Ethics and the ACCA P2 examination.

Ethics is examined in every P2 exam as part of the compulsory section A.

Accounting is principles based so applying accounting standards requires the use of

judgment.
Good financial reporting requires both quality principles based regulation but also
those standards applied in an ethical manner.
Being a professional implies acting in the public interest and ethically.
There are five pillars of ethical behaviour – think OPPIC

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Introduction

I quote from a recent examiner’s report “A quite surprising phenomenon is the fact
that candidates often do not answer all parts of all questions. This contributes to
failure in the examination. This is particularly the case in question 1c, which is
invariably a question, which requires ethical knowledge and application”. This
comment is not the only time that the examiner has dropped hints that marks are
going begging by students not answering the ethics question. Again I quote from a
recent examiner’s report. “It is often the case in question 1c, which is based around
ethical knowledge and application, that candidates do not attempt the question even
though marks can readily be gained for a well-argued answer to this part of the
question.”

The study guide to P2 talks about the professional and ethical duties of the
accountant, as well as the ethical requirements of corporate reporting and the
consequences of unethical behaviour. Ethics are of course examined in other ACCA
papers, but the particular emphasis in the P2 exam is the practical application of
ethics in an accounting context, and understanding the consequences of not
upholding ethical principles in the preparation of corporate reports.

It is often, and correctly, said that International Financial Reporting Standards take a
principles based, rather than a rules based approach to regulating financial reporting.
For example IFRS 10 Consolidated Financial Statements bases the definition of a
subsidiary on the principle of control rather than a simple percentage of ownership.

With this principles based approach comes the need for the accountant to make
judgements. In exercising this judgment it so important that the accountant act
ethically in order that the financial statements show a true and fair view. If the
accountant is unethical and therefore prepared to bend the rules or even disregard
them to manipulate the financial statements, then the financial statements will not be
true and fair. Ethics is more than just obeying the rules, it is about following the spirit
of the rules.

If the accountant is not independent and not component then incorrect judgments
and conclusions may be reached. For example whether or not a particular entity is,
or is not, a subsidiary can be a matter of judgement. Without being too cynical if the
entity being considered is highly geared it will be in the interests of the unethical
(creative) accountant to decide it is not a subsidiary and so should not be
consolidated. By not consolidating a highly geared entity that is in fact controlled,
results in the group statement of financial position being incomplete and not a faithful
representation of the group’s assets and liabilities. Because of this (off balance sheet
finance) users will have the wrong impression of the group’s gearing and are misled
as to the risks associated with investing or lending money to the group. The group
accordingly may find it easier and cheaper to raise finance.

Ethics are an inherent part of being an accountant. Adherence to an ethical code is

part of what makes accountancy a profession. The ACCA is a professional body that
proscribes an ethical code and requires its members to adhere to.

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Five fundamental ethical principles

I remember the five fundamental ethical principles by the mnemonic OPPIC.

O is for Objectivity. Objectivity means that bias, conflicts of interest or the undue
influence of others should not compromise professional or business judgement.
Where directors receive material profit related pay then there is a threat to
objectivity.

P is for Professional competence and due care. Accountants have a continuing duty
to maintain professional knowledge and skill at a level required to ensure that clients
or employers receive competent professional service. This requirement to engage in
continuing professional development (CPD) is consistent with other professions such
as medicine and law. Accountants are required to act diligently in accordance with
applicable technical and professional standards when providing professional
services. Being competent means that where errors are made then the issue of
unethical behaviour can be raised.

P is for Professional behaviour. Accountants are expected not only to comply with
relevant regulations but also to behave with courtesy and consideration towards all
with whom they come into contact in a professional capacity. Accountants should do
nothing that brings the profession into disrepute.

I is for Integrity. Integrity implies not merely honesty, but fair dealing and truthfulness.
Creative accounting, which implies that the accounts have been manipulated in
some way, cannot be regarded as being ethical as it involves deception and so is
dishonest and shows a lack of integrity.

C is for Confidentiality. Accountants shall respect the confidentiality of information

acquired as a result of professional and business relationships, and shall not
disclose any such information to third parties without proper and specific authority or
unless there is a legal or professional right or duty to disclose. Similarly, confidential
information acquired as a result of professional and business relationships shall not
be used to the personal advantage of members or third parties.

Past examination question

Let us see how this topic has been examined by considering the June 2013 exam
question on ethics.

The directors of Trailer are involved in takeover talks with another entity. In the
discussions, one of the directors stated that there was no point in an accountant
studying ethics because every accountant already has a set of moral beliefs that are
followed and these are created by simply following generally accepted accounting
practice. He further stated that in adopting a defensive approach to the takeover,
there was no ethical issue in falsely declaring Trailer’s profits in the financial
statements used for the discussions because, in his opinion, the takeover did not
benefit the company, its executives or society as a whole.

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Required:
Discuss the above views of the director regarding the fact that there is no
point in an accountant studying ethics and that there was no ethical issue in
the false disclosure of accounting profits. (6 marks)

Before I start my answer to this question let me give you another quote from the
examiner’s report “Candidates should try and use proper sentences and paragraphs
rather than bullet points, as this will contribute to the awarding of professional marks.
Candidates should never use abbreviations of words such as text language.”

Now if we look at the requirement of the question it contains the word and. This
means we can think of it as two separate questions that we need to answer. To para
phrase the requirement the two questions are – why bother studying ethics - and –
what is it unethical to falsely state profits.

When planning an answer we need to be conscious of the number of marks

available (as this determines the time that it deserves and the marking guide). As it is
for 6 marks this equates to just over ten minutes in the exam. The published marking
guide shows that it is a subjective assessment of one mark per relevant point. As
such I think we should aim at trying to write six mini paragraphs. In this way we are
challenging the marker to award one mark for each paragraph. My answer has three
mini paragraphs addressing each part of the question.

My answer

Ethics is an inherent part of the accounting profession. Not everyone has the same
set of moral beliefs, indeed some may none. For consistency and comparability it is
best if the same ethical code is used.

Personal moral beliefs may in any event be too simplistic to resolve the complex
financial situations that accountants can face. Accounting is not just about applying
rules but making estimates and judgments.

By studying the code of ethics required by the ACCA, the accountant will be able to
ascertain the most appropriate course of action in complex financial situations. The
code can act as a check list and provide a framework for reasoning through, to arrive
at the most appropriate course of action. For these reasons it is important that
accountants study ethics.

One of the pillars of the ethical code is integrity. Integrity is not just about being
honest but also being fair and doing the right thing.

Although the accountant has the personal belief that the takeover is not beneficial
this is not an excuse or reason for falsifying numbers that are going to be used by
users to make decisions.

The deliberate false statement of profit is dishonest and shows a clear lack of
integrity. In conclusion it is unethical to falsely state the profits of the company.

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Comment

Of course with a written and subjective question like this there is no one correct
answer. Each answer submitted by candidates will be different, as indeed mine is
from the examiner’s answer. Please take the time to look at the examiner’s answer
below. I know that it is a longer and more detailed answer than mine but the
examiner’s answer is a “perfect answer”. What my (shorter) answer is showing you
is what a good student might reasonably be expected to do in the exam room.
Remember if you write nothing it is a sure way to get no marks!

Examiner’s answer

There are several reasons why an accountant should study ethics. The moral beliefs
that an individual holds may not be sufficient because often these are simple beliefs
about complex issues. The study of ethics can sort out these complex issues by
teaching the principles that are operating in these cases. Often there may be ethical
principles which conflict and it may be difficult to decide on a course of action. The
study of ethics can help by developing ethical reasoning in accountants by providing
insight into how to deal with conflicting principles and why a certain course of action
is desirable. Individuals may hold inadequate beliefs or hold on to inadequate ethical
values. For example, it may be thought that it is acceptable to hold shares in client
companies for business reasons, which, of course, is contrary to ethical guidance.

Additionally, compliance with GAAP could be thought to be sufficient to meet the

duty of an accountant. However, it can be argued that an accountant has an ethical
obligation to encourage a more realistic financial picture by applying ethical
judgement to the provisions of GAAP. Another important reason to study ethics is to
understand the nature of one’s own opinion and ethical values. Ethical principles
should be compatible with other values in life. For example, one’s reaction to the
following circumstances: the choice between keeping your job and violating
professional and ethical responsibilities, the resolution of conflicts of interest if they
involve family.

Finally, a good reason for studying ethics is to identify the basic ethical principles
that should be applied. This will involve not only code-based decisions but also the
application of principles that should enable the determination of what should be done
in a given situation. The ethical guidance gives a checklist to be applied so that the
outcome can be determined. Ethical issues are becoming more and more complex
and it is critical to have knowledge of the underlying structure of ethical reasoning.
Professional ethics is an inherent part of the profession. ACCA’s Code of Ethics and
Conduct requires its members to adhere to a set of fundamental principles in the
course of their professional duty, such as confidentiality, objectivity, professional
behaviour, integrity and professional competence and due care. The main aim of
professional ethics is to serve as a moral guideline for professional accountants. By
referring back to the set of ethical guidelines, the accountant is able to decide on the
most appropriate course of action, which will be in line with the professional body’s
stance on ethics. The presence of a code of ethics is a form of declaration by the
professional body to the public that it is committed to ensuring the highest level of
professionalism amongst its members.

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Although the takeover does not benefit the company, its executives or society as a
whole, the action is deceptive, unethical and hence unfair. It violates the relationship
of trust, which the company has with society and the professional code of ethics.
There are nothing but good reasons against the false disclosure of profits.

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Q Rose – ethics

Rose was considering acquiring a service company. Rose stated that the acquisition
may be made because of the value of the human capital and the opportunity for
synergies and cross-selling opportunities. Rose estimated the fair value of the assets
based on what it was prepared to pay for them. Rose further stated that what it was
willing to pay was influenced by its future plans for the business. The company to be
acquired had contract-based customer relationships with well-known domestic and
international companies and some mining companies. Rose estimated the fair value
of all of these customer relationships to be zero because Rose already enjoyed
relationships with the majority of those customers.

Required:
Discuss the validity of the accounting treatment proposed by Rose and
whether such a proposed treatment raises any ethical issues. (6 marks)

Professional marks will be awarded for clarity and quality of the presentation
and discussion. (2 marks)

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A. Rose - ethics

Rose’s allocation of the cost of acquisition of companies is not based on ‘fair value’
as defined in IFRS 13 Fair Value Measurement. Further, the application of fair value
in accordance with FRS may result in the identification and allocation of the cost of
the business combination to other types of intangible assets in addition to those
recognised by Rose.

IFRS3 Business Combinations requires an acquirer to allocate the cost of a business

combination by recognising the acquiree’s identifiable assets, liabilities and
contingent liabilities that satisfy the recognition criteria at their fair values at the date
of acquisition. The fair value of intangible assets that are not traded in an active
market is determined at the amount that would be paid for the assets in an arm’s
length transaction between knowledgeable and willing parties, based on the best
information available. The fair value is not an amount that is specific to the acquirer,
nor should it take into account the acquirer’s intentions for the future of the acquired
business.

If Rose plans to allocate the cost of business combination to assets based on the
value that they have for Rose, this is not incompliance with IFRS.

The contract-based customer relationships are identifiable in accordance with IAS 38

Intangible Assets and would probably have value. In order to be recognised
separately, the identifiable assets, liabilities and contingent liabilities have to satisfy
the probability and reliable measurement criteria of IFRS 3. For intangible assets
acquired in business combinations the probability recognition criterion is always
considered to be satisfied.

Furthermore, IAS 38 states that the fair value of intangible assets acquired in
business combinations can normally be measured sufficiently reliably to be
recognised separately from goodwill. Part of the cost of the business combination of
the company should be allocated to customer relationships, assuming there to be a
positive value at the date of acquisition and notwithstanding the fact that many of the
customers were already known to Rose.

The fair value of the customer relationships could not be based on the lack of Rose’s
willingness to pay but, rather, should reflect what a well-informed buyer without
previous customer relationships with these customers would be willing to pay for
those assets.

Management often seeks loopholes in financial reporting standards that allow them
to adjust the financial statements as far as is practicable to achieve their desired aim.
These adjustments amount to unethical practices when they fall outside the bounds
of acceptable accounting practice. Reasons for such behaviour often include market
expectations, personal realisation of a bonus, and maintenance of position within a
market sector. In most cases, conformance to acceptable accounting practices is a
matter of personal integrity.

It is often a matter of intent and therefore if the management of Rose is pursuing

such policies with the intention of misleading users, then there is an ethical issue.