ACCA P2 (INT) Corporate Reporting - Study text

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Paper P2 (INT)

Corporate Reporting

CHAPTER

The professional and ethical

duty of the accountant

Contents

1 Professional behaviour and compliance with

accounting standards

2 Consequences of unethical behaviour

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Professional behaviour and compliance with accounting standards

 Introduction

 Professional behaviour

 ACCA Code of Conduct

 Compliance with accounting standards

1 Professional behaviour and compliance with

accounting standards

1.1 Introduction

Professional behaviour and business ethics have been in the foreground of media

attention over the last few years due to the high profile nature of cases such as

Enron, Worldcom, Parmalat and others.

Ethics can be difficult to define, but it is principally concerned with human

character and conduct. Ethical behaviour goes beyond obeying laws, rules and

regulations. It is about doing ‘the right thing’.

The accountancy profession as a whole has accepted the commitment to act ethically

and in the public interest. Professional accountants may find themselves in

situations where values are in conflict with one another, due to responsibilities to

employers, clients, and the public. Professional accountancy bodies have their own

codes of conduct which accountants are expected to follow and also provide

guidance to members in situations where ethical issues arise.

1.2 Professional behaviour

Accounting information is important for investors to make business decisions. If

information is inadequate then there is the potential for investors to lose money and

confidence in the accountancy profession is undermined.

Accountants in practice

Professional ethics is applicable to accountants in practice and in business. Auditors

have a duty to ensure that financial information has been prepared in accordance

with the relevant accounting standards and that it shows a true and fair view. It is

important for auditors to remain independent and ensure that they are not

pressured into accepting an accounting treatment they do not agree with.

Some commentators believe that auditors cannot be independent as they are

performing a service, which the client pays for. This debate has been raging for

years with no suitable outcome. Another issue is that auditors take on non-audit

work such as taxation advice, management consultancy and due diligence for

acquisitions. This work is often very lucrative and worth more than the value of the

Chapter 2: The professional and ethical duty of the accountant

audit. This is seen to be an inhibitor to independence in the audit; the firm may be

persuaded to accept a dubious accounting treatment so as not to lose other valuable

work.

Accountants in business

Accountants in business need to ensure that they do not prepare financial

information in a way that is misleading and does not show a true and fair view of

the entity’s operations.

Codes of conduct

The professional accountancy bodies want their members to act ethically and so

produce ethical codes of conduct which members are required to adhere to. These

are equally relevant for accountants in practice and accountants in business.

1.3 ACCA Code of conduct

The ACCA has published a Code of Conduct which members are expected to

comply with. It sets out five fundamental principles which should be complied

with. These are discussed below:

Integrity

Integrity requires members to be straightforward and honest in their business and

professional relationships.

Further to this, members should not be associated with any reports or information

where they feel it contains materially false or misleading statements or omits or

obscures information that must be included for a proper understanding of the

situation.

Objectivity

Objectivity requires that members do not compromise their professional judgement

because of bias, conflict of interest or the undue influence of others. Members may

be exposed to situations that impair their objectivity and they should try and avoid

such situations.

Professional competence and due care

Professional competence requires members to ensure they maintain professional

knowledge and skill at the level required to ensure clients or employers receive

competent service. They must also act diligently in accordance with technical and

professional standards when providing professional services.

This principle is of key importance as accountants must ensure they are capable and

have the ability to deal with a situation. If not, then the information that is produced

will be of inferior quality and reflects badly not only on the accountant preparing

the information but on the profession as a whole.

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There are two elements to professional competence: (1) achieving competence and

then (2) maintaining that competence. This is why there is a requirement for

continuing professional development (CPD) after qualification.

Confidentiality

The principle of confidentiality requires members to refrain from disclosing any

confidential information acquired in a business or professional setting without the

authorisation to do so, unless there is a legal or professional right or duty to

disclose.

Additionally, members should not use confidential information acquired through

business or professional relationships to make personal gain or gain for third

parties.

Confidentially does not end at the end of the relationship with the client. Members

should use their prior experience but not use the confidential information.

Professional behaviour

The principle of professional behaviour requires members to comply with relevant

laws and regulations and not do anything that could bring discredit to the

profession. Members should also behave with courtesy and consideration to those

they come into contact with in a professional capacity.

1.4 Compliance with accounting standards

Compliance with accounting standards is important if the financial statements are to

fairly represent the activities of the entity. If accounting standards are not complied

with, then it may be that the financial statements are misleading. Investors then

stand to lose money if they have made decisions based on misleading financial

information.

It is also important that employers have a code of ethics so that employees in a

situation where they feel they may have to act unethically have somewhere to go for

help. Some companies have codes of business ethics so that guidance is there for

employees to know how they are expected to act and ask for assistance in an ethical

dilemma.

Accountants who are responsible for the preparation of financial information must

ensure that the information they prepare is technically correct, reports the substance

of the transaction and is adequately disclosed. The danger is that they are put under

influence from senior managers to present figures that inflate profit or assets or

understate liabilities. This puts the accountant in a difficult position. On one hand,

they wish to prepare proper information and on the other hand, there is a possibility

they might lose their job if they do not comply with their managers wishes.

In this case, ethics starts with the individual preparing the information. They have a

difficult decision to make; whether to keep quiet or take the matter further. If they

keep quiet, they will certainly be aware that they are not complying with the ethics

of the accounting body they belong to. If they speak out, they may be bullied at

Chapter 2: The professional and ethical duty of the accountant

work into changing the information or sacked. Many accounting bodies have ethical

‘help lines’ where an individual can ring for advice.

A well publicised example of acting about unethical practices occurred in Enron

where Sherron Watkins wrote to the Enron chairman and the company’s auditors to

alert them of unethical practices in the business. Her action caused a chain of events

that would see the company go bankrupt and the auditors cease business. Enron

were hiding losses and liabilities in partnerships that were not consolidated into the

group accounts. The group had been reporting profits rather than losses for several

years. The auditors initially ignored the practices; which was to prove to be a fatal

error as once the public found out about Andersen’s involvement, the firm lost all of

its clients.

As a result of corporate accounting standards in the US, the Sarbanes-Oxley Act was

introduced in 2002. It aimed to take a legislative approach to corporate

accountability. The CEO and CFO are personally responsible for the accuracy of

their company’s financial information. All companies listed on US stock exchanges

must provide a signed certificate to the Securities and Exchange Commission (SEC)

confirming the accuracy of their financial accounts.

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Consequences of unethical behaviour

 The onsequences of unethical behaviour

 Exam focus

2 Consequences of unethical behaviour

2.1 The consequences of unethical behaviour

There are many consequences of unethical behaviour and most of them are very

serious.

 Accountants are expected to be competent, objective and reliable. If they are

not, then action is likely to be taken, leading to loss of reputation. An

accountant’s reputation is a very important asset.

 Other penalties include prison sentences, fines, and prohibition of holding a

director’s position in the future.

For example, in the Enron case, many senior managers were given prison sentences

and some were ordered to repay money they had gained from the fraud.

Another fraud at the US company, Worldcom resulted in prison sentences for senior

executives and a 25 year sentence for the CEO.

For accountancy firms, there is the prospect of the partners being sentenced to

prison sentences and a serious loss of professional reputation. After news of the

Enron fraud, Arthur Anderson lost its clients which eventually resulted in the

winding up of the partnership.

The accounting fraud at the Italian dairy company, Parmalat resulted in two audit

partners being banned from practising for two years as well as having to make huge

compensation payments to Parmalat.

2.2 Exam focus

The Examiner has said that ethical and social issues will be dealt with in question 1

of the paper. This is a 50 mark question, which is mainly computational and may

ask you to consider the ethical implication of a particular situation. You will need to

think about the right way to act and talk about the ethical principles discussed

above.

Example

The Finance Director has set up a company, River, through which Zambeze conducts

its investment activities. Zambeze has paid $400 million to River during the year and

this has been included in dividends paid. The money was invested in a specified

portfolio of investments.

Chapter 2: The professional and ethical duty of the accountant

Ninety five per cent of the profits and one hundred per cent of the losses in the

specified portfolio of investments are transferred to Zambeze. An investment

manager has charge of the company’s investments and owns all of the share capital

of River. An agreement between the investment manager and Zambeze sets out the

operating guidelines and prohibits the investment manager from obtaining access to

the investments for the manager’s benefit. An annual transfer of the profit/loss will

occur on 30th June annually and the capital will be returned in four years time. The

transfer of $400 million cash occurred on 1st January 2008 but no transfer of

profit/loss has yet occurred. The statement of financial position of River at 30th

June 2008 is as follows:

River – Statement of financial position at 30th June 2008

Investment at fair value through profit or loss 390

–––––––––––––

390

–––––––––––––

Share capital 400

Retained earnings (10)

–––––––––––––

390

–––––––––––––

Discuss briefly the importance of ethical behaviour in the preparation of financial

statements and whether the creation of River could constitute unethical practice by

the finance director of Zambeze. (6 marks)

Answer

Ethics in accounting is of utmost importance to accounting professionals and those

who rely on their services. Accounting professionals know that people who use their

services, especially decision makers using financial statements, expect them to be

highly competent, reliable, and objective. Those who work in the field of accounting

must not only be well qualified but must also possess a high degree of professional

integrity. A professional’s good reputation is one of his or her most important assets.

There is a very fine line between acceptable accounting practice and management’s

deliberate misrepresentation in the financial statements. The financial statements

must meet the following criteria:

(i) Technical compliance: A transaction must be recorded in accordance with

generally accepted accounting principles (GAAP).

(ii) Economic substance: The resulting financial statements must represent the

economic substance of the event that has occurred.

(iii) Full disclosure and transparency: Sufficient disclosure must be made so that

the effects of transactions are transparent to the reader of the financial

statements.

Paper P2: Corporate Reporting (International)

In the case of River it could be argued that the first criterion may be met because the

transaction is apparently recorded in technical compliance with IFRS, but technical

compliance alone is not sufficient. The second criterion is not met because the

transaction as recorded does not reflect the economic substance of the event that has

occurred.

Accounting plays a critical function in society. Accounting numbers affect human

behaviour especially when it affects compensation, and to deliberately mask the

nature of accounting transactions could be deemed to be unethical behaviour. River

was set up with the express purpose of keeping its activities off the balance sheet.

The Finance Director has an ethical responsibility to the shareholders of Zambeze

and society not to mask the true nature of the transactions with this entity.

Further, if the transaction has been authorised by the Finance Director without the

authority or knowledge of the Board of Directors, then a further ethical issue arises.

Showing the transfer of funds as a dividend paid is unethical and possibly illegal in

the jurisdiction. The transfer should not be hidden and River should be

consolidated.

Paper P2 (INT)

Corporate Reporting

CHAPTER

Social reporting

Contents

1 Corporate social responsibility

2 Management commentary

Paper P2: Corporate Reporting (International)

Corporate social responsibility

 Corporate social responsibility: the issues

 Reporting requirements

 Voluntary CSR reporting

1 Corporate social responsibility

1.1 Corporate social responsibility: the issues

Corporate social responsibility (CSR) is a term for the responsibility that a

company should have towards society and the environment in which it operates.

Another important term is sustainability. The concept of sustainability is that

organisations and individuals should meet their own needs today without

compromising the needs of future generations. It requires organisations and

individuals to preserve the environment and society at large.

Historically, companies have considered themselves responsible to their

shareholders by generating dividends and capital growth on their investment. More

recently, companies have been criticised for striving to maximise profits at the cost

of the environment, through underpaying its workforce or by abusing its power

over its smaller suppliers to negotiate prices and terms.

There is now a widely-accepted view that companies should be answerable to a

wider range of ‘stakeholders’ who are taking an increasing interest in their

activities. They are interested in the good and bad aspects of a company’s

operations – its products and services, its impact on the environment and local

communities and how it treats and develops its workforce.

Many large companies now accept (possibly for commercial reasons) that their

responsibilities extend beyond their shareholders to other stakeholders – their

employees, the government, the local community and society in general. Initiatives

include sourcing goods from deprived countries at fair prices, campaigns to

promote re-cycling of materials, job-sharing and flexi-time working to improve

working opportunities and conditions for employees.

The practice of CSR increases the transparency and accountability of an

organisation. Transparency is important as stakeholders want to know about an

organisation’s activities. (They want to ‘see into’ an entity, to understand what it is

doing and which strategic directions it is taking.) For example, if a local community

believe that a company is dumping waste in the local area, then it will be important

to understand what is actually happening. Likewise, the company needs to accept

that it is accountable for its actions. Stakeholders believe that they have a right to

know whether a company is acting in the best interests of society and the

environment and wish to understand what the company is doing to remedy any

faults.

ACCA P2 (INT) Corporate Reporting - Study text - 2010 (Emile Woolf)

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