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Importance of Ethics in Accounting and Financial Decision

Created on 16 Apr 2020

Wraps up in 4 Min

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Updated on 31 Aug 2020

Reserve Bank of India released that fraud in the Indian financial system rose by 74% to ₹71543 crores. The fraud means that this sum of money has been siphoned off through some loophole in the financial system.

What would happen with such fraud? Since the financial industry has received monetary investments from everyone, a ₹500 SIP investor to a High Networth Individual investor, each of us investors is bound to repay this in one way or another.

Can we stop this? One way to reduce such frauds is if accounting in the finance industry is clean and ethical. How it can be done is a question for experts, but how it can help in reducing fraud can be discussed.

Accountability

A business has several stakeholders. It has promoters who invest their money in the company, the retail shareholders who invest their savings, the management of the company that runs it, the vendors who supply the resources to the company.

All these people deserve to know what is happening to their money. Their money will grow only when the company does well. How can one quantify that the company is doing well? This is where accounting comes in the picture.

Accounting is expressing the company in numbers. It represents the health of the company. If a company is making profits or not, and by how much; how much is it investing to earn its revenue; its recurring expenses and whatnot.

What would happen if these numbers were fudged? If the accounting team, on the pressure of some factors, changes the numbers, the entire story would change. What would happen if the company that was making a loss, reports a profit? 

This is lying. If I give my money at your promise of good returns, I deserve the right to know how and when I will get this money. Fudging the numbers changes these dynamics. They change investor expectations concerning reality. This is the root of the infamous Satyam Fraud Case.

The numbers help vendors and other businesses know with whom they are dealing with. Will the company be able to pay the outstanding bills for long? How much should they supply their stuff to this company?

These questions are relevant to the business. After all, why should someone else face the brunt of wrongdoings of the accounting team of one company?

It is not only limited to finance, or any other sector, even the government lies under this ambit. It should not fudge the numbers of growth from its citizens. To accept the numbers is the first step to grow ahead.

Planning 

The right set of information is the right key for planning. Suppose you have guests coming to your place. You will see what ingredients you have and in what quantity, then you would cook the desired food. Similarly, companies plan their future based on their costs and earnings. This is why ethical accounting practice is important.

Assume a family member told you that the guests are coming and there is enough flour for sweets. Now when they are in your living room you realize that the information was wrong and you cannot prepare the sweets. Your planning did not work because the information you got was wrong.

A similar scenario happens when a company plan ahead. They need the right set of information because a lot lies at the stake. What would happen if the accounting were not done right or the company deliberately fudges the numbers? 

Assume that a company making the profit of ₹1 crore wrongly reports it ₹10 crores, and then show a rosy dream of expansion to all its shareholders. It goes ahead to banks to take a loan of ₹5 crores. Bank sees its huge profits, and the loan amount seems just reasonable. However, the reality is that this loan amount is 5 times the profit. Someday, when the company would not be able to perform and its crumble would be apparent, people would know the numbers were fudged. The company would fall, the banks will not be able to recover the loans and the depositors of the banks would face the brunt in terms of low interest.

Instead, if the company had rightly shown its profits, they would have held the trust of everyone. Though slowly, they would have expanded well and not ultimately crumble.

Taxes

Every company needs to pay tax and file returns with the government. The government tax agencies verify these accounts and see if the taxes paid to align with the numbers in the account.If the accounting is unethically done, the tax officials will find it. The company will be subject to fines, or even a case of perjury. Right accounting will help find the right tax amount, and its right payment would keep the company out of trouble.

Perception

Ethical accounting practices create a positive image for companies. The company loses a lot for every news it makes for the wrong reasons. It loses its current and potential customers. It loses the trust of stakeholders. What drives the market prices the most? The sentiment that is associated with the company, which gets hit a big dent went such news comes out. After the fall of IL&FS, the government is all out against Deloitte for its shoddy account auditing practice and now it is facing a severe credibility crisis.

Winding Down

The accounting is the basic representation of the company. When it gets wrong, everything else does. Satyam fraud, 2008 Subprime crisis, the fall of IL&FS, and what not; all these had one thing in common and that was a wrong portrayal of the accounts. Just like humans, companies cannot fake if they want to develop long-term relations based on trust. Only those coming out with reality and truth will survive, even in worst times, on their loyal stakeholders; or else, everyone would want to stay from them.

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Ayushi Upadhyay

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A Keen Learner. Tiny, brainy, and studious, this quiet one stays in her zone until she pops. And once she does, boy, are her comebacks snappy! There is no financial question that she can't answer through her magical blog-writing. 

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