Accounting Ethics (Foundations of Business Ethics) 3rd Edition
Much has happened in the accounting profession since we completed the ﬁrst edition of this book in 2002. The Sarbanes – Oxley Act has altered the approaches to ethical problems, resulting in the replacement of the Independence Standards Board with the Financial Accounting Standards Board (FASB) and the Public Company Accounting Oversight Board. The ﬁnancial crisis of 2008 put more pressure on accountants, speciﬁcally relating to the pros and cons of mark – to – market and fair – value accounting. Add to that the push to move to principles – based accounting as part of the impetus to adopt the International Financial Reporting Standards (IFRS) instead of Generally Accepted Accounting Principles (GAAP), and we have a whole new set of problems to explore.
To address these new topics, we have added an Afterword, in which we highlight the debates over the use of fair – value accounting and principles – versus rules – based standards. We have also reduced radically the amount of space the ﬁrst edition devoted to the Enron debacle, including the elimination of the chronology of The Wall Street Journal articles on the Enron/Andersen story. We have preserved the section on the responsibilities of accounting ﬁrms, because although ﬁrms now face new challenges, the responsibilities have not changed.
Finally, we have added Julie Anne Ragatz, a doctoral fellow at The American College Center for Ethics in the Financial Services, as a co – author. Julie has been researching new developments in accounting ethics and teaching accounting ethics to executive MBAs for the past several years.
“ To preserve the integrity of his reports, the accountant must insist upon absolute independence of judgment and action. The necessity of preserving this position of independence indicates certain standards of conduct. If the conﬁdence of the public in the integrity of accountants’ reports is shaken, their value is gone. ” (Arthur Andersen in a 1932 Lecture on Business Ethics.)
Rosemarie is the controller for a small construction company, Acme builders. She is new on the job and grateful to the CEO, Peter, for allowing her to work ﬂ ex – time so that she can take care of her young daughter, who is in day care. Rosemarie is concerned about the collectability of receivables from Fergus Motel, for whom Acme has done extensive work. Rosemarie thinks that the allowance for these receivables should be adjusted. When she expresses her concern to Peter, she learns that adjusting for the receivables might put the approval of a much – needed loan in jeopardy. It seems clear to Rosemarie that when Peter said, “ Well, do what you think is right, ” he was really saying that he expected her to look out for the company and fudge the ﬁgures. Should she be a team player and go along with what Peter obviously wants but didn’t speciﬁcally ask for?
John is a young accountant at a local CPA ﬁrm. He is wrestling with a problem: trying to decide whether to cover up a mistake made in not attaching an irrevocable election to a key client’s recently submitted tax return. If he does not report the mistake, he can relieve a signiﬁcant portion of the client’s tax burden. John thinks taxes are unfair anyway and believes that his obligation is to look out for the client’ s best interests and save him from paying as much tax as possible. John also knows that keeping the client is important for the company’s ﬁnancial health. Do you think most accountants would cover up such a mistake? Would they be justiﬁed in doing so?
Leo is a senior accountant assigned to audit CHC, a closely held corpora-tion. Leo discovers that CHC ’ s income has been materially misstated, probably because of a cutoff error, but possibly deliberately. The managing partner, who is negotiating a consulting contract with CHC, is pressuring Leo to get the ﬁ les to him as soon as possible. The audit has already taken signiﬁcantly longer than was projected in the budget, and an investigation into the misstatement would involve a lot of time. Leo talks to Adele, the audit manager, who tells him not to mention the adjustment in the working papers, because she sees no tax implications – no harm, no foul. Should Leo follow Adele’s “ advice, ” or does he have a responsibility beyond that to work for the beneﬁt of the client?
Situations like the ones in these scenarios happen every day. They typify the ethical concerns that accountants face, whether they are management accountants, tax accountants, auditors, valuation specialists, or accountants performing any number of other accounting activities.
Such situations occurred long before the now infamous Enron bankruptcy case, in which the auditors and consultants from the accounting ﬁ rm of Arthur Andersen came under criticism for not appropriately carrying out their responsibilities as accountants. In one instance, Arthur Andersen, functioning in the role of outside auditor, failed to detect and/or disclose ﬁnancial transactions wherein Enron shifted assets to a special purpose entity, which made the value of the company appear to be signiﬁcantly more than it was. While Andersen defenders declared that such activity was within the law and generally accepted accounting principles, critics maintain that accountants are obliged to do more.
We have seen the outcome of the Enron/Andersen case with the demise of both Enron and Andersen, passage of the Sarbanes – Oxley Act, and the institution of the Public Company Accounting Oversight Board, but it is important to remember that the Enron/Andersen case did not present new ethical difﬁculties. It simply brought to light ethical questions that had been simmering for well over a quarter of a century, and unfortunately continue to simmer. Enron/Andersen, because it involved billions of dollars and affected so many people’ s lives, illustrated dramatically the ethical difﬁ culties accountants face. The Enron/Andersen case, and each of the scenarios above raise these ethical questions: What is the appropriate behavior for accountants? What are accountants supposed to do? What are their responsibilities?
The scenarios given above, ironically, raise another important point. If you look at the citation, you will see that the scenarios were developed for a business ethics program sponsored by none other than Arthur Andersen.
It was a project that brought together leading thinkers of the business ethics community to develop teaching tools for use in college courses on business ethics. Arthur Andersen had the reputation from his earliest days in Chicago for being a person of impeccable integrity, and from its inception, the com-pany was dedicated to doing the right thing.
What went wrong with his company is a story told many times from many perspectives. From our perspective, there are two main reasons. One is on the individual level. Accountants, at least in the Houston ofﬁces of Andersen, did not do what they were supposed to do. They made the common mistake of many auditors who think their main obligation is to please the client who hires them. Rather, as we will try to show, accounting has a public purpose. It needs to serve the public good ﬁrst. We will discuss this purpose at length in the book. The second reason is that Arthur Andersen succumbed to the systemic temptations that regularly beset the accounting ﬁrms, particularly the large ﬁrms. Firms, or the human beings who run them, are susceptible to the pressures of incentives; we get what we reward. As an auditor, Arthur Andersen had a clear mission – to attest that the ﬁnancial statements it was auditing reﬂected what was really going on in the company. However, Andersen eschewed that mission in favor of fees.
A venerable ﬁrm like Andersen had prided itself on its role as auditor; as an auditing ﬁ rm, it ﬁlled an important public function. Along with other large accounting ﬁrms, however, Andersen apparently forgot its main function as it began to expand. What was the purpose of the expansion? To do consulting. Why? To bring in more proﬁ ts. There was little reﬂection on the effect of this consulting on an auditing ﬁ rm’ s primary function and responsibility. There was little speculation about the reliance on consulting fees ’ impact on auditing.
An auditor ’ s responsibilities are clear. If, however, consulting brings in more proﬁ t than auditing does, there will be pressure to do even more consulting. Some might say, if that results in soft auditing, so be it. It’s simply human nature to follow pursuits that enhance our income stream. But how can we reconcile giving in to such pressure with accounting ethics?
Individuals and systems are much alike. They both give in to temptations. Hence, any serious treatise on ethics must look at the pressures the system exerts on individual accountants and their ﬁ rms, and examine the rewards of the system to determine whether they align with its purposes. These are the major issues we will address in this book on accounting ethics.
Ethics is an overarching concern in all areas of life; it is involved in all human activity. Human activity is an activity for which an individual is responsible, one that he or she does deliberately and can control, one that helps or harms the individual or others, and one that is deemed to be either just or unjust, right or wrong. In this book, we will examine the ethical dimensions of the human activity of accounting. To understand it fully, we must ﬁrst consider where and how the activity of accounting ﬁ ts into the larger scheme of human activities.
We will look into how accounting is both an essential practice and a vital profession. It is an essential practice because today ’ s economically developed system could not exist without accounting. Business and the ﬁnancial mar-ket, as we know it, would grind to a halt if there were no way to account for the existence and disposition of the world ’ s wealth and goods. For markets to function efﬁciently, it is necessary to have transactions based on accurate portraits of the ﬁnancial worth of any entity being traded. Those portraits are painted by accountants. Power relationships, property rights, ownership claims, valuations, receivables, and debts are all social constructs that deﬁne who owns what and owes what to whom. All of these constructs are identiﬁed and tracked by accountants and bookkeepers.
Because of its essential role in tracking the complicated ﬁnancial relation-ships in today ’ s world, accounting has developed into a service profession. There are general ethical responsibilities that accrue to professionals and speciﬁc responsibilities that arise from being a professional accountant. Cov-ering all areas and activities that have an ethical dimension would require an inordinately large book. This book, therefore, will concentrate on what we perceive as major areas of concern for the ethics of accounting.
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