Accounting Business Reporting for Decision Making

CHAPTER 2 Accounting in society 77

the buoyancy of the property market. You note that there is a cap on the amount the developers are

collecting to fund developments. However, the investment would be one of mezzanine lending, and

this means high risk. (The term ‘mezzanine’ in this scenario is used to describe a structure where

a group of companies are formed in the middle, between the parent company and the property

development projects. This makes the investment more complex, and makes it harder to trace and

understand the flow of money and the property rights of each company.) The commission payable

to you is double the normal rate of commission. This arouses your suspicions regarding the project,

but the financial benefits to you would help fund the further growth of your own business.

Required

Would you recommend this investment to your clients? If yes, on what basis would you make the

recommendation? Use the Langenderfer and Rockness method presented in the chapter to help

answer the questions.

SOLUTION TO 2.1

Step 1: Determine the facts of the case.

The property investment is high risk due to mezzanine lending, which involves a complex company

structure. The commissions payable are high; and the accuracy of the information received seems

reasonable but also raises your suspicions.

Step 2: Determine the ethical issues in the case.

There is a duty:

• to ensure the clients are fully informed as to the risk inherent in the project


• to disclose the amount of commission payable


• to act in the best interests of the clients


• to ensure that the investment is the best choice for the clients regardless of the commission

payable.

Step 3: Determine the norms, principles and values related to the case.

The adviser should act with objectivity, integrity, honesty and trust.

Step 4: Determine the alternative courses of action.

These are the alternatives.

a. Recommend the investment and fully disclose the risk involved and the commission payable.

b. Recommend the investment and do not fully disclose the risk involved or the commission payable.

c. Inform the client of the investment and, if the client wants to proceed with the project, refuse the

commission.

d. Do not recommend the investment.

Step 5: Determine the best course of action consistent with 3 above.

The best course of action is (c) or (d). The mezzanine funding structure, the high annual

return of 12 per cent, and the commissions payable at twice the normal rate should arouse your sus-

picions and warrant further investigation of the proposal. A key issue is that the client trusts you and is

likely to invest in the project if you recommend it. Your objectivity could be clouded by the high com-

mission rates. Your integrity and honesty will be shattered if you recommend the investment when you

do not truly believe that the investment matches the risk profile and financial objectives of the clients.

Step 6: Determine the consequences of each possible course of action identified in 4.

These are the likely consequences.

a. If the investment goes well, the clients will be grateful. However, if the investment fails, you

will feel some responsibility due to the trust the clients placed on your recommendation — even

if they were informed of the risk involved. Public perception of you and your business could

be adversely affected if it were known that you recommended an investment that subsequently

failed.

b. If the investment goes well, the clients will be grateful. However, the non-disclosure of the com-

missions could weigh heavily on your conscience. Once again, public perception of you and your