Toshibas Creative Accounting for Construction Contracts

Requirement 5 For Project G, the $114 million and $107 million discrepancies were treated as uncorrected misstatements and hence were not disclosed. Under U.S. GAAP, is non-disclosure of unresolved differences in opinion between a companys management and its auditors permissible? On what criterion should the decision to disclose (or not disclose) the unresolved differences be based? Explain.

Westinghouse Electric Corporation (WEC), a subsidiary of the Power Systems Company (PSC), 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, Yasuharu Igarashi, the Company President of PSC, received a report from WEC that due to an increase in the total estimated cost of contract work, it would be necessary to recognize a loss of $50 million on the contract. More bad news followed shortly after. In October 2013, WEC reported to Toshiba that in light of comments received from its external auditors (Ernst \& Young LLP, USA), the total estimated cost of the contract had increased further and recognizing a higher loss at the end of the second quarter (ending September 30, 2013) was necessary. After further review of the consolidated financials, Toshiba's external auditor Ernst \& Young ShinNihon concluded that an additional loss of $114 million should be recognized in Toshiba's second quarter financial statements. However, Toshiba decided not to record a provision for that additional loss, so the loss actually booked for the second quarter remained at $50 million. The additional required loss of $114 million was treated as an uncorrected misstatement for the second quarter (ending September 30,2013 ) because Toshiba believed that equivalent savings could be achieved by shortening the contract work period and reducing certain costs by recovering additional amounts from the customer. 8 In the second half of the calendar year 2013, costs continued to escalate. On January 28, 2014, Ernst \& Young ShinNihon recommended that a loss of \$396 million for WEC be incorporated into Toshiba's third quarter (ending December 31, 2013) 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 discussions between Toshiba's CFO Makoto Kubo and Ernst \& Young ShinNihon on January 29, it was determined that based on the information received from WEC, a loss of at least $332 million should be accrued. 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 amount of \$107 million (\$332 million minus \$225 million) could be treated as an uncorrected misstatement. 9 That Th plan was approved by CEO Tanaka just in time for the Q3 financial statements to be released on January 30, 2014, although no explanations were given for the reduced loss recognition. Whether the uncorrected misstatements of \$114 million in Q2 and \$107 million in Q3, FY 2013 were large enough to be called manipulations (rather than misstatements) and whether Toshiba's external auditors should have agreed to this treatment of the unresolved differences are contentious issues. 10 Hideaki Kubori, an expert on corporate investigations, observed that the auditor was too quick to "yield to the company when there was any difference in view" (Reuters 2015 a)