A former executive of a subsidiary of Washington Group Inc. testified today that in April 1975, he warned company President Smith Bagley that the firm was "trading on deception" in its accounting practices.

Frederick Schuermann, who was controller of the textile subsidiary, Washington Mills, said that the company had "grossly overstated profits." Schuermann told of how in the first quarter of 1975, when Washington Mills was having trouble selling off its mounting inventories, the company added 20 cents a pound to every roll of yarn.

This 20 cents a pound then was recorded as profit on the company's books, even though the yarn remained unsold, according to Schuermann.

"In essence, (we were) adding profit out ofthin air," Schuermann said of the process. The effect was to increase the company's profits in 1975 by $420,000.

One of Bagley's attorneys, Daniel Rezneck of the Washington firm of Arnold and Porter, got the government witness to agree that Bagley "is an optimist by nature" as an explanation for the accounting practices.

Bagley and four other defendants in a criminal conspiracy trial here are accused by the government of manipulating the stock of the Washington Group between Feb. 1, 1974 and April 15, 1975. The Winston-Salem food and textile conglomerate went into bankruptcy in June 1977. In his questioning of Schuermann, Rezneck noted that the witness thought enough of the company to buy some 1,300 shares of its stock and to invest in its employe stock plan.

"Nobody coerced you into buying stock," Rezneck said, and the witness agreed.

But later, in answer to questions by Justice Department attorney Robert Clark, Schuermann claimed that two weeks after he was hired by Washington Group, "Mr. Bagley suggested a quantity of stock he wanted me to purchase."

The government is seeking to prove that stock purchases by employes were arranged by some of the defendants as a way of keeping the price of the company's stock artifically inflated.

Another government allegation is that Bagley along with James Gilley, who was chief employe profit sharing plans to inflate the price of the stock.

Government witness Clayton Boggan, a trust Co. in Winston-Salem, told of how Gilley and Bagley pressed the bank to invest a portion of the funds from employe profit-sharing into the stock of Washington Group.

Until 1972, when the two bought control of Washington Mills and made it a subsidiary of Washington Group, employe funds always had been invested in such blue-chip stocks and bonds as IBM and Eaton.