BBB2154 Business Ethics Prepared by Dr Khairul Anuar. L5 Ethics and Financial Reporting Compliance

Transcription

1 BBB2154 Business Ethics Prepared by Dr Khairul Anuar L5 Ethics and Financial Reporting Compliance 1

2 When is a Doughnut Hole a Real Doughnut Hole? Krispy Kreme became a sensation whenever a new store was opened. Initial public offering in April 2000 In the mid 1990 s, their strategy changed from a slow to an aggressively fast franchise growth. From , grew from 144 stores to 357 stores Pinnacle of success was when it was called the hottest brand in America by Fortune magazine 2

3 When is a Doughnut Hole a Real Doughnut Hole? Caught up in constantly having to increase its financial performance to satisfy the premium that investors were paying for its stock CEO Scott Livengood and former COO John Tate were blamed by the SEC managed earnings The company would always beat EPS targets by 1cent to say that it had exceeded Wall Street expectations Bonuses for top management were linked to surpassing the EPS forecast 3

4 Organizational Objectives Organizational objectives are: Reliable financial reporting; Efficiency and effectiveness of operations; Safe guarding of assets; Compliance with laws and regulations 4

5 When is a Doughnut Hole a Real Doughnut Hole? Manipulated revenue by shipping doughnut making equipment with high margins to franchise owners before they requested the equipment Booked the selling of the equipment as revenue 5

6 The Role of Creative Accounting Creative Accounting: the deviation from the traditional methods used to interpret an accounting rule or standard Often walks the fine line between legal and illegal activities It is sometimes hard to see where aggressive accounting stops and fraudulent accounting starts 6

7 The Role of Financial Reporting Accurate financial reporting is needed to provide investors and other interested parties with the ability to 1. Make investment, credit, and financial decisions that relate to the firm 2. Help to determine the level of cash flows for the firm 3. Identify the economic resources and obligations to the firm As identified by the Financial Accounting Standards Board 7

8 Where Were the Auditors? Many stakeholders are asking Where were the auditors? How could firms continue to make up imaginary numbers without raising a huge red flag? Audit: an inspection of the accounting records and other information deemed necessary to express an opinion on the fairness and adequacy of the financial statements Judgment must be used by the auditors 8

9 Potential Conflicts of Interest Remember; the responsibility of the auditors is to ensure the integrity for the financial reporting by the company Auditor-Firm conflicts of interest Shareholder-Management conflicts of interest Self Interest-Professional Standards conflicts of interest 9

10 Steps of An Audit Getting Started Planning Stage Field Work Stage Final Review Stage 10

11 Current Trends in Auditing Risk Based Audit Model Differs from the traditional audit model because auditors assess the level of risk of the chance of fraud by the client SEC Goals Responsibilities of management Responsibilities of auditors Responsibilities of audit committees 11

12 AICPA Code of Professional Conduct Established in 1988 Based on six principles: Responsibilities The public interest Integrity Objectivity and independence Due care Scope and nature of services 12

13 Role of Government Regulations Intended to protect the general public from unethical and illegal actions Established in response to decisions that corporate managers made along the path to business success 13

14 Major Components of a Firm s Financial Statements Balance sheet Income statement Statement of retained earnings Statement of cash flows Must also display comprehensive income in a conspicuous place All should be prepared in accordance with generally accepted accounting principles 14

15 Accounting Shenanigans or Tricks of the Trade Revenue recognition One time charges Raiding the reserves/cookie jar accounting Lease accounting Off balance sheet items Earnings management 15

16 Insider Trading Trading in the stock of publicly held corporations on the basis of Material, nonpublic information. Much of the uncertainty in the law on insider trading revolves around The relation of the trader to the source of the information 16

17 Insider Trading A person is engaging in insider trading when the Trader has violated some legal duty to a corporation and its shareholders Source of information has a legal duty The trader knows that the source is violating that duty 17

18 Ethical Investing Moral responsibility involves a causal connection to an action or result that is morally evaluated, and moral responsibility is properly ascribed and assumed only if the action in question was done knowingly and freely, and if there were no excusing conditions. Shareholders cannot be held morally responsible for what the firm does since the shareholder is in fact very distant from the causal relation between an action of the corporation and its effects but this does not relieve shareholders of all moral responsibility. Recall that no one is ethically allowed to invest in an unethical operation. 18

19 Ethical Investing In evaluating a company s ethical practices it is important to consider: The company s policies. The company s record. Whether a company is to be held responsible for anything that any of its employees do, or whether it is to be held unethical only if the action done by a corporate official is part of company policy. 19

20 Ethical Investing Some claims that the demands of ethical investing are too stringent and so are impossible to follow. Another attack on ethical investing claims that if some individuals and institutional investors do not invest in companies that act unethically, other less scrupulous individuals and institutions will. Another frequently used argument claims that ethical investing demands too much because it looks only at specific policies and fails to consider the broader picture. 20

21 Ethical Investing Many claim that there is no evidence that ethical investing actually applies pressure on companies to change their policies. The reply here is threefold: First, that is not the only reason for ethical investing. Even if companies do not change, that is no reason for others to indirectly engage in unethical practices by providing them with funding. Second, there is some evidence that the strong protests against American companies operating in South Africa during the apartheid period had some effect, since so many of them withdrew from South Africa in one way or another. Third, ethical investing should be seen as only one part of an overall strategy to apply moral pressure on companies to operate ethically. 21

22 2008 Financial Crisis - Mortgages, Risk, and Financial Institutions The traditional model for mortgages was slowly replaced as lenders no longer sought their profit from long-term mortgages. Instead, banks reaped profits from origination fees or from commissions on making loans. Banks then sold the mortgages to others who in turn bundled them, divided them, and sold them to still other investors. The name of the game was profit from commissions, in which no new value was added, but successive parties made their fortunes by reselling the basic properties in various ways. 22

23 Homebuyers The moral fault of homebuyers in the mortgage crisis is complex. Those who lied about their income are guilty of lying or falsification of some sort. Those who took on more house than they could afford seem to have acted imprudently, but with the housing market booming at the time, this did not seem as reckless as it turns out to have been. 23

24 Lenders Some people have blamed the mortgage lenders the banks and mortgage brokers, who received handsome fees for writing mortgages and who attracted as many buyers as possible. Critics charge them and others up the line with greed and acting unethically. Had the banks, savings and loans, and mortgage brokers simply lent money to home buyers and assumed the risk of their failure to keep up payments, the mortgage crisis likely would not have arisen. 24

25 Lenders The commercial banks sold mortgages, while the investment banks bought these mortgages, combined them into bundles, and then issued securities based on the collateral they provided. The bundles were divided into various sorts of securities and were in turn sold to investors of all kinds including pension and retirement funds, insurance companies, and state and local governments. The bundles often included subprime mortgages, and some were composed entirely of subprime mortgages. The investment banks developed the new financial instruments that became so complex that no one really knew what they represented and so no one really knew what they were worth. 25

26 Lenders The large investment banks became interested primarily in the commissions they could get from selling the various financial instruments they invented, and gave insufficient thought to the value of the underlying mortgages, their value, and the degree of risk they were incurring. No one was sure what MBSs were worth or whether they could rely on CDSs, and the lack of knowledge led to a lack of trust and a worldwide financial crisis. 26

27 May

28 Transmile Bhd Financial Fraud May Transmile shares saw a massive selldown following the company's announcement on 7 May 2007 concerning the reliability of its unaudited consolidated results for the financial year ended 31 Dec 2006, resulting from the Company's auditors not able to satisfy themselves on the fairness or validity of certain transactions. Consequently, the company commissioned a special audit relating to the matter. The Securities Commission had charged three former executives of Transmile, including its founder, with giving misleading financial statements. Revenues were overstated by RM622 million between Outflow of RM341 million for property, plant and machinery unsupported by documents Payment of RM189 million unsupported by payment vouchers Subsidiaries owed RM103 million from related party transactions 28