Topic 3.9 · Ethics and Financial Reporting

Ethics and Financial Reporting

Why unethical financial practices happen, and the laws, audits, professional codes and internal controls that discourage them.

15 min read Reviewed

Learning objectives

3.9.AExplain why an individual or a business might be incentivized to engage in unethical financial management and reporting practices.
3.9.BExplain how laws and professional codes of conduct encourage ethical behavior by accounting and financial managers.

Objective statements © College Board, quoted from the Course and Exam Description.

Unethical financial practices include misuse of funds, tax evasion, embezzlement, bribery, lack of transparency and fraud, including falsifying financial statements.

Why it happens

Access to large sums of cash tempts people to embezzle, misuse funds or falsify records for personal gain.
Making the finances look better than reality can boost the stock price or secure better loan terms.
Making them look worse than reality can help avoid taxes.

What discourages it

Safeguard	How it works
Laws	Misuse of funds, tax evasion, embezzlement, bribery and fraud are illegal in most countries, though laws and punishments vary
Independent audits	U.S. publicly held corporations must have their financial records audited annually by independent accounting firms
Financial market regulation	Ensures investors get accurate information and are protected from fraud

Key terms

Embezzlement: Stealing funds entrusted to you, for example an employee diverting company money.
Tax evasion: Illegally avoiding taxes owed, such as by hiding income.
Fraud: Deception for gain, including falsifying information on financial statements.
Independent audit: A review of financial records by an outside accounting firm. U.S. publicly held corporations must be audited annually.
Internal controls: Mechanisms such as codes of conduct, audit requirements and cash-handling processes that prevent unethical behavior.

Want to track your progress?