Ethics and Quarterly Profits The management of the Forward Electronics Company has been proud of the company’s record of growth over the past 5 years. Not only have sales and earnings been higher each year, but each quarter has been higher than the previous quarter for the past 20 quarters. The managers are happy because they have a good stock option plan and the stock price has been going up every quarter. However, operations in 2000 are a different story.

There is more competition, and some new products are beginning to take Forward’s market. Forward is developing a new sales strategy, but it will not go into effect until 2001.

In the middle of September, an emergency management meeting was called, and the accounting manager reported that unless something changed, third quarter sales and income would be much lower than last year. At the meeting, each manager was asked to do something to protect the growth record for one more quarter. Although it was not stated, everyone knew that a large number of stock options could be exercised and the shares sold in December. Continued growth would make these options much more valuable.

The sales manager proposed that they could add more sales and meet the original quota if the credit manager were to ease the credit limits a little and if the company relaxed its return policy so that more sales could be made that might eventually be returned. The credit manager agreed that the limits could be relaxed and some cash customers could be granted credit even though the uncollectible accounts would go up significantly. They all agreed to relax the company’s return policy. The operations manager reported that he could provide enough merchandise for shipment this month to push sales over the quota if the sales department could get the orders. The shipping manager said that enough units could be shipped if he could hold the records open for just a day or two, maybe just over the weekend, at the end of the quarter so everything would go out the door. The accounting manager reluctantly agreed that as long as sales and shipping documents were dated before September 30, the sales would be included in revenue and earnings for the third quarter. A higher rate of sales returns and bad debts should be estimated for the quarter, but since none will be returned or actually go bad until later in the year, the increased allowances can wait.
The management committee met again on December 15, 2000. All of the actions proposed in the earlier meeting had been carried out. Forward maintained its growth record, stock prices continued to climb, and the stock options were well priced. Since the aggressive strategy worked, all the managers agreed to continue the practices at the end of the year so that the company’s record of quarterly and annual growth would continue through all of 2001. This might also persuade the managers not to sell the stock acquired with the options until the year 2002. As a result of the agreement, the financial vice president drafted a management’s discussion and analysis section for the annual report that said the growth record was intact and, with the new strategies, even better things were expected in 2001.

a. What do you think about the actions by each of the individual managers of Forward Electronics? Which, if any, are in violation of generally accepted accounting principles at the end of the quarter or the end of the year?
Which, if any, are acceptable, but may not be ethical?

b. Even though Forward adopted a new sales strategy in 2001, it was not able to increase its sales. The structure of its market had changed. Management was able to sell its stock in early 2001 at good prices, but by April, revenues were down and Forward reported a loss for the first quarter. Sales returns and uncollectible accounts increased dramatically. Does this information affect your answers to the previous questions? Explain.