Keewee Company manufactures a single product for the military. Keewee Company had steady work, but it only had a return on investment of 6 percent.

The CEO of Keewee Company did a test flight of Keewee’s product and subsequently had a heart attack and died. The board of directors hired a new CEO of the company. The board of directors had been disappointed for many years at the meager 6 percent rate of return. The board of directors offered the new CEO a substantial bonus if he raised the return on investment to 10 percent.

The new CEO went about his task of raising the return on investment. It turned out to be easier than he ever imagined. By installing a new standard cost system, he substantially improved efficiencies in the operations of the company. He made remarkable progress in turning the company around. In fact, the new CEO anticipated a return on investment of 15 percent for the year. 

This created a dilemma for the new CEO. The board had promised a bonus if he reached the 10 percent threshold, but no additional bonus if he exceeded the 10 percent threshold. He discovered that if he deferred some revenue until next year, and prepaid some of next year’s expenses, he would achieve a return on investment of 11 percent. (The company should have debited a prepaid expenses account, but they debited expenses instead.) He justified this action by saying he was “saving for a rainy day.”

Before the end of the year, he renegotiated his contract with the board of directors, which specified additional bonuses if he exceeded the 10 percent percent return on investment. 

Required

Why would the new CEO want to defer some revenue and prepay some expenses? Is this ethical?