Ethics in Financial Reporting - Essay Example

Ethics in Financial Reporting Name Tutor Unit Code Introduction In recent times there have been many concerns in the financial area with the high number of financial troubles and corporate collapses. These troubles are characterised by too much leverage, poor risk controls, and “wilful blindness”. However, Dellaportas et al. (2005) indicates that there is a much more concern that could be the underlying cause: unethical behaviour by the accountants and leaders as well. This results from a wide belief that the waning in corporate ethical standards has mainly been propagated by the accountants and auditors. Due to a low ethical base in the financial firms, most of them have paid more concentration of short-term gains without considering the long-term impact to the firm, customers, employees and the broader economy. That’s why business ethics has drawn much concern today. The accounting profession has a responsibility towards guaranteeing high ethical standards, appropriate reporting mechanisms, adequate financial management, audit quality and strong governance regimes as a way of improving public assurance in financial reporting. At present, the conduct of accountants and auditors is a contemporary issue, which forms the context of this paper. Particular focus is on the role of ethics and judgement in the accounting profession and the impact of unethical conduct on organisations, considering the case of Enron collapse in 2001. Role of Ethics and Judgement Ethics is hard to define since it is moulded by individual, societal and professional values, all of which are hard to state. Whereas a number of people stress the prominence of society’s interests, others stress individual interests giving rather conflicting perspectives. However, ethics generally refers to choices. It shows how people act in making the ‘right’ or ‘wrong’ choice and producing ‘good’ or ‘bad’ behaviour. It is an everyday discipline that calls for appropriate moral conduct. Velasquez (2006) defines ethics as “the discipline that scrutinises one’s moral standards or the moral standard of a society”. The recent financial problems and corporate collapses provide enough evidence to state that the accounting professionals must be very much ethical in their work. The very nature of their career demands so. The accountants’ work places them in a distinctive position of trust as they relate with the employers, clients, and the general public, who bank on their expert judgment and leadership in decision making. These decisions turn out to upset the resource allocation practise of an economy. The parties depend on them because of their skilled statues and ethical ideals. So, the key to upholding confidence of clients and the general public is professional and ethical conduct (Gaffikin, 2008). Dellaportas et al. (2005) states that ensuring top ethical standards is vital for an accounting professional whether public (one who renders professional services to clients for a fee) or private (one who is in a job in a public or private sector establishment for a pay). Accounting professionals establish a fiduciary rapport with the client, the employer and the general public. In such an association, they are tasked with ensuring that what they have to do is accomplished in conformism to the ethical standards of integrity, honesty, due care, objectivity, confidentiality, and the binder to the public concern ahead of one’s own. In other words, accounting professionals are expected to uphold a level of ethical behaviour that goes further than society’s laws. That’s why the professional accounting bodies world over have developed code of ethics and professional conduct setting out the standards that delineate right from wrong. This is to make sure that members’ conduct abide by the professed public prospects of ethical values. These values have been shaped based on the ‘principles of professional conduct’ that form the base for the professional moral code. The Accounting Education Change Commission (AECC) has reacted to the situation of the accounting professionals’ negative ethical conduct by cheering ethics education at the undergraduate level in accounting courses. The organisation’s reform agenda seeks to express the perception that the accounting professional identity encompasses over and above the technical competency, social and communication skills. Accounting professional eminence depends upon the incorporation of one’s knowledge and skills with the routine application of moral judgment (Staubus, 2005). Professional character involves one’s espousal and practice of a code of ethical conduct. Moreover, an individual has got to develop habits that will enable them to make coherent ethical judgments regarding the preparation of financial statements and provide business recommendations. In this way, accounting education will be able to shape the accounting professional’s character (Wee, 2002). As an accountable professional, the individual will be able to incorporate the technical knowledge, problem-solving and communication skills in a self-controlled service ideal for fashioning clear, fair and reliable financial statements. Therefore, ethical conduct and judgement is extremely important in financial reporting. However, it cannot be limited to either personal or institutional ethics only. This complex problem is very much challenging and calls for a wider inclusion of organisational and systemic ethics. By and large, a three-level approach is required that pays outstanding attention to the key roles and responsibilities of individuals, organisations and systems (Staubus, 2005). Impact of Unethical Conduct Unethical conduct has huge consequences, not only to the firm, but also to the employees, customers, the general public and the economy. To the average person it is disgusting and scandalous. The long-term practicality of the industry loses any common sense of fiduciary accountability to the last client. Ethics and the prominence of ethical decision making have taken on collective meaning given the burdens placed on business managers by creditors, stockholders, plus other parties pretentious by a firm’s financial performance. That’s why today many people feel that unethical conduct, such as insider trading, and falsified financial reporting are areas of high distress (Johnson, 2001). People did not believe that a company would go outside any mistrust of falsifying its actions. However, it generally was taken for granted that the reports approved by widely renowned auditors adequately and correctly echoed companies’ financial performances. But the happenings of the recent past have washed away this confidence. Rather, serious doubts and even scepticism regarding current financial reporting practices have spread, mostly among investors. The ethics of financial reporting has turn out to be a vital challenge of the financial sector (Palazzo et al., 2012). The magnitudes of unethical behaviour in business are devastating. Consider the collapse of Enron in 2001. Enron was a great company in the United States and afore its collapse in December 2001 was ranked as the seventh-largest in the United States by the Fortune magazine, and the most innovative company in America in April 2001. The company was formed by Ken Lay, an economist and former undersecretary at the US Department Interior, in 1985 through a merger of two gas companies. It went through tough financial times just after formation, but it survived and was further buoyed by deregulations in the energy sector. Soon after Enron become the biggest natural gas company in the United States. It attracted a lot of investors since it commanded the confidence of individual and institutional investors (Fusaro & Miller, 2002). The company had a code of ethics that was based on integrity, respect, communication, and excellence. Lay professed to be a strong observer of business ethics. But, under his leadership and Andrew Fastow, previous Enron chief financial officer (CFO) as well as the CEO, Jeffrey Skilling, Enron collapsed. These individuals’ actions were very much questionable regarding the way in which they stuck to the values of integrity, respect, communication, and excellence. Clearly they did not abide by the code of ethics neither did they provide an appropriate example for other employees to follow (Prentice, 2003). Lay and Skilling wielded a lot of power within the company such that whoever opposed their opinion was removed from their position. These leaders feared any one individual who seemed to threaten their authority. Skilling was fast in eliminating his rivals and intimidated is juniors. It was also difficult to hand over power at Enron. From time to time, managers seemed not to realise what employees were doing or how the business was run. The board members were too overruled. They could not exercise proper oversight and hardly defied management decisions seeing as most of them were appointed by Lay and did trade with the firm or represented non-profit organisations that obtained hefty charities from Enron (Cruver, 2002). Enron’s executives used deceptive means to show that the company was more profitable than it really was. They pre-eminently used off-the-book entities (Special Purpose Vehicles (SPVs)) to which Enron’s huge debts were conveyed (Jennings, 2005). The SPVs were intended to keep debt off the firm’s balance sheets and facilitated propping up its share price. But even as the company’s stock rose, so did its debt. The top executives started to use insider information to trade millions of dollars in the company stocks. However, when the firm’s stock price started to slip, the company could not back its guarantees leading to a total collapse of the giant organisation (Fusaro & Miller, 2002). The unethical conduct was abetted by the many layers and specialisations within Enron. The company was divided horizontally. Mid-level employees were not privy to the information delivered to the executives. As a result, the employees could not get a clear and overall picture of the company’s business activities. From time to time the managers left their staffs to their own plans, cheering them to make their figures by any means possible. The employees used the behavioural prompts to figure their own engagements, as well as their choices not to report the unethical acts of other employees. Moreover, the company’s divided employees vertically into old-style divisions, such as financial, legal, and trade. As a consequence, the employees could not understand how each division’s operations joined with the other divisions to expedite the company’s actions (Gini, 2004). In a nutshell, Enron’s collapse was shocking in various regards. The energy industry was seriously affected. But maybe the greatest harm was to people’s trust in businesses and their leaders. The case of Enron demonstrates that a company’s leaders may not constructive influencers who lead the company to do the best good for its stakeholders at all times (Fox, 2003). Another key case regarding unethical conduct is the collapse of HIH Insurance. The company was originally established in 1968 by Ray Williams in partnership with Michael Payne as an underwriting agency. It went through several transformations. It was picked up by British company CE Health PLC in 1971, and renamed as HIH Winterthur after a merger with a large Swiss Company, Winterthur Insurance in 1995. The company expanded principally through an acquisition strategy. However, in March 2001 the company was came under receivership in the Australian Securities Exchange. At this time the company had debts of about $5.3 billion. By then HIH was the second largest insurance company in Australia. It had wide operations and interests in public and private liability, worker's compensation, property, industrial and commercial insurance. HIH had also expanded into the United States and United Kingdom markets (Sexton, 2001). When placed under liquidation in March 2001, HIH had literally collapsed. The $A5.3 billion debt was attributed to the company’s extensive under-estimation of liability and over-optimistic valuations of assets. HIH’s collapse epitomised the biggest corporate collapse in Australia. The collapse was attributed issues of an aggressive expansion strategy, having acquired over 200 subsidiaries in just about 10 years. There were also fundamental problems involving reserve and underpricing. But there also was the issue of unethical conduct that involved poor risk reporting, fraud, corporate governance, external auditing and regulation (Sexton, 2001). The management acted by concealing the debts so as to boost their profits and used “financial reinsurance” contracts also to boost profits. This of course happened under the watch of the accounting firm. The firm indicates the unethical conduct of the accounting professionals who failed to make these heinous acts known to the stakeholders. Surprisingly, Arthur Anderson was the accounting firm, the same firm linked to the collapse of Enron. The company had established a longstanding relationship with the management of the company have served them for around 30 years. In fact three of HIH's board members in 2000 were formerly working for Arthur Andersen (Amon, 2002). There were huge concerns for the dependence of the information delivered by company and their auditors. It is under this circumstances that the auditor could not give an independent opinion regarding whether the financial statements reflect a true and fair position of the company. The directors can influence the auditor’s independence and therefore opinion such that they act to their favour. Besides, Arthur Anderson was paid huge sums for their services. In 1999/2000 they were paid A$1.7 million in audit services and A$1.6 million in consultancy fees. Therefore, the firm drew huge fees that could have distracted it from providing the required audit services in the best interest of the shareholders. This raises a key ethical concern for their conduct (Amon, 2002). Conclusion The current financial world has been weakened by the many financial crises and corporate collapses that have happened in the recent past. There could be many reasons for failure, but one key reason that stood out pre-eminently is the issue of unethical conduct of the accounting professionals as well as the corporate leaders. The accounting profession has a responsibility towards guaranteeing high ethical standards, given the nature of their job. The consequences of unethical conduct of the accounting professionals are severe to the firm, employees, customers, the general public and the economy. The collapse of Enron and HIH Insurance are classic examples of what unethical conduct can do. The case highlights the significance of scrutinising an organisation’s actions to identify would-be unethical acts. The actions of the company’s top executives, the culture, the employee motivations, and the company’s structure can all provide indications regarding whether the company is ethically sound (Gini, 2004). References Amon, (2002). HIH Aggressive Accounting. The Courier Mail, pp. 17. Barreveld, D. J. 2002. The Enron collapse: Creative accounting, wrong economics or criminal acts? San Jose, CA: Writers Club Press. Betz, K. W. 2002. Enron’s abrupt crash and burn stuns energy markets. Energy User News, vol. 27, no. 1, pp. 1. Cruver, B. 2002. Anatomy of greed: The unshielded truth from an Enron insider. New York: Carroll & Graf. Dellaportas, S., Gibson, K., Alagiah, R., Hutchinson, M., Leung, P. and Homrigh, D.V. 2005. Ethics, Governance and Accountability: a Professional Perspective, John Wiley & Sons, Australia. Fox, L. 2003. Enron: The rise and fall. 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