Understanding Accounting Ethics

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Understanding Accounting Ethics

• Chapter 1 Ethics and Professionalism in
  Accounting

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Why are we here?

• A curious phenomenon professionals who are
  required by law to take (introductory) classes in
  ethics on a regular basis.
• as if there were a presumption of a lack of
  ethics!
• why just these professionals?

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The obvious answer

• This is a result of legislation in the wake of
  major scandals. (Enron, WorldCom, etc.)
• But If thats all it is, this would be
  misguided
• Punishing the many for the sins of a few
• These high-profile scandals are out of the
  ordinary
• A classic case of regulatory over-reaction

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No There are persistent and entirely general
problems

• The first
• persistent conflict between the high ideal and
  purpose of accounting, and its actual
  circumstances in business together with
• a sense that this conflict cannot be resolved by
  law, regulation, rules.

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The high ideals and purpose of accounting

• In the context of the decentralized economies
  that are now widely believed to serve the
  interests and aspirations of citizens of
  democracies in the 21st century, the role of
  investors (capitalists) is an important one.
• Success for absentee investors is critical to
  the continuing contribution of capital and
  capital markets to the welfare of those citizens.
  Information on enterprise success is a key link
  between suppliers of capital (household savers)
  and business enterprises employing that capital.
  
• When accountants (including auditors) fail to
  provide investors with reliable information that
  is relevant to their capital allocation
  decisions, investors and all citizens with stakes
  in the success of the economic system suffer.
• George Staubus

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in conflict with the actual circumstances of
accounting

• It is apparent that auditors are not paid for
  by investors, and are not motivated to meet
  investors objectives. The problem with this
  arrangement is illustrated by auditors customary
  terminology they refer to the enterprise being
  audited and/or its top management as the
  client. But if the system is to serve the
  American economic system as described in the
  previous section of this paper, auditing must
  serve the investing public and treat it as the
  client.
• In simple terms, management uses owners money
  to hire auditors to provide a stamp of approval
  on managements reports on its own performance to
  owners.
• The auditor is in an awkward position. He
  makes his living by pleasing management, but his
  societal justification requires serving
  investors.

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People look to ethics for the answer to this
structural problem

• True enough, there is plenty of regulation!
• But it is sensed that regulation, laws, and rules
  are intrusive, inadequate, and self-defeating.
• Intrusive imposed from without
• Inadequate cant cover all cases or be effective
  when no one is watching
• Self-defeating the crowding out effect,
  extrinsic motivation replaces intrinsic

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Regulation can actually be counter-productive

• It suggests that the bare minimum is acceptable
  that the legalthe ideal.
• When extrinsic motivation is increased, intrinsic
  motivation sometimes decreases (crowding out
  effect). E.g. higher pay may lead to worse
  performance.

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The crowding out effect

• In countries where most blood is supplied for
  free, offering money for donations can reduce
  total supply (Upton 1973).
• When citizens in Switzerland were asked whether
  they would agree to have a nuclear waste
  respository in their community, 50 agreed, but
  when this was proposed with compensation, as a
  quid-pro-quo, acceptance dropped to 25. (Frey
  and Oberholzer-Gee 1997)

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Regulation as presupposing and therefore
encouraging a governance of crooks

• The reactions of Principal Agent theorists and
  politicians to the malpractices and excessive
  compensations of top management by intensifying
  monitoring and sanctioning tend to worse the very
  problems they are designed to solve. The
  apparent remedy raises the incentives of managers
  and other employees to take advantage of the very
  firm they are supposed to care about. The
  conditions leading to a governance of crooks
  have to be taken into account. (Osterloh and
  Frey)

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• An axiom of management theory also.
• Any measure of activity contributing to the goal
  of an organization will be imperfect thus there
  will be occasions in which to satisfy (succeed
  according to) the measure will be at odds with
  what actually benefits the organization.
• To proliferate imperfect measures risks
  proliferating such choices.
• It follows, then, that in general it is
  impossible to have a system of evaluation and
  incentives, a set of standard procedures,
  budgetary targets, close monitoring, or any other
  formal system that can always guarantee that the
  results of actions by individuals will be ethical
  or in the best interest of the organization.
  Formal systems are not only incapable of doing
  the fine tuning needed for that purpose, but
  often they can be at the origin of unethical
  behavior on the part of executives. (Rosanas and
  Vellila)

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Summary of the first reason

• Regulation and rules are inadequate in dealing
  with the persistent problem of the circumstances
  of auditing.
• (Auditors are not paid by those whose interests
  they are supposed to represent.)

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Second reason The history of accounting as a
profession

• Basic issue Accounting is a profession, but one
  which lacks the lengthy history of the
  traditional professions (law, medicine,
  theology).
• Ethics is meant to substitute for the lack of
  guidance from history, tradition, and entrenched
  social practices.

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But What is a Profession?

• There are two accounts of what a profession is
• Sociological- Six Criteria
• Philosophical- Incommensurability

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Sociological Attributes of a Profession

• "they involve essentially intellectual
  operations with large individual responsibility"
  
• "they derive their raw material from science and
  learning"
• "this material they work up to a practical and
  definite end"
• "they possess an educationally communicable
  technique"
• "they tend to self-organization"
• "they are becoming increasingly altruistic in
  motivation."

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Some more Sociological Criteria

• Professions conform to a standard of professional
  qualifications governing admission.
• They maintain certain standards of conduct.
• They have a recognized status.
• They are constituted by associations devoted to
  the advancement of the social obligations of the
  profession.
• They have a distinctive culture, involving
  customs, traditions, and symbols.

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Philosophical Attributes of a Profession

• Distinguish commensurable from incommensurable
  goods.
• Identify honorable goods, not commensurable
  with market goods.
• A profession (unlike a business) dedicated to
  providing an honorable good.

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Examples of honorable goods and professions

• Health medicine
• Justice law
• Knowledge professors
• Salvation theologians and ministers
• Trust accountants

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An important corollary

• The payment received by an accountant insofar as
  he or she is providing the honorable good of
  trust has the character of an honorarium or
  stipend.
• Strictly speaking, it cannot be conceived of as a
  payment in kind, because the good provided is
  incommensurable with money.

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The resulting dilemma

• Accountancy has the high calling that every
  profession hasperhaps a higher calling insofar
  as it may claim to be more altruistic.
• But it lacks the history and clear understanding
  of itself which are possessed by law, medicine,
  and theology.
• Thus, the line between profession and business is
  easy to blur.
• Ethics is thought to be able to remedy this.

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A third problematic uniformity versus particular
judgment

• The task of accounting
• to declare the truth about the financial
  condition of an enterprise, thus providing the
  conditions of trust necessary for a market
  economy.

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Note the emphasis on truth

• Questions and cross-questionings, of owners, of
  stockholders, of directors, of presidents, are
  often to be answered as supplementary to the
  report the answer must be intelligent, ready,
  and never resentful. These gentlemen desire truth
  and nothing else it belongs to the spirit of
  professional Accountancy to seek out and reveal
  to them the truth.
• Charles Waldo Haskins

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• But the ideal conception of its true mission by
  the profession itselfa conception from within
  and not dependent upon extraneous
  exigenciesplaces Accountancy far outside the
  pale of all ordinary callings, and sets it upon a
  platform of its own as a learned profession,
  self-impelled to culture, to moral enlargement,
  and to scientific attainment it lays a basis of
  confidence for every business enterprise that in
  professional Accountancy there is a self-centered
  soul of economic truth. Charles Waldo Haskins

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• 1. The written records, the accounts of business
  transactions, in a vast number of cases were
  imperfectly, inaccurately or fraudulently stated.
  And many still are. Consequently the public
  accountants first duty was to fight figures.
• 2. It is astounding how many relevant figures may
  be omitted from records of business transactions,
  how many debits find their way to the credit side
  of ledgers, and how many debits are entirely
  omittedso that public accountants must find
  facts.
• 3. The third compelling reason for the employment
  of public accountants, and much the most
  important, is his duty, after fighting the
  figures and finding the facts, to assemble the
  figures and the facts and to tell the truth about
  them, with clarity, conciseness and intelligence
  so that he who runs may read.
• Robert H. Montgomery

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• Eternal vigilance is the price of accounting as
  well as of liberty. And so I see very little
  change from year to year in the more important
  attributes of the public accountant. For more
  than 48 of the 50 years under review I have
  intimately known the leaders of the profession in
  this country and in England and Scotland. Then,
  they were fearless seekers for the truth. Fifty
  years ago, poor as they were, no power on earth
  could have swerved them from their search. Nearly
  fifty years later, as I look into the faces of my
  brothers in our profession from far and near,
  from the ends of the earth, I see in these new
  faces the same proud determination, the same
  courage, the same stubbornness, the same men I
  saw nearly fifty years ago. And to those who are
  not here I extend a grateful prayer. I dont want
  to have anything to do with supermen. I want men
  in the profession with simple minds and
  indomitable courage to seek and tell the truth.
• Robert H. Montgomery

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Telling the truth requires a background of
truthful statement

• There can be no truth-telling about businesses
  and accounts, without uniform standards, to allow
  comparisons (vertical, horizontal, between
  enterprises, and across times).
• But particulars are so varied, that the truth
  cannot be captured by any system of rules,
  however complete.

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Orientation to the truth is a matter of good
character, or ethics

• This orientation to find and tell the truth in
  each case, even if this means departing from
  rules or interpreting them appropriately,
  requires a good orientation in the
  practitionergood character. It must come from
  within, because it cannot come from without (the
  rules).
• Ethics is thought to be relevant to this.

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Fourth reason The role of a watchdog, in a
context where money is at play

• Moneyespecially large sumsprovides a constant
  temptation to act solely in ones own
  self-interest, even if this is in disregard of
  ones obligations towards other.
• Greed the motive to act in this way.
• Greediness a trait of character by which one
  commonly acts in this way.

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In this context, the accountant is declared a
watchdog

• By certifying the public reports that
  collectively depict a corporations financial
  status, the independent auditor assumes a public
  responsibility transcending any employment
  relationship with the client. The independent
  public accountant performing this special
  function owes ultimate allegiance to the
  corporation's creditors and stockholders, as well
  as to the investing public. This public
  watchdog function demands that the accountant
  maintain total independence from the client at
  all times and requires complete fidelity to the
  public trust. (U.S. v. Arthur Young)

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Not that responsibility for the integrity does
not rest with others also!

• Management obviously!
• Accounting professors
• FASB

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The responsibility of accounting professors

• Academics, shielded by the academic freedom
  custom and by their protected source of income,
  might be the low-cost producers of
  reform-oriented activity. We can understand the
  pressures on corporate accountants to resist
  reforms favoring the public interest and we know
  the pressures auditors are under from their
  fee-paying clients under extant arrangements.
  They see reform activity as very costlyif they
  think of it at all. They would be high-cost
  producers, so it is understandable that they do
  not enter that market. If reform is to come from
  within the broad accounting profession, rather
  than from government regulatory agencies, it must
  come from academia, according to this view.
  Academics should take positions on issues in
  which they believe, such as a theory of
  investor-oriented accounting, the auditor bias
  problem, or inequities in tax laws, and write and
  speak on those positions as if we were confident
  of the prospects for success. What do we have to
  lose? Is it not our duty?
• George Staubus

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Three ethical failures of FASB (Staubus)

• Allowing too much weight to corporate interests
  and politicians when seeking input as regards
  proposed standards. (The views of investors
  should be paramount.)
• Cooperating with corporate managements desire
  for bright line standards, and a cookbook
  approach to accounting, rather than taking the
  lead in promoting principles-based accounting.
• Failure over its lifetime of 30 years to achieve
  the standardization of accounting methods that it
  was charged with achieving (e.g. depreciation and
  inventory methods).

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Nonetheless, accountants are watchdogs

• To be a reliable watchdog where large sums of
  money are involvedand thus constant temptations
  to greed and greedinessrequires a steadfast
  devotion to duty and principle (truth) which,
  again, comes from within.
• This is a matter of good character, good culture
  in the firm, good professionalism, and ethics.

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Recapitulation Four enduring reasons for ethics
courses

• Accountants are not paid by those whose interests
  they are supposed to represent, and regulation
  cannot solve this.
• Accountancy is a profession, which lacks the
  history, tradition, and self-understanding of the
  traditional profession.
• Accountants must state the truth in a way
  adequate to particular circumstancesthey need an
  inner orientation to the truth.
• Accountants must serve as watchdogs and thus be
  especially able to resist greed and greediness.