Accounting Ethics: The Moral of the Story Dinah Payne 1 Role of Financial Reporting To provide information that is useful in making business and economic decisions To serve the public interest To communicate accounting information that is Relevant Reliable Timely Fairly predictive 2 1
Who Cares? Stakeholders care: stakeholders are those who may be directly or indirectly affected by the accountant s behavior Stockholders Capital providers The government Special interest groups Media SEC officials 3 Individual practitioners Professional groups Clients employees of target firms Students International constituents Etc. Accountants and Fraud Accountants may have an increased potential to commit fraud from their positions as professionals: They have direct access to organizational assets They often have the ability to override internal controls They are skilled in practices that allow financial statement manipulation They are typically intimately aware of organizational needs and weaknesses 4 2
External Auditors Have Additional Challenges They need to generate client business so public accounting firms can remain profitable and can resolve potentially conflicting objectives of a plethora of stakeholders The expectation gap between what auditors actually do and what the public believes they do is a source of misunderstanding and distrust between the public and auditors 5 Auditors: the Reality and the Perception Auditors are to provide reasonable assurance about whether the financial statements are free of material misstatement, resulting from error or fraud The public perception is that auditors will search for and find all fraud, a unrealistic perception Recent audit failures support the perception that, even though the majority of audits are done with care and expertise, executives are honest and financial statements are fairly presented, accountants have failed in their duty to find fraud 6 3
Perception of Accountant Responsibility Scienter is guilty knowledge that is greater than simple negligence; it is intent to deceive At the instruction of Nay, CEO of First Securities, Ernst & Ernst s employee placed money into a nonexistent account from which Nay took the money for his own use The employee of Ernst & Ernst did not know the account was nonexistent or that fraud was being perpetrated; this was discovered upon Nay s suicide The question is that, because the auditor did not find the fraud, did he intend to commit fraud? 7 Why DO Accountants Commit Fraud? There are contributory factors to an accountant s commission of fraud Pressure emitted from, i.e., a need for a company or an accountant to look good Opportunity to commit fraud is massive, as the accountant has most control over his numbers The accountant s rationalization that his actions are acceptable can come from self-deception, selfindulgence, self-protection to hide some wrongful behavior, etc. 8 4
The Need for Ethics in Accounting The brand of accounting needs to be restyled away from the idea that accountants are unethical and responsible for any financial crisis and towards the idea that accountants are a group of honest professionals with specialized knowledge The symbiotic relationship of business and society also calls for ethics in accounting: neither of these groups could succeed/exist without the other; we need to have faith in each set of people that we can trust their good faith and specialized knowledge 9 Accountability for Accountants Because accountants act as protectors of the public trust and because accounting information can impact individual business decisions and the capital markets, accountants should be accountable for their work in a system of shared rights and responsibilities through two sets of moral directives: A code of professional conduct to guide behavior: codes of ethics A code of professional standards to guide process: Generally Accepted Accounting Principles 10 5
Codes: of Conduct and GAAP Professional codes of conduct represent moral norms of what is right or wrong Goals are to insure the accountant s personal and professional integrity and competency GAAP provide agreed-upon moral directives or norms rather than just processes Good reasons for accounting practice are those consistent with a process of deciding moral norms The use of codes of conduct and of GAAP should go beyond the minimalist legal requirements 11 Purpose of Codes of Conduct The regulative function: i.e., assurance of competence The protection of stakeholders The provision of honest, specific information The provision of policing mechanisms and penalties Overall, codes help deter professionals from engaging in behaviors that would bring disgrace to the profession and negatively affect its ability to serve the public good 12 6
Codes for Accountants These codes require an understanding of professional duties and the stakeholders to whom those duties are owed Values and ethical frameworks are utilized to develop codes of ethics by and for those members of professional accounting associations 13 To Create Codes of Conduct or Ethics Codes Codes of conduct require a mixture of a number of elements and relationships: Values as movers and products of: attitudes, beliefs, behaviors, and culture Professional certification Licensure Specificity to individual and/or firm Recognition of public interest Detailed codes of practice 14 7
Four Values Inherent to Good Codes Accountants codes of ethics should encompass these values Utility: the usefulness of the information for the public and individual targets Integrity: the use of good faith and sincerity in providing professional services Competence: the maintenance of qualifications to achieve utility and integrity Justice: the use of fairness and equity in the decision-making process 15 AICPA Code of Professional Conduct Accountants should: Place self-discipline and self-governance above and beyond legal requirements or regulations Accept responsibility to the public, clients, and colleagues and the community of people and institutions served by the profession Have an unswerving commitment to honorable behavior Recognize his essential role in society 16 8
More AICPA Rules of Conduct Further, accountants should: Act with integrity, objectivity, due professional care, and a genuine interest in serving the public Provide quality services and honor the public trust Maintain independence if in public practice Be scrupulous in their application of GAAP Discharge duties promptly, with competence and diligence Perform services that are within acceptable norms of professional behavior 17 Institute of Internal Auditors Code of Ethics Principles and Rules of Conduct Accountants should: Act with integrity, performing work with honesty, diligence, and responsibility Act within the law and do not perform acts discreditable to the profession or organization Not participate in activities or relationships that may impair unbiased assessment of information, relevant circumstances, or professional judgment Communicate all material information 18 9
Institute of Internal Auditors Code of Ethics Principles and Rules of Conduct, Con t. Accountants should: Maintain confidentiality unless there is a legal or professional obligation to make disclosures Not use information for personal gain or in an illegal manner Engage only in services for which one possesses the necessary knowledge, skills, and experience Continually improve proficiency, effectiveness, and quality of services 19 Financial Executives International Code of Ethics Accountants should: Act with honesty and integrity Avoid actual or apparent conflicts of interest in personal and professional relationships Provide accurate, complete, objective, relevant, timely and understandable information Comply with applicable rules, regulations, and laws of appropriate private and public regulatory agencies Proactively promote ethical behavior Be accountable for adhering to this Code 20 10
Financial Executives International Code of Ethics, Con t. Accountants should: Act in good faith, responsibly, with due care, competence and diligence and maintain skills Not allow independent judgment to be subordinated Respect the confidentiality of information unless legally obligated to disclose and not use confidential information for personal advantage Achieve responsible use of and control over all assets and resources employed or entrusted Report known or suspected Code violations 21 Synthesis of Codal Provisions These principles can shape the formation of a model code of ethics for accountants Respect of and responsibility to stakeholders Integrity Competence Justice (doing the right thing) 22 11
Stakeholder Perspective: Respect and Responsibilities Owed Accountants should recognize that their work will be employed by diverse users for a variety of purposes and, therefore, should view all stakeholders as valuable Accountants should prepare information (both financial and related disclosures) in a manner that can be comprehended by a stakeholder who is reasonably astute in business and who is willing to make a reasonable effort to understand the information presented 23 More Regarding Stakeholders Accountants should be willing to provide specialized information to stakeholders with specialized needs at an additional cost Accountants should treat all stakeholders fairly and uniformly in consistent situations 24 12
Integrity Accountants should perform their work honestly, responsibly, objectively, and legally Accountants should gather, record, analyze, and present information that is accurate in all material respects Accountants should gather, record, analyze, and present information that faithfully and objectively represents the underlying facts 25 More on Integrity Accountants should act in good faith towards all stakeholders of accounting information, other members of the profession, and other members of society Accountants should resist efforts by stakeholders to exert undue influence on the manner in which information is generated or presented 26 13
Competency Accountants should, through continued study and education, maintain the necessary professional competency to perform work assignments Accountants should be diligent in maintaining professional objectivity and confidentiality Accountants should exercise professional judgment in a prudent and thoughtful manner Accountants should be willing to mentor and share knowledge with others 27 Justice Accountants should proactively engage in and promote legal and ethical behaviors in all personal and professional activities Accountants should uphold the standards of professionalism and be honest in all professional interactions Accountants should uphold the fiduciary responsibilities that come with professional knowledge and position Accountants should use good faith in everything 28 14
Conclusion Encountering ethical dilemmas is difficult for any profession The ability to rely on not just one s own subjective sense of right or wrong can be very helpful in making good, defensible moral judgments about professional matters Codes of ethics can assure us that our subjective beliefs are compatible with objective beliefs and thereby strengthen the defensibility of our decisions 29 Accountants Liability to Clients Is based in three causes of action 1.) Breach of K (contract): the terms of the K appear in the engagement letter, which is a formal contract between the client and accountant An accountant who fails to perform according to the terms of the K can be sued for breach Damages are the expenses the client bore for getting another accountant to render the same service, plus any fines or penalties that may have been assessed by missing a deadline, etc. 30 15
More Accountants Liability to Clients 2.) Fraud, wherein compensatory damages can be collected: Actual fraud is the intentional misrepresentation or omission of material fact, relied upon by the client such that he suffers damage; punitive damages may be assessed Constructive fraud happens when the accountant shows reckless disregard for truth/consequences of his acts (aka, gross negligence) 31 More Liability to Clients 3.) Negligence: accountants owe a duty to use reasonable care, knowledge, skill and judgment in providing services Violation of GAAP or GAAS is prima facie evidence of negligence 32 16
Accountants Liability to 3 rd Parties There are three rules by which an accountant may be held liable to 3 rd parties 1.) The Ultramares doctrine states that if an accountant is not in privity with a party or in a privity-like relationship with a party, that party may not hold the accountant liable 33 More Ultramares So, only parties in privity or privity-like relationships with the accountant can sue, i.e., the client s bank that lent money to the client, whose accountant KNEW that the audited financials would be given to the bank in an attempt to secure a loan: this bank can sue 34 17
Liability to 3 rd Parties, Con t. 2.) Section 552 of the Restatement (2 nd ) of Torts states that if the accountant knew that the client was going to give a limited class of intended users the audited financials, any of those intended users, though none of them had been specifically named, would have a cause of action against the accountant 35 More Accountants Liability to 3 rd Parties 3.) The Foreseeability Standard holds an accountant liable to any foreseeable user of the client s financial statements; the accountant s liability does not depend on whether the accountant knew of any one specific or any group of users of the audited financials 36 18