Ethical Issues in Business Financial Reporting - Assignment Example

 Ethical Issues in Business Financial Reporting Table of Contents Overview 2 Ethical Issues While Preparing Financial Reports 3 Ethical Solution for the Issues 4 Motives for Creative Accounting 5 Regulations Considered While Making Decisions about Ethical Issues 5 Penalties for Fraudulent Financial Reports 6 Impact of Fraudulent Reporting 8 References 9 Bibliography 10 Overview Financial statements provide information that is used by stakeholders to assess the financial health of an organization. The users of the financial information assume that such information would be reliable. Information should be produced consistently and certain regulations should be abided while preparing these statements. People who prepare the financial statements often distort communication between the shareholders and entities in the organization and pass on totally different message. This is known as ‘creative accounting’ or ‘earnings management’ (Gowthorpe & Amat, n.d.). Financial teams may resort to two kinds of manipulation when they prepare financial statements: Micro Manipulation This type of manipulation is at an individual level whereby the accounting disclosures are altered in such a manner that a different view of reality is conveyed to the users of the report. Macro Manipulation In this type of manipulation when preparers of financial reports become aware of a proposal for alteration of accounting regulation which they consider will be unfavorable for them, they resort to various means to stop the change or bring a change which will serve their purpose. Ethical Issues While Preparing Financial Reports The intention of the regulators is to make financial reports useful to all users. The financial teams are intermediaries between the users and regulators. They have the freedom to interpret the regulation. At times they interpret the regulations in a manner that may suit their own views. This cannot be considered justifiable to the users. The second ethical issue is of morality. Dressing up financial statements just for the sake of the business is not ethical. Morality should not be compromised for the sake of profits. Clear and well designed financial reports shows that the preparers of the reports have abided by the law and followed the regulations. Often the accounting regulations are poorly formulated or not enforced properly. These loopholes lead to manipulations (Gowthorpe & Amat, n.d.). The following issues may arise while preparing financial reports: At times companies choose between different accounting methods to suit its purpose. At times entries in accounts have certain degree of estimation or prediction, the estimate might be too optimistic leading to errors. Even if an outside expert is consulted the valuation can be manipulated through the manner in which he has been briefed by the accountant or his personal nature (i.e., optimistic or pessimistic). Balance sheet may be manipulated by entering artificial transactions. This is done by entering into other related transaction with a third party. For example, an asset is sold to a bank and then leased back for the rest of the life. The sale price in this arrangement is set at a price above or below the current asset value. The difference is adjusted by increased or reduced rentals. Genuine transactions are also timed to provide a favorable impression. Ethical Solution for the Issues Accounting regulators tackle these issues in the following ways: The scope for choosing between various accounting methods should be reduced. There should be consistency in the method that the company is adopting with the intention that he may not switch over to another accounting method in another year to suit his purpose. The accounting rules should be drafted in a manner with the aim that there is no abuse of judgment. Auditors should be able to identify any kind of fraudulence. The scope of using timing of transactions is controlled by revaluation of account items (Amat & Et. Al., 1999). Motives for Creative Accounting Companies generally resort to fraudulent accounting to meet up the expectation of stockholders or at times to obtain loans. Companies generally prefer to report steady growth and stable profits rather than fluctuating profits. This is done by keeping the provision of liabilities high against assets. This is done with the aim that in the good years they may be reduced to show profits. People in favor of this approach believe that it is better than having a short term outlook and judging on the immediate following years. It avoids raising high expectation which cannot be matched up to. People against this approach believe that volatile condition should be reported. Another motive would be manipulating the profits with the intention that they match the forecasts. Creative accounting may assist to keep the share price high by showing fewer borrowings, less risk and good profits. The directors of the company may deliberately delay release of information if they are involved in insider dealing of their shares. There might be certain personal motives also like promotions or to avoid penalties because of poor performance (Amat & Et. Al., 1999). Regulations Considered While Making Decisions about Ethical Issues Accounting is regulated by certain standards in the form of accounting regulation and by local laws pertaining to the functioning of corporate in that particular country. These regulations are formed by certain organizations and foundations. The International Accounting Standards Committee (IASC) set these standards. An agreement with The International Organization of Securities Commission (IOSCO) resulted in IASC being entrusted with the responsibility of developing core standards. In 2001 IASC was reconstituted as International Accounting Standards Board (IASB) and was responsible of setting International Financial Reporting Standards (IFRS). Although several national standard setting bodies may not exist in future but the Financial Accounting standards Board will continue in the USA (McLeay & Riccaboni, 2001) The Sarbanes-Oxley Act was passed to regulate financial reporting. This Act ordered the Securities and Exchange Commission to draft rules with the intent that it would impose the obligation on all CFOs and CEOs to submit accurate annual reports and quarterly statements (Needles & Et. Al., 2007). Penalties for Fraudulent Financial Reports The Federal Reserve has been provided authority by the financial institutions Reform, Recovery and Enforcement Act 0f 1989 (FIRREA) and Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) to pass money penalties to institutions that creates false and late reports. This money penalty can also be imposed on outside auditors who provide fraudulent reports. The reports are verified by an examiner on whether they meet the regulatory requirements. Consolidated reports of condition and income (call reports) are submitted by banks. People involved in fraudulent reporting may have to lose their jobs, pensions, and so on. Moreover, at times there might be imprisonment (Rezaee, 2001). Impact of Fraudulent Reporting At times the choice of an accounting rule may impact the profitability and in turn the distribution of profits to shareholders, salaries, and pension funding. This is an economic affect of unethical accounting. If the profitability of a firm is inflated then it boosts up the shareholders’ confidence on the firm. Employees also become confident about the strength of the firm. References Amat, O. & Et. Al., (1999). The Ethics of Creative Accounting. Bitstream. Retrieved Online on December 01, 2010 from http://www.recercat.net/bitstream/2072/495/1/349.pdf Gowthorpe, C. & Amat, O., (No Date). Ethical Issues in Accounting Manipulation. Creative Accounting: Some Ethical Issues of Macro- and Micro-Manipulation. Retrieved Online on December 01, 2010 from http://www.econ.upf.edu/docs/papers/downloads/748.pdf McLeay, S. & Riccaboni, A., (2001). Contemporary Issues in Accounting Regulation. Springer. Needles, B. E. & Et. Al., (2007). Financial and Managerial Accounting. Cengage Learning. Rezaee, Z., (2001). Financial Institutions, Valuations, Mergers, and Acquisitions: The Fair Value Approach. John Wiley and Sons. Bibliography Weygandt, J. J. & Et. Al., (2009). Financial Accounting. John Wiley and Sons. Read More