Thus when components transferred from the oem to the

This preview shows page 6 - 8 out of 17 pages.

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 ( Toshiba Corporation— Independent Investigation Committee 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 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 46 Caplan, Dutta, and Marcinko Issues in Accounting Education Volume 34, Number 3, 2019
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 finished goods. The journal entries for the example above might be as follows: Deferred Liability, in contrast to Production Costs, is a permanent balance sheet account that does not have to be closed at the end of each accounting period. 8 Hence, the difference between goods transferred to the CM and goods transferred from the CM affects the balance of the Deferred Liability account and not the income statement. Had Toshiba used a Deferred Liability account, it would have had no incentive to channel-stuff components with the CM since doing so would not affect income. However, sending the CM more components than necessary requires cash to purchase the components from the vendor. 7 Examples of companies that have channel-stuffed include Sunbeam and Bausch & Lomb. See Crockett (1996) for a case on Bausch & Lomb, and Caplan, Dutta, and Marcinko (2017) for a case that includes allegations of channel-stuffing at Green Mountain Coffee Roasters.

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture