Ethical dilemma 20: Billing for Ernest's cover-up

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In 2008, ICAS Research published the report "What do you do now? Ethical Issues Encountered by Chartered Accountants" by Dr David Molyneaux containing 28 true life case studies of ethical dilemmas faced by accountants either in practice or business.

In recognition of this work, in 2009 the ICAS Technical Policy Board then published "Shades of Grey" containing a further series of case studies, one of which is reproduced below.

The views expressed in these respective case studies are those of the Ethics Committee and do not necessarily represent the views of the Council of ICAS.

This case study gives general guidance only and should not be relied on as appropriate or comprehensive in respect of any particular set of circumstances. It is recommended that users consider seeking their own professional advice.

The authors or the publisher can accept no responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication.


You are an audit senior manager for a manufacturing client in the FTSE 350 where your firm's working relationships with the Group's long-standing Finance Director, Ernest, are notoriously 'difficult'.  

Too often, he seems to equate 'compromise' with 'weakness' so that he makes few concessions to his position without protracted negotiations, whether on timetables, interpretation of Standards or fees. This can become disconcerting, not just because they seem unnecessarily time consuming but the outcomes can seem unreasonable too.  

For example, when, at the last audit, your firm had resolutely insisted on a more conservative valuation of long-term contracts, Ernest had dropped several unsubtle hints that the engagement should be put out early to tender.

Frustratingly, to the client's Audit Committee, Ernest's approach seems characterised not as, 'difficult' but as, 'principled'.  

Some weeks ago, Neil, the engagement partner, asked you to 'sort out' the accountancy and financial statements of a small private company that had been set up a few years ago to make 'artistic' films. This company had been persistently loss making and its one film, which had taken significantly longer to release than expected, had flopped at the box-office.

This was despite being more 'adult' than 'artistic'! During the leisurely production process, significant sums seemed to have been spent on hotels and restaurants.  

The shareholders and directors of the company are a young film director and the nubile actress who starred in the film. They are 'resting' and have told you that the company too is now dormant and will be wound up. There are just enough funds to cover the costs of this and of residual bills. Apart from a few small grants, the majority of the finance had been by way of loans that will not now be repaid.  

You were very surprised to discover that the source of all these loans had been Ernest. He had also given personal guarantees that all trade creditors will be paid. As requested by Neil, you have worked closely with a colleague in your firm's tax department to progress the efficient submission to HMRC of tax computations for the film company.

Alongside this, some advice was given personally to Ernest on the idiosyncrasies of tax and film finance. Apparently, he had previously always dealt with his own tax affairs.  

At the start of the assignment two separate charge codes, Accountancy and Tax were set up for the film company. Time costs for the work, at your firm's normal rates, have amounted to£20,000 for dealing with the Accountancy and £4,000 for the Tax. Neil has now sent you instructions relating to monthly billings.  

These include:  

  • A fee note of £2,000 to be issued to the film company with£2,000 of accountancy time costs written off against it. The Accountancy code is then to be closed.
  • The residual £18,000 is to be transferred to a 'Special Work' client account of the Group. This already has in it the time costs of £12,000 for an investigation into a stock discrepancy carried out earlier in the year. The partner tells you that the£4,000 of tax time will also be transferred across.
  • The raising of two further fee notes, one for £27,500 addressed to the Group and one for £500 to be sent to Ernest personally at his home address. In all cases the fee notes' descriptions are to be limited to "agreed professional fees".

You have asked Neil in person to confirm these arrangements. Clearly very amused, Neil explained that Ernest had funded the film company over the years on the persuasion of the young actress. Ernest now accepts his investment was seriously flawed and that the loans will never be re-paid.  

He is keen, to the extent legally possible, to minimise further his personal expenditure while gaining any tax advantages available. Moreover, the situation is, for himself, one of considerable potential embarrassment.

He wants the maximum discretion. He is now very grateful to the firm for the work done and, after some remarkably swift negotiation, has approved the three billings represented by Neil's instructions. Ernest accepts one further note of fee will be necessary for completing the tax work.

This will go to the film company and, as with all the other residual creditors, Ernest will ensure personally that it is paid.  

Neil commented that the total billing of £30,000 against incurred costs of £36,000, at 83%, was not as good a recovery as he would have hoped, or might even have negotiated. Yet, this has been his favourite assignment of the summer. He added:  

I could probably have gone for much higher margins. But I think that it will prove better in the long-term not to have been greedy. Of course, I know Ernest's gratitude won't linger forever.

Even so, I think he may be just that bit more co-operative and less aggressive in future. When he reflects that we haven't taken advantage of him and thinks carefully about what we now know, I sense that we will be able to count on his loyalty right through to his retirement! And given how much the old fool has lost on that actress, he'll need to go on working for a good few years yet!  

When you now ask Neil about the ethics of transferring the time costs between clients that have no formal relationship and the apparent subsidy to Ernest personally, he replies:  

OK, I know that I appear to be charging £27,500 to the Group for an assignment that incurred costs of only £12,000. But the Audit Committee delegated to Ernest the authority to agree fee notes of up to £30,000 for that stock investigation. This time it
came in at less.

Because of Ernest's attitudes in the past we have not been able to recover as much as we should for good work. It's swings and roundabouts.  

As for the film company job, I had no real clue from Ernest when we went into it just how heavily he was involved. He said it was primarily a referral to help friends where he has no official, company status.

It seemed like useful one-off work when staff members were not busy. Maybe, with hindsight, we wouldn't have taken it. Still, we've tidied up a mess and what the Audit
Committee members don't know won't grieve them. Ernest is hardly likely to start revealing all ~ even if he did with the actress!  

Overall, I haven't even pressed for full recovery. No one can tell me the recovery that I have to make on any individual fee note. If I choose, say, zero fee for one piece of work, only 10% for another but 230% for a third, that is my commercial decision. If this gives you a real problem, just don't transfer time costs between client codes and then don't make any explicit connections.

But it will simply be less effort to report one recovery of 100% and one of 82% for our billing department, rather than explaining the detail of 10% here and 200% plus there. The fee income is a done deal; the end result is the same; stand by for a new, more co-operative Ernest!"  

What do you do now?  

Scenario Analysis

What are the readily identifiable ethical issues for your decision?  

For you personally  

  • Do you consider yourself compromised ethically by the initial instructions over billing, such that you need to take alternative action?
  • If so what action?

For the CA firm  

  • Has an unacceptable conflict of interest arisen from doing, essentially, personal work for a client's FD, even though formally he is neither a shareholder nor officer of the film company?
  • How do you deal effectively with the sensitivities of billing for professional work and the difficulties of valuing and gaining a perceived 'fair' recovery from a client where there is a determination by the client to haggle over everything?
  • Can the outcome - while imperfect be justified on the grounds that the audit firm will be more secure and be able to take a 'tougher' line as auditors in future?
  • Or, is the solution, (of apparent exploitation of a lack of transparency in the billing process) symptomatic of an overall lack of professional integrity in the relationships?

Note: at the time when this occurred there were no formal constraints on providing a personal tax service to, and billing personally, an officer of a corporate client.

However, this regulatory detail does not alter the underlying issues. For example, in the Scenario described, the token £500 bill for tax and film finance destined for Ernest personally could have been ignored without material financial implications.

This charge (or for some other amount) could have been incorporated into the bill sent to the film company for Ernest to settle in full along with residual creditors.  

Who are the key parties who can influence, or will be affected by, your decision?

  • You as a senior manager (aspiring partner)
  • Neil as engagement partner
  • Ernest as commissioner of professional work, negotiator over fees and officer of the company
  • The Audit Committee as overseer of the process
  • The Group's stakeholders (including HMRC)
  • The film company's creditors (excluding Ernest).

What fundamental ethical principles for accountants are most applicable and is there an apparent conflict between them?  


Do billing arrangements agreed between Neil and Ernest represent honesty, full truthfulness and fairness?


Has the tense relationship with Ernest over fees been
replaced with another, if covert, set of dynamics for achieving pragmatic completion of mutual tasks in relation to the company?  

Professional competence and due care  



Could the Audit Committee justifiably consider that it
should have been informed of the 'new' assignment, once
the details of Ernest's involvement were known?

By contrast could Ernest justifiably consider that any initiative now by the audit firm to refer to his (indirect) relationship with the film company would be a breach of other expectations of confidentiality?  

Professional behaviour  

Longer term, there could be a loss of respect in an
environment where the exchange of 'favours' between
auditors and officers, at the apparent expense of others, seems the norm.

However, in the short and medium term, is Neil's approach
towards Ernest and to the billing an instance of where the
'end' of strengthening the auditor's position in relation to an
'awkward character' justifies an opportunistic and dubious

Is there any further information (including legal obligations) or discussion that might be relevant?  

Knowing precisely when Neil realised the extent of Ernest's involvement with the film company, hence the possible desirability of the transfer of work to another firm- albeit inefficiently for its winding up and likely to lead to added costs/irritation for Ernest.

More about the working relationship between Audit Committee and Ernest but in practice you may only ever be able to surmise, rather than know with any certainty, the details.  

The skills and integrity of the members of the Audit Committee (or maybe this should make no difference?).  

The full extent of the billing and recovery arrangements between the firm and the client, although it can be assumed that£30,000 is significant but not substantial.  

Is there a conflict between the 'Guardian' and 'Commercial' strands of an accountant's responsibilities?  

Yes. This appears to be a classic instance of a conflict between an accountant's 'Commercial' and 'Guardian' responsibilities.  

From a 'Commercial' perspective, you can accept that a compromise is a necessity, if messy. Clearly, some self-interest and fees are needed to keep a firm continuing as auditor. As noted in the opening paragraph, relationships have been strained with Ernest's uncompromising attitudes to negotiation on technical views and on fees.

The pragmatic outcome here seems to have provided some benefits to most parties ~ extra billing / summer work for staff (Neil); a personal problem sorted at lower cost (Ernest); a failed company sorted out with creditor recovery (creditors / public); an increased informal leverage for the Auditors over the Finance Director (the firm).

However, the outcome for a 'Guardian' role seems less satisfactory in that the Audit Committee, and through them other stakeholders, appear in this instance to have been hoodwinked through collusion.

The Group is paying £27,500 where the auditor's recorded costs are £12,000 (although they were prepared to pay up to £30,000 relying on Ernest to check more precisely). Although the Audit Committee have delegated to the FD responsibility for agreeing fees; the materiality level is more reasonable for the Group but not individuals.

The Auditor's future informal leverage over the Finance Director could
be open to abuse.  

Based on the information available, is there scope for an imaginative solution?

Probably not. Clearly you could 'whistleblow' by retrospectively disclosing the situation directly to the Audit Committee but otherwise 'you' appear to have few options, especially if you act as an individual. Even if your firm contact the Group's Audit Committee to tell retrospectively about the film company assignment and the substance (if not the form) of the conflict of interest, it is uncertain what this might achieve - beyond seriously embarrassing Ernest and exacerbating the troubled relationship with him.

The Audit Committee might in future be less likely to trust Ernest, and could even press for a reprimand but not necessarily for his dismissal.

Hence, following any such disclosures, deterioration of working relationships for the audit could lead to the early loss of the appointment. Whilst this would be likely to bring adverse reputational and commercial repercussions for your firm and, hence, yourself, without a change by Ernest, there could be only limited expectations of improved conditions for another CA firm taking on the assignment.

Are there any other comments?  

Is this situation acceptable as bringing the 'least bad' outcome within an imperfect systemic arrangement, where human relationships and weaknesses have also to be accommodated?

However, is it acceptable for you as a CA that your employer has been, apparently, so accommodating to Ernest?

Would your ethical perspective be different if the amounts were significantly lower, or larger?


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