Sharon Jacobs is CEO of Henderson Industries Inc., a public company. Henderson makes heavy construction equipment like bulldozers and cranes which it sells to small construction companies. These customers are generally in poor financial condition and must finance their purchases with banks or finance companies. Unfortunately lenders have had increasing trouble collecting on their loans. As many as 30% of customers default, requiring the lenders to repossess and resell the equipment. This usually avoids a loss, but it’s an administrative hassle. Because of the ups and downs of the construction industry, it is impossible at the time of sale to predict which customers will default.
The economy is going downhill at present and Henderson has been experiencing financial difficulties itself. The company’s problems are reflected in its stock price which has declined 40% over the last two years on weakening sales. In order to boost sales, Henderson would like to sell to new customers that are financially even weaker than its current customers. Unfortunately, the banks and finance companies won’t lend to even weaker borrowers. As a result, Henderson is considering offering product to these new customers on deferred payment terms. That means it will receive a stream of monthly payments over two or three years until the equipment is paid off. Defaults on this new business will probably be worse than the finance companies are now experiencing but no one knows by how much. The good news, however, is that Sharon thinks she can sell a lot of equipment to these new customers.
On top of all this, the deferred payment idea presents an accounting issue. Typically when a sale is made, the entire prices of the product along with its cost are recognized on the income statement at the time of sale. Any unpaid money is carried as a receivable regardless of how long the customer has to pay. But if there are serious questions about collecting the deferred payments, it’s more appropriate to use the installment sales method which recognizes revenue and a pro rata portion of cost only as cash is received from customers. What ethical issues does Sharon face with respect to disclosure of financial information including but not limited to the income statement?
Suppose Sharon has stock options and/or a bonus package that depend on stock price. How might her compensation plan affect her decisions?