Ethics - Financial Reporting and Analysis

“Ethics and morals are synonymous. While ethics is derived from Greek, morals isderived from Latin. They are interchangeable terms referring to ideals of character and conduct. These ideals, in the form of codes of conduct, furnish criteria for distinguishing between right and wrong.” Ethics has been a subject of investigation for hundreds of years. Individuals in financial positions must be able to recognize ethical issues and resolve them in an appropriate manner.

Ethics affect all individuals—from the financial clerk to the high-level financial executive. Individuals make daily decisions based on their individual values. Some companies and professional organizations have formulated a code of ethics as a statement of aspirations and a standard of integrity beyond that required by law (which can be viewed as the minimum standard of ethics).

Ten essential values can be considered central to relations between people.

  1. Caring
  2. Honesty
  3. Accountability
  4. Promise keeping
  5. Pursuit of excellence
  6. Loyalty
  7. Fairness
  8. Integrity
  9. Respect for others
  10. Responsible citizenship

Ethics can be a particular problem with financial reports. Accepted accounting principles leave ample room for arriving at different results in the short run. Highly subjective estimates can substantially influence earnings. What provision should be made for warranty costs? What should be the loan loss reserve? What should be the allowance for doubtful accounts?

The American Accounting Association initiated a project in 1988 on professionalism and ethics. One of the goals of this project was to provide students with a framework for evaluating their courses of action when encountering ethical dilemmas. The American Accounting Association developed a decision model for focusing on ethical issues.

  1. Determine the facts—what, who, where, when, how.
  2. Define the ethical issues (includes identifying the identifiable parties affected by the decision made or action taken).
  3. Identify major principles, rules, and values.
  4. Specify the alternatives.
  5. Compare norms, principles, and values with alternatives to see if a clear decision can bereached.
  6. Assess the consequences.
  7. Make your decision.

Example 1: Questionable Ethics in Savings and Loans In connection with the savingsand loan (S & L) scandal, it was revealed that several auditors of thrift institutions borrowed substantial amounts from the S & L that their firm was auditing. It was charged that some of the loans involved special consideration. In one case, dozens of partners of a major accounting firm borrowed money for commercial real estate loans, and some of the partners defaulted on their loans when the real estate market collapsed. It was not clear whether these particular loans violated professional ethics standards. The AICPA subsequently changed its ethics standards to ban all such loans.

In another case, an accounting firm paid $1.5 million to settle charges by the California State Board of Accountancy that the accounting firm was grossly negligent in its 1987 audit of Lincoln Savings & Loan. The accounting board charged that the firm had agreed to the improper recognition of approximately $62 million in profits.

Example 2: Questionable Ethics in the Motion Picture Industry Hollywood’s accounting practices have often been labeled “mysterious.” A case in point is Art Buchwald’s lawsuit against Paramount Pictures for breach of contract regarding the film Coming to America. Paramount took an option on Buchwald’s story “King for a Day” in 1983 and promised Buchwald 1.5% of the net profits of the film. Buchwald’s attorney, Pierce O’Donnell, accused Paramount Studios of “fatal subtraction” in determining the amount of profit.

Although the film grossed $350 million world wide, Paramount claimed an $18 million netloss. As a result of the studio’s accounting practices, Buchwald was to get 1.5% of nothing. Buchwald was eventually awarded $150,000 in a 1992 court decision.

Many Hollywood celebrities, in addition to Art Buchwald, have sued over Hollywood style accounting. These include Winston Groom over the movie rights to Forrest Gump, Jane Fonda over a larger share of profits relating to On Golden Pond, and James Garner over his share of profits from The Rockford Files (a television program). Some of the best creative work in Hollywood is in accounting.

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