Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 9-1 Chapter 9 Ethics and...

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 9-1

Chapter 9Ethics and Financial Reporting

Understanding Business Ethics

Stanwick & Stanwick

1st Edition


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


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



• 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



• 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


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


Ethical Philosophies and Accounting Issues

• Self-interest• Utilitarian beliefs• Personal virtues• Religious injunctions• Government

requirements

• Universal rules• Individual rights• Economic efficiency• Distributive justice• Contributing liberty


The Role of Financial Reporting

• 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


Five Philosophical Presuppositions of External Financial Reporting

• External Realism

• Representational Faithfulness

• Conceptual Relativism of Financial Reporting Schemes

• Subjective Judgment

• Commitment to Rationalism


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


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


Steps of An Audit

• Getting Started

• Planning Stage

• Field Work Stage

• Final Review Stage


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


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


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


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


Major Components of a Firm’s Financial Statements

• 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


Accounting Shenanigans or Tricks of the Trade

• Revenue recognition

• One time charges

• Raiding the reserves/cookie jar accounting

• Lease accounting

• Off balance sheet items

• Earnings management


Questions for Thought

1. Which stakeholders would be most concerned with

– 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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Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 9-1 Chapter 9 Ethics and...

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