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THESIS

Laszlo Mindszenti 2014

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Corvinus University of Budapest Faculty of Business Administration Corvinus School of Management

Accounting ethics, education and professional legitimacy

Made by Laszlo Mindszenti Executive MBA

2014

Laszlo Peter Lakatos

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I hereby confirm that every text, figure and table is original and my own work and does not rely on any other document or contributor (except for parts with proper references, according to the thesis guide). Laszlo Mindszenti

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Table  of  contents Introduction  ...........................................................................................................................................................  2  Ethical  theories  in  business  and  accounting  .............................................................................................  6  Accounting  ethics  history  ............................................................................................................................  6  Business  ethics,  accounting  ethics  ............................................................................................................  7  Ethical  behavior  in  accounting  ..............................................................................................................  17  

Why  accountancy  and  accounting  activities  must  consider  ethics  ...............................................  21  The  Nature  of  Accounting  ........................................................................................................................  21  Accountants  as  professionals,  roles  and  responsibilities  ..............................................................  25  Auditing  functions  .......................................................................................................................................  28  Accounting  practices  ..................................................................................................................................  36  

Bookkeeping activities by the book  ....................................................................................................  36  Earnings Management and applying logical accounting policy  .............................................  37  Creative Accounting  ...............................................................................................................................  41  Accounting Fraud  ....................................................................................................................................  44  

Causes  of  fraud  .............................................................................................................................................  46  Exposition  of  the  central  subject  matter  .................................................................................................  50  Financial  reporting  standards  ................................................................................................................  50  Accounting  scandals  then  and  now  ......................................................................................................  54  Enron  –  Case  study  ......................................................................................................................................  59  Parmalat  –  Case  study  ...............................................................................................................................  64  Lehman  Brothers  –  Case  study  ...............................................................................................................  66  Regulatory  response  -­‐  The  Sarbanes–Oxley  Act  (SOX)  ..................................................................  70  Have  SOX  and  other  new  regulations  reached  its  target?  ...........................................................  73  Business/Accounting  Ethics  in  education  ..........................................................................................  78  

Summary  ..............................................................................................................................................................  82  Biography  ............................................................................................................................................................  90  Attachments  ........................................................................................................................................................  94    

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Introduction Three candidates are short listed for the accountant's job. They're all equally excellent,

experienced and personable, etc.

So the chairman asks each the simple question "what is two and two?"

- The first replies " Four"

- The second replies " Statistically anything between 3.999 and 4.0111"

- The third replies "Well, what do you want it to be?"

I suppose everybody heard some kind of similar jokes regarding accountants and even there is

a misperception that good accountant is the one who can manipulate company’s numbers in a

way that it pays less tax, or represents more profit if that is necessary. However, according to

noted professors and experts, the main objective of accounting principles is to give a ‘true

and fair view’ of a business’ financial performance and situation.1 In the US, the equivalent

concept states that financial statements must ‘present fairly’, in all material respects, the

financial position of the company and the results of the operations and the cash flows’. The

term ‘true and fair view’ does not represent an accounting principle per se but defines the

intent of the adoption of the principles.

Figure 1.

                                                                                                               1  Financial  Accounting  and  Reporting  -­‐  A  Global  Perspective,  2013,  Lebas,  Stolowy,  Ding,  p.  122  

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True means that the financial statements do not falsify or dissimulate the financial situation

of the company at period-end or its profits (or losses) for the period then ended.

Fair means that accounts give all users the same complete, unbiased and relevant information

for decision-making.

Andrew, a CFO at a public energy and commodity trading company is concerned that the

upcoming quarter numbers will not fulfill shareholders and the upper-level management

expectations after several growing and profitable periods. He informs Kenneth, the president

and Jeff, the CEO about his findings and projected the not too bright consequences of the

stock market reaction on such news. The CEO does not really understand how it could happen

when everything looks so nice and asks Andrew to make everything that is possible in order

to bring those numbers back to plans.

Andrew has a “creative” idea how to take some of the bad investments and debts out (hide) of

the company’s book but afraid that it is not entirely legal. At the same time he thinks this

approach could save his and thousands of other people’s jobs and investments.

Erin, a famous investment bank’s CFO is looking at the bank’s portfolio and starts worrying

about a significant part of the bank’s assets as they turned to be bad ones. He talks to the

CEO, Dick, about the problem. After further discussions they agreed that any disclosure of

these results could cause serious problems in terms of the Bank’s results and reputation.

Erin takes a closer look into the accounting and reporting obligations (standards) and figured

it out a “legal solution”. In case the bank applies some repurchase agreement (repo) they can

manage to reduce leverage on the right-hand side of the balance sheet and, at the same time,

reduce assets (some of them undesirable) on the left-hand side. Dick and Erin are fully aware

that they are going to mislead the public but their trick is totally legal and not against any of

the current regulations.

In these unstable times every penny counts and a lot can be at stake when a company is

struggling to survive. Sometimes the pressure gets too much. Situations like the ones above in

a certain extent (hopefully less extent) happen every day. Most accountants in business and

the public sector, whether they are management accountants, tax accountants, auditors,

working in a small organization or serving as the chief financial officer (CFO) of an

international corporation, face ethical dilemmas during their professional careers. Ethical

dilemmas come in many forms and accountants sometimes need support to address complex

and challenging conflicts. Accountants may also treat ethical dilemmas as “business decisions”

and not utilize their professional code to assess potential courses of action.

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What would you do as an accountant?

We’ve all experienced ethical dilemmas in our business lives, maybe not as consequential as

these ones, but it’s the kind of situation that does happen. Who would suffer if you “massage”

the figures to make sure the company survives? Possibly no one – but also possibly a great

many. “Massaging” the figures may mean that some people benefit, but there is a bigger

picture. Confidence in accountants, in financial reporting and in business could be

undermined, and certainly would be if everyone did it. This would be bad news for business

as a whole and therefore bad for society too.

A business may be able to get by, even prosper, in the short term by abusing trust, and so can

a person. In the longer term, however, reputation and trust are what matters – a reputation

built up over the years can be destroyed in an instant and that can destroy an entire business.

For a professional, such as an accountant, reputation is the most valuable asset. Achieving a

truly professional business environment relies on all sorts of factors being in place, including

the behavior of the individual, and the workplace environment. A professional accountant’s

duty is to act in the public interest. However, regulations, principles, standards and rule books

cannot actually stop someone acting in an unethical way and there is no guarantee that

regulatory systems will catch those acting unethically either.

In 2011, the Association of Chartered Certified Accountants (ACCA) published a report2,

which collects different essays from experts in the public and private sectors, regarding the

importance of the ‘Ethical Leadership’. It said that it is the senior executives that set the tone

for the rest of the company. When they act ethically then their employees are likely to do so

too.

After the financial crisis, we have seen a huge focus on structural matters, most obviously the

regulation of the banking sector. But no matter how business activity is regulated, decisions

will always, be taken by individuals. Regardless of how ethical standards are designed or

enforced, it is the certain individuals that make the difference. It is they, who must ultimately

make the decisions about how to respond to ethical dilemmas and their behavior impacts on

those around them. Effective regulation and monitoring by regulatory bodies have an

important role to play, but they need to be accompanied by a genuine commitment to ethical

behavior by businesses, starting at the top.

Individuals are so important to achieving an ethical and professional environment that having

the right individual in the right place is absolutely critical. ACCA urges the business world to

prioritize the recruitment of senior executives and financial staff with strong ethical

compasses, and not just focus on business and financial skills.                                                                                                                2  ACCA,  2011,  Risk  and  reward:  shared  perspectives,  p:  30

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So the question is how today and future businessmen and businesswomen can get better

picture on ethical behavior. Is current teaching methodology provides enough information to

students to face with ethical issues in the future? Can ethics be taught or should it come from

parental education? Should ethics be taught in business schools at all? Business schools have

been giving students some education in ethics for at least the past 25 or 30 years, however we

still have the well known (and probably not known at all) scandals and problems. At the end

of the day the answer is probably no - ethics can't be taught. At least not in the same way one

can teach finance or management. However, learning experiences can be created in

classrooms that challenge students and faculty to discuss the complex ethical issues that

impact us and our community.

I believe, by now, the reader should have a clue what I would like to present in this thesis and

why I think ethics in business, especially in accounting, is important. The goal and the

intention of this study is to pay attention to the very essence of the accounting ethics in

business and to have an overview on ethics education and professional legitimacy. There is

and I believe there always be a dilemma between ethics and economy. Nowadays the attention

is much more dedicated to this topic, because the lack of ethics norms in business operations

produces creates damage at the micro and macro level. More than anything else the

significance of ethics becomes apparent through establishing of socially accepted ethical

norms, affecting in consequence all aspects of life.

In order to do that I will dig deep into the theories in terms of ethics, business ethics,

accounting ethics by going through the history of it. I will also examine accountancy as a

profession. I will show the major accounting standards. Then I will present a couple of serious

accounting scandals in the past one and a half decade and the regulatory reaction to these

problems. I will show how these new regulations and accounting standards prevents us or not

for further issues. At last I will examine current education and teaching methods of business

ethics in today’s business schools. It is my hope that this thesis will facilitate, in a certain

extent, the understanding of accountants’ ethical responsibilities and will improve accounting

behavior.

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Ethical  theories  in  business  and  accounting  

The relevant literature was identified through a search of several online documents and books

available on the Internet.

Accounting  ethics  history

Accounting ethics are as old as accounting itself, which exists since ancient times. Accounting

records dating back more than 7000 years have been found in Mesopotamia. Other early

accounting records were also found in the ruins of Babylon, Assyria and Sumeria. Evidences

were found also at the Phoenicians and in ancient Egypt as well. Similarly the Greek and

Roman empires have their own accounting processes and people with specific skills of

mathematics, accuracy and reliability3. Although accounting ethics as we know today was not

as sharp as today even at old times there were written and unwritten rules that this profession

required. If we are talking about modern accountancy or double bookkeeping we must note an

Italian person Luca Pacioli, the "Father of Accounting". He already wrote on accounting

ethics in his first book Summa de arithmetica, geometria, proportioni, et proportionalita,

published in 1494. Ethical standards have since then been developed through government

groups, professional organizations, and independent companies. These various groups have

led accountants to follow several codes of ethics to perform their duties in a professional work

environment. In the 19th century, more and more private companies were established and later

these companies became public and started to issue company shares. At this time, reliable and

more importantly comparable information or reports about the companies became absolutely

necessary for investors, bankers and governments. By the middle of the century Britain’s

industrial revolution was in full swing and London was the financial center of the world.

Evidently accountants were responsible for providing such information and were responsible

for their contents. To improve their status and combat criticisms of low standards, local

professional bodies in England united to form the Institute of Chartered Accountants in

England and Wales established by royal charter in 1880. Around the world, accountants

clustered in different similar professional bodies, organizations and associations in which they

agreed to follow certain code of ethics. Such organizations in the US were the American

Association of Public Accountants (AAPA, 1887). The AAPA was renamed several times

throughout its history, before becoming the American Institute of Certified Public

Accountants (AICPA) as its named today. The AICPA developed five divisions of ethical

principles that its members should follow: "independence, integrity, and objectivity";

                                                                                                               3  The  History  of  Accountancy,  2003,  NY  State  Society  of  CPAs  

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"competence and technical standards"; "responsibilities to clients"; "responsibilities to

colleagues"; as well as "other responsibilities and practices". In the 20th century the number of

accounting or accountant organizations increased and represented in all continents and regions

of the world.

Business  ethics,  accounting  ethics

According to my readings I would say that ethics are as old as human being and business

ethics are also not peculiarities of the 21st century. Even ancient Greeks and Romans had

written or unwritten rules of behavior of salesmen and marketers. In case we want to examine

business ethics or corporate behavior we have to look at the certain individuals behavior in

business. Thus we have to deal with the behavior of employees, business leaders and

executives.

The best if I start with those ethical studies that made for accountants specifically. ACCA (the

Association of Chartered Certified Accountants) assigns an entire chapter for professional and

corporate ethics. According to ACCA papers, ethics is4

! Concerned with right and wrong, and how conduct is judged to be good or bad.

! About how we should live our lives and, how we should behave towards other people.

! Relevant to all forms of human activity, including the business world.

This paper differentiates ethical theories, which can be shown the best with the figure 2.

below.

Figure 2.

                                                                                                               4  ACCA Paper P1 Governance, Risk and Ethics, 2013, Chapter 12.

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I will elaborate only Kohlberg’s Cognitive Moral Development (CMD) theory and Gray,

Owen & Adam’s theory of Positions on social responsibility parts, as they are more relevant

for my thesis.

Kohlberg’s stages of human moral development

Kohlberg describes the development of individuals’ ethical reasoning in terms of progression

through three levels with two planes within each level. These levels can be related to ethical

behavior. They show the reasoning process of individuals; it is possible that individuals at

different levels will make the same moral decisions, but they will do so as a result of different

reasoning processes. Kohlberg emphasizes how the decision is reached, not what is decided.

Level 1 - Pre-conventional

! Obedience and Punishment: suggests that obedience is compelled by the threat or

application of punishment

! Individualism, Instrumentalism, and Exchange considers that right behavior means acting

in one's own best interests

Level 2 - Conventional

! "Good boy/girl" view; is an attitude that seeks to do what will gain the approval of others

! Law and Order means abiding by the law and responding to the obligations of duty

Level 3 - Post-conventional

! Social Contract is an understanding of social mutuality and a genuine interest in the

welfare of others

! Principled conscience is based on respect for universal principle and the demands of

individual conscience

Organizations'  ethical  and  social  responsibility  

There is a belief that organizations should have some social responsibility. With social

responsibility there is social accountability – organizations must account for their actions. The

belief means that there may be a difference between how the world is now and how it should

be. The ethical positions of an organization is described by Gray, Owen & Adam as the extent

to which an organization will exceed its minimum obligation to stakeholders (figure 3).

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Figure 3.

1. Pristine capitalists:

Business has no moral responsibilities beyond their obligations to shareholders and creditors.

Anything that reduces shareholder wealth (such as acting in a socially responsible way) is

theft from shareholders.

2. Expedients:

Social responsibility may be appropriate if it is in the business’s economic interests. So they

recognize some social responsibility expenditure may be necessary to strategically position an

organization so as to maximize profits.

3. Proponents of the social contract

There is effectively a contract or agreement between the organizations and those who are

affected by their decisions.

4. Social ecologists

Believe that business activities result in resource exhaustion; waste and pollution must be

modified. It recognizes that a business has a social and environmental footprint and therefore

bears responsibility for minimizing that footprint.

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5. Socialists

Seek to promote egalitarian equality and business should be conducted so as to redress

imbalances in society.

6. Radical feminists

Aim to promote feminine values such as co-operation.

7. Deep ecologists

Suggest that man has no greater rights to resources or life than other species.

Code  of  ethics  and  conduct  

So what an accountant can do for the public interest? ACCA’s and IFAC’s (International

Federation of Accountants) code of ethics defines professionalism in terms of professional

behavior. It says, professional behavior imposes an obligation on professional accountants to

comply with relevant laws and regulations and avoid any action that may bring discredit to the

profession. Among the most important obligation for modern professionals is maintaining

confidentiality and upholding ethical standards. The public interest is considered to be the

collective well-being of the community of people and institutions the professional accountant

serves, including clients, lenders, governments, employers, employees, investors, the business

and financial community and others who rely on the work of professional accountants.5

Ethical guidance can either be principles-based (a conceptual framework approach like IFRS)

or rules-based (like US GAAP). The latter certainly has some advantages as certainty or

clarity regarding what is not permitted. However, it is virtually impossible for rules-based

systems to be able to deal with every situation that may arise, particularly across various

national boundaries and in a dynamic industry. They can also be interpreted narrowly in order

to circumvent the underlying ‘spirit’ or intention of the rule.

On the other hand principles-based approach have advantages over rules-based system. A

principle is more appropriate to changing circumstances in a dynamic profession. Principles

may be applied across national boundaries, where laws may not. The responsibility is placed

on the auditor to demonstrate that all matters are considered within the principles of the

framework. A principle approach may include some specific ‘prohibitions’ or deal with

specific matters. Later when I examine IFRS and US GAAP closely, I will go into more

details which one would be more favorable in our world and how US and International

business life react on such initiatives.

                                                                                                               5  IFAC  Handbook  of  the  Code  of  Ethics  for  Professional  Accountants,    2013,  Section  100.5  

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Both IFAC’ and ACCA’s fundamental principles are:

Objectivity

Professional accountants should not allow bias, conflicts of interest or undue influence of

others to override professional or business judgments.

Professional behavior

Accountants should comply with relevant laws and regulations and should avoid any action

that discredits the profession.

Professional competence and due care

Accountants have a continuing duty to maintain professional knowledge and skill at a level

required to ensure that a client or employer receives competent professional service based on

current developments in practice, legislation and techniques. They should act diligently and in

accordance with applicable technical and professional standards when providing professional

services.

Technical standards

Accountants should ensure that all work undertaken is performed to the highest standards.

Integrity

Accountants should be straightforward and honest in all business and professional

relationships.

Confidentiality

Accountants should respect the confidentiality of information acquired as a result of

professional and business relationships and should not disclose any such information to third

parties without proper or specific authority or unless there is a legal or professional right or

duty to disclose. Confidential information acquired as a result of professional and business

relationships should not be used for the personal advantage of members or third parties.

In order to apply these fundamental principles one must consider some threats that can occur

especially on objectivity. These threats are Self-interest, Self-review, Advocacy, Familiarity,

and Intimidation. Considering management tasks and responsibilities company management

may also create threats to independence. In some jurisdictions this is referred to as the

management threat. The firm should take steps to ensure that company management makes

significant judgments and decisions.

The influence of the accountancy profession on business and society is potentially huge.

Think about the different involvements they have like financial or management accounting,

taxation, auditing or consulting. However critics argue that accountancy regulations are too

passive, allowing too great variety of accounting treatments, and failing to impose meaningful

responsibilities on auditors such as an explicit responsibility to detect and report fraud or

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giving priority to client confidentiality over disclosure in the wider public interest.

Conflict  of  interest  

ACCA also provides clear guidance for conflict of interest. It says, professional accountants

and auditors should always act in the best interests of the audited company (the client). Any

form of financial gain to the audit firm as a result of engagements, other than the fees or

rewards from the clients, or concession properly earned, will amount to a significant conflict

of interest. Therefore, they should not accept or continue engagements where there are

significant conflicts of interest between the audit firm and its clients. However, where

conflicts of interest exist, such as when a firm acts for competing clients - which is common -

the firm’s work should be arranged to avoid the interests of one being adversely affected by

those of another and to prevent a breach of confidentiality. In order to ensure this, the firm

must notify all affected clients of the conflict and obtain their consent to act. The audit firm’s

work should be managed so as to avoid the interests of one client adversely affecting those of

another. There are several additional safeguards that can be considered in case of conflict of

interest such as

! advise the clients to seek independent advice

! separate engagement teams (with different engagement partners and team members)

! procedures to prevent access to information, e.g. physical separation of the team members

and confidential/secure data filing

! signed confidentiality agreements

! regular review of the application of safeguards by an independent person of appropriate

seniority

The audit firm should decline or resign its client in case the above safeguards cannot be

implemented.

This was how accountants as professionals define and approach ethics in business but there

are many others who elaborate this topic in the past. According to Laura P. Hartman ethics

represents rules or principles that inform behavior within a particular culture of a particular

group or organization. She wrote several book about business ethics and ethical decision

making says “corporate culture is important to business ethics because it is a vehicle for

imparting and maintaining the moral principles and the values, good and bad, that animate life

in the organization"6. Another book states, “ethics in organizations is not a result of individual

virtue alone, but a function of both individual virtue and contextual factors”7 Linda K.

                                                                                                               6  Business  Ethics,  2001,  L.P.  Hartmann,  J.  DesHardins,  C.  MacDonald,  p.150  7Leadership,  Ethics,  and  Responsibility  to  the  other,  2006,  D.  Knights.  M.  O.’Leary  p.125  

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Trevino writes “business organizations possessing ethical cultures should be creating and

maintaining a shared pattern of values, customs, practices and expectations which dominate

normative behavior in the organization”8 The formal element of ethical culture includes

mission and vision statements, codes of conduct, processes for socialization of new

employees, decision-making processes, etc. The core of the informal base of an ethical culture

is constituted by organizational values. Other elements of the informal ethical culture include

role modeling of ethical behavior; the belief in heroes and role models; metaphors, used in

discussions of organizational values; and myths and stories about ethical standards of the

organization being upheld and revered by members9.

Even though years have passed and other scandals have occurred, we still refer to the 2001

Enron Corporation collapse as the watershed event in this century’s business ethics news;

since that time ethics and values have seldom strayed from the front pages of the press. Recall

the 2008 collapse of the investment schemes of former NASDAQ chairman Bernie Madoff,

the largest fraud of its kind in history with total losses to investors in the billions. Reflect for a

moment on the businesses that have been involved in scandals or, at least, in questionable

decision making in the last one and a half decade: Siemens (bribery), Enron (Accounting

fraud - hiding debts), AIG (accounting fraud - book loan as revenue), WorldCom (accounting

fraud - move reserve to revenue), Arthur Andersen (obstruction of justice in the Enron case),

Ernst & Young, KPMG (assist Lehman Brothers repos), J.P. Morgan (accounting fraud hiding

losses), Merrill Lynch (accounting fraud hiding bad securities), Morgan Stanley (bribery),

Bear Stearns (market-timing and late trading), Citigroup (deceptive lending practices),

Goldman Sachs (insider trading), Deutsche Bank (severe tax evasion, Euribor manipulation),

Bank of America (hiding defective loans), UBS (unauthorized trading), Standard and Poor’s

(inflated ratings), Moody’s (inflated ratings), Johnson & Johnson (off-label marketing,

bribery) and even the New York Stock Exchange (fraudulent trading) itself. Beyond these

well-known scandals, consumer boycotts based on allegations of unethical conduct or

alliances have targeted such well-known firms as Nike, McDonald’s, Carrefour, Home Depot,

Chiquita Brands International, Fisher-Price, Gap, Shell Oil, ExxonMobil, Levi Strauss, Donna

Karan, Walmart, Nestle, Nokia, Siemens, BP, H&M, Target, Timberland, and Delta Airlines.

According to Paul Griseri we can look at business ethics as corporate social responsibility

(CSR) He says, business ethics are the study and examination of moral and social

                                                                                                               8  Managing  Business  Ethics,  1999,  L.  K.  Trevino,  K.  A.  Nelson  p.  151  9  Organizational  Culture  as  Matrix  of  Corporate  Ethics,  1996,  M.  Dion,  p.  331.  

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responsibility in relation to business practices and decision-making in business. They are

moral principles that guide the way a business behaves. The same principles that determine an

individual’s actions also apply to business. Acting in an ethical way involves distinguishing

between “right” and “wrong” and then making the “right” choice. It is relatively easy to

identify unethical business practices. For example, companies should not use child labor.

They should not unlawfully use copyrighted materials and processes. They should not engage

in bribery, etc. However, it is not always easy to create similar hard-and-fast definitions of

good ethical practice. A company must make a competitive return for its shareholders and

treat its employees fairly. A company also has wider responsibilities. It should minimize any

harm to the environment and work in ways that do not damage the communities in which it

operates. This is known as corporate social responsibility.10

In 2010, Corporate Responsibility Magazine11 published its Corporate Responsibility Best

Practices Survey, which featured information from more than 650 corporations. The survey

dug into the inner workings of corporate ethics programs and the role such programs play

within corporations. And the results were revealing that corporate ethics — or as CR

Magazine prefers to call it, “corporate responsibility”— plays an important role in the

corporate world today. For example, two-thirds of companies responding to the survey

indicated that at least one of their products is marketed by means of ethics-themed messaging.

This response can be interpreted to mean that these companies are making an effort to

produce goods and services that embody ethical values. Or, more cynically, it might be read

as evidence that these companies see value in marketing their products in ways that make

consumers think those products embody ethical values. Either way, this datum shows that

companies are paying serious attention to ethics. Another remarkable fact to come out of the

survey is that about one-third of companies said that they have actual evidence that attention

to corporate responsibility has improved their bottom lines. This result is impressive, because

establishing a strong causal connection between ethics and profits has long been a goal of

many who study business ethics professionally. But there is also a glass-half-empty version of

this finding. As the CR report itself points out, the fact that one-third of companies have such

evidence implies that the other two-thirds do not. One way of thinking of it is that for two-

thirds of companies, the link between ethics and profits just is not there. Alternatively, we

might think of this survey response as implying that for two-thirds of companies, attention is

paid to ethics in spite of the fact that doing so is not clearly profitable. In other words, such

                                                                                                               10  Business  ethics  and  corporate  social  responsibility,  2010,  P.  Griseri  11  “Corporate  Responsibility  Best  Practices,”  Corporate  Responsibility  Magazine  (December  2011),  www.croassociation.org/files/CR%20Best%20Practices%202011%20-­‐%20full%20report.pdf  

 15  

companies may be paying attention to ethical issues just because it is the right thing to do.

The survey also generated noteworthy international comparisons. Just over one-third of U.S.-

based companies reported employing a dedicated “corporate responsibility officer” — that is,

a person whose job it is to spearhead the company’s ethics efforts. One-third may seem like a

lot, considering that job titles like “corporate responsibility officer” or “head of ethics and

compliance” simply did not exist just a few decades ago. But consider that, according to the

survey, nearly two-thirds of European and Asian companies feature such a position, along

with nearly half of companies based in Canada. What can we learn from the CR survey about

what the future may hold, in terms of formal emphasis on ethics and responsibility? Of the

companies surveyed, more than half expected to heap additional responsibilities on personnel

responsible for in-house ethics and responsibility programs but less than a quarter of

companies were planning to increase either staff or budget dedicated to such efforts.

Simply put, ethics involves learning what is right or wrong, and then doing the right thing but

"the right thing" is not nearly as straightforward as conveyed in a great deal of business ethics

literature. Most ethical dilemmas in the workplace are not simply a matter of "Should John

steal from James?" or "Should James lie to his boss?"

Many ethicists consider emerging ethical beliefs to be "state of the art" legal matters, i.e.,

what becomes an ethical guideline today is often translated to a law, regulation or rule

tomorrow. Values, which guide how we ought to behave, are considered moral values, e.g.,

values such as respect, honesty, fairness, responsibility, etc. Statements around how these

values are applied are sometimes called moral or ethical principles.

The concept has come to mean various things to various people, but generally it's coming to

know what is right or wrong in the workplace and doing what's right - this is in regard to

effects of products / services and in relationships with stakeholders. Consequently, there is no

clear moral compass to guide leaders through complex dilemmas about what is right or wrong.

Many people react that business ethics, with its continuing attention to "doing the right thing,"

only asserts the obvious ("be good," "don't lie," etc.), and so these people don't take business

ethics seriously. For many of us, these principles of the obvious can go right out the door

during times of stress.

Business ethics has come to be considered a management discipline, especially since the birth

of the social responsibility movement in the 1960s. In that decade, social awareness

movement raised expectations of businesses to use their massive financial and social

influence to address social problems such as poverty, crime, environmental protection, equal

rights, public health and improving education. The emergence of business ethics is similar to

 16  

other management disciplines. As commerce became more complicated and dynamic,

organizations realized they needed more guidance to ensure their dealings supported the

common good and did not harm others and so business ethics was born.12

It is worth to mention that 90% of business schools now provide some form of training in

business ethics however not as a separate subject focusing on the issues but part of another

area as finance, strategy or SCR (which I believe is the closest). Today, ethics in the

workplace can be managed through use of codes of ethics, codes of conduct, roles of ethicists

and ethics committees, policies and procedures, procedures to resolve ethical dilemmas, ethics

training, etc.

Many people are used to reading or hearing of the moral benefits of attention to business

ethics. However, there are other types of benefits, as well. The following list describes various

types of benefits from managing ethics in the workplace.13

▪ Attention to business ethics has substantially improved society.

▪ Ethics programs help maintain a moral course in turbulent times.

▪ Ethics programs cultivate strong teamwork and productivity.

▪ Ethics programs support employee growth and meaning.

▪ Ethics programs are an insurance policy -- they help ensure that policies are

legal.

▪ Ethics programs help avoid criminal acts "of omission" and can lower fines.

▪ Ethics programs help manage values associated with quality management,

strategic planning and diversity Management.

▪ Ethics programs promote a strong public image.

Codes of Ethics

Code of ethics describes the highest values to which the company aspires to operate. It

contains the do’s and don’ts. A code of ethics specifies the ethical rules of operation. It's the

`you shall not's. In the latter 1980s 76% of corporations had codes of ethics.

Some business ethicists disagree that codes have any value. Usually they explain that too

much focus is put on the codes themselves, and that codes themselves are not influential in

managing ethics in the workplace. Many ethicists note that it's the developing and continuing

dialogue around the code's values that is most important.

                                                                                                               12  Association  Management,  2009,  A.  Dubey,  p.  89.  13  Ethics  and  corporate  social  responsibility,  2003,  R.  R.  Sims,  p.  18.  

 17  

Codes of Conduct

Codes of conduct specify actions in the workplace and codes of ethics are general guides to

decisions about those actions. Codes of conduct contain examples of appropriate behavior to

be meaningful.14

Ethical  behavior  in  accounting

It is extremely important for accounting professionals to be ethical in their practices due to the

very nature of their profession. The nature of accountants’ work puts them in a special

position of trust in relation to their clients, employers and general public, who rely on their

professional judgment and guidance in making decisions. These decisions in turn affect the

resource allocation process of an economy. The accountants are relied upon because of their

professional statues and ethical standards. Thus, the key to maintaining confidence of clients

and the public is professional and ethical conduct.

Ensuring highest ethical standards is important to a ‘public accountant’ (one who renders

professional services such as assurance and taxation service to clients for a fee) as well as to

an ‘accountant in business’ (one who is employed in a private or public sector organization

for a salary). Both ‘public accountants’ and ‘accountants in business’ are in a confidential

relationship, former with the client and latter with the employer. In such a relationship, they

have the responsibility to ensure that their duties are performed in conformity with the ethical

values of honesty, integrity, objectivity, due care, confidentiality, and the commitment to the

public interest before one’s own. Thus, accountants, as professionals, are expected to maintain

a level of ethical conduct that goes beyond society’s laws. This has made the professional

accounting bodies to develop a code of professional conduct, which sets rules or standards

that define right from wrong to ensure that members’ behavior complies with perceived public

expectations of ethical standards. These rules have been developed based on the ‘principles of

professional conduct’, which form the basis for professional ethics.15

However, accountants’ involvement with large corporate scandals in recent times reflects that

they have not complied with the expected ethical standards. It is often argued that accountants’

focus too much on technical issues and lack ethical sensitivity to recognize ethical dilemmas

involved with their work, which would ultimately lead to making wrong decisions. Thus,

accountants should be trained to be sensitive to identify the moral dimension of seemingly

technical issues. This emphasizes the need to include ethics education as a core component of

                                                                                                               14  Complete  Guide  to  Ethics  Management:  An  Ethics  Toolkit  for  Managers,  C.  McNamara,  http://managementhelp.org/businessethics/ethics-­‐guide.htm  15  The  role  of  ethics  in  accounting,  2011,  Prof.  S.  Senaratne  

 18  

professional accounting education to prepare the accounting professionals to face various

ethical dilemmas that they face in carrying out their duties. The ‘Framework for International

Education Standards for Professional Accountants’ 16 (2009) published by International

Accounting Education Standards Board (IAESB) of IFAC identifies that the overall objective

of accounting education should be to develop competent professional accountants, who

possess the necessary (a) professional knowledge, (b) professional skills, and (c) professional

values, ethics, and attitudes. In this respect, the International Education Standard (IES) 4 -

Professional Values, Ethics and Attitudes of IAESB recommends that a program of

professional accounting education should provide potential professional accountants with a

framework of professional values, ethics and attitudes to exercise professional judgment and

act in an ethical manner that is in the best interest of society and the profession. However, IES

4 requires professional accounting bodies to distinguish between teaching students about

professional values, ethics and attitudes and developing ethical behavior. Developing

professional values, ethics and attitudes should begin early in the education of a professional

accountant and should be re-emphasized throughout the career. Thus, developing an ethical

behavior is part of life-long learning of a professional accountant.

"Accountants and the accountancy profession exist as a means of public service; the

distinction which separates a profession from a mere means of livelihood is that the

profession is accountable to standards of the public interest, and beyond the compensation

paid by clients."17

Wherever there are investors and creditors involved, accounting ethics can never be ignored.

So what are these ethics, after all? Accounting ethics can be defined as a set of distinct

guidelines for a business to maintain clean balance sheets, accounting for their profits, losses

and expenses incurred and prevent it from mishandling financial reports and statements. For

an accountant, it is very important to understand the rules and regulations of his position in an

organization. Any deviation from the moral code of conduct or abusing accounting ethics can

result in dire consequences for him, such as suspension of license, termination of right to

practice and severe penalties.

Recent highly publicized accounting scandals have made it clear that ethical conduct of

accountants have not met the standards inherent in the foregoing quotations. In the article

“Scandal Scorecard,” The Wall Street Journal described 12 big accounting frauds involving

publicly owned business enterprises; many of the frauds involved the chief financial officer,

                                                                                                               16  Framework  for  International  Education  Standards  for  Professional  Accountants,  2009,  D.  McPeak,  p.  13  17  Robert  H.  Montgomery,  describing  ethics  in  accounting  

 19  

controller, chief accounting officer, and other accountants of the enterprises.18 One outcome

of those and other scandals was the implementation of the federal Sarbanes-Oxley Act of

2002 (SOX), which authorized the establishment of a Public Company Accounting Oversight

Board to regulate the conduct of accountants both in public practice and in publicly owned

business enterprises.

The vocabulary of accounting now includes the following terms19:

Cute accounting to describe stretching the form of accounting standards to the limit,

regardless of the substance of the underlying business transactions or events

Cooking the books to indicate fraudulent financial reporting

Many topics of advanced accounting have been the subject of both cute accounting and

cooking the books by accounting executives of business enterprises. Because the chief

financial officer, the controller, the chief accounting officer, and the accounting staffs of

business enterprises have the primary responsibility for preparing financial statements and

financial reports and disseminating them to users, this part of my writing deals with the

ethical standards appropriate for those preparers.

John Freedman says, “Unlike other general business positions in a company, accountants are

bound both by the rules of their organization and by the professional standards of the

accounting industry. Accountants have ethical responsibilities to many different parties, both

internal and external to the company. Understanding some of the ethical responsibilities of

accountants can help you understand what information is appropriate to share with those

working in your company's finance function.”20

Clients

Accountants are privy to confidential information regarding their clients and their clients'

businesses. Disclosure of this information to unauthorized third parties could put clients at a

competitive disadvantage. Accountants are ethically obligated to treat client information as

confidential and refrain from unauthorized disclosure. Clients and accountants should realize

that there is no accountant-client privilege, as exists between an attorney and a client, and that

accountants may be required to disclose business information about a client upon order of a

subpoena.

                                                                                                               18  “Scandal  Scorecard,”  The  Wall  Street  Journal,  October  3,  2003,  p.  B1.  19  Modern  Advanced  Accounting,  2006,  E.  J.  Larsen,  p.  1  20  Ethical  Responsibility  in  Accounting,  2012,  J.  Freedman  

 20  

Shareholders

Accountants working in public practice have an ethical duty to be able to objectively render

an opinion on a company's financial statements. This requires the accountant to be

independent from the company under audit in both "fact and appearance." Independence in

fact requires that the accountant does not have any kind of financial interest in the client, and

implies that the auditor is absolutely able to conduct the audit without any bias in attitude.

Independence in appearance concerns an outsider's observation of the auditor-client

relationship. Being independent in appearance requires that a neutral third-party observer

would not consider independence to be impaired.

Firm

Accountants working in public accounting firms have an ethical obligation to perform their

work with due diligence, and to only document and record work that has actually been

completed. Documenting audit procedures that have not been completed, known as "ghost-

ticking," is ethically wrong and may place an accountant or the accounting firm at risk. In

addition, some auditors may feel pressured to meet time budgets by recording fewer hours

than they actually worked. This phenomenon, called "eating time," is prohibited by nearly

every major accounting firm. Accountants should recall that this practice is tantamount to

falsifying records and is ethically questionable, at best.

Company

Accountants working in businesses are often subject to information that the rest of the

company is not privy to. For example, payroll accountants may have information about

salaries in different departments, revenue accountants may learn of new products before

others, and cost accountants may have inside information about profit margins. In some cases,

accountants are some of the first to know about potential layoffs. Accountants should

remember that they are bound by both their own ethics and professional standards to not

disclose this information to anyone. This responsibility extends to disclosure to individuals

within the company as well.

 21  

Why  accountancy  and  accounting  activities  must  consider  ethics  

The  Nature  of  Accounting

Certainly accounting is described in many ways but basically they all mean the same. Below

are just a couple of definitions I was able to find through search of online data and several

book of mine, which I put them in a specific order that explains it more and more

understandable.

! Accounting is the provision of information about the financial position, performance and

changes in the financial position of an enterprise that is useful to a wide range of potential

users in making economic decisions21

! Accounting is a systematic process of identifying, recording, measuring, classifying,

verifying, summarizing, interpreting and communicating financial information in a way

that is useful for decision making. It reveals profit or loss for a given period, and the value

and nature of a firm's assets, liabilities and owners' equity. It provides information on the

resources available to a firm, the means employed to finance those resources, and the

results achieved through their use.22

! Accounting is a specialized language that has the specificity of being able to describe state

or a result, describe the events that led to that result and provide a possibility of rank

ordering results.23

! Accounting is the process of identifying, measuring and communicating economic

information to permit informed judgments and decisions by users of the information.24

! Accounting is a technique, and its practice is an art or craft developed to help people

monitor their economic transactions.25

Accounting gives people a financial picture of their business. Its original – and enduring –

basic purpose is to provide information about the economic deals of a person or companies.

At the beginning, only the person or the company needed the information. Then the

government needed the information. As the economy became more complex and regulated,

                                                                                                               21  IASC  (International  Accounting  Standard  Committee)/IFRS  (International  Financial  Reporting  Standards)  22  Businessdictionary.com  23Financial  Accounting  and  Reporting  -­‐  A  Global  Perspective,  2013,  Lebas,  Stolowy,  Ding,  p.  4  24  AAA  (American  Accounting  Association)  25  Accounting  ethics,  2011,  Duska,  Ragatz  p.  10  

 22  

the number of those who needed the information, the number of users of economic statements,

increased. The extent of the importance of the information to the user increases the ethical

factors governing the development and disbursement of that information. Some people have a

right to the information; others do not.

According to an auditor Bob Schneider26 accounting can be divided into several areas of

activity. These can certainly overlap and they are often closely intertwined. But it's still useful

to distinguish them, not least because accounting professionals tend to organize themselves

around these various specialties.

Financial Accounting

Financial accounting is the periodic reporting of a company's financial position and the results

of operations to external parties through financial statements. Financial statements are relied

upon by suppliers of capital - e.g., shareholders, bondholders and banks - as well as customers,

suppliers, government agencies and policymakers.

There's little use in issuing financial statements if each company makes up its own rules about

what and how to report. When preparing statements, American companies use U.S. Generally

Accepted Accounting Principles, or U.S. GAAP. Companies in the EU and many other

countries like Japan, China and Russia use International Financial Reporting Standards

(IFRS)

Management Accounting

Where financial accounting focuses on external users, management accounting emphasizes

the preparation and analysis of accounting information within the organization. According to

the Institute of Management Accountants, it includes designing and evaluating business

processes, budgeting and forecasting, implementing and monitoring internal controls, and

analyzing, synthesizing and aggregating information in order to help drive economic value."

A primary concern of management accounting is the allocation of costs; indeed, much of what

now is considered management accounting used to be called cost accounting. Although a

seemingly mundane pursuit, how to measure cost is critical, difficult and controversial. In

recent years, management accountants have developed new approaches like activity-based

costing (ABC) and target costing, but they continue to debate how best to provide and use

cost information for management decision-making.

                                                                                                               26  http://www.investopedia.com/university/accounting/accounting2.asp

 23  

Auditing

Auditing is the examination and verification of company accounts and the firm's system of

internal control. There is both external and internal auditing. External auditors are

independent firms that inspect the accounts of an entity and render an opinion on whether its

statements conform to accounting standards and present fairly the financial position of the

company and the results of operations. In the U.S., four huge firms known as the Big Four -

PricewaterhouseCoopers, Deloitte Touche Tomatsu, Ernst & Young, and KPMG - dominate

the auditing of large corporations and institutions. The group was traditionally known as the

Big Eight, contracted to a Big Five through mergers and was reduced to its present number in

2002 with the meltdown of Arthur Andersen in the wake of the Enron scandals, which I will

write details about later.

The external auditor's primary obligation is to users of financial statements outside the

organization. The internal auditor's primary responsibility is to company management. The

internal auditor evaluates the risks the organization faces with respect to governance,

operations and information systems. Its mandate is to ensure (a) effective and efficient

operations; (b) the reliability and integrity of financial and operational information; (c)

safeguarding of assets; and (d) compliance with laws, regulations and contracts.

Tax Accounting

Financial accounting is determined by rules that seek to best portray the financial position and

results of an entity. Tax accounting, in contrast, is based on laws enacted through a highly

political legislative process. Tax accountants help entities minimize their tax payments.

Within the corporation, they will also assist financial accountants with determining the

accounting for income taxes for financial reporting purposes.

Fund Accounting

Fund accounting is used for nonprofit entities, including governments and not-for-profit

corporations. Rather than seek to make a profit, governments and nonprofits deploy resources

to achieve objectives. It is standard practice to distinguish between a general fund and special

purpose funds. The general fund is used for day-to-day operations, like paying employees or

buying supplies. Special funds are established for specific activities, like building a new wing

of a hospital. Segregating resources this way helps the nonprofit maintain control of its

resources and measure its success in achieving its various missions.

 24  

Forensic Accounting

Finally, forensic accounting is the use of accounting in legal matters, including litigation

support, investigation and dispute resolution. There are many kinds of forensic accounting

engagements: bankruptcy, matrimonial divorce, falsifications and manipulations of accounts

or inventories, and so forth. Forensic accountants give investigate and analyze financial

evidence, give expert testimony in court and quantify damages.

The information provided by an accountant can be used in a number of ways. A firm’s

managers use it to help them plan and control the firm’s operations. Owners, managers, and/or

legislative bodies use it to help them evaluate a firm’s performance and make decisions about

its future. Owners, managers, banks, suppliers, employees, and others use it to help to decide

how much time and/or money to devote to the organization. Finally, government uses it to

determine how much tax the firm must pay. Hence, the accountant’s role is to provide various

entities that have a legitimate right to know about a company’s deals with useful information

about those economic deals. Useful information is owed to those various entities, and the

accountant has an obligation to provide as true a picture of those deals as possible.

Public companies for financial markets to work well, stock analysts and investors need to get

a “ true picture ” of a company or a financial institution. The very notion of a “ true ” picture,

however, presents some problems, there are many number of ways to look at the economic

status of an organization, and in reality several pictures of a company can be developed. Often,

the picture an accountant develops may serve the interest of the party who hires the

accountant more than other parties. Depending on the techniques used, a corporate accountant

can make an organization look better or worse. For loan purposes, it can be made to look

better. For tax purposes it can be made to look worse.

As already mentioned Financial Accountants produce financial statements. Generally there

are four financial statements, which include the

- statement of financial position (Balance sheet),

- statement of comprehensive income (income statement or P&L),

- statement of cash flows and

- statement of changes in equity

There is a fifth document, which is often prepared especially at year-end or at main period

ends. This is so called “Notes” that contains additional information regarding the contents of

the above financial statements.

The balance sheet has three elements: (1) assets – the tangible and intangible items owned by

the company; (2) liabilities – the firm’s debts, involving money or services owed to others;

 25  

and (3) owners ’ equity – funds provided by the firm’s owners and the accumulated income or

loss generated over years. The total assets, of course, equal the total liabilities plus the

owners ’ equity. Owners’ equity equals the total assets minus the total liability (net assets). To

put it another way, total assets equals liabilities plus owners’ equity. This view of the equation

indicates how assets were financed: by borrowing money (liability) or by using the owner ’ s

money (owner’s equity). The statement of comprehensive income shows net income (profit)

when revenues exceed expenses and net loss when expenses exceed revenues. The statement

of changes in equity explains the changes in earnings over a reporting period: assets minus

liabilities equal paid-in capital and retained earnings. The statement of changes in financial

position identifies existing relations and reveals operations that do or do not generate enough

funds to cover a firm’ s dividends and capital investment requirement.

Accountants  as  professionals,  roles  and  responsibilities

When someone asked what accountants do, responses often mention roles such as tax advisors

and independent auditors. The real functions performed by the huge number of professional

accountants who work in businesses are often forgotten and not really understood.

What do the financial director, the internal auditor and the chief financial officer of companies

all have in common? The individuals in these positions could all be professional accountants

working in businesses. Besides these roles, professional accountants take on a vast variety of

other roles in businesses of all sorts including in the public sector, not-profit sector, regulatory

or professional bodies, and even academia. Their wide ranging work and experience find

similarity in one aspect – their knowledge of accounting.

The importance of the role of professional accountants in business in ensuring the quality of

financial reporting cannot be emphasized enough. Professional accountants in business often

find themselves being at the frontline of safeguarding the integrity of financial reporting.

Management is responsible for the financial information produced by the company. Therefore

professional accountants in businesses have the task of defending the quality of financial

reporting right at the source where the numbers and figures are produced.

Like their counterparts in taxation or auditing, professional accountants in business play

important roles that contribute to the overall stability and progress of society. Without public

understanding of all these roles and responsibilities of different accounting specialists

working in business, public perceptions of their value may be false.27

                                                                                                               27  Roles  and  Importance  of  professional  Accountants,  China  Accounting  Journal,  2013,  L.  Jui,  J.  Wong  

 26  

A competent professional accountant expert in business is an invaluable asset to the company.

These individuals apply an inquiring or searching mindset to their work founded on the basis

of their knowledge of the company’s financials. Using their skills and deep understanding of

the company and the environment in which it operates, professional accountants in business

ask challenging questions. Their training in accounting enables them to adopt a pragmatic and

objective approach to solving issues. This is a valuable asset to management, particularly in

small and medium enterprises where the professional accountants are often the only

professionally qualified members of staff.

Accountancy professionals assist with corporate strategy, provide advice and help businesses

to reduce costs, improve their top line and mitigate risks. As board directors, professional

accountants in business represent the interest of the owners or shareholders of the company.

Their roles usually include: governing the organization (such as, approving annual budgets

and reporting to the stakeholders for the company’s performance); appointing the chief

executive; and determining management’s compensation. As chief financial officers,

professional accountants have oversight over all matters relating to the company’s financial

health. This includes creating and driving the strategic direction of the business to analyzing,

creating and communicating financial information. As internal auditors, professional

accountants provide independent assurance to management that the organization’s risk

management, governance and internal control processes are operating effectively. They also

offer advice on areas for growths or entering new market field. In the public sector,

professional accountants in government shape fiscal policies that had extensive impacts on the

lives of citizens or community. Accountants in academia are entitled to educate and pass the

knowledge, skills and ethical behavior of the profession to the next generation.

A description of the versatile role of professional accountants is not complete without

discussing the duty that the profession owes to the general public. As a profession that has

been given a privileged position in society, the accountancy profession as a whole deals with

a wide range of issues that has a public interest perspective. In the case of professional

accountants in business, not only must they maintain high standards but they also have a key

role to play in helping organizations to act ethically.

This close link to the protection of public interest is the intention that public accountants need

to be trusted to provide public value. Accountants will lose their legitimacy as protectors of

public interest if there is no public trust. The accountancy profession has wide reach in society

and in global capital markets. In the most basic way, confidence in the financial data produced

by professionals in businesses forms the core of public trust and public value.

 27  

Accountants often face conflicts between values to their profession and the demands of the

real world. Balancing these competing demands is the challenge of being a professional in

contrast to simply having a job or performing a function. Professionals are expected to

exercise professional judgment in performing their roles so that when times get challenging,

they do not undertake actions that will result in the profession losing the public’s trust as

protectors of public interest.

Ethical codes for professional accountants globally forces professional accountants, regardless

of the roles that they perform, to upport values of integrity, objectivity, professional

competence and due care, confidentiality and professional behavior. However, competing

pressures can put professional accountants in challenging and often difficult situations. These

conflicts revolve around ethics, commercial pressures and the breach of regulation.

Situations may occur where professional accountants in businesses are expected to help the

organization achieve certain financial outcomes. In some of these cases, the required action

may risk compromising compliance with accounting and financial reporting rules.

Professional accountants in businesses encounter tension in these situations. As an example,

accountants in organizations may face pressures to account for inventories at higher values or

select alternative accounting methods which are more financially favorable to the company.

However, these actions may be contrary to what are allowable in the accounting standards or

to what the professional accountant may feel comfortable with.

Professional accounting bodies globally have the important role of representing, promoting

and enhancing the global accountancy profession. At the national or international level, the

professional accounting body is the voice for the professional accountants; this includes all

professional accountants both in practice and in business. Because they play different roles in

the society, the overall status of the accountancy profession can only be strengthened when

both professional accountants in practice and in business are well-perceived by society.

Because professional accountants in business are often the only members of staff who are

professionally trained and qualified in accounting in the organization, they are more likely to

rely on their professional accounting body for assistance in carrying out their work. They will

look to the professional accounting body to provide them with the support and resources they

need in doing their daily jobs and to keep their skills up-to-date. For example, professional

accountants in business may look to their subject matter experts in the accounting body for

advice on how to handle ethical dilemmas. They will also be dependent on their accounting

body to provide continuous professional development training initiatives to keep their

knowledge and skills current.

Like other professions, professional accountants are increasingly challenged to demonstrate

 28  

their relevance in the capital market and their ability to evolve and face new challenges.

Public expectations are high. The value of professional accountants will be measured by the

extent to which they are perceived to be accountable not only to their own organizations but

more importantly to the public.

Professional accountants are a key pillar in organizations helping to create and sustain value

and growth. Their ability to continue to fulfill these roles in the face of constant

environmental changes is vital to their continued relevance. Professional accountants are also

the front runners when it comes to upholding the quality of financial reporting and providing

the broader public with reliable financial information.

Professional accountants in business are an important critical mass in the global accountancy

profession. The same applies at the national level. Public education on the diverse roles of

professional accountants in business needs to be stepped up so as to increase the visibility of

these roles. Professional accounting bodies also need to pay attention to their members in

business and provide them with the support they need in order to succeed in their roles. Their

voices also need to be represented. Achieving success on all these fronts will drive continued

recognition by society of the value of professional accountants in business. This shapes the

continued success of the accountancy profession as a whole.

Auditing  functions

As I have mentioned earlier audit function is one important area of accounting functions.

There is both internal and external auditing with a straightforward purpose of examination,

verification of companies’ accounts. Although I have already given the short descriptions of

these audit functions but I would like to explain a bit more details on both.

Internal auditing is an independent function that is performed in a wide variety of companies,

institutions, and governments. What distinguishes internal auditors from governmental

auditors and public accountants is the fact that they are employees of the same organizations

or firms they audit. Their loyalty is to their organization, not to an external authority. Because

internal auditing has evolved only within the last few decades, the roles and responsibilities of

internal auditors vary greatly from one organization to another. Internal audit functions have

been structured based on the differing perceptions and objectives of owners, directors, and

managers. After the accounting scandals of the early 2000s, worldwide reforms like the

Sarbanes-Oxley Act (SOX in US) required a bigger attention in compliance with the new

regulations on the audit functions. Especially in publicly held corporations, the internal

 29  

auditing function has been greatly expanded as a part of fulfilling these requirements.

The structure given to the internal auditing function within a company depends to a great

extent on four things: 1) the size of the company; 2) the type of business it carries out; 3) the

philosophy of the management group, and 4) the level of interest or concern placed on

auditing by the chief executive and the board of directors.28 In a very small business, the

owner-manager will usually perform the role of internal auditor by continuously monitoring

all of the business's activities. In larger companies, employees who fulfill internal auditing

functions are known by a wide variety of titles—control analysts, systems analysts, business

analysts, internal consultants, evaluators, and operations analysts.

The Institute of Internal Auditors (IIA) is an international governing body for internal auditors

that brings some uniformity and consistency to the practice. The IIA provides general

standards for performing internal audits and serves as a source for education and information.

In its standards29, the IIA defines the internal auditing function as "an independent appraisal

function established within an organization to examine and evaluate its activities as a service

to the organization. The objective of internal auditing is to assist members of the organization

in the effective discharge of their responsibilities. To this end, internal auditing furnishes

them analysis, appraisals, recommendations, counsel, and information concerning activities

reviewed."

There is theoretically no restriction on what internal auditors can review and report about

within an organization. In practice, internal auditors work within the parameters of the

company's overall strategic plan, performing internal auditing functions so that they are

coordinated with the larger goals and objectives of the organization. Internal auditors perform

a variety of audits, including compliance audits, operational audits, program audits, financial

audits, and information systems audits. Internal audit reports provide management with

advice and information for making decisions or improving operations. When problems are

discovered, the internal auditor serves the organization by finding ways to prevent them from

recurring. Internal audits can also be used in a preventative way. For example, if the internal

auditor communicates potential problems and risks in business operations during his/her

review, management can take preventive action against the potential problem from

developing.

The IIA's standards30 outlines five key objectives for an organization's system of internal

control: 1) reliability and integrity of information; 2) compliance with policies, plans,

                                                                                                               28  Brink's  Modern  Internal  Auditing  (7th  edition),  2009,  R.  Moeller,  p.  274.  29  Standards  for  the  Professional  Practice  of  Internal  Auditing,  2008,  IIA  30  Standards  for  the  Professional  Practice  of  Internal  Auditing,  2008,  IIA  

 30  

procedures, laws and regulations; 3) safeguarding of assets; 4) economical and efficient use of

resources; and 5) accomplishment of established objectives and goals for operations or

programs. It is these five internal control objectives that provide the internal auditing function

with its conceptual foundation and focus for evaluating an organization's diverse operations

and programs.

There are three important assumptions implicit in the definition, objectives, and scope of

internal auditing: Independence, competence, and confidentiality.31

Independence

Internal auditors have to be independent from the activities they audit so that they can

evaluate them objectively. Internal auditing is an advisory function, not an operational one.

Therefore, internal auditors should not be given responsibility or authority over any activities

they audit. They should not be positioned in the organization where they would be subject to

political or monetary pressures that could inhibit their audit process, sway their opinions, or

compromise their recommendations. Independence and objectivity of internal auditors must

exist in both appearance and in fact; otherwise the credibility of the internal auditing work

product is jeopardized. Related to independence is the assumption that internal auditors have

unrestricted access to whatever they might need to complete an appraisal. That includes

unrestricted access to plans, forecasts, people, data, products, facilities, and records necessary

to perform their independent evaluations.

Competence

A business's internal auditors have to be people who possess the necessary education,

experience, and proficiency to complete their work competently, in accordance with accepted

internal auditing standards. An understanding of good business practices is essential for

internal auditors. They must have the capability to apply broad knowledge to new situations,

to recognize and evaluate the impact of actual or potential problems, and to perform adequate

research as a basis for judgments. They must also be skilled communicators and be able to

deal with people at various levels throughout the organization.

Confidentiality

Evaluations and conclusions contained in internal auditing reports are directed internally to

management and the board, not to stockholders, regulators, or the public. Presumably,                                                                                                                31  Audits  Internal,  www.inc.com/encyclopedia/audits-­‐internal  

 31  

management and the board can resolve issues that have surfaced through internal auditing and

implement solutions privately, before problems get out of hand. Management is expected to

acknowledge facts as stated in reports, but has no obligation to agree with an internal auditor's

evaluations, conclusions, or recommendations. After internal auditors report their conclusions,

management and the board have responsibility for subsequent operating decisions—to act or

not to act. If action is taken, management has the responsibility to ensure that satisfactory

progress is made and internal auditors later can determine whether the actions taken have the

desired results. If no action is taken, internal auditors have the responsibility to determine that

management and the board understand and have assumed any risks of inaction. Under all

circumstances, internal auditors have the direct responsibility to apprise management and the

board of any significant developments that the auditors believe warrant

ownership/management consideration or action.

Various types of audits are used to achieve particular objectives. The types of audits briefly

described below illustrate a few approaches internal auditing may take.32

Operational Audit

An operational audit is a systematic review and evaluation of an organizational unit to

determine whether it is functioning effectively and efficiently, whether it is accomplishing

established objectives and goals, and whether it is using all of its resources appropriately.

Resources in this context include funds, personnel, property, equipment, materials,

information, space, and whatever else may be used by that unit. Operational audits can

include evaluations of the work flow and propriety of performance measurements. These

audits are tailored to fit the nature of the operations being reviewed. "Carefully done,

operational auditing is a cost-effective way of getting a higher return from the audit function

by making it helpful to operating management," wrote Hubert D. Vos in What Every Manager

Needs to Know About Finance.

System Audit

A system analysis and internal control review is an analysis of systems and procedures for an

entire function such as information services or purchasing.

Ethical Practices Audit

An ethical business practices audit assesses the extent to which a company and its employees

follow established codes of conduct, policies, and standards of ethical practices. Policies that                                                                                                                32  Audits  Internal,  www.inc.com/encyclopedia/audits-­‐internal  

 32  

may fall within the scope of such an audit include adherence to specified guidelines in such

areas as procurement, conflicts of interest, gifts and gratuities, entertainment, political

lobbying, ownership of patents and licenses, use of organization name, speaking engagements,

fair trade practices, and environmentally sensitive practices.

Compliance Audit

A compliance audit determines whether the organizational unit or function is following

particular rules or directives. Such rules or directives can originate internally or externally and

can include one or more of the following: organizational policies; performance plans;

established procedures; required authorizations; applicable external regulations; relevant

contractual provisions; and federal, state, and local laws.

Financial Audit

A financial audit is an examination of the financial planning and reporting process, the

conduct of financial operations, the reliability and integrity of financial records, and the

preparation of financial statements. Such a review includes an appraisal of the system of

internal controls related to financial functions.

Information Systems Audit

A systems development and life cycle review is a unique type of information systems audit

conducted in partnership with operating personnel who are designing and installing new

information systems. The objective is to appraise the new system from an internal control

perspective and independently test the system at various stages throughout its design,

development, and implementation. This approach intends to identify and correct internal

control problems before systems are actually put in place because modifications made during

the developmental stages are less costly. Sometimes problems can be avoided altogether.

There is risk in this approach that the internal auditor could lose objectivity and independence

with considerable participation in the design and installation process.

Program Audit

A program audit evaluates whether the stated goals or objectives of a certain program or

project have been achieved. It may include an appraisal of whether an alternative approach

can achieve the desired results at a lower cost. These types of audits are also called

performance audits, project audits, or management audits.

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Fraud Audit

A fraud audit investigates whether the organization has suffered a loss through

misappropriation of assets, manipulation of data, omission of information, or any illegal or

irregular acts. It assumes that intentional deception has occurred.

Internal Audit

Internal auditors and external auditors both audit, but have different objectives and a different

focus. Internal auditors generally consider operations as a whole with respect to the five key

internal control objectives, not just the financial aspects. External auditors focus primarily on

financial control systems that have a direct, significant effect on the figures reported in

financial statements. Internal auditors are generally concerned with even small incidents of

fraud, waste, and abuse as symptoms of underlying operational issues. But the external

auditor may not be concerned if the incidents do not materially affect the financial

statements—which is reasonable given the fact that external auditors are engaged to form an

opinion only of the organization's financial statements. The external auditor does perform

services for management, including making recommendations for improvement in systems

and controls. By and large, however, these are financially oriented, and often are not based on

the same level of understanding of an organization's systems, people, and objectives that an

internal auditor would have. It should be recognized, however, that the traditionally limited

role of the external auditor has broadened in recent years to include an increased operational

review aspect.

External Audit

Major types of audits conducted by external auditors include the financial statements audit,

the operational audit, and the compliance audit. A financial statement audit examines

financial statements, records, and related operations to ascertain adherence to accounting

standards. An operational audit examines an organization's activities in order to assess

performances and develop recommendations for improvements, or further action. Auditors

perform statutory audits which are performed to comply with the requirements of a governing

body, such as a federal, state, or city government or agency. A compliance audit has as its

objective the determination of whether an organization is following established procedures or

rules.

External auditors are authorized by law to examine and publicly issue an opinion on the

reliability of corporate financial reports. Dennis Applegate describes the history of the

external audits as follows. "The U.S. Congress shaped the external auditing profession and

 34  

created its primary audit objective with the passage of the Securities Act of 1933 and the

Securities Exchange Act of 1934. This combined legislation requires independent financial

audits of all firms whose capital stock is bought and sold in open markets. Its purpose, in part,

is to ensure that the financial status and operating performance of publicly traded companies

are fairly presented and disclosed."33 Firms not obliged by law to perform external audits

often contract for such accounting services nonetheless. Smaller businesses, for example, that

do not have the resources or inclination to maintain internal audit systems will often have

external audits done on a regular basis as a sort of safeguard against errors or fraud.

The primary goal of external auditing is to determine the extent to which the organization

complies to managerial policies, procedures, and requirements. The independent or external

auditor is not an employee of the organization. He or she performs an examination with the

objective of issuing a report containing an opinion on a client's financial statements. The attest

function of external auditing refers to the auditor's expression of an opinion on a company's

financial statements. The typical independent audit leads to a certification regarding the

fairness and dependability of the statements. This is communicated to the officials of the

audited entity in the form of a written report accompanying the statements. During the course

of an audit activity, the external auditor also becomes familiar with the details and specialties

of the client's accounting procedures. As a result, the auditor's final report to management

often includes recommendations on methodologies of improving internal controls that are in

place.

The auditing process is based on standards, concepts, procedures, and reporting practices that

are primarily imposed by national or international bodies. The auditing process relies on

evidence, analysis, conventions, and informed professional judgment. General standards are

brief statements relating to such matters as training, independence, and professional care.

General standards usually declare that:34

▪ External audits should be performed by a person or persons having adequate

technical training and proficiency as an auditor.

▪ The auditor or auditors maintain complete independence in all matters relating

to the assignment.

▪ The independent auditor or auditors should make sure that all aspects of the

examination and the preparation of the audit report are carried out with a high

standard of professionalism.

                                                                                                               33  Internal  Auditor  Magazine,  2004  Oct.  Vol  61.  Issue  5,  D.  Applegate,  p.  23  34  Statements  of  Auditing  Standards,  2014,  SAS  No.  1,  AU  sec.  110.  

 35  

Standards of fieldwork provide basic planning standards to be followed during audits:

▪ The work is to be adequately planned and assistants, if any, are to be properly

supervised.

▪ Independent auditors will carry out proper study and evaluation of the existing

internal controls to determine their reliability and suitability for conducting all

necessary auditing procedures.

▪ External auditors will make certain that they are able to review all relevant

evidential materials, whether obtained through inspection, observation,

inquiries, or confirmation, so that they can form an informed and reasonable

opinion regarding the quality of the financial statements under examination.

Standards of reporting describe auditing standards relating to the audit report and its

requirements. They stipulate that the auditor indicate whether the financial statements

examined were presented in accordance with accounting principles; whether such principles

were consistently observed in the current period in relation to the preceding period; and

whether informative disclosures to the financial statements were adequate. Finally, the

external auditor's report should include 1) an opinion about the financial statements/records

that were examined, or 2) a disclaimer of opinion, which typically is included in instances

where, for one reason or another, the auditor is unable to render an opinion on the state of the

business's records.

The independent auditor generally proceeds with an audit according to a set process with

three steps: planning, gathering evidence, and issuing a report.

In planning the audit, the auditor develops an audit program that identifies and schedules

audit procedures that are to be performed to obtain the evidence. Audit evidence is proof

obtained to support the audit's conclusions. Audit procedures include those activities

undertaken by the auditor to obtain the evidence. Evidence-gathering procedures include

observation, confirmation, calculations, analysis, inquiry, inspection, and comparison. An

audit trail is a chronological record of economic events or transactions that have been

experienced by an organization. The audit trail enables an auditor to evaluate the strengths

and weaknesses of internal controls, system designs, and company policies and procedures.

Detection of potentially fraudulent financial record keeping and reporting is one of the central

charges of the external auditor. Not surprisingly, fraud cropped up most often in companies in

the grips of financial stress, and it was perpetrated most often by top-level executives or

managers. According to a study more than 50 percent of fraudulent acts uncovered involved

 36  

overstatements of revenue by recording revenues prematurely or fictitiously.35

Fraudulent techniques included false sales, recording revenues before all terms were satisfied,

recording conditional sales, improper cutoffs of transactions at period end, improper use of

percentage of completion, unauthorized shipments, and recording of consignment sales as

completed sales. In addition, many firms overstated asset values such as inventory, accounts

receivable, property, equipment, investments, and patent accounts.

Accounting  practices

Before I jump into real life issues and examples it is worth to clarify the different accounting

practices and approaches used in our business life. Below I will elaborate these approaches in

more detailed. I started my study with the main objective of accounting, which is a true and

fair view and presentation of the company’s financial status. More precisely, fair presentation

is using the flexibility within accounting rules to give a true and fair picture of the accounts so

that they serve the interests of users (like owners, investors, government). The main question

is; how flexible these accounting activities can be? Earnings Management and Creative

Accounting is using the maximum flexibility within accounting rules to manage the

measurement and presentation of the accounts so that they serve the interests of preparers. To

give a good impression of the firm’s financial situation, Accountants can use the flexibility of

the accounts (especially narrative and graphs) to show a more favorable view than is

warranted of a company’s results. One may say that this “impression management” is very

close to fraud but the truth is that in the latter case responsible persons are stepping outside

the regulatory framework deliberately to give a false picture of the accounts. In order to

differentiate and clarify these specific accounting activities, first I examine the purpose of

these methodologies, which examination will provide us better definitions as well.

Bookkeeping activities by the book

This is the basic. The accounting department or the accountant of a firm or organization is

fully and strictly compliant with accounting standards and regulations, furthermore never

stretches the limits and conservatively making all the postings, bookings and reporting.

Accuracy and prudence are the main characteristics of such an approach. Preparers of

financial statements are working according to the accounting books, that’s why I used the

                                                                                                               35  Fraudulent  Financial  Reporting  1998-­‐2007,  2010,  M.  S.  Beasley,  J.  V.  Carcello,  p.  17.  

 37  

expression “by the book”. In this case the main purpose of the accounting function is to

record, summarize and report all business transactions as they occur and as regulations

instruct to do so. Thus they can fulfill its primary objective preparing financial statements that

contain the company's operating performance over a particular period, and financial position

at a specific point in time. Nothing more and nothing less. This type of approach is more

common in small businesses where business activities are not complicated and firms just want

to be compliant with laws and having their tax properly calculated. Certainly there are

businesses that try to avoid tax paying hiding real revenues and profits but that is a category I

do not want to discuss, as they are not relevant from my thesis point of view. Accounting

activities in these companies are usually outsourced to small accounting firms. When

businesses and companies are getting bigger and more complex, they start creating accounting

departments within their own organization for better control of the financial reports. The more

complex a business, the more relations having with outside investors, banks or suppliers, the

more control is required by the preparers (company owners) regarding the firm’s financial

reports and the business results. This is the point where the companies start using the

flexibilities of the accounting rules and regulations in order to have a better picture of the firm.

Earnings Management and applying logical accounting policy

Let’s imagine that a company has a long-term contract for a certain service activity that

requires significant initial investment, which occur at the beginning of the contract. Without

applying some logical, common sense accounting technique the company would have huge

losses in the first couple of years of its service contract because of the initial investment costs,

which could show a false company image. Instead, logically costs and earnings can be booked

distributed throughout the service contract life showing more realistic company results.

Although in such a case, the company posts a transaction that never happened literally, in the

sense of “true and fair” view it had to be posted. One thing is very important though;

information about these changes in the books must be disclosed in company’s financial

reports or notes otherwise it causes information asymmetry, which harms relationship with

the public. So, there are situations when simply applying principals and rules cause unreal

picture of the company and accountants need to seek rational and logical methods to avoid it.

Another real example for applying logical and reasonable accounting methods, is related to

pension funds, which have significant impacts on the future and have to have a today’s

liability. Pension benefits are paid far out into the future, but how and when they’ll be paid is

uncertain. Today’s 70-year old pensioners are promised payments for the rest of his or her

 38  

lifetime. How long will he or she live? Today’s 35 year-old active worker will earn additional

benefits, terminate employment, and receive payments for the rest of their lifetimes. How

long will 35-year old employees work for their employer? How might their pay increase?

When will they start to receive their retirement benefits? How long will they live after

retirement? These are the questions and considerations that need to be reflected in the books

by the accounting.

Both pension funding and accounting require assumptions to be made about the future. These

assumptions are called actuarial assumptions and they, along with current plan participant

data and the benefit formula described in the pension plan, are used to project future benefits.

For pension funding, the law gives the plan’s actuary responsibility for the selection of

actuarial assumptions. For pension accounting, the plan sponsor selects the actuarial

assumptions, with guidance from the actuary. Actuarial assumptions for pension accounting

are also generally reviewed by and approved by the company’s external auditors in their

general auditing of a company’s financial statements.

There are different types of assumptions. For instance economic, which consider current

interest rates, salary increases, inflation and investment markets. Demographic assumption

deals with the employees expected behavior and life expectancy. Siemens the well-known

German originated engineering company has its own pension fund to their employees and

facing with similar issues when putting together a consolidated financial statement. Siemens

use the following actuarial assumptions:

Assumed discount rates, compensation increase rates, pension progression rates and mortality

rates used in calculating the Defined Benefit Obligation (DBO) vary according to the

economic and other conditions of the country in which the retirement plans are situated.

The weighted-average discount rate as well as the mortality tables used for the actuarial

valuation of the DBO at period-end were as follows (figure 4):36

                                                                                                               36  Siemens  Annual  Report  2013,  Note  23  Post  Employment  Benefits,  P.  296  

 39  

Figure 4.

Usually, the actuary calculates the expected future pension payments for each employee in the

pension program using the company’s employee data and plan provisions. These future

benefit payments consider the individual’s compensation and service history, and when that

individual might be expected to die, quit, become disabled or retire. Each future payment is

discounted from the date of payment to today using the actuarial assumptions. Actuaries call

this discounted amount the present value of future benefits and it represents the present value

of all benefits expected to be paid from the plan to current plan participants. If assumptions

are correct, the company could theoretically set aside that amount of money in a plan today

and it would cover payments from the plan, including those for service not yet provided.

Based on these assumptions and calculations Siemens, for instance, projected future cash-

flows for the next 10 year.

Regarding the topic of my thesis the main focus is on the pension plan related liabilities,

which could give an opportunity to managements to influence or manipulate company’s

financial statements as it can vary according to the assumptions and calculations. Ethical

decisions could come to light if the company gets to trouble and investments don’t produce

the necessary returns. Management could decide to “touch” pension fund related liabilities

 40  

and connected profit postings in order to keep overall profit margin steady. Would it be

possible? Legally, yes. They could decide to change the actuary assumption method but at the

same time they should disclose this information too. In this case, this activity would be called

earnings management. Unethical management can decide not to provide this information to

shareholders and investors because a good business analysts could read between the lines and

it could turn out that the firm is not in a good shape. In this case we can talk about rather fraud

than earnings management.

For better understanding of Earnings Management, it is important to clarify why earnings

need to be managed. Earnings are the profits that the company generates within a certain

period of time. Any kind of investors and analysts look to earnings to determine the

attractiveness of a particular stock. Companies with less or bad earnings prospects will

typically have lower share prices thus value than those with good prospects. Basic rule is that

a company's ability to generate profit in the future plays a very important role in determining

a stock's price and the value of a company. Given the importance of earnings, it is no surprise

that company management has a vital interest in how they are reported. That is why every

executive needs to understand the effect of their accounting choices so they can make the best

possible decisions for the company. They must, in other words, learn to manage earnings.

Having this clarification, we can say that the main purpose of earnings management is to

show a better or more stable, in some cases more realistic earnings of the company using

accounting rules flexible but legal. In other words, Earnings management is a strategy used by

the management of a company to deliberately manipulate the company's earnings within the

regulatory framework so that the figures match a pre-determined target. This practice is

carried out for the purpose of income smoothing. Thus, rather than having years of

exceptionally good or bad earnings, companies will try to keep the figures relatively stable by

adding and removing cash from reserve accounts. Earnings management may be defined as

“reasonable and legal management decision making and reporting intended to achieve stable

and predictable financial results.”

Let’s take an example, a manager may know some part of the company’s inventory has

become obsolete, but if earnings in the current period are lower than desired, he might defer

recording the loss, or “write-down,” until a future period.

Examples of legitimate earnings management efforts include postponing an acquisition or a

disposal of assets or other transaction until a later period, or otherwise accelerating expenses

when earnings are high and postponing expenses when earnings are low (for example, by

accelerating or deferring advertising expenditures in a quarter). Others might include not

replenishing inventories, or for financial organizations, selling securities for a gain or loss

 41  

during a period of high or low earnings. As you get closer to the line between legitimate and

less legitimate, some companies opt for disclosure.

Earnings management is not to be confused with illegal activities to manipulate financial

statements and report results that do not reflect economic reality. These types of activities,

popularly known as “cooking the books,” involve misrepresenting financial results. However

abusive earnings management is deemed by the regulators to be "a material and intentional

misrepresentation of results". When income smoothing becomes excessive, the regulators may

issue fines. Accounting laws for large corporations are extremely complex, which makes it

very difficult for regular investors to pick up on accounting scandals before they happen.

Some of the red flags that help detecting earnings management activities are

▪ checking cash flows that are not correlating with earnings,

▪ receivables that are not matching revenues,

▪ allowances for uncollectible accounts that are not correlated with receivables,

▪ reserves that are not correlated with balance sheet items,

▪ questionable acquisition reserves,

▪ earnings that consistently and precisely meet analysts’ expectations

Creative Accounting

Many people and experts say Creative Accounting and Earnings Management are the same

but I would like to differentiate them a bit based on their purposes, which are not entirely the

same. Although the outcome of Creative accounting is also provides a better view of the

company in terms of profits or growth the main purposes are maintaining revenue to be more

stable, avoid raising expectations because of extraordinary good year, conceal long-term

changes in company results, maintain or boost share price by reducing apparent levels of

borrowing and by creating good appearance of a profit trend. By definition creative

accounting is a “process whereby accountants use knowledge of accounting rules to

manipulate figures reported in the accounts of a business”37. It is a transformation of financial

accounting figures from what they actually are to what management or preparers desire by

taking advantage of existing rules. In terms of techniques creative accounting can be really

creative and there are too many ways to do that. One can increase income with e.g. premature

sales recognition or decrease expenses with e.g. provision accounting or capitalization of

interest. At the same time, it is possible to increase assets with e.g. enhancing goodwill or

revalue fixed assets. On the other hand liabilities can also be manipulated by e.g. off balance                                                                                                                37  The  ethics  of  creative  acounting,  198,  O.  Amat,  J.  Blake,  J  Dowds  

 42  

sheet financing or reclassified debt and equity. 38 In order to understand creative and

fraudulent accounting cases, which I will show later I need to give a bit more details on the

methods and techniques.

If I want to categorize these techniques, there are two major classes of creative accounting:

▪ On balance sheet

▪ Off balance sheet

The two can be further be categorized into the following types

▪ Big bath charges39

This application is applied when a company places large amounts of money into charges

associated with company restructuring, this in turn, relieves finances from the balance sheet

giving them a so called big bath. The theory behind this on balance sheet technique is that

when future earnings fall short, these conservative estimates miraculously become income

and allow the company to achieve their expected earnings

▪ Cookie Jar Reserves

This application is achieved when companies portray unrealistic assumptions when

calculating estimates for sales returns, loan losses or warranty costs. These accruals are then

hidden in "cookie jars" during good times and used up during bad times.

▪ Creative Acquisition accounting40

This occurs when companies allocate a large portion of an acquisition price as "in process".

Research and Development can also be used advantageously due to the fact that this

allocation can be written off in a one-time charge.

▪ Materiality

This occurs when a company intentionally records errors within a defined percentage ceiling

and when they are questioned or challenged on the implied errors they simply argue that the

profits are too small to matter

▪ Revenue Recognition

Is a method applied when companies increase their earnings by recognizing a sale prior to the

completion of that sale, before the product is delivered to the customer or at a time when the

customer still has the option to terminate the deal resulting is a lower revenue being observed

                                                                                                               38  Creative  Accounting,  1987,  I.  Griffiths,  p.  90  39  http://www.investopedia.com/terms/b/bigbath.asp  40  http://www.finance-­‐lib.com/financial-­‐term-­‐creative-­‐acquisition-­‐accounting.html  

 43  

▪ Round trip technique

The round trip technique used to trade stocks is a method used to increase the volume of

transactions through buying and selling products simultaneously between companies working

together. It is a manipulation practice, which misrepresents the number of transactions

happening. This gives the company the ability to increase their revenues and expenses without

changing the net income of the company.

Round tripping, also known as "capacity swaps", formally known as "capacity purchase

agreements". They are very controversial business transactions. In some cases they are

legitimate transactions but in other cases they may be used to simply improve the books.

▪ Off Balance sheet financing

Off -balance-sheet financing will always result in low financing costs and managing its

earnings by offsetting losses with "one-time" gains resulting from the sale of large assets.

▪ One time charges

The one-time charges mainly work in two ways: with the sale of an asset or the write-off of a

business or inventory. The sale of an asset is simply a sale that results in a one-time cash

inflow. A write-off however can be helpful in several ways. First, it can be timed to work

against a one-time gain such that it has no effect on earnings and the company can get the

write-off off the books with no attention drawn to the issue. Also, if the write-off is later

found to be too large, which may have been the intention all along; some of it can be

reimbursed at a future date, directly adding to profits. Usually it is timed to occur when the

company is trying to cleanse the books and may occur at a time when it works against a one-

time gain, leaving the net effect whatever value is required to make the quarter.

▪ Reversals of Actual Expenses

In certain quarter, the company reverses amounts that had been recorded for various expenses

incurred and already paid. In each instance, these reversals are put back on the books in the

subsequent quarter, thus moving the expenses to a period other than that in which they had

actually been paid. The effect was to overstate company’s income during the period in which

the expenses were actually incurred

▪ Playing Reserve

Banks are able to lend out most of the money they receive in deposit (they also can lend

money they borrow from other banks). However, to protect against bad loans, banks must

keep aside a supply of money called a "reserve". The bank, within general guidelines, gets to

set the size of this reserve to what it feels is prudent compared to how risky its outstanding

loans are. However, when the bank wants to make it look like it made more money this

quarter than last, one way to do that is to take money from the reserve and call it profit with

 44  

the excuse that the loans are safer now than before and that amount was no longer needed. In

my opinion all the above methods should ring a bell and raise ethical issues in the mind of an

accountants or executives who actually instruct accountants to do such tricks

Accounting Fraud

Fraudulent accounting methods are not very different from creative accounting or even

regular accounting activities, however the clear purpose of these intentionally made

transactions is to misinform either the public or the management. This could be anything that

makes a better or worse look of a company’s financial situation in order to hide something,

which is against the law. For example fraudulent financial reporting involves misstatements in

financial statements that are caused by fraudulent financial reporting. The reasons for and

methods of committing fraud are the followings:

Misstatements arising from fraudulent financial reporting are intentional misstatements or

omissions of amounts or disclosures in financial statements to deceive financial statement

users. Fraudulent financial reporting may involve acts such as the following:41

▪ Manipulation, falsification, or alteration of accounting records or supporting

documents from which financial statements are prepared

▪ Misrepresentation in, or intentional omission from, the financial statements of

events, transactions, or other significant information

▪ Intentional misapplication of accounting principles relating to amounts,

classification, manner of presentation, or disclosure

Rita Crundwell very well summarized the legal elements of fraud, which are

▪ A material false statement

▪ Knowledge that the statement was false when it was made

▪ Reliance on the false statement by the victim, and

▪ Damages as a result

Fraud frequently involves either a pressure or an incentive to commit fraud and/or a perceived

opportunity to do so. For example, fraudulent financial reporting may be committed because

                                                                                                               41  Accounting  Irregularities  in  Financial  Statements,  2005,  B.K.B.  Kwok,  p.  22  

 45  

management is under pressure to achieve an unrealistic earnings target. Fraud may be

concealed through falsified documentation, including forgery. For example, management that

engages in fraudulent financial reporting might attempt to conceal misstatements by creating

fictitious invoices. Fraud also may be concealed through collusion among management,

employees, or third parties. For example, through collusion, false evidence that control

activities have been performed effectively may be presented.

Fraudulent accounting uses similar but unlawful methods like misappropriate assets by

stealing cash, inventory or applying fictitious transactions inventing sales of even subsidiaries.

There is a very thin line between creative accounting and fraudulent accounting and I believe

these two are overlapping.

Summarizing the above-mentioned accounting approaches we can say that there are different

categories of applied accounting. It starts from pure bookkeeping and tax reporting activities

through logical and legal manipulation of books and earnings management till extremely

flexible interpretation and usage of creativity of regulations and standards. And last where this

latter creativity is combined with deliberate information hiding in order to generate personal

gain we call it accounting fraud. Below figure 5. shows these approaches:

Figure 5.

 46  

Causes  of  fraud

We cannot continue without examining the root causes of fraudulent actions and try to find

out why employees, managers and top managers step out from the legal zone and crossing the

line to commit fraud. Based on known accounting frauds that were investigated we could

draw a simple conclusion that the motivation is just greed but I doubt that because there must

be some triggers or combination of reasons that urge people to do crime.

Businesses’ primary aim is to maximize profit, which is highly emphasized at almost all

organizations (other than public services or NGOs) and this purpose is supported by

incentives too, which can confuse people.

If we look at scientific answers we cannot miss Cressey’s Fraud Triangle (figure 6.). The

concept of the Fraud Triangle was developed by an American criminologist and sociologist

Donald R. Cressey, who known for his extensive research into the minds of white-collar

criminals. His model explains the factors that cause someone to commit occupational fraud. It

consists of three components which, together, lead to fraudulent behavior:

1. Perceived non-shareable financial need (as pressure)

2. Perceived opportunity

3. Rationalization

Cressey said; “Trusted persons become trust violators when they conceive of themselves as

having a financial problem which is non-shareable, are aware this problem can be secretly

resolved by violation of the position of financial trust, and are able to apply to their own

conduct in that situation verbalizations which enable them to adjust their conceptions of

themselves as trusted persons with their conceptions of themselves as users of the entrusted

funds or property”.42

                                                                                                               42  Other  People's  Money,  Donald  R.  Cressey,  1973,  p.  30  

 47  

Figure 6.

The Fraud Triangle's pressure element is defined as the problematic personal financial

circumstances that motivate an individual to commit a fraud crime. In a typical case, the

potential criminal feels unable or unwilling to disclose his or her situation to others or to seek

assistance. Substance abuse, gambling debts and unmanageable personal financial obligations

are all examples of the sorts of pressures encompassed by Cressey's theory.

The opportunity element in Cressey's Fraud Triangle refers to the potential criminal's access

to the literal and logistical means to commit the fraudulent act. This generally requires the

offender to identify some way to exploit their insider status within a corporate or business

environment and to act accordingly. White-collar criminals might take advantage of their

heightened knowledge of internal operations or their access to important accounts or assets to

facilitate their schemes. In many cases, such individuals are under the impression that their

detailed personal knowledge of internal operations and corporate procedures greatly

minimizes the danger of being caught.

Rationalization is the third and final part of the Fraud Triangle theory, and it refers to the

failure of those who commit white-collar fraud crimes to assume guilt or culpability for their

actions. Instead, such individuals tend to see themselves as victims of unfair circumstances

 48  

that are beyond their control and that justify the decision to abuse their position of trust within

the employer's organization. The type of rationalization involved in a given case might stem

from the criminal's belief that he or she has not been properly compensated for work

performed or perhaps from a misguided belief that he or she is somehow entitled to borrow or

appropriate company funds to fulfill personal financial obligations.

I rather agree with this theory than not, however the more I investigate into the known

accounting scandals the more certain I am that those people who have been involved in these

criminal action did not intend to commit fraud at the time they started cooking the books.

The theory is right regarding the pressure people have bringing the numbers period by period,

deliver growth and profits quarter by quarter. I believe companies’ incentive structures are

one major cause that led to such monumentally risky activity. It is a popular perception that

greed motivated the main players and that the system encouraged their greedy, risky behavior

by handing out high rewards when they succeeded and virtually no punishment when they

failed. In reality, incentive structures can indeed push employees and managers toward

unthinking and even unethical behavior. The strong emphasis on short-term performance

goals may encourage both managers and employees to behave unethically. Where

remuneration is tied to the profitability, executives may want to enlarge profitability in order

to assure their performance bonuses. Perpetrators feel that their actions are legitimized

because they act in order to a higher cause. Employees are aware when a company is greedy,

and that greed, that uncaring search for profit, erodes their morale and loyalty as they realize

that it is their company’s only motivation.

I think managers and executives usually start with small accounting tricks (earnings

management, creative accounting) to meet short-term goals because they’re overly confident

about their company’s ability to recover in the future. The problem is that, if the company’s

performance doesn’t improve, the executive or manager is forced to do more number

manipulation to cover up the initial cooked book, and later this initial small error can easily

grow into a huge fraud. So, their motivations can be a fear that various stakeholders will view

a bad reporting period as a sign of bad things to come. Or a strong belief that hiding poor

performance is in everyone’s best interest, including shareholders, employees, creditors, and

customers. And they have confidence that things will turn around before anyone discovers the

accounting tricks.

Some people enjoy having lots of money and will break the law to get it. Accounting, whether

it is on an individual basis or within the context of a multinational corporation, offers the

opportunity to "cook the books" and take a little or a lot more for yourself without actually

pointing a gun or breaking into someone's house. The white-collar nature of accounting

 49  

crimes make them very tempting because nobody seems to be getting hurt. Personal gain is

certainly a strong motivator, and executives and managers can use it effectively to encourage

high performance without condoning ethical breaches. But personal gain isn’t necessarily the

only factor in this play when it comes to structuring incentive and reward programs.

While ignorance is no excuse for committing unethical or illegal actions, it may play a role in

accounting crimes. Everyone knows that one can't walk into a bank with a gun and steal the

money without breaking the law, but accounting regulations aren't nearly this simple. Tax law,

regulations about insider trading and similar arcane rule books are easily misunderstood, and

inexperienced accountants or businesspeople may engage in unethical behavior without even

being aware of it. So it can be simply and error instead of an intentional fraud. Of course,

when someone is caught and charged, he may make this claim of ignorance when it isn't

actually true.

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Exposition  of  the  central  subject  matter  

Financial  reporting  standards

The obligation to serve the various (and numerous) users of financial statements, requires that

financial information be the result of a unique coding of events and transactions. For that

reason, within each country, local regulations issue generally accepted accounting principles

(GAAP) that are called accounting standards or financial reporting standards. Accounting

standards are authoritative statements of how particular types of transactions and other events

should be recorded and reflected in financial statements. These standards include specific

principles, bases, conventions, rules and practices necessary to capture the data and prepare

the financial statements.43 Originally standards were established country by country (local

GAAP) to reflect its specific cultures and tradition as translated into tax and commercial laws.

With development of international trade of multinational companies and globalization of

financial markets, the need for common, international standards became imperative. Today,

they are prepared by national or supranational no-for-profit agencies. The main issuers are the

IASB (IFRS) for most of the world and the FASB (SFAS, US GAAP) for the United States.

While establishing GAAPs, issuers were mainly concerned about the end users of financial

statements. End users include people like investors, banks, lenders who use third party

financial statements to evaluate business decisions. For instance, an investor will look at a

company's financial statements in order to decide whether to invest. These bodies want to

make consistent standards that help end users understand and use the company's financial data.

GAAP's primary intent is not to help businesses. It is intended to help the end users. All of the

objectives that accounting standard setting bodies wanted to accomplish can be simplified to

one main objective: to make financial statements universally understandable and usable for all

of their users.

The IFRS principal objectives are:

1. to develop, in the public interest, a single set of high quality, understandable,

enforceable and globally accepted international financial reporting standards

(IFRSs) based upon clearly articulated principles. These standards should

require high quality, transparent and comparable information in financial

                                                                                                               43  Financial  Accounting  and  Reporting  -­‐  A  Global  Perspective,  2013,  Lebas,  Stolowy,  Ding,  p.  14

 51  

statements and other financial reporting to help investors, other participants in

the world's capital markets and other users of financial information make

economic decisions;

2. to promote the use and rigorous application of those standards;

3. in fulfilling the objectives associated with (1) and (2), to take account of, as

appropriate, the needs of a range of sizes and types of entities in diverse

economic settings; and

4. to promote and facilitate adoption of IFRSs, being the standards and

interpretations issued by the IASB, through the convergence of national

accounting standards and IFRSs.

Basic objectives of US GAAP are:

Financial reporting should provide information as following:

1. The provided info should be appropriate to be presented to creditors and

potential investors in addition to other users for making potent decisions

concerning investment, credit and similar financial activities =>

comparability

2. The provided info should be helpful to the creditors and potential investors in

evaluating the amounts, timing, and uncertainty of expected cash receipts

about economic resources, the claims to those resources, as well as the changes

occurring in them => relevance

3. The provided info should be helpful in making financial and long-term

decisions and improving the business performance => reliability

4. The information should be helpful in maintaining records => consistency

In the above texts, I have not read anything about ethics or ethical behavior however if we

think about the real meaning of all these regulations it is obvious that these standards not just

determine the statements and accounting activities but at the same time they set ethical

borderlines too. The rules don’t say that something should not be done because it is morally

wrong but they determine exactly what needs to be done and how. So after all, the standards

themselves have a certain ethical contents even if it cannot be found literally. All standards

whether it is a local or international attempt to regulate and guide accounting profession. If we

accept this theory, we can say that every time in history when there was any introduction of

regulation of accounting activities and standardization of financial statements that also set

moral and ethical levels with or without intention. I would say standards conformity depends

 52  

on a strong set of ethical values to guide behavior and an ability to make professional

judgments with respect to the relevance and reliability of financial information. Obviously,

non of these earlier or recent regulations (standards) closed all the possibilities to use creative

accounting but started to draw a solid line between good and wrong. Certainly standards will

never, ever prevent deliberate wrongdoing as fraudulent accounting activities but reduce the

possibilities to make wrong decisions.

IFRS implementation in the US (replacing US GAAP) is continuously on the table. There

were several dates and deadlines aiming introduction, however it seems it is a never ending

story. There are too many obstacles starting from the corporations themselves through FASB

till the US government. There are argues against IFRS and lobbies beside US GAAP. Some

says US GAAP is as good as it is if not better, there is no need to fix it, other says the changes

would be very expensive, or it is not compatible with US-style governance. Either way, I

personally think, we won’t see IFRS in the US soon. A good question is why are US

companies so reluctant to accept IFRS? One reason may be concerns about ethical standards.

According to Steven Mintz IFRS does not ensure the necessary level of ethics what is

enforced by US state boards. The U.S. has a code of professional ethics for CPAs

(professional accountants) that relies on strict independence of auditors from their clients. The

need to approach an audit with a healthy dose of skepticism and an objective mind-set and an

integrity standard that requires CPAs to not give in to the pressure of a superior or client to

deviate from proper accounting and financial disclosure standards. Top management may

want their financial statements to “tell the clients’ side of the story” rather than present

financial information in accordance with GAAP.

On an international level, the Global Code of Ethics issued by the International Federation of

Accountants, a voluntary organization, provides guidance similar to the independence,

integrity and objectivity standards in the U.S. but it is predicated on following principles that

underlie decision making such as economic substance over legal form and the “true and fair

view override.” The latter enables an accountant to deviate from the requirements of an

accounting standard to present fairly financial information. There is no such standard in the

U.S. Moreover, no organization currently exists to enforce the Global Code whereas in the US

each state board of accountancy is responsible for enforcement. Therefore, there are no

required, enforceable international ethics standards that would protect the public interest short

of the regulatory boards in each country adopting the Global Code. Therein lies the rub. While

IFRS has the support of accounting standards setting bodies and regulatory organizations in

 53  

over 100 countries, the same cannot be said about ethics. Can US investors trust that auditors

from another country will follow similar ethics standards as we have in the US? If not, does

that diminish the value of IFRS-prepared financial statements? 44

On the other hand Alexis V. Nisbett and Aamer Sheikh have different opinion. The IFRS are

widely viewed as being more flexible or “principles-based” whereas U.S. GAAP are often

viewed to be more rigid or “rules-based.”45 IFRS are widely regarded to be more principles-

based than U.S. GAAP. These principles-based accounting standards emphasize the spirit of

the accounting rules rather than strict adherence to a set of written requirements.

Rules-based systems encourage creativity (and not the good kind) in financial reporting. They

allow some to stretch the limits of what is permissible under the law, even though it may not

be ethically or morally acceptable. A principles-based system requires companies to report

and auditors to audit the substance or business purpose of transactions; not merely whether

they can qualify as acceptable under incredibly detailed or overly technical rules. A rules-

based system allows managers to ignore the substance and, instead ask, “Where in the rules

does it say I can’t do this?”

Benston, Bromwich, Litan and Wagenhofer point out that: “the rules-based U.S. accounting

standards have been blamed for allowing and even encouraging opportunistic managers to

structure transactions to produce misleading financial statements that their IPAs (Independent

Public Accountants) would have to or could attest did ‘fairly’ present the financial conditions

of the corporation in accordance with generally accepted accounting principles.” In particular,

with respect to Enron, the audit firm Arthur Andersen was charged with designing financial

instruments that met the technical requirements of US GAAP while violating the intent.

Public disclosure of Enron’s procedures has given rise to a renewed debate over whether

accounting standards should be based on rules or principles.46

The EU’s adoption of IFRS was a major shift in the international convergence in accounting

standards. Nevertheless, it is not clear that such convergence would have taken place without

the accounting scandals of early 2000s for example Enron and Worldcom in 2001-2002

respectively. These scandals undermined investors’ confidence in the superiority of US

GAAP and of course other financial reporting standards used around the world. Moreover, the

fact that accounting fraud took place on such a scale even while US GAAP’s detailed rules

had been followed suggested that the problem with US GAAP is fundamental.

As I already mentioned one of the major difference between the IFRS promoted by the EU

                                                                                                               44  Ethics  Sage,  IFRS  and  GAAP,  2010,  S.  Mintz,    45  The  Wall  Street  Journal,  What’s  better  in  accounting,  rules  or‘feel’?,  D.  Reilly,  2007,  p.  C1.  46  Worldwide  Financial  Reporting:  The  development  and  future  of  accounting  standards,  2006,  G.  Benston,  M.  Bromwich,  R.  Litan,  A.  Wagenhofer  

 54  

and the US GAAP is that the IFRS is based on shared principles while the US GAAP is based

on precise rules. Once it became clear that US rules could be followed to the letter but not

respected in their spirit, this made a principles-based, as opposed to a rules-based, approach

more attractive to investors. Although less precise, accounting standards based on principles

make it more difficult for accountants to exploit loopholes in the wording of the standards. By

applying standards in accordance with general accounting principles, financial accountants

have no choice but to follow the spirit of the rules. In turn, the fact that IFRS are based on

principles rather than detailed rules contributed to their increasing legitimacy worldwide.

While the policy makers and regulators in the EU and other countries considered IFRS good

enough to follow and implement in the US regulator wanted to change and introduce stricter

rules and principles. In 2002, a new US federal Law was accepted, which set new and

enhanced standards for all US public companies. It was named after sponsors US Senator

Paul Sarbanes and US representative Michael G. Oxley. The Sarbanes-Oxley Act (SOX) of

2002, which was a direct result of the Enron and Worldcom scandals, recognized the validity

of IFRS and principles-based accounting standards. As a result, it enjoined the SEC

(Securities and Exchange Commission) and the U.S. Financial Accounting Standards Board

(FASB) to take greater account of what was happening internationally when setting financial

reporting standards for the United States.

The Sarbanes – Oxley Act was designed primarily to regulate corporate conduct in an attempt

to promote ethical behavior and prevent fraudulent financial reporting. The legislation applies

to a company’ s board of directors, audit committee, CEO, CFO, and all other management

personnel who have influence over the accuracy and adequacy of external financial reports.

The Sarbanes – Oxley Act has changed the basic structure of the public accounting profession

in the United States.

Accounting  scandals  then  and  now  

I believe accounting fraud and accounting scandals have the same age as accounting itself

however I don’t want to go back hundreds of years but rather focusing on the last one-two

decades since we have much better and detailed information about them. This study is

focusing on accounting and ethical issues and I simply cannot write about accounting frauds

without mentioning Enron although many expert, professor and schools have examined its

collapse. As this particular event (and Worldcom too) triggered many preventive actions and

new regulations by the authorities we can say it was a milestone in history. First, I show a list

 55  

of accounting frauds and scandals in chronological order providing the key issues and the

accounting fraud techniques. Then I will elaborate 3 cases in order to provide more details

and background information of those specific examples in terms of motivation reasons,

applied accounting tricks and outcomes.

Enron 2001 – the beginning of a new era

Enron was one of the world's leading electricity, natural gas, pulp and paper, and

communications companies, with claimed revenues of $111 billion in 2000. After a series of

revelations involving irregular accounting procedures bordering on fraud perpetrated

throughout the 1990s involving Enron and its accounting firm Arthur Andersen, Enron stood

on the verge of undergoing the largest bankruptcy in history by mid-November 2001. Enron

had created offshore entities, units, which may be used for planning and avoidance of taxes,

raising the profitability of a business. This provided ownership and management with full

freedom of currency movement, and full anonymity, that would hide losses that the company

was taking. These entities made Enron look more profitable than it actually was, and created a

dangerous spiral in which each quarter, corporate officers would have to perform more and

more contorted financial deception to create the illusion of billions in profits while the

company was actually losing money. This practice drove up their stock price to new levels, at

which point the executives began to work on insider information and trade millions of dollars

worth of Enron stock.

HIH Insurance 2001

Its corporate downfall can be considered the largest in Australia’s history. HIH Insurance was

Australia’s second-largest insurance company until it entered into provisional liquidation in

2001. It incurred losses totaling $5.3 billion where its director, Rodney Adler, was sentenced

to four and half years of jail time due to obtaining money by false or misleading statements,

and failure to discharge his duties as a director in good faith and in the best interests of the

company.

WorldCom 2002

On June 25, 2002, WorldCom, the Nation’s second largest long distance telecommunications

company, announced that it had overstated earnings in 2001 and the first quarter of 2002 by

more than $3.8 billion. The announcement surprised financial analysts and, coming on top of

accounting problems at other corporations, had a noticeable effect on the financial markets.

The accounting maneuver responsible for the overstatement – classifying payments for

 56  

using other companies’ communications networks as capital expenditures – was

characterized by the press as fraudulent. WorldCom filed for bankruptcy protection on July

21st 2002. On August 8th, the company announced that it had also manipulated its reserve

accounts in recent years, affecting an additional $3.8 billion.

Xerox 2002

Xerox, the photocopying and printing giant, admitted it had overstated its revenues from 1997

by almost $2bn. Xerox’s auditor KPMG, was fired after working for the firm for 30 years.

The SEC accused Xerox of having "misled and betrayed investors" via a series of accounting

tricks designed to manipulate its earnings and enrich top executives. One Xerox accounting

scheme was known internally as "project Mozart" because of its supposed creative brilliance.

Xerox agreed to pay a $10m fine to settle the charges but the SEC sued a number of former

executives and KPMG and filed civil charges against them.

Parmalat 2003

Parmalat SpA, an Italian dairy and food company, declared bankruptcy in late 2003 primarily

due to an accounting scandal worth 8 billion euro. The saga began when Parmalat defaulted

on a $185 million bond payment in mid-November 2003. This act made the auditors and

banks look more closely at the company accounts. Some 38% of Parmalat’s assets were

supposedly held in a $4.9 billion Bank of America account of a Cayman Island based

subsidiary of Parmalat called Bonlat. But before Christmas 2003, Bank of America reported

that no such account existed. Accounting issues revealed are fictitious sales, double billing,

fabrication of operating subsidiaries’ sales, not recording debts, overstating assets and

forged € 3.95 billion Bank of America cheque.

Baninter 2003

Banco Intercontinental or BANINTER was the second-largest privately held commercial bank

in the Dominican Republic, whose demise resulted from fraud and political corruption in

2003. This caused the Dominican’s economy to go into a steep decline as fraudulent

bookkeeping and political influence by the administration of former President Hipólito Mejía

and all the major Dominican political parties resulted in a $2.2 billion deficit or equal to 12 to

15% of the country’s GDP.

 57  

47Bernard L. Madoff Investment Securities 2008

In December 2008, it was revealed that the Wall Street Firm Bernard L. Madoff Investment

Securities LLC was a massive ponzi scheme–meaning it paid back investments with money

from other investors instead of actual profit. This activity must have been covered by

fraudulent accounting. Prosecutors estimated the size of the fraud to be $64.8 billion. the

people Madoff conned are some of the smartest people in the world. People entrusted him

with their charitable funds but they were instead used for his luxurious lifestyle and personal

gain.

Société Générale Bank 2008

Jerome Kerviel is a rogue trader who tripped up the world’s financial market when his

unauthorized trading in the securities markets using the bank’s computers resulted in €4.9

billion losses to the Société Générale funds. The worst part of the issue came when the bank’s

executive tried to mask the fraud by “unwinding” his trades. This resulted in trading panic

all over the Atlantic causing a decline in European markets.

Hypo Alpe Adria Bank 2008

One of the biggest bank in Austria and in the South-East Europe used false accounting in

order to hide fraudulent activities. In 2008 it emerged that a canny group of investors

borrowed money from Hypo Leasing at a rate of 4% and lent it to Hypo Alpe Adria with

special agreements that resulted in a repayment at 6.25%. In an extra layer of fraud, the lent

money was booked as capital to give the impression that Hypo Alpe Adria was highly

leveraged and not weighed down by illiquid assets worth far less than inflated market values

to ensure a sale to Bayern Landes Bank. Right after this sale the Bank collapsed immediately

and was nationalized by the Austrian government.

Wolfgang Kulterer the CEO of Hypo was fined for false accounting. Then, in mid-August,

2008 he was arrested on suspicion of fraud relating to his time at the bank. Forensic

accountants revealed many kinds of illegal activities ranging from money laundering of the

entire Balkan, secret bank accounts of politicians, financing criminalities and purchases of

apparently worthless Croatian lands.

Lehman Brothers 2008

Lehman Brothers went bankruptcy in September 2008 starting the world financial crisis. A

report from Anton R. Valukas, the Bankruptcy Examiner, called attention to the use of Repo                                                                                                                47  http://list25.com/25-­‐biggest-­‐corporate-­‐scandals-­‐ever/  

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105 transactions to boost Lehman Brother’s apparent financial position around the date of the

year-end balance sheet. Repo 105 is an accounting trick in which the Bank classifies a

short-term loan as a sale and subsequently uses the cash proceeds from said sale to reduce

its liabilities. In the repo market, companies are able to gain access to the excess funds of

other firms for short periods in exchange for collateral (usually a bond). The company that

borrows the funds will promise to pay back the short-term loan with a small amount of

interest and the collateral typically never changes hands. This is what allows the Bank to

record the incoming cash as a sale; the collateral is assumed to have been "sold off" and

bought back later. Attorney general Andrew Cuomo later filed charges against the bank’s

auditors Ernst & Young in December 2010, alleging that the firm “substantially assisted… a

massive accounting fraud” by approving the accounting treatment. A month later, a New York

Times story revealed that Lehman had used a small company named Hudson Castle to move a

number of transactions and assets off Lehman’s books as a means of manipulating

accounting numbers of Lehman’s finances and risks.

Countrywide Financial 2009

In June 2009, the SEC charged Angelo Mozilo, former executive of mortgage lender

Countrywide Financial with fraud for allegedly misleading investors about the quality of

Countrywide’s loans. Among other things, this included tens and billions of dollars of risky

subprime and adjustable-rate mortgages. Before Countrywide was sold to Bank of America, it

had been the largest NY mortgage lender.

Kabul Bank 2010

In 2010 it was reported that a Kabul Bank took $861 million out of war-ravaged Afghanistan

in a massive fraud centered around fake loans to 19 individuals and companies. A bailout of

the bank costs the equivalent of 5 percent of Afghanistan’s GDP, ensuring this is one of the

world’s largest banking failures of all-time.

The global economic crisis, major financial scandals and the collapse of the banking sector

have highlighted the importance of accounting and finance professionals applying the right

ethical values to ensure the long term sustainability of our businesses and economies.

Accountants have been publicly criticized. In some cases for turning a blind eye to corporate

wrongdoings or failing to expose irregularities, in others for helping to mislead the public by

certifying the financial statements of fraudulent companies such as Enron as true and fair.

Accountants typically have access to and responsibility for an organization’s assets and

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financial reporting. Such roles offer significant temptation and the opportunity to commit or

conceal acts of fraud.

Enron  –  Case  study48

Enron is known as one of the largest accounting fraud scandals in the United States history

(so far). As a result of the investigations, the company was forced to file for bankruptcy in

December 2001. In May 2006, Enron’s former chief executive, Jeffrey Skilling was sentenced

to 24 years in jail while the ex-chairman Kenneth Lay died of heart-attack in July 2006. Andy

Fastow CFO, faced a 10-year prison term but was given a six-year sentence, handed down on

September 26, 2006, as a result of cooperation with prosecutors. He has served just shy of

five years and three months and released in December 2011.

I don’t want to write about Enron’s history as there are hundreds of professional and less

professional case studies, articles, films, movies and books about it49, however I would like to

focus on the accounting techniques and tools what was used at Enron in the 2000s. Enron did

not do anything new, they did not invent accounting again but they went too far with

creativity and obviously broke the line of “true and fair view” and ethics. Most of their

fraudulent act was simply misstatements of their financial records and financial statements.

We will look at them a bit more detailed but in order to see clearly and provide a better

understanding I must start with some background information.

Certainly there were many players by Enron who were involved in the fraudulent activities

but I would like to mention only the big guys. Enron was founded as a result of a merger of

gas companies in 1985. Founded by Kenneth Lay it originated in Omaha Nebraska. Lay was

Chairman and CEO of Enron Corporation and had a PhD in Economics. That time, Enron was

not in a very good shape and there were already mis-reporting issues together with Arthur

Andersen (their Audit firm). These problems were often overlooked however they were signs

of the wrong direction of the corporate culture. With company revenues hurting and a need

for fresh blood into the company, Ken Lay hired an up and coming Harvard Business School

graduate Jeff Skilling. Skilling had a big idea about trading energy, especially natural gas, as

a commodity. His plan to trade natural gas as a valued asset was only one of his brilliant

ideas; the other being adopting an accounting system that would ensure the success of Enron

for the foreseeable future.

Skilling had a condition on which he would work for Enron, the corporation would have to                                                                                                                48  Enron  and  World  Finance,  2006,  P.H.  Dembinski,  C.  Lager,  A.  Cornford,  JM.  Bonvin  49  https://www.youtube.com/watch?v=gxzLX_C9Z74

 60  

adopt a new form of accounting called mark to market. Developed by traders in the 1980’s

this new form of accounting allowed accounting for the fair value of an asset or liability to be

based on the current market price, however this figure could also be obtained through any

other objective process; in effect accountants could value assets and liabilities at any value

they saw fit. Because the accounting system was a new and popular idea and so was the idea

of trading natural gas as a commodity, Arthur Andersen, Enron’s accounting firm and the

Securities and Exchange Commission (SEC) both signed off on approval for Enron to adopt

Mark to Market Accounting. Regardless of how much revenue Enron was earning, Enron

could speculate natural gas futures and record them on their books as earned revenues. When

Mark to Market was approved the company immediately posted huge earnings and the

Executives took the first of many large bonuses from these inflated earnings. The Enron

executives literally threw a party when Mark to Market was approved; they immediately paid

themselves bonuses based on un-earned revenue. This event was both the beginning, and the

beginning of the end for Enron. Andy Fastow (BA in Economics and Chinese, MBA), was 29

when he was hired by Skilling at the Enron Finance Corp. based on his work at Continental

Illinois National Bank and Trust. Fastow was named the Chief Financial Officer at Enron in

1998. Many people says that he was clearly the brain within the team and figured it out how

Enron can keep growing numbers and results quarter by quarter.

The CEO wanted to support investor confidence so much that the price of Enron stock would

never go down. Promising 10-15% returns annually, Enron stepped into different markets and

different types of energy in order to continually drive the price of their stock. The stock price

drove the company and was prominently displayed as a constant reminder to employees what

the company was worth. In the meantime Enron ran its original business as well, for example

in 1996 built a natural gas power plant in India where other investors wouldn’t. The culture of

the company of constant growing results was beginning to affect major business decisions.

The company lost over $1 Billion on the project when the local population could not afford

the power the plant supplied. Meanwhile Enron executives had already paid themselves

bonuses based on the potential earnings of the power plant. This loss encouraged Enron’s next

move a year later, a merger with Portland General Electric, the electric company that

controlled California and most of the Pacific Northwest. Enron continued its policy of

acquiring companies and in 1998 acquired Wessex Water in the United Kingdom, which

formed the basis for its water subsidiary Azurix. With a wealth of new employees to invest

their retirements in the company Enron continued to cover the tracks of its accounting follies

by expanding into new markets and creating new revenue streams, even if they were

investments from their own employees. Stock market analysts would use certified documents

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from Enron’s accounting firm in order to make buy and sell recommendations on Enron’s

stock, the only problem was the company continually had a buy rating, thus driving the price

higher. The first person to notice this otherwise unheard of financial anomaly was a Merrill

Lynch analyst named John Olsen. When he raised questions about the companies reporting

practices he was fired.

In 2000, Enron’s annual revenues reached $100 billion, more than double the year before,

reflecting the growing importance of trading. However, real problems continued with earlier

investments like Azurix in Europe or the power plant in India or the online business. The

same year, The Energy Financial Group ranked Enron the sixth-largest energy company in the

world, based on market capitalization. As CFO Fastow’s responsibility was to report the

company’s earnings, or rather in this case, to fabricate the company’s earnings and cover the

tracks of the failing company. There are some who feel Fastow was set up as the fall guy in

this situation, as someone who “lacked a strong moral compass” he would be the perfect point

man to make all of Enron’s problems disappear. Fastow was young and ambitious but posting

gains year after year when Enron was in fact losing money landed them $30 Billion in debt.

Fastow began layering liability’s in order to post gains for Enron. While this is normally

common business practice, the layers that Fastow was creating were in fact shadow

companies or special purpose entities (SPE) used to suck off Enron’s debt. In this way the

liabilities of the SPEs grew exponentially while Enron was able to continually post gains

quarter after quarter. One of the many SPEs called LJM, started by Fastow in order to sell

Enron’s assets to major banks. By temporarily removing certain assets from the books Fastow

could continue to make Enron’s numbers look good. As partner in LJM Fastow secured

significant profits and bonuses for himself, he sold the idea to major banks by insuring the

assets with Enron stock. It was effectively a guaranteed money maker, backed by stock

options so the legality of the plan was overlooked by 96 of the world’s major banks who

invested as much as $25 Million each in the project. At this point the major banks of the

world knew that Enron was engaging in unethical and even illegal accounting practices, but

like so many others they wanted to take their share of the profits before exposing the scandal.

All of these banks were fully aware that some things were too good to be true. Enron’s

accounting firm Arthur Andersen was collecting nearly $1 Million in fees every week for

their part in the deception, and it is reported that their attorneys were collecting similar fees.

Don’t even mention the Enron executives or even the top level employees that did not raise

their hands when they realized the deception. Motivated by many things, among them greed,

dozens if not hundreds of people could have spoken up at any time and decreased the

magnitude of the failure of Enron, instead they lined their pockets while they watched the

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company sink deeper and deeper.

In April 2001 Enron disclosed it had owned $570 million by bankrupt California utility

Pacific Gas & Electric Co. While the top executives were likely aware of the debt and the

illegal practices, the fraud was not revealed to the public until October 2001 when Enron

announced that the company was actually worth $1.2 billion less than previously reported.

This problem prompted an investigation by the Securities and Exchange Commission (SEC),

which has revealed many levels of deception and illegal practices committed by high-ranking

Enron executives, investment banking partners, and the company’s accounting firm, Arthur

Andersen. At the end of the year Enron’s shares closed at $8.63 per share, an 89% drop since

the beginning of the year.

The critical dates in the scandal are October 16, 2001 and November 8, 2001. On October 16,

Enron disclosed that it had made a loss of $618 million that quarter, while on the second date

it disclosed that it had overstated its earnings since 1997 by $586 million. In other words,

Enron’s accounts for the previous four years had not shown the true state of its huge

indebtedness.

During the 1990s, Enron expended quickly into several areas such as developing power

plants and pipelines. This expansion, however, required large initial capital investments and

long gestation period. By that time, Enron already raised a lot of debt funds from the market

and hence any other attempt to raise funds would affect Enron’s credit rating. But Enron had

to maintain the credit ranking at investment rate in order to continue business. On top of that,

the company wasn’t making enough profits either, as it promised to investors. Hence, Enron

began making partnerships and other special “arrangements” (Special Purpose Entity, or SPE).

These companies were used to keep Enron’s debts and losses away from its balance sheets,

therefore allowing it have a good credit rating and look good in front of the investors. Enron’s

ultimate goal was to overcome the rules of consolidation and, in the same time, still increase

credibility. If a parent company (in this case Enron) financed less than 97% of an initial

investment in a SPE, it didn’t have to consolidate in into its own accounts3. In order to

achieve non-consolidation, according to US GAAP, two conditions must be met:

▪ the assets must be legally isolated from the transferor (i.e. sold to the SPE); and

▪ an independent third party owner has to make a substantive capital investment

which should amount to at least 3% of the SPE’s total capitalization. The

independent third party owner must exercise control over the SPE in order to avoid

consolidation.50

                                                                                                               50  http://www.crmpolicygroup.org/docs/CRMPG-­‐III-­‐Sec-­‐II.pdf

 63  

If properly done, the legal isolation and the third party control over the SPE, reduce the risk of

the credit. Therefore, off-balance sheet treatment of such a SPE involves enough third party

equity. The third party’s equity must be “at risk”, otherwise the transferor would be required

to consolidate the SPE into its own financial statements. Therefore, Enron thought that the

solution was to find outside investors willing to enter into financial arrangements with them

and started several structured entities in the name of SPEs. To allow the SPE to borrow from

the market, Enron, in many cases, provided a guaranty or other form of credit support. Or, in

other cases, the SPEs mutually supported among themselves. Since Enron’s accounting

treatment of SPEs was subject to the test of accounting to determine whether the SPE should

be consolidated or not, that’s how easily Enron achieved the off-balance sheet treatment of all

its SPEs.

The corporation followed this policy in financing which ultimately would enable Enron to be

valued more attractively by rating agencies and Wall Street analysts. Ever since, the huge debt

took place into the subsidiaries and many obligations flew from US companies into Enron’s

SPEs, while the contracts likely to end up in loses were mentioned vaguely in the footnotes of

company accounts. Enron used several related parties in rising of equity and structured its

financial arrangements using the loopholes in laws, trying to not consolidate into its accounts

by intentionally not fulfilling certain conditions. Here is a graphical description of how SPEs

worked51 (figure 7.):

Figure 7.

Enron used SPEs (such as JEDI, Chewco, Raptors, etc.) transactions to facilitate accounting

and financial reporting abuses. No mater, which SPE was used, the aim was not to be

consolidated, Enron’s true financial position would have been disclosed much earlier.

Opening new SPEs was considered necessary for Enron to mitigate market exposures on

                                                                                                               51  University  of  Cincinnati  Law  Review,  Enron & the use & abuse of SPE in corporate structures, 2002, S.L. Schwarcz, p. 1311

 64  

Enron’s investments, including investments in energy-related companies. The transactions in

derivatives were intending Enron’s risk in certain investments in their subsidiaries or related

parties. Therefore, as seen in the figure, Enron transferred its own equity to SPEs in exchange

for a note payable immediately and a derivative contract later, in order to cover the risk of

Enron’s investments. Hence, if the SPEs were required to pay Enron for loss of value in

investments, the stock transferred by Enron earlier would be the principal source of

repayment. In the last two quarters of 2000, Enron recognized revenue Raptor that offset

losses in Enron’s merchant investments. In total, Enron was having an aggregate amount of

investments in related parties of up to $1.9 billion.

The Enron Corp. case was the biggest in a series of scandals that damaged the reputations of

public corporations and Accountancy. As a direct result, the US Congress passed a law,

called the Sarbanes-Oxley Act, which imposed stricter rules on auditors and made corporate

executives criminally liable for lying about their accounts. I will provide more details on SOX

later in this paper. The Enron scandal moved the balance of power away from the company

boards towards the investors.

Years after the Enron case everybody thought that there is more caution among corporate

executives about spinning off accounts that might be inaccurate, as now they can face

criminal liability. But recent history shows that it’s almost the opposite. I think the temptation

to boost stock prices is still a feature of booming markets because the rewards for executives

are still high.

I have already justified earlier why I wanted to show the Enron case more detailed although

Enron did not belong to the financial industry. Nevertheless I would like to provide more

details about another well-known accounting fraud case of the Lehman Brothers that actually

unraveled the worst financial crisis since the Great Depression.

 

Parmalat  –  Case  study

Parmalat, Europe's Enron of fraud, undermined European accounting and reporting standards.

The fraud, totaling nearly 18 billion Euros, brought down the Italian dairy giant and ruined

investors across the globe. Such enormous fraud, supposed to be highly complex and fully

developed in plan as well as execution. However, as Parmalat executives began to cooperate

in the investigation, it was uncovered how primitive their fraud was despite the enormity in

which it occurred.

The story began in 1997, when Parmalat decided to become a "global player" and started a

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campaign of international acquisitions, especially in North and South America, financed

through debt. Soon, Parmalat became the third largest cookie-maker in the United States. But

such acquisitions, instead of bringing in profits, started to bring in losses. Losing money on its

productive activities, the company shifted more and more to the high-flying world of

derivatives and other speculative enterprises. Parmalat's founder and former CEO Calisto

Tanzi engaged the firm in several exotic enterprises, such as a tourism agency called

Parmatour, and the purchase of the local soccer club Parma. Huge sums were poured into

these two enterprises, which have been a loss from the very beginning.

While accumulating losses, and with debts to the banks, Parmalat started to built a network of

offshore mail-box companies, which were used to hide losses, through a mirror-game which

made them appear as assets or liquidity, while the company started to issue bonds in order to

collect money. The security for such bonds was provided by the alleged liquidity represented

by the offshore schemes. The largest bond placers have been Bank of America, Citicorp, and

J.P. Morgan. These banks rated Parmalat bonds as sound financial paper, when they knew, or

should have known, that they were worth nothing. I would like to notice that this time we

were just a couple of month away from Enron’s bankruptcy and both the investigation and

court events were just happening with significant publicity.

The Parmalat crisis finally broke out on Dec. 8 in 2003, when the company Parmalat

defaulted on a €150 million bond. The management claims that this was because a customer, a

speculative fund named Epicurum, did not pay its bills. Allegedly, Parmalat has won a

derivatives contract with Epicurum, betting against the dollar. But it was soon discovered that

Epicurum is owned by firms whose address is the same as some of Parmalat's own offshore

entities. In other words, Epicurum is owned by Parmalat. On Dec. 9, as rumors spread that

Parmalat's claimed liquidity was not there, Standard & Poor's finally downgraded Parmalat

bonds to junk status, and in the next few days, Parmalat stocks fell 40%. On Dec. 12, the

Parmalat management somehow found the money to pay the bond, but on Dec. 19 came the

end: Bank of America announced that an account with allegedly €3.95 billion in liquidity,

claimed by Parmalat at BoA, did not exist. In one shot, the bankruptcy was revealed, and

Parmalat stocks fell an additional 66%.

Parmalat, under the direction of Fausto Tonna (CFO), forged documents as well as created

fake transactions that any reasonable auditor should have been able to uncover. The forgeries

were not considered sophisticated at all. The forgeries were done literally with scissors, a

scanner and with fake stamps. What turned out after the investigations Parmalat created

fictitious sales, double counts sales or fictitious subsidiaries. The company had dubious loans

treated as equity.

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Grant Thornton, Parmalat’s auditor's, were seemingly asleep confirming account amounts as

well as their simple existence. The firm did not confirm the forged documents with outside

third parties such as banks and other creditors. Also, by relying on Parmalat to mail

confirmation letters to various creditors, Thornton could have been directly involved in the

fraud. Some believe that Thornton could have tipped the company off as to what

confirmations were being mailed and when they were being sent out.

Perhaps the most surprising part of the fraud, which was never questioned by auditors, was

the fake sales transactions that were so incredibly large that such a figure would be merely

impossible. According to its quarterly results, a transaction to Cuba, resulting in a $620

million sale, would have provided "every Cuban with about 210 liters of milk a year". Such

gross inflation of financial transactions should have created some professional skepticism by

accountants and internal auditors working for Parmalat.

Many who have examined the Parmalat fraud believe that the fraud was not only an audit

failure but a corporate governance failure as well as a regulatory failure. The corporate

governance acted in a highly unethical manner. Only approximately a dozen executives were

able to create such a large and far-reaching fraud. Tighter internal controls, like those directed

in the Sarbanes Oxley Act, would have made this fraud harder to perpetuate. Despite the

difference in European versus U.S. accounting standards (specifically rules based v. principles

based), Europe should react with a tougher stance on the regulation of its auditing and

governance standards.

Despite Parmalat being one of Europe's largest corporate fraud case in history, it comes as a

great surprise how easily, and with basic skill, that the fraud was conducted. There was some

increased complexity in the subsidiary companies created by Parmalat. However, poorly

forged documents were the key to the fraud. Any reasonably prudent auditor should have

uncovered that the bank accounts, some containing nearly 3.9 billion Euros, did not exist.

Such a material amount should have been treated with much more professional skepticism

than was exercised by Grant Thornton and Deloitte & Touche.

Lehman  Brothers  –  Case  study

The significance of the investment bank Lehman Brothers case does not need to be

emphasized as everyone knows that we count the financial crisis of modern times from the

moment its collapse. Again, I don’t want to write the full case of the company as that would

worth an entire dissertation but would like to highlight the accounting practices that allowed

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Lehman to manipulate its books in order to show a better picture than it was.

Background

In 2003 and 2004, with the U.S. housing boom well under way, Lehman acquired five

mortgage lenders, including subprime lender BNC Mortgage and Aurora Loan Services.

Record revenues from its real estate businesses enabled revenues in the capital markets unit to

surge 56% from 2004 to 2006, a faster rate of growth than other businesses in investment

banking or asset management. Lehman reported record profits every year from 2005 to 2007.

In 2007, the firm reported net income of a record $4.2 billion on revenue of $19.3 billion.

However, by the first quarter of 2007, serious problems in the U.S. housing market were

already becoming visible as defaults (when customers cannot pay their loans) on subprime

mortgages rose to a seven-year high. 52

In the middle of March 2007, a day after the Lehman’s stock had its biggest one-day drop in

five years based on concerns of increasing defaults would affect Lehman's profitability, the

firm reported record revenues and profit for its fiscal first quarter. As the credit crisis erupted

in August 2007 with the failure of two Bear Stearns hedge funds, Lehman's stock fell sharply.

During that month, the company eliminated 2,500 mortgage-related jobs, shut down units and

also closed offices in three states. Even as the correction in the U.S. housing market gained

momentum, Lehman continued to be a major player in the mortgage market. In 2007, Lehman

underwrote more mortgage-backed securities than any other firm, accumulating an $85-billion

portfolio, or four times its shareholders' equity. In the fourth quarter of 2007, Lehman's stock

rebounded, as global equity markets reached new highs and prices for fixed-income assets

staged a temporary rebound. However, the firm did not take the opportunity to decrease its

massive mortgage portfolio.

Prior to its collapse in 2008, Lehman Brothers actively participated in, what is widely

considered now, trickery in order to mislead the investing public. Repurchase agreements

(repos) are a commonly used method of borrowing for many financial institutions across the

nation. According to the financial standards that time53 (has been changed since then) these

agreements should be classified as a liability on a financial institution’s balance sheet. An

increase in liabilities connects to an increase in leverage or debt. Lehman Brothers however

found a loophole in the financial accounting standards, which allowed it to move its

repurchase agreements (liabilities) off its balance sheet. Obviously the intent of the

accounting standard was not to facilitate investor deception, but Lehman Brothers apparently

exploited the loophole in that way. As asset quality decline began to accelerate during the

                                                                                                               52  http://www.investopedia.com/articles/economics/09/lehman-­‐brothers-­‐collapse.asp 53  (US  GAAP)  Statement  of  Financial  Accounting  Standards  No.  140,  2000,    

 68  

subprime crisis and the public began to focus their concern on leverage. Lehman Brothers

relied on this loophole to decrease leverage and maintain investor confidence and their stock

price. With this trick, Lehman managed its balance sheet – by temporarily removing

approximately $50 billion of assets from the balance sheet at the end of the first and second

quarters of 2008. In an ordinary repo, Lehman raised cash by selling assets with a

simultaneous obligation to repurchase them the next day or several days later; such

transactions were accounted for as financings, and the assets remained on Lehman’s balance

sheet. In a Repo 105 transaction, Lehman did exactly the same thing, but because the assets

were 105% or more of the cash received, accounting rules permitted the transactions to be

treated as sales rather than financings, so that the assets could be removed from the balance

sheet. With Repo 105 transactions, Lehman’s reported net leverage was 12.1 at the end of the

second quarter of 2008; but if Lehman had used ordinary repos, net leverage would have to

have been reported at 13.9.

So after all we could say it was rather creative accounting than illegal activity but certainly

against all accounting standards’ objectives. At the same time repos generally cannot be

treated as sales in the United States because lawyers cannot provide a true sale opinion under

U.S. law. And hence there was no American law firm willing to sign off Lehman’s accounting

practice contrary an English law firm did with emphasizing that their opinion was limited to

English law as applied by the English courts and was given on the basis that it will be

governed by and construed in accordance with English law. Where was the auditor this time?

We can ask this rightful question. Lehman Brothers’s audit firm Ernst & Young signed off on

the practice with full understanding that it was being used to deceive investors. My opinion is

that the motivation is as simple as any other similar case; money. From the launch of 'Repo

105' until the Lehman Brothers bankruptcy in 2008, Ernst & Young was paid more than $150

million for its auditing and accounting work for Lehman Brothers. I think it is understandable

now, isn’t it? End of the story that the investors sued Ernst &Young and at the end of the

trials, they agreed to paid $99 million to settle litigation.

So can we state explicitly that Lehman Brothers legally or illegally moved repurchase

agreement debts off of their balance sheet during reporting periods? What is for sure is that

they did it in order to mislead investors by decreasing leverage and investors were unaware of

Lehman Brothers’ repurchase agreement shell games. Assuming investors had known about

this trick, it would have most probably negatively impacted Lehman Brothers’ stock price.

That is exactly what the management wanted to avoid at all costs.

Overall, after considering the relevant moral and ethical behavior, Lehman should not have

exploited the accounting standard’s loopholes and misled the investing public. We can

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conclude that Lehman’s actions were unethical because ethical persons would not have done

the same. Instead would have been to fully disclose the transactions in their filings.

Reading the details of these two cases shows amazing similarities between the collapses of

Enron in 2001 and Lehman Brothers in 2008. In Enron, the misbehavior of top executives

(Ken Lay, Jeff Skilling and Andrew Fastow) was possible because of the inaction of both the

board and the auditing firm. By means of the pre-pay transactions, these Enron executives

managed to transform increases in leverage into positive cash flows, without any balance

sheet impact and with a very simple off-balance sheet structure. In the absence of the pre-pay

transactions, Enron's debt-to-assets ratio would have been 45% instead of the reported 38% in

1999. Does it sound familiar? Lehman's equivalent of the pre-pay transactions is the Repo 105,

a fascinating term that was going to become the new example of how to fool analysts and

investors. Magically, Lehman Brothers used repos reportedly for financing reasons, but

accounted for them as asset disposals These repo proceeds amounted to about $50 billion by

September 2008, which was more than the amount of General Motors’ outstanding bonds

when it went bankrupt and is one third of Hungary’s GDP in 2008 (when it was the highest).

Thanks to the Repo 105 program, Lehman's reported leverage assets to equity dropped from

13.9 times to 12.1 times in the second quarter of 2008. Sounds like Enron.

Lehman's CEO Dick Fuld denied any awareness of Lehman's use of Repo 105 transactions, at

the same time, Bart McDade, Lehman's latest president, confirmed that he had specific

discussions with Fuld about Lehman's Repo 105 usage in June 2008. However, with respect to

the board of directors it is also clear that without exception, former Lehman directors were

unaware of Lehman's Repo 105 program and transactions earlier. Exactly like Enron.

There was controversy on the role of Ernst & Young and its knowledge of the Repo 105

program. The lead partner in the auditing firm stated that Ernst & Young did not approve the

Accounting Policy, it rather became comfortable with the Policy for purposes of auditing

financial statements. Interestingly, when the examiner asked the auditor whether Ernst &

Young should have considered the possibility that strict compliance to accounting rules could

nonetheless lead to a material misstatement in Lehman's publicly reported financial

statements, he refrained from comment. It brings back to memory the images of Arthur

Andersen's auditors shredding incriminating evidence in the Enron scandal.

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Regulatory  response  -­‐  The  Sarbanes–Oxley  Act  (SOX)

In response to the accounting scandals and these ethical lapses we have seen a several

significant changes in legislation, governance codes and compliance measures all over the

world. In the United States the Sarbanes-Oxley Act 2002 (SOX) was implemented, as well as

comprehensive New York Stock Exchange Listing Rules. In the United Kingdom the Tyson

Report on Recruitment and Development of Non-Executive Directors (2003) was

commissioned and a Combined Code on Corporate Governance 2003 established. Australia

responded by implementing CLERP 9 Amendments (2004) and various Corporate

Governance Codes. Singapore amended its Companies Act (2002) and revised its Corporate

Governance Code in 2005. In 2002, the European Union made the bold decision to require

IFRS for all companies listed on a regulated European stock exchange starting in 2005.

As we can see almost all region of the world reacted on these detected issues, that were not

exclusive for US only, but I would like to examine US SOX deeper as the US economy was

hit by these problem worse than other regions and also because SOX has brought significant

changes in business life.

In the US, the public pressure was so high and strong after the Enron and Worldcom scandals

that the Sarbanes–Oxley Act was signed by George W. Bush and passed very quickly through

the Senate. The Act was enacted by spectacularly straightforward votes in both chambers of

Congress: 423-3 in the House and 99-0 in the 100-member Senate. This Act placed personal

responsibility on the CEO and the CFO for the accounts, with serious penalties for misleading

accounts. Also auditors had to confirm that companies had adequate systems and internal

controls. Following the collapse of Arthur Andersen and the introduction of SOX, a large

number of companies had to restate and revise their previous accounts. This raises questions

as to the ethics of those who were responsible for the preparation and auditing of those

restated accounts. However, there is resistance from business and, in spite of the progress in

terms of better accounting, there has recently been a push by industry and commerce to wind-

back the SOX provisions particularly in relation to smaller listed entities.54

SOX has 11 so called Titles and each has several sections (see Attachments) which would be

too much to detail in this document, however I would like to highlight some of the sections

that supposed to bring immediate fix against future problems:

▪ II. Title regulates auditors and focus on the conflicts of interest that are prevented

to ensure that the auditors provide unbiased assessments. Highlights are Section

                                                                                                               54  Financial  Accounting  and  Reporting,  2011,    B.  Elliott,  J.  Elliott,  p.  160  

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201 outlines prohibited auditor activities and Section 203 requires audit partner

rotation.

▪ Title III establishes regulations to ensure that only accurate financial records are

distributed to the public. Highlight is; Section 302 describes the CEO's and CFO's

new responsibilities regarding corporate reports.

▪ Title IV creates further regulations to enhance the transparency and accuracy of

financial disclosures.. Highlights are; Section 401. Disclosures in periodic reports,

Section 404 addresses the Management Assessment of Internal Controls and

Section 409 outlines Real Time Disclosure.

▪ Title VIII contains sections that impose criminal penalties and extends the statute

of limitation for acts of fraud. Highlights are; Section 802 describes criminal

penalties for altering documents, Section 806 describes whistleblower protection

and Section 807 describes criminal penalties for fraud.

Among other things, SOX requires inclusion of all material financial information from

companies. They have to report any and all assets and liabilities on their financial statements,

including many off-balance-sheet items. It requires regular review of internal audit controls.

Company executives who sign off on quarterly and annual financial statements also must

certify that they’ve reviewed their own procedures for ensuring that those statements are

accurate and complete. SOX also requires executives to disclose any weaknesses they’ve

identified in their internal controls. Additionally it requires third-party sign-off on internal

audit controls, which means an external accounting firms also have to assess and report on the

effectiveness of their client companies’ internal procedures and controls.

SOX also imposes serious penalties (up to 20 years in prison, plus fines) on anyone convicted

of “altering, destroying, mutilating, concealing, falsifying records, documents, or tangible

objects” in the course of a legal investigation. Accountants who intentionally violate the

requirement to keep records on hand for a minimum of five years can face fines and up to ten

years in prison.

Whistle Blowing

There is an interesting action since SOX and other regulations throughout the world have

been released or changed. This action is the whistle-blowing activity that is legitimized and

even encouraged by these new Acts. I believe it is an effective way to avoid further

accounting frauds but there are a couple of things that I would like to point out. An accountant

in a culture that expects, promotes, or encourages unethical behavior – even silently excuses

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illegal activity – his or her honesty is in danger. The best course of action is never to engage

in such behavior, even if it means losing your job. Accountants have been fired many times.

Fortunately, it is a profession with many opportunities. But, what if this person decide to blow

the whistle and discuss the problem with his or her immediate superior except when it appears

that the superior is involved, in which case the problem should be presented initially to the

next higher managerial level and so on. In the context of business ethics, whistle blowing is

the practice in which employees who know that their company or a colleague is engaged in

illegal activities in any kind, inform superiors, professional organizations, the public, or some

governmental agency of those activities.

Nevertheless, I believe there is a strong judgment against whistle blowing that comes form

our human nature. When we were children, we learned not to “tell on others”. This behavior is

characterized by such words as ‘traitor, ‘mole’ or some other pejorative expression. People

are not just hesitating to blow the whistle, but they also might think it is wrong. Whistle

blowing is viewed as an act of disloyalty, and there is a resistance against it. On the other

hand, there are situations when whistle blowing is acceptable. There must be an ethical

obligation for human beings to prevent harm in certain circumstances. If the only way to

prevent harm is to blow the whistle, then whistle blowing becomes an obligation. The

obligation to prevent harm to the public overrides the obligation of loyalty to a person’ s

profession or company. Whistle blowing is not that simple as we think it is. The person, who

decides to blow the whistle should consider having enough evidence, choose the right time,

build up a support and select the right audience. If the whistle blower is not prepared enough,

he or she can significantly harm his or her position within an organization.

Blowing the whistle on a firm’ s fraudulent accounting procedures may prevent harm as well

as fulfill the accountant’ s responsibility to the general public, but it might violate the

accountant’ s sense of loyalty to the company. For those who give precedence to harm

considerations, there is a reason to blow the whistle. For those who give precedence to rights

considerations, there is a reason not to do so. After the 2008 crisis and the stress to keep up

the numbers or just stay on the surface generated higher probability of wrongdoing in all

organizations. These situations likely contributed and will contribute to more instances of

fraudulent financial reporting. So regulators increased the motivation of whistle blowing.

New statutory and regulatory changes provide greater rewards to individuals who blow the

whistle on fraudulent activities and to organizations that actively encourage an effective

ethical culture.

As we saw from the list of revealed accounting frauds previously, some companies have not

stopped using and still use accounting tricks to blur the lines between assets and liabilities in

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addition manipulate financial statements. Both SOX and new rules from the Financial

Accounting Standards Board (FASB), the designated private organization that establishes

accounting and reporting standards in the United States, require public companies to disclose

all material off-balance-sheet assets, liabilities, and transactions. But even after these

standards passed, firms like Lehman Brothers continued to use legal accounting methods to

move debts off its books at reporting time, making it look healthier financially than it actually

was.

In addition, neither SOX nor the FASB (nor the accounting profession itself) has effectively

addressed the inherent conflicts of interest in the relationships between accounting firms and

the companies they audit. As long as companies pay outside accountants for their services,

accountants have a vested interest in keeping their clients happy, which may mean looking the

other way when a client breaks the rules, either because of inadequate internal procedures or

through malicious intent.

I think, accounting rules and regulations only ensure accurate financial reporting from honest

companies. Stricter penalties for breaking the rules may act as a brake for executives who are

considering whether to play with their numbers, but the real barrier to such behavior comes

from individuals’ moral compasses and the ethical environment in which they work.

Have  SOX  and  other  new  regulations  reached  its  target?

According to a US report55, done by the Federal Bureau of Investigation (FBI) in 2010 and

2011, financial crimes and frauds have increased and even peaked by 2011 in the corporate

world especially in the banking sector in the last decade (Figure 8.). FBI’s mission was to

investigate financial crimes and activities such as corporate fraud, securities and commodities

fraud, financial institution fraud, mortgage fraud, insurance fraud, mass marketing fraud, and

money laundering. The majority of corporate fraud cases pursued by the FBI involve

accounting schemes designed to deceive investors, auditors, and analysts about the true

financial condition of a corporation or business entity. Through the manipulation of financial

data, the share price, or other valuation measurements of a corporation, financial performance

may remain artificially inflated based on fictitious performance indicators provided to the

investing public.

                                                                                                               55  http://www.fbi.gov/stats-­‐services/publications/financial-­‐crimes-­‐report-­‐2010-­‐2011  

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Figure 8.

So, we can raise the question why did fraudulent activities increase although newly

introduced stricter regulations? I think one of the reason is simply because authorities are

close monitoring financial institutions like the mentioned FBI. Furthermore, so-called forensic

accounting developed great tools and methodologies for detecting and capture criminal

activities which are actually working well. Other reason could be that companies themselves

strengthen their internal audit and compliance departments and spend significant amounts

avoiding fraudulent activities and even if some of them are kept within the company, many

reach serious legal actions, which become public. Since the motivation of doing fraud has not

changed and has not declined the actual number of criminal activities has not changed either,

however they are now better recognized and explored because of the above mentioned

investigations.

Financial institutions, including commercial banks, investment banks, credit agencies, equity

firms, insurance companies, and other similar kinds, are considered by most people to have no

other objective than the creation of wealth and generating profit. The performance of financial

institutions is therefore measured solely on the basis of their capacity to maximize financial

assets, which is measured with evaluation factors that review only their monetary results.

How much return do they get on their investment decisions? How much are they able to

maximize the assets in their portfolio? How much profit can they generate from the loans and

credits they subscribe, from the bonds they handle, from the equity they successfully issue on

the financial markets?

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Banks are judged by their ability to develop financial instruments such as complex derivatives

and sophisticated credit schemes that help connect the money of investors with the companies

in need of those financial resources in the best possible way. In pursuing these ends, banks,

and financial institutions in general, have long defended the confidentiality of the information

related to their business, be it data about their clients, the sources and the destinations of the

economic resources they handle, their credit-giving policies and procedures, and many more

aspects of the banking profession that tend to be little transparent and not very communicative

about their way of doing business.56

Financial institutions have become very complex and sophisticated in terms of their operation.

The products and services they offer tend to be more and more complicated. The methods

they invest resources, how they design, promote, and implement credit products, all become

less understandable and straightforward year after year, and the speed at which they develop

is accelerating. This complexity and sophistication of the banking industry is in part a

response to the shifting and ever-growing needs of the banks’ clients. Companies in need of

financing, and of financial services, are having more and more complex businesses with

complex needs and requirements of capital. Globalization also plays an important role. I think

today, it is more difficult for banks to know in detail where these customers operate and what

exactly they do and how they run their businesses. Furthermore, clients change, merge, get

acquired, move in and out of businesses and markets much more rapidly than in the past. It is

not only banks that change so quickly, but their clients, and their clients’ needs also move and

evolve at a higher speed.

After the past years, we can say that governments, regulators, and other authorities simply

cannot cope with this rate of evolution very well. Banks are moving too quickly for the

reaction-time of governments and other authorities. As a consequence, many important issues

are being overlooked or missed by these authorities charged with the regulation.

Sarbanes-Oxley and similar regulations were developed for the purpose of restoring trust but

to reduce information asymmetry as well. This is a natural occurrence between public

companies and their investors because it is impossible for every investor to be intimately

involved with day-to-day operations. Although complete transparency is highly unlikely to

ever happen, financial reporting reduces this asymmetry by giving investors a look at the

financial health and status of the companies they invest in. Both the company and the

investors have a role in making this arrangement work. Investors must trust that the financial

data provided by the company is accurate. This trust by investors is derived from the

Accounting standards like US GAAP or IFRS to which public companies must adhere.                                                                                                                56  Ethical  Issues  facing  the  Banking  Industry,  2010,  R.  S.  Serrano  

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Auditors must ensure that these companies are in accordance with these standards. The

accounting frauds during early 2000’s destroyed that trust. SOX and other new rules were

developed to prevent further inaccuracies and to rebuild lost trust. The public wanted an end

to corporate fraud and called for executives to be punished. But, perhaps paradoxically, the

language of rules and requirements they placed on companies makes it appear that Regulators

have attempted to quiet public outcry rather than pass regulations that would prevent future

frauds. Specifically, Sarbanes-Oxley has been detrimental for two reasons. First, the penalties

and restrictions are too punitive in nature, which renders them ineffective. Second, the Act has

added more costs, both financial and non-financial, to public companies, which have been

detrimental to operations and growth.

SOX requires that the CEO and CFO certify that there are no “material misstatements” and

that financials are accurate. The problem is that “material misstatements” is a subjective term.

It is a determination made by the company’s auditor using both quantitative and qualitative

factors which results in a dollar value threshold. This dollar value, if achieved or surpassed by

inaccurate transactions, would result in the company’s financial statements to be “materially

misstated.” There is no standard set across all companies that must be met. The SEC directed

auditors to not determine materiality solely on a quantifiable (dollar value) basis. Rather, the

determination was to be considered with other factors. The auditor then makes a

determination whether there is a “substantial likelihood” that a “reasonable person” would

consider the information important. Well, in my opinion, this is even blurrier.

Other major problem is the significant costs that companies must invest to fulfill all these

regulatory requirements (costs vs benefits). Complying with Sarbanes-Oxley Section 404

(Management Assessment of Internal Controls) is very time consuming. On a quarterly basis,

employees are required to meet with their auditors and go over their internal control policies

and procedures. Auditors use this opportunity to determine if there are proper controls in

place to ensure that only employees who are allowed to perform duties to carry them out. The

reasoning behind this test is to ensure fraudulent or incorrect transactions can be reasonably

prevented from being processed. In addition, auditors look for evidence of oversight or review

by superiors to ensure transactions are not be performed one-sidedly without review by one or

more parties. They use their findings to submit a report regarding the “effectiveness” of the

company’s internal controls. Effectiveness, as defined by the SEC with respect of internal

controls, is the ability to prevent even one material accounting error from occurring. Although

this thorough practice ensures a periodic review, it requires too much time and resources to be

allocated to ensure auditor compliance. Quarterly tests of internal controls divert employee

time and attention away from business practices and to administrative tasks. Thus it is

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inevitable that these activities have impact on companies’ performance and profit margin.

Audits are not exclusive to public companies. They can also be required for private or

companies not publicly traded because of their size or volume of revenue. A typical example

of a required audit for a non-public company is when a bank will issue a line of credit to a

private company. To ensure the financial health, the bank will require a yearly audit be

conducted in return. For smaller public companies or private companies considering going

public (IPO), the cost of compliance can be prohibitive. The cost is not uniform amongst

companies of all sizes. However, larger companies can absorb the cost better than a smaller

company.

Mandatory rotation of audit firms

In the major accounting frauds and scandals, audit firms were always involved directly or

indirectly. In order to avoid strong familiarity at audit firms several project have started after

the 2008 crisis. These projects aimed to regulate or even force public companies to change

their audit firms time to time. As a result mandatory audit rotation requirement and other audit

market reforms have formally became part of European Union law. Rules published on 27th of

May 2014 in the Official Journal of the European Union—the authoritative source of EU

law—include:57

A requirement that public interest entities—which include listed companies, banks, and

insurance companies—change auditors after 10 years. This period can be extended to 20 years

if the audit is put out for bid, or 24 years in instances of joint audits, in which more than one

firm conducts the audit.

A prohibition on EU audit firms from providing several non-audit services to their clients,

including certain tax, consulting, and advisory services. Firms will be banned from providing

services to audit clients linked to management or decision-making, as well as many services

linked to financing, capital structure, and investment strategy of the audited entity.

A prohibition on contractual clauses in loan agreements that require the audit to be performed

by one of the Big Four firms. The rules came into force on June 16 2014, and most of the

regulations apply beginning June 17, 2016. The prohibition on Big Four-only loan agreements

applies beginning June 17, 2017.

After 3 years of project work, in the United States, the PCAOB (Public Company Accounting

Oversight Board) considered a possible mandatory audit firm rotation requirement, but has

                                                                                                               57  http://eur-­‐lex.europa.eu/legal-­‐content/EN/TXT/PDF/?uri=OJ:L:2014:158:FULL&from=EN    

 78  

dropped the issue from its agenda after receiving pushback from legislators. Also there was a

heavy resistance to the idea of auditor rotation, receiving hundreds of comment letters from

corporate board members and companies who argued that auditor rotation would leave

companies with inexperienced auditors and harm audit quality.

Other countries, however, are still moving ahead with proposals. Last year, India proposed

corporate auditor rotation after 10 years, which project is still ongoing.

Business/Accounting  Ethics  in  education  

In my opinion we have to start with some fundamental question as kick-off this topic. Can

Business Schools teach ethics? Is teaching ethics in business programs effective? Is it

teachable or should come from individuals’ upbringing? Is there an effective way to teach?

In our Executive MBA course in the Corvinus University in Budapest we don’t I have a

separate course covering ethical issues or studying business ethics however I remember

several subject, which have touched ethical topics either with or without specific intention.

For example Corporate Sustainability (CSR), Business and Government Relations, Financial

Accounting and Corporate Finance however I don’t remember any emphasize on specific

ethical dilemmas or issues, which we students analyzed or discussed thoroughly. Contrary,

according to my quick research on the web, nowadays in US and in western European

business schools the question about teaching ethics has changed from “whether we should

teach ethics” to “what are the best methods for teaching ethics”.

Some says teaching business ethics would be like preaching to students and telling them what

is right and what is wrong. Most of us think that people are born with a good sense of right

and wrong and nothing can change the way one will act when faced with an ethical dilemma.

First of all, I think ethics can be and should be taught to children with the age of around 10 –

12, to those whose ethical values aren’t set in stone yet and can be influenced by ethics

education. This is actually happening in elementary and high schools either with the subject

of ethics or religious education. Any religion, if not all set specific lines for good and wrong

similarly to ethical lessons. However going back to our original question it is more valid for

business schools with university people or even professionals who are acting in business life

for years.

Based on my findings that many business schools teach ethics we can assume that ethics can

be taught, and we should focus on how best to teach ethics for our purposes.

I agree with Steven Mintz an ethic teacher in a business school who says “To be effective the

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goal of teaching ethics should not be tell students what’s right and what’s wrong but, instead,

it should be to sensitize students to some of the dilemmas they might experience in business

and to give them the tools to handle the challenges.”58

Business school students are taught from their very first class in a MBA program that

maximization of shareholder value is the primary goal that should drive business decision

making. Ethics in business requires that CEOs, at least sometimes, place the interest of others

ahead of their own self-interests, which for all too many is to maximize their pay packages.

Some of the biggest names of the frauds of the early 2000s stole their way to fortunes and

received MBAs from our most prestigious business schools. For example, Jeffrey Skilling

(Enron) graduated from Harvard. He was driven by greed and the pursuit of short-term profits.

The short-term goal of maximizing profits crowds out the long-term goal of establishing an

ethical culture in an organization, which requires an ongoing commitment to ethical behavior.

Teachers must help students spot the ethical issues before they become so confused in them

that their action choices are limited. Ethical sensitivity can be enhanced in all business and

accounting courses by talking about ethical issues related to the technical issues being covered.

Ethics cases and problems at the end of the courses for instance, might also be utilized to help

enhance ethical sensitivity.59

Ethical reasoning skills can be enhanced in a number of ways like philosophy courses,

specialized accounting or business ethics courses, courses in critical thinking, or integrated to

every single course that are taught. The majority of research studies on ethics education in

accounting concentrate on this component of ethical behavior. Ethical motivation, the desire

to act ethically, is not a cognitive skill, but accounting academics still have a role in

enhancing it in their students. Therefore, developing a sense of professionalism and enhancing

pride in the profession are powerful motivators. One way to enhance pride in the profession is

to tell stories about “accounting heroes.” In its December 30, 2002 issue, Time Magazine

featured three women as “Persons of the Year”: Cynthia Cooper of WorldCom, Coleen

Rowley of the FBI, and Sherron Watkins of Enron. Two of the three were accountants.

Encouragement or stimulation can also be a powerful tool used by academics to help increase

students’ desire to act ethically.

If students are going to truly come to appreciate the important role ethics has in the

accounting profession and to develop a process for recognizing and thinking through ethical

issues, they will need to be engaged in the material, think about it deeply and apply

themselves to it. This requires slowing down the classroom experience and encouraging

                                                                                                               58  Ethics  Sage,  Business  Ethics  Education,  2014,  S.  Mintz,  59  The  Certified  Accountant,  2008,  Dr.  I.  Faour,  3rd  Quarter  Issuse  #  35  

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discussion. Teachers should start initiate dialogs with their students and give enough time to

them to think about cases, situations and digest available information. Mintz calls this method

reflective learning. “Reflective learning helps to transform existing ideas and understandings

to come to a new understanding of a situation. As a tool for ethics education in accounting,

reflective learning provides the link that may enhance ethical understanding and enable

students to apply virtue and reflective thinking to a variety of situations discussed in

accounting courses ... reflective learning slows down classroom activity giving students more

time to process the material, linking it to prior ideas”60. With this method teachers can find

countless activities that can be incorporated into reflective learning. Some examples include

reflection journals, case analyses, role playing, live cases, group interaction and class

discussion.

We can argue about whether ethics is best taught in a separate course or integrated throughout

the curriculum. I am not in a position to judge which way is the best however my opinion is

that in integrated way students are taught that being ethical is part of every discipline, every

decision they make in business, and everything they do. At the same time others say that

while integration sounds good it also means that every professor has (or can learn) the tools

needed to teach ethics to business students. That’s why the stand-alone course may be best.

Not every professor cares about gaining the tools and one can’t fake teaching ethics.

Some says that today’s students are unreachable because they expect instant rewards for their

efforts and ethics gets in the way. I think the problem is what we actually see wherever we

look at in the world or in the news. All the wrongdoings by our leaders that set a bad example

especially since all too many get away with unethical/illegal behavior. For example, Bank of

America that agreed to a settlement with the government of $16.65 billion for their role in the

mortgage meltdown while no BOA executives were sent to jail for their role in the fraud.

Today’s students are tomorrow’s leaders. The public interest requires leaders of the

accounting profession to understand their unique role as professionals and to embrace their

responsibility to act in the public interest. But being responsible leaders does not end with

personal ethical choices. Ethical leaders will also recognize the need to create organizations

where ethical decisions are not undermined but are supported and encouraged, even when

painful. Leaders of the profession will also recognize the need to work at a global level,

through professional societies and/or together with governmental organizations, to create

systems designated to protect and enhance the public interest.

Accountants will increasingly be required to appreciate the critical role ethics serves in the

accounting profession and work continuously improving their process for recognizing and                                                                                                                60  Ethics  Sage,  Business  Ethics  Education,  2014,  S.  Mintz,  

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thinking through ethical issues. As many accountants demonstrate a weakness in the area of

ethical reasoning, it is especially important that the accounting education system be better

designed to assist students in developing these essential skills.

So, after all I think business schools should teach ethics in whatever way they find effective

but it will require significant actions from post-secondary institutions, e.g. committed

professors, supportive university administrators and from the accounting bodies in order to

improve teaching methods and increase the instructional time dedicated to ethics material.

It is more of a challenge today than ever before to get students to care because of the general

decline of ethics in society. Wherever we look there’s another scandal and consequences are

sometimes not dissuasive enough. Finally, if business schools don’t teach ethics they are

sending a signal that it’s not important so why should students care?

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Summary  

The main purpose of this study was to provide a detailed overview about ethics in business

life especially in accounting and how weak or strong our business life was and is ethically

nowadays. Why ethics is important in accounting and what happens if accountants don’t

behave ethically. How lack of ethics caused serious problems and how these events impacted

entire economies and our overall business life. Recognizing the importance of ethical issues, I

examined what regulators, professional bodies and institutions did and what they try to

achieve in the future.

First I searched business and accounting ethics history, its existence and its meaning.

According to the definition provided by Encyclopedia Britannica, ethics deals with what

people consider to be morally good, bad, right or wrong.61 I think it can be applied to any

value belief system. People use ethics in their decision making process. Ultimately, people

make decisions based on their belief of what is right or wrong. Companies have a

responsibility to their stakeholders to ensure all business and accounting activity is handled

ethically. Then I collected different ethical theories from professional bodies and slightly

different representations from other experts and authors. I connected business ethics with

social responsibility and provided my opinion on the subject matter. Based on these

researches and readings I found the following important facts. Integrity and client

confidentiality are extremely important in accounting ethics. Accounting rules and regulations

exist to ensure that financial statements are useful to their end users in their financial decision-

making. For financial statements to be useful, the information presented therein must be

accurate, faithful to the financial circumstances and be produced in time to help the decision-

making process. Poor ethics in accounting result not only in increased incidences of criminal

activities, but also inflict damages on the business' reputation and trustworthiness of its

stakeholders, such as customers and business partners. The absence of trust ensures that the

business finds it difficult to conduct business with others. This damage to a business'

reputation is particularly devastating to accounting firms who rely heavily on that reputation

to remain in business. Arthur Andersen LLP effectively perished as a business because of its

poor conduct in the Enron scandal.

Individuals in the accounting profession have a considerable responsibility to the general

public. As I stated, accountants provide information about companies that allow the public to

make investment decisions. For the public to rely on the information provided, there must be

                                                                                                               61  http://www.britannica.com/EBchecked/topic/194023/ethics  

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a level of confidence in the knowledge and behavior of accountants. Ethical behavior is

necessary in the accounting profession to prevent fraudulent activities and to gain public trust.

Companies must safeguard their business practices and strive to keep the confidence of their

customers and stakeholders. Business scandals of recent years have shaken public trust in

corporate ethics. Firms can quickly fall when public confidence in them is shaken. Trust is

earned by corporations based upon their performance and their record in dealing with ethical

issues. A long-term strategy is necessary for a business to nurture and increase public trust in

its organization. On an individual employee level, the most common ethical issue in

accounting is the misappropriation of assets. Misappropriation of assets is the use of company

assets for any other purpose than company interests. Otherwise known as stealing or

embezzlement, misappropriation of assets can occur at nearly any level of the company and to

nearly any degree. For example, a senior level executive may charge a family dinner to the

company as a business expense. At the same time, a line-level production employee may take

home office supplies for personal use. In both cases, misappropriation of assets has occurred.

My study also provides detailed information of accountancy as a profession and its roles and

responsibilities within and organization and within an economy. I listed the different type of

accounting activities and their main tasks in order to better understand the importance of

accountancy in business life. I showed differences between management, financial accounting

and auditing functions. Having these information collected and clarified I can now summarize

how I see accountancy in the context of ethics. Accountants as professionals have serious

responsibilities whether they working in the public or private sector, they must remain

impartial and loyal to ethical guidelines when preparing a company or individual's financial

records for reporting purposes. An accountant frequently encounters ethical issues regardless

of the industry and must remain continually vigilant to reduce the chances of outside forces

manipulating financial records, which could lead to both ethical and criminal violations.

The burden for public companies to succeed at high levels may place extreme pressure on

accountants creating balance sheets and financial statements. The ethical issue for these

accountants becomes maintaining true reporting of company assets, liabilities and profits

without giving in to the pressure placed on them by management or corporate officers.

Unethical accountants could easily alter company financial records and maneuver numbers to

paint false pictures of company successes. This may lead to short-term prosperity, but altered

financial records will ultimately spell the downfall of companies when fraud is discovered.

After a good understanding of accountants’ and auditors’ roles and responsibilities I

concentrated on the different accounting activity approaches that led us to differentiate certain

accounting activities from conservative bookkeeping, through earnings management and

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creative accounting, to fraudulent actions. I managed to highlight past and current issues in

accounting that can be ethical. I also determined, what are the characteristics of these

activities that help to differentiate them to each other. My opinion is regarding these

accounting practices, that first of all accountants must stay within the regulatory and legal

framework in all situations. Because of the accounting scandals in the past 15 years resulted

better and better accounting standards that leave not much room for individual accounting

steps however not all things can be covered by them. There is always a small opportunity to

play with assets and liabilities or with revenues and expenses for a certain extent. Which, I

also found necessary sometimes. Let’s take my examples for logical accounting practices or

some of the earnings management tools. I truly believe that these accounting activities show

even better picture of a firm actual financial situation than without them, but I also would like

to emphasize the importance of these tools disclosure. In case any of these practical

accounting steps are done, companies should be obliged to disclose these information and

make it clear for the public what they have done and why. The same is valid for creative

accounting activities, which I found very similar to earnings management and honestly, I also

found very close to fraudulent activities

Most accounting scandals over the last two decades have centered on fraudulent financial

reporting. Fraudulent financial reporting is the misstatement of the financial statements by

company management. Usually, this is carried out with the intent of misleading investors and

maintaining the company's share price. While the effects of misleading financial reporting

may boost the company's stock price in the short-term, there are almost always ill effects in

the long run. As a subtopic of fraudulent financial reporting, disclosure violations are errors of

ethical omission. While intentionally recording transactions in a manner that is not in

accordance with generally accepted accounting principles is considered fraudulent financial

reporting, the failure to disclose information to investors that could change their decisions

about investing in the company could be considered fraudulent financial reporting, as well.

Company executives must walk a fine line; it is important for management to protect the

company's proprietary information. However, if this information relates to a significant event,

it may not be ethical to keep this information from the investors. Each time that an unethical

accountant deliberately breaks the rules and regulations to manipulate the information

presented on the financial statements to illegal advantage, those financial statements become

less and less useful. Since financial statements must remain accurate and truthful to help end

users in making their financial decisions, financial statements tainted deter the decision-

making process. Erroneous figures cast all other figures into doubt and end users simply

become unable to trust the information presented.

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I examined the main reasons and motivations committing fraudulent activities based on

scientific research from Donald R. Cressey who stated that 3 factors (pressure, opportunity

and rationalization) are needed for these actions. I partly agreed with his theory but I

emphasized the initial situations of such fraudulent activities that start with covering off of a

small problem in many cases because of people who truly believe that their company can do

better in following periods. Unfortunately in those cases where this “innocent” cover was not

enough later in time more and more serious and illegal steps were followed and became fraud

after all. But I also believe that in many cases we don’t even know about such a case because

companies did really better in next periods and those covers could be removed from books.

We can ask the question rightfully whether creative accounting and fraud can ever be

stopped?

My answer is; probably not because it is part of human nature and the best we can do is to set

up a sound conceptual framework and sound standards, promote good ethical conduct and last

but not least we should be aware that it can happen anytime.

In order to step forward and understand real cases of fraud and other issues first, I had to

provide detailed information about the main accounting standards that exists and regulate

accounting activities in the world. It was not always like today when mainly every booked

transaction is determined by these standards. Prior to 1929, there were no official standards

for accounting practices and ethics. Accountants were not obligated to disclose profits and

losses of companies, and were beholden to no one other than the corporation for which they

worked. The idea of setting official standards for accounting, reporting and disclosure took

shape in the aftermath of the 1929 stock market crash and the Great Depression. Something

big had to happen that triggered these standards implementations. Officials all over the world

introduced accounting standards in order to regulate companies accountancy and standardized

financial reports, which serve after all investors and the public providing them comparable

information of different companies.

In my thesis I detailed the main objectives of IFRS and the US GAAP as these are the main

standards that implemented throughout the developed world. IFRS ethical approach is so

called ‘principal based’ while US GAAP approach is ‘rules-based’. IFRS is implemented in

more than 120 countries including the entire EU, China, Russia, Brazil, Australia, etc., on the

other hand US GAAP is implemented obviously in the US. There are serious considerations

adopting IFRS in the US as well however local lobbies for US GAAP is very strong and IFRS

implementation was postponed several times.

Why I thought standards examination important is, because this is how we can better

understand accounting fraud cases I presented and realize what rules were breached in these

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cases. Unfortunately I could provide quite a long list of big scandals caused by unambiguous

accounting fraud that caused significant damage in international level both in terms of

economy and society. From these cases, I analyzed 3 major ones from the early 2000’s Enron

and Parmalat that triggered major restriction in accounting regulations. In 2001, the collapse

of Enron resulted in losses of more than $60 billion, which impacted investors, individuals

whose retirement accounts were decimated, and the 5,600 people who lost their jobs. The

Parmalat fraud brought down the Italian dairy giant in 2003 and ruined investors across the

globe with a total loss of nearly 18 billion Euros. My third choice was from 2008 with $639

billion in assets and $619 billion in debt, Lehman Brothers’ bankruptcy filing was the largest

in history as its assets far surpassed those of previous bankrupt giants such as WorldCom and

Enron. I believe Lehman Brothers’ case set the financial crisis off and proved that regulations

are still not perfect and there are other factors that regulators must consider in the future.

Interestingly but not surprisingly, similar cases have not stopped happening, in late 2008 the

entire activity of Madoff Securities International turn out to be a Ponzi scheme, which

estimated a total loss of investors money of $65 billion. In 2009 Bank of America misled

shareholders before its merge with Merrill Lynch. In 2012, Barclays and UBS Banks were

involved the LIBOR manipulation, where these banks lend each other money at high rates.

These were just major cases scratching the surface but there were and are hundreds of cases

both national and international level with similar accounting fraud.

Following several large corporate scandals in the US such as Enron and WorldCom, in 2002,

the Sarbanes-Oxley Act (SOX) was signed into law. This act aimed to protect the public from

unethical accounting practices. New disclosure standards require companies to institute

internal control systems and assess those systems annually. Companies also are required to

provide full disclosure of off-balance sheet items in periodic reports. The act clearly states the

penalties for unethical accountants, which includes fines and imprisonment. This act was

introduced due to unethical accounting professionals and the companies for whom they

worked.

But US was not the only country that introduced changes in legislation. We can see that UK,

Australia, Singapore also implemented new regulations and EU committed to IFRS for all

listed companies, which standard was better appreciated in terms of ethical approach. The

purposes of these regulations among others were to focus on the roles and responsibilities of

the auditor firms especially regarding conflict of interest, to ensure and enhance accurate

financial records and reports disclosed to the public and to specify internal controls of public

companies. They also projected serious penalties for fraudulent activities as executives and

other corporate officers could also face criminal prosecution, leading to heavy fines and

 87  

prison time. Furthermore they encouraged a so-called whistle blowing. When an accountant

may face the ethical dilemma of reporting discovered accounting violations to superiors or

regulators. While it is an ethical accountant's duty to report such violations, the dilemma

arises in the ramifications of the reporting.

At first companies started to modify their previous year financial statements, which

surprisingly did not necessarily caused drops of share prices as the market appreciated

companies’ “honesty”. Then firms invested significant amounts to review and improve their

internal procedures, controls, and systems in order to fulfill new regulatory requirements.

Many say new rules and its bureaucracy deterred small and mid-sized companies who planned

to go public. Others stated that overall there was more loss than benefits implementing new

rules but I don’t agree. Truthful companies who has nothing to hide these rules bring more

efficient internal processes and transparent and secured operation, which also good for the

companies themselves.

I am sure these changes in legislations were necessary and brought improvement in

companies behavior but as I mentioned after more than 10 years, these new rules have not

stopped fraud cases immediately. However we could just imagine what would have happened

if they had not been in introduced. Investigated the number of corporate fraud cases increase

continuously year by year, which could have several reasons. First, the financial crisis put a

lot of pressure on companies and certainly on management. These people are willing to go to

the limits and obviously more often cross the line in order to keep the good picture of the

results and create good future projections. On the other hand I don’t think the increasing

number of fraudulent cases shows the true picture. Nowadays, forensic accounting, regulatory

audits, all these control mechanisms help to detect and capture these cases, which tools and

controls were not available earlier. So simply, we have more information about the problems

and easier to find them. It is important to note, that accounting standards, rules and

regulations – whether they strict or even stricter – will never prevent firms and the public

from individuals to commit fraud. The examined cases in my thesis, present certain

individuals (accountants, CFOs, CEOs) who were highly educated, intelligent people and

were smart enough to be 2 steps ahead of regulators and auditors. They applied new

accounting methodologies and tricks that only a few could understand if any at all. These

smart people will not die out in the future and next generation of accountants will invent

something new again before it can be regulated.

With the development of accounting standards, accountants will increasingly be required to

understand and appreciate the critical roles of ethics in accounting profession. They will also

be required to work continually at improving their ability to recognize and think through

 88  

ethical issues. As many accountants demonstrate an inherent weakness in the area of ethical

reasoning, it is especially important that the accounting education system be better designed

to assist students in developing these essential skills. This will require significant action from

both the post-secondary institutions and the professional accounting bodies in order to

improve teaching methods and increase the instructional time dedicated to ethics.

There is debate over whether the attempts to teach ethics are worthwhile or is it effective

enough. However there is no doubt that schools and professional bodies should raise

awareness of how important ethics are to the accounting profession. Accounting is part of the

economic system to create trust in the financial information provided to the public. The

financial markets will not operate efficiently and effectively if there is no a certain level of

trust in this system. If the accounting profession is no longer trusted then there is no role for

them to play in the system.

I think ethics in accounting is more important than ever before. This profession has lost a big

portion of its trust and respect due to the well known scandals of fraudulent accounting cases.

This is what professional bodies and schools can turn around. I remember that in my first

business school I definitely did not study any ethical topic and that was the case a couple of

years later in a chartered accountant course too. This was back in the late 90’s before any of

the above mentioned scandals happened but thinking back ethical problem was simply not

obvious at all. Not because accountants never committed any accounting tricks or crime but

the cases were not well known and information did not spread as fast as today. Later, complex

business transactions required special expertise, which were not always understandable for

controlling authorities even not for auditors and they did not have tools for detecting

accounting problems. I don’t know whether this situation has changed in schools in the past

decades but even today, in this MBA course I personally miss a dedicated subject of ethics

and more ethical topics in the existing subjects of the program. The main reason for ethical

guidelines is not to provide an exact solution to every problem, but to help an aid in the

decision-making process. An established set of guidelines provides a business person or an

accounting professional with a compass to direct him or her toward ethical behavior. So

strengthening the appropriate ethical education should be a must in every business school and

professional schooling.

Specific responsibilities of the accounting profession are expressed in the various codes of

ethics established by the major organizations and professional bodies. These Code of

Professional Conducts outline an accountants’ responsibilities towards the public interest and

emphasizes integrity, objectivity and due care.

Another area where accounting activities can be more ethical is to make as many accounting

 89  

activities “stupid proof” and safe (from ethical perspective) as we can. I truly believe that

companies can create procedures that can help to be more ethical avoiding opportunity of

fraud for example. Accounting tasks require well-defined systems for accurate financial

reporting, and process excellence plays a role in eliminating errors or omissions from the

general ledger. Quality control procedures reflect the attitudes of management and

accountants. If accounting personnel fail to optimize their systems and remove from their

routines activities that do not add value, they are not living up to their ethical obligations.

There are a number of quality tools that can improve and standardize accounting processes.

For this to occur, experts can meet to discuss process steps leading to ideas for improvement,

standardization and waste reduction. This is an ethical approach to process or system

optimization because it requires stakeholders to look at routines in an objective manner.

Organizational improvement, quality assurance and ethics are closely tied together in an

accounting environment. In light of the financial scandals, quality assurance in bookkeeping

and related tasks is important for the well-being of businesses and their stakeholders.

Appropriate internal controls - like a four eye principle - can also improve ethical accounting

procedures with securing transaction authorization, financial statement creation and similar

activities. Internal controls today are built in accounting systems which helps accountants to

follow are also required from regulators, such as the SOX/Section 404, which internal

controls are getting more emphasis than earlier. However we can raise some valid questions if

it is really the control mechanisms that will prevent us from all future accounting frauds or

can we prepare our companies for fending off these situations? Well, as I wrote above, these

controls can help companies to avoid and detect some or the majority of these activities but

there will always be cases until people are involved.

Today transparency regarding a company's accounting methods and practices has become

increasingly important to the general public. A company that provides a clear explanation of

the accounting methods used to prepare its financial statements appears to be more ethical and

trustworthy than companies that do not provide such information. Often, the more ethical and

trustworthy a company appears, the more likely it is to attract new investors.

By today, ethics has become a key area of concern in accounting because of the series of

corporate scandals that had taken place in the world questioning the credibility of the

accounting profession. These scandals have placed in doubt the effectiveness of contemporary

accounting, auditing and corporate governance practices, for which accounting profession is

responsible for. Thus, recognition of the accounting profession is closely linked with the

maintenance of highest ethical standards. Therefore, competence in ethics has become an

essential component of being a professional accountant.

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Biography  

Books, chapters in edited books:

• Lebas, Stolowy, Ding (2013): Financial Accounting and Reporting - A Global Perspective,

p. 122

• ACCA (2011): Risk and reward: shared perspectives, p. 30.

• NY State Society of CPAs (2003): The History of Accountancy

• ACCA (2013): Paper P1 Governance, Risk and Ethics, Chapter 12.

• IFAC (2013): Handbook of the Code of Ethics for Professional Accountants, Section

100.5

• L.P. Hartmann, J. DesHardins, C. MacDonald (2001): Business Ethics, p.150

• D. Knights. M. O.’Leary (2006): Leadership, Ethics, and Responsibility to the other,

p.125

• L. K. Trevino, K. A. Nelson (1999): Managing Business Ethics, p. 151

• M. Dion (1996): Organizational Culture as Matrix of Corporate Ethics, p. 331.

• P. Griseri (2010): Business ethics and corporate social responsibility

• A. Dubey (2009): Association Management, p. 89.

• R. R. Sims (2003): Ethics and corporate social responsibility, p. 18.

• Prof. S. Senaratne (2011): The role of ethics in accounting

• C. McNamara (2011): Complete Guide to Ethics Management: An Ethics Toolkit for

Managers

• D. McPeak (2009): Framework for International Education Standards for Professional

Accountants, p. 13

• Robert H. Montgomery (1912): Auditing Theory and Practice

• E. J. Larsen (2006): Modern Advanced Accounting, p. 1

• J. Freedman (2012): Ethical Responsibility in Accounting

• IASC (International Accounting Standard Committee)/IFRS (International Financial

Reporting Standards) (2013)

• Lebas, Stolowy, Ding (2013): Financial Accounting and Reporting - A Global Perspective,

p. 4

• AAA (American Accounting Association)

• Duska, Ragatz (2011): Accounting ethics p. 10

• , L. Jui, J. Wong (2013): Roles and Importance of professional Accountants, China

Accounting Journal

• R. Moeller (2009): Brink's Modern Internal Auditing (7th edition), p. 274.

 91  

• Standards for the Professional Practice of Internal Auditing (2008), IIA

• D. Applegate (2004): Internal Auditor Magazine, Oct. Vol 61. Issue 5, p. 23

• Statements of Auditing Standards, (2014): SAS No. 1, AU sec. 110.

• M. S. Beasley, J. V. Carcello (2010): Fraudulent Financial Reporting 1998-2007, p. 17.

• Siemens Annual Report (2013): Note 23 Post Employment Benefits, p. 296

• O. Amat, J. Blake, J Dowds (1998): The ethics of creative accounting, p.198

• I. Griffiths (1987): Creative Accounting, p. 90

• B.K.B. Kwok (2005): Accounting Irregularities in Financial Statements, p. 22

• Donald R. Cressey, (1973): Other People's Money, p. 30

• Lebas, Stolowy, Ding (2013): Financial Accounting and Reporting - A Global Perspective,

2013, p. 14

• S. Mintz (2010): Ethics Sage, IFRS and GAAP

• G. Benston, M. Bromwich, R. Litan, A. Wagenhofer (2006): Worldwide Financial

Reporting: The development and future of accounting standards

• P.H. Dembinski, C. Lager, A. Cornford, JM. Bonvin (2006): Enron and World Finance

• S.L. Schwarcz (2002): University of Cincinnati Law Review, Enron & the use & abuse of

SPE in corporate structures, p. 1311

• US GAAP (2000): Statement of Financial Accounting Standards No. 140

• B. Elliott, J. Elliott (2011): Financial Accounting and Reporting, p. 160

• R. S. Serrano (2010): Ethical Issues facing the Banking Industry

• S. Mintz, (2014): Ethics Sage, Business Ethics Education

• Dr. I. Faour (2008): The Certified Accountant, 3rd Quarter Issuse # 35

Journals:

• “Corporate Responsibility Best Practices,” Corporate Responsibility Magazine (December

2011),

• “Scandal Scorecard,” The Wall Street Journal, October 3, 2003, p. B1.

• “What’s better in accounting, rules or ‘feel’?” The Wall Street Journal, D. Reilly, 2007, p.

C1.

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Attachments  

Sections of the `Sarbanes-Oxley Act of 2002'.

Title I--Public Company Accounting Oversight Board

Sec. 101. Establishment; administrative provisions.

Sec. 102. Registration with the Board.

Sec. 103. Auditing, quality control, and independence standards and rules.

Sec. 104. Inspections of registered public accounting firms.

Sec. 105. Investigations and disciplinary proceedings.

Sec. 106. Foreign public accounting firms.

Sec. 107. Commission oversight of the Board.

Sec. 108. Accounting standards.

Sec. 109. Funding.

Title II --Auditor Independence

Sec. 201. Services outside the scope of practice of auditors.

Sec. 202. Preapproval requirements.

Sec. 203. Audit partner rotation.

Sec. 205. Conforming amendments.

Sec. 206. Conflicts of interest.

Sec. 207. Study of mandatory rotation of registered public accounting firms.

Sec. 208. Commission authority.

Sec. 209. Considerations by appropriate State regulatory authorities.

Title III--Corporate Responsibility

Sec. 301. Public company audit committees.

Sec. 302. Corporate responsibility for financial reports.

Sec. 303. Improper influence on conduct of audits.

Sec. 304. Forfeiture of certain bonuses and profits.

Sec. 305. Officer and director bars and penalties.

Sec. 306. Insider trades during pension fund blackout periods.

Sec. 307. Rules of professional responsibility for attorneys.

Sec. 308. Fair funds for investors.

 95  

Title IV--Enhanced Financial Disclosures

Sec. 401. Disclosures in periodic reports.

Sec. 402. Enhanced conflict of interest provisions.

Sec. 403. Disclosures of transactions involving management and principal stockholders.

Sec. 404. Management assessment of internal controls.

Sec. 405. Exemption.

Sec. 406. Code of ethics for senior financial officers.

Sec. 407. Disclosure of audit committee financial expert.

Sec. 408. Enhanced review of periodic disclosures by issuers.

Sec. 409. Real time issuer disclosures.

Title V--Analyst Conflicts of Interest

Sec. 501.Treatment of securities analysts by registered securities

associations and national securities exchanges.

Title VI--Commision Resources and Authority

Sec. 601. Authorization of appropriations.

Sec. 602. Appearance and practice before the Commission.

Sec. 603. Federal court authority to impose penny stock bars.

Sec. 604. Qualifications of associated persons of brokers and dealers.

Title VII --Studies and Reports

Sec. 701. GAO study and report regarding consolidation of public accounting firms.

Sec. 702. Commission study and report regarding credit rating agencies.

Sec. 703. Study and report on violators and violations

Sec. 704. Study of enforcement actions.

Sec. 705. Study of investment banks.

Title VIII--Corporate and Criminal Fraud Accountability

Sec. 801. Short title.

Sec. 802. Criminal penalties for altering documents.

Sec. 803. Debts nondischargeable if incurred in violation of securities fraud laws.

Sec. 804. Statute of limitations for securities fraud.

Sec. 805. Review of Federal Sentencing Guidelines for obstruction of justice and extensive

criminal fraud.

 96  

Sec. 806. Protection for employees of publicly traded companies who provide evidence of

fraud.

Sec. 807. Criminal penalties for defrauding shareholders of publicly traded companies.

Title IX--White Collar Crime Penalty Enhancements

Sec. 901. Short title.

Sec. 902. Attempts and conspiracies to commit criminal fraud offenses.

Sec. 903. Criminal penalties for mail and wire fraud.

Sec. 904. Criminal penalties for violations of the Employee Retirement Income Security Act

of 1974.

Sec. 905. Amendment to sentencing guidelines relating to certain white-collar offenses.

Sec. 906. Corporate responsibility for financial reports.

Title X--Corporate Tax Returns

Sec. 1001. Sense of the Senate regarding the signing of corporate tax returns by chief

executive officers.

Title XI--Corporate Fraud and Accountability

Sec. 1101. Short title.

Sec. 1102. Tampering with a record or otherwise impeding an official proceeding.

Sec. 1103. Temporary freeze authority for the Securities and Exchange Commission.

Sec. 1104. Amendment to the Federal Sentencing Guidelines.

Sec. 1105. Authority of the Commission to prohibit persons from serving as officers or

directors.

Sec. 1106. Increased criminal penalties under Securities Exchange Act of 1934.

Sec. 1107. Retaliation against informants.