MAN 20005LECTURE 5

Financial Ethics :

Accounting Governance

& Regulation Updated 3.10

Financial ethics

• refers to the guidelines (consisting of judgments and moral values) that a professional needs to follow while practicing accounting

• The people who receive the services of an accounting professional not only rely on his skill and ability, but also on his professional integrity.

• The essence of accounting ethics is in the maintenance of professional objectivity and integrity.

Creative Accounting

• deviate from traditional methods used to interpret accounting rule or standard

• Often walks between the line of legal and illegality

Accounting Shenanigans• Revenue recognition

• One time charges

• Raiding the reserves/cookie jar accounting

• Lease accounting

• Off balance sheet items

• Earnings management

• Krispy Kreme was public listed in April 2000

• The company’s strategy is to aggressively grow its chain of franchise store

• From 2000-2004, number of store grew from 144 to 357 stores

• Fortune magazine called it the ‘hottest brand in America’.

• Firm under pressured having to constantly increase its financial performance to satisfy the premium that investors were paying for its stock

• As a result, its CEO and COO ‘managed earnings’

• Accounts are always adjusted to beat EPS targets by 1cent and claimed to having exceeded Wall Street expectations

• Bonuses for top management were linked to surpassing the EPS forecast

• Krispy Kreme also manipulated revenue by shipping doughnut making equipment with high margins to franchise owners before they requested the equipment, then booked the sale as revenue

Policing role of Auditors

• Audit inspection on the accounting records is necessary to ensure accuracy and reliability of financial information

• Unqualified Opinion – no material weaknesses in internal control over financial reporting

• Adverse Opinion – one or more material weaknesses has exist

• Disclaimer of Opinion – there are restrictions on the scope of the auditor’s work preventing the auditor from expressing an opinion on the company’s internal control over financial reporting.

• Auditors’ duty to report matter suggesting dishonesty or fraud uncovered in the course of their audit process

• To inform the authority when he ceases, for any reason, to hold office. Failure to inform will subject the offender to penalty of a fine

• Auditor is an officer, not employee, of the company.

Companies Act 2006

Ethical Accountants

• Accounting information produced by Accountants impacts decisions about wealth transfers

• Accountants can give legitimacy to organisations which may not otherwise be deemed legitimate

• Personal preference of individual Accountant affects the “character” if information issued.

ExampleAn Accountant who is not concerned with social and

environmental responsibility will not record expenses for environmental preservation and therefore will not be brought to the attention of information user

• Information generated should faithfully represent underlying transactions and be neutral and verifiable

• Accountants objectivity – while accounting treatment of many transactions are regulated, many others are still unregulated. Accountants are expected to decide objectively and free from bias

Accounting Standards

International Accounting Standard

IASC – International Accounting Standard Committee

• Established in 1973

• Formulate and publish worldwide accepted and observed accounting standards

• to improve and harmonize regulations, accounting standards and procedures without overriding local regulations

IASB 2001 – International Accounting Standard Board

• The successor of IASC

• Responsible for developing the International Financial Reporting Standards (IFRS)

Development of mandatory accounting standards in UK

• problems with accounting information led to poor and uninformed investment decisions

• Mandatory accounting standards was developed in UK by 1970s when the Accounting Standards Steering Committee was established

• departures from principles had to be disclosed in footnotes

• Standards provides Investors with some form of protection from fraudulent organisations producing misleading information

• Regulation leads to uniform methods thus enhancing comparability

Argument against regulating a/c practice

• Capital markets will punish firms that fail to provide information

• Regulation restricts the accounting methods able to be used so organisations may be prohibited from using methods which best reflect their particular performance and position. This has implications on the efficiency with which the firm can inform the market about its operations.

Support for regulating a/c practice