1) 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 thirty percent 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
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
forty percent 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 price 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.
2) You’re the CFO of Nildorf Inc., a maker of luxury consumer goods that, because of its product, is
especially sensitive to economic ups and downs. (People cut back on luxury items during
recessionary times.) In an executive staff meeting this morning, Charlie Suave, the president,
proposed a major expansion. You felt the expansion would be possible if the immediate future
looked good, but were concerned that spreading resources too thin in a recessionary period could
wreck the company. When you expressed your concern, Charlie said he wasn’t worried about the
economy, because the spread between AAA and B bonds is relatively small, and that’s a good
sign. You observed, however, that rates seem to have bottomed out recently and are rising along
with the differential between strong and weak companies. After some general discussion, the
proposal was tabled pending further research. Later in the day, Ed Sliderule, the chief engineer
came into your office and asked, “What in the world were you guys talking about this morning?”
Prepare a brief written explanation for Ed.