Chapter 1

Ethical Issues in
Advanced
Accounting
 Scope of Chapter

 Why need ethical conduct in accounting?

 What is fraudulent financial reporting?
 Ethical standards for preparers of financial
statements & reports.
 Significant events in establishment of
ethical standards.

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 Scope of Chapter

 IMA standards of ethical conduct.

 FEI code of ethics.
 AICPA code of professional conduct.
 ACCA code of professional conduct
 Resolutions, articles, definitions, rules,
appendices.
 Examples, review questions and case studies.

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 Why To Study Ethical Issues In
Accounting?

 Critics have alleged that ethical standards of

accountants have deteriorated.
 Cute accounting to describe stretching the
form of accounting standards to the limit,
regardless of the substance of the underlying
business transactions or events.
 Cooking the books to indicate fraudulent
financial reporting.

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 Fraudulent Financial Reporting

 Misstatements in financial statements.

 Intentional misstatement or omission of
amounts or disclosures in financial statements
to deceive users.
Reasons & Methods of committing fraud.
 Manipulation, Falsification, or Alteration of
accounting records or supporting documents.

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 Fraudulent Financial Reporting

 Misrepresentation in or intentional
omission from, the financial statements of
events, transactions or other significant
information.
 Intentional misapplication of accounting
principles relating to amounts,
classification, presentation or disclosure.

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 Fraudulent Financial Reporting

 Fraud frequently involves either a pressure

or an incentive to commit fraud.
 Fraud may be concealed through falsified
documentation, including forgery.
 Fraud also may be concealed through
collusion among management, employees
or third parties.

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 An Example of
Fraudulent Financial Reporting

The SEC’s accounting and auditing

enforcement release no. 923 provides
an example of fraudulent financial
reporting. According to the SEC, the
four officers overstated the company’s
net income for the quarters ended Dec
31, 92 and mar 31, 93 by taking
following “ cooking the books” actions:

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 An Example of
Fraudulent Financial Reporting

1. Recognizing January 1993 revenues in

December 1992 and April 1993 revenues in
march 1993.
2. Deferring write-offs of uncollectible accounts
past the end of the appropriate quarter.
3. Recognizing as assets certain expenses
incurred during the quarters ended December
31, 1992 and march 31, 1993.

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 An Example of
Fraudulent Financial Reporting

4. Making fictitious journal entries in

connection with business combinations
accomplished in march 1993, the effect of
which was to understate doubtful accounts
expense.
5. Recognizing in the 1st quarter of 1993, a
gain from the sale of an asset during the
quarter ended June 30, 1993.

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 Ethical Standards
 American Institute of Certified Public
Accountants (AICPA) adopted first code of
ethics in 1917.
 The Institute of Management Accountants
(IMA) first issued its “Standards of Ethical
Conduct for Management Accountants” in
1983.
 The Financial Executives Institute (FEI) first
issued its “Code of Ethics” in 1985.

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 Significant Events in
Establishment of Ethical Standards

 The Seaview Symposium of 1970

 The Equity Funding Fraud of 1973
 Action by IMA in 1983
 Action by FEI
 Treadway Commission Recommendations
 Sarbanes-Oxley Act in 2002

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 The Equity Funding Fraud

 In 1973, a major fraud was discovered at

equity funding corporation of America
(equity), a seller of mutual fund shares
that were pledged by the investors to
secure loans to finance life insurance
premiums.
 During the nine-year period, at least $143
million of fictitious pretax income was
generated.
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 The Equity Funding Fraud
 A period in which the equity reported a total net
income of $ 76 million, instead of the real
pretax losses totaling more than $ 67 million.
 The fraud was carried out by at least 10
executives of equity, including the chief
executive officer (CEO), chief financial officer
(CFO), controller, and treasurer.
 Several of the executives were CPAs with
public accounting experience.

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 Treadway Commission …
 The National Commission on Fraudulent
Financial Reporting.
 Sponsored by the AICPA, IMA, FEI, the
American Accounting Association, and the
Institute of Internal Auditors.
 Defined “Fraudulent Financial Reporting” as
“intentional or reckless conduct, whether act
or omission, that results in materially
misleading financial statements.”
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 Treadway Commission…

 TheTreadway Commission was formed in June

1985.
 The mission was "to identify causal factors that
can lead to fraudulent financial reporting and
steps to reduce its incidence."

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 Treadway Commission…

 The Treadway Commission made 49

recommendations for curbing/
controlling such reporting.
 The recommendations dealt with the
public company; the independent public
accountant; the SEC, financial institution
regulators, and state boards of
accountancy; and education.
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 Treadway Commission

 The responsibility for reliable financial

reporting resides first and foremost at the
corporate level.
 Public companies should maintain
accounting functions that are designed to
19 meet their financial reporting obligations.
 Sarbanes-Oxley Act 2002

 Authorized the establishment of Public

Company Accounting Oversight Board
 Purpose: Regulate conduct of accountants
both public practice and publicly owned
business enterprises

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 Analysis of Ethical Standards For
Management & Financial Execs.

 The ethics pronouncements of IMA, FEI

and AICPA have several similarities.
 All three require members to be
competent, act with integrity and
objectivity, maintain confidentiality of
sensitive information, and avoid
discreditable acts.

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 Analysis of Ethical Standards For
Management & Financial Execs.

 TheIMA & AICPA codes specifically

prohibit conflicts of interest, but the
FEI code only indirectly addresses
such conflicts in its confidentiality
provision.

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 Analysis of Ethical Standards For
Management & Financial Execs.

 Only IMA and FEI codes specifically

require communication of complete
information to users of their
members’ reports; AICPA members
are indirectly comparably obligated
by rule 202.

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 Analysis of Ethical Standards For
Management & Financial Execs.

 The IMA standards in essence

require members to report violations
of the standards by members of their
organization to responsible officials of
the organizations.
 The FEI and AICPA codes have no
such requirements.

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 Analysis of Ethical Standards For
Management & Financial Execs.

 The FEI code requires members to

conduct their personal, as well as
their business affairs with honesty
and integrity.
 The IMA and AICPA standards do
not address personal affairs.

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 Conflict of Interest

 Conflictof Interest results when

individuals reap inappropriate
personal benefits from their acts in
an official capacity.

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 Conflict of Interest

 For example, a chief accounting officer might

cook the books to overstate pretax income of
the employer corporation in order to obtain a
larger performance bonus.
 The controller of a publicly owned corporation
might involve in “insider trading” to maximize
gains or minimize losses on purchase or sales
of the employer corporation securities.

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 Discreditable Acts

 None of the three codes defines

“Discreditable Acts”.
 The term can not be adequately defines
or circumscribed.
 A discreditable act to one observer might
not be so construed by another.

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 Concluding Observations

 The number of SEC proceedings

against reporting companies from
1981 to 1986 was less than 1% of
the number of financial reports filed
with the SEC during that period.

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 Concluding Observations
 The Chairman of the Federal Deposit
Insurance Corporation contended that
management fraud (presumably including
cooking the books) contributed to one-
third of bank failures.
 10% of total bankruptcies in a study
authorized by the Treadway Commission,
involved fraudulent financial reporting.
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 Concluding Observations

 Former SEC Chairman John Shad

estimated that all fraudulent securities
activities amount to a fraction of 1% of
the $50 billion of corporate and
government securities traded daily.

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 Concluding Observations

 Thus, cooking the books, though

serious and despicable, apparently do
not indicate a wholesale breakdown of
ethical conduct by management
accountants and financial executives
of business enterprises.

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 Concluding Observations

 Can the codes of conduct for

management accountants and financial
executives established or revised by
IMA, FEI and AICPA help those key
players in corporate financial reporting to
resist pressures, often from top
management but sometimes from within
themselves, to falsify financial statements
and reports?
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 Professional ethics issues of
Accountancy in Ethiopia

 Is there code of professional ethics /conduct

in Ethiopia for preparers of financial report?
by :
 professional associations
 AABE
 Other body

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 Thank You for
Your Attention

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