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 for the parts 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, the masking ratio used was 2.5 [(¥84,000-¥24,000)/ ¥24,000], and the Masking Profit was ¥60,000 per PC (¥84,000 - ¥24,000). Address the following requirements, ignoring Pegatron’s processing charge.
a. Assume that in January 2008, TTIP purchased parts for 100 PCs and supplied them to Pegatron. 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 for 100 PCs that it had received in January 2008, and shipped 100 assembled 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 five PCs remained in Pegatron’s warehouse but is guaranteed to be purchased by TTIP. 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:
Period,Amount of Profit misstatement, Over- or Under-stated?
Total for the Quarter
b. Continue with the data in (a) above, including the assumption that the price paid by TTIP for the parts was ¥24,000 per PC and it supplied them at the masking price of ¥84,000 to Pegatron. Further, assume that Toshiba sold the PCs to distributors (for resale to retail customers) for ¥30,000 each.
The average number of parts purchased and supplied to Pegatron per month in FY 2007 and prior was just sufficient for manufacturing 100 PC units. During each fiscal year from 2008 to 2013, TTIP purchased and supplied parts for 3 additional PCs per month (i.e., parts for 36 additional PCs every successive year) to Pegatron. In other words, it supplied parts for 103, 106, 109, 112, 115, and 118 PC units per month respectively during the period from FY 2008 to FY 2013. The number of PCs assembled each month by Pegatron, shipped to Toshiba and sold to independent customers remained constant at 95 throughout this six-year period.
Compute the profit misstatement for each of the six years, FY 2008 to FY 2013, assuming 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 the requirement 2(c).
c. Continue with part (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 fiscal year from 2008 to 2013.
Answer to Requirement 2(b), Answer to Requirement 2(c)
d. The Investigation Report (Page 266) mentioned that the operating profit for the single month of December FY 2012 was ¥80.6 billion, which exceeded the sales amount of ¥63.7 billion.” Using the insights derived from your answer to part (c) above, explain how it was possible for Toshiba to report profits higher than sales.
a. Refer to the table of Masking Differences at the end of the ‘Practice of Channel-Stuffing’ section of the case. For each fiscal year from 2008 to 2014, compute the income misstatement (in ¥billion) 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:
FY 2008 FY 2009 FY 2010 FY 2011 FY 2012 FY 2013 FY 2014
Income misstatement (amount)
Overstated or understated?
b. Using the table of Masking Differences at the end of the ‘Practice of Channel-stuffing’ section of the case, explain why Toshiba’s management was willing to reduce the Masking Difference in FY 2010. Suggest plausible reasons for the large reduction in the Masking Difference in FY 2014.
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