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ETHICS IN SBR EXAMS Exam Scope:  Section A Question No2 (20 Marks)  Exam Style: Accounting Implications, Ethical Issues and sometimes performance measurement aspects. What are ethics? Ethics are a code of moral principles that people follow with respect to what is right or wrong. Ethical principles are not necessarily enforced by law, although the law incorporates moral judgements. (Murder is wrong ethically, and is also punishable legally.) Ethical principles in corporate reporting The ACCA Rulebook contains the bye-laws, regulations and Code of Ethics and Conduct, which every ACCA member should follow. The accountant should comply with the fundamental ethical principles set out in the ACCA Rulebook: to act with integrity, objectivity, professional competence and due care, confidentiality and professional behaviour. Integrity To be straightforward and honest in all professional and business relationships Objectivity Not to allow bias, conflict of interest or undue influence of others to override professional or business judgments Professional Competence and Due Care To maintain professional knowledge and skill at the level required to ensure that a client or employer receives competent professional service based on current developments in practice, legislation and techniques and act diligently and in accordance with applicable technical and professional standards Confidentiality To respect the confidentiality of information acquired as a result of professional and business relationships and, therefore, not disclose any such information to third parties without proper and specific authority, unless there is a legal or professional right or duty to disclose, nor use the information for the personal advantage of the professional accountant or third parties Professional Behavior To comply with relevant laws and regulations and avoid any action that discredits the profession.

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Threats – Ethical Principles ACCA's Code of Ethics and Conduct identifies the following categories of threats to the fundamental principles. Threat Explanation Self-Interest A financial or other interest may inappropriately influence the accountant's judgement or behaviour. Self-Review The accountant may not appropriately evaluate the results of a previous judgement made or activity or service performed by themselves or others within their firm. Advocacy A threat that the accountant promotes the client's or employer's position to the point that their objectivity is compromised. Familiarity Due to a long or close relationship with a client or employer, the accountant may be too sympathetic to their interests or too accepting of their work. Intimidation The accountant may not act objectively due to actual or perceived pressures. The accountant should be mindful of any above threats to the fundamental ethical principles. In doing so, the accountant should consider  the relevant facts (Accounting Implications),  the ethical issues involved,  the fundamental principles which are threatened,  whether internal procedures exist which mitigate the threats, and  what alternative courses of action could be taken. The following example will develop mindset to deal any accounting related ethical issues

Mind Set for SBR Exams -Basic Example Maash has a number of investments in listed shares that are designated to be measured at fair value through other comprehensive income. A new ACCA qualified accountant has started work

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at Maash and she has discovered that the finance director measures the fair value of these investments as the present value of the expected future dividend receipts. This calculation gives a higher fair value figure than the quoted share price. The finance director has justified this fair value measurement to the accountant on the grounds that Maash does not trade shares in the short-term and so quoted share prices understate the value that Maash will realise over the lifetime of these investments. Required: Discuss why the finance director’s fair value measurement is not in line with International Financial Reporting Standards, and discuss the ethical issues that arise. Answer Identify the Relevant Facts – Accounting Implications Maash is using an estimation technique to measure fair value. This is unobservable and so, according to IFRS 13 Fair Value Measurement, is a level 3 input. Maash’ intention to hold the asset is not relevant. IFRS 13 states that fair value is a market-based measurement, and not an entityspecific measurement. Maash should be measuring fair value using the quoted share price. This is a level 1 input, which IFRS 13 prioritises. Write the Knowledge about Ethics for Professional Accountants (Standard Answer) Financial statements are important to a range of user groups, such as shareholders, banks, employees and suppliers. These stakeholder requires the financial statements to faithfully represent the performance and position of the company so that they can make adequate investment decisions. The accountant should comply with the fundamental ethical principles set out in the ACCA Rulebook: to act with integrity, objectivity, professional competence and due care, confidentiality and professional behaviour. By following the code of ethics, it is more likely that a faithful representation of the company will be offered because the needs of the users will be prioritised. The accountant should be mindful of any threats to these fundamental ethical principles. In doing so, the accountant should consider the relevant facts, the ethical issues involved, the fundamental principles which are threatened, whether internal procedures exist which mitigate the threats, and what alternative courses of action could be taken. Ethical Issues – Case (Threats and Principal)

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If the sole purpose of using the level 3 input is to increase the carrying amount of the investment (like self-interest threat), then the principles of integrity and objectivity have been compromised. If the director is unaware of the requirements of IFRS 13, then it could be argued that they are not complying with the ethical principle of professional competence. Stakeholders are becoming increasingly reactive to the ethical stance of a company. Deliberate falsification of the financial statements could harm the reputation of Maash. It could also harm the reputation of the accountancy profession as a whole. Action - Accountant (Conclusion Paragraph) The accountant must not therefore comply with the director’s instructions. The accountant should remind to the director of their obligations to comply with the Code of Ethics. Should the accountant feel unable to approach the director directly, they could consider talking to those charged with governance and, in particular, non-executive directors to explain the situation. The accountant could also seek help from the ACCA ethical helpline and take legal advice. Ultimately, if the situation cannot be resolved, the accountant could consider resigning and seeking employment elsewhere.

SBR EXAM STANDARD ANSWER “ETHICS POINTS” Knowledge about Ethics for Professional Accountants (Standard Answer)

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Financial statements are important to a range of user groups, such as shareholders, banks, employees and suppliers. These stakeholder requires the financial statements to faithfully represent the performance and position of the company so that they can make adequate investment decisions. The accountant should comply with the fundamental ethical principles set out in the ACCA Rulebook: to act with integrity, objectivity, professional competence and due care, confidentiality and professional behaviour. By following the code of ethics, it is more likely that a faithful representation of the company will be offered because the needs of the users will be prioritised. The accountant should be mindful of any threats to these fundamental ethical principles. In doing so, the accountant should consider the relevant facts, the ethical issues involved, the fundamental principles which are threatened, whether internal procedures exist which mitigate the threats, and what alternative courses of action could be taken. Action - Accountant (Conclusion Paragraph) They must not therefore comply with the (management) instructions. The accountant should remind the (management) of their obligations to comply with the Code of Ethics. Should the accountant feel unable to approach the (management) directly, they could consider talking to those charged with governance and, in particular, non-executive directors to explain the situation. The accountant could also seek help from the ACCA ethical helpline and take legal advice. Ultimately, if the situation cannot be resolved, the accountant could consider resigning and seeking employment elsewhere. This standard conclusion paragraph only relevant for the ethical issues between accountant and management

ACCA Technical Article – Accounting Ethics in the digital age https://www.accaglobal.com/uk/en/student/exam-support-resources/professional-examsstudy-resources/strategic-business-reporting/technical-articles/ethics-digital.html

Specimen 2 - 2018

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Gustoso is a public limited company which produces a range of luxury Italian food products which are sold to restaurants, shops and supermarkets. It prepares its financial statements in accordance with International Financial Reporting Standards. The directors of Gustoso receive a cash bonus each year if reported profits for the period exceed a pre-determined target. Gustoso has performed in excess of targets in the year ended 31 December 20X7. Forecasts for 20X8 are, however, pessimistic due to economic uncertainty and stagnant nationwide wage growth. Provisions A new accountant has recently started work at Gustoso. She noticed that the provisions balance as at 31 December 20X7 is significantly higher than in the prior year. She made enquiries of the finance director, who explained that the increase was due to substantial changes in food safety and hygiene laws which become effective during 20X8. As a result, Gustoso must retrain a large proportion of its workforce. This retraining has yet to occur, so a provision has been recognized for the estimated cost of $2 million. The finance director then told the accountant that such enquiries were a waste of time and would not be looked at favourably when deciding on her future pay rises and bonuses. Wheat contract Gustoso purchases significant quantities of wheat for use in its bread and pasta products. These are high-value products on which Gustoso records significant profit margins. Nonetheless, the price of wheat is volatile and so, on 1 November 20X7, Gustoso entered into a contract with a supplier to purchase 500,000 bushels of wheat in June 20X8 for $5 a bushel. The contract can be settled net in cash. Gustoso has entered into similar contracts in the past and has always taken delivery of the wheat. By 31 December 20X7 the price of wheat had fallen. The finance director recorded a derivative liability of $0·5 million on the statement of financial position and a loss of $0·5 million in the statement of profit or loss. Wheat prices may rise again before June 20X8. The accountant is unsure if the current accounting treatment is correct but feels uncomfortable approaching the finance director again. Required: Discuss the ethical and accounting implications of the above situations from the perspective of the accountant. (13 Marks) Professional marks will be awarded in question 2 for the application of ethical principles. (2 marks) (15 marks) Answer

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Accounting Implications Provision IAS 37 Provisions, Contingent Liabilities and Contingent Assets states that a provision should only be recognized if: – there is a present obligation from a past event, – an outflow of economic resources is probable, and – the obligation can be measured reliably. No provision should be recognized because Gustoso does not have an obligation to incur the training costs. The expenditure could be avoided by changing the nature of Gustoso’s operations and so it has no present obligation for the future expenditure. The provision should be derecognized. This will reduce liabilities by $2 million and increase profits by the same amount. Contract Derivatives IFRS 9 Financial Instruments applies to contracts to buy or sell a non-financial item which are settled net in cash. Such contracts are usually accounted for as derivatives. However, contracts which are for an entity’s ‘own use’ of a non-financial asset are exempt from the requirements of IFRS 9. The contract will qualify as ‘own use’ because Gustoso always takes delivery of the wheat. This means that it falls outside IFRS 9 and so the recognition of a derivative is incorrect. The contract is an executory contract. Executory contracts are not initially recognized in the financial statements unless they are onerous, in which case a provision is required. This particular contract is unlikely to be onerous because wheat prices may rise again. Moreover, the finished goods which the wheat forms a part of will be sold at a profit. As such, no provision is required. The contract will therefore remain unrecognized until Gustoso takes delivery of the wheat. The derivative liability should be derecognized, meaning that profits will increase by $0·5 million.

Ethical implications

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The users of Gustoso’s financial statements, such as banks and shareholders, trust accountants and rely on them to faithfully represent the effects of a company’s transactions. IAS 1 Presentation of Financial Statements makes it clear that this will be obtained when accounting standards are correctly applied. Both of the errors made by Gustoso overstate liabilities and understate profits. It is possible that these are unintentional errors. However, incentives exist to depart from particular IFRS and IAS standards: most notably the bonus scheme. The bonus target in 20X7 has been exceeded, and so the finance director may be attempting to shift ‘excess’ profits into the next year in order to increase the chance of meeting 20X8’s bonus target. In this respect, the finance director has a clear self-interest threat to objectivity and may be in breach of ACCA’s Code of Ethics and Conduct. Action The accountant is correct to challenge the finance director and has an ethical responsibility to do so. Despite the fact that the finance director is acting in an intimidating manner, the accountant should explain the technical issues to the director. If the director refuses to comply with accounting standards, then it would be appropriate to discuss the matter with other directors and to seek professional advice from ACCA. Legal advice should be considered if necessary. The accountant should keep a record of conversations and actions. Resignation should be considered if the matters cannot be satisfactorily resolved. Marking Scheme Accounting issues – 1 mark per point up to maximum Ethical issues – 1 mark per point up to maximum

6 7 ––– 13 –––

Professional

2 ––– 15 –––

September 2018

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Background Farham manufactures white goods such as washing machines, tumble dryers and dishwashers. The industry is highly competitive with a large number of products on the market. Brand loyalty is consequently an important feature in the industry. Farham operates a profit related bonus scheme for its managers based upon the consolidated financial statements but recent results have been poor and bonus targets have rarely been achieved. As a consequence, the company is looking to restructure and sell its 80% owned subsidiary Newall which has been making substantial losses. The current year end is 30 June 20X8. Factory subsidence Farham has a production facility which started to show signs of subsidence since January 20X8. It is probable that Farham will have to undertake a major repair sometime during 20X9 to correct the problem. Farham does have an insurance policy but it is unlikely to cover subsidence. The chief operating officer (COO) refuses to disclose the issue at 30 June 20X8 since no repair costs have yet been undertaken although she is aware that this is contrary to international accounting standards. The COO does not think that the subsidence is an indicator of impairment. She argues that no provision for the repair to the factory should be made because there is no legal or constructive obligation to repair the factory. Farham has a revaluation policy for property, plant and equipment and there is a balance on the revaluation surplus of $10 million in the financial statements for the year ended 30 June 20X8. None of this balance relates to the production facility but the COO is of the opinion that this surplus can be used for any future loss arising from the subsidence of the production facility. (5 marks) Sale of Newall At 30 June 20X8 Farham had a plan to sell its 80% subsidiary Newall. This plan has been approved by the board and reported in the media. It is expected that Oldcastle, an entity which currently owns the other 20% of Newall, will acquire the 80% equity interest. The sale is expected to be complete by December 20X8. Newall is expected to have substantial trading losses in the period up to the sale. The accountant of Farham wishes to show Newall as held for sale in the consolidated financial statements and to create a restructuring provision to include the expected costs of disposal and future trading losses. The COO does not wish Newall to be disclosed as held for sale nor to provide for the expected losses. The COO is concerned as to how this may affect the sales price and would almost certainly mean bonus targets would not be met. The COO has argued that they have a duty to secure a high sales price to maximise the return for shareholders of Farham. She has also implied that the accountant may lose his job if he were to put such a provision in the financial statements. The expected costs from the sale are as follows: Future trading losses

$30 million

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Various legal costs of sale Redundancy costs for Newall employees Impairment losses on owned assets

$2 million $5 million $8 million

Included within the future trading losses is an early payment penalty of $6 million for a leased asset which is deemed surplus to requirements. (6 marks) Required: (a) Discuss the accounting treatment which Farham should adopt to address each of the issues above for the consolidated financial statements. Note: The mark allocation is shown against each of the two issues above. (b) Discuss the ethical issues arising from the scenario, including any actions which Farham and the accountant should undertake. (7 marks) Professional marks will be awarded in question 2 for the quality of the discussion. (2 marks) (20 marks)

Answer

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Accounting Implications Factory subsidence IAS 36 – Impairment The subsidence is an indication of impairment in relation to the production facility. Consideration would be required to choose a suitable cash generating unit as presumably the factory (as individual asset) would not independently generate cash flows for Farham as a standalone asset. The facility is likely to consist of both the factory and various items of plant and machinery and so it would not be possible to independently measure the cash flows from each of the assets. An impairment has occurred where the carrying amount exceeds the recoverable amount. Any impairment loss is allocated to reduce the carrying amount of the assets of the unit. This will be expensed in profit or loss and cannot be netted off the revaluation surplus as the surplus does not specifically relate to the facility impaired. The recoverable amount of the unit would need to be assessed as the higher of fair value less costs to sell and value in use. Reference to IFRS 13 Fair Value Measurement would be required in estimating the fair value of the facility. For example, by considering whether similar faci...