Cell-Works Technology, Inc., a biotech company, has a $24,000,000 bond issue outstanding. The bond indenture has several restrictive provisions, including requirements that current assets exceed current liabilities by a ratio of 2 to 1 and that income before income taxes exceed the annual interest on the bonds by a ratio of 3 to 1. If those requirements are not met, the bondholders can force the company into bankruptcy. The company is still awaiting Food and Drug Administration (FDA) approval of its new product, CMZ-12, a cancer treatment drug. Management has been counting on sales of CMZ-12 this year to meet the provisions of the bond indenture. As the end of the fiscal year approaches, the company does not have sufficient current assets or income before income taxes to meet the requirements.
Barry Kwak, the chief financial officer, proposes, “Because we can assume that FDA approval will occur early next year, I suggest we book sales and receivables from our major customers now in anticipation of next year’s sales. This action will increase our current assets and our income before income taxes. It is essential that we do this to save the company. Look at all the people who will be hurt if we don’t do it.”
Is Kwak’s proposal acceptable accounting? Is it ethical? Who could be harmed by it? What steps might management take?