At a small Japan entity, day-to-day operations often take priority, and building out internal controls tends to be deferred. As the business grows, however, and transaction volume and stakeholders increase, gaps in internal controls become more likely to surface as a risk of error or fraud.
- It is unclear how much internal control is enough
- The small team makes it hard to build in approval and checking mechanisms
- Headquarters' internal control standards do not translate directly to the Japan entity
- There is uncertainty about how well the company can respond to an audit or tax inspection
This article explains what foreign companies should keep in mind when building internal controls in Japan.
Why Internal Controls Tend to Be Deferred
At a small Japan entity, day-to-day operations often take priority, and building out internal controls tends to be deferred. As the business grows, however, and transaction volume and stakeholders increase, gaps in internal controls become more likely to surface as a risk of error or fraud.
Applying headquarters' internal control standards as-is is also difficult, because a small Japan entity often cannot separate duties enough to create effective checks. The framework needs to be adjusted to a scale that actually works for the entity's size.
Internal Control Items Worth Building Out
The following items are worth prioritizing when building internal controls.
| Item | What to Build |
|---|---|
| Approval process | Whether the approval route for payments and contract execution is clearly defined |
| Authority rules | Whether it is documented who can make which decisions and approve which expenditures |
| Record and document management | Whether transaction records and supporting documents are kept in a form that can withstand an audit or tax inspection |
| Checks and balances | Whether duties and approvals are separated to the extent possible even with a small team |
| Working with outside experts | Whether tax accountants, auditors, or other outside experts review the entity regularly |
Making Internal Controls Actually Effective
Internal controls need more than documented rules; it is important to regularly confirm that they are actually being followed. In a small team especially, rules can easily become a formality, so having outside experts review the entity periodically provides added assurance.
Internal controls should also not be built once and left alone; strengthening them in stages as the business grows is a reasonable approach. Rather than aiming for a perfect system from the earliest stage of expansion, it is more practical to prioritize the areas with the greatest risk first.
Summary
- Gaps in internal controls become more likely to surface as risk as transaction volume and stakeholders increase
- Build out approval processes, authority rules, record and document management, checks and balances, and outside expert involvement
- Confirm regularly that rules are actually being followed, not just documented
- Prioritize the highest-risk areas first rather than aiming for a perfect system from the start
Contact
JBN supports foreign companies in building internal controls in Japan, working together with tax and accounting specialists.
To discuss building your internal controls, please contact us.