AcFn 611-ch I.ppt-LK-2013

Addis Ababa University
School of Business & Public Administration

Department of Accounting & Finance
Module Title: Advanced Financial Accounting & Auditing

Module Code: Acfn 611
Module Credit Value: 270 hours [9 ECTS]
ACFN 611: Advanced Financial Accounting and Auditing

1 Dr. P. Laxmikantham
Acct 611: Advanced Financial Accounting and Auditing
Ethical Issues and Financial Statement

Fraud in Advanced Financial Accounting

Objectives
The main objectives of the chapter Ethical Issues in

Advanced Financial Accounting are as follows:
1. To discuss the alleged erosion of ethical conduct of
accountants.
2. To define cute accounting and cooking the books.
3. To explain and describe fraudulent financial
reporting.

Objectives
4. To discuss significant events in the establishment of ethical
standards for management accountants and financial executives.
5. To compare the IMA, FEI, and AICPA ethics pronouncements for

financial executives and management accountants.
6. To consider the effectiveness of IMA, FEI, AICPA, EPAAA and

FOAG ethical standards in preventing fraudulent financial
reporting.
7. To consider the relevant points of the Proclamations No.

235/2001, 236/2001, 239/2001, 77/2002, and 262/2002.

Scope of Chapter
z Why need ethical conduct in accounting?

z What is fraudulent financial reporting?
z Ethical standards for preparers of
financial statements & reports.
z Significant events in establishment of
ethical standards.

Scope of Chapter
z IMA standards of ethical conduct.
z FEI code of ethics.
z AICPA code of professional conduct.
z EPAAA code of conduct
[Article XXIII, 23.01 – 23.10]
z FOAG Code of Ethics
z IFAC Code of Ethics
z Resolutions, articles, definitions, rules,
appendices.
z Examples, review questions and case studies.
Why To Study Ethical Issues In Accounting?
Why should an accountant get involved in this

study of ethics?
Doesn’t every accountant already have a set of
moral beliefs that he or she already follows?
Certainly, but even so, there are several
reasons for studying ethics.

z First, some moral beliefs one holds may be

inadequate because they are simple beliefs
about complex issues.
z The study of ethics can help a person sort out
these complex issues, by seeing what
principles operate in these cases.

z Second, in some situations, because of

conflicting ethical principles, it may be difficult
to determine what to do.
z In this case, ethics can provide insights into
how to adjudicate between conflicting
principles and show why certain courses of
action are more desirable than others.

z Third, individuals may hold some inadequate beliefs or

cling to inadequate values.
z Subjecting those beliefs or values to ethical analysis
may show their inadequacy.
z It could be that at one time you thought some things
were wrong but now you think they are acceptable, or
vice versa.
z In short, after consideration you changed your mind
about some of your ethical beliefs.

z A fourth, and very important, reason to study ethics is

to understand whether and why our opinions are worth
holding on to.
z The philosopher Socrates is known for showing that

the unexamined life is not worth living.

z As an accountant, what are your basic goals in life?

z Are they compatible with other values that you have?
z If you need to choose between keeping a job and

violating your professional responsibilities, what should
do?
z When your responsibility to family conflicts with your
responsibility to your job, how do you resolve this?

z A final reason for studying ethics is to learn to

identify the basic ethical principles that can be
applied to action.
z That should help develop the skill of

determining what should be done and an
understanding of why it should be done.

z Critics have alleged that ethical standards of

accountants have deteriorated.
z Cute accounting to describe stretching the form
of accounting standards to the limit, regardless
of the substance of the underlying business
transactions or events.
z Cooking the books to indicate fraudulent
financial reporting.
Professionalism and Ethics
15
Objectives
- characteristics of a “professional”
– Explain how those characteristics apply to the accounting
profession
– Define “ethics”
– Discuss various models / schools of ethical decision making
– Explain and apply the professional ethical codes of various
accounting professional organizations
– Explain how to resolve ethical dilemmas
– Give examples of recent ethical cases in accounting

Characteristics of a professional
Bell said a professional: – Exhibits ethical

professional behavior
– Communicates effectively
– Recognizes the influence
– Thinks rationally, logically
of political, social,
and coherently
economic, legal and
– Appropriately uses regulatory forces
technical knowledge
– Actively seeks additional
– Integrates knowledge from knowledge
many disciplines

McDonald proposed a different, but related, set

of ideas:
– Specialized knowledge base
– Complex skills
– Autonomy of practice
– Adherence to a code of ethical behavior

Houle focused on the process of becoming a

professional, dividing his ideas into three
groups:
– Conceptual
– Performance
– Collective identity

Ethics concepts
z Definitions: Ethics
z Moral philosophy – Metaethics: where ethical
z Systematizing, principles come from
defending, and – Normative ethics: moral
recommending standards that regulate
concepts of right and right and wrong behavior
wrong behavior – Applied ethics: specific
z Rules or standards controversial issues
governing the conduct
of a person or the
members of a
profession
Ethics concepts
Schools of ethical thought

– Utilitarianism: the end justifies the means
– Rights and duties: individuals have certain rights;
others should not interfere with them
– Justice: people should get what they deserve
– Virtues: everyone should do what is right, moral and
virtuous

Ethics codes in accounting
Institute of Management Accountants

– Principles
z Honesty and fairness
z Objectivity and responsibility
– Standards
z Competence and confidentiality
z Integrity and credibility

– Comply with lawful court

orders
Association of Certified Fraud – No expressed opinion on
Examiners guilt or innocence
– Commitment to – Keep information
professionalism confidential
– Avoid illegal and unethical – Reveal all matters which
conduct, conflicts of could influence outcome
interest – Strive to increase
– Exhibit the highest levels of
competence and
integrity effectiveness

American Institute of CPAs – General Standards

– Principles of Professional Accounting Principles
Conduct – Responsibilities to Clients
– Rules: Applicability and – Responsibilities to
Definitions Colleagues
– Independence, Integrity – Other Responsibilities and
and Objectivity Practices

Resolution of ethical dilemmas
Langenderfer and Rockness proposed an

eight-step process:
– Identify the facts
– Identify the ethics issues and the stakeholders
involved
– Define the norms, principles and values related to
the situation

Langenderfer and Rockness (continued)

– Identify the alternative courses of action
– Decide the best course of action consistent with
the norms, principles and values
– Evaluate the consequences of each possible
course of action

Langenderfer and Rockness (concluded)

– If appropriate, discuss the alternative with a
trusted person to help gain greater perspective
regarding the alternatives
– Reach a decision as to the appropriate course of
action

Recent ethics cases
z Charles Ponzi
– Multi-million dollar fraud with international postal reply
coupons
– Used money from new investors to pay off old
investors
– Five years in federal prison for mail fraud with
additional time in Massachusetts

Recent ethics cases
z Adelphia Cable
– Rigas family
– Company funded over $2 billion in personal loans to
family
– Deceptive accounting practices
– Co-mingled personal assets with corporate assets

Recent ethics cases
z Enron – Stock price increased 20

– Natural gas and pipeline quarters in a row
industries – Earnings management, off
– Moved into trading rights balance-sheet debt,
for oil and gas pipelines related-party transactions,
disclosure issues
– Earnings increased
without cash flow – Bankruptcy in December
2001
– Demise of Arthur
Andersen followed

Fraudulent Financial Reporting

z Misstatements in financial statements.

z Intentional misstatement or omission of
amounts or disclosures in financial statements
to deceive users.
z Reasons & Methods of committing fraud.
z Manipulation, Falsification, or Alteration of
accounting records or supporting documents.

z Misrepresentation in or intentional
omission from, the financial statements of
events, transactions or other significant
information.
z Intentional misapplication of accounting
principles relating to amounts,
classification, presentation or disclosure.
z Fraud frequently involves either a pressure

or an incentive to commit fraud.
z Fraud may be concealed through falsified
documentation, including forgery.
z Fraud also may be concealed through
collusion among management, employees
or third parties.

An Example of
The sec’s accounting and auditing

enforcement release no. 923 provides
an example of fraudulent financial
reporting. According to the SEC, the
four officers overstated the company’s
net income for the quarters ended Dec
31, 92 and mar 21, 93 by taking
following “ cooking the books” actions:
An Example of
1. Recognizing January 1993 revenues in

December 1992 and April 1993 revenues in
march 1993.
2. Deferring write-offs of uncollectible accounts
past the end of the appropriate quarter.
3. Recognizing as assets certain expenses
incurred during the quarters ended December
31, 1992 and march 31, 1993.
An Example of
4. Making fictitious journal entries in

connection with business combinations
accomplished in march 1993, the effect of
which was to understate doubtful accounts
expense.
5. Recognizing in the 1st quarter of 1993, a
gain from the sale of an asset during the
quarter ended June 30, 1993.
Financial Statement
Fraud

38Ethics Dr. P. Laxmikantham Advanced Financial Accounting /LK
Financial Statement Fraud: Overview
z Financial statement fraud (FSF) is any undisclosed intentional or

grossly negligent violation of generally accepted accounting
principles (GAAP) that materially affects the information in any
financial statement.
z General areas for FSF schemes:
– Improper revenue recognition.
– Overstatement of assets (other than accounts receivable
related to revenue fraud).
– Understatement of expenses/liabilities.
– Misappropriation of assets.
– Inappropriate disclosure and Other miscellaneous techniques.
z About half of all FSFs involve overstating revenues/assets
Revenue Schemes
z Sham sales
z Premature revenue recognition
z Recognition of conditional sales
z Abuse of cutoff date of sales
z Misstatement of the percentage of
completion
z Unauthorized shipments or channel stuffing

Revenue Schemes
z Sham sales This scheme involves recording

fictitious sales and frequently includes falsified
sales, inventory, and shipping records. In some
cases, company employees go so far as to
hide part of the inventory to make it appear that
the hidden items have been sold.

Revenue Schemes
z Premature revenue recognition Company
employees record sales after receiving customer
orders but before shipping the goods.
z Recognition of conditional sales Employees record
sales for transactions that are not yet complete
because of unresolved contingencies. In some cases,
employees make secret agreements with the customer
that alter the terms of the sale. For example, a
company could secretly agree that the customer can
return all unsold goods.

Revenue Schemes
z Abuse of cutoff date of sales Normally, a

company’s books are “closed” at the end of
each reporting period, and sales that occur
after the closing date do not appear on the
current period income statement. Some
companies keep the books open after the
closing date and include the next period’s sales
on the current period income statement.

Revenue Schemes
z Misstatement of the percentage of

completion Revenue from some types of
contractual work, such as construction, is
considered to be earned according to the
estimated percentage of the project completed.
In this scheme, employees overstate the
percentage that projects are completed and
thus overstate revenues.

Revenue Schemes
z Unauthorized shipments or channel stuffing
Employees create sales orders at the end of the
accounting period by shipping goods that have not
been ordered to record the shipments in current period
sales. When they goods are returned in the next
period, they will be charged against the next period’s
sales. Channel stuffing is similar but the company has
a relationship with the customer to which it
automatically ships goods according to the company’s
estimates of the customer’s demand. The company
takes advantage of this relationship and ships too
many goods toward the end of the accounting period.

Schemes Involving Overstating Assets
z Inventories The most common inventory fraud involves the

overstatement of assets.
z Accounts receivable Accounts receivable are overstated by
understating allowances for bad debts or falsifying accounts
balances.
z Property, plant, and equipment In this scheme, depreciation is
not taken when it should be or property, plant, and equipment is
simply overstated. A corresponding overstatement is made to the
revenues.
z Other overstatements These involve other accounts such as
loans/notes receivables, cash, investments, and so on.

Schemes Involving Improper Accounting
Treatment
z Recording an asset at market value or some other incorrect value

rather than cost.
z Failing to charge proper depreciation or amortization against
income.
z Capitalizing an asset when it should be expensed.
z Improperly recording transfers of goods from related companies
as sales.
z Not recording liabilities to keep them off the balance sheet.
z Omitting contingent liabilities (e.g., pending product liability
lawsuits, pending government fines, and so on) from the financial
statements.

Other Schemes
z Fictitious and Fraudulent Transactions Recording sham
transactions and legitimate transactions improperly.
z Fraudulent Transaction Processing Intentionally misprocessing
transactions to produce fraudulent account balances. For
example, accounting software is modified to incorrectly total sales
and accounts receivables so that all transactions in the account
are real but the total is overstated.
z Direct Falsification of Financial Statements Producing false
financial statements when management ignores account
balances.

Characteristics of Financial Statement
Fraud
z The median amount of the fraud is approximately 25 percent of

the median total assets.
z Most frauds span multiple fiscal periods with the average fraud
time being approximately two years.
z The majority of fraud involves overstating revenues by recording
them fictitiously or prematurely. <<AU: In the section
z FSF is much more likely to occur in companies whose assets are
less than $100 million.
z FSF is much more likely to occur in companies with decreased
earnings, earnings problems, or a downward trend in earnings.

Fraud
z In a large majority of cases, either the CFO or CEO is involved in

the fraud.
z In many cases, the board of directors has no audit committee or
one that seldom meets, or none of the audit committee members
has the required skills to perform as intended.
z The members of the board are frequently dominated by insiders
(even related to managers) or by those with financial ties to the
company.
z Auditor changes occurred about one-fourth of the time in and
around the time of the fraud.

Fraud
z Nearly half of audit reports indicate some type of anomaly, such

as a change of auditors, doubts about the company’s ability to
continue as a going concern, a change in accounting principle, or
a litigation issue. Problems with departures from GAAP seldom
occur, however.
z The size of the audit firm does not seem to matter. FSF occurs
frequently in companies audited by both large and small audit
firms.
z Nearly one-third of the enforcement action cases that name
individuals allege wrongdoing on the part of the external auditor.
About half the time, the auditor is accused of participating in a
fraud; the other half the time the auditor is accused of negligence.
Motives for FSF
z Poor Income Performance

z Impaired Ability to Acquire Capital.
z Product Marketing
z General Business Opportunities
z Compliance with Bond Covenants
z Generic Greed
z Theft, Bribery, or Other Illegal Activities
Prevention of Financial Statement Fraud
The general philosophy behind SOX is to minimize FSF by

promoting strong corporate governance and organizational
oversight through the oversight of the following six organizational
groups.
z Board of directors
z Audit committee
z Management
z Internal auditor
z External auditor
z Public Oversight Bodies

Red Flags: Indications of Possible
Financial Statement Fraud
z Lack of Independence, Competence, Oversight, or

Diligence
z Weak Internal Control Processes
z Management Style
z Personnel-Related Practices
z Accounting Practices
z Company’s Financial Condition
z Industry Environment and Conditions

Lack of Independence, Competence,
Oversight, or Diligence
z Any lack of independence between

management, internal auditors, and external
auditors undermining the basic structure
designed to prevent FSF.
z Any lack of competence, oversight, or diligence
on the part of the audit committee or the
internal auditor.

Weak Internal Control Processes
z Weak internal control processes or failure of

top management to participate actively in
developing and overseeing internal control.
z Lack of a corporate code of conduct with no
related employee training and awareness.

Management Style
z Excessive pressure on employees to perform.
z Excessive focus on short-run performance, which
could cause employees to cheat to achieve goals.
z Excessively authoritarian style that can cause
employees to blindly agree to participate in fraudulent
schemes.
z Excessive decentralization resulting in too lax
management.
z Crisis management.
z Missing or poor strategic and operational planning.
Personnel-Related Practices
z High employee turnover, especially among top

management.
z Hiring unqualified employees or hiring without
screening the background of potential
employees.
z Inexperienced top management.
z Inadequate employee compensation.
z Low employee morale.

Accounting Practices
z Restatements of prior year reports.
z Aggressive accounting methods (discussed later).
z Weak audit trails.
z Losses of accounting records.
z Weak or poorly organized accounting information system.
z Overly optimistic or inadequate budgets.
z Arguments with auditors or lack of cooperation with auditors or the
audit committee.
z Late or last-minute financial reports.
z Large or unusual end-of-year accounting adjustments or
transactions.
z Frequent changes of the external auditor.
z Large or frequent accounting errors
Company’s Financial Condition
z Deterioration in the company’s financial condition
associated with a large percentage of financial
statement frauds. Extremely high earnings or sudden
increases in earnings.
z Declining net income.
z Declining cash flows from operations or low cash flows
relative to net income.
z Declining sales or market shares.
z Increases in debt leveraging.
z Inadequate liquidity.
z Product obsolescence.
Company’s Financial Condition
z Lagging collections in accounts receivables.
z Tax problems.
z Serious legal or contractual problems.
z Significant failure to meet analysts’ earnings
expectations.
z Doubt about the company’s ability to remain a going
concern.
z Insider sale of stock shares.
z Excess accumulation of inventory relative to sales.

Management Discretion, Earnings Management, And
Earnings Manipulation
z Management Discretion. GAAP give

accountings choices in their selection of
accounting methods. Managers have discretion
to select the methods they prefer. For example,
managers may choose LIFO or FIFO inventory
methods. Managers also have financial
discretion. For example, they have the
discretion to defer a given expense to
sometime in the future.

Management Discretion, Earnings Management,
And Earnings Manipulation
z The term earnings management is used

frequently confused with earnings
manipulation. The term earnings
management refers to management’s routine
use of non-fraudulent accounting and
economic discretion.

Management Discretion, Earnings Management,
And Earnings Manipulation
z Earnings manipulation has a more nebulous

meaning. It can refer either to the legitimate or
aggressive use, or fraudulent abuse, of
discretion. By definition, then, earnings
management is legitimate, and earnings
manipulation can be legitimate, marginally
ethical, unethical, or illegal, depending on its
extent.

Earnings Smoothing and Earnings
Management
z Earnings smoothing is the manipulation of earnings to reduce

their volatility. In simple terms, this means using manipulations to
increase earnings in years when they are weak and to lower them
in years when they are strong.
z It’s very well known on Wall Street that investors prefer steadily
increasing earnings that consistently meet or exceed financial
analyst expectations. This stems from the general economic
principle that investors are risk averse.
z In financial terms, risk aversion is associated with earnings
volatility.

Cookie Jar and Big Bath Accounting
z Cookie Jar Accounting One type of earnings management and

earnings manipulation. The practice treats the balance sheet as a
cookie jar: In good years, the company stores cookies (reserves)
in the cookie jar (the balance sheet) so that it can take them out
and eat them (place them on the income statement) when
management is hungry (needs extra income to look good).
z Big-Bath Accounting When a company makes a large one-time

write off, it is said to take a big bath to improve future earnings.
Many companies take a big bath (often in the form of restructuring
or inventory write-downs) when earnings performance is already
poor.
Cases of Financial Statement Fraud and
Manipulation
z McKesson & Robbins: Financial Statement Fraud 101.

z The Great Salad Oil Swindle
z Equity Funding: They Made a Movie about It
z Cedant Corporation: Manufacturing Revenues
z Zzzz Best: The Teenager Who Fooled Wall Street
z Sunbeam Corp.: Channel Stuffing
z Nortel: The Ultimate Big Bath
z WorldCom: Boosting Earnings in a Big Way
z Enron: Lessons in Creative Accounting
z Qwest and Global Crossing: Swap Sales

Ethical Standards
z American Institute of Certified Public Accountants
(AICPA) adopted first code of ethics in 1917.
z The Institute of Management Accountants (IMA) first
issued its “Standards of Ethical Conduct for
Management Accountants” in 1983.
z The Financial Executives Institute (FEI) first issued its
“Code of Ethics” in 1985.
z Ethiopian Professional Association of Accountants and
Auditors adopted first code of conduct in 1973/74
[EPAAA]

Significant Events in
Establishment of Ethical Standards
z The Seaview Symposium of 1970

z The Equity Funding Fraud of 1973
z Action by IMA in 1983
z Action by FEI
z Treadway Commission Recommendations

The Equity Funding Fraud
z In 1973, a major fraud was discovered at

equity funding corporation of America
(equity), a seller of mutual fund shares
that were pledged by the investors to
secure loans to finance life insurance
premiums. During the nine-year period,
at least $143 million of fictitious pretax
income was generated.
The Equity Funding Fraud
z A period in which the equity reported a total net

income of $ 76 million, instead of the real
pretax losses totaling more than $ 67 million.
z The fraud was carried out by at least 10
executives of equity, including the chief
executive officer (CEO), chief financial officer
(CFO), controller, and treasurer.
z Several of the executives were CPAs with
public accounting experience.
Treadway Commission
z The National Commission on Fraudulent

Financial Reporting.
z Sponsored by the AICPA, IMA, FEI, the
American Accounting Association, and the
Institute of Internal Auditors.
z Defined “Fraudulent Financial Reporting” as
“intentional or reckless conduct, whether act or
omission, that results in materially misleading
financial statements.”
Treadway Commission
z The Treadway Commission made 49

recommendations for curbing such
reporting.
z The recommendations dealt with the
public company; the independent public
accountant; the SEC, financial institution
regulators, and state boards of
accountancy; and education.
Treadway Commission
z The responsibility for reliable financial

reporting resides first and foremost at the
corporate level.
z Public companies should maintain
accounting functions that are designed to
meet their financial reporting obligations.

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Analysis of Ethical Standards For
Management & Financial Execs.
z The ethics pronouncements of IMA, FEI

and AICPA have several similarities.
z All three require members to be
competent, act with integrity and
objectivity, maintain confidentiality of
sensitive information, and avoid
discreditable acts.
z TheIMA & AICPA codes specifically

prohibit conflicts of interest, but the
FEI code only indirectly addresses
such conflicts in its confidentiality
provision.

z Only IMA and FEI codes specifically

require communication of complete
information to users of their
members’ reports; AICPA members
are indirectly comparably obligated
by rule 202.

z The IMA standards in essence

require members to report violations
of the standards by members of their
organization to responsible officials
of the organizations. The FEI and
AICPA codes have no such
requirements.
z The FEI code requires members to

conduct their personal, as well as
their business affairs with honesty
and integrity. The IMA and AICPA
standards do not address personal
affairs.

Conflict of Interest
z Conflictof Interest results when

individuals reap inappropriate
personal benefits from their acts in
an official capacity.

Conflict of Interest
z For example, a chief accounting officer might

cook the books to overstate pretax income of
the employer corporation in order to obtain a
larger performance bonus.
z The controller of a publicly owned corporation
might involve in “insider trading” to maximize
gains or minimize losses on purchase or
sales of the employer corporation securities.
Discreditable Acts
z None of the three codes defines

“Discreditable Acts”.
z The term can not be adequately defines
or circumscribed.
z A discreditable act to one observer might
not be so construed by another.

Some Observations
z The number of SEC proceedings

against reporting companies from
1981 to 1986 was less than 1% of
the number of financial reports filed
with the SEC during that period.

Some Observations
z The Chairman of the Federal Deposit
Insurance Corporation contended that
management fraud (presumably including
cooking the books) contributed to one-
third of bank failures.
z 10% of total bankruptcies in a study
authorized by the Treadway Commission,
involved fraudulent financial reporting.
Some Observations
z Former SEC Chairman John Shad

estimated that all fraudulent securities
activities amount to a fraction of 1% of
the $50 billion of corporate and
government securities traded daily.

Some Observations
z Thus, cooking the books, though

serious and despicable, apparently do
not indicate a wholesale breakdown of
ethical conduct by management
accountants and financial executives
of business enterprises.

Some Observations
z Can the codes of conduct for

management accountants and financial
executives established or revised by IMA,
FEI and AICPA help those key players in
corporate financial reporting to resist
pressures, often from top management
but sometimes from within themselves, to
falsify financial statements and reports?
Accounting and
Ethical Conduct
Some Types of Unethical Conduct
z Abuse of accounting information

z Acceptance of bribes or gifts
z Conflict of interest
z Disclosure of confidential information

Standards of Ethical Conduct for
Accountants
z Competence
z Confidentiality
z Integrity
z Objectivity

Competence
Accountants have a responsibility
to
z Maintain professional competence.

z Perform professional duties in accordance with
relevant laws, regulations, and technical
standards.
z Prepare complete and clear reports and
recommendations.

Confidentiality
to
z Refrain from disclosing confidential information.

z Inform subordinates as to how to handle
confidential information.
z Refrain from using confidential information for
unethical or illegal advantage.

Integrity
to
z Avoid conflicts of interest.

z Refrain from activity that would prejudice their ability to
carry out their duties ethically.
z Refuse gifts, favors, or hospitality that would influence
their actions.
z Refrain from subverting attainment of the organization’s
legitimate and ethical objectives.

Integrity (continued)
to
z Recognize and communicate professional

limitations that would preclude responsible
judgment.
z Communicate unfavourable as well as
favourable information.
z Refrain from engaging in or supporting any
activity that would discredit the profession.

Objectivity
to
z Communicate information fairly and objectively.

z Disclose fully all relevant information that could
reasonably be expected to influence user's
understanding of the reports, comments, and
recommendations presented.

Professional Ethics
Ethical business practices build trust and

promote loyal, productive relationships with
customers, employees and suppliers.
Many companies have written codes of ethics
which serve as guides for employees to follow.

EPAAA: Code of Ethics
z The word “ethics” in general usage means the philosophy of
human conduct with emphasis on “right” and “wrong” which are
moral questions.
z “Right action” for a professional will of course include conformity
with moral standards, but will also include behavior designed for
practical as well as idealistic purposes.
z A code of professional ethics may be designed in part to
encourage ideal behavior but basically such a code is intended to
be enforceable.
z It should be at a higher level than the law but it must be at a lower
level than the ideal.
z It is a practical working tool.

z “Professional ethics” therefore, may be

regarded as a mixture of moral and practical
concepts all reduced to rules which are
intended to be enforceable, to some extent at
least, by disciplinary action.

z A member of the Ethiopian Professional Association of
Accountants and Auditors shall at all times maintain:
1. independence of thought and action,
2. hold the affairs of his clients in strict confidence,
3. strive continuously to improve his professional skills,
4. observe prescribed auditing standards,
5. promote sound and informative financial reporting,
6. uphold the honor and dignity of the accounting
profession, and
7. maintain high standards of personal conduct.
10
Ethiopian Code of Ethics for Professional Accountants
Issued by Office of Federal Auditor General (OFAG)
(January 2004)
The Objectives of the Accountancy

Profession
z The Code recognizes that the objectives of the
accountancy profession are:
– to work to the highest standards of professionalism,
– to attain the highest levels of performance and
generally
– to meet the public interest, honor public trust, and
demonstrate commitment to professionalism
10
Four basic needs to be met:
z Credibility: In the whole of society there is a need for credibility in
information and information system. It is essential that the
information be considered to be thoroughly accurate, reliable and
viewed as impartial.
z Professionalism: There is a need for individuals who can be
clearly identified by clients, employers and other interested parties
as professional persons in the accountancy field.
z Quality of services: There is a need for assurance that all
services obtained from professional accountant are carried out to
the highest standards of performance.
z Confidence: Users of the services of professional accountants
should be able to feel confident that there exists a framework of
professional ethics, which governs the provision of those services.
10
Basic Principles
z Integrity: A professional accountant should be

straightforward and honest in performing professional
services.
z Objectivity: A professional accountant should be fair
and should not allow prejudice or bias, conflict of
interest or influence of others to override objectivity.
z Independence: Professional accountants working in
attestation function should be independent of their
clients and maintain an independent attitude.
10
Basic Principles
z Professional Competence and Due Care: A professional

accountant should perform professional services with due
care, competence and diligence and has a continuing duty to
maintain professional knowledge and skill at a level required
to ensure that a client or employer receives the advantage of
competent professional service based on up-to-date
developments in practice, legislation and techniques.
z Confidentiality: A professional accountant should respect the

confidentiality of information acquired during the course of
performing professional services and should not use or
disclose any such information without proper and specific
authority or unless there is a legal or professional right or
duty to disclose.
10
Basic Principles
z Professional Behavior: A professional accountant

should act in a manner consistent with the good
reputation of the profession and refrain from any
conduct, which might bring discredit to the profession.
The obligation to refrain from any conduct which might
bring discredit to the profession requires IFAC member
bodies to consider, when developing ethical
requirements, the responsibilities of a professional
accountant to clients, third parties, other members of
the accountancy profession, staff, employers, and the
10 general public.
Professional Code of Ethics applicable to auditors only
Issued by the OFAG (August 2008)
Fundamental Principles
z Integrity (Propriety): Auditors should maintain a high
standard of professional and personal conduct in performing
their audit work and in their relationships with staff of audited
bodies.
z Independence: Auditors should be independent of the
audited body and maintain an independent attitude.
z Objectivity/Impartiality: Auditors must be fair and must not
allow prejudice or bias to override their objectivity. They
should carryout their work impartially and objectively.
10
Fundamental Principles [Cont]
z Professional Competence/Professional development: An
auditor has a duty to maintain high level of competence
throughout his/her professional career. He/she should only
undertake work, which he/she or the OFAG can expect to
complete with professional competence.
z Confidentiality: Auditors should respect the confidentiality
on information required in the course of their work and
should not disclose any such information to a third party
without specific authority or unless there is a legal or
professional duty to disclose.
10
z Political neutrality: To maintain both actual and perceived
political neutrality of the OFAG, and to maintain their
independence from political influence and discharge their
duties in an impartial way the Auditor General, Deputy
Auditor General, executive officers and all auditors should
not be involved in a partisan politics.
z Conflict of Interest: Conflict of interest involving an auditor
and an audited organization must always be avoided.
z Reasonable care: Auditors should take all reasonable care in
planning and carrying out their audit work in gathering and
evaluating evidence and in reporting audit findings.
10
z Constructiveness: Auditors should adopt a

constructive and positive approach to their
work and relationships.
z Economy, Efficiency and Effectiveness of
operations: Auditors should seek to improve
the economy, efficiency and effectiveness with
which the office uses its own resources in
carrying out its work.
10
Office of Federal Auditor General
z Vision:
– To strengthen the
z performance,
z transparency,
z democratization process,
z accountability as well as
z the good governance of the Federal Government
for the benefit of the Ethiopian people.
11
Office of Federal Auditor General
z Core Values:
– Professional independence
– Transparency and integrity
– Professional competence and quality of work
– Good ethical behavior
– Strengthening accountability
– Professional confidentiality
– Efficient and timely service delivery
– To see proper utilization of country’s scarce
11 resources
Federal Ethics and Anti-Corruption
Commission [FEAC]
z Objectives:
– In cooperation with relevant bodies, to strive to
create an aware society where corruption will not be
condoned or tolerated by promoting ethics and anti-
corruption education,
– in cooperation with relevant bodies, to prevent
corruption offences and other improprieties,
– To expose, investigate and prosecute offences and
impropriety.
11
IFAC: Code of Ethics
z The objectives of the accountancy profession

are:
z to work to the highest standards of
professionalism,
z to attain the highest levels of performance, and
z to meet the public interest requirement
z These objectives require four basic needs to
be met:
11
z Credibility: In the whole of society there is a need for credibility
in information and information systems.
z Professionalism:There is a need for individuals who can be
clearly identified by clients, employers and other interested parties
as professional persons in the accountancy field.
z Quality of Services:There is a need for assurance that all
services obtained from a professional accountant are carried out
to the highest standards of performance.
z Confidence:Users of the services of professional accountants
should be able to feel confident that there exists a framework of
professional ethics which governs the provision of those services.
11
In order to achieve the objectives of the
accountancy profession, professional accountants
have to observe a number of prerequisites or
fundamental principles:
z Integrity
z Objectivity
z Professional Competence and Due Care
z Confidentiality
z Professional Behavior
11
Proclamation No. 1/1995
Conduct and Accountability of Government

[Art. 12]
– The conduct of affairs of government shall
be transparent
– Any public official or an elected
representative is accountable for any failure
in official duties
– ……
11
Important Websites Relating to
Ethics
z http://www.imanet.org
z http://www.ifac.org
z http://www.oagethiopia.gov.et
z http://www.feac.gov.et
z http://www.transparency.org
z http://www.transparencyethiopia.org
z http://www.ethiopar.net
11
Some Related Proclamations:
z No. 235/2001: Federal Ethics and Anti-Corruption

Commission,
z No. 236/2001: Anti-Corruption Special Procedure
and Rules of Evidence,
z No. 239/2001: Anti-Corruption Procedure and Rules
of Evidence [Amendment],
z No. 77/2002: Federal Civil Servants Disciplinary
and Grievance Procedure …
z No. 262/2002: Federal Civil Servants Proclamation
11

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Addis Ababa University

School of Business & Public Administration

Module Title: Advanced Financial Accounting & Auditing

ACFN 611: Advanced Financial Accounting and Auditing

Ethical Issues and Financial Statement

ACFN 611: Advanced Financial Accounting and Auditing

The main objectives of the chapter Ethical Issues in

ACFN 611: Advanced Financial Accounting and Auditing

5. To compare the IMA, FEI, and AICPA ethics pronouncements for

6. To consider the effectiveness of IMA, FEI, AICPA, EPAAA and

7. To consider the relevant points of the Proclamations No.

ACFN 611: Advanced Financial Accounting and Auditing

z Why need ethical conduct in accounting?

ACFN 611: Advanced Financial Accounting and Auditing

Why should an accountant get involved in this

ACFN 611: Advanced Financial Accounting and Auditing

z First, some moral beliefs one holds may be

ACFN 611: Advanced Financial Accounting and Auditing

z Second, in some situations, because of

ACFN 611: Advanced Financial Accounting and Auditing

z Third, individuals may hold some inadequate beliefs or

ACFN 611: Advanced Financial Accounting and Auditing

z A fourth, and very important, reason to study ethics is

z The philosopher Socrates is known for showing that

ACFN 611: Advanced Financial Accounting and Auditing

z As an accountant, what are your basic goals in life?

z If you need to choose between keeping a job and

ACFN 611: Advanced Financial Accounting and Auditing

z A final reason for studying ethics is to learn to

z That should help develop the skill of

ACFN 611: Advanced Financial Accounting and Auditing

z Critics have alleged that ethical standards of

ACFN 611: Advanced Financial Accounting and Auditing

Bell said a professional: – Exhibits ethical

ACFN 611: Advanced Financial Accounting and Auditing

McDonald proposed a different, but related, set

ACFN 611: Advanced Financial Accounting and Auditing

Houle focused on the process of becoming a

ACFN 611: Advanced Financial Accounting and Auditing

Schools of ethical thought

ACFN 611: Advanced Financial Accounting and Auditing

Institute of Management Accountants

ACFN 611: Advanced Financial Accounting and Auditing

– Comply with lawful court

ACFN 611: Advanced Financial Accounting and Auditing

American Institute of CPAs – General Standards

ACFN 611: Advanced Financial Accounting and Auditing

Langenderfer and Rockness proposed an

ACFN 611: Advanced Financial Accounting and Auditing

Langenderfer and Rockness (continued)

ACFN 611: Advanced Financial Accounting and Auditing

Langenderfer and Rockness (concluded)

ACFN 611: Advanced Financial Accounting and Auditing

ACFN 611: Advanced Financial Accounting and Auditing

ACFN 611: Advanced Financial Accounting and Auditing

z Enron – Stock price increased 20

ACFN 611: Advanced Financial Accounting and Auditing

ACFN 611: Advanced Financial Accounting and Auditing

z Misstatements in financial statements.

ACFN 611: Advanced Financial Accounting and Auditing