Question

Kali flower, manufactures spinning machines for the textile industry. The company had purchased
USD 100,000 of small hand tools to use in its business. The company's accountant recorded the
tools as an asset account and the company was going to write them off in 20 years. Management
wanted to write these tools off as an expense of this year in their financial statement, because
revenues of this year is abnormally high and expected to be lower in the future. The management
is thinking to expand their business. As per the revenues the business units can be expanded to
other cities. The company expect to increase the production to high level by starting more units.
Management is continuously pressurizing the accountant not to include some of the transactions
in the financial statement to bring a positive image on stakeholders. Many investors are keen to
invest in shares of the Kali flower manufacturers. The company is expecting an annual audit from
the international audit firm. This situation may put them in critical circumstances.
a. In your opinion, what are the violations of the ethical norms by considering the intentions of the
management of the company?

b. How are they going to satisfy the auditors in the above case and what important principles they
are neglecting. Explain your answer.

Answer 1

(a) solution:

- The main objective of the management of the Company is to carry out the business functions ethically which are in the best interest of its stakeholders.

- This also emphasizes on being transparent at all times with the stakeholders.

- Further, transparency means showing the true financial positions of the company and not hiding any important information from the stakeholders.

- In the given case, the managment of the company has some hidden and greedy intentions and that is why they don't want to show the correct financial position of the company. The managment of the company is trying to pressure the accountant to change the accounting treatment for the small hand tools so as to expense it off to Profit and loss account and thereby reducing the Profit of the Company. The managment of the company is also trying to pressure the accountant to not to include some of the transactions in the financial statement so as to bring a positive image towards stakeholders.

- The violations regarding ethical norms include the followings:

1) The management in the first instance of pressurizing the accountant for changing the accounting treatment for the small hand tools for reduction in the profit violates the ethical norms of accountability which it has towards the stakeholders.

2) Further, the first instance also violated the norms of Integrity as by doing this action the integrity of the managment comes into question. Also it violated the norms of procedural fairness as it is not allowed by the Accounting standard.

3) The second instance of not to include some of the transaction in the financial statement so as show a positive image is also not acceptable. This instance violated the ethical norms of Trustworthiness. This instance shows that management is not at all trustworthy.

4) Further, the first and second instance both violates the ethical norm of abiding the Laws. As inclusion of both the transaction in the financial statement will result in different tax liabilities and other law reporting issues.

(b) Solution:

- The first instance of changing the accounting policy of small hand tools and expensing it off in the profit and loss account will be caught by the auditors and on this a proper explanation will be demanded by the auditors from the management. The management will have to provide proper reason for such a treatment. The management will have accept its mistake and will have to corrects the mistake by capitalising the small hand tools and by charging proper depreciation. So this is how the first instance will be detected by the auditors and in my opinion, the management has to correct it and doing the auditors will get satisfied.

- Further, if the management refuses to cover then it may lead to a qualification in the auditor's opinion. This will be more negative for the company.

-The second instance of not to include or not to record some of the transactions in the financial statements so as create a positive image in the minds of the stakeholders will be very difficult to get detected through any of the auditor's procedures. So this act of managment will not be identified by the auditors. Also, it is said that ' An Auditor is a watchdog and not bloodhound' which states that auditors duty is to obtain a reasonable assurance that the financial statements as a whole are free from material mistatement whether caused by fraud or error i.e in other words auditor will try to find out any frauds which have taken place but does not gurantee that he will find all frauds. So here the management will be at fault it later got detetcted.

The following principles are being neglected:

1. HONESTY. Ethical executives are honest and truthful in all their dealings and they do not deliberately mislead or deceive others by misrepresentations, overstatements, partial truths, selective omissions, or any other means. In this case, the management has tried to deceive the stakeholders by understating the profit of the company and by not including some transactions in the financial statements.

2. LOYALTY. Ethical executives are worthy of trust, demonstrate fidelity and loyalty to persons and institutions by friendship in adversity, support and devotion to duty; they do not use or disclose information learned in confidence for personal advantage. For personal advantage the management not included some transactions in the financial statements just as to show a positive image.

3. FAIRNESS. Ethical executives and fair and just in all dealings; they do not exercise power arbitrarily, and do not use overreaching nor indecent means to gain or maintain any advantage nor take undue advantage of another’s mistakes or difficulties. The management was not fair and transaparent towards the stakeholders.

4. REPUTATION AND MORALE. Ethical executives seek to protect and build the company’s good reputation and the morale of its employees by engaging in no conduct that might undermine respect and by taking whatever actions are necessary to correct or prevent inappropriate conduct of others. The act of pressurizing the accountant and forcing him to make changes in the books of accounts results in a low employee morale. If the acts of management comes before the stakeholders, it will have a negative impact of the company's reputation as well.

5. ACCOUNTABILITY. Ethical executives acknowledge and accept personal accountability for the ethical quality of their decisions and omissions to themselves, their colleagues, their companies, and their communities. The management remains accountable to stakeholders. The managment has neglected this principle.