please use FASB as reference source and cite reference for the answers. All the questions would like to be answered and written. Thank you very much. I am wiling to give extra credits for this entire case question.

Toshiba's Creative Accounting for Construction Contracts 1 "It's not my understanding that I gave orders for improper accounting, but the reality is that such an observation has been made." (Hisao Tanaka, Toshiba's President and CEO when he resigned on July 21, 2015) Introduction In one of the most egregious instances of wrongdoing in Japanese corporate history, Toshiba Corporation (hereafter, Toshiba, or the Company) was accused by Japan's Securities and Exchange Surveillance Commission (SESC) of overstating operating profit by 151.8 billion ($1.22 billion). On February 12, 2015, Toshiba received an order from the SESC informing the Company that it was \"subject to a disclosure inspection with respect to some projects in which the percentage-of-completion method was used.\" Realizing the seriousness of the issue, Toshiba set up an in-house investigation committee (hereafter, the Committee) which issued its 334-page report 2 (hereafter, the Report) on July 20, 2015. Eventually, the Company restated earnings for a seven-year period (2008-2014) which resulted in slashing its profits by 224.8 billion ($1.86 billion). Background of Earnings Manipulation Toshiba's 2015 annual report stated that the earnings manipulations resulted from \"pressure caused by an awareness of concerns in the capital market, and a need to find new business opportunities in a harsh environment where individual divisions were recording weak performance as a result of negative impacts from the financial crisis, the Great East Japan Earthquake, the flooding in Thailand and an extremely strong yen, all at a time when traditional business markets were shrinking.\" Westinghouse Electric, a major subsidiary of Toshiba, also put a drag on the Company's earnings. The acquisition of Westinghouse in 2006 for $5.4 billion is widely perceived as expensive and ill-timed because subsequent developments such as the nuclear meltdowns in Fukushima in 2011, and the revolution in shale oil and gas extraction, slowed demand for the nuclear technology. 1 This case has been developed for the purpose of class discussion by Professors Mahendra Gujarathi and Amitabh Dugar of Bentley University. Please do not quote without permission. 2 The English translation of this report can be accessed at: https://www.toshiba.co.jp/about/ir/enews/20151208_2.pdf 1 The financial press ascribed Toshiba's earnings manipulations to the global financial crisis of 2008 which weakened demand for Toshiba's products. However, the improper accounting began earlier under Atsutoshi Nishida, Toshiba's CEO during 2005-2009. When he was installed as Toshiba's CEO in 2005, Nishida told Reuters in an interview: \"Since 2000 we didn't clear our annual forecasts even once. We've lost the trust of the market. I want to start by getting people to trust Toshiba as a company that's solid in terms of hitting numerical targets.\" In 2008, when he heard that the firm was heading for a loss of 18.4 billion, he called the figure \"so embarrassing that we cannot announce it\". His subordinates obliged by turning that number into a profit of 500m. Toshiba used several techniques to manipulate earnings within each of its major divisions. This case deals only with the accounting issues related to construction projects in Toshiba's Energy and Infrastructure segment, where the use of inappropriate accounting techniques was particularly widespread. As mentioned in the Report, the irregularities included \"instances in which the total estimated cost of contract work was calculated without being based on the latest information regarding incurred costs; instances in which provisions for contract losses were not recorded at the time when it became clear that losses would arise; and instances in which the total estimated cost of contract work was calculated on expected cost reductions that lacked concrete substantiation.\" Of the total amount of overstatement of pre-tax income (224.8 billion), the amount related to the incorrect application of the percentage-ofcompletion method was 47.9 billion (21 percent). Toshiba Corporation Founded in 1875, Toshiba Corporation is one of Japan's oldest, largest and most diversified manufacturers of consumer electric and electronic products, and industrial and social infrastructure systems. In FY 2014 3, with sales of over 6.5 trillion (approximately, $63 billion), and about 200,000 employees, Toshiba ranked as the tenth largest industrial conglomerate in Japan. Although more than 60 percent of its sales were domestic, Toshiba brought Japan to the forefront of international business through its overseas sales (16 percent of its sales in 2014 were in North America, 11 percent in Asia, and 10 percent in Europe). Toshiba is credited for having developed the world's first color video phone (in 1970) and world's first expanded integrated-circuit color television (in 1971). Capturing its emphasis on innovation, Toshiba adopted in 2006 a brand tag line, "TOSHIBA Leading Innovation". Although it is well-known globally as a major manufacturer of PCs, tablets, TVs, washing machines, and 3 All companies in Japan including Toshiba are required to follow a uniform fiscal year (FY) that starts on April 1 and ends on March 31 of the following year. 2 robot vacuum cleaners, the segment that manufactures these products (\"Lifestyle Products and Services\") accounted for only 16 percent of Toshiba's sales in 2014. The other major segments of the Company consisted of Energy and Infrastructure (28 percent of sales), Electronic Devices and Components (24%), and Community Solutions (19%). Business Units of Toshiba that engaged in Long-term construction projects At the time of investigation, Toshiba Corporation (also known as Toshiba Group) comprised of seven companies, each being treated and operated as an independent company. Of the seven companies, the three that dealt in long-term construction projects included Power Systems Company (PSC), Social Infrastructure Systems (SIS) Company, and Community Solutions Company (CSC). PSC designs and constructs facilities such as nuclear power plants, fast reactors, and reprocessing plants, and manufactures and sells steam and water turbines, turbine generators, power generation monitoring and control systems, etc. The SIS Company provides a wide range of products such as power distribution systems, railway and automotive systems, solutions and automation equipment, and radio wave systems. CSC develops smart solutions for society as a whole, by using information and communications technology and promoting the use of renewable energies. Corporate Governance and Performance Evaluation at Toshiba In 1999, Toshiba introduced an in-house performance evaluation system, under which each division is treated and operated as an independent Company. Each division/company has a profit and loss responsibility and its president (called Company President or CP) has the authority over most business execution matters. The company presidents report to the President and CEO of Toshiba Corporation (Group). The CPs are designated Executive Officers who report directly to the Board of Directors. The Executive Officers report any material violation of laws and regulations to Toshiba's Audit Committee. The Company also has a Corporate Audit Division the general manager of which reports to the Board of Directors on internal audit results. Toshiba's performance evaluation system aims to energize the organization, promote autonomous responsible management, and improve the corporate value of the Group. Every month, each division/company submits its performance results and forecasts for the upcoming one and six-month periods to the Corporate Finance & Accounting Division, which is headed by Toshiba's CFO. The CFO compiles and reports this information to Toshiba's CEO. Based on the 3 actual performance results for the preceding month and forecasts for the current month, each Division also submits proposals to the CEO regarding desirable performance improvement targets (called "Challenges"). Company Presidents report on their respective companies' performance results relative to forecasts at CEO Monthly Meetings, and at these meeting the CEO issues them Challenges as necessary. Accounting policies for long-term projects Although Toshiba follows accounting principles generally accepted in Japan, certain adjustments and reclassifications are made in its consolidated financial statements to conform to the accounting principles generally accepted in the U.S. Its stated accounting policies for long-term projects are described below. The Power Systems Company and the SIS Company use the completed contracts method for smaller contracts (less than I billion for the Power Systems Company, and less than 500 million for the CS Company), or a construction period of one year or less (the Report, p. 42). For the bigger and/or longer duration projects, when estimates of the extent of progress toward completion and contract costs are reasonably dependable, revenue from the contract is recognized based on the percentage of completion. To measure the extent of progress towards completion, the Group generally compares the costs incurred to date to the estimated total costs to complete based upon the most recent available information. A provision for contract losses is recorded in its entirety when the loss first becomes evident (Toshiba Annual Report, March 31, 2014, Financial Review, p. 47). For the equipment that requires installation, such as Energy and Infrastructure, revenue is recognized when the installation of the equipment is completed, the equipment is accepted by the customer and other specific criteria of the equipment are demonstrated by the Group (Toshiba Annual Report, March 31, 2014, Financial Review, p. 47). Role of Culture in Accounting Manipulation Toshiba's corporate leadership handed down strict profit targets, known as Challenges, often at "CEO monthly meetings" attended by the division heads. In some cases, quarterly Challenges were handed down near the end of the quarter when there was no time left to 4 materially affect unit performance. The only way to achieve these Challenges was by manipulating accounts. The \"Challenges\" set off a vicious circle: Toshiba operating divisions would manipulate the accounts to meet the Challenges, fearful of being shrunk if they didn't meet the Challenges. The divisions were then given even tougher goals for subsequent periods. The investigation panel concluded that Toshiba's corporate culture, which demanded deference to superiors, played an important role in fraudulent accounting practices. The culture operated at the level of business unit presidents and at every level of authority down the chain to the accountants who ultimately selected and applied the accounting techniques. The Report mentioned that the priority for the presidents was to secure profits for each quarter, and thus they set high targets, demanding their subordinates improve the company's results. The business culture at Toshiba did not allow lower-level managers \"to go against the bosses.\" Neither the board's audit committee nor Toshiba's external auditor, Ernst & Young ShinNihon, detected anything amiss. The investigation panel pointed to weak corporate governance and a poorly functioning system of internal controls at every level. Whether Toshiba's audit committee discharged its responsibilities and the reasons for their lack of timely detection and prevention of accounting manipulations are also hotly debated items. It is interesting to note that only one of the three external directors on the audit committee was well-versed in financial matters, in a company that had succumbed to the Japanese tendency to not question orders from above. The earnings manipulation came as a shock because Toshiba had been lauded for its ethical culture and sound corporate governance practices. In 2013, it was ranked ninth out of 120 publicly traded Japanese companies with good governance practices by the Japanese Corporate Governance Network, a Tokyo based non-profit organization. Select Contracts The Investigation Committee identified 19 projects for which the accounting procedures followed either violated company policies, or seemed aggressive or unusual. The contours of select contracts (labeled as projects by the Company) are summarized below Project B In May 2013, the Power Systems Company (PSC) accepted a 2.1 billion contract to design and produce systems equipment for installation at a research institute with a delivery date of March 2015. This was the first of the project of its type to be handled by PSC. At the time of the initial bid, although the estimated total cost of the contract was expected to be higher (3.4 billion), PSC accepted it for strategic reasons. 5 Standard accounting practice at the Power Systems Company was to delay recognition of a provision for expected losses until it became clear that losses would definitely arise. Immediately after work on the contract started, Toshiba's management team began vigorous efforts to find cost savings and negotiate an increase in the sales price of the contract to pare the loss. Therefore, no provision for loss was recognized until the third quarter of FY2014. Furthermore, the percentage of completion method was not applied in view of uncertainty surrounding the estimate of contract costs and revenues. Project G Westinghouse Electric Corporation (WEC), a subsidiary of the Power Systems Company, received orders with a total contract amount of $7.6 billion to build a power Plant with delivery dates from 2013 to 2019. At the end of August 2013, the President of the Power Systems Company - Yasuharu Igarashi received a report from WEC that an increase of $69 million in the total estimated cost of contract work was expected. In October 2013, WEC reported to Toshiba that the total estimated increase in the cost of contract work for the quarter ending September 30, 2013 had been re-evaluated at $385 million in light of comments received from Ernst & Young LLP, WEC's statutory auditors. After further review of the consolidated financials, Toshiba's statutory auditor Ernst & Young ShinNihon concluded that the increase in the total estimated cost of contract work by WEC could be restricted to $167 million. However, the loss actually booked for the second quarter remained at $69 million. The difference of $149 million ($385 million - $167 million - $69 million) was treated as an uncorrected misstatement because Toshiba believed that equivalent savings could be achieved by shortening the contract work period and by recovering additional amounts from the customer. 4 In the second half of the calendar year 2013, costs continued to escalate. On January 28, 2014, Ernst & Young ShinNihon recommended to incorporate a loss of $396 million for WEC into Toshiba's third quarter consolidated financial statements to reflect the higher estimate of contract costs. On the same day, CEO Tanaka told President Igarashi that "it would be catastrophic if that (Q3, FY 2013 loss) was 396 million". After protracted discussion between Toshiba's CFO Makoto Kubo and Ernst & Young ShinNihon, it was determined on January 29, 4 However, no shortened work schedules or evidence to support the view that the customer was responsible for these costs was subsequently found; in fact, Toshiba's subsequent internal review of documents revealed that very few of those cost items were judged to be still recoverable, while further additional costs were incurred. 6 2014 that a loss impact of at least $332 million would need to be incorporated in Toshiba's Q3, FY 2013 financial results. The CFO devised a plan the same afternoon to restrict the increase in the total estimated cost of contract work so that a lower loss of $225 million could be reported, and the remaining negative $107 million could be treated as an uncorrected misstatement. 5 That plan was approved by CEO Tanaka just in time for the third quarter financial statements to be released the next day (on January 30, 2014) although no explanations were given for the reduced estimate of the loss of $225 million. Whether the uncorrected misstatement of $107 million - equal to about a fourth of Toshiba's pre-tax profit in the third quarter of 2013 - is material to be called manipulation (rather than a misstatement) and whether the external auditors should have qualified their report are contentious issues. Hideaki Kubori, an expert on corporate investigations, said the auditor was too quick to "yield to the company when there was any difference in view." (Reuters, August 5, 2015). Project H In September 2013, SIS Company received an order of 31.9 billion to develop a communication system for 27 million Smart Meters to be installed within client H's premises, and to manufacture, install and maintain the Smart Meter equipment, with a delivery deadline of March 2024. This was a substantially reduced price negotiated with the client following a failed prior bid a few months earlier, when the total contract cost had been estimated at 45.7 billion. SIS Company's President Toshio Masaki asked CEO Tanaka to approve the recording of a provision of losses of 4.2 billion in FY 2013 at the time the contract was signed. His request was based on the premise that the expected loss could indeed be restricted to 4.2 billion if specified cost reduction measures were implemented and common development expenses for the project were allocated to other contracts. Tanaka did not grant permission to do so. When the contract commenced, the manufacturing part of the Smart Meter equipment was accounted for on an inspection basis (contract revenue amount of 17.8 billion), while the 5 When questioned by the investigative team about these events, Kubo explained that in discussions that day, Ernst & Young ShinNihon made a statement to the effect that an amount of around $100 million could be treated as an uncorrected misstatement as a special case in the third quarter of FY 2013 on the condition that the estimated increase in the total estimated cost of contract work could definitely be reduced to enable a profit and loss impact of negative $75 million or less by the end of FY 2013. However, Ernst & Young ShinNihon explicitly denied that it made such a statement. 7 other parts of the contract (development, installation and maintenance) were accounted for under the percentage-of-completion method (contract revenue amount of 14.1 billion and total contract costs of 14.1 billion). Project I In December 2010, SIS Company's Railway & Automotive Systems Division received an order to provide electric equipment for subway trains with delivery period of July 2013 through July 2015 for a price of $129 million (10.7 billion). Cost estimates at the time of the order indicated that the project would incur a loss of 4.2 billion (approximately $51 million at the prevailing exchange rate). In exception to normal practice, the project was approved by the SIS Company President Toshio Masaki without having been deliberated at the company's Order Policy Meeting. Since the contract was neither a construction-type nor a software development project, SIS Company decided to apply inspection basis accounting. Based on the design review with the client, it was determined (towards the end of FY 2011) that the project would incur a loss of $85 million. Soon after, Railway & Automotive Systems Division managers identified several cost reduction measures the implementation of which could reduce the loss or even make the project profitable. However when they mentioned this possibility to CEO Norio Sasaki, he was openly skeptical, given the size of the anticipated loss in relation to the total price of the contract. At the end of FY 2011, Hideo Kitamura (the Executive Officer in charge of all business groups), and CFO Makoto Kubo decided not to record a provision for contract losses in that period on the grounds that \"cost reduction measures and ways to increase the contract price were not yet determined." At that point, Kitamura strongly urged the SIS Company to implement the measures to get the project into the black and warned that they should be prepared to see the collapse of the Railway Systems Division if they were not successful because the projected losses on this contract would wipe out SIS Company's entire FY 2011 profit. At the end of FY 2012, the projected loss on the contract was $41 million but SIS Company President Masaki continued to express optimism about the success of the cost reduction measures. On that basis, he requested and received permission to not record loss provision for FY 2012 (at a meeting where CEO Sasaki, Executive Officer in charge of all business groups, Kitamura, and CFO Kubo were present). At the end of FY 2013, the estimated loss on the contract had grown to $63.8 million, of which approximately half was recorded in in FY 2013 and the remainder was built into the budget for the following fiscal year. 8 In subsequent discussions, Kitamura stated that in general, he did not approve the recording of provisions for contract losses because the persons in charge of the project might feel that it was acceptable to incur losses up to the amount of the provision, thereby robbing them of the incentive to aggressively implement cost reduction measures. CEO Sasaki was confronted with the minutes of the aforementioned meetings at which he repeatedly mentioned the impact that recording a provision for contract losses would have on the financial results of the Railway Systems Division and the SIS Company. His responses included the following statements: "I constantly say that improprieties are unacceptable, and ask [my staff] to comply with the law." "The finance & accounting people are supposed to ensure that accounting treatment is appropriate." "The CEO does not make the final decision on whether provisions for contract losses will be recorded with respect to individual projects; I just receive a financial report in April. And I never gave any instructions not to record a provision for contract losses in relation to [this project] in the fourth quarter of FY 2011." "I was also not aware that a provision for contract losses in relation to [this project] had not been recorded in the fourth quarter of FY 2011." Project K On November 29, 2011, the Social Infrastructure Systems (SIS) Company entered into a construction contract with a client for 9.7 billion. The project involved the large-scale construction of 472 lanes of roadway amidst a large volume of traffic, a complex toll structure, unique specification adjustments such as zoning, and the need to change over from the existing system. Detailed contract specifications were unavailable at the outset and hence SIS Company was unable to produce a reliable estimate of construction costs. A preliminary amount of 8.8 billion (7.6 billion for cost of work plus an additional 1.2 billion to cover known risks) was recorded for expected total costs, resulting in an M-ratio 6 of 110%. Work commenced in the 6 M-ratio is the ratio of estimated total cost + profit to estimated total cost. SIS Company's policy requires the M-ratio to be 110% or greater for a contract to be accepted, so that the gross profit does not turn negative even after contract risks are considered. 9 fourth quarter of FY 2011 and at the end of that quarter, the SIS Company recorded sales of 200 million and a gross profit from sales of 20 million under the percentage-of-completion method. Due to delays in specifications approval, staff shortages, and system troubles, by the end of FY 2011 it had become clear that project costs would increase significantly. SIS Company began negotiations for an increase in the contract price but no changes to the original estimate of contract price or total costs were recorded due to the lack of reliable forecasts. During FY 2012 the contract costs continued to escalate. In the fourth quarter of 2012, negotiations with the client led to a revised contract price of 10.4 billion. The efforts to seek further contract price increases and additional cost savings continued. By the end of the first quarter of 2013, it became clear that contract costs would be higher than contract revenues and the probable loss would be in the range of 3.5 billion to 10.1 billion. Nevertheless, SIS Company President Toshio Masaki decided not to revise the 2012 cost estimate of 10.4 billion until all the opportunities for achieving meaningful cost reductions and revenues enhancements had been exhausted. In the second quarter of 2013, Masaki requested CEO Tanaka for an approval to record a loss on the contract because SIS Company's anticipated loss for the second quarter (excluding this contract) was already at 7.4 billion and a budget shortfall was expected, but Tanaka did not respond. 7 During the third quarter of 2013, Masaki continued to receive reports that the estimated contract costs had increased further. By the end of that quarter it was clear that the loss could reach 11.5 billion. These reports were centered around two cost figures, one if rank A through rank D cost reduction initiatives were to be implemented, leading to a forecasted loss of 3.5 billion (based on a further renegotiated contract price of 12.1 billion and a contract cost of 15.6 billion) and the other where only rank A through rank C cost reduction initiatives would be realized and the contract loss could be as high as 8.7 billion. 8 7 When questioned about this matter, he stated that the need for a provision for loss on this contract had been discussed between the General Managers of the SIS Company Finance & Accounting Division and the Corporate Finance & Accounting Division, and since they had confirmed that there were no accounting issues of note, he paid little attention to whether there was any problem with respect to the actual timing of recording a provision for contract losses. 8 Cost reduction initiatives classified as rank A are those that can be reliably implemented, rank B and C have a relatively high degree of accuracy and rank D require significant efforts to be realized. 10 Objectively speaking, the feasibility of these cost reduction initiatives, not only of rank D, but also ranks B and C, was not considered to be high but SIS Company President Masaki ordered a provision for a loss of 3.5 billion to be booked for the fourth quarter of 2013 based on the understanding that even if a loss for the current quarter was shifted to the next quarter, it was not a big issue as long as the provision was recorded during that same fiscal year. 9 In addition, a provision for the remaining expected loss of 5.2 billion was built into the budget for FY 2014. Contracts X and Y The details of two illustrative contracts for which Toshiba used the percentage of completion method are provided below. 10 Contract X was accepted by Toshiba at the beginning of fiscal 2012 for 6,408.17 million, when the original estimate of the total contract costs was 4,806.13 million. Although the costs and cost estimates changed as the contract progressed (see table below), for reasons similar to those described in the case, Toshiba did not change the original cost estimates. 2012 1,105.50 3,700.63 1,400.00 1,300.00 Costs incurred to Date Estimated additional costs to complete Partial billings, to date Collections during the year 2013 3,247.00 1,906.83 4,000.00 2,100.00 2014 7,208.17 0 6408.17 3,008.17 Contract Y was accepted by Toshiba at the beginning of fiscal 2012 for 1,336.13 million. Although the cost estimate at that time was 1,402.94 million and the contract was expected to incur a loss, Toshiba accepted it for competitive reasons. However, it did not record a provision for loss at the inception of the contract. As Contract Y progressed, although the costs and cost estimates changed (see table below), and the eventual total costs (1,510.81 million) exceeded the original cost estimate, Toshiba did not change the original cost estimates. In other words, it assumed that the total costs would not exceed the contract price of 1,336.13 million. Management's rationale for this position was that it lacked reliable forecasts as its efforts to seek contract price increases and additional cost savings were under way. In 2014, when the final cost data confirmed the costs to be 1,510.81 million, Toshiba recorded a loss on the 9 This view was shared by CEO Tanaka and the rank and file of Toshiba employees. 10 Although the amounts and financial details of these contracts are hypothetical, these contracts resemble several projects described in the investigation report. 11 contract of 174.68 million (revenues of 1,336.13 million minus expenses of 1,510.81 million). 2012 575.21 862.81 410.00 390.00 Costs incurred to Date Estimated additional costs to complete Partial billings, to date Collections during the year 2013 1,031.78 442.19 800.00 325.00 2014 1,510.81 0 1,336.13 621.13 Epilogue Like most accounting scandals, Toshiba's top executives incited subordinates to cook the firm's books and inflate profits. The amount of the profits slashed (224.8 billion or $1.86 billion) is huge by any measure, but the similarities end there. First, unlike some manipulations (Tyco International, for instance), there is no evidence that Toshiba's bosses plundered the company to fund their lavish lifestyles. Second, the period (2008 - 2014) over which accounting manipulations went undetected was also staggering. Finally, compared with many other accounting scandals (WorldCom, for instance), the junior employees in Toshiba did not receive explicit instructions to cook the books. Instead, top management relied on implicit threats and cultural norms of unquestioned obedience, conformity, and loyalty that led the junior personnel to do whatever it took to meet the \"Challenges\". The earnings manipulation started in CEO Nishida's regime, continued unabated during CEO Norio Sasaki's regime, and eventually ended in a scandal when it came to light under the leadership of CEO Tanaka. Toshiba's CEO Hisao Tanaka and seven top executives were forced to resign in the aftermath of the accounting scandal. These resignations resulted in half of its 16-member board of directors being removed. Toshiba was also removed from JPX-Nikkei Index 400, an index showcasing Japan's best companies. Toshiba is also facing further enforcement action in America. The U.S. can exert jurisdiction in part because the allegations involve its Westinghouse Electric Co. unit, which is based in the U.S. Toshiba also has American Depository Receipts (ADRs) traded on the over-the-counter (OTC) market in the U.S. under the symbol TOSYY. 12 References Independent Investigation Committee for Toshiba Corporation. \"Investigation Report.\" July 20, 2015. Available at https://www.toshiba.co.jp/about/ir/enews/20151208_2.pdf Reuters, August 5, 2015. How Toshiba delayed a $100 million loss with two words: 'uncorrected misstatement'. Available at: http://www.reuters.com/article/us-toshiba-accounting-auditorinsight-idUSKCN0QA2H120150805 Toshiba Corporation, Annual Reports, available at http://www.toshiba.co.jp/about/ir/en/finance/ar/ 13 Requirements The FASB and the IASB have recently issued a joint standard on revenue recognition. Although this standard is not yet applicable, please address all the requirements below, including FASB codification references, in accordance with the new U.S. standard. Requirement 1 Compliance of accounting policies with U.S. GAAP Is Toshiba's accounting policy for long-term construction contracts (as described in the accounting policies section of the case) consistent with U.S. GAAP? Cite authoritative pronouncements in support of your answer. Requirement 2 Choice of accounting policies for select contracts (a) Was Toshiba's choice of accounting method for Project B appropriate? Why? For the accounting method it used, was it appropriate for Toshiba not to recognize a provision for loss until the third quarter of FY 2014? Why? (b) Was Toshiba's choice of accounting method for Project K appropriate? Why? What plausible reason/s can you suggest for Toshiba's choice of accounting method for Project K? (c) What do you understand by the inspection basis of accounting? For Project I, is Toshiba's application of the inspection basis method consistent with the U.S. GAAP? Explain, and cite authoritative pronouncements. (d) For Project H, the manufacturing part of the Smart Meter equipment was accounted for on an inspection basis while the other parts of the contract (development, installation and maintenance) were accounted for under the percentage-of-completion method by Toshiba. Is this appropriate? Specifically, under the U.S. GAAP, is it permissible to use different accounting methods for different parts of the same contract? Cite authoritative pronouncements. 14 Requirement 3 Loss recognition under the percentage of completion method (a) For the illustrative Contracts X and Y described in the case, compute the percentage of completion, construction revenues, expenses, and gross profit (or loss) for each year, and balances in the construction in progress (net of partial billings and provision for loss, if any) and accounts receivable in the balance sheet at the end of each year. You should present the numbers according to Toshiba's accounting and the numbers according to U.S. GAAP in Table 1 (Panel A for Contract X, and Panel B for Contract Y). All the amounts should be in millions of yen (). (Hint: It might be helpful for you to prepare journal entries for each contract separately and then complete the table.) (b) For Contract Y, calculate the loss, if any, at the inception of the contract that Toshiba should record to be compliant with the U.S. GAAP. Explain your rationale and cite authoritative pronouncements. (c) For Contract Y, do you agree with the rationale of Toshiba's management to not change the original cost estimate? Is Toshiba's accounting treatment consistent with the provisions of U.S. GAAP? Cite authoritative pronouncements. Requirement 4 Quarterly versus annual financials For Project K, Toshiba's top management believed that recording of the provision for losses could be deferred from Q3, 2013 to Q4, 2013 and it was not a big issue, as long as the provision was recorded during the same fiscal year (2013). (a) Do you agree that postponing the loss recognition for Project K from Q3, 2013 to Q4, 2013 should not matter? Explain and cite authoritative pronouncements, if any. (b) In your opinion, why did the deferral to record the provision for losses from Q3, 2013 to Q4, 2013 for Project K remain unquestioned by the company's statutory auditor? 15 Table 1: Panel A: (Illustrative Contract X) 2012 Amounts per Toshiba's books 2013 Correct (U.S. GAAP) Amounts Amounts per Toshiba's books 2014 Correct (U.S. GAAP) Amounts Amounts per Toshiba's books Correct (U.S. GAAP) Amounts Percentage of Completion Income Statement: Construction revenues Construction expenses Gross profit (loss) Balance Sheet: Construction in progress (net of partial billings) Accounts receivable Table 1: Panel B: (Illustrative Contract Y) At Project Inception Amounts per Toshiba's books Correct (U.S. GAAP) Amounts __ __ Construction revenues __ __ Construction expenses (and losses, if any) __ __ __ __ Percentage of Completion 2012 (excluding inception) Amounts per Toshiba's books Income Statement: Gross profit (loss) Balance Sheet: Construction in progress (net of partial billings and provision for loss on construction contracts) Accounts receivable 16 Correct (U.S. GAAP) Amounts 2013 Amounts per Toshiba's books Correct (U.S. GAAP) Amounts 2014 Amounts per Toshiba's books Correct (U.S. GAAP) Amounts Requirement 5 Uncorrected misstatements - country differences For Project G, the $107 million discrepancy was classified as an "uncorrected misstatement", an accepted accounting treatment in Japan used to address differences in opinion between management and auditors that is not disclosed to investors. Is such non-disclosure permissible in the U.S. context? Why? On what basis should the decision to disclose or not disclose a discrepancy be based? Explain. Requirement 6 CEO responsibilities for representational faithfulness Consider the quote at the beginning of the case. At a press conference, Tanaka (President and CEO of Toshiba) also maintained that he had no intention of encouraging accounting irregularities and was unaware that false accounting was going on in Toshiba. Using the case information (especially the parts pertaining to projects G, I, and K), would you agree that Tanaka (and his predecessor, CEO Norio Sasaki, who followed similar practices) bore no direct responsibility for the improper accounting practices at Toshiba? Could the CEOs of public companies in the U.S. have made similar assertions? 17