Category: University of Mumbai BMS Notes

Accounting rules and regulations exist to ensure that financial statements are useful to their end users in their financial decision-making. For financial statements to be useful, the information presented therein must be accurate, faithful to the financial circumstances and be produced in time to help the decision-making process. Poor ethics in accounting result not only in increased incidences of criminal activities, but also hurt the business through harming its reputation and rendering their financial statements untrustworthy and thus useless.

Due to a series of recent corporate collapses, attention has been drawn to ethical standards within the accounting profession. These collapses have caused a widespread disregard for the reputation of the accounting profession. To combat the criticism and prevent unethical and fraudulent accounting practices, various accounting organizations and governments have developed regulations and guidelines aimed at improved ethics within the accounting profession.

Personal Consequences

Once caught and tried, accountants so unethical as to commit crimes related to their profession are punished. Depending on the specific circumstances of the case, this can result in prison time, financial costs and other legal punishments to the accountants found guilty. Not only is this devastating for said accountant, it is also devastating on both friends and family, particularly the family.

Criminal Activities

Poor ethics amongst a business’ accountants means that those persons are more willing to break the rules to benefit either themselves or their business illegally. For example, an unethical accountant granted too much control and too little oversight from superiors can embezzle from the business and conceal the evidence. In contrast and comparison, an unethical accountant working at the behest of the business can manipulate the data to commit a number of crimes including fraud and tax evasion.

Business Reputation

Poor ethics can also inflict damages on the business’ reputation and trustworthiness of its stakeholders, such as customers and business partners. The absence of trust ensures that the business finds it difficult to conduct business with others. This damage to a business’ reputation is particularly devastating to accounting firms who rely heavily on that reputation to remain in business. Arthur Andersen LLP effectively perished as a business because of its poor conduct in the Enron scandal.

Usefulness of Financial Statements

Each time that an unethical accountant deliberately breaks the rules and regulations to manipulate the information presented on the financial statements to illegal advantage, those financial statements become less and less useful. Since financial statements must remain accurate and truthful to help end users in making their financial decisions, financial statements tainted deter the decision-making process. Erroneous figures cast all other figures into doubt and end users simply become unable to trust the information presented.

Guidance to help CPAs solve ethical dilemmas not explicitly addressed in the code. Even though this guidance is for CPAs, it makes sense for anyone facing an ethical dilemma:

• Recognize and consider all relevant facts and circumstances, including applicable rules, laws or regulations,
• Consider the ethical issues involved,
• Consider established internal procedures, and then
• Formulate alternative courses of action.
• After weighing the consequences of each course of action, you select the best course of action based on your own judgment.

Accounting ethics is primarily a field of applied ethics and is part of business ethics and human ethics, the study of moral values and judgments as they apply to accountancy. It is an example of professional ethics. Accounting was introduced by Luca Pacioli, and later expanded by government groups, professional organizations, and independent companies. Ethics are taught in accounting courses at higher education institutions as well as by companies training accountants and auditors.

Due to the wide range of accounting services and recent corporate collapses, attention has been drawn to ethical standards accepted within the accounting profession. These collapses have resulted in a widespread disregard for the reputation of the accounting profession. To combat the criticism and prevent fraudulent accounting, various accounting organizations and governments have developed regulations and remedies for improved ethics among the accounting profession.

Ethical behaviors can be identified in both individual relationships and work relationships. The concept can also be applied to corporations as entities. It evaluates the moral implications of actions being taken on each of the previously mentioned contexts. An ethical behavior is essential for a society to function properly. Individuals that behave unethically will normally loss other people’s confidence and their unethical behavior should be also punished by the law.

The nature of the work carried out by accountants and auditors requires a high level of ethics. Shareholders, potential shareholders, and other users of the financial statements rely heavily on the yearly financial statements of a company as they can use this information to make an informed of the decision about investment. They rely on the opinion of the accountants who prepared the statements, as well as the auditors that verified it, to present a true and fair view of the company. Knowledge of ethics can help accountants and auditors to overcome ethical dilemmas, allowing for the right choice that, although it may not benefit the company, will benefit the public who relies on the accountant/auditor’s reporting.

Most countries have differing focuses on enforcing accounting laws. In Germany, accounting legislation is governed by “tax law”; in Sweden, by “accounting law”; and in the United Kingdom, by the “Company law”. In addition, countries have their own organizations which regulate accounting. For example, Sweden has the Bokföringsnämden (BFN – Accounting Standards Board), Spain the Instituto de Comtabilidad y Auditoria de Cuentas (ICAC), and the United States the Financial Accounting Standards Board (FASB).

Principles and rules

“When people need a doctor, or a lawyer, or a certified public accountant, they seek someone whom they can trust to do a good job not for himself, but for them. They have to trust him, since they cannot appraise the quality of his ‘product’. To trust him they must believe that he is competent, and that his primary motive is to help them.” John L. Carey, describing ethics in accounting

The International Financial Reporting Standards (IFRS) are standards and interpretations developed by the International Accounting Standards Board, which are principle-based. IFRS are used by over 115 countries or areas including the European Union, Australia, and Hong Kong. The United States Generally Accepted Accounting Principles (GAAP), the standard framework of guidelines for financial accounting, is largely rule-based. Critics have stated that the rules-based GAAP is partly responsible for the number of scandals that the United States has suffered. The principles-based approach to monitoring requires more professional judgment than the rules-based approach.

There are many stakeholders in many countries such as The United States who report several concerns in the usage of rules-based accounting. According to recent studies, many believe that the principles-based approach in financial reporting would not only improve but would also support an auditor upon dealing with client’s pressure. As a result, financial reports could be viewed with fairness and transparency. When the U.S. switched to International accounting standards, they are composed that this would bring change. However, as a new chairperson of the SEC takes over the system, the transition brings a stronger review about the pros and cons of rules- based accounting. While the move towards international standards progresses, there are small amount of research that examines the effect of principle- based standards in an auditor’s decision- making process. According to 114 auditing experts, most are willing to allow clients to manage their net income based on rules- based standards. These results offer insight to the SEC, IASB and FASB in weighing the arguments in the debate of principles- vs. rules based- accounting.

Advantages of Accounting Ethics

If the person does not follow it, then the person will be liable for the punishment as decided by the governing bodies. This creates fear in the mind of the person and leads to follow up appropriately.

As the different rules and guidelines are set by the governing bodies that govern the action of the person associated with the accounting profession, this prevents the misuse of the information available of the client with the accountant, auditor, or any other accounting person.

The businesses which pay proper attention to accounting ethics always do better when compared with the other businesses as it creates the right image in the eyes of the customers and the other parties and thereby helps in increasing the business in the long run.

There is decreased legal liability. This is so because almost all the things are taken care of well in advance by the concerned persons so that they are liable for any legal actions.

It creates a better Professional Environment as everyone has the proper mindset of maintaining a high level of ethical standards. Also, respect is given to that person who follows the ethics accurately in the place where they are working.

Disadvantages of Accounting Ethics

As the person is required to know every aspect that he has to follow and also to update the information regularly for any changes if taken place, it requires lots of efforts and time of the person.

As the proper training should be given to everyone associated with accounting for providing the information on the different rules and guidelines to be followed for accounting ethics, such training involves a considerable cost.

When a person tries to follow the accounting ethics, there are high chances that it will not get the support from the management of the company. Management will try to find and work with the person who follows the rules and guidelines which provide the benefit to the company.

Important:

As the different rules and guidelines are set by the governing bodies that govern the action of the person associated with the accounting profession, this prevents the misuse of the information available of the client with the accountant, auditor, or any other accounting person.

There are various rules and guidelines which are required to be followed by everyone who is associated with accounting. Some of these rules include the rule of non-acceptability of the contingent fees like setting the audit fees based on the net profits of the clients, Confidentiality where the auditors have to keep all the information of its clients confidential and are not allowed to disclose it to any outsider, duty concerning the reporting of the breach of the rules by anyone, etc.

Accounting is a representation of the business processes with numbers. In order to provide stakeholders with an accurate picture of the business operations from a financial perspective, the bookkeeping needs to be honest and accurate. While accountants adhere to ethical guidelines, the topic of ethics has become more important than ever as the corporate world has been littered with financial scandals from Enron in 2001 to Satyam Computer Services in 2009. As accountants, it is our responsibility to represent the information in a way that truly shows what is going on in the company. Failure to do so can lead to serious consequences for the company and its stakeholders.

Financial planning

It is the duty of the accountants to provide information that helps facilitate planning for the future of the business. In addition to accuracy, the information needs to be provided in a timely manner so that the company can make sound judgments based on the numbers. Failure to do so can result in missed opportunities and higher costs for the organisation.

The Code of Ethics helps companies ensure that there is no misrepresentation of the numbers or information provided to the stakeholders in the company. The rules and regulations stated on the document by the governing body need to be followed by every accounting process in the organisation to ensure that accurate and reliable information is presented to the users of the information. Decision-making doesn’t always come down to a ‘yes’ or ‘no’ and there is always a grey area. Ethics gives accounting companies more clarity in this area of doubt.

The company’s reputation

The code of Ethics states that accountants need to abide by all the rules and regulations listed by the governing body. This will help the company maintain professionalism and ensure that the financial statements are a fair and accurate representation of the company’s position. Failure to comply with the Ethics code can affect the reputation of the company and could even land them in legal trouble.

In the U.K companies need to comply with the U.K GAAP which is a regulatory body that states how financial statements should be prepared in the U.K. The goal of the GAAP is to standardise accounting practices and ensure that all companies maintain integrity and professionalism when it comes to preparing financial statements.

The integrity of the employees

The Ethics code ensures that all members of the company demonstrate integrity and honesty in their work with clients and other professional relationships. The ethics code also prevents accountants from associating themselves with any information that could be misleading or damaging to the client or the organisation.

The European Union has regulations to protect the privacy of the clients with the General Data Protection Regime (GDPR). This is a set of privacy regulations that is applicable to all companies that store or process the client’s personal information. The policies include the right to receive a copy of the information retained by the company, data breach notifications and the requirement of each company to name the individuals who are in charge of protecting the client’s personal information. This helps ensure that the integrity of the client’s personal information is retained and there are no unsolicited leaks. If companies or individuals fail to comply with the rules and regulations listed under GDPR, it could result in serious consequences. Therefore, it is essential for companies to maintain the integrity of the employees and ensure that they abide by GDPR rules.

It is inherent to the accounting profession

Accounting and ethics go hand in hand with the accounting profession. As accountants, it is important that we make neutral, unbiased decisions that help the client. If the company benefits from the sale of one financial product over another, it could lead to bias and misrepresentation of information for the client. As part of the ethics code, it is important that the information provided is not subject to any external influence.

In India, companies have to comply with Ind AS which stands for Indian Accounting Standards. These policies provide companies with principles for recognition, measurement and treatment of accounting transactions in the financial statements. The goal of Ind AS is to bring consistency to the accounting principles and practices followed by companies.

Tax payments

All companies have a legal obligation to represent accurate financial information on their tax forms. Some companies can provide inaccurate information to the tax authority to reduce their financial burden. However, they can face perjury and high fines if they get caught. The Code of Ethics ensures that accurate information is provided when filing taxes and keeps you in the clear.

Professional ethics:

Independence and Objectivity

Ethics and independence go hand in hand in the accounting profession. A critical component of trust is making unbiased decisions and recommendations that benefit the client. Conflicts of interest, for example, demand exposure under independence guidelines. Benefiting from the sale of one financial product over another could lead to a bias that skews financial advice to a client.

To remain objective and independent, it is also necessary to ensure that recommendations are not subject to outside influence. An accountant’s professional judgment is compromised if they subordinate their judgment to someone else’s.

Confidentiality

Disclosure of financial information or revealing the disposition of a potential merger by an accounting professional without express permission violates the trust that is the foundation of a professional relationship unless there is a legal or professional reason to do so.

Professional Behavior

Ethics require accounting professionals to comply with the laws and regulations that govern their jurisdictions and their bodies of work. Avoiding actions that could negatively affect the reputation of the profession is a reasonable commitment that business partners and others should expect.

Integrity

Demonstrating integrity means being straightforward and honest in all business and professional relationships. Upholding integrity requires that accountants do not associate themselves with information that they suspect is materially false or misleading or that misleads by omission.

Professional Competence

As technology, legislation and best practices change, a professional accountant must remain up to date. To exercise sound judgment, an accountant must stay abreast of developments that could affect a decision’s outcome.

Practicing due care means recognizing your skill level and not suggesting that you have expertise in an area where you do not. Consulting with other professionals is a standard practice that helps to bond a network of individuals and generate respect.

Similar guidelines also apply to accounting professionals who supervise others. These accountants must ensure that the subordinates receive proper training and guidance as they carry out their responsibilities.

Accounting ethics is an important topic because, as accountants, we are the key personnel who access the financial information of individuals and entities. Such power also involves the potential and possibilities for abuse of information or manipulation of numbers to enhance company perceptions or enforce earnings management. Ethics is also absolutely required in the course of an audit. Without meeting the requirements of auditing and accounting ethics, an audit must instantly be paused.

Ethics and the Code of the Conduct

Ethics and ethical behavior refer more to general principles such as honesty, integrity, and morals. The code of professional conduct, however, is a specific set of rules set by the governing bodies of certified public accountants. Although the rules set out by different bodies around the world are unique, some rules are universal. Let’s take a closer look at some of these important rules.

Rules and Guidance

One of the key rules set out by professional accounting bodies in North America is the idea of independence. This is the idea that, as an auditor, you must be totally objective and must be without ties to or relationships with the client since that could potentially impair your judgment and impair the overall course of the audit work.

There are two forms of independence:

• Independent in fact
• Independent in appearance

Independence in fact refers to any factual information such as whether you, as an auditor, own any shares or other investments in the client firm. These facts are usually easy to determine.

Independence in appearance, however, is more subjective. Let’s say, for example, that as an auditor you were invited to a year-end party at the client firm. The party turns out to be extremely luxurious and you also receive a nice watch as a gift. In appearance, would the auditor, who was invited to the party and who also received a gift, be able to maintain independence in the audit? In order to solve a potential conflict of interest, a reasonable observer’s test is used  i.e., what would a reasonable observer say about the situation?

Threats to Independence

There are always threats and situations that can reduce the level of independence. Let’s take a look at some of these threats:

• Familiarity Threat: If the auditor has a long relationship with the client or they are close friends/relatives
• Intimidation Threat: If the auditor changes the financial statements, the client threatens to switch auditors
• Self-Interest Threat: If the auditor has a direct financial interest through shares or a large fee outstanding from the client
• Self-Review Threat: If the auditor performs both audit and bookkeeping services, it is a review of the auditor’s own work

Rules outlined by professional accounting bodies include the following:

• Contingent fees are not allowed: For example, audit fees that are based on a percentage of the net income figure or a percentage of a bank loan received
• Integrity and due care: Audit work must be done thoroughly, diligently, and in a timely manner.
• Professional competence: Auditors must be competent, which means he/she must have both the necessary academic knowledge and experience in the relevant industry.
• Duty to report a breach of rules: This rule is commonly referred to as the whistleblower rule. If a CPA observes a fellow CPA violating any of these rules, he/she has a responsibility to report it.
• Confidentiality: Auditors must not disclose any information regarding the client to outsiders.

The International Federation of Accountants (IFAC) is a global organization representing the accounting profession. IFAC establishes and promotes international standards, and speaks for the profession on public policy issues. According to the IFAC website, the group serves the public interest through advocacy, development, and support for our member organizations and the more than 3 million accountants who are crucial to our global economy.

Many elements of this work program are still relevant today.

• Develop statements which serve as guidelines for international and auditing guidelines
• Establish the basic principles which should be included in the code of ethics of any member body of IFAC and to refine or elaborate on such principles as deemed appropriate
• Determine the requirements and develop programs or the professional education and training of accountant
• Collect, analyze, research, and disseminated information on the management of public accounting practices to assist practitioners in more effectively conducting their practices
• Evaluate, develop, and report on financial management and other management techniques and procedures
• Undertake other studies of value to accountants, such as a possible study on the legal liabilities of auditors
• Foster closer relationships with users of financial statements including preparers, trade unions, financial institutions, industry, governments, and others
• Maintain good relations with regional organizations and explore the potential for establishing other regional organizations, as well as assisting in their organizations and development
• Establish regular communications among the members of IFAC and other interested organizations, principally through an IFAC Newsletter
• Organize and promote the exchange of technical information, educational materials and professional publications, and other literature emanating from member bodies
• Organize and conduct an international congress of accountants approximately every five years
• Seek to expand the membership of IFAC

Confidentiality of Information

Accountants see the good, the bad and the ugly of a company or a person’s financial situation. Clients have a right to know that this information is kept in the strictest of confidentiality and is only shared with other professionals if consultation is required to address a specific problem. Failure to keep information confidential could result in bad publicity and possible defamation of a company or person. It could also open the door to fraud, identity theft, and other illegal activities if the information is shared with the wrong parties.

Professional Skill and Competence

Accounting is a detail-oriented career that requires knowledge and skills to do the job correctly. Mistakes lead to problems with investors, business partners, finance lenders and the Internal Revenue Service. It is imperative that anyone working at any level in accounting understands what is required of the job and how to execute it properly.

Independence and Objectivity

Most accountants are partnered or licensed to advise clients on investing and financial services. It is important that accountants maintain a fiduciary responsibility, seeking an objective solution, and providing advice based on that objectivity. It has been a rampant problem in the financial services industry that products were recommended to clients simply because they provided the highest compensation to the adviser. Accountants must be objective with independent viewpoints, especially since they are dealing with the financial details of the company.

Honesty and Integrity Standards

Integrity covers a lot of different ethical standards that include honesty and professional conduct in all circumstances. An accountant should always present the facts objectively and refrain from slanting information in a misleading way. An accountant who doesn’t demonstrate a high level of integrity isn’t trustworthy and loses the confidence of clients.

Professionalism and Demeanor

Professionalism is a standard that goes beyond the office. Whether at a networking event or a party, maintaining a professional demeanor is good business. Accountants should be law-abiding citizens who don’t have bad habits, such as gambling, that could put them in a risky position to compromise client information. No one trusts an accountant who gets drunk at a party and starts spouting off information that probably is bound by confidentiality standards.

Whistleblowing is when an individual reports wrongdoing in an organisation, for example financial misconduct or discrimination. This person is often an employee but can also be a third-party such as a supplier or customer.

Internal whistleblowing is when someone makes a report within an organisation. Often companies implement whistleblowing channels for this purpose so that employees and other stakeholders can speak up if they become aware of misconduct. Employees can also report to their line manager.

External whistleblowing is when a person blows the whistle publicly, either to the media, police or via social media channels.  People often opt to blow the whistle publicly if they have little faith in their organisation’s investigation or reporting procedure, have tried speaking up internally with no result or if there is no whistleblowing system in place.

Whistleblowing complaints focus on conduct prohibited by a specific law such as a criminal offence, discrimination or evidence of a cover up. Speak up policies may however cover a broader range of issues related to compliance and ethics.

In response to this decline in trust, we have seen legislative reform, mandating increased corporate transparency: the Commonwealth Parliament introduced legislation that will fundamentally change whistleblower protections. The Treasury Laws Amendment (Whistleblowers) Bill 2017 (the Bill) is expected to be passed later this year and aims to:

• Increase protection for whistleblowers and their family members;
• Extend protection for reports to media or to politicians (see the full list of regulatory changes here); and
• Underline a commitment to trust by requiring large corporations to implement a whistleblower policy addressing mandatory criteria.

Business should start with the things they can control. In particular:

• Building internal capabilities for transparent and consistent communication which align to the mandatory requirements in the Bill, and
• Implementing policies, processes and training which support a sustainable, “speak-up” organisational culture that commits to addressing risks and preventing workplace retaliation.

Whistleblowing means when an employee makes fraud, corruption, and wrongdoing in an organization known to the public. A whistleblower in India is a current or ex-employee who exposes information regarding what is believed to be fraud, corruption or deviation from the company rules and company law India. The employee discloses what they believe to be the unethical or illegal behavior of higher management.

The whistleblower policy in India is aimed to safeguard the interest of the general public. Employees who reveal fraud, corruption or mismanagement to the senior management are called internal whistleblowers. Employees who report fraud or corruption to the media, public or law authorities are external whistleblowers. Indian whistleblowers are protected under the Whistleblower Protection Act India.

Law dealing with whistleblowing in India

Laws relating to whistleblowing and protection of whistleblowers are inadequate in India. However, the Companies Act, 2013 lays down provisions for whistleblowing and corporate governance in India and the elimination of fraud by establishing adequate vigil mechanism. Sections 206 to 229 of the Companies Act, 2013 lay down laws relating to Inspection, Inquiry, and Investigation incorporate.

Section 208 of the Act empowers an Inspector to inspect company records and furnish any recommendations to conduct investigations. Section 210 states that the Central Government may order an investigation into the affairs of the company in the following cases:

• On receipt of a report by Registrar or Inspector of the company.
• On intimation of a Special Resolution passed by a company that the affairs of the company must be investigated.
• To uphold the public interest.

Additionally, the Securities and Exchange Board of India (SEBI) amended the Principles of Corporate Governance in 2003. Clause 49 of the Listing Agreement now includes the formulation of a Whistleblower policy in Indian companies. A company may establish a mechanism for employees to report concerns regarding unethical behavior, actual or suspected fraud or violation of the company’s code of conduct or ethics policy. However, it is currently not mandatory for companies to have a whistleblowing policy in place.

The Whistleblower Protection Bill, 2011 which replaced the Government Resolution, 2004 has not come into force yet. The bill aims to balance the need to protect honest officials from undue harassment with protecting persons making a public interest disclosure.

Shortcomings or wrongdoings in a company may lead to a loss of the company’s goodwill and capital. It is important for every company to have a whistleblowing policy in place for both the organization and employees. To encourage employees in raising their voices against wrongdoing and reach the appropriate authority, a company must get a tailored whistleblowing policy through an experienced corporate lawyer.

The whistleblowing policy must include stipulations that will ensure confidentiality and anonymity of the informant. The policy must also include provisions for the establishment of an internal committee of members from each level of management to deal with potential whistleblowers.

Principles-based accounting seems to be the most popular accounting method around the globe. Most countries opt for a principles-based system, as it is often better to adjust accounting principles to a company’s transactions rather than adjusting a company’s operations to accounting rules.

The international financial reporting standards (IFRS) system the most common international accounting standard is not a rules-based system. The IFRS states that a company’s financial statements must be understandable, readable, comparable, and relevant to current financial transactions.

Encourages Professional Judgment

ICAEW notes that rules-based accounting is mechanical and only encourages accountants to look at the letter of the law. Accounting principles require accountants to look deeper into the substance of the transaction. This promotes sound professional judgment in the profession and instills more of a sense of responsibility in the accountant.

Flexibility

Principles-based accounting is more flexible than rule-based accounting. The Institute of Chartered Accountants of New England and Wales ICAEW for short  points out that principles are better suited to help accountants respond to rapid changes in a business environment. It can take the FASB years or even decades to amend accounting rules. In contrast, an accounting principle or idea can be applied to new types of transactions or financial instruments immediately.

Disadvantages

Compliance Is More Difficult

Complying with accounting principles is more complex, expensive and time-consuming. If companies are required to constantly interpret principles, they need accounting staff with vast experience and an expert understanding of accounting frameworks. Work that was previously done by a lower-level accountant has to be handled by a higher-level accountant, and more time may be needed to come to a conclusion.

Decreased Comparability

If principles are used rather than rules, accounting information may start to become less consistent. Raymond Thompson, Ph.D., a certified management accountant, points out that it’s possible for two accountants to look at the same data and come to completely different conclusions about what the data mean. Two companies with the same assets, in this case, could present them differently on the balance sheet.

Enforcement Is More Difficult

Companies and accounting firms are constantly accused of misstating financial information, but asking judges and juries with no financial experience to interpret accounting principles during enforcement cases may be a bad idea. Sue Anderson, program director for CPE Link, points out that it’s hard enough for courts to come to a conclusion based on explicit accounting rules and it would be even worse with accounting principles.