applied research in financial reporting: text and cases chapter 9 ethical considerations in judgment...
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Applied Research in Financial Reporting: Text and Cases
Chapter 9
Ethical Considerations inJudgment and Decision Making in
Accounting
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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
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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
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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
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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
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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
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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
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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Principles – 300: Responsibilities to Clients – 400: Responsibilities to Colleagues: No longer
in force (replaced with peer review in 1988)– 500: Other Responsibilities and Practices
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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
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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
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Business Ethics
• Defined:
– A management process comprised of programs, management practices, and systems designed to motivate, measure, and monitor the organization's ethical performance
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Business Ethics
Strategies:Code of conduct 208 93.3%
Employee training in ethics 99 44.4%
Social auditing & reporting 98 43.9%
Corporate structural changes 46 20.6%
Ethics committees 40 17.9%
Ombudsman 17 7.6%
Judiciary board 3 1.3%
None of the above 2 .9%
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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
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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
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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
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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).
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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.
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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.
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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.
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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.
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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).
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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
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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).
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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).
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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)
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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)
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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
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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
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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.
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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
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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
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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
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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
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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
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Individual Ethics
• Ethical Training: The Case Method– Identify stakeholders
– Identify ethical issues
– Identify alternative solutions
– Make a decision: Select a preferred solution
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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.
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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.
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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.
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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?
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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
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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!
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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.