10 insert figure 2 here based on the details provided

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10 ***Insert Figure 2 Here*** Based on the details provided in the Investigation Report (pp. 51 54), we infer Toshiba’s journal entries for these transactions were as follows: Procurement of components from outside supplier for $50: Inventory 50 Cash 50 Transfer of components to CM at a masking price of $200: Accounts Receivable 200 Production Costs 150 Inventory 50 Repurchase of the finished product from the CM which includes $20 fee to CM: Inventory 70 Production Costs 150 Accounts Receivable 200 Cash 20 Sale of finished product to end-user for $100: Accounts Receivable 100 Revenue 100 Cost of Goods Sold 70 Inventory 70 The account “Production C ost” is similar to Cost of Sales, a temporary account, which is closed to the Income Summary at the end of each accounting period. The effect of transfers of
11 components to the contract manufacturer can be understood by analyzing the corresponding T- accounts. Production Costs When finished products are transferred from CM __________________ Closing entry with corresponding credit going to Income Summary account When components are transferred to CM __________________ Ending balance Thus, when components transferred from the OEM to the CM exceed finished products sent back from the CM to the OEM, the production cost account has a credit balance. At the end of the period, the account is closed with a debit, with the corresponding credit to Income Summary, thereby reducing reported costs and overstating reported income for that period. The internal auditors understood that this accounting was technically incorrect but were informed that the impact on income would be immaterial because parts held by the CMs were limited to approximately three days of production (Investigation Report 2015, 58). Based on this assurance, the internal auditors approved the accounting. In contrast, in accounting periods when the CM sends more finished products to the OEM than components transferred by the OEM to the CM, the production cost account would have a debit balance. At the end of the period, the account is closed with a credit, with the corresponding debit to Income Summary, thereby reducing reported income for that period. Toshiba inflated income in many accounting periods by shipping more components to the CM
12 than needed to fulfill production needs. When these outbound shipments exceeded finished products received from the CM, Toshiba generated more credits to the Production Cost account than debits, thereby inflating reported income. This strategy to inflate income is similar to the practice of channel-stuffing, in which companies encourage customers to absorb ever-increasing quantities of product. 7 Customers might be incentivized to do so by more favorable credit terms, or liberal return policies. An alternative way to account for the transfer would be to retain the inventory on the balance sheet of the OEM and to recognize any consideration received from the CM in advance of the repurchase as a deferred liability. That liability is relieved upon payment to the CM for the

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