Prior to the start of fiscal 2010, managers of MultiTech hosted a Web conference for their shareholders, financial analysts, and members of the financial press. During the conference, the CEO and CFO released the following financial projections for 2010 to the attendees (amounts in millions):
Sales ............ $40,000
Cost of Goods Sold ..... (32,000)
Gross Margin .......... $8,000
Operating expenses ........ (4,000)
Operating income ........ $4,000
As had been their custom, the CEO and CFO projected confidence that the firm would achieve these goals, even though their projections had been significantly more positive than the actual results for 2009. Not surprisingly, the day following the Web conference, MultiTech’s stock rose 15 percent.
In early October 2010, the CEO and CFO of MultiTech met and developed revised projections for fiscal 2010, based on actual results for the first three quarters of the year and projections for the final quarter. Their revised projections for 2010 follow:
Sales .......... $38,000
Cost of Goods Sold ... (30,500)
Gross Margin ....... $7,500
Operating expenses ..... (4,000)
Operating income ...... $3,500
Upon reviewing these numbers, the CEO turned to the CFO and stated, “I think the market will be forgiving if we come in 5 percent light on the top line (sales), but if we miss operating income by 12.5 percent ($500 ÷ $4,000) our stock is going to get hammered when we announce fourth quarter and annual results.”
The CFO mulled the situation over for a couple of days and started to develop a strategy to increase reported income by increasing production above planned levels. She believed this strategy could successfully move $500 million from Cost of Goods Sold to Finished Goods Inventory. If so, the firm could meet its early profit projections.
a. How does increasing production, relative to the planned level of production, decrease Cost of Goods Sold?
b. What other accounts are likely to be affected by a strategy of increasing production to increase income?
c. Is the CFO’s plan ethical? Explain.
d. If you were a stockholder of MultiTech and carefully examined the 2010 financial statements, how might you detect the results of the CFO’s strategy?