Role of Ethics and Judgment in Preparation of the Production of Financial Reports - Example

Number Subject Name Lecturer’s Name Role of Ethics and Judgment in Preparation of the Production of Financial Reports Due date Date Submitted Table of Contents Role of Ethics and Judgment in Preparation of the Production of Financial Reports Role of Ethics and Judgment in Preparation of the Production of Financial Reports Executive Summary The present paper seeks to address the role of ethics and judgment in preparation and production of financial statements. Through the review, the concept of ethics and judgment in financial reporting is discussed, which indentifies a link among them. It is later indentified that ethics helps to ensure effective and financial reporting, while judgment ensures consistency in financial reporting. The analysis is made on the basis of the case study of BHP and OK Tedi. Ethics and Judgment in financial Reporting Financial reporting implies the process of producing reports, which are generally referred to as the financial statements, for the purpose of disclosing the financial status of the organization, to its stakeholders, such as shareholders, management investors, customer among others. In this case, a financial report is prepared at the end of the accounting period, which presents a summary off the accounting data, for that particular accounting period. It also contains background information, notes and forms, to support and explain the accounting data (Akenbor & Onuoha, 2013). As illustrated by Drnevich & Stuebs (2013), these financial reports should present the financial information of the organization in question in a comprehensive, clear and concise manner, to both the entity and other interested parties. Basically, the statements contained in financial reporting include the statement of comprehensive income, statement of financial position, cash flow statement, and statement of retained earnings, among other possible and important statements. Akenbor & Onuoha (2013), explained the importance of financial reporting by stating that the main purpose of these report is relying the financial information of the undertaking and performance of the concerned firm, to all its stakeholders, as well as interested parties. In this case, the interested parties include the government, suppliers, share holders, various authorities, as well as the general public. For this purpose, it is quite significant for these reports to be presented in a comprehensive manner, and should give correct information concerning the performance of the company. In this case, financial reporting is governed by different statutes and common law, and it is set to observe required ethical standards. For instance, the financial reporting, as illustrated by Mastracchio, Jiménez-Angueira & Toth (2015) are supposed to adhere to different provisions of the generally accepted accounting principles (GAAP). In this case, they are aimed at observing the ethical standards of maintaining the continuity of financial information and its presentation internationally. For ethical compliance, these financial reports are also edited by the different accounting firms, auditors and government agencies, with an aim of ensuring accuracy and transparency, for investment, taxation, financing, as well as protection of the general public. Therefore, financial reports are integral for ensuring that honesty and accuracy, in accounting and reporting for the individuals and businesses as well. However, Hsiang-Tsai & Shu-Lin, (2012) noted that financial reporting often fall short of the ethical and legal standards. In addition, the requirement for ethical and legal standards keeps on changing from time to time. Therefore, it is significant for the firm to remain update regarding the ethical requirements in financial reporting. As illustrated by Martinov-Bennie & Mladenovic (2015), the reason for these changes includes the complexity and scandals. There has been an increased complexity in the manner, in which the business is conducted, particularly because of the use of financial derivative instrument and contracts. Further, without doubt, there has been several cases of scandals related to the accounting and financial reporting, for the last two decades. It is for these reasons which have necessitated the importance of ethical and judgment in financial reporting. Therefore, it is clear that ethics and judgment has a significant role to play in financial reporting. Ethics ensures that the organization reports truthful information concerning their undertakings, as well as recognize their responsibilities to all the stakeholders. Ethics observance is quite different from financial reporting standards requirement (Akenbor & Onuoha, 2013). There are several important ethical and issues that should be observed by an organization, but are not stipulated in GAAP. For instance, GAAP requires protection of the environment and social responsibility, but does not illustrate in to details, how the reporting concerning such responsibility should be done. The theoretical aspect related to this situation is illustrated in the case study of BHP and OK Tedi. Brief Summary of BHP and OK Tedi Case BHP Billiton is a mining company with its headquarters in Melbourne. Hit was the company managing the Ok Tedi mines which was located in PNG. The Ok Tedi mines were in PNG was considered as one of the worst mining disaster in the world, in terms of its environmental damage and pollution. The company avoided reflecting its responsibility and liability concerning the level of pollution, which raised the interest t off journalists regarding those responsible. They revealed the environmental damage which resulted to public castigation of BHP. BHP did not account for the in its financial reports, the liabilities which were related to the environmental degradation that was caused by the OTML. Further, it did not recognize the investment in OTML as an asset. It therefore raised the question of whom bears the risk of the continuing environmental damage, and whether non-recognition of a liability removes the existence of the responsibility. OTML was owned partially by BHP and the PNG independent state. After increase in interest, BHP recognized the asset but not the liability. As discussed by BHP, there was no need to report the environmental damage responsibility for two reasons. First, the environmental damage were externalities, which were considered outside the organization boundaries by the GAAP. The second reason was that the mining operations in the OTML were under the mining and legislative exceptions. It did not record the environmental damage as a liability because pollution of the environment was neither a consequence of failure in legist ration enforcement nor was it an issue of compliance. Similarly, no liability was recorded in the financial reports of the company, when the villagers sought to be paid 4 billion dollars, from BHP and OTML as a compensation for the environmental damage. According to the argument of BHP, it did not disagree with the provisions of the GAAP. GAAP provides that a transaction or an event must be significant enough to warrant its inclusion in the financial statement. In this case, it means it must affect profit. The materiality and significance considered is not from the perspective of the shareholder. As a result, BHP did not transgress the requirements of GAAP. However, according to the journalists, the BHP actions have social and environmental consequences, and the company applied the accounting standards to play down its obligations. After BHP announced that there was no financial benefit left from the project, there was still no liabilities were recorded. Further, the company entered in to an agreement for protection against future liabilities that may come from their mining operations. Therefore, this case clearly demonstrates that financial reports alone are not in a position to ensure that all corporate responsibilities of the company are highlighted in the in the reports of the company. Role of Ethics and Judgment in financial reporting As mentioned earlier, financial reports are very significant for all the stakeholders. Therefore, they should present truthful and correct accounting information. Though the financial reporting is governed by the GAAP, it does not comprehensively cover all the areas. As a result, a firm my use the GAAP provisions as a way to avoid some responsibilities. It is the situation which was experienced in the case of BHP. The company did not recognize its liability for the environmental pollution its mining activities caused. It relied on the provisions of GAAP, which indicates that for a transaction of an item to be recognized in the financial statements, it must be material and significant. However, the materiality in this case was addressing on the firms perspective, rather than the stakeholders perspective. As a result, the company managed to avoid the social and environmental liabilities and obligations of its environmental pollution. In such situations, the company is expected to behave ethically, and make responsible judgments, regarding the protection of the environment, as well as social responsibilities. Therefore, judgment and ethics plays a very significant role. Role of ethics in financial reporting As discussed by Akenbor & Onuoha, (2013), ethics the first qualities of an ethical financial reporting is observation of accuracy and honesty. For a company to truly represent what is going on within the organization, it sought be honest and accurate. Honesty and accuracy are both financial and ethical issues. Observance of ethics, as illustrated by Hollingworth & Valentine (2015), ensures that the firm is honest in its financial reporting. In this case, the company presents in its reports, an accurate and honest account of what is going on in the organization, in terms of assets and liabilities. Failure to do so have significant consequences to the owners, tax agencies, as well as the general public. The present pint can effectively be clarified by the BHP financial reporting. The firm relied exclusive on the provisions of GAAP, and disregarded the provisions of the ethics, which requires honesty and accuracy in their requirements. Ethically, it is significant to recognize the effects the activities of a firm. In this case, BHP should have recognized the environmental pollution of its mining activities as a liability in its financial reports. However, the company failure to observe the ethical requirements made it not to recognize its effect on environmental pollution. Another role of ethics in financial reporting is ensuring accountability. As indicated by Martinov-Bennie & Mladenovic (2015), firms should be accountable to a range of stakeholders. The accountability in this case involves revealing the company’s financial performance, as indicated in terms of assets, liabilities and equity. Ethically, firm’s stakeholders are entitled to know the financial health of the company. In the case of BHP, was not fully financially accountable to its stakeholders. For instance, after the company announced that it did not any future economic benefit from the OTML, it indicated that it could not retain its interest on its books. The reason was that the investment did not provide direct financial returns to its private shareholders. The investment was no longer an asset, and because an asset was written off, there was no need to take an account of it. However, from the journalists’ ethical point of view, several issues needed to be addressed. Writing off an asset was reasonable. However, it did not follow the relinquishing of shares, which also implied relinquishing of responsibilities. Another fundamental of ethics in business, which affects the financial reporting of a firm is social responsibility. An ethical firm needs to consider the economical, environmental and social effects of its operational activities. As clarified by Beaudoin, Cianci & Tsakumis, (2015), environmental pollution needs to be recognized in the financial reports as a liability. After the recognition, the company should also address its effort towards reducing the environmental pollution, as well as social t5esposibility in general. Therefore, every asset should be recognized against its associated liability in financial reporting. In addition from observing the provisions of GAAP, every firm should act ethically in all its undertakings. Role of Judgment in financial reporting Professional judgment is a key skill required in the preparation of financial statements. There are several judgments that the preparers of financial reports need to make, in terms of the assumptions (Brown-Liburd & Zamora, 2015). This particularly applies to the firms applying principle based accounting regime. It implies applying the relevant knowledge experience and training, within the context which is provided by the relevant technical and professional standards, and applicable in making informed decisions in the appropriate circumstances. Judgment plays a significant role in the increasing complexity of the global business. There is need for more accurate, transparent and reliable financial information in a more pronounced manner than ever before. Due to this complexity and increased demands of the concerned stakeholders, it is expected the financial statement preparers to apply high level of judgment, in a professional manner. The judgment ensures that all the decision made before the information is presented to its stakeholders is accurate and reliable. Professional judgment is also very significant in determination of the accounting policies to apply by a particular organization. There are several situations where a firm is left to decide the policy to apply in preparation of the financial reports. In such situations, the preparers of financial statement have to choose the suitable policy, depending on the nature of their organization, and the industry in which they are operating. For instance, the GAAP and international financial reporting standards does not dictate the method for accounting for intangible assets, method of depreciation among others. The judgment is left at the discretion of the concerned firm. Therefore, the standards leave a room for preparation of financial reports, most fitting the undertaking of the company. Another important application of judgment is the decision of what to be recognized in financial reports. It involves the decision of the assets, liabilities, and equity to be included in the financial statements. Further, judgment is also used in determination of the value to be attached to these assets and liabilities. In this case, Ardelean (2015) indicated that the decision makers need to apply professionalism and accuracy, in decision of what to recognize. The BHP applied the principle of judgment, in their recognition of assets and liabilities related to the OHTL mining. According to their judgment, there was no need to recognize the liability from their environmental damage. The reason was that the environmental consequences were considered externalities and they did not violate the provisions of the GAAP. As a result, they avoided their responsibility and obligations to care for the environmental pollution caused by their mining activities. It is for this reason that Ok Tedi Mining was considered one of the most disastrous in the world. Further, the use of judgment is also significant as it demonstrates clearly that financial statements exclusively are not sufficient to ensure a company observes its corporate responsibility. Conclusion From the above analysis, it is clear that judgment and ethics has a significant role to play, in preparation and production of the financial statements. The financial reports should present the financial information of the organization in question in a comprehensive, clear and concise manner, to both the entity and other interested parties. Ethics ensures compliance with the required standards and policies required in preparation of financial reports. It also protects the stakeholders from the harmful activities of the firm. Judgment on the other hand ensures that the firm should consistency in financial reporting, as well as suitable and understandable financial reports. References Akenbor, CO, & Onuoha, TE 2013, 'Ethical concept and professional judgment in corporate financial reporting: empirical evidence from Nigeria', International Journal of Business & Economic Development, vol. 1, no. 3, pp. 46-59. Ardelean, A 2015, 'Study regarding the Clarification of Ethical Dilemmas in Financial Audit', Audit Financiar, vol. 13, no. 125, pp. 75-90. Brown-Liburd, H, & Zamora, VL 2015, 'The Role of Corporate Social Responsibility (CSR) Assurance in Investors' Judgments When Managerial Pay is Explicitly Tied to CSR Performance', Auditing: A Journal of Practice & Theory, vol. 34, no. 1, pp. 75-96. Available from: 10.2308/ajpt-50813. [4 June 2015]. Beaudoin, C, Cianci, A, & Tsakumis, G 2015, 'The Impact of CFOs' Incentives and Earnings Management Ethics on their Financial Reporting Decisions: The Mediating Role of Moral Disengagement', Journal of Business Ethics, vol. 128, no. 3, pp. 505-518. Available from: 10.1007/s10551-014-2107-x. [4 June 2015] Drnevich, D, & Stuebs, M 2013, 'Teaching and educational notes: Cultural differences and judgment in financial reporting standards', Journal of Accounting Education, vol. 31, pp. 461-482. Available from: 10.1016/j.jaccedu.2013.09.009. [4 June 2015]. 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