Sales had slowed down for a number of periods, but managers kept pushing inventory onto drug store customers. The company was hit with several rounds of income restatements and legal inquiries.
In the opening vignette, analysts expressed similar concerns about Harley-Davidson. Harley dealers reported that they were carrying inventories, whereas they had previously waited one to two years to fill customer orders. Analysts concluded that Harley was trying to hide a slowdown in sales by pushing dealers to buy bikes. This scenario seemed plausible because dealers may well buy excess inventories because their future allocations of hot models would depend on past purchases. Furthermore, Harley provided dealers with financing, so revenue could be recognized even if sales were slow (Brown, 2002).
Harley’s managers responded that they had boosted inventories to meet customer demand. For a number of years prior to 2002, production had increased by 15% annually. Harley’s managers said they wanted to keep frustrated biker “wannabes” from buying competing brands instead of waiting for a backordered Harley. They also claimed to have increased inventories for the company’s 100-year anniversary in 2003 (Brown, 2002).
When the SEC investigates and asks companies to restate income, it alleges fraudulent behavior on the part of managers. When companies restate income, they often explain that they were not behaving fraudulently, but rather they are restating income to appease the SEC. When auditors discover a misstatement (a situation where the financial statements do not comply with GAAP or
IFRS), they must determine whether it is caused by an error or by fraud.
Source: K. Brown, “Heard on the Street,” The Wall Street Journal, February 12, 2002, p. C1.

REQUIRED
A. In your own words, define channel stuffing.
B. Explain why the managers of companies such as Bristol-Myers and Harley-Davidson cannot know for sure what their sales will be next period or how much inventory to produce.
C. Explain why the customers of companies such as Bristol-Myers and Harley-Davidson might be willing to purchase excess inventories.
D. Assume that you are a manager at Harley-Davidson and are defending the decision to encourage dealers to stock up on inventory. Write a brief paragraph defending Harley’s behavior.
E. How could the SEC claim that Bristol-Myers had improperly recognized revenue? In other words, does channel stuffing violate revenue recognition under GAAP or IFRS? In your answer, discuss and refer to relevant financial accounting standards and concepts.
F. From an auditor’s perspective, discuss the likelihood that the Bristol-Myers restatement of $1.5 billion in sales resulted from error (unintentional) versus fraud (intentional).
G. Explain why it might be considered so important to continue showing sales and earnings growth that managers might behave in an allegedly fraudulent manner.
H. Describe the costs for this kind of behavior, in addition to negative reputation effects for the company.