allowance except that in direct labor cost)

[3]
(a) Ancillary labor expenses, (b) retirement benefit expenses, (c) depreciation cost, (d) real estate rent, (e) movable estate rent, (f) insurance fee, (g) taxes & dues, (h) repair fee, (i) electric rate, (j) gas rate, (k) water rate, (l) transport cost (except delivery cost of goods) , (m) storage fee, (n) travel expense, (o) communications expense, (p) meeting expense, (q) stock losses & shrinkage (r) processing fees for subcontract, (s) petty expenses.

[4]
(a) Directors’ salaries & allowances, (b) employees’ salaries & allowances, (c) welfare expense, (d) retirement benefit expense, (e) office supplies cost, (f) depreciation cost, (g) real estate rent, (h) movable estate rent, (i) insurance fee, (j) taxes &d dues, (k) repair fee, (l) utilities, (m) transport cost (except delivery cost of goods), (n) storage fee, (o) travel expense, (p) communications expense, (q) meeting expense, (r) advertising expense, (s) sales commission, (t) research and development expense, (u) petty expense.

The Board of Audit has strong authority and can request correction against unjust or violation of related laws & regulations, and also request improvement from view point of laws & regulations, institution and administration."


PETE'S QUESTIONS

The Japanese entity wishing to sell to Australia is an unusual hybrid of a government Ministry of Defense (JMoD) and two companies (MHI and KHI). This is instead of the usual single company selling (eg. TKMS and DCNS).

How the Japanese Board of Audit will handle/is handling the submarine pricing and potential sales process is a mystery (to me). For example:

1. If MHI is the official seller to Australian won't this downgrade the Board of Audit's power and responsibility?

2. What will be JMoD's status in the procurement of parts for an Australian submarine?

3. Will the JMoD act as if it is buying submarine parts from MHI or KHI? 
(Then those parts will be assembled into a submarine in Adelaide.)

4. What will happen if the Japanese Board of Audit finds any irregularities in the Japanese bid for the future Australian submarine or JMoD's involvement in the bid?

S's RESPONSE TO THE QUESTIONS ABOVE

S's response was made in Comments of February 23, 2016.


Questions 1, 2 and 3

"These depend on the contract on submarine building. Judging from role of the Board of Audit (BoD) [1], the depth and scope of audit depend on the contract which is very unclear in the current tender status."

Question 4

Answer [Board of Audit] will fulfill its responsibilities.

[1] http://www.jbaudit.go.jp/english/index.html , Home page of the Board of Audit of Japan
“As a constitutional organization that is independent of the Cabinet and belongs neither to the Diet nor to the Courts, the Board of Audit (hereinafter referred to as 'the Board') audits the State accounts as well as those of public organizations and other bodies as provided by law, and also supervises public accounting to ensure its adequacy.

S and Pete

6 comments:

Anonymous said...

French President Hollande called PM Turnbull today while Mr. Hollande was in French Polynesia.
KQN

imacca said...

Interesting post. I'd say that with the unknowns, a deal with Japan will be reliant on the Japanese Govt being seen as the reliable guarantor that whatever price is contracted for is what is paid. That could work well for Australia, unless there is some kind of legal challenge to it in Japan.

The Japanese deal seems to have its own unique set of risks.

Anonymous said...

Hi Pete

Questions 1, 2 and 3
These depend on the contract on submarine building. Judging from role of the Board of Audit (BoD) [1], the depth and scope of audit depend on the contract which is very unclear in the current tender status.

Question 4
Answer BoD will fulfill its responsibilities.

[1] http://www.jbaudit.go.jp/english/index.html, Home page of the Board of Audit of Japan
“As a constitutional organization that is independent of the Cabinet and belongs neither to the Diet nor to the Courts, the Board of Audit (hereinafter referred to as 'the Board') audits the State accounts as well as those of public organizations and other bodies as provided by law, and also supervises public accounting to ensure its adequacy.”

Regards
S

Peter Coates said...

Thanks KQN

I assume French President Hollande made only a phonecall to Prime Minister Turnbull?

Hollande in French Polynesia yesterday discussed France's "nuclear debt" after France's nuclear testing in the Pacific. http://www.france24.com/en/20160222-hollande-address-nuclear-test-victims-polynesia-trip

Hollande is on a tour of:

- the "Pacific" that includes French Polynesia, Wallis and Futuna and

- Latin America including Peru, Argentina and Uruguay

Hollande's touring party even includes very submarine related Thales, but Hollande's delegation is not visiting Australia?

I wonder why?

Regards

Pete

Peter Coates said...

Hi imacca

Yes it may be a help that the Japanese Govt might be "seen as the reliable guarantor that whatever price is contracted for is what is paid."

But the Japanese Government could cause business and political complexities for Australia if the Australian Government, or companies like ASC, have tough business negotiations downstram with MHI.

In the whole life of a future submarine project (40+ years) defence sustainment overseas is a major area of Japanese inexperience. This means long term uncertainty.

Also if Abe (and his LDP) are voted out and a more socialist-centrist government replaces the LDP such a new government may have reservations (legal or constitutional challenge?) about Japan being in an alliance via arms trade with Australia.

Regards

Pete

Peter Coates said...

Hi S

Thankyou for your answers [at 23/2/16 12:24AM] to the 23 February questions.

I have placed your answers in the article text.

Regards

Pete