The Fore Corporation is an integrated food-processing company that has operations in over two dozen countries. Fore's corporate headquarters is in Chicago, and the company's executives frequently travel to visit Fore's foreign and domestic facilities.
Fore has a fleet of aircraft comprising two business jets with international range and six smaller turbine aircraft, which are used on shorter flights. Company policy is to assign aircraft to trips on the basis of minimizing cost, but the practice is to assign the aircraft based on the organizational rank of the traveler. Fore offers other organization its aircraft for short-term lease or for charter whenever Fore itself does not use the aircraft. Fore surveys the market often to keep its lease and charter rates competitive.
W. Earle, Fore's vice-president of finance, has claimed that a third business jet can be justified financially. However, some staff in the controller's office have surmised that the real reason for a third business jet is to upgrade the aircraft used by Earle. Presently, the people outranking Earle keep the two business jets busy, with the result that Earle usually flies in smaller turbine aircraft.
The third business jet will cost $11 million. A capital expenditure of this magnitude requires a formal proposal with projected cash flows and net present value computations using Fore's minimum required rate of return. If Fore's president and the finance committee of the board of directors approve the proposal, it will be submitted to the full board of directors. The board has final approval on capital expenditures exceeding $5 million, and has established a firm policy of rejecting any discretionary proposal that has projected cash outflows in excess of cash inflows.
Earle asked R. Arnett, assistant corporate controller, to prepare a proposal for a third business jet. Arnett gathered the following data:
(a) Acquisition cost of the aircraft, including instrumentation and interior furnishing.
(b) Operating cost of the aircraft for company use.
(c) Projected avoidable commercial airfare and other avoidable costs from company use of the plane.
(d) Projected value of executive time saved by using the third business jet.
(e) Projected contribution margin from incremental lease and charter activity.
(f) Estimated resale value of the aircraft.
(g) Estimated income tax effects of the proposal.
When Earle reviewed Arnett's completed proposal and observed that projected cash inflows were less than cash outflows, he returned the proposal to Arnett. With a glare, Earle commented, "You must have made an error. The proposal should look better than that."
Feeling some pressure, Arnett went back and checked the computations and found no errors. However, Earle's message was clear. Arnett discarded the realistic projections and estimates and replaced them with figures that had only a remote chance of actually occurring but that were more favorable to the proposal. For example, first class airfares were used to refigure the avoidable commercial airfare costs, even though company policy was to fly coach, and charter and lease time was increased to 100% of the expected time not used by Fore instead of the 50% actual experience rate. Arnett found revising the proposal to be distressing.
The revised proposal still had projected cash inflows less than cash outflows. Earle's anger was evident, and Arnett was directed to revise the proposal again, and to start with a $100,000 positive net cash inflow (that is $100,000 of cash inflows in excess of cash outflows) and work backward to compute supporting estimates and projections.
Required:
(1) Explain whether Arnett's revision of the proposal was in violation of Standards of Ethical Conduct for Practitioners of Management Accounting and Financial Management (Chapter 1).
(2) Was Earle in violation of Standards of Ethical Conduct for Practitioners of Management Accounting and Financial Management by telling Arnett how to revise the proposal? Explain.
(3) What elements of the projection and estimation process are compromised in preparing an analysis for which a preconceived result is sought?
(4) Identify specific internal controls that Fore Corporation could implement to prevent unethical behavior on the part of the vice-president of finance.