12

Ethics In Accounting And Finance

Learning Objectives
After reading this chapter you should be able to understand,

the importance of ethics for a finance and accounting professional;

the various principles which need to be adhered to by finance and accounting

professionals;

the concept of ethical dilemma and conflict resolution;

the various threats which can be faced by a finance and accounting professional while
working as an auditor, consultant or an employee in an organisation;

the various safeguards which need to be adopted to counter threats.

A business that makes nothing but money is a poor kind of business.

HENRY FORD

12.1 Introduction
Finance and Accounts is perhaps the only business function which accepts responsibility to act in
public interest. Hence, a finance and accounting professionals responsibility is not restricted to
satisfy the needs of any particular individual or organisation While acting in public interest, it
becomes imperative that the finance and accounting professional adheres to certain basic ethics in
order to achieve his objective.
Until recently, various surveys conducted globally had ranked finance and accounting professionals
very high in terms of professional ethics. However, various accounting scandals witnessed during
the past few years have put a serious question mark on the role of the finance and accounting
professional in providing the right information for decision making, both within and outside their
respective organisations. In companies such as Enron, World Com, Tyco, Global Crossing,
Adelphia, Quest, Xerox and most of the late dotcoms, the accounting information used by the
Finance Department was false and manipulative.
What was the role of finance and accounting professionals in all these high profile failures? Of
course there were a few professionals who were directly involved in fraudulent activities, however,
the majority, at most of the times, refused to challenge what they had already known.

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Enron is a classic example of such behaviour. Months before Enron Corp declared
bankruptcy, an employee of the name of Sherron Watkins sent the companys top executive
(Kenneth Lay) a message which had detailed information of the accounting hoax in the form of
the now famous off the book liabilities. However, instead of taking note of what was
mentioned in the message, the management of the company demoted Sherron. It is well
known now, that, like Sherron, hundreds of finance and accounting employees at Enron knew
about the happenings but preferred to remain silent. Hence, most of them did not lie, but
neither did they disclose the truth nor did they attempt to correct the misleading and confusing
information. Shouldnt they have blown the whistle the way Sherron did? Was the behaviour of
these employees un ethical? Cases like Enron exist in plenty, example World Com, Global
Crossing, Xerox, Qwest and many other companies have been known to have created
accounting entries with the sole purpose of making their financial statements look attractive
thereby inviting further investments from unsuspecting individuals and organisations.

12.2 Ethics and Ethical Dilemma

The word thikos (Ethics) imbibes within itself both individual behaviour and community
culture. Various iIndividuals would be having different opinions on the same subject because
of which what is perceived as right by one may be considered wrong by the other. Hence,
doing what one thinks is right, may not always be the right thing to do! This is the essence of
the term Ethics which may be defined as those moral principles which guide the conduct of
individuals irrespective of the differences of opinions amongst individuals. Ethical behavior
implies such course of actions which are taken after giving due thought to their impact on the
society and other stake holders. Hence when accounting and finance professionals at Enron
did not report of the wrongs which they believed were being done at the top, their behaviour
amounted to being unethical in spite of the fact that they were not directly involved in any of
the fraudulent or manipulative activities. In contrast, when Cynthia Cooper, Vice President
Internal Audit of World Com found wrong accounting entries resulting in inflated profits, she
immediately reported the matter to the Board of Directors, this, in spite of the fact that she was
reporting against seniors whom she had come to admire over the past so many years of
working together. These two examples mentioned above provide an insight into the meaning
of Ethical dilemmas. Ethical Dilemmas exist when finance and accounting professionals need
to choose from amongst alternatives and there are (1) significant value conflicts among
differing interests, (2) actual alternatives which can all be justified and (3) significant
consequences to all stakeholders. Let us consider an example of a finance and accounting
professional who has been asked to provide a profit forecast which needs to be given to a
banker for a much wanted loan to be utilised in launching a new product. The company has
not been doing well for the past few years and without this loan there is a likelihood of its
closing down. However, the loan can only be availed if the banker is convinced that the
projected profitability shall be at least ` 50,00,000 per annum. A optimistic projection of the
profits shows that if everything goes extremely well the company may be able to make profits
of ` 50,00,000, however, a realistic assumption provides a much lower figure. In such a
situation the concerned professional will need to resolve the dilemma of the type of profit

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forecast to be provided to the banker. In case he gives a realistic projection the company may
not get the loan and perhaps may need to close down. On the other hand if he makes a
optimistic projection, he may be misleading the banker. There is no right answer to such a
situation. Both actions proposed have got there own risks.

12.3 Potential Conflicts

For a finance and accounting professional working as consultant or auditor
A finance and accounting professional in public practice should take reasonable steps to
identify circumstances that could pose a conflict of interest. Such circumstances may give rise
to threats to compliance with the fundamental principles. For example, a threat to objectivity
may be created when a professional accountant in public practice competes directly with a
client or has a joint venture or similar arrangement with a major competitor of a client. More
examples of such threats are discussed later.
For a finance and accounting professional working as an employee
A finance and accounting professional has a professional obligation to comply with certain
fundamental principles which have been detailed below. There may be times, however, when
their responsibilities to an employing organization and the professional obligations to comply
with the fundamental principles are in conflict. Ordinarily, a finance and accounting
professional should support the legitimate and ethical objectives established by the employer
and the rules and procedures drawn up in support of those objectives. Nevertheless, where
compliance with the fundamental principles is threatened, a finance and accounting
professional must consider a response to the circumstances. As a consequence of
responsibilities to an employing organization, a finance and accounting professional may be
under pressure to act or behave in ways that could directly or indirectly threaten compliance
with the fundamental principles. Such pressure may be explicit or implicit; it may come from a
supervisor, manager, director or another individual within the employing organization. A
finance and accounting professional may face pressure to:
Act contrary to law or regulation.
Act contrary to technical or professional standards.
Facilitate unethical or illegal earnings management strategies.
Lie to, or otherwise intentionally mislead (including misleading by remaining silent) others,
in particular:

The auditors of the employing organization; or

Regulators.

Issue, or otherwise be associated with, a financial or non-financial report that materially

misrepresents the facts, including statements in connection with, for example:

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The financial statements; Tax compliance; Legal compliance; or Reports required by

securities regulators.

12.4 Creating an Ethical Environment

In light of the various corporate scandals mentioned above, the following three points need to
be addressed for creating a sound ethical environment in any company. They are,
1.

Ensuring that employees are aware of their legal and ethical responsibilities.

Ethical organisations would have policies to train and motivate employees toward ethical
behaviour. This would require initiation from the top. A number of companies, both in the West
and in India have been known for their quality and soundness of their Ethics programmes.
Companies like Raytheon make ethics training compulsory for everyone. Similarly Texas
Instruments has a well drafted Ethics programme from as long as 1961. In India Wipro was
amongst the pioneers to establish an organised set of beliefs which would guide business
conduct. This was done as early as 1970s. In the process the company has established an
Integrity manual which helps employees take ethical decisions when faced with choices.
2.

Providing a communication system between the management and the employees so that
any one in the company can report about fraud and mismanagement without the fear of
being reprimanded.

Ethical organisations need to provide facilities for employees through which they could
communicate with responsible positions for reporting frauds, mismanagement or any other
form of non routine detrimental behaviour. In India Wipro has introduced a helpline comprising
of senior members of the company who are available for guidance on any moral, legal or
ethical issues that an employee of the company may face.
3.

Ensuring fair treatment to those who act as whistle blowers.

This is perhaps the most important and sensitive issue. When Sherron had raised questions at
Enron, she was demoted. Similar fate would have met all those who had followed Sherron.
Fair treatment to whistle blowers is a basic necessity to check fraud. It is re assuring that two
of the three persons of the year, selected by the popular Time magazine were accountants
from Enron and World Com who had dared to blow the whistle, however, needless to say that
the appreciation is much more needed from within the company rather than outside.

12.5 Reasons for Unethical Behaviour

A creation of a proper ethical environment requires a proper understanding of the reasons
which lead to un ethical behaviour. Four such reasons are discussed below-.,
1.

Emphasis on short term results. This is one of the primary reasons which has led to the
downfall of many companies like Enron and WorldCom. Manipulating accounting entries
to depict good profitability can help companies raise further capital from the market

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2.

Ignoring small unethical issues: It is a known fact that most of the compromises we make
start are small however they lead us to large problems. Similarly, companies need to
develop an environment where small ethical lapses are taken seriously so that they do
not repeat in the future. Otherwise, toleration of such small lapses could lead to larger
problems.

3.

Economic cycles: When Enron was doing well, no one had bothered to understand its
actual financial position. There were no question marks on its financial statements.
However, when the economy took a downward turn, finance and accounting managers
took decisions which were compromises over the established code of conduct. This was
done to reflect a financial position which would keep the investors in the market satisfied.
All this resulted in a huge crisis and the ultimate fall of this US Giant. Hence, to prevent
disclosure of ethical problems in times of depression, company need to be extremely
careful and vigilant during good times.

4.

Accounting rules: In the era of globalisation and massive cross border flow of capital,
accounting rules are changing faster than ever before. The rules have become more
complex and it is difficult to identify deviations from these complex set of requirements.
The complexity of these principles and rules and the difficulty associated with identifying
abuse are reasons which may promote unethical behaviour.

12.6 Fundamental principles relating to Ethics

Certain fundamental principles need to be adhered with for behaving in an ethical manner.
These principles have been summarised below;
1. The principle of Integrity: The dictionary meaning of integrity is veracity. Accordingly, the
principle calls upon all accounting and finance professionals to adhere to honesty and straight
forwardness while discharging their respective professional duties. In addition the following
acts of responsibility would help comply with the Integrity principle,

Avoid being involved in activities which would impair the goodwill of the organisation

Communicate adverse as well as favourable information with those concerned

Refuse any gift or favour which could influence actions taken or to be taken

Refuse to get involved in any activity which would adversely affect the achievement of an
organisations objective.

Avoid conflicts and advise related parties on apparent conflicts which could arise in the future.

2. The principle of objectivity: This principle requires accounting and finance professionals
to stick to their professional and financial judgement. They should not allow bias, conflicting
interests or undue influence of others to override their business judgements . They should
communicate information fairly and objectively in such a way that the communication with the
end user is complete and transparent.

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3. The principle of confidentiality: This principle requires practitioners of accounting and financial
management to refrain from disclosing confidential information related to their work. Such
information may be however be disclosed to their subordinates and care should be taken that the
latter maintains confidentiality. The only exception to this principle is when there are requirements
to disclose information under a legal obligation or because of some statutory ruling.
4. The principle of professional competence and due care: Finance and accounting
professionals have a need to update their professional skills from time to time. This has
assumed a greater significance in the modern day competitive environment where updated
knowledge and skill shall ensure that the client or employer receives competent professional
services based upon current and contemporary developments in the related areas.
5. The principle of professional behavior: This principle requires accounting and finance
professionals to comply with relevant laws and regulations and avoid such actions which may
result into discrediting the profession.

12.7 Threats
The dynamic environment in which businesses operate today may usher a broad range of
circumstances because of which compliance with the abovementioned fundamental principles
may potentially be threatened. Such threats may be classified as follows:
(a) Self-interest threats, which may occur as a result of the financial or other interests of a
finance and accounting professional or of an immediate or close family member;
(b) Self-review threats, which may occur when a previous judgment needs to be reevaluated
by the finance and accounting professional responsible for that judgment;
(c) Advocacy threats occur when a professional promotes a position or opinion to the point
that subsequent objectivity may be compromised;
(d) Familiarity threats occur when a finance and accounting professional has close
relationships in the work environment and such relationships impair his selfless attitude
towards work.
(e) Intimidation threats occur when a professional may be prohibited from acting objectively
by threats, actual or perceived.

12.8 Examples of circumstances creating above mentioned Threats.

Circumstances leading to the actual happening of the various threats are given below. Students
may note that this is not an exhaustive list and has been provided to give a basic idea
Self interest threat for finance and accounting professionals working as consultants or auditors

A financial interest in a client or jointly holding a financial interest with a client.

Undue dependence on total fees from a client.

Having a close business relationship with a client.

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Concern about the possibility of losing a client.

Potential employment with a client.

Contingent fees relating to an assurance engagement.

12.7

Self interest threat for finance and accounting professionals working as an employee

Financial interests, loans and guarantees in the company the professional is working.

Incentive compensation arrangements

Inappropriate personal use of corporate assets.

Concern over employment security

Commercial pressure from outside the employing organisation

Self review threat for finance and accounting professionals working as consultants or auditors

The discovery of a significant error during a re-evaluation of the work of the finance and
accounting professional.

Reporting on the operation of financial systems after being involved in their design or
implementation.

Having prepared the original data used to generate records that are the subject matter of
the engagement.

A member of the assurance team being, or having recently been, a director or Officer of
that client.

A member of the assurance team being, or having recently been, employed by the Client
in a position to exert direct and significant influence over the subject matter of the
engagement.

Self review threat for finance and accounting professionals working as an employee
Such threats occur when business decisions or data is subjected to review and justification is
required to be given by the same professional who was responsible for taking such decisions or
preparing that data.
Advocacy threat for finance and accounting professionals working as consultants or auditors

Promoting shares in a listed entity when that entity is a consultancy or a financial statement
audit client.

Acting as an advocate on behalf of an assurance client in litigation or disputes with third

parties.

Advocacy threat for finance and accounting professionals working as an employee

When furthering the legitimate goals and objectives of their employing organizations finance and
accounting professionals may promote the organizations position, provided any statements made
are neither false nor misleading. Such actions generally would not create an advocacy threat.

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Familiarity threats for finance and accounting professionals working as consultants or auditors

A member of the engagement team having a close or immediate family relationship with
a director or officer of the client.

A member of the engagement team having a close or immediate family relationship with
an employee of the client who is in a position to exert direct and significant influence over
the subject matter of the engagement.

A former partner of the firm being a director or officer of the client or an employee in a
position to exert direct and significant influence over the subject matter of the
engagement.

Accepting gifts or preferential treatment from a client, unless the value is clearly
insignificant.

Long association of senior personnel with the assurance client.

Familiarity threats for finance and accounting professionals working as an employee

A finance and accounting professional, in a position to influence financial or non financial

reporting or business decisions having an immediate or close family member who is in a
position to benefit from that influence.

Long association with business contacts influencing business decisions.

Acceptance of a gift or preferential treatment, unless the value is clearly insignificant.

Intimidation threat for finance and accounting professionals working as consultants or auditors

Being threatened with dismissal or replacement.

Being threatened with litigation.

Being pressured to reduce inappropriately the extent of work performed in order to

reduce fees.

Intimidation threat for finance and accounting professionals working as employees

Threat of dismissal or replacement of the finance and accounting professional or a close

or immediate family member over a disagreement about the application of an accounting
principle or the way in which financial information is to be reported for external use as
well as for decision making purposes.

A dominant personality attempting to influence the decision making process, for example
with regard to the exclusion of irrelevant costs from projected cost estimates.

12.9 Safeguards
It is important to have safeguards which may increase the likelihood of identifying or deterring
unethical behavior. Such safeguards, which may be created by the finance and accounting
profession, legislation, regulation or an employing organization, shall ensure an ethical
environment. Safeguards that may eliminate or reduce the abovementioned threats to an

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acceptable level fall into two broad categories:

(a) Safeguards created by the profession, legislation or regulation; and
(b) Safeguards in the work environment.
(c)

Some of the safeguards created by the profession, legislation or regulation are as follows

Educational, training and experience requirements for entry into the profession.

Continuing professional development requirements.

Corporate governance regulations.

Professional standards.

Professional or regulatory monitoring and disciplinary procedures.

External review by a legally empowered third party of the reports, returns, communications or
information produced by concerned professionals.

(d) Safeguards in the work environment are as follows.

The employing organizations systems of corporate oversight or other oversight structures.

The employing organisations ethics and conduct programs.

Recruitment procedures in the employing organisation emphasizing the importance of

employing high caliber competent staff.

Strong internal controls.

Appropriate disciplinary processes.

Leadership that stresses the importance of ethical behavior and the expectation that
employees will act in an ethical manner.

Policies and procedures to implement and monitor the quality of employee performance.

Timely communication of the employing organisations policies and procedures, including any
changes to them, to all employees and appropriate training and education on such policies
and procedures.

Policies and procedures to empower and encourage employees to communicate to senior

levels within the employing organization any ethical issues that concern them without fear of
retribution.

12.10 Ethical Conflict Resolution

While evaluating compliance with the fundamental principles, a finance and accounting
professional may be required to resolve a conflict in the application of fundamental principles.
The following needs to be considered, either individually or together with others, during a
conflict resolution process,
(a) Relevant facts;

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(b) Ethical issues involved;

(c) Fundamental principles related to the matter in question;
(d) Established internal procedures; and
(e) Alternative courses of action.
Having considered these issues, a finance and accounting professional should determine the
appropriate course of action that is consistent with the fundamental principles identified. The
professional should also weigh the consequences of each possible course of action. If the
matter remains unresolved, the professional should consult with other appropriate persons
within the firm or employing organization for help in obtaining resolution. During times where a
matter involves a conflict with, or within, an organization, finance and accounting professional
should also consider consulting with those charged with governance of the organisation, such
as the board of directors.
It may be in the best interests of the professional to document the substance of the issue and
details of any discussions held or decisions taken, concerning that issue.
If a significant conflict cannot be resolved, a professional may wish to obtain professional
advice from the relevant professional body or legal advisors, and thereby obtain guidance on
ethical issues without breaching confidentiality. For example, a professional accountant may
have encountered a fraud, the reporting of which could breach the professional accountants
responsibility to respect confidentiality. The professional accountant should consider obtaining
legal advice to determine whether there is a requirement to report.
If, after exhausting all relevant possibilities, the ethical conflict remains unresolved, a
professional should, where possible, refuse to remain associated with the matter creating the
conflict. The professional may determine that, in the circumstances, it is appropriate to
withdraw from the engagement team or specific assignment, or to resign altogether from the
engagement, the firm or the employing organization.

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