Ethics and responsibility in accounting and auditing

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'The maintenance of ethical standards is the shared concern of the Institute and its members.….. However, a man may often place his personal gain above service and therefore, it is important to keep on reinforcing the idea of observing the highest ethical standards repeatedly' (icai.org, 2010)

The discipline of finance is faced with a number of ethical issues such as window dressing, capital structure planning, dividend declaration, insider information and earnings management. This essay aims to analyse the ethical dilemmas in the auditing and accounting profession. It examines the ethical issues that arise in businesses and how these issues test the ethical principles of the persons involved in financial planning and decision making.

All financial activities of companies are regulated by regulations and so the financial issues are often seen at as matters of law rather than ethics (Boatright, 2002). However it is commonly seen that accounting data is manipulated by taking advantage of the loopholes in laws to provide results as per the management's desire. These practices are neither illegal nor in violation of the accounting standards and so ethics plays an important role in such decisions. So it is rightly said that business ethics begins where the law ends and they tend to cover the grey areas not addressed by law (as cited by Crane et al., 2010).

A company whose profits are modest in a particular year may adopt some unethical methods of accounting to artificially increase its earnings. The world has witnessed numerous examples where accountants have adopted various means of creative accounting to manage the earnings of a company. These techniques are adopted to mislead the users of the financial statements and thus these actions lead to gain for a handful of people and losses to the large investor community.

Auditors play a significant role in providing assurance on the fairness of the accounting data and so it may be thought that these unethical behaviours of accountants can be restricted by the auditors, who are bound by their professional code of conduct. However this is far from true, there have been incidences where auditors have collaborated with companies and have purposely ignored issues that would have factually reduced the profits of the company. As suggested by Mintz (1995) auditors not only need technical but also require ethical expertise and the right intention to act against self-interest when required to do so.

Cheffers (2005) says that there are professional codes of ethics which establish ethical requirements for professional accountants. They are governed by disciplinary codes and aspirational codes. The codes are established from the view point that the profession is in control of the discipline mechanism. The basic principle behind these codes is that 'Pleasing the client' should not involve unethical behaviour. However over the years it has been seen that the codes are not followed in principle and this introducers the needs to consider other ethical theories.

According to Duska (2003) accountants have a number of ethical responsibilities towards their family, their company and their clients. In this regards, an important aspect here is to recognize that accountants do not understand their actions of earnings management or insider trading to be unethical. In such situations it becomes extremely important for them to self evaluate an action before its performance.

To evaluate any proposed action one need to ask a few ethical questions.

Is the action good for me? If a person gains additional benefits or maintains his level of existing benefits from performing an action, it is good for him. However one needs to be careful as what is of benefit to oneself is not necessarily what one wants or desires.

Is the action good or harmful for society? One should think of the benefits and effects for the others. However there is a dilemma when the action benefits others but is harmful for oneself.

Is the action fair or just? In all of us there is a belief that equals should be treated equally.

Does the action violate any one's life? All humans are equal and have equal fundamental rights. If any action treats someone unfairly or violates their rights, then there is a reason not to do it.

Have I made a commitment, implied or explicit? If one had made any promises to act in a certain way, then one ought to keep them.

The ethical issues of accounting and auditing can be analysed based on these five points. Certainly the unethical financial actions are beneficial to the individual himself as he gains monetary benefits. However these actions fail the test of the balance questions. The actions are harmful for the society at large and are certainly not fair as the benefits accrue only to a group of individuals. These actions violate the human rights of correct information and their right to make informed decisions. The accountants and auditors are always needed to make a promise to their profession to present a truth and fair view on the details of their organisation, where required under a law.

An ethical dilemma arises in a situation where the reason to act in a certain way is offset by a reason not to act in that way. Ethical theories are used to resolve these dilemmas. The theories that appeal to fairness and rights over consequences are called deontologists and those that appeal to consequences over fairness and rights are called consequentialists (Duska, 2003).

According to Crane (2010), the two main consequential theories are egoism and utilitarianism. Both of these theories look at the outcome of a particular action. However egoism focuses on outcome for the decision maker and utilitarianism on the outcome for the larger society.

Egoism theory explains that individual ought to act in their self interest. This theory tries to say that though pursuing one's self interest is a good thing, but egoist go too far at times and pursue selfish behaviour. Here it is important to understand the difference between self-interest behaviour and selfish behaviour. Self interest pursuits are good and it is healthy for everyone to peruse their self interest. Self interest is a good reason for doing something that will be good for themselves. However, many times the pursuit of one's interest can only be done at the expense of others. This behaviour that brings gains only for a few and loss to many is not self-interest behaviour but it is self-fish behaviour (Duka, 2003).

Creative accounting is a classic example of the egoism theory. By adopting creative accounting the individuals display selfish behaviour and make large gains. The agreement of an auditor with these deceptive acts of his clients is also governed by the selfish motive of additional fees and client continuity. These gains made by a few people cause huge losses to the society at large. If these behaviours are continued for a prolonged period, they probably lead to liquidation of the company which in turn has many impacts such as loss of investor wealth, loss of revenue to the government, legal costs for the creditors and loss of job for employees. Additionally, this behaviour is not acceptable in the field of accounting as the code of ethics in accounting requires acting in a way that will serve the public interest.

In July, 2002, WorldCom filed for one of the largest corporate bankruptcy ever. WorldCom blamed the company's former chief financial officer and the former controller for overstating cash flows and inflating total assets through capitalization of operating costs for an amount estimated to be about $11 billion. Charged with securities fraud, conspiracy and other charges, they face 65 years in prison. These forged transactions that were frequently recorded from 1999 to 2002 were not even identified or highlighted by the auditors (Guardian, 2002). This shows how the management and the accountants follow selfish behaviour.

In contrast, utilitarianism theory says that an action is ethically right if it results in the greatest amount of good for all the people affected by the decision. Utilitarianism requires an individual to identify potential the problem and the available courses of action; it requires him to identify the potential impact of his actions on all the affected party. Utilitarianism is different from egoism because it does not simply see the consequence for the agent but it sees the consequence for everyone concerned by the action. Suppose the management of a company want to reduce the tax liabilities and so they reduce the profits of that company by artificially increasing the amount of expenses and the auditors ignores such adjustments. Here it may be in the interest of the company and the auditor might receive additional compensation for this behaviour but it is certainly not in the interest of the greatest number of people of that country. According to utilitarianism theory this is an unethical behaviour and it requires accountants to merely convey unbiased information that is beneficial for the larger interest group (Preuss, 1998).

Utilitarianism theory also says that it is not necessary to know all the implications of a particular action and a person can rely on the past evidence to get a judgement of the potential consequences of his actions (Crane, 2010). Here the important point for auditors is that before entering into any unethical behaviour, they should look into the past and see the effects of similar events that lead to significant losses to numerous investors and job losses for the employees. This action causes more harm than benefit and is condemned by utilitarian's. Here if one evaluates the actions of these individuals using the cost-benefit approach, the total cost outweighs the benefits of these unethical behaviours. Accountants and auditors need to always think about the larger public interest as they are always seen as professional providing services for the betterment of society.

Peregrine Systems Inc., an enterprise software company filed for bankruptcy in 2003. The US SEC charged the company for massive financial fraud. The officers of the company were involved in inflating the company's revenue and stock price. Due to the failure of the company shareholder lost more than $4 billion in equity and the company laid off thousands of its employees (worldlingo.com, nd). If the auditors of the company would have pointed out these adjustments at the initial stage, the larger losses caused to all the people could have been avoided,

According to Crane (2010), the two main non-consequential theories are ethics of duties and ethics of rights and justice. Both of these theories look at the basic universal principles of right and wrong.

Ethics of duty comes from the works of philosopher Immanuel Kant. He said that humans act rationally and so they can decide their principles themselves and make their own rational decisions regarding right and wrong. He developed three maxims which individuals may use as a test for every possible action and then they can take make a decision if their actions are right or wrong. Maxim one says to check if the action could be performed by everyone and in every situation. Maxim two focuses that all humans deserve autonomous respect and says human dignity should be given upmost importance. The third maxim scrutinises your respond to the prior two maxims and requires you to check if your actions are acceptable to all human beings (Crane, 2010).

Certainly the actions of accountants such as revenue management should not be performed by all the accountants in the world as this will destroy the trust amongst all individuals and no person will invest in another's business. There will neither be stock markets to raise equity capital nor any banks to lend money for the activities of businesses. Additionally these activities do not support the second maxim of respect to all human beings.

Parmalat was one of the biggest dairy company in Europe which filed for bankruptcy in 2003. The company collapsed due to a number of reasons such as investment disasters, non-existent cash in bank, fake transactions, hidden debts and the use of derivatives and accounting fraud to hide these facts. These illegal acts were carried out at its worldwide offices and the bankruptcy affected not only the company and its employees but also many international financial institutions (hubpages.com, nd).

These unethical actors do not respect the fundamental rights of investors of true information on the affairs of the company. It shows that the investors are treated as only means to fund the activities of a business and the companies ignore the investor's needs for security of their investments and reasonably assured returns. Certainly these actions are not acceptable by the society.

The issue of window dressing can also be analysed from the view point of virtue ethics. Virtue ethics considers intentions and outcomes, whereas duty-based ethics and utilitarianism only see one of them (Preuss, 1998). Virtue ethics contend that morally correct actions are those undertaken by actors with honest characters. Aristotle emphasises that a person's character is very important for morality. One does not acquire character by birth, it is acquired through learning and being in relationship with others in a community (MacIntyer, 1984 as cited by Crane et al, 2010).

Central of ethics of virtue is the notion of good life and in business good life does not mean only profitability. Virtue ethics also takes into view the way the profits are made (Crane et al, 2010). Integrity and trustworthiness are the two virtues that are required by the professionals to maintain objectivity and the public confidence. Virtue ethics can enable accountants and auditors to resolve conflicting duties and loyalties in a morally appropriate way because virtues provide the inner strength of character to withstand pressures that might otherwise overwhelm and negatively influence professional judgments.

Francis (1990) states three obstacles for honest auditing. First, the relationship between internal and external rewards is biased towards external monetary rewards. The integrity of auditor may be compromised for the benefits of retaining a client and obtaining higher business. Secondly, under the prevailing competitive pressure the profession of auditing has demonstrated a lack of solidarity which has manifested itself in auditor switching. Thirdly, virtues require the application of practical wisdom, which is different for all individuals and which differs from the routine application of rules adopted by the professional bodies. If one interprets these ethics and relates them to the profession of audit, it encourages the auditors to show courage and choose the right path even if it requires him to sacrifice the monetary gains.

This view is also supported by the stakeholder theory which states that the corporations are not only responsible to its shareholders alone but they have responsibility towards all the stakeholders. A broad view of stakeholders would include customers, suppliers, employees, stockholders, political action groups, the media, communities, and governments. As seen in companies, managers have a fiduciary relationship with the shareholders and so they always act in their interest, in these situations the stakeholder theory provides a compelling reason that other groups also have a legitimate claim on the company. Managers must balance their responsibility towards shareholders and other stakeholders as this is important for the long term survival of the corporation (Crane, 2010). This theory gains significance in situations where the management pays greater attention to profits of a company and ignores their responsibility towards the other stakeholders. This also becomes imperative in view of the importance gained by corporate social responsibility (CSR) in the modern business environment.

As highlighted by Carroll (1991), an important aspect to behave ethically can be argued that corporations have social as well as financial responsibilities. The emerging importance of corporate social responsibility (CSR) has made it clear that business have responsibility beyond simply making profits. Carroll's four-part model of CSR presents the responsibilities as constructive layers in a pyramid. These are the economic, legal, ethical and philanthropic expectations from a company.

Economic responsibility: A company has responsibility towards a number of stake holders such as that it has to protect and enhance share holders wealth, provide job security and fairly paid jobs to its employees, provide good quality goods and services to its customers, make timely payments to banks and creditors and make appropriate tax payments to government. So the primary responsibility of businesses is to stay in business.

Legal responsibility: It requires a company to abide by the all the laws and regulations. Laws are the codification of the society's moral view and so companies ought to abide by these. The satisfaction of the legal responsibilities is required seeking to be socially responsible.

Ethical responsibility: This requires organisations to do what is right, just and fair. This places additional responsibility on the companies to behave ethically in all circumstance even when not specifically stated by the law. It is very important to avoid ethical norms from being compromised to achieve corporate goals.

Philanthropic responsibilities: The companies are required to undertake activities that improve the quality of life of employees, local community and the society in general. It is important to behave in a manner consistent with the philanthropic and charitable expectations of society.

However when talking of responsible business most of the companies ignore the key issues such as transparency, ethics, corporate governance, anti-corruption and responsibility towards society. The billion dollar fraud in 2009 at Satyam Computer Services Limited, an Indian IT company has raised doubts on how companies practice and define corporate social responsibility. Here inquires have disclosed the role played by the top management and in the fiasco and have also pointed out the involvement of auditors in these practices (Crane, 2010). Similar circumstances were observed in the case of Enron. Enron was a classic example of corporate philanthropy which donated millions in charity to charity organizations and won several awards for its corporate social responsibility work. It also won the climate protection award from the EPA and a corporate conscience award from the Council on Economic Priorities. However the failure of Enron resulted in displacement of more than 20,000 employees (suite101.com, 2010).

Here if we analyse the two cases using Carroll's four-part model of CSR, we see that there were significant failures on part of the company on all the four stages. The companies employed suspicious accounting practices in collusion with the auditors and defrauded the stakeholders. The economic impacts were significantly depressing for all the stake holders. It showed how the companies did not abide by the laws and exposed their unethical practices.

An approach is considered to be ethical if it considers the rights and interests of all the groups affected and tries to develop solutions that are acceptable to all (Dillard et al, 2002). The discussion set out here acknowledges that the codes of ethics in accounting may still be insufficient for addressing issues of moral conflict and thus there is a need for moral development of the person. These theories give a set of ethical approaches that accountants and auditors should use to evaluate their actions and practices. The theories bring out the important judgmental decisions such as larger interest of the investor community, responsibility towards society, integrity and honesty in practice and importance of virtues in life. However none of these theories can be considered in isolation and accountants needs to see the largely picture portrayed by these theories and integrate them with their professional code of conduct.

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