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9706 · 3.2.2

Ethical Considerations — practice questions

Practice and worked examples for 9706 Ethical Considerations. Short previews only — attempt the full question in MarkScheme against the official scheme.

Worked example 1

The directors of Z plc review the Statement of Cash Flows for the year. Net cash from operating activities was $420,000; investing outflows $180,000; dividends paid $95,000.

Explain why the Statement of Cash Flows is essential for assessing liquidity.

Show solution outline

Profit per the SoPL can include non-cash items (depreciation, accruals). The SoCF shows actual cash generated ($420,000 from operations), whether the firm can fund investments ($180,000) and dividends ($95,000) without external borrowing, and highlights liquidity risk even when reported profit is higher.

Worked example 2

You are a management accountant at Innovate Ltd. The company's profit target for bonus purposes is $500,000. The current profit forecast is $480,000. The Financial Controller has asked you to reduce the provision for doubtful debts from 5% to 2% of trade receivables, which stand at $1,000,000. There has been no significant change in customer payment patterns. Advise the management accountant, with reference to ethical principles and calculating the financial impact of the request.

Show solution outline
  1. Calculate the financial impact:
    • Current provision: $1,000,000 * 5% = $50,000
    • Proposed provision: $1,000,000 * 2% = $20,000
    • Reduction in expense (and increase in profit): $50,000 - $20,000 = $30,000
    • Revised profit forecast: $480,000 + $30,000 = $510,000. This now exceeds the bonus target.
  2. Identify Ethical Principles Breached:
    • Integrity: Making this change without justification would be dishonest and misleading to stakeholders who rely on the financial statements.
    • Objectivity: The accountant's professional judgement would be compromised by the undue influence (intimidation threat) from the Financial Controller. The decision would not be based on evidence but on achieving a bonus.
    • Professional Competence and Due Care: Changing an accounting estimate without a valid basis is not acting with due care and misrepresents the company's true financial position.
  3. Recommended Course of Action:
    • The management accountant should not make the adjustment.
    • They should explain to the Financial Controller that the change is not justifiable and would breach ethical principles.
    • If pressure continues, the issue should be escalated to the audit committee or a non-executive director. Seeking advice from a professional body's ethics helpline would also be appropriate.
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