Download Models of Accounting Research

Applied Research in Financial
Reporting: Text and Cases
Chapter 9
Ethical Considerations in
Judgment and Decision Making in
Accounting
Presentation Plan
• Objectives
• Professional Ethics
– AICPA’s Code of Professional Conduct
•
•
•
•
•
Business Ethics
Ethics Audit Services
Individual Ethics
Ethical Training: The Case Method
Illustrative Case
Objectives
• AICPA's Code of Professional Conduct and
CPA’s responsibilities
• Principles, rules, interpretations, and
enforcement of the AICPA's Code of
Professional Conduct
• Definition of business ethics
• Various components of a business ethics
program
Objectives
• Corporate ethics audits as an area of assurance
about effectiveness of a clients’ business ethics
programs
• A general framework for individual ethical
behavior
• A method of measuring individual ethical
reasoning
• Characteristics of an ethical accountant
• A model for analysis of ethical dilemmas
Professional Ethics
• AICPA’s Code of Professional Conduct:
– To serve the public interest in performing the
highest quality of professional services
– Supported by:
•
•
•
•
Education
Certification
Licensing
Practice
Professional Ethics
• AICPA’s Code Components:
– Principles of Professional Conduct
– Rules of Conduct
– Interpretations of Rules of Conduct
– Rulings by:
• The Professional Ethics Division
• Trial Board
Professional Ethics
• Principles of Professional Conduct (Exhibit 9-1)
– Responsibilities
– The Public Interest
– Integrity
– Objectivity and Independence
– Due Professional Care
– Scope and nature of Services
• A problem: Principles are not enforceable
Professional Ethics
• Rules of Conduct and Interpretations:
– 100: Independence, Integrity, and Objectivity
– 200: General Standards and Accounting
Principles
– 300: Responsibilities to Clients
– 400: Responsibilities to Colleagues: No longer
in force (replaced with peer review in 1988)
– 500: Other Responsibilities and Practices
Professional Ethics
• Rulings by the Professional Ethics Division:
– Professional Ethics Division may:
• levy automatic penalties (e.g., expulsion)
• recommend a course of action (e.g., CPE course)
• refer to Trial Board for a hearing
– Professional Ethics Division rulings are
published in AICPA’s publication: the CPA
Letter
Business Ethics
• Is the profit motive in conflict with ethical
conduct?
– Two views: Yes and No!
– US Sentencing Guidelines
– Psychological tendencies in need of correction
Business Ethics
• Defined:
– A management process comprised of
programs, management practices,
and systems designed to motivate,
measure, and monitor the
organization's ethical performance
Business Ethics
Strategies:
Code of conduct
Employee training in ethics
Social auditing & reporting
Corporate structural changes
Ethics committees
Ombudsman
Judiciary board
None of the above
208
99
98
46
40
17
3
2
93.3%
44.4%
43.9%
20.6%
17.9%
7.6%
1.3%
.9%
Business Ethics Components
(Exhibit 9-2)
Ethical Tone:
– Corporate Culture & Climate
– Board of Directors
– Management
Ethical Guidance
– Code of Ethics
– Training and Development
Enforcement
–
–
–
–
Control Environment
Ombudsman, Officer, Committee, Board
Whistle-blowing
Investigation & Action
Ethical Tone:
Corporate Culture & Climate
• To foster an environment supportive of ethical
behavior:
• Corporate Culture is
– A set of formal and informal understandings that
guide employees in their daily conduct
• Corporate Climate is
– Aggregated employee perceptions of organizational
values such as providing warmth and support to
colleagues and customers
• Ethical climate is a subset of corporate climate
Ethical Tone:
Board of Directors
• The company should have:
– A process to select BOD members with
reputation for personal integrity
• individuals with possible conflicts of interest or
undue influence must be disqualified
Ethical Tone:
Management
• The importance of management integrity is
recognized in professional standards.
– SAS 53 indicates that management is above the
controls that constrain employees, or can
override them easily -- thus management
integrity is important.
– Management must exercise constant vigilance and
timely intervention to foster the firm's ethical
standards (Aguilar, 1994, 95).
Ethical Guidance:
Code of Ethics
• A code of ethics provides a
frame of reference
• defines areas of ethical
concerns
• defines core values that are to
guide action.
Ethical Guidance:
Training and Development
• Formal training program is needed for:
– developing employees' understanding,
competence, and commitment with respect to
ethical behavior on the job. (Aguilar, 1994,
104)
– Similar to any other training program, an ethics
training program must have clear objectives to
accomplish.
Enforcement:
Control Environment
• Per COSO, 1992, sets:
– the tone of an organization
– providing discipline and structure integrity
– ethical values
– competence of ... people
– management's philosophy and operating style
– the way management assigns authority and
responsibility, and organizes and develops its people
– and the attention and direction provided by the board of
directors.
Enforcement:
Ombudsman, Ethics Officer, Ethics Committee,
Judiciary Board
• Ombudsman, ethics officers, ethics
committees, or judiciary boards play an
important role in the development and
enforcement of ethical processes.
Enforcement:
Whistle-Blowing
• The disclosure by organization members of
illegal, immoral, or illegitimate practices
• "Co-workers who are willing to monitor
their peers' behavior and report violations to
management represent a potentially
important supplemental control resource for
organizations." (Trevino & Victor, 1992, p.
38).
Ethics Audit Services
• An Area of Assurance Services Identified by the
AICPA (Elliott & Pallais, 1997)
• An ethics audit is similar to the audit performed for
ISO 9000 certification and is a "positive
confirmation of the existence and effective
implementation of best ethical practices." (KPMG,
1996).
• Also applicable are a host of SASs (e.g., SAS 78 and
SAS 82)
• But no SAS directly on Ethics Audits
Examples of Ethics Items/Audit
Tasks
• From Culture & Climate:
– Does the client have a positive moral
atmosphere ... [i.e., is individual diversity
tolerated, encouraged)? (Ponemon, 1994)
• From Board of Directors:
– Is the board of directors actively involved in the
evaluation of management's enforcement of
corporate ethical code?" (POB, 1994, 13).
Examples of Ethics Items/Audit
Tasks
• From management:
– Assess ethical behavior of management
because, "Knowledge that the CEO has 'done
the right thing' ethically when faced with a
tough business decision sends a strong message
to all levels of the organization" (COSO, 1992,
21).
Examples of Ethics Items/Audit
Tasks
• From the Code of Ethics:
– Does the code provide guidance on acceptance
of gifts from vendors in violation of company
policy
• From Training and Development:
– Does the client have clear cut policies with
respect to employee ethics training? (Sears,
1993)
Examples of Ethics Items/Audit
Tasks
• From Control Environment:
– Assess organizational structure (SAS 55 Guide,
2.22).
• From Ethics Officer:
– Does the client have a Report Recipient Office?
(Miceli & Near, 1992, p.176)
• From Whistle-blowing:
– Is anonymity assured? (Miceli & Near, 1992)
Individual Ethics
• Definition:
– The study of what is right in human behavior
– Focuses on ultimate goals that ought to be
pursued and the actions that ought to be taken
to achieve those goals
– “Ought to be” has different interpretations
based on the ethical principles adopted
Individual Ethics
• Ethical Principles
– “Self-interest”, but not selfishness: not to the
point that other people’s interests are unduly
harmed
• Example: do not trade on insider information
because it harms the interest of others
– Harm minimization -- “self control” so that
physical or psychological harm to others is
minimized
Individual Ethics
• Ethical Principles
– Utilitarianism. Optimize public interest:
greatest good for the greatest number of people
– Universality. Consistency in actions under
similar circumstances
– Human rights. Justice principle where the
freedom and human rights of all others are
respected.
Individual Ethics
• Kohlberg Stage Model of Moral
Development (Exhibit 9-3)
– Level I - Pre-conventional. Ethics of
Convenience and self-interest:
• Stage 1: Avoid punishment
• Stage 2: Seek personal rewards
Individual Ethics
• Kohlberg Stage Model of Moral
Development (Exhibit 9-3)
– Level II - Conventional. Ethics of
Conformity:
• Stage 3: Group loyalty and acceptance
• Stage 4: Belief in obeying the civic or
religious laws and professional
regulations
Individual Ethics
• Kohlberg Stage Model of Moral
Development (Exhibit 9-3)
– Level III - Post-Conventional. Ethics of
Conviction:
• Stage 5:Commitment to high order principle
such as utilitarianism
• Stage 6: Commitment to the highest order
principles such as justice, duties and equal
human rights
Individual Ethics
• Measures of Ethical Cognition:
– Kohlberg’s Moral Judgment Interview (MJI)
– Rest’s Defining Issues Test (DIT)
• The P-score
– Provides norms for various strata of the society
(e.g., mean of 31.03 for high school graduates)
– Business versus liberal arts students
– Men versus women
Individual Ethics
• Rest’s Model of Moral Behavior:
–
–
–
–
Component I: Moral sensitivity
Component II: Moral Judgment (or reasoning)
Component III: Moral Motivation
Component IV: Moral Character
Individual Ethics
• Ethical Training: The Case Method
– Identify stakeholders
– Identify ethical issues
– Identify alternative solutions
– Make a decision: Select a preferred
solution
Antelope Financial: Facts
• Explosion of the number and variety of
financial instruments in recent years;
• A practice known as “gain-on-sale
accounting” is used for transactions
– Borrowing money at a low rate, and lending at
a higher rate and recognize the spread as profit
by discounting to present value all scheduled
future cash flows for a given sale.
Antelope Financial: Facts
• Antelope is interested in buying One firm,
Put-You-In-Housing Financial (PYIHF).
– PYIHF lends to individuals for the purchase of
trailer homes, manufactured housing, and small
houses
• PYIHF has relied on gain-on-sale accounting, securitizing all
of its loans for sale, booking profits, and loaning the proceeds
to additional customers. PYIHF has over one billion dollars on
the books in this manner.
Antelope Financial: Facts
• As a CFO you are asked to closely inspect
PYIHF’s books and report to the CEO
– You find high risk of default because
• PYIHF’s borrowers have poor credit histories with
high rates of default.
• The residences are at risk to fire and hurricane due
to their small size and construction, yet few
homeowners have fire and casualty insurance.
• PYIHF has many loans on the books yet to be
securitized.
Antelope Financial: Facts
• You ask that a note be added to the
financials and to the SEC Form 8-K, but the
CEO disagrees, stating that the board would
bar the transaction
• What do you do?
Antelope Financial: Discussion
• Identify Stakeholders
– CFO, CEO, Creditors, Stockholders, etc.
• Identify ethical issues
– Discuss self interest, harm minimization,
utilitarianism, universality, and human rights
related to each of the stakeholders
Antelope Financial: Discussion
• Identify Alternative Courses of Action
– Agree with acquiring PYIHF, but spin-off bad
loans
• Difficult given the poor quality of PYIHF’s loans
– Report your concern privately to Antelope’s
board
• CEO will be mad at you for sure
– Blow the whistle and resign!
Antelope Financial: Discussion
• Choose the more preferred option:
– The third option, resign, may be preferable
under the circumstances
• This requires a personal sacrifice, but you have little
choice
– If you stay and try to spin-off PYIHF’s bad loans and it
does not work, Antelope may be in trouble blaming you
for it, and perhaps firing you.
– If you report to the board, the CEO will be mad at you and
may try to make life difficult for you or fire you.