ACCG835

International Accounting

Week 3 – Ethical Behaviour in Accounting

1
Announcements
• Test 1 is next week in class.

• The Group Preference form is now up on iLearn.

Complete and bring to class in Week 5.

2
Why is ethical behavior important
• Accountants are professionals with high standing in society
• Role of accounting is critical within any organisation.
• Decisions about resource allocation are based on accounting numbers.
If numbers are wrong then there will not be an efficient allocation of
resources.
• Unethical behavior may undermine the firm and jeopardize its future.
• May ruin the career of a professional.
• Can undermine faith in the financial system and cause instability
within markets.
• Ethical behavior inspires others to act in a similar way.
• Being ethical is important as it is the ‘right thing to do’.

3
Codes of Conduct
• International
– International Federation of Accountants (IFAC) “Code of Ethics for Professional
Accountants” located at www.ifac.org
– Prepared by the International Ethics Standards Board for Accountants (“IESBA”),
an independent standard-setting body within IFAC.

• Australia
– Australian Professional Ethics Standard (APES) 110 Code of Ethics for
Professional Accountants.
– Issued by the independent Accounting Professional and Ethical Standards Board
(APESB). Based on IFAC standard.
– APES 110 is mandatory to members of both CPA Australia (CPAs) and the
Institute of Chartered Accountant’s in Australia (CA).

4
Fundamental principles of professional ethics
• IFAC Code has 5 fundamental principles.

1. Sec. 110 Integrity

– Be straightforward, honest and sincere in professional and business relationships.
– Be fair and truthful.

2. Sec. 120 Objectivity

– Professional and business judgement cannot be compromised because of bias,
conflict of interest or the undue influence of others.

3. Sec. 130 Professional Competence and Due Care

– Must attain and maintain professional and technical knowledge for clients or
employers.
– Requires diligence and appropriate training and supervision.

5
Fundamental principles of professional ethics

4. Sec. 140 Confidentiality

– Must not disclose outside of the firm, confidential information acquired as a result
of professional or business relationships, unless the client or employer authorises it
or there is a legal duty to disclose it.
– Cannot use confidential information for personal benefit or to benefit third parties .

5. Sec. 150 Professional Behavior

– Members must comply with relevant laws and regulations.
– Must avoid action or omission which may discredit the image of the profession.

6
Threats to members in practice or business
• Compliance with principles may be undermined by the following 5
threats (sec 100.12).

1. Self-Interest Threat
– may occur as a result of the financial or other interests of a member or of an
immediate or close family member. e.g.
• A direct material interest in an audit client.
• A loan from a client.

2. Self-Review Threat
– may occur when a previous judgment needs to be reevaluated by the member
responsible for that judgment. e.g.
• An audit team member having recently been a director of the audit client.

7
Threats to members in practice or business
3. Advocacy Threat
– may occur when a member promotes a position or opinion to the point that
subsequent objectivity may be compromised. e.g.
• Dealing in or promoting shares in the audit client.

4. Familiarity Threat
– may occur when, because of a close relationship, a member becomes too
sympathetic to the interests of others. e.g.
• An audit team member has a family member who is a director of the audit client.
• Acceptance of a gift or preferential treatment.

5. Intimidation Threat
– may occur when a member may be deterred from acting objectively by threats,
actual or perceived. e.g.
• Threat of replacement over a disagreement with the application of an accounting principle.
• A dominant personality attempting to influence the decision making process, such as the awarding of
contracts.

8
Ethics in a global environment
Relativism perspective
• the argument that what is right and wrong depends on the individual,
time, and circumstance.
• Advantage: Allows for flexibility in ethical judgements and avoids
imposing values on other people.
• Disadvantage: Culture can be used as an excuse for not following
internationally acceptable practice.
• e.g. Paying money to people to ‘get things done’ in my country is
acceptable as this has been part of our culture and our way of doing
business.

9
Ethics in a global environment
Universalism perspective
• there are rights and wrongs that apply to all societies, regardless of
culture, level of development etc.
• Advantage: Allows for consistency in behaviour and upholds
fundamental rights.
• Disadvantage: can be inflexible and ignore the values of other
people/cultures who may think differently.
• e.g. Bribery is fundamentally wrong as it provides an unfair advantage
to parties and can never be justified under any circumstance.

10
Ethics theory classification
• Prescriptive principles or rules for determining right from wrong

Teleological or Consequential Ethics

– The consequences of a decision or action is the sole determinant of whether it is
right from wrong.
– A morally correct action occurs when benefits outweigh costs.
– How you get to the result is less important than what is the outcome.
– e.g. telling a lie is OK if people benefit at the end of the day.

Deontology or Non-Consequential Ethics

 Consequences are not important.
 The intention to do the right thing is more important than the final result.
 One does the right thing because it is the “right thing to do”.
 Following the right process is more important than the end result.
 e.g. telling a lie is never OK regardless whether people are better off or not.

11
Ethical Decision Making Example – (to be completed in class)

Jenny works as an accountant at a local firm. During a stocktake audit at one of the clients at year end,
she uncovers a problem where boxes which were supposed to have contained inventory, contained
instead sand. Jenny brought the matter up with the Managing Director Steven. Steven suggested to
Jenny that if she kept quiet about the sand in the boxes, he would pay her $10,000. He would dispose
of the boxes of sand, and in the future the problem would not re-occur, and nobody would know any
difference. “If I pay you $10,000, you could sign off on the accounts, the boxes of sand would
disappear, it would not happen again, and you would be $10,000 richer. Nobody else would need to
know, and we would both be better off for it” stated Steven. ‘Of course we could always hire another
audit firm if you didn’t agree’. Jenny is considering the offer.

Required

1.Use the issues listed in the ‘ethical conflict resolution’ section (sec 100.18) of the IFAC
Code of Ethics to address the ethical dilemma.
2.Assuming that Jenny chose to reject the $10,000 bribe. What may be her justification for
doing so under the teleological perspective as opposed to the deontological perspective?

12
Ethical Decision Making Example - Solution
1.

Step 1 - What are the relevant facts of the case?

 There is a deliberate inventory error.
 There are one or more employees who are dishonest.
 Jenny has been offered a bribe.
 The shareholders will have their accounts misstated.

Step 2 - What are the ethical issues involved in the case?

 Jenny has been offered a bribe.
 It is wrong to deliberately falsify accounts.
 Bribery contravenes professional requirements and may result in criminal action.

Step 3 - What are the fundamental principles related to the case and the threats to
those principles?
 Section 110 – Integrity. In considering the bribe, Jenny would not be straightforward,
honest and sincere in her work. This would not be fair to others and would be untrue.

13
Ethical Decision Making Example - Solution
Step 3 - continued
 Section 120 Objectivity - Jenny would have a conflict of interest and would be biased in
being subject to the influence of Steven and in signing the accounts as correct.
 Section 150 - Professional Behavior – Jenny’s conduct would discredit the image of the
profession.
 Jenny faces an ‘intimidation’ threat.

Step 4 - What are established internal procedures which might represent safeguards against
the threats?
Inventory transactions usually require two signatures.
Jenny can get advice from the audit partner.
Jenny can inform the Board of Directors or the Audit Committee.
Jenny can report the matter to the regulatory authorities.

Step 5 - What are the alternative courses of action?

Accept the bribe – may or may not be caught.
Investigate the matter - Is it part of a wider problem?
Reject the bribe- clear conscience. Report the matter.

14
Ethical Decision Making Example - Solution

2.

Teleological Ethics
 Jenny believes that the costs of bribery (the harm to her career and possible jail time for having
the bribe uncovered) far outweigh the monetary benefits obtained, so she rejects the bribe.
 Consequences of rejection are that investors would not lose their money and she could inform
the Board of Directors about Steve, who would get the sack.

Deontological Ethics
Jenny believes that bribery is fundamentally wrong and dishonest regardless of the consequences.
Even if nobody found out about the bribe and even if the company survived and kept on making money
it would still be wrong.
She would not want to have someone steal resources from her so why would she partake in such
behaviour?

15
 Ethics in a global environment
• Apart from academic studies, a measure of cross country ethical behaviour is the
Corruption Perceptions Index (CPI) by ‘Transparency International’ (see 2015 report
next page).
• Examines ‘degree to which corruption is perceived to exist among public officials and
politicians’.
• Data sourced from many institutions:
– Columbia University, Economist Intelligence Unit, Freedom House, Information International, International
Institute for Management Development, Merchant International Group, Political and Economic Risk
Consultancy, United Nations Economic Commission for Africa, World Economic Forum and World Markets
Research Centre.
• Public opinions no longer used.
• Criticisms include
– use of third party data,
– yearly changes in methodology, and
– what constitutes ‘corruption’?.

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Ethics in a global environment
Corruption Perceptions Index
Rank CPI 2015 Country

To what degree 1
2
91
90
Denmark
Finland
do you think this 3 89 Sweden
4 88 New Zealand
table reflects 5 87 Netherlands

reality? 7
8
86
85
Switzerland
Singapore
9 83 Canada
10 81 Germany

Yes/No? 10 81 United Kingdom

13 79 Australia
Remember it is 13 79 Iceland
15
based on
77 Belgium
16 76 Austria

perceptions as 16
18
76
75
The United States Of America
Hong Kong

opposed to actual 18
18
75
75
Ireland
Japan
cases of 30 62 Taiwan
54 50 Malaysia
corruption. 76 38 India
76 38 Thailand
83 37 China
88 36 Indonesia
112 31 Vietnam
167 8 Korea (North)
167 8 Somalia

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Ethics in a global environment
• A similar index (not shown) is the Bribe Payers Index (BPI). Asks
over 11,000 business executives from over 120 countries to;
1. identify the country of origin of foreign-owned companies doing
the most business in their country, and
2. extent to which firms from the countries you have selected make
undocumented extra payments or bribes.
• Where 1 is common (or even mandatory) and 10 (bribes are
unknown).

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Creative accounting
• Distort "financial reality" to suit the client.
• Also called “earnings management” or “aggressive accounting”.
• Transactions often fall into ‘grey areas’ whereby;
– they are not covered by particular accounting standards,
– reliance is placed on Generally Accepted Accounting Principles (GAAP) which
may not be mandatory,
– existing standards are not explicit about how a transaction is to be handled.

• Can be changes in accounting policy through;

– Manipulation of GAAP (mild form creativity), or
– Fraudulent transactions (extreme form creativity)

• When making an ethical judgment it is important that accountants use ‘professional

judgement’, and examine the economic ‘substance’ or spirit of a transaction or
relationship, as opposed to its ‘legal’ form or matter.

19
Creative accounting
• Why is it undertaken?
• Companies may wish to ‘income smooth’
– Indicates better stewardship and lowers share price volatility.
• Companies may wish to increase earnings
– Improves managerial bonuses and reduces debt/equity ratio.
• Companies may also wish to decrease earnings
– Political Cost hypothesis. Politically sensitive industries do not like unwarranted
attention.
– Companies can dump discretionary expenses (i.e. write-off goodwill) into one year,
called “big bath” if they know they will have a loss anyway. In future years profits
are therefore increased.

• Example: "BIG BATH" by News Corporation:

– record loss in 2002 $11.7 billion. Included investment write-offs (expensing) of $13.2 billion in
assets associated with its Gemstar TV/Satellite services in Asia.
– What happened to News Corp in 2003?
– Profit of $1.8 billion!!.

20
How is creative accounting undertaken?
• Asset or Revenue Overstatement
– Companies may wish to ‘income smooth’
– Capitalise (asset) instead of expensing costs. Also reported on investing rather than operating
cash flows.
– software development,
– research and development.
– Book premature revenue in the current year.
– Recognising revenue prior to goods shipped.
– Change inventory valuation methods.
– Extended amortisation periods for long life assets.

• Liability or Expense Understatement

– Delay inventory write-down (obsolescence).
– Cookie Jar Reserves – accrue operating expenses and create liability accounts in good years, in
order to reduce future years operating expenses in years where profit is not so good.
– Failure to provide for accurate bad and doubtful debts i.e. 2% instead of 5%.

21
How is creative accounting undertaken?
• Disclosure of transactions or events
– "Materiality" defined in terms of impact on decisions.
– professional judgment b/w 5%  10%.
– Format & use of graphs and pictures.

22
Conclusion
• Ethics are beliefs about how people ‘should’ behave.
• Ethical behavior is critical to the overall function of international
accounting.
• Should use ‘substance over form’ when looking at ethical issues.
• People deal with ethical issues differently. Some are more inclined to
‘whistle blow’ than others.
• Should use principles and methods as a guide for avoiding and
resolving ethical conflict.
• Cannot assume IASB and IFAC standards are neutral & value-free.
• Differences in judgment have effects on Big 4 ‘accounting firms’ and
MNCs who may have a single global audit procedure and codes of
professional conduct. How are these interpreted?

23
Criticisms of Hofstede

1. Study is dated
• Data undertaken between 1968-1972.
• World is a different place now.
• Difficult to see culture as static. It is dynamic, multicultural etc.
2. Survey questions constructed from a western mindset
• Survey of IBM - a unique western multinational.
• Alternate Chinese Value Survey (CVS) has a Chinese bias. CSV found
uncertainty avoidance was unique to western society.
» Chinese Culture Connection (1987), “Chinese Values and the Search for Culture
Free Dimensions of Culture”, Journal of Cross - Cultural Psychology, pp.143 –
164.
» Confucianism is important in understanding Chinese culture.

3. Alternative dimensions are ignored

• Emotion is excluded from survey as linear scaling precludes other value
constructs. i.e either one or other.

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Influences on Accounting Development
» It is still useful. The culture connotation cannot be changed through a short
period. The later IBM researches have proved the relevant dimensions.

» Level of economic development – affects types of business transactions and

therefore the accounting issues faced. US spends a lot on accg practices, it has
comprehensive standards.
» Culture and Religion – values and shared attitudes/beliefs. China doesn’t allow
FV since its conservative culture
» History – can influence accounting standards/practices adopted. Au was colony
of UK. Still employing a similar accg standrads.

25
 Figure 11: Hypothesized relationships between Hofstedes cultural values and
Gray’s accounting values
Power Uncertainty
Individualism Distance Short/long Masculinity
Avoidance
Cultural Dimensions G Japan G Japa G Japan G Japan G Japan
n

Professionalism High Low Low Low High √

Statutory control Low √ High √ High √ High Long L

Uniformity Low √ High √ H √

Flexibility High Low L

Conservatism Low √ H √ H √ H √
Optimism High L Low L

Secrecy Low High √ High √ High √ L

Transparency High Low L L H √

26
 Example: Assigning Values to Hofstede’s
Data

To make the Gray model workable, we must assign the

Hofstede data to a high or low value. (Note: the five scales do not
have the same ranges or averages.)
USA JAPAN
Power 40 Low 54 High
Individuality 91 High 46 Low
Uncertainty 46 Low 92 High
Masculinity 62 High 95 High
Short/Long 29 Short 80 Long
. 27
. 28
Fundamental principles of professional ethics
• IFAC Code has 5 fundamental principles.

1. Sec. 110 Integrity

– Be straightforward, honest and sincere in professional and business relationships.
– Be fair and truthful.

2. Sec. 120 Objectivity

– Professional and business judgement cannot be compromised because of bias,
conflict of interest or the undue influence of others.

3. Sec. 130 Professional Competence and Due Care

– Must attain and maintain professional and technical knowledge for clients or
employers.
– Requires diligence and appropriate training and supervision.

29
Fundamental principles of professional ethics

4. Sec. 140 Confidentiality

– Must not disclose outside of the firm, confidential information acquired as a result
of professional or business relationships, unless the client or employer authorises it
or there is a legal duty to disclose it.
– Cannot use confidential information for personal benefit or to benefit third parties .

5. Sec. 150 Professional Behavior

– Members must comply with relevant laws and regulations.
– Must avoid action or omission which may discredit the image of the profession.

30
Threats to members in practice or business
• Compliance with principles may be undermined by the following 5
threats (sec 100.12).

1. Self-Interest Threat
– may occur as a result of the financial or other interests of a member or of an
immediate or close family member. e.g.
• A direct material interest in an audit client.
• A loan from a client.

2. Self-Review Threat
– may occur when a previous judgment needs to be reevaluated by the member
responsible for that judgment. e.g.
• An audit team member having recently been a director of the audit client.

31
Threats to members in practice or business
3. Advocacy Threat
– may occur when a member promotes a position or opinion to the point that
subsequent objectivity may be compromised. e.g.
• Dealing in or promoting shares in the audit client.

4. Familiarity Threat
– may occur when, because of a close relationship, a member becomes too
sympathetic to the interests of others. e.g.
• An audit team member has a family member who is a director of the audit client.
• Acceptance of a gift or preferential treatment.

5. Intimidation Threat
– may occur when a member may be deterred from acting objectively by threats,
actual or perceived. e.g.
• Threat of replacement over a disagreement with the application of an accounting principle.
• A dominant personality attempting to influence the decision making process, such as the awarding of
contracts.

32
Creative accounting
• Distort "financial reality" to suit the
client.
• Why is it undertaken?
• Companies may wish to ‘income smooth’
– Indicates better stewardship and lowers share price volatility.
• Companies may wish to increase earnings
– Improves managerial bonuses and reduces debt/equity ratio.
• Companies may also wish to decrease earnings
– Political Cost hypothesis. Politically sensitive industries do not like unwarranted
attention.
– Companies can dump discretionary expenses (i.e. write-off goodwill) into one year,
called “big bath” if they know they will have a loss anyway. In future years profits
are therefore increased.

33
How is creative accounting undertaken?
• Asset or Revenue Overstatement

• Liability or Expense Understatement

Irresponsible for the shareholders & company to provide untrue records.

investors may be misled to have wrong business decisions
Ethically wrong for own benefits
Breach the fundamental principle of integrity objectivity and pro
behaviour.

34
Ethical Decision Making Example - Solution
1.

Step 1 - What are the relevant facts of the case?

 There is a deliberate inventory error.
 There are one or more employees who are dishonest.
 Jenny has been offered a bribe.
 The shareholders will have their accounts misstated.

Step 2 - What are the ethical issues involved in the case?

 Jenny has been offered a bribe.
 It is wrong to deliberately falsify accounts.
 Bribery contravenes professional requirements and may result in criminal action.

Step 3 - What are the fundamental principles related to the case and the threats to
those principles?
 Section 110 – Integrity. In considering the bribe, Jenny would not be straightforward,
honest and sincere in her work. This would not be fair to others and would be untrue.

35
Ethical Decision Making Example - Solution
Step 3 - continued
 Section 120 Objectivity - Jenny would have a conflict of interest and would be biased in
being subject to the influence of Steven and in signing the accounts as correct.
 Section 150 - Professional Behavior – Jenny’s conduct would discredit the image of the
profession.
 Jenny faces an ‘intimidation’ threat.

Step 4 - What are established internal procedures which might represent safeguards against
the threats?
Inventory transactions usually require two signatures.
Jenny can get advice from the audit partner.
Jenny can inform the Board of Directors or the Audit Committee.
Jenny can report the matter to the regulatory authorities.

Step 5 - What are the alternative courses of action?

Accept the bribe – may or may not be caught.
Investigate the matter - Is it part of a wider problem?
Reject the bribe- clear conscience. Report the matter.

36
Ethical Decision Making Example - Solution

2.

Teleological Ethics
 Jenny believes that the costs of bribery (the harm to her career and possible jail time for having
the bribe uncovered) far outweigh the monetary benefits obtained, so she rejects the bribe.
 Consequences of rejection are that investors would not lose their money and she could inform
the Board of Directors about Steve, who would get the sack.

Deontological Ethics
Jenny believes that bribery is fundamentally wrong and dishonest regardless of the consequences.
Even if nobody found out about the bribe and even if the company survived and kept on making money
it would still be wrong.
She would not want to have someone steal resources from her so why would she partake in such
behaviour?

37