Download Chapter 9 Ethics and Financial Reporting

Chapter 9
Ethics and Financial Reporting
Understanding Business Ethics
Stanwick & Stanwick
1st Edition
Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall
9-1
Ethical Thoughts
• “When money speaks, the truth keeps
silent.”
– Russian proverb
• “A firm’s income statement may be likened
to a bikini – what it reveals is interesting,
but what it conceals is vital.”
– Burton G. Malkiel, author of A Random Walk
Down Wall Street
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9-2
When is a Doughnut Hole a Real
Doughnut Hole?
• Krispy Kreme became a sensation whenever a
new store was opened.
• Initial public offering in April 2000
• In the mid 1990’s, their strategy changed from a
slow to an aggressively fast franchise growth.
• From 200-2004, grew from 144 stores to 357
stores
• Pinnacle of success was when it was called the
‘hottest brand in America’ by Fortune magazine
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When is a Doughnut Hole a Real
Doughnut Hole?
• Caught up in constantly having to increase its
financial performance to satisfy the premium that
investors were paying for its stock
• CEO Scott Livengood and form COO John Tate
were blamed by the SEC – ‘managed earnings’
• The company would always beat EPS targets by
1cent to say that it had exceeded Wall Street
expectations
• Bonuses for top management were linked to
surpassing the EPS forecast
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When is a Doughnut Hole a Real
Doughnut Hole?
• Manipulated revenue by shipping
doughnut making equipment with high
margins to franchise owners before they
requested the equipment
– Booked the selling of the equipment as
revenue
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9-5
The Role of Creative Accounting
• Creative Accounting: the deviation from
the traditional methods used to interpret
an accounting rule or standard
• Often walks the fine line between legal
and illegal activities
• It is sometimes hard to see where
‘aggressive’ accounting stops and
‘fraudlent’ accounting starts
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Ethical Philosophies and
Accounting Issues
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Self-interest
Utilitarian beliefs
Personal virtues
Religious injunctions
Government
requirements
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Universal rules
Individual rights
Economic efficiency
Distributive justice
Contributing liberty
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9-7
The Role of Financial Reporting
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Accurate financial reporting is needed to
provide investors and other interested parties
with the ability to
1. Make investment, credit, and financial decisions that
relate to the firm
2. Help the reader determine the level of cash flows for
the firm
3. Identify the economic resources and obligations to
the firm
– As identified by the Financial Accounting Standards
Board
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9-8
Five Philosophical Presuppositions
of External Financial Reporting
• External Realism
• Representational Faithfulness
• Conceptual Relativism of Financial
Reporting Schemes
• Subjective Judgment
• Commitment to Rationalism
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9-9
Where Were the Auditors?
• Many stakeholders are asking – “Where were
the auditors?”
• How could firms continue to make up imaginary
numbers without raising a huge red flag?
• Audit: an inspection of the accounting records
and other information deemed necessary to
express an opinion on the fairness and
adequacy of the financial statements
• Judgment must be used by the auditors
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9-10
Potential Conflicts of Interest
• Remember; the responsibility of the
auditors is to ensure the integrity for the
financial reporting by the company
– Auditor-Firm conflicts of interest
– Shareholder-Management conflicts of interest
– Self Interest-Professional Standards conflicts
of interest
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Steps of An Audit
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Getting Started
Planning Stage
Field Work Stage
Final Review Stage
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9-12
Current Trends in Auditing
• Risk Based Audit Model
– Differs from the traditional audit model
because auditors assess the level of risk of
the chance of fraud by the client
• SEC Goals
– Responsibilities of management
– Responsibilities of auditors
– Responsibilities of audit committees
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9-13
AICPA Code of Professional
Conduct
• Established in 1988
• Based on six principles:
– Responsibilities
– The public interest
– Integrity
– Objectivity and independence
– Due care
– Scope and nature of services
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9-14
Role of Government Regulations
• Intended to protect the general public from
unethical and illegal actions
• Established in response to decisions that
corporate managers made along the path
to business success
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9-15
Gramm-Leach-Bliley Act
• Sometimes called the ‘Citigroup Relief Act’
• Legal name – Financial Modernization Act of
1999
• Enacted partly in response to the failed 1998
merger of Citicorp and Travelers’ Group
• Allows companies classified as financial holding
companies to own banks, insurance companies
and securities firms
• Eliminated the Glass Steagall Act of 1933 and
the Bank Holding Company Act of 1956
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Major Components of a Firm’s
Financial Statements
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Balance sheet
Income statement
Statement of retained earnings
Statement of cash flows
• Must also display comprehensive income in a
conspicuous place
• All should be prepared in accordance with
generally accepted accounting principles
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Accounting Shenanigans or Tricks
of the Trade
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Revenue recognition
One time charges
Raiding the reserves/cookie jar accounting
Lease accounting
Off balance sheet items
Earnings management
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Questions for Thought
1. Which stakeholders would be most concerned
with
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A. the income statement?
B. the balance sheet?
C. the statement of retained earnings?
D. the statement of cash flows?
2. Why is earnings management considered a
trick of the trade? Explain.
3. In all of the accounting scandals of the past
decade, where were the auditors. Explain.
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