The Ethics of Accounting
Creative Accounting- Everyone is doing it!
Gone are the days, when the accounting profession was associated closely with ethics, morality and religion. These days, accountants are perceived as those who enable fraudulent corporate culture and tax evasion through loopholes and re-engineering of companies’ financial statements. But exactly how did we get here?
In a sense, accounting can be classified as both an art and social science. Much like sociology, it is a body of knowledge dependent on human decisions, but at the same time it is an art form that requires creative judgement and skill. Since the body of knowledge is constantly expanding and evolving, so do accountants. But you may be wondering how fraudulent behaviour is possible if accountants are required to comply with both regulation and law. Well if you look at all the big corporate scandals e.g. Enron, OneTel, Lehman Brothers, they were all on paper “legal,” and were complying with the regulation and laws at the time which gave rise to what we call creative accounting. Creative accounting follows required laws and regulations but deviates from what the standards and laws intended to accomplish by capitalising on loopholes. This creates a financial reality that is a stark contrast to the company’s economic reality.
Let’s look at Enron, till its demise in 2001 it was heralded as one of the “Wall Street Darlings”, and many schools were teaching its company structure and culture as the gold standard for companies. However, beneath this facade Enron was struggling financially. Its books indicated that nothing was wrong, but was hid mountains of debt and toxic assets disguised as investments through Special Purpose Entities (SPEs). Despite Enron owning 97% of the SPEs, the regulation allowed the remaining 3% to be independent parties that would on record be controlling the entity, hence allowing Enron to keep this off its books. However, it later surfaced that the “independent” parties were still in some way related or connected to Enron.
Let’s look at another example closer to home, One-Tel rose to become the fourth largest telecommunications company in Australia but as quickly as it went up, it crashed even harder. One of the issues accelerating its demise was that its provision for bad debts was too low, so when debtors defaulted on their loans, One-Tel was not in a financially stable cash position to continue operations. The fact the provision was so low just goes to show how subjective accounting can be. In fact, the inability to generate a universal, blanket set of regulations highlights the heavy reliance on professional judgement in the accounting field. This then begs the question, who are accountants responsible to?
Is it the public? The shareholders? Or the management? A very direct answer would be the management who pay the accountants their fees and salaries. However, the less obvious answer is actually to all of these people. Accounting information is used by various stakeholders, and misleading information can have massive ramifications. The incentive to earn their salary is what sometimes leads to poor accounting practices as accountants fail to realise their broader role in society as trusted professionals that are required to act in accordance with the highest professional and ethical standards.
As a result, many professional bodies have incorporated a code of ethics in which their members are held accountable to. The fundamental principles in these codes are:
· Professional competence and due care
· Professional Behaviour
This code of ethics is heavily dependent on ethical theories and biases of accountants and Boards. As possibly through the doctrines of subjectivism and utilitarianism, a Board could justify not reporting creative accounting, because when the information is leaked people dependent on the company also suffer from it. In a complicated manner, by stalling the inevitable, the CFO could be argued to be giving more time to its stakeholders to deal with the trauma of releasing the information. However, this is wishful thinking as it is hard to prove the actual intentions of the Board of Directors, and this is one of the reasons it’s hard to regulate Corporations as statute and case law are mainly derived from intention.
This is the issue facing many accountants today and possibly in the future, and I personally don’t think we will ever find an encompassing framework or solution that will fix all our problems. But reinforcing the importance of ethics in accounting helps understand the nuances of companies. Hopefully resulting in better intuition and foresight to avoid future Enrol and One-Tel scandals.