Review of Part C of the Code Jim Gaa IESBA June 2012 New York, USA

To inform the development of IESBA’s Strategy and Work Plan To determine whether recent accounting irregularities reveal ethical implications for professional accountants in business (PAIBs) To determine whether Part C of the Code should be amended Background Review of Part C of the Code

Jim Gaa (Chair) Alice McCleary (Board member) Lisa Snyder (Technical Adviser) Larry Kean (SME -- USA) Ian Rushby (PAIB Committee -- UK) Significant input from PAIB/SME perspective Working Group Membership Review of Part C of the Code

Consideration of accounting irregularities Informal survey of selected member bodies Analysis of Part C of Code Tentative conclusions Activities to Date Review of Part C of the Code

Reports focus mainly on illegal acts rather than “legal but unethical”, and actions of senior management Little attention to –Legal but unethical acts –PAIBs who act on the instructions of superiors Role of auditors not directly relevant to Part C Limited discussion of questionable payments (section 350) Consideration of Accounting Irregularities Review of Part C of the Code

Survey of selected member bodies that have significant number of PAIBs Conducted to identify PAIBs’ ethical issues as reported to member bodies and to identify ways of providing guidance Survey of member bodies Review of Part C of the Code

Few ethical queries received from PAIBs than from from PAIPs Only significant recurring issue: pressure by senior management or supervisors to report misleading information Some information was provided about forms of additional guidance Survey of member bodies Review of Part C of the Code

Focus: –Areas in Part C that could be amended –Areas not currently in Part C that could be addressed –What forms additional guidance might take Discussion of results of selected cases of accounting irregularities and survey of member bodies Paragraph by paragraph examination of Part C Preliminary discussion of additional guidance Working Group Activity Review of Part C of the Code

Part C provides limited guidance on: Responsibilities of PAIBs: –What PAIBs should do: produce financial information that is a faithful representation of the economics of transactions –What PAIBs should not do: be associated with misleading information and reports Dealing with pressure on PAIBs from superiors to violate legal or ethical standards Working group’s major findings Review of Part C of the Code

Financial reporting –More guidance to PAIBs about preparing and reporting faithfully representative (truthful) information –Confirm that is intended to go beyond financial reporting principles –Provide guidance on earnings management Pressure –Section 340 could be expanded to include pressures of all kinds, not just financial self-interest –Code could include guidance for PAIBs who may exert pressure Preliminary recommendations Review of Part C of the Code

PAIBs have a responsibility to produce financial reports that are faithful (complete, neutral and free of material errors) or truthful representations of the economics of transactions Code mentions this only briefly in two places: indirectly in paragraph (“truthful”) and in (“fair and honest”) Faithful representation: Limited content Review of Part C of the Code

320.1 requires information to be presented “fairly, honestly and in accordance with relevant professional standards.” Issue: contains two tests: –To present information fairly and honestly –To present information in accordance with relevant professional standards Should the Code provide guidance about what accountants should do –Provide faithfully representative (truthful) information? Faithful representation: two “tests” Review of Part C of the Code

PAIBs have a responsibility not to be associated with misleading information and reports –A number of references, especially and (current code), but limited guidance Financial statements may be misleading even though they do not violate applicable financial reporting standards. Earnings management is an important issue in relation to truthful versus misleading information Association with misleading information Review of Part C of the Code

Most businesses undertake earnings management without violating any laws Diversity of views about its ethical status –There is no problem –It is never acceptable (always misleading) –It is acceptable in some circumstances, not in others Current Code makes no reference to it –It is included in proposed 300.6, and also (Illegal Acts task force) Earnings management Review of Part C of the Code

Should Part C address earnings management? Should Part C provide guidance on distinguishing acceptable from improper earnings management? Earnings Management Review of Part C of the Code

Part C provides limited guidance about how a PAIB should deal with –The unethical acts of others (small addition to (Illegal acts Task Force) –Pressure to engage in illegal or unethical acts Survey and working group discussion: Pressure to improperly influence earnings are as likely to be the result of corporate culture, cajoling, bullying and threats of job loss as personal financial gain Pressure from Superiors Review of Part C of the Code

Section 310 (current version) addresses pressures of many types –Deleted from Part C by conflict of interest exposure draft Section 320 focuses on threats relating specifically to financial reporting Section 340 is limited to self-interest and familiarity threats (incentives) related to financial reporting Sections 310,320,340 Review of Part C of the Code

Subordinates: Should section 340 be expanded beyond financial interests and incorporate the pressure on subordinates to act inappropriately in Section 320? –Guidance similar to the escalation process in proposed Section 360 (Illegal acts) may help the PAIB Superiors: Should the Code include guidance for PAIBs who may exert pressure on subordinates? Pressure Review of Part C of the Code

Receipts and Offers of Items of Value (Section 350) Should section 330 (“Sufficient Expertise”) be incorporated into section 300? Whistleblowing (reporting unethical/illegal acts of others) Responsibility of PAIBs to advance the legitimate objectives of the employing organization Other matters identified Review of Part C of the Code

Are there any other issues the IESBA would like the Working Group to examine? Discussion Review of Part C of the Code