CHAPTER 6

ETHICAL ISSUES IN ACCOUNTING AND

FINANCE
Chapter objectives
• Recognise the dominant ethical principles that relate to
Accounting and Finance.
• Describe a few of the more renowned corporate collapses in
recent times.
• Identify the primary areas where misrepresentation and
inaccurate reporting often occur.
• Contrast the various forms that fraud can take.
• Discuss insider trading from the perspective of fairness.
• Contrast how conflict of interest and objectivity relate to each
other.
• Clarify the distinction between tax minimisation, tax avoidance
and tax evasion.
• Identify the key features of a Ponzi scheme.
• Identify what investments are commonly avoided in socially
Ethical principles in accounting & finance
Trust
The information accountants provide is vital to aiding managers,
investors, and others in making rational economic decisions.
As such, ethical improprieties by accountants can be detrimental to
society, resulting in distrust by the public and, on a broader scale,
disruption of efficient capital markets (Williams & Elson 2010).

Ethics in accounting and finance also relates to those who do not

belong to the accountancy profession but are individual managers and
employees both directly, and indirectly, involved in this functional area.
Introduction
Financial fiascos
International financial fiascos have occurred in organisations such as:
• Enron, WorldCom, Barings Bank, Livent Royal Ahold, Tyco,
Adelphia, US Savings and Loan.

Australasian financial fiascos include:

• HIH, One.Tel, Ansett Airlines.

All imploded largely because of financial mismanagement by the

leaders of, and employees within, these organisations.
Introduction
Three levels of accounting scandals through which we can view these
financial scandals:

• The individuals who were in key

Individual organisational positions.

• The collective responsibility of all

Corporate employees as well as the governance
structures, systems and processes.

• The interconnected organisations,

Regulatory such as auditors, bankers and other
financial institutions.
Ethics in the media: Deceiving analysts
Former top Enron executives were apparently personally involved in
stage-managing a fake trading room to impress analysts. Jokingly
referred to as ‘the sting’, secretaries and other staff posed as busy
energy traders in an unused trading room as part of the charade
(Duska & Duska 2003).
Introduction
It can easily happen…
In the educational documentary Crossing the line: ordinary people
committing extraordinary crimes
(see <http://www.youtube.com/watch?v=QIwH5E7nX-A>), Dr Kelly
Richmond-Pope chronicles the lives of five white-collar criminals who
have been engaged in different types of financial manipulations at
some stage in their careers.
Ethical principles

• Integrity
• Confidentiality
• Objectivity
• Honesty
• Fiduciary duty
• Duty of care (also called professional competence)
• Non-maleficence
• Trust
Ethical principles
While there are numerous ethical issues that can be examined, we will
focus on the more topical and significant. These are: misrepresentation
and inaccurate financial reporting, accounting fraud, insider trading,
conflict of interest, tax avoidance and tax evasion, money laundering
and investment scams.
Misrepresentation and inaccurate
financial reporting
1.Inappropriate recognition of revenue – e.g. America Online, a unit of AOL
2.Inappropriate recognition of expenses – e.g. WorldCom
3.Mis-statement of earnings – e.g. FannieMae
4.Understatement of liabilities and overstatement of assets – e.g. Enron
5.Hiding losses – e.g. Olympus
Accounting fraud
‘Theft committed by a member of an organisation or professional
practice involving the use of deception to obtain a financial advantage
from their employing organisation or client such as money, property or
information’ (Dellaportas et al. 2005, p. 188).
Accounting fraud
Types of fraud:
• Embezzlement (sometimes referred to as misappropriation
embezzlement)
• Falsifying documentation
• Fraudulent billing
• Deceptive expenses
• Fraudulent tendering
• Cybercrime
• Inflating profit
• Extortion
Accounting fraud
1. The pressure
or motivation to
2. The commit the
opportunity, for fraud
example, lax
processes or
policies

3. The
rationalisation or
reasoning that is
used to justify the
behaviour or
action

Three dimensions of fraud

Insider trading
‘Intentional disclosure of information which may be used to gain some
modest benefit’ (‘Judge Rakoff a hot bench’ 2011).

Market manipulation – where individuals or financial entities

construct circumstances to move the market in their favour.
Conflict of interest
Defined as a situation where the primary interest of a professional
may have their judgment impaired by a secondary interest.
Tax avoidance and tax evasion
Tax minimisation – when corporate structures, processes and practices
are legitimately organised to reduce the amount of tax paid.

Tax avoidance – is an arrangement which complies with the letter of

the law but is possibly not within the spirit of the law.

Tax evasion – where unlawful actions are taken to avoid tax.

Tax avoidance and tax evasion
Accounting techniques for tax avoidance:
•Transfer pricing – allows companies to shift money between certain
tax jurisdictions to avoid paying tax twice on the same amount.
•Offshore billing – the parent company charges Australian consumers
for services from its offshore tax haven subsidiary and the money goes
directly to the tax haven.
•Thin capitalisation – the parent company lends money to its
Australian subsidiary via an offshore finance arm based in a low tax
jurisdiction.
•Intangible assets – the parent company in the tax haven owns
intangible assets such as Intellectual Property and licenses the use of
that property to the Australian operation which pays significant sums
to the tax haven based subsidiary, thereby stripping out taxable
revenue from the Australian company and placing that revenue in the
low tax location.
Tax avoidance and tax evasion
The top ten jurisdictions used by Australian companies for tax
evasion:

(Source: Data - Zirnsac 2013)

Tax avoidance
An alternative view on tax avoidance in relation to Starbucks in the UK.
<http://www.youtube.com/watch?v=IF4o6Ps0hkw>.
Money laundering
The process of concealing the origin, ownership, or destination of
illegally or dishonestly claimed money by hiding it within legitimate
economic activities (Transparency International 2009).
Ethics in the media: Money laundering
Europe’s largest money laundering operation was discovered in Spain
in 2005, when an international network was accused of laundering
€250 million by investing in Costa del Sol real estate, using illegally
obtained money from drug trafficking, prostitution rings, international
arms trading, kidnapping, blackmail and tax evasion (Transparency
International 2009).
Investment scams
Investment scams are also sometimes called Ponzi schemes, named
after Charles Ponzi (1882–1949), an Italian immigrant to the US, who
famously defrauded numerous investors. These images are of Charles
Ponzi.

(Sourced from: Marquet 2011).

Investment scams
Ponzi scheme
The scheme essentially rewards early investors by returns of funds
from latter investors. In 2013, the FBI was probing more than 1000
investment scams cases; more than double the number outstanding
in 2008.

But the award for the largest investment scam to date goes to Bernie
Madoff, whose victims lost an aggregate of US$20 billion. For a
description of Madoff’s Ponzi scheme, see:
<http://www.youtube.com/watch?v=K5bzLbIcIxw>. <
http://www.youtube.com/watch?v=52nYNE9DYYQ>.
Ethical investment
The socially responsible investing (SRI) movement (also called ethical
investment) has been growing worldwide, and in the US has nearly
10% of assets under management, which is roughly US$2.3 trillion in
both public and private markets (Social Investment Forum Foundation
2010).

See Australian Ethical’s advert on ethical investing: <

http://www.youtube.com/watch?v=52-kOJWNSGs>.
Ethical investment
Investment strategy
• Most socially responsible investing avoids key industries such as
tobacco, gambling, alcohol and weapons, investing instead in
organisations that have demonstrated significant efforts in
environmental and social impact.
Socially responsible investment
• Socially responsible investment - Session 6 - Socially responsible
investments 2013, TV program, ABRC TV, 21 February, <
https://www.youtube.com/watch?v=PxyblmAu-rg>
Ethics in the media: Ethical investment
The global investment company BlackRock has launched the
BlackRock Developed World ex Tobacco Index Fund, which supports
investors seeking socially responsible investment and equity markets
by removing tobacco and weapons industry investments from their
portfolios. The fund promotes exposure to the healthcare sector,
charities, medical foundations and pension schemes (‘New BlackRock
fund screens out tobacco stocks’ 2014).
Ethics at the movies
*Enron: The Smartest Guys in the Room

A documentary based on the book outlining a large business scandal

in American history.

Enron: The Smartest Guys in the Room 2005, documentary, Gibney, A,

Cuban, M, Elwood, A, Motamed, S & Kliot, J, <
http://www.youtube.com/watch?v=1dNZaKLjYbc>.

* Author’s pick
Image credits
• Shutterstock.com / Anthony Correia; Pincasso; Vladamir Tronin; Nata789