Michael Less was hired as chief executive officer (CEO) in late November by the Board of Directors of Hunter Electronics, a company that produces a state-of-the-art computer chip used in the automotive industry. The previous CEO had been fired by the board due to a series of questionable business practices including prematurely recording revenues on products that had not yet been shipped to customers.

Michael felt his first priority was to restore employee morale, which had suffered during the previous CEO's tenure. He was particularly anxious to build a sense of trust between himself and the company's employees. His second priority was to prepare the budget for the coming year, which the board wanted to review in their December 15 meeting.

After hammering out the details, Michael was able to put together a budget he felt the company could realistically meet during the coming year. That budget appears here:

HUNTER ELECTRONICS

Budget Income Statement

(Absorption Method)

Sales $40,000,000

COGS:

Beginning inventory $ 0

Cost of goods manufactured

(200,000 units @ $152 per unit) 30,400,000

Goods available for sale 30,400,000

Less: Ending Inventory $ 0 30,400,000

Gross Margin 9,600,000

Less: Selling and admin expenses

Variable selling and administrative 2,000,000

Fixed selling and administrative 3,600,000 5,600,000

Operating Income $ 4,000 000

While the board of directors did not oppose the budget, they made it clear that it was not as ambitious as they had hoped. The most influential member of the board said, "Our top managers should have to really stretch to meet profit goals." After some discussion, the board decided to set a profit goal of $4,800,000 for the coming year. To provide strong incentives and a win-win situation, the board agreed to pay out bonuses to top management of $200,000 if this profit goal was met. Michael's share of the bonus pool would be $50,000. The bonus would be all-ornothing. If actual income turned out to be $4,800,000 or more, the bonus would be paid. Otherwise, no bonus would be allowed. In order to meet the target income of $4,800,000, without an increase in inventory levels, Hunter Electronics would have to sell an additional 10,000 units.

Unfortunately, by October of the next year it had become clear that the company would not be able to make the $4,800,000 target profit. In fact, it looked like the company would wind up the year as originally planned, with sales of 200,000 units, no ending inventories, and a profit of $4,000,000.

Several managers who were reluctant to lose their year-end-bonus approached Michael and suggested that the company could still show a profit of $4,800,000. The managers argued that at the present rates of sales, there was enough capacity by working overtime to produce tens of thousands of additional chips for the warehouse. Overtime costs might have to be incurred, but all of this additional cost would be assigned to the chips in ending inventory. If actual sales were 200,000 units and the selling price and cost structure remained the same over 5000 chips would need to be added to inventory. These additional inventory items would build up the asset value on the Balance Sheet, but would remove enough cost from the Income Statement to enable the company to show a profit of $4,800,000.

Required

1. Identify all the issues faced by Hunter Electronics.

2. State the consequence of each issue. What are the pressures and issues confronting Michael?

3. Is the board of directors contributing to the issues? Explain how and why?

4. Identify the alternatives available to mitigate the issues. 5. State your recommendations. Include whether Michael should approve to build inventories in order to attain the desired profit?