ACCA P1 Governance, Risk and Ethics - 2011 - Study text

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Paper P1: Governance, risk and ethics

414 © Emile Woolf Publishing Limited

At a pre-conventional level of morality, there are two stages of development. The

first is an obedience and punishment orientation, where the ‘rightness’ or

‘wrongness’ of an action depends entirely on the reward or punishment that

follows. The second level of development is an individualism and exchange

morality, where individuals act in an entirely selfish way but recognise the benefit

of mutual help. (‘You scratch my back and I will scratch yours.’)

The next level of morality is a conventional stage, which contains the third and

fourth levels of moral development. The third level is based on the concept that

good behaviour means having good motives and showing love, trust and concern

for others. The actions of another person are often judged by the reasoning: ‘He

means well….’ The fourth level is one where ethical judgements are based on a

concern for maintaining the social order. Rules and regulations are there to be

obeyed.

Kohlberg also identified a post-conventional level of morality, containing the fifth

and sixth levels of moral development. The fifth level is a social contract orientation.

Individuals at this level recognise that people are different and have the right to

their own views and opinions. Society should protect certain basic rights for all

individuals, such as the right to life and freedom. In addition laws might be morally

wrong and there should be some form of democratic procedure for changing laws

that are unfair.

The sixth and final level of morality is based on a belief in universal ethical

principles. However, very few individuals reach this stage.

This framework of moral development can be used in all aspects of life, including

business and accountancy, to evaluate ethical dilemmas and understand the

different ethical views of individuals. For example, it can help to create an

understanding of a dilemma in which an individual is faced with showing loyalty to

a colleague or a boss (Level 3) and applying the rules and regulations because the

rules exist for a reason and have to be obeyed (Level 4). It can also help to create an

understanding of individuals who argue that the current rules are wrong and

unfair, and ought to be changed (Level 5).

Ethics is not a simple matter of ‘right’ and ‘wrong’, and ethical problems and

dilemmas are made even more complex by different perspectives and views.

Kohlberg’s views might therefore have some relevance to business and accounting,

by providing a framework for the formulation of ethics codes and for giving

guidance when ethical dilemmas occur.

41 Social responsibility

The seven different positions on the social responsibility of business identified by

Gray, Owen and Adams are as follows.

 Pristine capitalists. These individuals put self-interest before the collective

benefits of society as a whole. They believe in ‘free market’ forces and argue that

market forces will find solutions to major social problems such as the threat to

the global environment.

Answers to practice questions

 Expedients. These individuals take the view that companies cannot succeed in

the long term unless they accept certain social responsibilities.

 Proponents of the social contract. These individuals believe that companies

exist only through the goodwill of society and they therefore have an obligation

to act in the interests of society. Government regulation is needed to restrain the

damaging effects on society and the environment of free market forces.

 Social ecologists. These individuals take the view that problems in society and

the environment have been created by companies, and it is therefore the

responsibility of companies to admit their liability and solve the problems.

 Socialists. These individuals argue for a re-distribution of assets between

members of society and against the concentration of resources and power in the

hands of large organisations (companies and governments)

 Radical feminists. These individuals believe that there is too much male

domination of society and too much aggression. More feminine values are

needed, such as care and compassion.

 Deep ecologists/ deep greens. These individuals argue that human beings have

no more right to life than any other living species. Ethical decisions should be

based on a concern for all forms of life.

Individuals who work in business take the first two or three positions in the list,

whereas many opponents of business and critics of unethical business practices take

one of the last four positions in the list.

The analysis by Gray, Owen and Adams can be useful in adding to an

understanding of ethical differences, and differing views about the morality of

business. A better understanding of different ethical views can help individuals

(managers and professional accountants) for search for solutions to disagreements.

42 Integrity

Integrity means honesty. In business, it means ‘straight dealing’. If you deal with a

person of integrity, you know that he or she will tell you the truth and will not try to

mislead you.

A person of integrity will behave in accordance with a set of ethical values, and so

will always behave in an ethical way.

Integrity is important because it creates trust. Trust is an essential requirement for

the creation and maintenance of constructive relationships.

It is important in corporate governance. Directors of companies should be

individuals of integrity. If they are, the shareholders will believe what the directors

tell them and will trust them to govern the company in the interests of the

shareholders and not in the self-interest of the directors themselves.

Integrity is also important for professional accountants, and is one of the

fundamental ethical values that accountants should demonstrate at all times. If

accountants are able to show integrity, they will have the trust of their employer or

Paper P1: Governance, risk and ethics

416 © Emile Woolf Publishing Limited

clients and also the trust of the general public. (This is important, in view of the

responsibility of accountants to consider the public interest.)

The behaviour of directors and professional accountants can be regulated to some

extent, by rules and detailed codes of conduct. However, there are many situations

that are not covered by rules or detailed codes. In these situations, directors or

accountants with integrity can be trusted to ‘do the right thing’ and act in an ethical

way.

43 Public interest

The public interest is the collective well-being of society or the community of people

an institutions in which an individual lives and works.

Showing a concern for the public interest means recognizing responsibilities to the

public. For a professional accountant, the public includes employers, clients,

government, investors, employees, creditors, customers, the business and financial

community and all people who rely on the objectivity and integrity of professional

accountants to maintain the orderly functioning of business and commerce.

Professional accountants are required to show a concern for the public interest in

the work that they do. They should put the public interest before their

responsibilities to their employer or clients, for example when the employer or a

client is acting illegally.

Accountants also have an obligation to the public in their everyday life, because

they help to create public trust in business.

The public has a right to expect that:

 auditors will try to ensure the reliability of financial statements that are issued

by companies

 financial managers will help to ensure the efficient and effective use of resources

by the companies or other entities they work for

 tax experts will ensure a fair application of the tax rules

 accountants will give competent business advice to management.

44 Business and professional ethics

(a) A business code of ethics is developed for a company and is a statement of the

ethical stance of the company. It is also a statement by the company about

how it expects its employees to behave, in order to uphold the ethical values

of the company.

A professional code of ethics for accountants is for all individual professional

accountants, and is a statement of how they are expected to behave as

individuals. It includes a requirement that accountants should consider the

public interest.

Answers to practice questions

(b) An accountant might face an ethical dilemma in the following situations.

(1) The accountant is under pressure from a senior manager to agree with

the manager’s point of view and provide formal support, even though

the accountant does not agree.

(2) The accountant is expected to support a decision taken by management,

which might also be in the accountant’s personal interests, even though

the accountant knows the decision to be wrong. (For example, the

accountant might be expected to keep quiet about an illegal activity by

the company.)

(3) The accountant is asked to do something that is contrary to an

accounting standard, or other professional or technical standard, in

order to present information in a more favourable way.

(4) The accountant is asked to keep quiet about a mistake made by a boss.

The accountant might feel obliged to agree, out o f loyalty to the boss.

(5) The accountant misleads his boss of his client about this technical

expertise and knowledge, in order to be given some work.

45 Two clients

(a)

(1) The first step in assessing the situation is to decide whether an ethical

issue does exist. The partners have agreed a valuation for the business,

and an amount that the remaining partner will pay the retiring partner

to take over the entire business. There is a concern that the valuation of

the balance sheet might have been based on a balance sheet valuation of

assets, and that the value of the workshop might not have been brought

to the attention of the retiring partner. If these are the actual facts, the

retiring partner will be paid less than his or her fair share of the business

on retirement.

If possible, as much information about the valuation of the business

should be obtained, without (yet) alerting the partners to your concerns.

There may be a written agreement between the partners about what

should happen on the retirement of one of the partners. For example,

there may be a written partnership agreement in which a process is

specified for valuing the business on the retirement of a partner. If the

partners have reached their agreed valuation of the business in a fair

and open way, there is no ethical problem for the accountant.

If there are doubts about whether the valuation of the business has been

fair, there is an ethical issue to resolve, because one of the clients could

be treated unfairly by the other.

(2) The next step is to assess the threats to the accountant’s compliance with

the fundamental ethical principles. The two clients could have a conflict

of interests. This raises threats to the accountant’s integrity (objectivity)

and ability to treat the affairs of each client with confidentiality.

Integrity is threatened because at some stage, the accountant might have

to take sides, and support the interests of one client against the interests

of the other. Confidentiality is threatened because by raising concerns

Paper P1: Governance, risk and ethics

418 © Emile Woolf Publishing Limited

with one client, the accountant would be breaching confidentiality for

the other client.

The threats would seem to be sufficiently significant to make the

accountant consider whether additional safeguards could be introduced

to eliminate the risk.

(3) The next step is therefore to consider safeguards. In a large accounting

practice, it might be possible to appoint another senior member of staff

to take over dealing with the affairs of one of the client partners. Since

the accountant here is a sole practitioner, this is not possible in this

situation.

There are no other obvious safeguards that can be introduced, and the

accountant is therefore faced with a significant threat to compliance with

the fundamental ethical principles. He should not allow this to happen.

(4) A solution to the problem has to be found. The most suitable solution in

this case would be to arrange a meeting with both partners, where the

accountant should inform them that he is unable to continue providing

professional services to both of them.

At the meeting, the partners might agree that the accountant should

continue to provide a service to one of them, but the accountant should

not ‘take sides’ and indicate any preference for one client.

46 Errors in the numbers

(a) Judy did not learn about the error in the figures for the board until after they

had been submitted. The consequence of the error could have been very

serious, and the board might have taken a big investment decision based on

misleading and incorrect information.

There is a threat to the integrity of Tom and the members of his team,

including Judy, when information is provided that is known to be materially

incorrect.

Judy was probably correct to wait until the board made its investment

decision. Since the board decided not to invest, the failure of Tom to report the

corrected figures to the board did not have any immediate consequence.

However, Judy was also correct to recognise that a similar problem might

happen again in the future, and she looked for a suitable safeguard. She

thought that she had found a safeguard by obtaining agreement from Tom to

involve his team more closely in the future in preparing and checking figures.

In conclusion, the action by Judy in this first instance was probably

appropriate, and she complied with the fundamental ethical principles (even

though Tom did not).

Answers to practice questions

However, she should maintain documentary evidence or a documentary

record of the incident, in case she needs to raise the matter again at some time

in the future.

(b) The second incident showed to Judy that the safeguard she agreed with Tom

earlier had not worked. Tom submitted figures to Will that were presumably

not checked by anyone else in Tom’s team. However, Judy would need to

check this point: errors in checking Tom’s figures could have been made by

someone else in the team.

Another ethical issue arises, however, because Tom has asked Judy not to

correct all the errors she found, only those that Will knows about. If Judy

agrees to do what Tom has asked, she will be in breach of the fundamental

principle of objectivity. Accountants should not be involved in the provision

of information that is materially incorrect or misleading.

There is pressure from Tom to make her do what he wants, possibly by asking

her to act out of a sense of loyalty to him (a familiarity threat) or because Judy

feels intimidated by the possible consequences of arguing with her boss and

refusing to comply with his instructions.

Judy is in a very difficult position. She must comply with the fundamental

ethical principles, but in doing so she will inevitably cause problems in her

working relationship with Tom.

I recommend that Judy should take the following action.

(1) She should speak to Tom about her concerns, and explain that she

cannot agree to do what he has asked.

(2) She should discuss the failure of their previous agreement and her

concern that there could be more similar situations in the future where

Tom prepares incorrect information and asks his staff to cover up the

errors.

(3) She should explain that she will provide corrected figures to Will with

corrections to all the errors that she has found. She will draw the

additional errors to the attention of Will.

(4) She should tell Tom that she is concerned with his unprofessional

conduct, and that she cannot continue to work for him in the future. She

will therefore need to consider her position.

This leaves a problem unresolved. If Judy asks for a transfer to another

department, she will be leaving tom to continue to do what he has done in the

past, preparing figures without due care and covering up any errors. This is

likely to be a serious situation for the company. Judy might therefore decide

that she needs to inform Will about the problems she has experienced. She

should inform him about Tom’s reluctance to admit to his mistakes (and she

could explain the consequences by giving Will another set of figures

containing corrections only to the errors that he had found, so that he can

compare them with Judy’s own corrected figures). She should also mention

the earlier incident about the errors in the board papers and Tom’s similar

refusal on that occasion to admit to the errors.

Will can then make a decision about what action is appropriate.

Paper P1: Governance, risk and ethics

420 © Emile Woolf Publishing Limited

47 Discount

The problem here is that by offering to sell a necklace to Peter at a discount, the

finance director might be trying to influence Peter by obtaining his goodwill. The

risk is to Peter’s objectivity, which is a fundamental ethical concept.

Peter does not have to reject the offer from the finance director without

consideration. He can begin by establishing some basic facts.

(1) He should decide whether he would he want to buy any of the necklaces. If he

didn’t, he could politely refuse the offer from the finance director.

(2) If he is interested in buying a necklace, he should ask what the price would be

both without the discount and with the discount.

(3) He should ask whether the company normally offers discounts, and if so what

a normal commercial discount to a customer would be.

He could then tell the finance director that he is grateful for the offer and is

interested in buying a necklace, but he must first clear the matter with his audit

manager. He can explain that this is a professional requirement.

He can tell the audit manager about the offer from the finance director. If the size of

the discount is one that is normally offered to other customers of the company, or if

it is insignificant in amount, they might agree that Peter can accept the offer without

any threat to his objectivity. Otherwise he should politely thank the finance director

for the offer, but say no.

48 Principles and rules

A rules-based code of ethics is one in which detailed rules are specified about the

way in which professional accountants must behave or act in particular

circumstances.

In practice, there are many different situations, with differing circumstances, where

accountants might have an ethical dilemma. It would be difficult to foresee every

type of situation and specify the exact rule for each. The appropriate resolution of an

ethical problem might also vary between countries, according to the differing

cultures and ethical outlook of each country.

For this reason, except where particular behaviour is required from accountants by

the law (for example, with regard to reporting suspicions of money laundering

activities by a client), accountants are required to act in accordance with a

principles-based code of ethics.

The code of ethics for accountants requires compliance with five fundamental

ethical principles: integrity, objectivity, professional competence and due care,

confidentiality and professional behaviour and care.

Answers to practice questions

49 Imported meat

(a) A professional accountant has the following responsibilities to his or her

employer:

 To act with integrity and diligence and with the highest standard of

care, in all situations.

 As far as possible, to observe the confidentiality of information obtained

during the course of work. This requirement to maintain confidentiality

applies even when the accountant has left the job and no longer works

for the employer.

 To act in the interests of the shareholders as far as possible.

 To show loyalty to the employer, although only within the limits of

what is legal and ethically proper.

(b) As a ‘professional’, an accountant has a responsibility to comply with

additional ethical requirements.

 The accountant must comply with the law.

 The accountant must comply with any relevant professional codes that

apply.

 In the absence of any specific codes, the accountant must comply with

the fundamental ethical principles (of integrity, objectivity, professional

competence and due care, and so on).

 Crucially, the professional accountant must also act in the public

interest, even if this means in an extreme case reporting an employer to

the authorities for a breach of the law or other regulations.

finance, Ben cannot ignore the problem. The company’s management appear

to be breaking the law on food health and safety, and could be putting the

public health at risk.

He must decide what the most suitable course of action is. He should try to

obtain evidence of the law-breaking. If he cannot obtain documentary

evidence, he should make a record of all relevant conversations and actions.

He should report his concern. Senior management are involved in the crime,

and he should therefore begin by reporting his concern outside the normal

hierarchical channels. He might report the problem to the company chairman,

for example, or another director.

It should then be the responsibility of the chairman or board of directors to

take action.

If no action is taken internally, Ben Meakin will probably be obliged to report

to an external agency, such as a food standards agency or a public health

agency. However, this would be an extreme measure, and internal procedures

for dealing with the problem should be tried first.

Paper P1: Governance, risk and ethics

50 Footprint

An environmental footprint is a term used to mean the mark that has been left

behind on the environment, usually by social and economic activities. All economic

activity has an effect on the environment, and so leaves a ‘footprint’ after it has

occurred.

A company might report on its environmental footprint by providing information

about three things:

(1) The quantities of natural resources it has used, and (in some cases) the

quantity of land that it uses for its business purposes. An environmental

report may indicate the quantities of natural resources consumed where these

are important renewable resources (such as timber and fish stocks) or where

they are valuable non-renewable resources (such as mineral deposits, oil and

natural gas).

(2) The amount of pollution or emissions created by its activities. These could be

emissions into the air or into the sea, lakes and rivers which pollute the air or

water. They might also be emissions that contaminate land.

(3) Another aspect of the environmental footprint is the effect that the use of

natural resources and the creation of pollution have on the environment. In

addition to quantifying resources consumed and pollution created, there

should be an assessment (in qualitative or quantitative terms) of how the

environment has been affected. For example a company that uses large

amounts of timber might report on the amount of timber it has used, and also

specify the amount of deforestation (allowing for re-planting of new trees)

that this has created in different parts of the world.

51 Sustainability

(a) Sustainability refers to the ability of a company to achieve a sustainable

business. Sustainable development has been defined as business development

that meets the needs of the present without compromising the ability of future

generations to meet their own needs. An important aspect of sustainable

development is the effect of business on the environment. Companies meet

the needs of present-day customers by using resources. When these resources

are non-renewable, or when the rate of use of the resources exceeds the rate of

renewal, current business activity obviously reduces the ability of future

generations to meet their needs.

Another definition of sustainability, which is possibly easier for companies to

accommodate, is expressed in terms of value creation. Value creation is

measured in three dimensions: economic, social and environmental.

Sustainability could be described as creating more value in these three

dimensions than the cost of the resources consumed (economic and

environmental).

A sustainability report typically provides performance measurement in three

dimensions: economic, social and environmental. This is called ‘triple bottom

Answers to practice questions

line reporting’, which is advocated by organisations such as the Global

Research Initiative (GRI).

(b) Users of sustainability reports should have a right to believe that they can

trust and accept the information in sustainability reports.

When a sustainability report presents measures of performance as a triple

bottom line, the economic performance can be verified from information in the

published financial statements. However, there is no way in which the audit

of financial statements can provide verification of performance measures

relating to social and environmental performance.

Unless the published social and environmental information can be formally

verified, there is no way of assessing whether the company is telling the truth

or not. The claims that a company makes could be misleading, or even totally

wrong.

Verification of sustainability report information can be provided by an

environmental audit, provided that the audit is conducted by independent

experts. Specialist firms have been established to provide environmental

audits. The major audit firms have also established environmental audit

groups within their firm.

information about the effects that a company has had on society and the

environment. They do not necessarily discuss social and environmental

strategy concerns or even social and environmental strategy – although they

might.

Social and environmental risk reports are reports about the social and

environmental risks facing a company and how these have been managed. In

the UK for example quoted companies are required to include a section on

social and environmental risks in their annual business report to shareholders.

ACCA P1 Governance, Risk and Ethics - 2011 - Study text - Emile Woolf Publishing

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