caf 7 – ethics ethics in financial reporting...

CAF 7 – Ethics

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- Ethics in Financial Reporting

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ICAP CODE OF ETHICS

INTRODUCTION

What is ethical behaviour?

Ethics can be difficult to define but it is principally concerned with human character and conduct. Ethical behaviour is more than obeying laws, rules and regulations. It is about doing ‘the right thing’. The accountancy profession is committed to acting ethically and in the public interest.

Ethics for professional accountants

Professional accountants may find themselves in situations where values are in conflict with one another due to responsibilities to employers, clients and the public. ICAP has a code of conduct which members and student members must follow. The code provides guidance in situations where ethical issues arise.

Applicability of ICAP code

All members and student members of ICAP are required to comply with the code of ethics and it applies to both accountants in practice and in business.

FUNDAMENTAL PRINCIPLES

Integrity Members should be straightforward and honest in all professional and business relationships. Integrity implies not just honesty but also fair dealing and truthfulness.

Objectivity Members should not allow bias, conflicts of interest or undue influence of others to override their professional or business judgements.

Professional competence and due care

Members have a duty to maintain their professional knowledge and skill at such a level that a client or employer receives a competent service, based on current developments in practice, legislation and techniques.

Confidentiality

Members must respect the confidentiality of information acquired as a result of professional and business relationships and should not disclose such information to third parties without authority or unless there is a legal or professional right or duty to disclose.

Professional behaviour

Members must comply with relevant laws and regulations and should avoid any action which discredits the profession. They should behave with courtesy and consideration towards all with whom they come into contact in a professional capacity.

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THREATS TO FUNDAMENTAL PRINCIPLES

Self-interest threat

Self-interest threats may occur as a result of the financial or other interests of members or their immediate or close family members. Such financial interests might cause members to be reluctant to take actions that would be against their own interests.

Self-review threats

Self-review threats occur when a previous judgement needs to be re-evaluated by members responsible for that judgement.

Advocacy threat

A chartered accountant in business may often need to promote the organisations position by providing financial information. As long as information provided is neither false nor misleading such actions would not create an advocacy threat.

Familiarity threat

Familiarity threats occur when, because of a close relationship, members become too sympathetic to the interests of others.

Intimidation threat

Intimidation threats occur when a member’s conduct is influenced by fear or threats (for example, when he encounters an aggressive and dominating individual at a client or at his employer).

SECTION 320: CHARTERED ACCOUNTANTS IN BUSINESS

Scope of work

Chartered accountants in business are often involved in the preparation and reporting of information that may either be made public or used by others inside or outside the employing organisation. Such information may include financial or management information, for example: forecasts and budgets; financial statements; management discussion and analysis; and the management letter of representation provided to the auditors as

part of an audit of financial statements.

Duty

Information must be prepared and presented fairly, honestly and in accordance with relevant professional standards. In particular financial statements must be prepared and presented in accordance with the applicable financial reporting standards.

POSSIBLE CONFLICTS AND SAFEGUARD

Possible conflicts

A chartered accountant in business may face pressure to: Act contrary to law or regulation. Act contrary to technical or professional standards. Lie to, or otherwise intentionally mislead (including misleading by

remaining silent) others, in particular: The auditors of the employing organization; or Regulators.

Issue, or otherwise be associated with, a financial or non-financial report that materially misrepresents the facts, including statements in connection with, for example: The financial statements; Tax compliance; Legal compliance; or Reports required by securities regulators.

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Evaluation of threats

The significance of threats must be evaluated and unless they are clearly insignificant, safeguards should be considered and applied to eliminate them or reduce them to an acceptable level.

Safeguards

Such safeguards may include: Obtaining advice where appropriate from within the employing

organisation, or an independent professional advisor or a relevant professional body.

The existence of a formal dispute resolution process within the employing organization.

Seeking legal advice.

SYLLABUS

Reference Content/Learning outcome

C1

Ethics Fundamental principles (sections 100 to 150 of the Code of Ethics

for Chartered Accountants) An understanding of ethics relating to preparation and reporting of

financial information (Section 320 of Code of Ethics for Chartered Accountants)

LO3.1.1 Describe with simple examples the fundamental principles of professional ethics of integrity, objectivity, professional competence and due care, confidentiality and professional behavior

LO3.1.2 Apply the conceptual framework to identify, evaluate and address threats to compliance with fundamental principles.

LO3.1.3 Explain using simple examples the ethical responsibilities of a Chartered Accountant in preparation and reporting of financial information.

Proficiency level: 2 Testing level: 1 Past Paper Analysis A14 S15 A15 S16 A16 S17 A17 S18 A18 S19 A19 S20 05 05 06 06 06 08 08 08 08 09 - 031

1 Total Marks 08 (including IAS 37)

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PRACTICE Q&A

Sr.# Description Marks Reference 1C Ibrahim – fundamental principle and threat 03 ST 2C Ibrahim – logical error in spreadsheet 04 ST 3H Ali – incorrect lease accounting 07 ST 4H Etishad – property revaluations 07 ST 5H Theory – Fundamental principles esp. integrity 05 PE A14 6H List threats to ethics 05 PE S15 7H Fortune Limited: Categories of threats and safeguards to

scenario 06 PE A15

8H Ali and Bashir: objectivity and integrity focused scenario 06 PE S16 9H Zia: Confidentiality, professional behavior and self-interest

threat scenario 06 PE A16

10H Atif: Integrity, professional behavior, objectivity and self-interest threat 08 PE S17

11C Waheed: Ethical issues and required action 10 QB 12C Jafar: Ethical and Accounting issues 20 QB 13H Usman: Self-interest and intimidation threat 08 PE A17 14H Umer Sheikh: Breach, potential threats and required action 08 PE S18 15H Baqir: Insider trading 08 PE A18 16C Amir Ali working in Circle Limited 09 PE S19

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QUESTION 01 Ibrahim is member of ICAP working as a unit accountant. He is a member of a bonus scheme under which, staff receive a bonus of 10% of their annual salary if profit for the year exceeds a trigger level. Ibrahim has been reviewing working papers prepared to support this year’s financial statements. He has found a logic error in a spreadsheet used as a measurement tool for provisions. Correction of this error would lead to an increase in provisions. This would decrease profit below the trigger level for the bonus. Required: Which threat to fundamental principle Ibrahim is facing? What fundamental principle is mainly affected by the above threat? (03) QUESTION 02 Ibrahim is member of ICAP working as a unit accountant. He is a member of a bonus scheme under which, staff receive a bonus of 10% of their annual salary if profit for the year exceeds a trigger level. Ibrahim has been reviewing working papers prepared to support this year’s financial statements. He has found a logic error in a spreadsheet used as a measurement tool for provisions. Correction of this error would lead to an increase in provisions. This would decrease profit below the trigger level for the bonus. Required: Discuss the responsibility of Ibrahim and suggest course of action. (04)

QUESTION 03 Ali is a chartered accountant recruited on a short-term contract to assist the finance director, Bashir (who is not a chartered accountant) in finalising the draft financial statements. The decision on whether to employ Ali on a permanent basis rests with Bashir. Ali has been instructed to prepare information on leases to be included in the financial statements. He has identified a number of large leases which are being accounted for as rental arrangements even though the terms of the contract contain clear indicators that the risks and benefits have passed to the company and constitute right of use. Changing the accounting treatment for the leases would have a material impact on asset and liability figures. Ali has explained this to Bashir. Bashir responded that Ali should ignore this information as the company need to maintain a certain ratio between the assets and liabilities in the statement of financial position. Required: Discuss the responsibility of Ali and suggest course of action. (07) QUESTION 04 Etishad is a chartered accountant who works as in a team that reports to Fahad, the finance director of Kohat Holdings. Fahad is also a chartered accountant. He has a domineering personality. Kohat Holdings revalues commercial properties as allowed by IAS 16. Valuation information received last year showed that the fair value of the property portfolio was 2% less than the carrying amount of the properties (with no single property being more than 4% different). A downward revaluation was not recognised on the grounds that the carrying amount was not materially different from the fair value. This year’s valuation shows a continued decline in the fair value of the property portfolio. It is now 5% less than the carrying amount of the properties with some properties now being 15% below the carrying amount.

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Etishad submitted workings to Fahad in which he had recognised the downward revaluations in accordance with IAS 16. Fahad has sent him an email in response in which he wrote “Stop bothering me with this rubbish. There is no need to write the properties down. The fair value of the portfolio is only 5% different from its carrying amount. Restate the numbers immediately”. Required: Discuss the issue, responsibility and course of action. (07) QUESTION 05 List the fundamental principles as mentioned in the ICAP’s Code of Ethics and describe the guidance expressed in respect of ‘principle of integrity’. (05) QUESTION 06 According to the ICAP’s Code of Ethics, in complying with the fundamental principles, a chartered accountant in business may be subject to various threats. List categories of such threats in business and give one situation which may create such threats. (05)

QUESTION 07 Fortune Limited (FL) is quoted on the stock exchange, with revenue of over Rs.5 billion per Annum During the year ended 30 June 2015, FL has incurred a loss of Rs.26 million. The Chief Executive is of the view that declaration of loss may result in the bankers’ refusal to renew the credit facility. Therefore, he wants to incorporate certain adjustments in the books of account that will result in a net profit of Rs.100 million. However, the Chief Financial Officer (CFO), who is a chartered accountant, is of the view that all possible adjustments allowable under the applicable accounting regulations have already been considered and incorporated. Required: Identify the categories of threats to the fundamental principles of objectivity or professional competence and due care, that may be created in the above situation and discuss the safeguards available to the CFO in this respect, under the ICAP’s Code of Ethics. (06) QUESTION 08 Ali and Bashir are chartered accountants and have been working as Managing Director (MD) and Chief Financial Officer (CFO) in a listed company. In a recent meeting of the Board, the directors have decided to expand the business within six months by opening 20 retail outlets. This expansion would require financing of Rs. 300 million which may be arranged through bank loan. MD has advised the CFO to arrange the loan from MN Bank. He has also informed that the President of the bank is his good friend and the loan can be arranged on a fast track basis at a mark-up of 15% per annum, subject to the following conditions: current ratio and quick ratio should be at least 2:1 and 1:1 respectively; gearing ratio should not exceed 40%; and interest cover should be at least 3. CFO is not comfortable with this deal as the mark-up offered by the bank is much higher than the rate on the existing loan and it is difficult for the company to meet the gearing

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requirements of the bank. However, MD has asked him to make certain changes in the draft financial statements before submission to the bank; which according to the CFO are not in accordance with the IFRSs. Required: Briefly explain how the MD may be in breach of the fundamental principles of ICAP’s code of ethics. Also state the potential threats that CFO may face under the circumstances, along with available safeguards (if any). (06) QUESTION 09 Zia is a Chartered Accountant and works as a financial controller in Unique Engineering Limited (UEL). UEL is currently considering the acquisition of Top Storage Limited (TSL) and Zia is a member of the team which is currently negotiating the acquisition with the management of TSL. After becoming aware of the prospective acquisition, Zia purchased 1,000,000 shares of TSL in the name of his wife and son. Required: Briefly explain how Zia is in breach of the fundamental principles of ICAP’s code of ethics. Also explain the potential threats that may be involved in the above situation. (06) QUESTION 10 Atif is a chartered accountant and has been working as Manager – Accounts in an unlisted public company MNZ Limited. While preparing the financial statements for the year ended 31 December 2016, CFO of MNZ who is also a chartered accountant informed Atif that the directors are considering to have the company listed on Pakistan Stock Exchange. Consequently, CFO wants to show higher profit and has asked Atif to identify areas where book adjustments can be made. He has also informed that if MNZ is able to list the shares at a price of Rs. 35 or more, all managerial staff would be given an additional bonus this year. Required: Briefly explain how the CFO is in breach of the fundamental principles of ICAP’s code of ethics. Also state the potential threats that Atif may face under the above circumstances and how he should respond. (08) QUESTION 11 Waheed is a chartered accountant, recently employed by AA plc as deputy to the finance director, Arif (also a chartered accountant). AA plc is listed on the Lahore stock exchange. On Waheed’s first day on the job he met with Arif who said ‘Look, keep it to yourself but I’m having a second interview next week for a new job. The first thing that I need you to do is to review the financial statements before the auditors arrive. I qualified a few years ago and am not up to date on all of the little technicalities in IFRS. You should now these better than me and you’ll know more about what the auditors might focus on. We must do our best to present the financial statements in the most favorable light as the bonus paid to employees (including me) depends on profit being more than 10% bigger than last year’s and remember that you qualify for this too. Keep this in mind when you carry out the review as we do not really want to find anything. Do well at this and I might put in a good word for you when I leave as I’m sure you’ll be a great replacement for me.” Required: Explain the ethical issues inherent in the above conversation and what Waheed should do about them. (10)

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QUESTION 12 Jafar has recently been appointed as financial controller to Sindh Industries Ltd. Until a month ago, Sindh Industries had a finance director, who resigned suddenly, due to ill health. Since Jafar joined the company, he has learned that his resignation was related to stress caused by a series of disagreements with the managing director about the performance of the business.

The directors have not yet appointed a replacement. It is now March 2016 and you have been asked to finalize the financial statements for the year ended 31 December 2015. The draft statement of profit or loss extract and statement of financial position are shown below:

Draft statement of profit or loss for the year ended 31 December 2015 $000 Profit before tax 2,500 Draft statement of financial position at 31 December 2015 $000 Property, plant and equipment 12,000 Current assets 3,500 Total assets 15,500 Share capital 2,000 Retained earnings 6,000 Equity 8,000 Non-current liabilities 5,000 Current liabilities 2,500 Total equity and liabilities 15,500

During the year ended 31 December 2015 Sindh Industries entered into the following transactions.

1) Just before the year end Sindh Industries signed a contract to deliver consultancy services for a period of 2 years at a fee of $500,000 per annum. The full amount of this fee has been received in advance and is nonrefundable.

2) Sindh Industries has constructed a new factory. The construction has been financed from the pool of existing borrowings. Land at a cost of $1.8 million was acquired on 1 February 2015 and construction began on 1 June 2015. Construction was completed on 30 September 2015 at an additional cost of $2.7 million. Although the factory was usable from that date, full production did not commence until 1 December 2015. Throughout the year the company’s average borrowings were as follows:

Amount $

Annual interest %

Bank overdraft 1,000,000 9.75 Bank loan 1,750,000 10 Debenture 2,500,000 8

An amount of $450,000 has been included in property, plant and equipment in respect of borrowing costs relating to the construction of the factory. The useful life of the factory has been estimated at 20 years. No depreciation has been charged for the year. The reason for this is that the factory has only been in use for one month and that the depreciation charge would be immaterial.

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3) A blast furnace with a carrying amount at 1 January 2015 of $3.5 million has been depreciated in the draft financial statements on the basis of a remaining life of 20 years. In December 2015 the directors carried out a review of the useful lives of various significant items of plant and machinery, including the blast furnace and came to the conclusion that the useful life of the furnace was 20 years at 31 December 2015. The reasoning behind this judgment was that the lining of the furnace had been replaced in the last week of December 2015 at a cost of $1.4 million. Provided that the lining is replaced every five years, the life of the furnace can be extended accordingly. You have found a report, commissioned by the previous finance director and prepared by a firm of asset valuation specialists, which assesses the remaining useful life of the main structure of the furnace at 1 January 2015 at 15 years and the lining of the furnace at 5 years. You have also found evidence that the managing director has seen this report.

Jafar has had a conversation with the managing director who told him, “We need to make the figures look as good as possible so I hope you’re not going to start being difficult. The consultancy fee is non-refundable so there’s no reason why we can’t include it in full. I think we should look at our depreciation policies. We’re writing off our assets over far too short a period. As you know, we’re planning to go for a stock market listing in the near future and being prudent and playing safe won’t help us do that. It won’t help your future with this company either.”

Required: (a) Explain the required IFRS accounting treatment of these issues, preparing relevant

calculations where appropriate. (b) Prepare a revised draft of the statement of profit or loss extract for the year ended 31

December 2015 and the statement of financial position at that date. (c) Discuss the ethical issues arising from your review of the draft financial statements

and the actions that you should consider. (20)

QUESTION 13 Usman is a Chartered Accountant and has been working as Finance Director in Mehran Limited (ML) for the past one year. He reports to the CEO who is also a Chartered Accountant.

Recently, Usman has received a bill issued by an advertising agency which is duly approved for payment by the Director Marketing. Usman believes that the amounts agreed to be paid under the contract far exceed the value of services to be provided by the advertising agency and that the payment would be redirected to obtain a sales contract. He has discussed the matter with CEO who has advised him to process the payment in ML’s business interest. The CEO also informed Usman that if the said contract is secured, the management staff will be entitled to a handsome bonus.

Required: Briefly explain how CEO is in breach of the fundamental principles of ICAP’s code of ethics. Also state the potential threats which Usman may face under the circumstances, along with available safeguards (if any). (08) QUESTION 14 Umer Sheikh, ACA is Manager Finance at Charming Limited (CL) and reports to Abid, FCA who is the Chief Financial Officer of CL. Abid is also a close relative of the major shareholder of CL. CL is negotiating an important financing arrangement with Union Standard Bank (USB) in order to expand its business in foreign markets. The rate quoted by USB is comparatively higher than existing rates being paid by CL.

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During a meeting with the Executive Vice President (EVP) of USB, where Umer Sheikh was also present, Abid revealed that his son has applied for a house financing in USB last month but has not received any response from USB so far. Abid requested EVP to consider his application. EVP agreed to look into the matter. On conclusion of the meeting, Abid asked Umer Sheikh to prepare a note for the board of directors proposing the acceptance of the rate offered by USB. Required: Briefly explain how Abid may be in breach of the fundamental principles of ICAP’s code of ethics. Also state the potential threats that Umer Sheikh may face in the above circumstances and how he should respond. (08) QUESTION 15 Baqir, ACA is working as Finance Manager at Kiwi Limited (KL), a listed company, and reports to Shahid, FCA who is the Chief Financial Officer of the company. Before the date of authorization for issuance of KL’s financial statements for the year ended 30 June 2018, Zahoor (a mutual friend of Baqir and Shahid) informed Baqir that Shahid has recommended him to purchase KL’s shares as higher EPS is expected this year. Zahoor also sought Baqir’s advice on this matter. Required: Briefly explain how Shahid may be in breach of the fundamental principles of ICAP’s code of ethics. Also state the potential threats that Baqir may face in the above circumstances and how he should respond. (08) QUESTION 16 Amir Ali, ACA is CFO at Circle Limited (CL) and reports to Junaid, FCA who is the CEO. The financial year of CL ends on 30 April and its profit for the nine months ended 31 January 2019 was below target. In a management meeting held in February 2019, Junaid has proposed the following measures to improve the results.

(i) Annual maintenance of the manufacturing plant which is due in March 2019 should

be deferred to May 2019. Production manager has warned that the deferral may affect the safety of the plant. However, Junaid is of the view that the maintenance was delayed two years ago as well and nothing adverse happened at that time.

(ii) Incorporation of the new revaluation report of CL’s buildings should be deferred to the next year as the resulting increase in valuation is substantial and would result in increase in the deprecation for the year. Amir had initiated the revaluation during the year since the fair values of the buildings had increased materially. Junaid is of the view that the buildings were revalued last year and there is no need of such frequent revaluations. Due to the dominant nature of Junaid, none of the participants opposed his views. The summary to implement the above actions has been received by Amir. Amir has recently applied for an interest free car loan from CL which is expected to be approved in few days.

Required: Briefly explain how Junaid may be in breach of the fundamental principles of Code of Ethics for Chartered Accountants. Also state the potential threats that Amir may face in the above circumstances and how he should respond. (09)

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ANSWER 01

Which threat to fundamental principle Ibrahim is facing? Self-interest threat

What fundamental principle is mainly affected by the above threat? Objectivity

ANSWER 02

Issue Ibrahim faces a self-interest threat which might distort his objectivity.

Responsibility

Ibrahim has a professional responsibility to ensure that financial information is prepared and presented fairly, honestly and in accordance with relevant professional standards. He has further obligations to ensure that financial information is prepared in accordance with applicable accounting standards and that records maintained represent the facts accurately and completely in all material respects.

Course of action

Ibrahim must make the necessary adjustment even though it would lead to a loss to himself.

ANSWER 03

Issue Ali faces a self-interest threat which might distort his objectivity. The current accounting treatment is incorrect.

Responsibility

Ali has a professional responsibility to ensure that financial information is prepared and presented fairly, honestly and in accordance with relevant professional standards. He has further obligations to ensure that financial information is prepared in accordance with applicable accounting standards and that records maintained represent the facts accurately and completely in all material respects.

Course of action

Ali must explain his professional obligations to Bashir in particular that he cannot be party to the preparation and presentation of knowingly misleading information.

Ali should refuse to remain associated with information that is misleading.

If Bashir refuses to allow the necessary changes to the information Ali should report the matter to the audit committee or the other directors.

As a last resort if the company refuses to change the information Ali should resign from his post.

Ali may need to consider informing the appropriate authorities in line with the ICAP guidance on confidentiality.

ANSWER 04

Issue

Etishad faces an intimidation threat which might distort his objectivity.

The current accounting treatment might be incorrect. The value of the properties as a group is irrelevant in applying IAS 16’s revaluation model. IAS 16 allows the use of a revaluation model but requires that the carrying amount of a property should not be materially different from its fair value. This applies to individual properties not the whole class taken together. (It could be that Fahad is correct because there is insufficient information to judge materiality in this circumstance. However, a 15% discrepancy does sound significant).

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Responsibility

Etishad has a professional responsibility to ensure that financial information is prepared and presented fairly, honestly and in accordance with relevant professional standards. He has further obligations to ensure that financial information is prepared in accordance with applicable accounting standards and that records maintained represent the facts accurately and completely in all material respects.

Course of action

Etishad should arrange a meeting with Fahad to try to explain Fahad’s misapplication of the IAS 16 guidance and to try to persuade Fahad that a change might be necessary.

Fahad should be reminded that he too is bound by the same guidance that applies to Etishad. Indeed he has a greater responsibility as the more senior person to show leadership in this area.

Etishad cannot be party to the preparation and presentation of knowingly misleading information. He should explain that he cannot remain associated with information that is misleading. If Fahad refuses to allow the necessary changes to the information Etishad should report the matter to the audit committee or the other directors.

As a last resort if the company refuses to change the information Etishad should resign from his post.

Etishad may need to consider informing the appropriate authorities in line with the ICAP guidance on confidentiality.

ANSWER 05 Fundamental principles: (i) Integrity (ii) Objectivity (iii) Professional competence and due care (iv) Confidentiality (v) Professional behavior Guidance in respect of integrity: Members should be straight forward and honest in all professional and business relationships. A chartered accountant should not be associated with reports, returns, communication or other information where they believe that the information: Contains a materially false or misleading statements; Contains statements or information furnished reckless; or Omits or obscures information required to be included where such omission or obscurity

would be misleading. ANSWER 06 According to the ICAP’s Code of Ethics, the threats which a chartered accountant may face while complying with the fundamental principles have been categorized as under:

(i) Self interest

Incentive compensation arrangement Concern over employment security Commercial pressure from outside the employing

organization

(ii) Self review

Business decisions or data being subject to review and justification by the same chartered accountant in business responsible for making those decisions or preparing that data.

(iii) Advocacy Providing misleading and false information to promote its organization’s position.

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(iv) Familiarity

A chartered accountant in business in a position to influence financial or non-financial reporting or business decisions having an immediate or close family member who is in a position to benefit from that influence.

Long association with the business contacts influencing business decisions.

Acceptance of a gift or preferential treatment, unless the value is clearly insignificant.

(v) Intimidation

Threat of dismissal or replacement over a disagreement about the application of an accounting principle or the way in which financial information is to be reported.

A dominant personality attempting to influence decisions of the chartered accountant.

ANSWER 07 Fortune Limited Categories of threats: The given situation may create following threats to the fundamental principles of objectivity or professional competence and due care:

Self-interest Intimidation

Safeguards available to the CFO: If, these threats are significant, the CFO should consider and apply the following safeguards to eliminate or reduce them to an acceptable level:

Consultation with superiors within the employing organization, for example audit committee.

Consultation with other body responsible for governance Consultation with a relevant professional body.

Where it is not possible to reduce the threats to an acceptable level, a CFO:

Should refuse to remain associated with information which is or may be misleading. If issuance of misleading information is either significant or persistent, he should

consider informing appropriate authorities keeping in view the confidentiality and the legal requirements.

May seek legal advice or resign. ANSWER 08 The existence of threats to fundamental principles will depend on following factors: Whether financing from other banks is available at lower mark up; Whether it is feasible to borrow @15% for the expansion.

If financing from other banks is available or it may not be feasible to finance the project at the rate of 15%, and still MD is pressurizing the CFO to obtain financing at higher rate of markup the MD may be in breach of : (i) Principle of objectivity

It can be a bias decision on part of MD, as he may be favoring his friend who is the president of the bank or may have any other interest in taking loan from that particular bank.

(ii) Principle of integrity MD may be in breach of principle of integrity because he is asking CFO to manipulate the financial information.

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Potential threat to CFO along with safeguards: Preparation of financial information as per the instructions of MD, will result in intimidation threat to integrity and objectivity. Identified threat is significant as the CFO is being instructed from the highest level of management. In order to reduce the threat to an acceptable level, the following safeguards should be applied.

Consult with superiors such as audit committee or those charged with governance or with a relevant professional body.

Where it is not possible to reduce the threat to an acceptable level, CFO shall refuse to be remain associated with the financial information.

CFO may consider to obtain legal advice or may consider resigning from the post of CFO.

ANSWER 09 Mr. Zia breached the following fundamental principles of ICAP code of ethics: (i) Confidentiality

Under the Code of Ethics, member must respect the confidentiality of information acquired as a result of professional and business relationship. Confidential information acquired should not be used for the personal advantage by a member. In the above scenario, Mr Zia has breached the principle of confidentiality by using the confidential information for the personal advantage since the information was not publicly available.

(ii) Professional behavior Under the Code of Ethics, member must comply with relevant laws and regulations and should avoid any action which discredits the profession. Since it can be a non-compliance of laws and regulation, he may be in breach of the principle of professional behavior.

Potential threats involved in the circumstances: Self-interest threat Since Mr. Zia is part of a team which is negotiating the price of the shares and he has purchased shares in the name of his wife and son, it creates self-interest threat and he would be reluctant to take any decision that would be against his own interest. ANSWER 10 In given situation, CFO is in breach of: (i) Principle of integrity

Chartered Accountant should be straight forward and honest in all professional and business relationship. Since he asked Accounts Manager to identify the areas where through adjustments, profit may be reported on higher side, he has breached the principle of integrity.

(ii) Principle of professional behavior This principle imposes an obligation on all chartered Accountants to avoid any action that the Chartered Accountant knows or should know may discredit the profession. Since CFO asked Accounts Manager for booking the adjustments to increase the current year profit, which have a negative effect on the reputation of the profession.

(iii) Principle of objectivity Chartered Accountant should not compromise their professional or business judgment because of bias, conflict of interest or the undue influence of others. In this

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circumstances, he has compromised his professional and business judgment due to business.

Self-interest threat faced by Mr. Atif Self-interest threat occurs as a result of financial or other interest of members or their immediate family member. In this case, he has been told by the CFO that he would be given an additional bonus this year so he faces self-interest threat. Available safeguards If this threat is significant Atif should consult with superiors within the organization in order to eliminate or reduce it to an acceptable level. Where it is not possible to reduce the threats to an acceptable level, Atif:

(i) Should refuse to remain associated with information which is or may be misleading

(ii) Should consider informing appropriate authorities keeping in view the confidentiality and the legal requirements, if issuance of misleading information is either significant or persistent

(iii) Seek legal advice or may resign. ANSWER 11 The range of comments made by Arif raises questions over his ethical behavior and professional standards.

A chartered accountant should be unbiased when involved in preparing and reviewing financial information. A chartered accountant should prepare financial statements fairly, honestly, and in accordance with relevant professional standards and must not be influenced by considerations of the impact of reported results.

Arif’s failings Arif appears to be influenced by the need to achieve a specified level of profit. This is not appropriate and calls his integrity into question. In addition Arif’s professional competence seems to be suspect. His comment on not being up to date on all of the little technicalities in IFRS s suggests that he has not maintained a level of professional competence appropriate to his professional role.

ICAP members have a responsibility to engage in continuing professional development in order to ensure that their technical knowledge and professional skills are kept up to date. Arif should seek continuing professional development activities and improve his knowledge on ethical standards. Furthermore, it might be expected that as Waheed’s superior he should set an example to Waheed and guide him in his responsibilities. Clearly this is not happening.

As a member of ICAP Arif should be aware of the ICAP code of ethics. Arif should know of the danger of self-interest threats and intimidation threats to himself and to others. His attempt to influence the outcome of a fellow professional by applying such a threat to that individual is very unprofessional.

Waheed’s ethical issues Waheed faces a self-interest threat, in that there is the possibility of a bonus provided the earnings per share figure remains the same as last year. Arif has also suggested that he can influence the Board’s decision over employing him as are placement finance director – another self-interest threat to Waheed. Both of these threats must be ignored.

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Arif’s comments imply that his application of professional responsibility is lacking. This may extend into the way in which the current financial statements have been prepared. Waheed must be very careful (as always) to carry out the review with all due care.

Waheed should first discuss his recommendations with Arif and remind him of his professional responsibilities to ensure that the accounting standards are correctly followed. If the financial statements are found to contain errors or incorrect accounting treatment then they must be amended. If Arif refuses to amend the draft financial statements if necessary Waheed should discuss the matter with other board members (including non- executives and the audit committee, if possible).

Further action might include consulting with ICAP. ANSWER 12 Revenue The fact that the customer cannot cancel the contract is not relevant to the recognition of revenue. Revenue from providing a service is recognized according to the progress of completion of contract.. In the absence of other information the revenue in this contract should be recognized over the life of the contract as time progresses. As the contract was only signed just before the year end, none of the revenue can be recognized in 2015.

The credit for the amount received should be recognized as a liability and be disclosed separately between current and non-current liabilities i.e. 500,000 as current liability and 500,000 as non-current liability. This represents the obligation that the company has to provide the service over the next two years.

New factory Borrowing costs directly attributable to construction of an asset which necessarily takes a substantial period to get ready for its intended use should be capitalized as part of the cost of that asset under IAS 23.

IAS 23 states that the capitalization of borrowing costs should commence when three conditions are all met for the first time: borrowing costs are being incurred, expenditure is being incurred and activities to prepare the asset are being undertaken. Although borrowing costs were incurred throughout the year and expenditure was incurred from 1 February 2015 (the date the land was purchased), construction only started on 1 June 2015. Therefore this is the date on which capitalization commences.

Capitalization ceases when substantially all of the activities required to make the asset ready for use/sale have been completed, that is on 30 September2015. (The actual date on which the factory was brought into use is irrelevant.)Therefore the period of capitalization should be four months.

Where construction is financed from general borrowings, the calculation of the amount to be capitalized should be based on the weighted average cost of borrowings. This is:

($1,000,000 × 9.75%) + ($1,750,000 × 10%) + ($2,500,000 × 8%) = 9% ($1,000,000 + $1,750,000 + $2,500,000)

Therefore the amount capitalized should be 9% × $4.5 million (land $1.8million plus construction costs $2.7 million) × 4/12 = $135,000. The total cost of the factory should be measured at $4,635,000 ($1.8 million plus $2.7 million, plus $135,000). The amount that has been recognized in the statement of financial position should be reduced by $315,000 ($450,000– $135,000). Finance costs recognized in profit or loss should be increased by $315,000.

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Land should not be depreciated because it has an indefinite life. Under IAS 16depreciation charges should start when the asset becomes available for use, from 1 October 2015 in this case. Depreciation of $35,000 (($2.7 million, plus ($135,000 × 2.7/4.5) ÷ 20) ×3/12) should be recognized in profit or loss for the year ended 31 December2015 and the carrying amount of the asset reduced by the same amount to $4.6 million.

Useful life of the blast furnace Depreciation of the blast furnace has been based on an estimated useful life of 20 years. This is at variance with a report by a qualified expert. The asset valuation specialist treats the furnace as being made up of two components, the main structure and the lining, which must be replaced at regular five yearly intervals over the life of the asset. This is the approach required by IAS 16. The uncertainties inherent in business mean that many items in financial statements cannot be measured with certainty, but estimates should always be made using the most up to date and reliable information. Where estimates have been prepared by professionals with relevant qualifications, then it is nearly always most appropriate to use those estimates. Therefore in accordance with the valuer’ report the main structure of the furnace should be depreciated over 15 years from 1 January 2015 and the lining should be depreciated over five years from that date.

The reassessment of the estimated lives of assets is a change in accounting estimate, rather than a change in accounting policy (IAS 8). Changes in accounting estimate should be dealt with on a prospective basis. This is achieved by including the effect of the change in profit or loss in current and future periods. The additional depreciation should be calculated as:

$000 Revised depreciation Main structure (($3.5m – $1.4m)/15 years) 140 Lining ($1.4m/5 years) 280 420 Current depreciation ($3.5m/20 years) (175) Additional depreciation 245

IAS 8 requires the disclosure of the nature and amount of the effect of the change in the estimate of useful lives on the profit for the year.

Part (b) Revised financial statements Statement of profit or loss revised extract for the year ended 31 December 2015

$000 Profit before tax (from draft) 2,500 Revenue (1,000) Borrowing cost (315) Depreciation (35) Blast furnace (245) Revised profit 905

Statement of financial position (revised draft) as at 31 December 2015

Non-current assets $ 000 PPE (12,000 – 315 – 35 - 245) 11,405 Current Assets 3,500 Total Assts 14,905 Share capital 2,000 Retained earnings (6,000 -2,500 + 905) 4,405 Equity 6,405

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Non-current liabilities (5,000 + 500) 5,500 Current liabilities (2,500 + 500) 3,000 Total equity and liabilities 14,905

Part (c) Ethical issues It is noticeable that all the adjustments required reduce profit. This and the background to the previous finance director’s resignation suggest serious problems.

It is not clear who actually prepared the draft financial statements. If they were prepared by more junior staff in the absence of a finance director, some of the adjustments (for example, the calculation of borrowing costs to be capitalized) could be the result of genuine errors or lack of accounting knowledge.

However, it seems reasonably clear that the managing director has attempted to influence the treatment of the revenue and the estimated useful life of at least one significant non-current asset. (Note: the directors have reviewed the useful lives of several items of plant and machinery and it is possible that other assets besides the furnace are being depreciated over unrealistically long periods.)

It seems almost certain that the previous finance director resigned as a result of pressure from the managing director (and possibly from other members of the Board) to present the financial statements in a favorable light. The directors intend to seek a stock market listing in the near future. Therefore they have clear motives for manipulating the profit figure and also (perhaps) for making controversial decisions before the financial statements come under much greater scrutiny as a result of the listing. The job title of financial controller is also significant. It suggests that the role has been downgraded and that the person holding it has less authority than the rest of the Board.

Possible courses of action: Discuss with the managing director the financial reporting standards that apply to the transactions and explain the implications of non-compliance. If the managing director is himself a member of a professional body then it might be worth pointing out to him that he himself is bound by an ethical code.

Advise him that as a Chartered Accountant you are bound by the ICAP code of ethics, and that you would not be prepared to compromise your views of the figures he has prepared for career advancement.

Consider speaking to the other directors (or audit committee if there is one) and seeking their support. If all of these actions produce a negative response then it would be appropriate to consult the ICAP ethical handbook and/or the Institute.

If all else fails then consider seeking alternative employment.

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ANSWER 13 Chartered Accountants should be straight forward and honest in all professional and business relationships. Since the CEO advised Usman to process the payment about which Usman believes that the said payment is unreasonable and would be made to obtain a sales contract, therefore he is in breach of principle of integrity and professional behavior. In the given circumstances, the decision of CEO may also induce lack of objectivity due to the expected bonuses to the management. Self interest threat faced by Usman Usman might get influenced by the CEO due to the expected bonus therefore he might process the payment in his own self interest. Intimidation threat faced by Usman Usman may have to leave this job if the disagreement continues. Available safeguards Where it is not possible to reduce the threats to an acceptable level, Usman: (i) should refuse to sign the cheque / refuse to associate with the transaction. (ii) should consider informing appropriate authorities like Audit Committee. (iii) seek legal advice or may resign. ANSWER 14 In the given situation, CFO may be in breach of: Principle of professional behavior: This principle imposes an obligation on all chartered accountants to avoid any action that the chartered accountant knows or should know may discredit the profession. CFO should have avoided discussing his personal interest in official meeting. Principle of objectivity: Chartered Accountant should not compromise their professional or business judgment because of bias, conflict of interest or the undue influence of others. In this circumstance, he has compromised his professional and business judgment due to his personal interest as he requested the EVP to consider application of his son who has applied for house financing in USB. Principle of integrity: Chartered Accountant should be straight forward and honest in all professional and business relationship. It seems that CFO may be inclined to accept higher mark-up rate as compared to existing rate being paid by CL, resulting breach of integrity.

Intimidation threat faced by Mr. Umer Umer may face intimidation threat from his superior if he would raise his objection on acceptance of higher mark-up rate offered by the Bank specially where his superior i.e. Abid is a relative of principal shareholder too.

Available safeguards If this threat is significant Umer should consult with superiors within the organization in order to eliminate or reduce it to an acceptable level. Where it is not possible to reduce the threats to an acceptable level, Umer: should refuse to associate with this financing arrangement. should consider informing appropriate authorities like Audit Committee / CEO. seek legal advice or may resign.

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ANSWER 15 In the given situation, CFO may be in breach of: Principle of Professional behavior: This principle imposes an obligation on all chartered accountants to comply with relevant laws and regulations and avoid any action that discredits the profession. According to Zahoor, Shahid revealed inside information to him which is non-compliance of regulations pertaining to inside information and his act may discredit the profession as well. As a result Shahid has breached this principle. Principle of confidentiality: This principle imposes an obligation on all chartered accountants to refrain from using confidential information acquired as a result of professional and business relationships to their personal advantage or the advantage of third parties. In given scenario, Shahid misused the confidential information for the advantage of his friend so Shahid has breached this principle. Threats faced by Baqir Intimidation threat: Baqir may face intimidation threat from his superior if he raises objection on non- compliance of regulations by Shahid. Self interest threat: Baqir may also face self interest threat as his interest towards friendship with Zahoor may be at stake if he refuses to disclose (confirm or deny) the confidential information to him. Available safeguards for Baqir: (i) He should refrain himself from disclosing any confidential information to his friend. (ii) He should discuss the concerned issue with Shahid. (iii) He should consider informing appropriate authorities like Audit Committee/CEO. (iv) He seeks legal advice ANSWER 16 In the given situation, Junaid may be in breach of the following fundamental principles of Code of Ethics for Chartered Accountants: (i) Professional behavior:

This principle imposes an obligation on all chartered accountants to comply with relevant laws and regulations and avoid any action that discredits the profession. Junaid has breached this principle as his proposed suggestion in respect of incorporation of the new revaluation report is not in accordance with IAS 16. Under IAS 16, carrying amount of property carried at revaluation model should not be materially different from its fair value so his proposal is against the requirement of IAS 16.

(ii) Integrity: Chartered Accountant should be straight forward and honest in all professional and business relationship. It seems that Junaid’s decision to defer the maintenance of plant despite warning of production manager in terms of safety of plant and non-incorporation of new annual report in financial statement would make them misleading.

(iii) Objectivity: Chartered Accountant should not compromise his professional or business judgment because of bias, conflict of interest or the undue influence of others. In this circumstance, he has compromised his professional and business judgment by proposing unethical/unlawful measures to just improve the falling profit of the company.

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Potential threats: Amir may face following threats: (i) Self-interest threat:

Amir may face self-interest threat as the disbursement of his car loan may be at stake if he refuses to obey the instructions.

(ii) Intimidation threat: Amir may face intimidation threat from Junaid as refusal to obey instruction may risk his job.

Safeguards: Identified threats are significant as the CFO is being instructed from the highest level of management. In order to reduce the threat to an acceptable level, one or more of the following safeguards should be applied:

(i) Discuss the matter with CEO and persuade him to follow code of ethics. (ii) Consider informing appropriate authorities like audit committee. (iii) Refuse to implement the given proposals. (iv) Seek legal advice. (v) Resign.

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ICAP OBJECTIVE BASED QUESTIONS 01. Which of the following are true about “Ethics”?

(i) Ethical behaviour is more than obeying laws, rules and regulations. (ii) Ethics is about doing ‘the right thing’. (iii) The accountancy profession is committed to acting ethically and in the public interest.

(a) (i) and (ii) only (b) (i) and (iii) only (c) (ii) and (iii) only (d) (i), (ii) and (iii) all

02. ICAP code of ethics is applicable to: (i) Members: Accountants in practice (ii) Students (iii) Members: Accountants in business

(a) (i) and (ii) only (b) (i) and (iii) only (c) (ii) and (iii) only (d) (i), (ii) and (iii) all

03. Ibrahim is member of ICAP working as a unit accountant. He is a member of a bonus scheme under which, staff receive a bonus of 10% of their annual salary if profit for the year exceeds a trigger level. Ibrahim has been reviewing working papers prepared to support this year’s financial statements. He has found a logic error in a spreadsheet used as a measurement tool for provisions. Correction of this error would lead to an increase in provisions. This would decrease profit below the trigger level for the bonus. Which threat to fundamental principle Ibrahim is facing?

(a) Self-interest threat (b) Intimidation threat (c) Familiarity threat (d) Advocacy threat

04. Ibrahim is member of ICAP working as a unit accountant. He is a member of a bonus scheme under which, staff receive a bonus of 10% of their annual salary if profit for the year exceeds a trigger level. Ibrahim has been reviewing working papers prepared to support this year’s financial statements. He has found a logic error in a spreadsheet used as a measurement tool for provisions. Correction of this error would lead to an increase in provisions. This would decrease profit below the trigger level for the bonus. Which fundamental principle is mainly affected in above situation?

(a) Integrity (b) Objectivity (c) Professional behaviour (d) Confidentiality

05. Fortune Limited (FL) is quoted on the stock exchange, with revenue of over Rs. 5 billion per Annum. During the year ended 30 June 2015, FL has incurred a loss of Rs.26 million.

The Chief Executive is of the view that declaration of loss may result in the bankers’ refusal to renew the credit facility. Therefore, he wants to incorporate certain adjustments in the books of account that will result in a net profit of Rs.100 million. However, the Chief Financial Officer (CFO), who is a chartered accountant, is of the view that all possible adjustments allow able under the applicable accounting regulations have already been considered and incorporated.

Identify TWO categories of threats to the fundamental principles of objectivity or professional competence and due care

(a) Self-interest threat (b) Self-review threat (c) Advocacy threat (d) Intimidation threat

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06. Zia is a Chartered Accountant and works as a financial controller in Unique Engineering Limited (UEL). UEL is currently considering the acquisition of Top Storage Limited (TSL) and Zia is a member of the team which is currently negotiating the acquisition with the management of TSL. After becoming aware of the prospective acquisition, Zia purchased 1,000,000 shares of TSL in the name of his wife and son. Which of the following fundamental principles of ICAP code of ethics, Zia has breached?

(a) Objectivity and Confidentiality (b) Confidentiality and Professional behaviour (c) Objectivity and Professional behaviour (d) None of above

07. Zia is a Chartered Accountant and works as a financial controller in Unique Engineering Limited (UEL). UEL is currently considering the acquisition of Top Storage Limited (TSL) and Zia is a member of the team which is currently negotiating the acquisition with the management of TSL. After becoming aware of the prospective acquisition, Zia purchased 1,000,000 shares of TSL in the name of his wife and son. Which potential threat is involved in above circumstances?


08. Atif is a chartered accountant and has been working as Manager – Accounts in an unlisted public company MNZ Limited. While preparing the financial statements for the year ended 31 December 2016, CFO of MNZ who is also a chartered accountant informed Atif that the directors are considering to have the company listed on Pakistan Stock Exchange. Consequently, CFO wants to show higher profit and has asked Atif to identify areas where book adjustments can be made. He has also informed that if MNZ is able to list the shares at a price of Rs.35 or more, all managerial staff would be given an additional bonus this year. Which fundamental principles of ICAP code of ethics have been breached by CFO?

(a) Integrity (b) Objectivity (c) Professional behaviour (d) All of above

09. Atif is a chartered accountant and has been working as Manager – Accounts in an unlisted public company MNZ Limited. While preparing the financial statements for the year ended 31 December 2016, CFO of MNZ who is also a chartered accountant informed Atif that the directors are considering to have the company listed on Pakistan Stock Exchange. Consequently, CFO wants to show higher profit and has asked Atif to identify areas where book adjustments can be made. He has also informed that if MNZ is able to list the shares at a price of Rs.35 or more, all managerial staff would be given an additional bonus this year. Which threat to fundamental principles is being faced by Atif?


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10. Integrity means: (a) Members should be straightforward and honest in all professional and business

relationships. (b) Members should not allow bias, conflicts of interest or undue influence of others to

override their professional or business judgements. (c) Members have a duty to maintain their professional knowledge and skill at such a level

that a client or employer receives a competent service, based on current developments in practice, legislation and techniques.

(d) Members must comply with relevant laws and regulations and should avoid any action which discredits the profession.

11. Objectivity means:

(a) Members should be straightforward and honest in all professional and business relationships.

(b) Members should not allow bias, conflicts of interest or undue influence of others to override their professional or business judgements.

(c) Members have a duty to maintain their professional knowledge and skill at such a level that a client or employer receives a competent service, based on current developments in practice, legislation and techniques.


12. Professional competence and due care means:





13. Professional behaviour means:





14. Which of the following are correct responses, where it is not possible to reduce the threats to an

acceptable level: (i) The member must refuse to remain associated with information which may be

misleading (ii) The member must report the matter to audit committee or other governance authority

within organisation. (iii) The member may seek legal advice if it seems necessary to report the matter to legal

authorities. (a) (i) and (ii) only (b) (i) and (iii) only (c) (ii) and (iii) only (d) (i), (ii) and (iii) all

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15. Naveed is a chartered accountant, recently employed by KK Limited as deputy to the finance director, Harris (also a chartered accountant). KK Limited is listed on the Pakistan stock exchange. On Naveed’s first day on the job he met with Harris who said ‘Look, keep it to yourself but I am having a second interview next week for a new job. The first thing that I need you to do is to review the financial statements before the auditors arrive. I passed exams few years ago and I am not up to date on all of the little technicalities in IFRS. You should know these better than me and you will know more about what the auditors might focus on. Also keep in mind that you and I would be entitled to bonus if the profits are 10% higher than last year, so I hope you understand that you do not want to find any irregularity in the financial statements. Do well at this and your chances of promotion are quite high.” Which of the following fundamental principles, Harris is failing to comply with?

(a) Integrity (b) Professional competence (c) Professional behaviour (d) All of above

16. Members should be straightforward and honest in all professional and business relationships. Name the fundamental principle indicated by above statement.

___________

17. Members should not allow bias, conflicts of interest or undue influence of others to override their professional or business judgements. Name the fundamental principle indicated by above statement.

___________

18. Members should behave with courtesy and consideration towards all with whom they come into contact in a professional capacity. Name the fundamental principle indicated by above statement.

___________

19. A threat to fundamental principles occurs when a previous judgement needs to be re-evaluated by members responsible for that judgement. Name the type of threat.

___________

20. A threat to fundamental principles occurs when, because of a close relationship, members become too sympathetic to the interests of others. Name the type of threat.

___________

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OBJECTIVE BASED ANSWERS

01. (d) All three statements are correct.

02. (d) Applicable to all listed in the question.

03. (a) Ibrahim is facing self-interest threat.

04. (b) Objectivity is mainly affected as Ibrahim may not be able to make an independent judgment due to his self-interest threat.

05. (a) & (d) Self- interest threat

Intimidation threat

06. (b) Zia has breached confidentiality by using inside information for his persona advantage.

He has not behaved professionally as he disregarded the law and regulations.

07. (a) Since Zia is part of a team which is negotiating the price of the shares and he has purchased shares in the name of his wife and son, it creates self-interest threat and he would be reluctant to take any decision that would be against his own interest.

08. (d) CFO is in breach of all three fundamental principles.

09. (a) Self-interest threat occurs as a result of financial or other interest of members or their immediate family member. In this case, he has been told by the CFO that he would be given an additional bonus this year so he faces self-interest threat.

10. (a)

11. (b)

12. (c)

13. (d)

14. (d) All three may be possible course of action.

15. (d) Harris is failing all three fundamental principles mentioned.

16. Integrity

17. Objectivity

18. Professional Behaviour

19. Self-review threat

20. Familiarity threat

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