4004YPCAF

Introduction to Financial Reporting &

Corporate Governance
 Lecture 4
ETHICS AND REGULATORY
FRAMEWORK
Business Ethics (Company
ethics)
Business Ethics (Company ethics)

Deals with the attitude and behaviour of an

entity in its application of ethical values.
 It includes different areas from board
strategies to how companies negotiate with
their suppliers.
 Most disclosures of an entity’s ethical
approach can be found on their CSR report.
CSR will be discuss later in the chapter.
Business Ethics (Company ethics)

 Disclosure extends beyond legal

requirements and, in this respect, could be
viewed as discretionary
 The entity should have developed policies in
a number of areas in an effort to ensure the
continued survival of the entity
Key areas of business ethics include:

purpose of the business

workforce

customer relations

shareholders and other providers of finance

suppliers

society

implementation
Purpose of the business

 the reason for the entity’s existence

 key areas in the purpose or mission
statement of the company. Such as:
 broad outline of the entity’s products or
services
 entity’s financial objectives
 role of the business in society, as seen by
the entity itself
Workforce (employees)

 The company must have information on how

it relates with its employees.
 Employees have rights and they are to be
treated respect and dignity, not work as
slaves.
Workforce (employees)

THERE SHOULD BE DISCLOSURE OF THE ENTITY’S POLICIES ON:

 working conditions  retirement

 recruitment  redundancy
 training and  discrimination
development  use of entity assets by
 rewards and bonuses employees
 health and safety and
security
 equal opportunities
Customer relations

 how can the entity maintain the quality of its

product or service and, in that way keep its
customers loyal
 how should the entity arrive at a fair price for its
products so that the entity makes a profit, but
the customer pays a reasonable price
 how can the entity improve its after–sales service

Therefore the company should invest in product

quality, fair pricing and after sales service
Shareholders and other providers of
finance
 because the shareholders provide much of the
finance for an entity, it is only right that they
should want a return on their investment
 in addition, they are entitled to expect a timely set
of financial statements and other financial
information
 to a greater or lesser extent, under the principles
of good corporate governance, shareholders will
be involved in the decision making process of the
entity
Shareholders and other providers of
finance

Therefore the company must be

committed to providing a return
on shareholders return and
publishing accurate past and
future business information for
shareholders
Suppliers
 the providers of goods and services to the entity also
need to be considered
 the entity can expect goods and services of
appropriate and acceptable quality to be delivered
on a timely basis
 in turn, the entity should try to settle their debts to
suppliers promptly
 try to arrange with suppliers for the more efficient
delivery of goods
 and not use doubtful practices to secure contracts
with suppliers – so no bribes or excessive hospitality!
Society

 as a member of society, each entity should

accept its role within that society and within
the
 community at large
 this acceptance can be communicated
through the CSR and, in particular, the entity
should
Society
 include within the report information
about:
 how the entity complies with relevant
legislation
 the steps taken by the entity to protect and
improve the environment
 how the entity is involved with the local
community
 the entity’s policy with reference to
sponsorship and charitable donations
Implementation

 the entity should identify the CGC, and the

process of the entity’s implementation of the
CGC’s provisions
 it should also include within its processes an
annual review of the CGC, its provisions, and
the way the entity is making efforts to
comply

Therefore having rules or codes will help in resolving

any ethical dilemma
Benefits of a code

 Provides framework for resolving conflict

 Provides guidelines for similar ethical
disputes and how to resolve them
 Provides the ‘boundaries’ across what is
ethically incorrect to pass
Limitation of a code

 It is a code only. So may not the fit specific

ethical issue
 It can be interpreted in different ways.
 Two different conflicting actions may appear
to be ethically correct to two different
people.
 In some cases no punishment for breach of
code
2) The Importance of Ethical Behaviour

 The work of accountants needs to be trusted by

society at large, as well as by employers, clients
and other stakeholders.
 This work is expected to be free from personal
bias, performed competently, and capable of being
verified.
 These qualities are ensured by the accountant’s
membership of a professional body, which
enforces standards of independence and
competence.
2) The Importance of Ethical Behaviour

 By becoming a professional accountant, a

person can put himself or herself in the
public eye and, potentially, be vulnerable to
the attention of the media.
 What he or she does reflects not only on
themselves, but, also, on their employer, the
accounting body to which they belong, and,
ultimately, their profession.
2) The Importance of Ethical Behaviour

 Accountants submit to rigorous education, training

and assessment, coupled with continuing
professional development (CPD) when qualified.
 This equips them to deal with complex issues,
frequently with a high technical content.
 Accepting to be bound by the published high
standards of ethical behaviour is a powerful way
for accountants to create confidence that they will
not use their knowledge and power to mislead
anyone or to gain an unfair personal advantage.
3) Ethical Code for Accountants

 Following widely publicised company scandals, in

which the actions of accountants, working for
either the organisations concerned or for their
external auditors, were criticised, there has been a
movement in the accountancy profession
worldwide to review and update standards.
 Initially, this covered financial reporting, auditing
and corporate governance, but has now been
extended to the ethical and behavioural context in
which accountants operate.
3) Ethical Code for Accountants

 Previously, the different professional

accountancy bodies issued their own guidance on
ethics, and, indeed, adherence to a code of ethics
is one of the hallmarks of true professionalism.
 There were, however, differences of emphasis
between the bodies.
 The guidance did not prevent a number of widely
publicised corporate failures, such as Enron,
Parmalat, and WorldCom.
3) Ethical Code for Accountants

 In response to this the International

Federation of Accountants (IFAC) decided that
an international code of ethics was needed to
address the perceived causes of the failures.
 IFAC set up the International Ethics Standards
Board for Accountants (IESBA) to produce the
code and to develop and promote ethical
standards and guidance for professional
accountants.
3) Ethical Code for Accountants

 The IESBA Code of Ethics for Professional

Accountants applies to all professional
accountants, whether in public practice, in
business, education, or the public sector.
 It was agreed by the IFAC Board in 2005 and
revised in 2011 and 2013.
3) Ethical Code for Accountants
 The Code serves as the foundation for codes of ethics
developed and enforced by members of IFAC.
 All member bodies must adopt the Code as their own
or show that their own code complies with the IESBA
Code in all material respects.
 No member body of IFAC or firm issuing reports in
accordance with International Auditing and Assurance
Standards is allowed to apply less stringent standards
than those stated in the IESBA Code.
 In the UK a series of Ethical Standards has been
published.
4) The IESBA Code
A) The IESBA Code is divided into 3
sections:
PART A
 Establishes the fundamental principles of professional
ethics for accountants and provides guidance on these
principles.
 Accountants are required to use the Code to identify
actual or potential threats to compliance with the
fundamental principles, to evaluate the significance of
those threats, and to apply safeguards to eliminate
them or to reduce them to an acceptable level such that
compliance with the fundamental principles is not
compromised.
A) The IESBA Code is divided into 3
sections:
PART B & C
 Parts B and C illustrate how the Code is to be applied in
specific situations.
 Examples are given of safeguards that may be
appropriate to address threats.
 There are also examples of situations where safeguards
are not available to address the threats.
 Here the activity or relationship leading to the threats
should be avoided.
 Part B gives specific guidance to accountants in public
practice (those offering their services to the public).
A) The IESBA Code is divided into 3
sections:
PART C
 Applies to all accountants in business irrespective of their work
role.
 IFAC uses the expression ‘in business’ to describe the general
working environment of accountants outside public practice.
 This description embraces not just the private sector but all public
sector and voluntary sector roles, as well.

(Note the differing meanings of ‘public practice’ and ‘public sector’).

 Accountants in public practice may also find the guidance in Part C

relevant to their particular circumstances.
B) How the IESBA Code works

 The Code is built on two conceptual

foundations:
a) A set of fundamental principles, and
b) An awareness of threats to complying with the
principles. These threats must be countered by
safeguards.
C) Fundamental Principles
a) Integrity

 This is about being truthful, straightforward

and honest and dealing fairly with people and
situations.
 It rules out making, either knowingly or
through not taking proper care, misleading or
false statements.
b) Objectivity

 The avoidance of bias; this is closely allied to

independence
c) Professional Competence and Due
Care
 Accountants must acquire and maintain the
appropriate technical and other relevant skills
to perform work thoroughly, correctly and on
a timely basis, ensuring that users of
information produced understand its context
and limitations.
 (It is why IFAC has also made continuing
professional development compulsory in all
its member bodies.)
d) Confidentiality
 Information about organisations and people encountered in
the course of accountancy assignments should not, without
authorisation, be disclosed, inside or outside the work
environment, especially, not to secure a personal advantage
for anyone.
 This principle is overridden only by the force of law.
 If information has to be released, for example under the
Freedom of Information Act 2000, or other Acts of
Parliament (e.g. as a ‘protected disclosure’ under the Public
Interest Disclosure Act 1998):
 the Code requires that such information be complete and
presented in its proper context.
e) Professional Behaviour

 This is about complying with standards and

laws, and not acting in a way that might bring
the profession into disrepute, such as making
unwarranted criticisms of a fellow
professional, or exaggerating one’s abilities
and experience.
D) The concept of threats and safeguards

 The approach of the IESBA is to consider the most likely

reasons why someone would fall short of the standards
of behaviour called for by the fundamental principles.
 The code identifies a series of motivations (which it calls
threats) that could persuade an individual to override his
or her objectivity, cut corners, mislead or otherwise
breach any of the principles.
 Some threats are more likely to be encountered in the
circumstances of an audit, where independence may be
compromised, but wherever accountants work, the
Code expects them to be alert to potential threats.
THREAT.......
 Needs to be countered by a safeguard, i.e. an action or
process put in place to make the threat unlikely to
result in an ethical lapse.
 Safeguards range from protecting individuals, entirely
eliminating a threat, or introducing checks and
balances in organisational procedures to prevent
future threats.
 The nature and extent of safeguards to be applied
depend on the significance of the threats.
 Where a threat is clearly insignificant, no safeguards
are needed.
 The systematic consideration of situations in
order to identify whether a threat exists, how
it might influence matters, and how to
counter it with safeguards is a useful way of
looking at ethical issues.
 The approach strongly resembles what
accountants are accustomed to doing under
the badge of ‘Risk Management’.
E) Threats

 Compliance with the fundamental principles

may potentially be threatened by a broad
range of circumstances.
 Most threats fall into the following
categories:
 a) Self-interest
 b) Self-review
 c) Advocacy
 d) Familiarity
 e) Intimidation / Undue Pressure
 Certain circumstances may give rise to more
than one type of threat.
 For example, where an audit firm wishes to
retain the fee income from a large client, but
encounters an aggressive and dominating
individual, there may be a self-interest threat
as well as an intimidation threat.
a) Self-interest

 Any situation in which individuals, or someone

close to them, have a vested interest in an
outcome, over which they have some degree of
influence or control, has the potential to tempt
them to behave
 unethically.
 For example, an accountant might be aware that if
profits fail to reach a certain target he and his
fellow employees will not be in line for a bonus, or,
more drastically, could even face redundancy.
b) Self-review

 When an accountant is called on to check, audit or

approve a piece of work they were involved in
originating.
 This might happen if, for example, an internal
auditor is seconded for a short period to an
operating unit to cover the absence of its
accountant.
 Later he may return to the unit to perform an
audit and be in a position where he is reviewing
his own work.
c) Advocacy

 A threat to independence mainly affecting

accountants who take on a role representing a
client.
 Examples would be acting on a client’s behalf in a
court case or in a loan application.
 In order to act in an advocacy role, the accountant
has to adopt a position closely aligned to that of
his client.
 This creates both actual and perceived threats to
the auditor’s objectivity and independence.
c) Advocacy

 Accountants in business are expected to

promote the interests of their employers:
 an advocacy threat only arises if it leads to making
false or misleading statements, or presenting
judgements as facts.
c) Advocacy
 In the UK it is normally expected that public servants
will be politically neutral.
 Political bias, a variant of the advocacy threat, may
arise in any public body where the leadership is
democratically elected, e.g. the Civil Service or a local
authority.
 Accountants in such an organisation should act in
accordance with its policies: they should, however,
ensure that their support of (or opposition to)
proposals’ having a party-political dimension is based
on sound evidence and objective analysis.
c) Advocacy

 It is unethical knowingly to misstate or falsify

a case, or deliberately to suppress relevant
information, in furtherance of a party-
political position.
 d) Familiarity
 Arises through a long association with individuals, whether in
an accountant’s own organisation, a client, a customer or a
supplier.
 Objectively reviewing the work of somebody one knows well is
hard because it impacts on the personal relationship with them.
 Similarly, dealing with a buyer or salesperson for many years
may influence the commercial relationship, substituting habit
or ‘not wanting to upset an individual’ for proper analysis and
judgement.
 The offering of inducements becomes a more potent
temptation in the context of a relationship of familiarity.
e) Intimidation @ Undue Pressure
 Involves the exercise of disproportionate pressure by someone in
a position of power and influence.
 At worst this could involve threats of violence against the
accountant;
 BUT, in the work context is more likely to take the form of a hint at
damage to his or her career, the loss of a contract, or some withdrawal of
co-operation that will make his or her life difficult.

 Often, directors and senior managers are under pressure to

achieve profits, and their expressed desire for the business’s
results to be good can feel intimidatory to the accounting staff:
 the perception of intimidation can be as powerful as its actual existence.
 2 broad categories:
a) Institutional safeguards
b) b) Personal safeguards
F) Safeguards
a) Institutional safeguards
 The accountancy profession is heavily controlled both by
statute and regulation and high standards of conduct are
expected.
 Extensive safeguards are also built into the internal
procedures of organisations.
 Financial regulations, separation of powers
 Regimes of corporate governance (CG)
 Internal control
 Declaration of personal and financial interests
 Rules for reporting gifts and hospitality and dealing with suppliers
 All exist to try to create an environment free from abuse,
fraud and corruption.
 Corporate Governance (CG)
 The system of rules, practices and processes by which a company is
directed and controlled.
 Essentially involves balancing the interests of the many
stakeholders in a company including its:
 Shareholders
 Management
 Customers
 Suppliers
 Financiers
 Government
 The community

Source: www.investopedia.com/terms/c/corporategovernance.asp
 Internal Control
 Systematic measures (such as reviews, checks and
balances, methods and procedures) instituted by
an organization to:
 (1) conduct its business in an orderly and efficient manner
 (2) safeguard its assets and resources
 (3) deter and detect errors, fraud, and theft
 (4) ensure accuracy and completeness of its accounting data
 (5) produce reliable and timely financial and management information; and
 (6) ensure adherence to its policies and plans

Read more: 
http://www.businessdictionary.com/definition/internal-control.html#ixzz40O57cUX1
 Sound internal control systems are the first line of defence
against unethical conduct.
 Professional accountants, particularly in senior positions,
should review such systems to ensure that they are fit for the
purpose of countering the threats
 identified above.
 Compliance with these institutional safeguards should be
second nature.
 Following the rules is not enough on its own: professional
and ethical conduct requires accountants to think about the
reasons behind the rules, and to monitor, constantly, the
rules’ effectiveness.
 An organisation may also have adopted rules of conduct for
its entire workforce.
 This is another helpful safeguard but an accountant should
ensure that these rules do not conflict with any of the ethical
requirements of the IESBA Code and, if they do, should try to
have the rules amended.
 Accountants should make sure that they understand where
the IESBA Code imposes ethical considerations specific to
their profession.
 For example, in auditing firms the Code specifically requires
that internal procedures be in place to monitor ethical issues.
 Unethical conduct is always less likely in an
organisation subject to public scrutiny.
 Where public feedback and complaint is
encouraged, even though it usually focuses on
operational performance;
 it can be monitored for concerns about ethics issues.
 The existence of ‘whistle-blowing’ procedures
too provides a route for the detection of
unethical conduct.
 Whistleblower

 Anyone who has and reports insider knowledge of

illegal activities occurring in an organization.
 Whistleblowers can be employees, suppliers,
contractors, clients or any individual who
somehow becomes aware of illegal activities
taking place in a business either through
witnessing the behavior or being told about it.

Read more: Whistleblower Definition | Investopedia 

http://www.investopedia.com/terms/w/whistleblower.asp#ixzz40O4MrqEe 
B) PERSONAL SAFEGUARDS

 Ultimately the responsibility for an individual’s

ethical conduct is a personal one.
 No matter how strong an organisation’s procedural
framework is, sometimes threats will create
pressure to bypass a control, ignore procedures, or
breach ethical standards.
 The Code should guide an accountant on what to
do, but some situations are not clear-cut.
 In such cases, taking advice from a fellow
professional would be a sensible step.
B) PERSONAL SAFEGUARDS

 This would normally take place within the

organisation, but if the matter concerns a
colleague, and, in particular, one of his or her
bosses, the accountant may need to seek help
from outside the organisation.
 In such situations the professional accounting
bodies offer the opportunity to obtain
confidential, informal advice on ethical issues
from one of a carefully selected panel of fellow
members.
G) Situations which may cause
problems
a) Conflicts of Interest

 A conflict of interest is best resolved by removing

its cause.
 Often this can be achieved by withdrawing from
the activity or decision that involves the conflict,
either by passing it to a colleague, perhaps in a
different department, or to someone more senior.
 Devolving the matter to a subordinate may put
that subordinate under pressure and is not
guaranteed to remove the threat.
a) Conflicts of Interest

 Where an extreme conflict of interest exists,

possibly fostered by intimidation, it may be
impossible to apply sufficient safeguards.
 In such a case the situation may become
intolerable for the accountant and
resignation may be the only remaining
course.
b) Financial Interests

 A financial interest can often simply be

avoided e.g. by selling shares in an audit
client.
 From an ethical point of view the problem
may not necessarily be a financial interest
held by the accountant himself but one
belonging to a family member or close friend.
c) Gifts and Hospitality

 Just as openness and transparency operate at

the organisation level to reduce the risk of
unethical behaviour, documenting and
disclosing potential threats to objectivity and
independence is a sound course for an individual.
 For example:
 It should be routine to report the offer of
hospitality or gifts to a superior, and to consider
whether it would appear reasonable to an
impartial observer to accept such an offer.
 Under the Bribery Act 2010 bribery occurs when a
person offers, gives or promises to give a
"financial or other advantage" to another
individual in exchange for "improperly"
performing a "relevant function or activity".
 It is an offence to either offer or accept a bribe.
 The Act applies to both private and public sectors,
and encompasses activities performed outside
the UK, even activities with no link to this country.
 If there are any concerns that hospitality or a gift
may be intended as an inducement, or the
possibility of it being perceived as influencing an
outcome, such as the award of a contract, the
hospitality or gift should be declined.
 Public sector organisations, e.g. local authorities,
have very strict rules on gifts and hospitality.
 Often, a register of all gifts and hospitality will be
maintained, irrespective of whether they are
accepted, declined, returned, or given to charity.
d) Insider Information

 If an accountant has knowledge not yet in the

public domain, whether of a current situation
or an impending decision, it is unethical – and
probably illegal
 to use it for personal advantage e.g. by buying
shares in a company that the accountant has
learnt is about to be subject to a takeover bid.
 In addition, care must be taken not to leak
confidential information, even inadvertently.
H) Summary

 The IESBA Code requires accountants to

uphold fundamental principles of integrity,
objectivity, professional competence and due
care, confidentiality, and professional
behaviour.
H) Summary
 As it is a principles-based rather than rules-
based Code;
 It does not attempt to define a set of exhaustive
rules to follow
 But rather considers how threats such as self-
interest, intimidation and familiarity create the
conditions in which people might be tempted to
act in a manner contrary to the principles, and
invites the application of safeguards in the form of
institutional procedural frameworks and personal
responses to overcome them.
 Although the Code contains some quite
prescriptive actions, it cannot hope to cover
all the circumstances that may face the
professional accountant.
 It is for the individual to become familiar with
the principles, and be vigilant for potential
threats to his or her integrity, objectivity and
independence.
I) Case Studies ON ethical
Dilemmas
a) Case Study 1 – Grant Claim

 An accountant is responsible for the submission

of her company’s claim for a government grant.
 This is the first year she has been involved with
the claim as she is new to the company, although
the company has been claiming the grant for a
number of years.
 The claim must be approved by the company’s
external auditor before it can be submitted to the
Department of Business, Innovation and Skills.
 When reviewing the detailed cost
information, she found that invalid
expenditure items had been included which,
as a consequence, have inflated the amount
of the claim.
 This incorrect approach was consistently
applied to past claims approved by the
auditor.
 The accountant’s manager, who is also new
to the organisation, is a member of the same
golf club as the auditor.
 The accountant must decide if she should
raise her concerns over claims with her
manager and with the auditor so that both
are aware of the previous overclaiming of
grants.
Required:

I. State which IESBA Code principles apply and comment on

their relevance:
Integrity Confidentiality
Objectivity Professional behaviour
Professional competence and due care

II. Identify the possible threats faced by the accountant:

Self-interest Familiarity
Self-review Intimidation / Undue Pressure
Advocacy

III. Advise the accountant on what she should do.

b) Case Study 2 – Insider Information

 The Chief Internal Auditor of a district council

is about to tender on her department’s behalf
for the contract for the provision of internal
audit services to the council.
 It will be an open tender process for both
external and internal providers. Bids from
external providers are being encouraged.
 The evaluation process has been designed
with this in mind.
 A new administrator for her team has
recently been recruited from the department
responsible for awarding the tender contract.
 Although the administrator himself was not
involved in the tender process, his former
colleague and friend is responsible for the
tender specification document and has told
him details about the other bids.
 The administrator has offered to share this
information with the Chief Internal Auditor.
 The information, however, is confidential and
ought not to be seen by any of the tendering
parties.
 If the contract is awarded externally, the
Chief Internal Auditor will lose her job.
 She understands that the use of any insider
knowledge of the tendering process would be
inappropriate when preparing the tender
proposal, but she knows that her bid would
have a better chance of success if this
confidential information was used.
Required:

I. State which IESBA Code principles apply and comment on

their relevance:
Integrity Confidentiality
Objectivity Professional behaviour
Professional competence and due care

II. Identify the possible threats faced by the accountant:

Self-interest Familiarity
Self-review Intimidation / Undue Pressure
Advocacy

III. Advise the Chief Internal Auditors on what she should do.