Ethical Financial Reporting

Ethics is a code of conduct that applies to everyday life. It addresses the question of whether actions are right or wrong. Actions—whether ethical or unethical, right or wrong—are the product of individual decisions. Thus, when an organization acts unethically by using false advertising, cheating customers, polluting the environment, or treating employees unfairly, it is not the organization that is responsible—it is the members of management and other employees who have made a conscious decision to act in this manner.


Ethics is especially important in preparing financial reports because users of these reports must depend on the good faith of the people involved in their preparation. Users have no other assurance that the reports are accurate and fully disclose all relevant facts.


The intentional preparation of misleading financial statements is called fraudulent financial reporting.6 It can result from the distortion of records (e.g., the manipulation of inventory records), falsified transactions (e.g., fictitious sales), or the misapplication of various accounting principles. There are a number of motives for fraudulent reporting—for instance, to cover up financial weakness to obtain a higher price when a company is sold; to meet the expectations of investors, owners, and financial analysts; or to obtain a loan. The incentive can also be personal gain, such as additional compensation, promotion, or avoidance of penalties for poor performance.


Whatever the motive for fraudulent financial reporting, it can have dire consequences, as the accounting scandals that erupted at Enron Corporation and WorldCom attest. Unethical financial reporting and accounting practices at those two major corporations caused thousands of people to lose their jobs, their investment incomes, and their pensions. They also resulted in prison sentences and fines for the corporate executives who were involved.