Managing Finance and Budgets
Lecture 12
Ethical & Legal Issues
Session 12 – Ethical & Legal Issues
KEY CONCEPTS
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Accounting Rules
Auditor responsibilities
Creative Accounting
Whistle blowing
Corporate Social Reporting
Accounting for the environment
Ethical & Legal Issues
A
B
C
Accounting: Regulatory Frameworks
Creative Accounting
Ethical Accounting
Section A:
Accounting:
Legal and Regulatory
Frameworks
Accounting Rules
There are three distinct Sources of Accounting Rules
for PLCs:
1. Company Law
2. Accounting Standards
3. Stock Exchange Rules
Sources of accounting regulations for a UK limited
company listed on the Stock Exchange
Company
law
External
accounting
rules
Stock exchange
rules
Accounting
standards
Company Law
Company Law as embodied in the Companies Acts
1985 & 1989 requires that Directors are responsible
and accountable for their actions in respect of their
management of the company’s assets:
1. To maintain appropriate accounting records
2. To prepare an annual profit & loss account, a
balance sheet that shows a true and fair* view of
accounts as well as a Directors’ Report and to make
these available to all shareholders and the public at
large.
*The term “true & fair” is not clearly defined in the legislation
Accounting Standards
Accounting Standards or Financial Reporting
Standards are the rules established by the Accounting
profession that should be followed in the preparation of
the annual accounts of companies.
These rules are not legally binding, however they do
define more clearly what is meant by “true and fair”
Different standards are concerned with:
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how an item should be treated
presenting information
disclosing information
valuing assets and measuring profits.
Stock Exchange Rules
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These rules extend the accounting rules for those
companies listed on the Stock Exchange.
These rules require:
• Summarised interim (I.e. half-yearly) accounts in
addition to the annual accounts.
• A geographical analysis of turnover
• Details of shareholdings in other companies where
the investment is greater than 20%
The Audit Process
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Shareholders are required to elect a qualified
independent person to act as Auditor.
The role of this person (or firm) is to report on whether
or not the company’s financial statements are “true and
fair”, and whether they comply with the regulatory
frameworks.
In order to do this, auditors must not only scrutinise the
statements, but the evidence on which the statements
are based.
Their report is sent to the Registrar of Companies.
Auditors
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Shareholders elect the directors to act on their behalf.
The directors account for the financial performance
and financial position of the company.
The shareholders elect an auditor to check that the
statements made by directors are accurate
The auditors report to the shareholders.
The relationship between the shareholders, the
directors and the auditors
Directors
review
elect
Auditors
account
elect
Shareholders
Section B:
Creative Accounting
Deviant Accounting Practice
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The Collapse of ENRON, the investigations into Xerox in
2002 and other high-profile events has raised questions
about the effectiveness of the Regulatory Frameworks.
The accounting methods used by Anderson Associates for
example seem to have successfully persuaded the
corporate community that certain companies were
profitable, when in reality those companies were in deficit.
Many of the accounting practices used, while not exactly
illegal, do not abide by the spirit of the regulations. They
are sometimes euphemistically termed “Creative
Accounting”
Creative Accounting
“ Every company in the country is fiddling its profits. Every
set of published accounts is based on books which have
been gently cooked or completely roasted.”
Ian Griffiths – Creative Accounting (1985)
“Much of the apparent growth in profits which had occurred
in the 1980s was the result of accounting sleight of hand
rather than genuine economic growth.”
Terry Smith –Accounting for Growth (1992)
Creative Accounting
“ The accounting process consists of dealing with many
matters of judgement and of resolving conflicts between
competing approaches to the presentation of results of
financial events and transactions. This flexibility provides
opportunities for manipulation, deceit and
misrepresentation”
Michael Jameson
A Practical Guide to Creative Accounting (1988)
Creative Accounting - Methods
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Selection of accounting policies
Using judgement to give an optimistic or pessimistic
view as required
Using artificial transactions to manipulate balance sheet
entries or to move profits between periods
Timing transactions to move profits to required time
frame
Creative Accounting - Example
REAL Balance Sheet:
Fixed Assets
£25m
Current Assets
Stock
£10m
Debtors
£5m
Current Liabilities -£10m
LT Liabilities
-£15m
£15m
Capital
£20m
LOSS
-£5m
£15m
Old
stock revalued
upwards
by £5m
CREATIVE Balance Sheet:
Fixed Assets
£25m
Current Assets
Stock
£15m
Debtors
£5m
Current Liabilities -£10m
LT Liabilities
-£10m
£25m
Capital
£20m
PROFITS
£5m
£25m
£5m Loan taken out in
final part of year; 1st
payment not yet due.
Creative Accounting - Motivation
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Hide volatility of profits thereby reducing perceived risk in
organisation
Delay tax burden
Increase personal rewards where linked to profits
Improve perceived wealth of company
Deceive stakeholders
Move blame for poor results onto predecessor (or
successor)
Monitoring
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Given the existence of a multiplicity of frameworks, one
question which needs to be asked is: “How is it that these
anomalies are not picked up during the auditing process”?
One answer to this may be that in many cases the firm
appointed to do the auditing has close links with the firm
which does the accounting.
The Role of Auditors
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Role conflict – should be objective but are also a supplier
Often unable to detect fraud
Frequently reluctant to report fraud
Suffer from lack of accountability and independence
Insist on self-regulation
Subject to competitive pressures
Auditors’ unprofessional behaviour
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Allocating insufficient time due to budget restraints
Accepting weak client explanations
Focusing on completion deadlines instead of
thoroughness
Excluding awkward items from samples
Accepting doubtful evidence from clients
Conflict of interests
How is Deviant Practice Uncovered?
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If the movements of money are a one-off, simple shift
from one reporting period to another, this may never be
detected. This is the primary motivation.
However, invariably when this has been done once, it
needs to be repeated. This creates a downward spiral
from which it is difficult to recover.
In many cases, it is employees who are required to
construct or falsify records who alert the press or
authorities .
Such people are called “Whistle blowers”
Whistle blowing
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Financial management provides privileged view of the
organisation’s dealings
Deviant managerial procedures may become apparent
E.g. Use of company assets for personal use
Hiding income from tax or vat authorities
Breaking of reporting regulations
Over-valuing (or under-valuing) of stock
Damages for whistle blower could be loss of reputation;
personal liability; dismissal
Section C:
Ethical Accounting Practice
Corporate Social Reporting
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Organisations ought to be answerable to stakeholders
Currently, regulations only relate to financial reporting
Other information is only given selectively or for PR
Suggested five elements of CSR:
Environmental reporting
Fair business practices (e.g. to employees/suppliers)
Community involvement
Products – safety and impact
Social policy
Accounting for the environment
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Adopting environmental policies
Carrying out environmental audits
Controlling energy costs and waste
Packaging and recycling
Life cycle analysis
Ethical borrowing and investment
Social audits
Incorporating sustainability in organisational priorities
Managing Finance and Budgets
EVALUATION
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There is a short questionnaire to fill in on the module.
The purpose behind the questionnaire is to examine
correlations between your academic experience on the
module and other factors.
These factors may include gender, country of origin, previous
experience of finances, time allocated to study, etc.
I aim to make changes to the module for next year. This will
allow me to focus energy precisely where it is needed.
Managing Finance and Budgets
THE END!
GOOD BYE, THANKS AND GOOD LUCK
MAY SEE YOU NEXT TERM
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