Ethical issues

Financial managers and accountants who prepare financial reports should ensure the decisions they make are ethical and that they act with the highest standards. They have an ethical and legal obligation to ensure financial records are accurate. Any attempt to engage in creative accounting to portray a more favourable but inaccurate financial picture should always be avoided. In recent years, unethical practices have been highlighted and increasingly questioned

Ethical financial management can be seen in the valuing of assets, including inventories and accounts receivable. Such valuations influence the level of working capital and, hence, the short-term financial stability of a business. If inventories and accounts receivable are overvalued (the business makes no provisions for bad or doubtful debts), working capital will be high and indicate an untrue working capital figure for a business. If debt funds are used extensively to finance activities in a business, although debt funds may be used to increase profits, there is added risk for shareholders. The impact of debt funds on risks to shareholders is an ethical issue that must be considered.

Laws relating to corporations include the responsibilities of directors and requirements for disclosure for corporations. Directors have a duty to:

• • act in good faith

  • exercise power for proper purpose in the name of the corporation.

  • exercise discretion reasonably and properly

  • avoid conflicts of interest

The Australian Securities Exchange (ASX) corporate governance council officiates the requirements of corporations listed with the ASX and their responsibilities in regard to compliance with law, disclosure and transparency of company details to shareholders and the public.

Audits are an important part of the control function and are generally used to examine the financial affairs of a business. There are 3 types of audits:

1. Internal audits. These are conducted internally by employees to check accounting procedures and the accuracy of financial records.

2. Management audits. These are conducted to review the firm’s strategic plan and to determine if changes should be made. The factors affecting the strategic plan may include human resources, production processes and finance.

3. External audits. These are a requirement of the Corporations Act 2001 (Cwlth). The firm’s financial reports are investigated by independent and specialised audit accountants (CPAs) to guarantee their authenticity. They must comply with Australian auditing standards. In small businesses, external auditors are usually used only if the business is for sale or as a check against theft and fraud. When they are satisfied, the auditor certifies that the financial data presented in the business’s financial reports is in accordance with generally accepted accounting standards and practices.

If cash received in this way is not recorded, it will not show up as business revenue, and will reduce the business’s profit for the year, possibly resulting in a lower tax burden. While reducing the tax burden in this way may be tempting, the Australian Taxation Office (ATO) regularly monitors business operators, and those found to be evading their taxation responsibilities can receive fines far in excess of the amount they may believe they have saved in tax.

Shareholders in a private company are legally entitled to receive financial reports annually, even if the company is a small business and the shareholders are family members. To pretend that profit is lower than it should be is to attempt to defraud the ATO. This is not only illegal and unethical. It can hurt a business wishing to raise additional capital as understating profit may make it more difficult to persuade those sources of finance to lend to the business.  Furthermore, financial records must be kept for a minimum of 5 years.

Activity

Case study pg 367 Unethical financial practices — tax minimisation