BU4530 Financial reporting and analysis Ethics in Accounting

Lecturer: Dr. Domenico Campa

What is Ethics?
A system of moral principles and a branch of philosophy which defines what is good for individuals and society. The term is derived from the Greek word ethos which can mean custom, habit, character or disposition. Ethics covers the following dilemmas: how to live a good life our rights and responsibilities the language of right and wrong moral decisions - what is good and bad?
Source:http://www.bbc.co.uk/ethics/introduction/intro_1.shtml

campad@tcd.ie

What is Ethics for

Ethical standards are personal and depend on each employees individual values. To be successful, an accountant (and not only accountants) must act with total integrity and more companies are seeking for potential employees with outstanding ethical commitment. The fact of developing high personal standards and integrity must start while you are still a student, this is when you set your moral compass. Cheating is not a path to success, and it destroys value. By maintaining your ethical standards as a student you will create more value for yourself; as an employee you will also create more value for your company by maintaining integrity. Inexorably, businesses and society both look better with high ethical standards.

campad@tcd.ie

Ethics in Accounting
Accounting ethics is a field of professional ethics which pertains specifically to accounting. One of the key issues with this topic is that poor ethical behaviour on the part of an accountant does not just potentially hurt a client but also the society as a whole. Company stakeholders expect the company to be proactive in terms of social responsibility, safety and environmental issues besides corporate ethics. An ethics code has also become essential in the corporate culture in order to give trust in the company business. Professional accounting organizations are defining high standards of ethical behaviour as well as setting mechanisms to enforce professional ethics. The ethical guideline aims to ensure accountants follow the basic principles to ensure integrity, objectivity, confidentiality, professional competence and due care. Moreover, integrity and support for ethical standards by senior managers is an unparalleled motivator of ethical behaviour in an organization.

campad@tcd.ie

Test your Ethics

You work in the same firm together with a close friend, John. You discovered, by chance, that he is stealing money from the company covering this action using fraudulent double entries. What would you do?
a)This behaviour is unacceptable! You report this fact to the manager of the company. b) You inform John that you know what he is doing. You want half of his additional wealth otherwise you are going to report this fact to the manager and the police. c) You ask him information about the safety of these actions and tips to do the same as you also want to increase your salary. d) You meet John, saying what you have discovered, and suggest him to go to the manager, talk to him and give all the stolen money back. campad@tcd.ie

Ethical dilemmas in business

1. In July, 2002, a GM noticed that scrap costs in the plant were running way ahead of plan. So that senior management would not become alarmed, he instructed his controller to "bury" most of the scrap costs in other expense accounts where they would not be noticed. Over the remainder of the year, the controller buried approximately $60,000 of scrap costs. Effect on net income: zero 2. At the end of December, a division was struggling to meet its profit targets. The GM told his production manager to ship some customer orders early so that the associated revenue and profits could be recognized in the current year. The items were in inventory, and expected delivery times were two days. The customers' firm delivery date was: February 12 3. At the beginning of December, 2001, a GM realized that the division would exceed its budgeted profit targets for the year. He ordered his controller to develop the rationale for increasing the reserve for inventory obsolescence. By taking a pessimistic view of future market prospects, the controller was able to identify $700,000 worth of finished goods that conservative accounting would say should be fully reserved (i.e., written off), even though the GM was fairly confident the inventory would still be sold at a later data at close to full price.
Source: Giacomino, D. and Bellovary J. (2006) The Ethics of managing short-term earnings: business managers and business students rate earnings management practices, Journal of College Teaching &Lernings

campad@tcd.ie

Ethical dilemmas in business (2)

4. State Electric, a publicly held electrical generating company, is faced with rapidly escalating costs of its low sulfur coal which it purchases from midwestern suppliers. Reliable estimates show this price trend to continue over the next five years necessitating an across-the-board price increase to customers. Lower cost, high sulfur coal is readily available, however its use will increase State's overall pollution emissions by 25%. Management opts for the high sulfur coal rather than raising the cost per KWH to customers. 5. Kiddie Textiles, Inc., a manufacturer of children's sleepwear, responded to the appeal by the National Safety Council and treated its entire fall line with the flame retardant agent, TRIS. Research found this to be a carcinogenic agent and TRIS treated textiles were subsequently banned from sale in the U.S. Left with more than one million dollars in inventory of the banned products, Kiddie sold the entire lot at cost to an export agent whom it was sure would sell the TRIS treated sleepwear to markets in underdeveloped countries which had no such ban.
Source: Okleshen M., and Hoyt, R. (1996) A cross cultural comparison of ethical perspective and decision approaches of business students: US vs New Zealand , Journal of Business Ethics.

campad@tcd.ie

Triangle of fraud

campad@tcd.ie

Fundamental Principles
Integrity Objectivity

Professional Competence & Due Care

Confidentiality

Professional Behaviour

campad@tcd.ie

Conceptual Framework Approach

Threats are created by circumstances and relationships that could compromise an accountants ability to comply with the fundamental principles. Safeguards are actions or other measures that may eliminate threats or reduce them to an acceptable level.

Identify threats to compliance with the fundamental principles. Evaluate the significance of the threats identified. Apply safeguards, when necessary, to eliminate the threats or reduce them to an acceptable level.
campad@tcd.ie

Categories of Threats
Self-interest threats Self-review threats Advocacy threats Familiarity threats Intimidation threats

campad@tcd.ie

Safeguards
Safeguards are actions or other measures that may eliminate threats or reduce them to an acceptable level.

Safeguards created by the profession, legislation or regulation

Prohibitions: When safeguards are not adequate

Safeguards in the work environment

campad@tcd.ie

Independence
Independence of Mind
The state of mind that permits the expression of a conclusion without being affected by influences that compromise professional judgment, thereby allowing an individual to act with integrity and exercise objectivity and professional skepticism.

Independence in Appearance

The avoidance of facts and circumstances that are so significant that a reasonable and informed third party would be likely to conclude, weighing all the specific facts and circumstances, that a firms, or a member of the audit teams, integrity, objectivity or professional skepticism has been compromised.

campad@tcd.ie

Valuation Services
A valuation comprises the making of assumptions with regard to future developments, the application of appropriate methodologies and techniques, and the combination of both to compute a certain value, or range of values, for an asset, a liability or for a business as a whole. A self-review threat may be created when a firm performs a valuation that is to be incorporated into the clients financial statements.

The firm shall not provide a valuation service (or withdraw from the audit engagement) if the valuation service has a material effect on the financial statements and the valuation involves a significant degree of subjectivity. For public interest entity audit clients the firm shall not provide valuation services to an audit client if the valuations would have a material effect, separately or in the aggregate, on the financial statements.
campad@tcd.ie

Taxation Services
1. 2. Tax return preparation. Tax calculations for the purpose of preparing the accounting entries. Tax planning and other tax advisory services. Assistance in the resolution of tax disputes.

3. 4.

For public interest entity audit clients the firm shall ordinary not prepare such tax calculations of entries that are material to the financial statements.

A firm is not permitted to provide tax advice when the tax advice depends on a particular accounting treatment or presentation in the financial statements, and: (a) the audit team has reasonable doubt as to the appropriateness of the related accounting treatment or presentation under the relevant financial reporting framework; and (b) the outcome or consequences of the tax advice will have a material effect on the financial statements.

campad@tcd.ie

Internal Audit Services

Internal audit services involve assisting the audit client in the performance of its internal audit activities. In providing such services the firm shall not assume management responsibility.

Provision of internal audit services creates a self-review threat to independence if the firm uses the internal audit work in the course of a subsequent external audit.

For public interest entity audit clients the firm shall not provide internal audit services that relate to a significant part of the internal controls over financial reporting; financial accounting systems that generate information that is, separately or in the aggregate, significant to the clients accounting records or financial statements; or amounts or disclosures that are, separately or in the aggregate, material to the financial statements.
campad@tcd.ie

IT System Services
IT system services related to information technology (IT) systems include the design or implementation of hardware or software systems. Provision of IT systems services may create a self-review threat to independence when the system generate information that affects the accounting records or financial statements.

For public interest entity audit clients the firm shall not provide services involving the design or implementation of IT systems that form a significant part of the internal control over financial reporting or generate information that is significant to the clients accounting records or financial statements.

campad@tcd.ie

Litigation Support Services

Litigation support services include activities such as acting as an expert witness, calculating estimated damages or other amounts that might become receivable or payable as the result of litigation or other legal dispute, and assistance with document management and retrieval.

Litigation support services to an audit client may create may create a self-review or advocacy threat.

Where the result of a valuation for litigation support will have a direct effect on the financial statements, the requirements in the Code relating to valuation services are applicable.
campad@tcd.ie

Recruiting Services
Recruiting services include services such as reviewing the professional qualifications of applicants, interviewing candidates and providing advice on their suitability for the post.

Providing recruiting services to an audit client may create self-interest, familiarity or intimidation threats.

The significance of the threats will depend on factors such as the nature of the requested assistance and the role of the person to be recruited.

campad@tcd.ie

Corporate Finance Services

Corporate finance services comprise a broad range of services including assisting in developing corporate strategies, identifying possible targets for the client to acquire, advising on disposal transactions, assisting financeraising transactions and providing structuring advice.

Providing corporate finance services to an audit client may create services may create advocacy or selfreview threats.

Certain corporate finance services are not permitted, such as services involving promoting, dealing in or underwriting an audit clients shares.
campad@tcd.ie