Evaluating an Ethical Dilemma: Management Incentives, Revenue Recognition, and Sales with the Right of Return Symbol Technologies, Inc., was a fast-growing maker of bar-code scanners. According to the federal charges, Tomo Razmilovic, the CEO at Symbol, was obsessed with meeting the stock market’s expectation for continued growth. His executive team responded by improperly recording revenue and allowances for returns, as well as a variety of other tricks, to overstate revenues by $230 million and pretax earnings by $530 million. What makes this fraud nearly unique is that virtually the whole senior management team is charged with participating in the six-year fraud. At the time this case is being written, five have pleaded guilty, another eight are under indictment, and the former CEO has fled the country to avoid prosecution. The exact nature of the fraud is described in the following excerpt dealing with the guilty plea by the former vice president for finance:
Ex-Official at Symbol Pleads Guilty
By Kara Scannell
26 March 2003
The Wall Street Journal
(Copyright © 2003, Dow Jones & Company, Inc.)
A former finance executive at Symbol Technologies Inc. pleaded guilty to participating in a vast accounting fraud that inflated revenue at the maker of bar-code scanners by roughly 10%, or $100 million a year, from 1999 through 2001.
. . .
The criminal information and civil complaint filed yesterday accused Mr. Asti and other high-level executives of stuffing the firm’s distribution channel with phony orders at the end of each quarter to meet revenue and earnings targets. Under generally accepted accounting practices, revenue can be booked only when the products are shipped to a customer. Symbol’s customers include delivery services and grocery stores.
Investigators alleged that Mr. Asti and others engaged in “candy” deals, where Symbol bribed resellers with a 1% fee to “buy” products from a distributor at the end of a quarter, which Symbol would later buy back. Symbol then allegedly would convince the distributor to order more products from the company to satisfy the newly created inventory void. The SEC said the inflated revenue figures helped boost Symbol’s stock price, as well as enriching Mr. Asti. He allegedly sold thousands of shares of Symbol stock, which he received from exercising stock options, when the stock was trading at inflated levels.
Required:
1. What facts, if any, presented in the article suggest that Symbol violated the revenue principle?
2. Assuming that Symbol did recognize revenue when goods were shipped, how could it have properly accounted for the fact that customers had a right to cancel the contracts (make an analogy with accounting for bad debts)?
3. What do you think may have motivated management to falsify the statements? Why was management concerned with reporting continued growth in net income?
4. Explain who was hurt by management’s unethical conduct.
5. Assume that you are the auditor for other firms. After reading about the fraud, what types of transactions would you pay special attention to in the audit of your clients in this industry? What ratio might provide warnings about possible channel stuffing?