Every rule in this unit assumes the person applying it is honest. Most accounting choices involve judgement: when a sale is really complete, how long a machine will last, how much of a receivable will never be collected. Those choices can be nudged. A small nudge to meet a bonus target this quarter becomes a bigger one next quarter to cover the first. When the nudges are finally discovered, investors lose savings, employees lose jobs and pensions, and trust in every company's statements suffers. Understanding how manipulation works, and how to stop it, is part of being an accountant.
Making ethical decisions in accounting
Professional codes of conduct, including the one CPA Ontario enforces, are built on principles such as integrity, objectivity, professional competence and due care, confidentiality and professional behaviour. They require a CPA to put the public interest ahead of a client's or employer's wishes. When a situation feels wrong, a structured approach helps.
- Get the facts: what exactly is being asked, and what has actually happened?
- Identify the stakeholders: owners, lenders, investors, employees, the CRA, the public.
- Identify the rules and principles involved: GAAP, tax law, the code of conduct.
- List the alternatives, including raising the concern with a supervisor or the audit committee.
- Weigh the consequences of each alternative for each stakeholder.
- Decide, act, and document what you did and why.
The fraud triangle and internal controls
The fraud triangle, based on criminologist Donald Cressey's research, says fraud usually requires three conditions at once. Pressure (or incentive) is a financial or emotional need: personal debt, a bonus tied to profit, a loan covenant about to be broken, analysts expecting growth. Opportunity is a way to commit the fraud and hide it, usually because of weak controls. Rationalization is the story the person tells themselves: "I'll pay it back," "everyone does it," "it's only timing."
A business has little control over an employee's pressure or rationalization, but it can control opportunity. That is the job of internal controls: the policies and procedures that protect assets and make the records reliable.
- Segregation of duties: the person who handles cash does not record it or reconcile the bank account.
- Authorization: purchases, payments and journal entries above a limit need approval; software enforces it with user permissions.
- Physical and digital safeguards: locked inventory, safes, passwords, multi-factor authentication, backups.
- Independent checks: bank reconciliations, inventory counts, review of unusual entries, internal and external audits.
- Documentation: pre-numbered source documents and an audit trail showing who entered or changed each record.
- Mandatory vacations and job rotation: many concealed frauds surface when someone else does the job for two weeks.
How earnings get manipulated
| Technique | What it does | Principle violated | Red flag |
|---|---|---|---|
| Recording revenue early | Books next period's sales (or goods not yet shipped) in this period | Revenue recognition | Receivables grow much faster than sales; big sales in the last days of the year |
| Capitalizing expenses | Records ordinary operating costs as assets, spreading them over future years | Matching and cost | Capital assets rise while repair or operating expenses fall unusually |
| Skipping or understating accruals | Leaves out wages, interest or warranty costs owed at year end | Matching | Payables and accrued liabilities shrink as the business grows |
| Cookie-jar reserves | Overstates estimated expenses in good years, then releases them to boost weak years | Faithful representation (neutrality) | Smooth profits regardless of economic conditions |
| Changing estimates to lift income | Lengthens useful lives or lowers bad-debt estimates without a real reason | Consistency and neutrality | Changes disclosed in the notes that conveniently raise profit |
| Hiding debt off the balance sheet | Moves liabilities into separate entities or arrangements | Full disclosure | Complex related entities; large guarantees in the notes |
Two US cases from the early 2000s reshaped the rules. Enron, a large energy company, used special-purpose entities to keep debt and losses off its balance sheet; when the arrangements came to light in 2001 the company went bankrupt, and its auditor, Arthur Andersen, collapsed soon after. In 2002 WorldCom, a telecommunications company, was found to have recorded billions of dollars of ordinary operating costs as capital assets, turning losses into reported profits; its own internal auditors uncovered the scheme. The US responded with the Sarbanes-Oxley Act of 2002. Canada followed with similar rules requiring the chief executive and chief financial officers of public companies to certify their filings and report on internal controls, and created the Canadian Public Accountability Board to oversee the auditors of public companies.
Off-balance-sheet arrangements and global convergence
Not every off-balance-sheet item is fraud. Guarantees of another company's loan, commitments to buy goods and some leases are legitimate, but they create obligations a reader needs to know about, so full disclosure requires them in the notes. Standards have also tightened. For years, lessees could keep long equipment and building leases off the balance sheet as operating leases. IFRS 16, effective in 2019, now requires lessees under IFRS to record most leases as an asset and a liability. ASPE still allows operating leases to stay off the balance sheet, one more ASPE and IFRS difference.
Global convergence is the movement toward one set of high-quality standards worldwide. IFRS is now required or permitted in well over 100 jurisdictions, and Canada adopted it for publicly accountable enterprises in 2011. The United States still uses its own US GAAP, set by the Financial Accounting Standards Board, although the two boards have worked together on major topics such as revenue recognition and leases. Benefits of convergence: investors can compare companies across borders, multinational companies prepare one set of statements, and capital moves more easily. Costs: conversion is expensive, principles-based standards require more judgement, and local needs (such as small private businesses) can be poorly served, which is why Canada kept ASPE.
Technology and the future of the profession
- Cloud accounting: the books live online, so owners, accountants and auditors see the same up-to-date figures from anywhere, and bank feeds bring transactions in daily.
- Automation: software matches invoices to payments, codes recurring transactions and posts entries, so routine bookkeeping takes far less time.
- Data analytics: instead of testing a small sample, auditors and accountants can test every transaction, for example flagging entries made on weekends, round amounts or payments to new suppliers.
- Artificial intelligence: tools can read source documents, suggest account codes, draft reports and spot anomalies, but they can be confidently wrong, so a professional must review and remains responsible for the result.
- New risks: cybersecurity breaches, privacy obligations for customer and employee data, and errors that spread instantly when an automated rule is set up wrong.
- Changing work: less time on data entry, more on analysis, advising, controls, systems and ethics. Judgement cannot be automated away.