Australian Journal of Basic and Applied Sciences, 5(11): 2092-2096, 2011

  ISSN 1991-8178

The Impact of Professional Ethics on Financial Reporting Quality

1
Mahdi Mahdavikhou, 2Mohsen Khotanlou
1-2
Young Researchers Club, Hamedan Branch, Islamic Azad University, Hamedan, Iran.

Abstract: This research aims to study the impact of professional ethics on promoting quality of
financial reporting. The statistical population in this study includes 440 listed companies in Tehran
Stock Exchange (TSE) in 2010. Using Krejcie and Morgan's table for determining sample size, 205
companies were selected as the statistical sample and a 24-item questionnaire was designed to study
professional ethics and qualitative characteristics of financial reporting based on code of ethics of
International Federation of Accountants (IFAC) and qualitative characteristics of financial reporting of
International Accounting Standards Board (IASB), then the questionnaires were distributed among the
financial managers of companies. For testing the hypothesis, relevant statistical tests such as the
Spearman's correlation coefficient and other required tests were used. The data collected was analyzed
using the SPSS statistical package. The results pointed to statistically significant relationship between
professional ethics and quality of financial reporting.

Key words: Ethics, Professional Ethics, Financial Reporting Quality, Tehran Stock Exchange (TSE).

INTRODUCTION

Accountants have obligations to shareholders, creditors, employees, suppliers, the government, the
accounting profession and the public at large. In other words, their obligations go beyond their immediate client.
Decisions made on information provided by accountants can materially affect the lives of any or all of these
stakeholders. Therefore Behaving ethically is an essential and expected trait (Carroll, 2005). As a result, an
accountant is responsible for the consequences of his moral choices not only for his own life but also on the
lives of other people. An accountant who commits fraud not only ruins his own moral being but also harms the
interests of the other members of society who depend on him (Catacutan, 2006). Professional ethics is important
to accountants and those who rely on information provided by accountants because ethical behavior entails
taking the moral point of view. This can be seen as a formal method of declaring to all that the occupation can
be trusted (Carroll, 2005). Internalizing and developing professional ethics in accounting profession lead to
promoting the quality of financial reporting (Mahdavikhou, 2010). This paper examines the relationship
between professional ethics and qualitative characteristics of financial reporting. The structure of the research is
as follows: section 2 presents the literature review, section 3 discusses the research hypotheses, section 4
describes the research method, section 5 discusses the data analysis, section 6 presents discussion and section 7
concludes the discussion.

Literature Review:
Ethics in Accounting:
“Ethics” is a term subject to numerous, sometimes conflicting, interpretations (Luoma, 1989). Ethical
problems are a very relevant issue present in many aspects of real life. These situations can be examined through
several branches and under several grids of analysis, modern or classic (Filipe et al., 2011). A distinguishing
mark of the accountancy profession is its acceptance of the responsibility to act in the public interest (IFAC,
2005). Key qualities which appear in the codes of ethics of professional bodies include independence, integrity,
objectivity, competence and judgment. For example, the ICAEW’s introduction to its ‘Guide to Professional
Ethics’ (ICAEW, 1997:178) includes a list of five fundamental principles which either expressly mentions or
clearly implies all of these qualities, along with other related qualities such as honesty, fair-dealing, truthfulness,
courtesy, skill and diligence (Gowthorpe, 2005).
Because of the importance of the issue, many researchers in developed countries have conducted studies on
accounting ethics education. They have indicated that ethics education must be given in business schools for the
development of future generations (Caliyurt, 2007). Ethics education helps students identify the link between
ethical decision-making and real-life behavior (Helps, 1994). Abu Bakar et al., (2008) explore the ethical
attitudes of the final year accounting students. The study indicates that the majority of respondents would prefer
not to indulge in unethical behavior. Professional ethics has a significant position in the organization of the Thai
Federation of Accounting Professions (FAP) and In Australia, ethics are at present the responsibility of an
Accounting Professional and Ethical Standards Board limited (Gaffikin, 2009).

Corresponding Author: Mahdi Mahdavikhou, Young Researchers Club, Hamedan Branch, Islamic Azad University,
Hamedan, Iran.
E-mail: mahdavikhou@iauh.ac.ir 
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Gammie in a study predicated on the Kantian approach to ethical decision making which is located in the
domain of deontological ethic theories, suggests that ethics is based on a set of unbreakable ethical rules and is
concerned with the simple notion of right and wrong (Gammie and Gammie, 2009). Another study has
investigated the influence of knowledge of ethics (KOE) on auditors' perceived ethical problems (PEP). The
results indicated that statistically significant relationships exist between knowledge of ethics (KOE) on auditors'
perceived ethical problems (PEP) (Zakaria et al., 2010). Jabbarzadeh Kangarluei and Bayazidi investigated the
relationship between ethical values and agency cost in accounting system. Findings showed that executing of
ethical affairs from managers and other employees in Iranian companies increase agency costs, but causes the
existence of weak relation between ethical criteria and agency costs, these findings should considerate
cautiously (Jabbarzadeh Kangarluei and Bayazidi, 2010).

Qualitative Characteristics of Financial Reporting:

Qualitative characteristics are the attributes that make the information provided in financial reports useful to
users. As figure 1 shows, the four principal qualitative characteristics are understandability, relevance, reliability
and comparability (IASB, 2006).

Fig. 1. The four principal qualitative characteristics of financial reporting.

According to the theoretical concepts of Iran’s financial reporting, the aim of financial reports is to provide
brief as well as classified data about the financial status, financial functions, and flexibility of the commercial
unit so that they can be useful to the users of such reports in making economic decisions (Talebnia et al., 2011).
The qualitative characteristics are complementary concepts in achieving decision-useful financial reporting
information; their application, in contrast, should maximize the usefulness of financial reports. Each qualitative
characteristic discussed in this chapter makes its own distinct contribution to the decision usefulness of financial
reporting information. The objective of financial reporting is to provide information that is useful to present and
potential investors and creditors and others in making investment and similar resource allocation decisions
(IASB, 2006).

Professional Ethics and Qualitative Characteristics of Financial Reporting:

The quality of financial reporting indicates a limit in which the financial reports of a company, its economic
status, and functions, which are measured over period of time, are presented honestly (Talebnia et al., 2011).
Truthfulness of and trust in the financial reporting system depend on far more than the actions and decisions of
individuals or sophisticated “mechanisms” for the whole system (Enderle, 2006). Companies in the energy,
accounting, and banking industries and the professional associations of the certified public accountants and the
investment managers and researchers have, in varying degrees, affected the quality of and confidence in the
financial reporting systems. Therefore, truthfulness of and trust in the financial reporting system cannot be a
matter of either personal or institutional ethics alone (Brenkert, 2004).
In 1980 the President of AICPA William Gregory warned members over the fact that “accountants have
subordinated courtesy, mutual respect, self-restraint and fairness for a quest for firm growth and a preoccupation
with the bottom line”. Representatives of the big firms however denied ethical responsibility for the corporate
scandals that occurred. According to them what happened between Enron and Andersen was not so much a
consequence of the lack of ethics on the part of the auditors, but was due to the failure in the current financial
reporting system that advocated for “backward-looking” financial statements (Catacutan, 2006). Behaving
ethically in accounting is more important than auditing because accounting system prepares financial statements
for auditing (Mahdavikhou, 2010).

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Research Hypotheses:
1. Main Hypothesis:
There is a significant relationship between professional ethics and qualitative characteristics of financial
reporting information of listed companies in Tehran Stock Exchange.

2. Sub Hypothesis:
Sub. H1:
There is a significant relationship between professional ethics and presenting the financial information of
listed companies in Tehran Stock Exchange.
Sub. H2:
There is a significant relationship between professional ethics and financial information content of listed
companies in Tehran Stock Exchange.

MATERIALS AND METHODS

The study reported here is a survey study which examines the correlation between professional ethics and
qualitative characteristics of financial reporting information. Financial managers were asked to rate each item on
Likert scale of 5 in which 1 strongly disagreement and 5 indicated strongly agreement. The application of Five-
point Likert scale is supported by Sclove (2001).

Sample and Statistical Population:

The statistical population in this study includes the 440 listed companies in Tehran Stock Exchange in
2010. Using Krejcie and Morgan's (1970) table for determining sample size, 205 companies were selected as the
statistical sample.

Data Collecting Tools and Data Analysis Method:

In order to collect the required data for analysis, a 24-item questionnaire was designed to study professional
ethics and qualitative characteristics of financial reporting based on code of ethics of International Federation of
Accountants (IFAC) and qualitative characteristics of financial reporting of International Accounting Standards
Board (IASB) and was distributed among the financial managers of companies. The reliability of the
questionnaire was established through a pilot study including 32 financial managers. As a result, Cronbach's
alpha was equal to 0.7303 (≈ 0.73) and therefore the reliability of the questionnaire was confirmed. For testing
the hypotheses, relevant statistical tests such as the Spearman's correlation coefficient and other required tests
were used and for testing the normality of data Kolmogorov-Smirnov's test was used. Table 2 shows the Sig.
value of the K-S Test. As the table shows probability level for a 2-tailed distribution is less than 0.05, which
means that variables are not normally distributed. So the Spearman's correlation coefficient was used. The data
collected were analyzed using the statistical software package Statistical Product and Service Solutions (SPSS).

Table 1: Descriptive Statistics.

Percentiles
N Mean Std. Deviation Minimum Maximum
25th 50th (Median) 75th
Content 205 18.0634 3.06000 7.00 30.00 17.0000 18.0000 19.0000
presenting 205 8.0000 1.88388 4.00 14.00 7.0000 8.0000 9.0000
professional Ethics 205 14.6000 3.03993 6.00 24.00 14.0000 15.0000 16.0000

Table 2: One-Sample Kolmogorov-Smirnov Test.

Content Presenting Professional Ethics
N 205 205 205
Normal Parameters Mean 18.0634 8.0000 14.6000
Std. Deviation 3.06000 1.88388 3.03993
Most Extreme Differences Absolute .149 .151 .184
Positive .147 .151 .184
Negative -.149 -.112 -.178
Kolmogorov-Smirnov Z 2.140 2.162 2.638
Asymp. Sig. (2-tailed) .000 .000 .000

Sub-H1:
There is a significant relationship between professional ethics and presenting the financial information of
listed companies in Tehran Stock Exchange.
Table 3 indicates that the level of Sig. at p≤0.01 is enough to reject null hypothesis and thus, the hypothesis
that "There is a significant relationship between professional ethics and presenting the financial information of
listed companies in Tehran Stock Exchange" is confirmed.

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Table 3: Correlations coefficient between Professional Ethics and Presenting.

Presenting
Spearman's rho Professional Ethics Correlation Coefficient .360**
Sig. (2-tailed) .000
N 205
**
. Correlation is significant at the 0.01 level (2-tailed).

Sub-H2:
There is a significant relationship between professional ethics and financial information content of listed
companies in Tehran Stock Exchange.
Table 4 indicates that the level of Sig. at p≤0.01 is enough to reject null hypothesis and thus, the hypothesis
that "There is a significant relationship between professional ethics and financial information content of listed
companies in Tehran Stock Exchange" is confirmed.

Table 4. Correlations coefficient between Professional Ethics and Content

Content
Spearman's rho Professional Ethics Correlation Coefficient .515**
Sig. (2-tailed) .000
N 205
**
. Correlation is significant at the 0.01 level (2-tailed).

Main H:
There is a significant relationship between professional ethics and qualitative characteristics of financial
reporting information of listed companies in Tehran Stock Exchange.
Table 5 indicates that the level of Sig. at p≤0.01 is enough to reject null hypothesis and thus, the Main
hypothesis that "There is a significant relationship between professional ethics and qualitative characteristics of
financial reporting information of listed companies in Tehran Stock Exchange" is confirmed.

Table 5: Correlations coefficient between Professional Ethics, Content and Presenting.

Content Presenting
Spearman's rho Professional Ethics Correlation Coefficient .515** .360**
Sig. (2-tailed) .000 .000
N 205 205
**
. Correlation is significant at the 0.01 level (2-tailed).

Discussions:
Lack of professional ethics accompanied with qualitative characteristics of financial reporting can make an
unrealistic picture of financial reporting. Regardless of accounting standards and rules, without professional
ethics, accountants can provide manipulated financial reports. The existence of accounting standards and rules
per se does not guarantee a sound and appropriate financial reporting. Hence, combination of professional ethics
and qualitative characteristics of financial reporting must be used. This idea can be seen in figure 2. Ethics is the
heart of economic and social freedom. Unethical behavior is a dagger in the heart. Company policies and
internal controls are ineffective without ethical leadership from the top. Likewise, the future of the accounting
profession depends on ethical leadership by accounting professionals and accounting educators (Smith, 2003).

Fig. 2: Impact of professional ethics on qualitative characteristics of financial reporting.

Conclusion:
The aim of this study was to investigate the impact of professional ethics on promoting quality of financial
reporting in listed companies in Tehran Stock Exchange (TSE) in 2010. Findings of this study showed
professional ethics has high effect on promoting quality of qualitative characteristics of financial reporting. It
should be noted that the professional ethics and financial information content and professional ethics and
presenting the financial information had positive correlation coefficient .515 and .360 respectively. For the
future researches, the authors believe that methodology and tools used in this research need to be improved,
completed, and developed to encompass other aspects of financial reporting.

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ACKNOWLEDGEMENT

The authors would like to thank Dr. Ali Gholami Mehrdad, Dr. Alireza Isfandyari-Moghaddam, Dr. Asghar
Seif, Prof Murphy Smith and Prof Georges Enderle for their consultation and respected reviews of the paper.
The authors would also like to extend their appreciation to participants who participated in this study.

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