Ethical and Legal Obligations

Ethical and Legal Obligations

Financial statements are a tool that management can use to discuss, evaluate, and formulate financial decisions to maximize and ensure the financial security of the company. Many of today's businesses have stockholders who have a financial stake in the company, as well as, senior company officers who own company stock and have a personal and financial interest in the value of the company. The pressure to reflect maximum profit and value for stockholders, as well as serve greedy individual agendas, has created unethical and criminal accounting activity in corporate society. This has caused much public skepticism and mistrust of the accounting field and the financial sector, and has led to an increased awareness by governing boards and governmental agencies.

Marshall, McManus and Viele (2004) state "in a broad sense, the theory of accounting is the process of identifying, measuring, and communicating economic information about an organization for the purpose of making decisions and informed judgments" (p. 5). This process results in financial statements and is done by public, industrial or government and not-for-profit accountants. Just as there are different types of accountants, there are also various types of accounting - financial, bookkeeping, managerial/cost accounting, auditing-public accounting, internal auditing, income tax accounting, and governmental and not-for-profit accounting.

The basic assumptions of accounting include the following:

1. Separate entity assumption - the business is an entity that is separate and distinct from its owners, so that the finances of the firm are not co-mingled with the finances of the owners.

2. Going concern assumption - the business is going to be operating for the foreseeable future.

3. Stable monetary unit assumption - the U.S. dollar.

4. Fixed time period assumption - information prepared and reported periodically (quarterly, annually, etc.)

The basic assumptions of accounting result in the following accounting principles:

1. Historical cost principle - assets are reported and presented at their original cost and no adjustment is made for changes in market value.

2. Matching principle - matching of revenues and expenses in the period earned and incurred.

3. Revenue recognition principle - revenue is realized (reported on the books as earned) when everything that is necessary to earn the revenue has been completed.

4. Full disclosure principle - all of the information about the business entity that is needed by users is disclosed in understandable form.

Financial statements are not only comprised of absolute numerical values, but are also based on opinion and estimation of those figures. There is not a specific set of rules that accountants must specifically adhere to. Although there are generally accepted principals of accounting, "different accountants may reach different but often equally legitimate conclusions about how to account for a particular transaction" (Marshall et al, 2004, p. 27). Due to the lack of a strict code, this gray area of assumptions in accounting enabled the manipulation of financial statements as in the Enron and WorldCom scandals, and created much scrutiny of accounting practices

The Securities and Exchange Commission (SEC), created by the Securities Act of 1933 and the Securities Exchange Act of 1934, initially had the authority in the establishment of accounting principles. Eventually, due to controversies and criticism a more independent entity was needed to monitor the accounting standard-setting process, thus the Financial Accounting Foundation was established which created the Financial Accounting Standards Board (FASB) as the authoritative standard-setting body within the accounting profession. Due to the recent accounting scandals, the accounting and auditing standard-setting processes have come under much public attack. The crisis and dilemmas led to the Sarbanes-Oxley Act of 2002, creating a five-member Public Company Accounting Oversight Board (PCAOB). The PCAOB has the authority to enforce and regulate auditing, attestation, quality control and ethics for public companies, (Marshall et al., 2004, p.35).

There has been much concern and debate regarding business ethics, especially regarding accounting. One of the most important attributes for any profession is the acknowledgement of the importance of an ethical code. "An indication of the breadth of this concern is the development of the term stakeholder to refer to the many entities - owners, managers, employees, customers, suppliers, communities, and even competitors - who have a financial stake in the way an organization conducts its activities", (Marshall et al., 2004, p.3). A cross-cultural study done by Mohamed M Ahmed, Kung Young Chung and John W Eichenseher (2003) show some of the variables regarding values