Applied Research in Financial Reporting: Text and Cases

1
Applied Research in Financial Reporting Text and
Cases

• Chapter 9
• Ethical Considerations inJudgment and Decision
  Making in Accounting

2
Presentation Plan

• Objectives
• Professional Ethics
• AICPAs Code of Professional Conduct
• Business Ethics
• Ethics Audit Services
• Individual Ethics
• Ethical Training The Case Method
• Illustrative Case

3
Objectives

• AICPA's Code of Professional Conduct and CPAs
  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

4
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

5
Professional Ethics

• AICPAs 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

• AICPAs 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• 400 Responsibilities to Colleagues No longer in
  force (replaced with peer review in 1988)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

9
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 AICPAs publication the CPA Letter

10
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 ToneBoard 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 GuidanceCode 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.

19
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.

20
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.

21
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).

22
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)

27
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 peoples 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

29
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 5Commitment 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
• Kohlbergs Moral Judgment Interview (MJI)
• Rests 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

• Rests 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

36
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.

37
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.

38
Antelope Financial Facts

• As a CFO you are asked to closely inspect PYIHFs
  books and report to the CEO
• You find high risk of default because
• PYIHFs 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?

40
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

41
Antelope Financial Discussion

• Identify Alternative Courses of Action
• Agree with acquiring PYIHF, but spin-off bad
  loans
• Difficult given the poor quality of PYIHFs loans
• Report your concern privately to Antelopes board
• CEO will be mad at you for sure
• Blow the whistle and resign!

42
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 PYIHFs 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.