Assignment: Channel Stuffing Reinvented: The inside story of Toshiba's Personal Computers Division
Requirement 1
a. Does the use of masking prices violate GAAP? Why? Is it appropriate for Toshiba to increase profit (by the amount of the masking difference) at the time of supplying parts to ODMs? Why? When and how should Toshiba record the masking differences in its consolidated financial statements? Explain.
b. For the PCs that are manufactured by its subsidiary TIH, is it appropriate for Toshiba to record the masking difference as a reduction in the cost of goods manufactured? Why?
Requirement 2
a. Refer to the table of masking differences in the ‘Practice of Channel Stuffing' section of the case. For each fiscal year from 2008 to 2014, compute the income misstatement and specify whether the reported income is overstated or understated. For simplicity, assume that there were no masking differences at the beginning of FY 2008. Present your answer in the following table:
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Period
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Profit misstatement
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Over- or Under-statement?
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January 2008
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February 2008
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March 2008
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Total for the Quarter
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b. The table of masking differences indicates that the total masking difference declined noticeably in FY 2010. Why do you think Toshiba's management was willing to reduce the masking difference in FY 2010? The masking difference was again reduced sharply in FY 2014. What could have caused that to happen?
Requirement 3
Assume that TTIP, a fully-owned subsidiary of Toshiba, purchased key PC parts and supplied them to Pegatron, an Original Design Manufacturer (ODM) in Taiwan, for assembling PCs. The price paid by TTIP was ¥24,000 per PC. However, to keep Pegatron from knowing TTIP's true cost, the parts were supplied at the masking price of ¥84,000 per PC. In other words, th masking ratio used was 2.5 [(¥84,000-¥24,000)/ ¥24,000]. Address the following requirements, ignoring Pegatron's processing charge.
(a) In January 2008, TTIP purchased parts for 100 PCs and supplied them to Pegatron and no assembled PCs were shipped back by Pegatron. In February 2008, TTIP did not purchase or supply additional PC parts to ODMs. However, during that month, Pegatron assembled the parts that it had received in January 2008, and shipped 100 PCs to TTIP. In March 2008, TTIP purchased parts for 100 PCs and supplied them to Pegatron. It assembled 95 PCs and shipped them back to TTIP. The remaining inventory of parts for 5 PCs remained in Pegatron's warehouse but is guaranteed to be purchased by TTIP.
Required: Compute the profit misstatement for each month, and indicate whether it would be overstated (O/S), or understated (U/S). Present your answer in the following table:
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Period
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Profit misstatement
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Over- or Under-statement?
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January 2008
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February 2008
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March 2008
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Total for the Quarter
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(b) The average number of parts purchased and supplied in FY 2007 and prior was for approximately 100 PC units per month. However, during the years FY 2008 to FY 2013 (respectively), TTIP decided to purchase and supply to Pegatron the parts for 102, 104, 106, 108, 110, 112 PC units per month (i.e. the number of units for which parts were supplied per month increased by 2 PC units every year). The number of PC assembled each month by Pegatron, shipped to Toshiba and sold to independent customers each month remained at 95 throughout the six years. The PCs were sold for ¥30,000 each. Compute the profit misstatement for each of the six years, FY 2008 to FY 2013. Assume that there were no masking differences at the beginning of the investigation period (i.e., FY 2007 and before). Present the answer to this requirement and the next requirement [part (c)] in the table following requirement 3(c).
(c) Continue with (b) above. In addition to supplying more parts to Pegatron, TTIP also increased the masking ratio to 3.0, 3.5, 4.0, 4.5, 5.0, and 5.5, respectively in FY 2008, FY 2009, FY 2010, FY 2011, FY 2012, and FY 2013. Compute the profit misstatement for each of the six years, FY 2008 to FY 2013.
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Answer to Requirement 3(b)
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Answer to Requirement 3(c)
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FY 2008
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FY 2009
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FY 2010
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FY 2011
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FY 2012
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FY 2013
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(d) The case mentions that the "operating profit for the single month of December FY 2012 is ¥80.6 billion, which is the highest profit on record and is an amount that significantly exceeds the sales amount of ¥63.7 billion." How is it possible for the profit to be higher than the sales? Explain.
Requirement 4
In interviews conducted by the Investigation Committee, each President and CEO of Toshiba (i.e., Nishida, Sasaki, and Tanaka) denied that he was aware of the fact that profits were overstated by Channel Stuffing of ODM parts. Would you agree to the explanations given by each? Why?
Requirement 5
The presidents of the PC business claimed that the overstating of profit by Channel Stuffing of ODM parts was dictated by the top management and hence they were not responsible. Do you agree with this view? If you were the president of the PC business facing similar circumstances, what other possible courses of action would you have considered?
Requirement 6
Investopedia.com defines channel-stuffing as "a deceptive business practice used by a company to inflate its sales and earnings figures by deliberately sending retailers along its distribution channel more products than they are able to sell to the public." Read the following article on channel-stuffing. Explain the difference between the technique and effectiveness of typical channel-stuffing, and channel-stuffing as practiced by Toshiba during the period of investigation.
"The SEC wants to know if Diageo used the oldest - and worst - trick in the book to fudge its numbers" in Business Insider (July 24, 2015). It can be accessed.
Requirement 7
Did Toshiba's external auditors (Ernst & Young ShinNihon) fulfill their responsibilities? Explain.
Attachment:- Case-Study.pdf