Global business ethics lesson 10

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97 Ethics in Accounting and Finance UNIT UNIT V 98 Global Business Ethics 99 Ethics in Accounting and Finance LESSON 10 ETHICS IN ACCOUNTING AND FINANCE CONTENTS 10.0 Aims and Objectives 10.1 Introduction 10.2 Accountability and Acquisitions 10.3 Success 10.4 Trends 10.5 Fair Value 10.6 Finance and Ethics 10.7 Financial Markets 10.7.1 Equity and Efficiency 10.7.2 Unfairness in Markets 10.7.3 Fraud and Manipulation 10.7.4 Equal Bargaining Power 10.8 Financial Statements 10.9 Let us Sum up 10.10 Lesson End Activity 10.11 Keywords 10.12 Questions for Discussion 10.13 Suggested Readings 10.0 AIMS AND OBJECTIVES After studying this lesson, you should be able to understand: z The accountability and acquisitions z The finance, ethics and excessive trading z The equity, efficiency and unfairness in markets 10.1 INTRODUCTION What possible moral decisions are involved in preparing cash flow forecasts for a firm, auditing a company's books or advising a business on how to cost its good or services? The apparent mathematical precision of accountant’s right cause the public to believe that - at least in so far as they are engaged in accounting procedures, there is no scope for making any kind of ethical decisions Accountants should present ‘a true and fair view.’ The picture the accountant paints can be either enlightening or misleading, depending on how he or she chooses to 100 Global Business Ethics deficit it Even within the law, various maneuvers can be carried out by accountants which are often regarded as being in ethically gray areas The most common practice of this kind is known as 'creative accounting'; a phrase which is popularly associated with 'cooking the books' in a way which is legal although morally dubious The practice of creative accounting, however, is not necessarily unethical Those who express outrage at the apparent creativity of certain firms’ book keeping are often those whose limits of accountancy are confined to their own personnel accounting and perhaps to organising small scale events where monetary transactions are clear and unambiguous In the average company by contrast, things are seldom so clear 10.2 ACCOUNTABILITY AND ACQUISITIONS Accountability is a concept in ethics with several meanings It is often used synonymously with such concepts as answerability, enforcement, responsibility, blameworthiness, liability and other terms associated with the expectation of accountgiving As an aspect of governance, it has been central to discussions related to problems in both the public and private (corporation) worlds Acquisition means the process of acquiring, with appropriated funds, by contract for purchase or lease, property or services (including construction) that support the mission and goals of an executive agency, from the point at which the requirements of the executive agency and include: z the process of acquiring property or services that are already in existence, or that must be created, developed, demonstrated, and evaluated; z the description of requirements to satisfy agency needs; z solicitation and selection of sources; z award of contracts; z contract performance; z contract financing; Merger accounting techniques are much more effective for measuring the success of acquisitions than are standard acquisition accounting methods Merger accounting produces accurate performance improvement records because it produces profit and loss accounts that are comparable between years Merger accounting is also better for measuring acquisition success because it is less susceptible to manipulation that current acquisition accounting methods Buying a business makes sense when the benefit exceeds the cost This means to find a seller who excepts too low a price, so that you can secure a benefit from acquisition by improving the targets performance Buyers of course, run into problems with competition law when their plans to improve a targets performance depends in the creation and use of monopoly power, they can actually be said to create wealth They have to use the targets resources more efficiently than the seller or they exploit opportunities for synergy with exists 101 Ethics in Accounting and Finance Target Performance Target Performance Target Resources Target Resources Firm X Firm Y Total Target Performance Total Target Resources X+Y Figure 10.1: Total Target Performances/Resources The principal argument for a free acquisitions market is that it should allow business to gravitate towards the managers who can the most with them Buyer’s accounts often not reflect real success and failure There is therefore a danger that businesses will gravitate towards the most creative accountants than the best managers The prospects of creating value from an acquisition arises whenever a potential target is poorly managed Two courses of action are open to a corporate buyer/buy out or buy in team The target is well positioned in a market with a good future, and then the buyer should aim to turn the business round If the target is poorly positioned, perhaps in a stagnant market with poor products and people it makes more sense to strip the target Most buyers other than management buy - out or buy-in teams have an existing business to which they can add an acquisition target This existing business provides a further opportunity for a buyer to create from an acquisition through synergy (2+2=5) Two businesses can together achieve what is beyond their individual capabilities If the targets management is poor, little is lost by taking over the running of acquired business and forcing the pace on realizing synergy gains Alternatively, if it is good, such a takeover is likely to be damaging The acquisition needs to be viewed as a merger and two business needs to be fused more gently Negotiating a deal so that the extra value is not given away to the sellers also requires particular skill, where there are rival buyers Example In the course of our employment within a large firm, we are asked to organise a meeting How much does it cost to so? (Managers who wish to call meetings are obliged to cost them first, to ascertain whether or not they are justified) It appears that a meeting costs nothing at all If attendees are paid no overtime, no rooms to be hired, no external consultants demanding fees, it could be argued that the costs are zero It is likely that at least there were printed agendas that the telephone costs of calling the meeting The meeting cost can be calculated on the basis of: The cost of materials and services which would have been incurred if no meeting had been contemplated These methods of costing were naive, meetings are to be attended by people, since attendees are present as part of their paid employment, a suitable proportion of salaries should be attributed to the cost of holding the meeting, one could calculate the average number of hours worked in the course of each members week and determine 102 Global Business Ethics what proportion of one's time (one's salary) was attributable A more conservative approach might be to consider the costs of hiring part time staff at cheaper rates to execute the heavy work load of attendees, while on the other end of the scale one might consider the 'opportunity costs' cancelled by tying up employees time, after all in most firms employees are worth more to the firm than they are paid (opportunity costs are the costs of not doing alternative tasks; if a member of a sales department can sell goods at a profit of say 500 pounds an hour, then the opportunity cost of attending an hour long meeting is 500 pounds) Do we consider the marginal costs to the firm for holding the meeting, or the proportion of total costs of rents, heating and lighting? There is no clear or right answer to the question; different answers may well suit the purposes of different firms If holding the meeting means a reduction in selling, then the firm might be well advised to include opportunity costs; if the attenders are happy to work unpaid overtime, the more conservative methods of costing may be appropriate Just as a poet and a civil engineer might describe the same landscape differently (because of different purposes), so two accountants could present the accounts of the same firm in two entirely different ways This is not unethical, any more than civil engineers are unethical for describing the physical environment in terms of its potential use rather than for its inherent beauty like the poet All accounting is to some extent creative accounting because there is no clear inarguable answer as to whether we regard, something as a cost, as a loss, as an expense, or whatever Example A firm whose profits are modest in a given financial year may decide to sell off some of its capital and treat the proceeds as profits Equity accounting is another technique of enhancing profits In UK, if the firm owns more than 20% of another firm, it may declare that proportion of the other firms profits as its own (including losses) Due to a problem of dropping sales, a firm might enhance its sales figures by allowing the bank to 'buy' goods when in reality the goods are being appeared as security for a loan The company would buy back its stock at a later date and for a higher priceexactly the same monetary transaction as taking out a loan The goods themselves not change position, remains in the warehouse, without any necessity for the company to deliver them physically to the bank and back again? There can actually be ambiguity about where a sale represents a profit or a loss If a firm has sold a consignment of product one would imagine that such a sale would be reflected in the accounts If the buyer has been given credit, not only is it possible for the vendor to omit the sale figure in accounts during the period of credit but it is possible for the vendor to consider the sale as a loss of goods without payment and hence a debit He may thus omit the sales figure in accounts during the period of credit Another form of creative accounting involves placing a hypothetical monetary value on 'intangibles' Companies are often worth more than the physical assets If a firm has built up enough 'good will' amongst customers and suppliers then its name is surely worth something e.g., Coca Cola, if sold to another firm be of substantial value, even perhaps if that firm consisted of functional directors Coca Cola has never tried to sell it - no one has ever tried to buy the name Any figure therefore that is placed on its value must be a 'guesstimate' or may be even just a guess Well known firms quite typically include intangible assets in their annual accounts Creative accounting can be described in a variety of ways, not all ways are correct Some are certainly false (If there is a hill there is a valley similar to if there is a will, there is a way), and some although not false, can be down right misleading (a student attends the occasional evening class) The same is true of accounting e.g., legally one may not claim under the heading of 'expenses' costs of entertaining one's colleagues to dinner (unless they are from abroad) or keep two sets of account books, one for personal use and the other for the auditors (Rama's account and Krishna's account) For creative accounting, freedom is important, which is a fundamental human right Companies should enjoy the fundamental right of deciding how to organise their own affairs, including how they decide to present their accounts One system of accounting may be particularly appropriate to one firm, but inappropriate to another The law recognises that small businesses are not necessarily run by those who excel in accounting Consequently a sole trader or partnership which has no limited liability is not obliged to present accounts with the same degree of exactitude as a Public Limited Company (PLC) The affairs of an educational establishment, a charity, a chain store, and a multinational company are all very different No standard accounting scheme could be devised A company like an individual, has the right to enjoy the best possible advantage within the law (like IT returns), a car sales firm to treat a part exchange as a reducedprice single sale, rather than two separate transactions in which the new car is sold for the full price and the old car bought as a separate deal Business executives have the duty of securing for their shareholders the best possible return for their investment (of course, within the law) Creative accounting is favoured by many since they seem to be convincing When the creative accounting is so carefully controlled it is a relatively harmless weapon 10.3 SUCCESS The successful turn around leads to bigger operating profits although turnover can go up or down Asset strip means the end of operating profits and turnover as trading assets are realised and liabilities are settled to generate a one of non operating profit In take over or merger, profit margins can be improved by a greater bargaining power, rationalised overheads and better asset utilization turnover can be increased when the buyers products are sold to the targets customers and vice versa Broad range of complementary products are sold to new customers who prefer 'one stop shopping.' It should be straight forward to translate the reasoning behind an acquisition into projections of profits, margins and sales In most organisations, this will be part of the moral process of planning and budgeting and the reporting of achievements will form the basis for determining the success of each acquisition and the effectiveness of management Even if a target business remains a separate limited company, it is unlikely that its statutory accounts will allow a reliable company to be made of performance before and after an acquisition Inter company charges and the effects of positive or negative synergy on the other parts of the buyers group will conceal the real results of an acquisition Investors must therefore rely on the consolidated acquisition of the buyer to judge the success of an acquisition 10.4 TRENDS Under acquisition accounting the results of an acquired business are consolidated from the date of acquisition This make nonsense of trying to assess whether buying management have achieved real improvements in profits and sales 103 Ethics in Accounting and Finance 104 Global Business Ethics By contrast, merger accounting requires a buyer to consolidate the results of a target for the whole of the year of purchase and for any previous periods that are presented Only an underlying improvement in performance will generate an improving trend in reported sales and profits Management seem to take credit for results which were achieved prior to their stewardship Such accounting is therefore often only seen as appropriate when two business and their managements really 'merge' A feature of both acquisition and merger accounting is that all companies included in the consolidated accounts should apply consent accounting policies 10.5 FAIR VALUE Fair Value is the estimated value of all assets and liabilities of an acquired company used to consolidate the financial statements of both companies In the futures market, fair value is the equilibrium price for a futures contract This is equal to the spot price after taking into account compounded interest (and dividends lost because the investor owns the futures contract rather than the physical stocks) over a certain period of time Merger accounting calls for the assets and liabilities of a target business to be brought into the buyers consolidated accounts at their previous book values, subject only to adjustments to achieve consistency with the buyers accounting policies Acquisition accounting is different and requires adjustments to ensure that the consolidated balance sheet at the end of the acquisition reflects the fair values of the targets separable assets and liabilities The concept of fair value can be illustrated by looking at fixed assets and provisions The fair value of a fixed asset is represented by the cost of replacing it with an asset which would give the same service Because of inflation, an assets fair value is usually greater than to its net book value Check Your Progress 1 What is asset strip? ……………………………………………………………………………… ……………………………………………………………………………… What you understand by ‘fair value’? ……………………………………………………………………………… ……………………………………………………………………………… 10.6 FINANCE AND ETHICS "Ethics in Finance comprehensively analyzes important ethical issues in the field of finance both theory and application by focusing on key concepts and practices In so doing, he demonstrates the critical importance of ethics for this vital industry." –Thomas W Dunfee, The Wharton School, University of Pennsylvania Investor responsibility is a concept with content, notably spreading more and more widely, involving the Pension Fund The ethical guidelines for the Pension Fund were globally adopted unanimously by the Norwegian parliament Sustainable development is dependent on three main elements, the so-called “Threelegged stool” – with government, civil society and the business sector each representing a leg Over the recent years, we have reached some important milestones regarding involvement of the business community in a meaningful way as contributors to sustainable development Many sectors of the business community may still regard ethical considerations as a cost, or at least as not relevant for the company’s financial return For those investors with a long-term perspective, there is self interest in encouraging companies to prioritize sustainability in all areas, also socially and environmentally If we think seriously, we are bound to say that finance would be impossible without ethics We are placing our assets in the hands of the others, most of the times with unknown people which requires immense trust Unknown people includes an untrustworthy stock broker or an insurance agent, an untrustworthy physician or attorney, finds few takers for his or her services Financial scandals shock us precisely because they involve people and institutions that we should be able to trust Innumerable number of organisations in India has cheated many highly ethical people who trusted them and their companies Hard earned money has been put by many people in cash to seek their better living in the post retirement stage The company starting have booted money by cheating the public and had themselves without address and no action has been taken on them neither by the concerned authorities nor by the Government Even if caught, no stringent actions have been taken on them This is more predominant in India It is shameful on the part of the concerned who cheat and those who doesn’t take action Finance covers a broad range of activities, but the two most visible aspects are financial markets, such as stock exchanges and the financial services industry Figure 10.2: Most Visible Aspects in Finance Ethical issues in finance are important because they bear on our financial well being Ethical misconduct as everyone knows, may be by individuals acting alone or by financial institutions has the potential to rob people of their life savings As huge money is involved in financial dealings, there must be well-developed and effective safeguards in place to ensure personal and organisational ethics Though the law governs much financial activity, strong emphasis must be placed on the integrity of the finance professionals and on ethical leadership in our financial institutions Certain principles in finance ethics are common to the other aspects of business: z Duties of fiduciaries (held in trust) z Fairness in sales practices z Securities markets z Activities like insider trading and hostile takeover raise unique issues that require special consideration 105 Ethics in Accounting and Finance 106 Global Business Ethics Financial Services This industry operates largely through personal selling by: z Stock brokers z Insurance agents z Financial planners z Tax advisers z Other finance professionals Personal selling creates innumerable opportunities for abuse though financial professionals take pride in the level of the integrity in the industry, misconduct still found Customers are unhappy over failed investments or rejected insurance claims Hence they blame the seller of the product, sometimes with good reason Three objectionable practices in selling financial products to client: Deception Churning Suitability Deception Deception is the act of deceiving Sales people have to explain all the relevant information truthfully in an understandable, non- misleading way This should be the ethical treatment provided to clients Brokers, Insurance agents and other sales people have developed a new vocabulary to obfuscate rather than reveals Obfuscate is to darken or to confuse For example, A Financial adviser will help you select an appropriate planning vehicle or offer a sense of investment choices or options among which to allocate your money (Insurance agents) peddle such euphemisms as: z Private retirement accounts, z College savings plans, z Charitable remainder trusts Among other linguistic sleights of hand in common usage these days saying ‘Tax free' when it is only Tax deferred' 'High yield' when it is only 'Down right risky' Projected returns' when it is more likely in your dreams Sales people avoid speaking of commissions even though they are the source of compensation, Commissions on mutual funds are 'front end' or 'back end loads' and insurance agents whose commissions can approach 100% of the first year's premium are not legally required to disclose this fact and they rarely The agents of one insurance company represented life insurance policies as 'retirement plans' and referred to the premiums as 'deposits.' Deception is often a matter of interpretation e.g., promotional material for a mutual fund may be accurate but misleading if it emphasises only the strengths of a fund and minimizing the weakness Deception aside, what information ought to be disclosed to a cheat? e.g., the issuer of a security is to disclose all material information, which is defined as information about which an average prudent investor ought reasonably to be informed or to which a reasonable person would attach importance in determining a course of action in transaction The analysis of deception by a financial service provider is similar to that provided for deceptive advertising In general, a person is deceived when that person is unable to make a rational choice as a result of holding a false belief that is created by some claim made by another The claim may be either a false or misleading statement or a statement that is incomplete Churning Churning is the act of making butter in dictionary Churning is defined here as excessive or inappropriate trading for a clients account by a broker who has control over the account with the intent to generate commissions rather than to benefit the client Though churning occurs, there is a disagreement on the frequency or the rate of detection Churning is a rare occurrence as per the brokerage industry's contention This can be easily detected by firms as well as clients But there are no statistics kept on churning However, unauthorised trading and other abuses are rising sharply in the recent years Churning is a breach of a fiduciary duty Fiduciary is confident, held in trust This is to trade in ways that are not in a clients best interests Churning as different from unauthorised trading occurs only when a client turns over control of an account to a broker The latter in turn assumes a responsibility to serve the clients interests He only recommends a trade and is not acting on behalf of the client or customer He is more or less like a traditional seller Example Table 10.1: Ethical Issues Involved (Examples) Case 1: Brokerage firm buys a block of stock, prior to issuing a research report • This contains a buy recommendation to ensure that enough shares are available to fill customer orders • The customers are ignorant about buying stocks from the firm's own holdings • Customers are charged for the customer’s market place + Standard commission for a trade Case 2: Broker assures a client than an initial public offering (IPO) of a closed-end-fund is sold without a commission and encourages quick action by saying that the IPO is sold, subsequent buyers have to pay a 7% commission • Fact is that a 7% commission is built into the price of IPO • This charge is revealed in the prospectus but will not appear on the settlement statement for the purchase • A client might be induced to buy an IPO in the mistaken belief that the purchase would avoid a commission charge Ethical issue Ethical issue The client is buying the stock at the current market price and paying a fee as though the stock were purchased at the order of the client The circumstances of the purchases are not explained to the client Does the broker have any obligation to so? Would this knowledge have any effect on the client's decision? • Commission charge is disclosed in the prospectus might ordinarily exonerate the broker from a charge of deception except that the false belief is created by the brokers claim, which at best, skirts the edge of honesty • The broker made the claim with an intent to deceive, and a typical, prudent investor is apt to feel that there was an attempt to deceive Figure 10.3: Legal Definition of Churning (3 Elements) 107 Ethics in Accounting and Finance 108 Global Business Ethics Excessive trading: This depends on the character of the account A client who is more speculative investor, willing to assume higher risk for a greater return, should expect a higher trading volume High volume is not the only factor; pointless trades might be considered churning even if the volume is relatively low Churning might be indicated by a pattern of trading that consistently favours trades that yield higher commissions High volume trading that loses money might still be defended as an intelligent but unsuccessful investment strategy; Investments that represent no strategy beyond generating commissions are objectionable, no matter the amount gained or lost Suitability Brokers, Insurance agents and other sales people have to recommend only suitable securities and financial products Figure 10.4: Common Causes for unsuitability Unsuitable trading technique includes the use of margin or options This can leverage an account and create greater volatility and risk Unsuitable liquidity is limited partnerships e.g., not very marketable and hence unsuitable for customers who would like to liquidate the investment Investments are most often deemed to be unsuitable since they involve excessive risk However, a few risky investments may be appropriate in a well-balanced, generally conservative portfolio Even an aggravate risk taking portfolio may include unsuitable securities if the risk is not compensated by the expected return Assuming recommended security is suitable for a given investor involves many factors, financial services industry personnel offer to put their specialised knowledge and skills to help, much more than expected from other areas of personnel like physicians, lawyers anti accountants Finance professionals are expected to much more 10.7 FINANCIAL MARKETS The transaction typically takes place in organised markets like: z Commodity markets z Futures or option markets z Currency markets etc In these markets, one expects certain moral rules and expectations of moral behaviour Most fundamental is a prohibition against fraud and manipulation Generally, the rules and expectations for markets are concerned with fairness expressed as a level playing field But this gets tilted in financial markets by many factors like: z Unequal information z Bargaining power z Resources Participants in markets, in addition to making one time economic exchanges, also engage in financial contracting by entering into long term relations Those involve the assumption of fiduciary duties or obligations to act as agents and financial markets are subject to unethical conduct when fiduciaries and agents fail in their duties The terms of a contract specify the conduct required of each party and the remedies for noncompliance There is a little 'wiggle room' in a well drafted contract Many contractual relations in finance and other areas fall short of this ideal, because actual contracts are often vague, ambitious, incomplete or problematic resulting in uncertainty and disagreement about ethical (and legal) conduct We shall deal with the following topics in detail z Equity and efficiency z Unfairness in markets z Fraud and manipulation z Equal bargaining power z Resources z Processing ability z Vulnerability z Efficient pricing 10.7.1 Equity and Efficiency Efficiency Economists have a particular kind of efficiency in mind, called Pareto efficiency It is defined as follows: z A Pareto efficient outcome is one that cannot be changed so as to make someone better off without also making someone else worse off as a natural corollary, z A Pareto improvement is a change that makes at least one person better off without also making anyone else worse off Any outcome that we can change to yield a Pareto improvement is said to be Pareto inefficient When economists use the words efficient or inefficient alone, they mean Pareto efficient or Pareto inefficient Equity The term Equity is generally used when referring to the equity available from an asset, in simple terms equity is the amount of money you have tied up in an asset Equity is the UK Trade Union representing professional performers and other creative workers from across the spectrum of the entertainment, creative and cultural industries Here we find a wide range of information including rates of pay, how to join Equity, contacts, careers advice and how you can get involved in helping theatres and companies at risk 109 Ethics in Accounting and Finance 110 Global Business Ethics An economic situation is, in which there is a perceived trade-off between the equity and efficiency of a given economy This trade-off is commonly viewed within the context of the production possibility frontier, where any additional gains in production efficiency must be offset by a reduction in the economy's equity Within this equity and efficiency trade-off, equity refers to the economy's financial capital, while efficiency refers to the future efficiency in the production of goods and services This theory asserts that, in order for a nation to become wealthier, it must save its equity Main aim of financial market regulation is to ensure efficiency Markets will be efficient only when people have confidence in their fairness or equity Figure 10.5: Efficiency in Markets People will participate in capital markets, only if the markets are perceived to be fair Fairness has value as a means to the end of efficiency Society is generally better off when capital markets allocate the available capital to its most productive use We also value fairness as an end in itself since fairness can conflict with efficiency; some choice or trade off between the two must often be made known as equity/efficiency trade off Figure 10.6: Painful Choices Fairness always contributes to the efficiency even these two conflicts 10.7.2 Unfairness in Markets What does this mean? Fairness is not a matter to prevent losses Markets produce winners and losers Most of the cases, the gain of one may equal loss to other, though market exchanges are advantageous to both the parties Involvement in a stock market is like playing a sport The aim is not to prevent losses but to ensure that the game is fair The regulation of financial markets protects the general public apart from the individual investors The latter can be treated unfairly by the operations of financial markets in many ways The main kinds of unfairness are: z Fraud and Manipulation z Equal Information z Equal bargaining power z Efficient pricing 10.7.3 Fraud and Manipulation 111 Ethics in Accounting and Finance The main purpose of security regulation is to prevent fraud and manipulation practices in the sale of securities Investors (buyers and sellers) are vulnerable to fraud because the value of financial instruments depends almost entirely on information that is difficult to verify Important information lies mostly in the hands of the issuing firm Hence antifraud provisions in securities law place an obligation also on the issuing firm in addition to buyers and sellers The company that fails to report proper information may be committing fraud, even though the buyer of that company's stock buys it from a previous owner who may or may not be aware of the news Insider trading is prosecuted as a fraud on the grounds that any material of nonpublic information ought to be revealed before trading Manipulation involves the buying or selling of securities in order to create a false or misleading impression about the direction of their price so as to induce other investors to buy or sell the securities Table 10.2 Fraud Manipulation Meaning Fails to report proper information Insider trading is also a fraud Buying or selling of securities for the purposes of creating a false or misleading impression about price (direction) to induce investors to buy or sell Designed to deceive others Yes Yes Effect achieved by False or misleading representations Creation of false or misleading appearances Addressed by mandatory disclosure regulations and penalties for false and misleading state in any information released by a firm Yes Yes With easy access to reliable information Difficult to commit Difficult to commit Better informed investors Will make more rational investment decisions at lower overall cost Possession of unequal information is unfair (when the information has been illegitimately acquired and its use violates some obligation to others) e.g Insider trading – Insider has not acquired the information legitimately but has stolen (or misappropriated) information that rightly belongs to the firm Information asymmetries are objectionable to the extent that they reduce efficiency The notion of equal access (while defining equal information) is not absolute but relative What one person possesses information could be acquired by another with enough time, effort and money Everyone could make the same investment and gain the same access or a person could simply buy the analyst's skilled services People should seek information available at the lowest cost To force people to make costly investments in information-or to suffer loss from inadequate information is a loss to the economy, if the same information could be provided at little cost Issue of new securities to be accompanied by a detailed prospectus is needed to prevent fraud through the concealment of facts and to make it easier for buyers to get certain kinds of information, which benefits society Efficiency and fairness both support attempts to reduce information asymmetries in financial markets What fairness or justice requires is not easy to determine? e.g A geologist can buy a land where oil is found, without revealing what he knows 112 Global Business Ethics 10.7.4 Equal Bargaining Power The fairness of bargained agreements assumes that the parties have relatively equal bargaining power A trader who negotiates for a future contract those results in great loss has only himself or herself to blame Unequal bargaining power can result from many sources (including unequal information) Other sources are: z Resources z Processing Ability z Vulnerabilities Resources Wealth has an advantage in all transactions The rich as compared to the poor negotiates better over almost all matters Similarly, wealthier customers have more options Large investors have plenty of opportunities because they are better diversified, bear greater risk and obtain higher leverage, volume trading will benefit them, access to investment closed to small investors Processing Ability Unsophisticated investors are ill-advised to play the stock market and invest in markets that only professionals understand Even with equal access to information, people vary enormously in their ability to process information and to make informed judgements Securities firm and institutional investors overcome the problem of people's limited processing ability by employing specialists marketwise and using computers/programs Vulnerabilities Investors are human and they have many weaknesses which can be exploited Regulation is designed to protect people from the exploitation of vulnerabilities Consumer protection legislation provides protection for them with a cooling off period At that time shoppers can cancel an impulsive purchase Prospectus of the company accompany offers of securities carefully serve to curb impulsiveness Investors have to read this carefully to discourage speculative investment This protects incautious investors from over extending themselves and to protect the market from excess volatility The brokers recommend only suitable investments and warn adequately of the risk of any investment instrument providing a further check on people’s greedy impulses Success of financial market depends on wide participation If unequal bargaining power were permitted to drive all but the most powerful from the market place, the efficiency of the financial markets gets affected maximum Efficient Pricing Fairness in financial markets includes efficient prices that reasonably reflect all available information Volatility results from a mismatch of buyers and sellers in eventually self correcting Meantime, great harm may result by inefficient pricing Individual investors are harmed by buying at too high a price or selling at too a high price during periods of mispricing Volatility also affects the market by reducing investor’s confidence and driving them away The loss of confidence depresses stock prices 113 Ethics in Accounting and Finance Check Your Progress Fill in the blanks: Accountants should present _ Broad range of complementary products are sold to new customers who prefer _ 10.8 FINANCIAL STATEMENTS The definition of the accounting in any business book is the process by which any business keeps track of its financial activities by recording its debits and credits and balancing its accounts." This offers a system of rules and principles which govern the format and content of financial statements Accounting is a system of principles applied to present the financial positions of a business and the results of its operations and cash flows Adherence to these principles will result in fair and accurate reporting of this information Table 10.3 Responsibility Accountant Independent accountant Works for the company Hired by the company as outsider counsel Salaried Employee Nature of the audit May or may not work independently May be guided by the corporation executives certified public Individual comes in to perform an audit for the benefit of the public, the shareholders and the government, in order to maintain the public's confidence More independent nature of the audit The ethical issues surrounding accounting practices are varied like: z Under reporting income z Falsifying documents z Allowing or taking questionable deductions z Illegally evading income taxes and otherwise engaging in fraud To prevent accountants questioned in these types of conflicts: American Institute of CPAs publishes their professional rules Financial Accounting Standards Board governs accounting practices and establishes the Generally Accepted Accounting Principles (GAAP) that stipulate the methods by which accountants gather and report information International Accounting Standards Committee is in the process of developing standards that would allow foreign companies to sell securities in the US as long as their accounting confirms to the International standards, though not comply with the GAAP Accountants are also governed by the American Institute of Certified Public Accountants (AICPA) which has a code of professional conduct The code relies on the judgement of accounting professionals in carrying out their duties rather than stipulating a set of extremely specific rules 114 Global Business Ethics 10.9 LET US SUM UP The love of money is a healthy emotion as long as it is earned in the rightful way Everyone has a right to earn so as to live in comfort and happiness Illegal Accounting Principles and practices in amounting to fraudulent behaviour and conduct of business It should be treated as a heinous crime since it is equal to robbing the livelihood of other people Generally Accepted Accounting Principles and Practices should be universally adopted and practiced if all of us have to live in equality, peace and harmony 10.10 LESSON END ACTIVITY The practice of creative accounting, however, is not necessarily unethical Explain the statement 10.11 KEYWORDS Accounting: Discipline of measuring, communicating and interpreting financial activity Ethics: Ethics is concerned with human behavior that is acceptable or "right" 10.12 QUESTIONS FOR DISCUSSION The picture the accountant paints can be either enlightening or misleading, depending on how he or she chooses to depict it' Enlighten on this subject What is creative accounting? Explain What is acquisition? How it works? What is acquisition accounting? What is merger accounting? Discuss on the ethical issues involved in finance 'Finance would be impossible without ethics' Do you agree? Comment Which are the most visible aspects in finance? Explain each one of them Which are the principles found in finance ethics common with other aspects of business? Explain 10 Explain the three objectionable practices in selling financial products to clients Check Your Progress: Model Answers CYP 1 Asset strip means the end of operating profits and turnover as trading assets are realised and liabilities are settled to generate a one of non operating profit The fair value of a fixed asset is represented by the cost of replacing it with an asset which would give the same service Because of inflation, an assets fair value is usually greater than to its net book value CYP 'a true and fair view 'one stop shopping.' 10.13 SUGGESTED READINGS Manuel G Velasquez, Business Ethics Laura P Hart Man, Business Ethics John R Boat Right, Ethics in Conduct of Business William A Wines, Ethics Law and Business 115 Ethics in Accounting and Finance ...98 Global Business Ethics 99 Ethics in Accounting and Finance LESSON 10 ETHICS IN ACCOUNTING AND FINANCE CONTENTS 10. 0 Aims and Objectives 10. 1 Introduction 10. 2 Accountability... Acquisitions 10. 3 Success 10. 4 Trends 10. 5 Fair Value 10. 6 Finance and Ethics 10. 7 Financial Markets 10. 7.1 Equity and Efficiency 10. 7.2 Unfairness in Markets 10. 7.3 Fraud and Manipulation 10. 7.4 Equal... Power 10. 8 Financial Statements 10. 9 Let us Sum up 10. 10 Lesson End Activity 10. 11 Keywords 10. 12 Questions for Discussion 10. 13 Suggested Readings 10. 0 AIMS AND OBJECTIVES After studying this lesson,
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