Essay on “Ethics and true and fair view in financial reporting”
Financial reporting according to Pervan et al. (2010) is presenting all the relevant financial information of a business in a structured way for easy comprehension. A look at Tesco’s financial statements, there is a clear indication that that it is specifically aimed at impressing the shareholders(Tesco, 2012). The company may be giving true and accurate information but the focus is on creating benefit to stakeholders involved including customers and shareholders. For instance, the review by the chief executive focuses on strengthening the company for the future and there are numerous illustrations that show the company’s impressive performance and organizational culture(Tesco, 2012). Just like in many other company reports, too much focus is laid on the positive outcomes about the company’s operations. According to Hardin (2002), this is a common way for corporate to use financial reporting as a means of hiding behind formalities(Hardin, 2002).
Financial reporting is not only crucial to the companies that send out the report but also to public agencies, competitors, business partners, consumers and investors who receive and use the reports. Enderlie (2004) says that during reporting, companies portray and explicitly convey an image of their philosophies and activities to the public. He further says that the companies use reporting as a means to enhance their reputation and be accountable for their activities and objectives. With regards to the recipients of the report, Enderlie says that they need some truthful information to base their decision on and to hold the corporations accountable(Enderlie, 2004). This further implies that financial reports cannot primarily be designed for shareholders alone. Companies cannot make an assumption that shareholders are finance specialists or the industry. It is for this reason that other users such as banks, customers, suppliers, governments, and employees have to be considered during preparation of the report. There is a lot of vested interest from all these recipients.
Other authors such as Albert (2002) agree with these assertions of Enderlie (2004). Albert even goes ahead to cite examples of cases that support the importance of ethics in financial reporting. For instance, the collapse of Enron was due to unethical practices in financial reporting. The free market policy is basically made possible by the ability of stakeholders to properly evaluate the financial disclosures of companies(Criado-jiménez, et al., 2008). The accuracy of the information presented in the financial reports is not supposed to be subjected to individual evaluation by stakeholders. However, the interpretation of the information in the reports is subject to individual evaluation(Enderlie, 2004).
Aims of financial reporting
There are several aims of financial reporting identified by scholars. Frecka (2008) says that financial reporting is useful in identifying the economic resources of a company. The reports can also be used to identify the claims to economic resources of a company and the impact that circumstances, events, and transactions will have on the identified resources(Ionescu, 2010). Potential and existing investors and creditors are among the group of focus in financial reporting. This is because they use the statements to assess the uncertainty, timing, and amount of cash inflows to a company(Jo & Kim, 2008). In addition, financial reporting is useful to both potential and existing creditors and investors for making important decisions relating to investment and credits(Frecka, 2008).
The role of ethics in financial reporting
According to surveys conducted by Gallup, there is evidence of dishonesty by business people in the corporate world. Compared to other sectors, the poll showed that business people have a 25 percent level of honoring ethical practices in their reporting(Marx & Els, 2009). This is quite a low figure. Gibson (2002) says that it is likely that such polls are discriminating and biased against corporations. However, the one thing that makes them to be more accurate and significant is the fact that they are individually reviewed(Gibson, 2002).
Because of the numerous concerns about the accuracy and comprehensiveness of corporate financial reporting, analysts have always sought to answer the question whether corporations use financial reporting to hide behind their formalities or represent a true substance of their performance(Palmrose & Saul, 2001). Ethics in financial reporting therefore refers to the standards and requirements of trust and transparency by auditors, certifiers, corporate, and any other individual who uses the financial reports. According to Staubus (2005), little attention was given to truthfulness and honesty in reporting before the occurrence of the major scandals of Enron and Andersen in the US. Staubus notes that the reports were believed to be accurate because ofthey were subjected to auditing by publicly recognized auditors. But the point is that auditors can also take part in unethical practices in financial reporting. He therefore notes that the ethics of reporting is a serious problem witnessed by professionals within the financial sector(Zeff, 2003). The problem is not only concentrated in the US but also in companies from other regions such as Europe(Blake, et al., 1996).
Trust and truthfulness of financial reporting is argued to be very complex and that it takes more than just decisions and actions of accounting professionals and corporate executives to enforce ethical practices in reporting(Xu, et al., 2007). Even though the cited cases of Enron and Andersen indicated that the problem lied at the micro level or the individual level of all aspect of a company, it would still be unfair to lay blame on individuals(Jo & Kim, 2008). The macro level or the regulatory level can also be considered since it plays a significant role in preventing unethical practices in reporting.
Importance of ethics
It is important to have ethical standards in financial management as well as reporting because issues to do with finances can sometimes make professionals do strange things(Stolowy & Breton, 2004). Most of the applications used in accounting and finance are designed in such a way that organizations and their constituents can use them to their benefits. This makes it possible for accounting and finance professionals to move around numbers in all different ways just to ensure they add up in a particular manner(Roychowdbury, 2006). In response to such kind of practices, companies have to adopt ethics in financial management so that they can have a source of guidance. Without the moral barometer, cases of mismanagement and unethical practices in reporting will remain to be witnessed. Frecka (2008) says that without considering ethical standards in reporting, it is hard to create limitations or boundaries to corporate culture.
With the nature of accounting, management decisions about statements and financial reports become necessary. Management decisions impact reporting and cause it to range from fraud to high quality reporting at both extreme ends of the spectrum(Rockness & Rockness, 2005). This implies that some management decisions during financial reporting can be regarded as unethical but not fraudulent(Kalbers, 2009). The three ethics models that are commonly used in management decision include deontology, utilitarianism, and virtue ethics.
When considering the Kant’s deontological approach to ethical decision making, the results or consequences of action has little significance in establishing what is right or wrong(Nandi, 2006). This implies that the consequences of unethical practices in financial reporting have very little significance of determining whether the practices are moral or immoral. In this view, the end is not related to the means used to reach the end and the results cannot be used to justify the means. Therefore, Kant argues that the bottom line is to maintain the standards of morality irrespective of the outcome(Nandi, 2006). When it comes to financial reporting, as long as a company meets the standards of reporting, the outcome does not matter.
The other model of ethical decision making is utilitarianism which gives considerations to the consequences of an action. Essentially, this approach requires individuals to only do the actions that have the best results. According to Ugleitta (2001), in order for an individual to act morally, he or she has to choose the actions that bring the best outcome. Therefore, if an individual is aware that the outcome or consequence of one action is better compared to those of another action, common sense should dictate that the individual chooses the one with the best outcome. Utilitarianism can be used in making financial decision in organizations(Bok, 1999).
Lastly, according to virtue ethics model, a lot of emphasis is laid on moral characters or virtues. It contrasts with deontological approach which emphasizes on rules or duties and utilitarian approach which emphasizes on the consequences of an action. Supposing it is obvious that accounting professionals should always give true and accurate information during reporting, a virtue ethicists will point out to the fact it is good to be honest. According to the utilitarian model, the argument will be based on the fact that giving truthful information has consequences beneficial to many people; while deontologists will argue that giving truthful information honors rules and standards of morality despite the outcome(Nandi, 2006).
Trust and transparency are the most basic aspects in proper financial reporting. Looking at this from the angle of utilitarianism, finance managers have to be aware that the trust and transparency will bring the best positive and beneficial outcome in reporting. The benefits of transparency and trust will be felt by the company as well as every other recipient of financial reporting. The confidence of shareholders, employees, governments, banks, suppliers, and customers to companies will increase(Pervan, et al., 2010). On the contrary, if financial managers decide to engage in unethical practices during reporting, the outcome will be detrimental to all the stakeholders involved as well as the company. Some of the cases cited as examples of compromised ethical standards in finance reporting provided by Albert (2002) include: the case of IBM, Global Crossing, and Enron.
True and fair view in financial reporting
True and fair view in financial reporting has been a subject to debate by many financial analysts with regards to their usefulness, importance, and meaning. In addition, the general accepted principles of accounting have also been subjected to debate. According to Kirk (2001), true and fair view in financial reporting is closely associated with judgment. He distinguishes the true and fair view from the general accepted accounting principles and says that the latter tends to be rule based as there are established standards expected to be followed. Kirk points out that there is no specific definition in true and fair judgment in financial accounting. This therefore allows users to make professional judgment and find meaning of the phrase ‘true and fair’ through usage(Blake, et al., 1996). Interpretation of accounting statements requires fairness and truth in order for the information presented within the statements to be reliable. Assets and liabilities reported in financial statements have to have a one to one relationship with the quantities they purport to measure(Blake, et al., 1996).
What is considered to be true and fair, can only be established through professional judgment. The intention behind the use of this view is associated with the wider moral stances within the society. The view makes an attempt to balance between the abuse and use of power during reporting by providing judgment based on legal standards. Several scholars have agreed to the fact that both the terms truth and fair do not have precise definition(Blake, et al., 1996). For instance, truth has a nature to be either absolute or relative. However, despite this fact, the concept of truth has been applied in accounting and research.
The concept of fairness has also been described to be very open. It varies in several degrees and subjected to individual interpretation and application. Scholars, and analysts also agree to the fact that time and place can be factor that causes both truth and fairness to vary(Blake, et al., 1996). It is for this reason that one cannot be surprised when such varying patterns are witnessed during financial reporting. The concept of true and fair view is therefore a very slippery one when relating it in accounting and financial reporting. Circumstances can actually be used to give meaning to the concept rather than the definition of the concept.
According to (Jo & Kim, 2008), in order for financial managers to achieve a true a fair judgment in their reporting, they have to present data both in a manner that is easily understood by others and a manner that is impartial. This is however in contrast to the definition of fairness by other authors, who tend to describe the concept as applying judgment to rules and standards which are already established. Instead of being neutral to matters that raise different interest, it is only fair if one follows the rules. Other authors have also leaned more towards the general accepted accounting principles to be the description of truth and fair(Blake, et al., 1996). Hence, when the accounting principles are applied consistently, it will amount to true and fair judgment.
From the discussion of the concept of true and fair view in application of accounting theory and general reporting, it is clear that financial reports go against the three ethical models. Both fairness and truth are considered to be relative, abstract, and subject to individual interpretation. Circumstances and time can be used to determine application of financial standards during reporting. The model of utilitarianism may fail to apply during financial reporting because the outcome does not matter. The concept of fairness and truth allows different circumstances to determine whether to apply standards of financial reporting.
The Tesco financial statement 2012 uses the model of utilitarianism where a lot of consideration is given to the outcome of the accounting practices. The company focuses on ensuring that the financial reporting brings benefit to all the stakeholders involved. Financial reporting in Tesco relates to…