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Ethics is the lifeblood of the accounting profession. An ethical breach by a few unscrupulous partners and employees in the Houston office of Arthur Andersen led to the demise of this huge international accounting firm (see the Reality Bytes side bar for more details). Thousands of people lost their jobs and hundreds of millions of dollars of damages were incurred. This debacle stands as convincing evidence of the importance of ethical conduct to the accounting profession. The importance of ethical conduct is universally recognized by accountants. All the major professional accounting organizations require their members to follow formal codes of ethical conduct. The underlying principles of the Code of Professional ConductA set of guidelines established by the American Institute of Certified Public Accountants (AICPA) to promote high ethical conduct among its membership.6 adopted by the American Institute of Certified Public Accountants are summarized in Exhibit 1.7. Other codes follow similar principles.
Sarbanes-Oxley Act of 2002Codes of ethics cannot deter all unethical behavior. The massive surprise bankruptcies of Enron in late 2001 and WorldCom several months later suggested major audit failures on the part of the independent auditors. An audit failure means a company’s auditor does not detect, or fails to report, that the company’s financial reports are not in compliance with GAAP. The audit failures at Enron, WorldCom, and others prompted Congress to pass the Sarbanes-Oxley Act, which became effective on July 30, 2002. The provisions of this legislation are complex, and their full effects will not be known for some time. However, it is clear that the act has tightened the rules governing auditors’ independence. Prior to Sarbanes-Oxley, independent auditors often provided nonaudit services, such as installing computer systems, for their audit clients. The fees they earned for these services sometimes greatly exceeded the fees charged for the audit itself. This practice had been questioned prior to the audit failures at Enron and WorldCom. Critics felt the independent audit firm was subject to pressure from the company to conduct a less rigorous audit, or risk losing lucrative nonaudit work. The Sarbanes-Oxley Act prohibits auditors from providing most types of nonaudit services to companies they audit. Another provision of Sarbanes-Oxley clarifies the legal responsibility that company management has for a company’s financial reports. The company’s chief executive officer (CEO) and chief financial officer (CFO) must certify in writing that they have reviewed the financial reports being issued, and that the reports present fairly the company’s financial status. An executive who falsely certifies the company’s financial reports is subject to significant fines and imprisonment. Additional details of the Sarbanes-Oxley Act are presented in Chapters 11 and 14. Further discussion of the problems at WorldCom and Enron are presented in Chapters 6 and 10, respectively. Common Features of Ethical MisconductPeople who become involved in unethical or criminal behavior usually do so unexpectedly. They start with small indiscretions that evolve gradually into more serious violations of trust. To reduce the incidence of unethical or illegal conduct, business persons must be aware of conditions that lead to trust violations. To increase awareness, Donald Cressey studied hundreds of criminal cases to identify the primary factors behind ethical misconduct. Cressey found three factors common to all cases: (1) the existence of a nonsharable problem, (2) the presence of an opportunity, and (3) the capacity for rationalization.7
As the term implies, a nonsharable problem is one that must be kept secret. Individuals differ about what they keep to themselves. Consider two responses to the problem of an imminent business failure. One person may feel so ashamed that he or she cannot discuss the problem with anyone. Another person in the same situation may want to talk to anyone, even a stranger, in the hope of getting help. Other nonsharable problems include personal vices such as drug addiction, gambling, and promiscuity. Cressey’s findings suggest that the person who is inclined toward secrecy is more likely to accept an unethical or illegal solution. In other words, the perceived need for secrecy increases vulnerability. Accountants establish policies and procedures designed to reduce opportunities for fraud. These policies and procedures are commonly called internal controlsA company's policies and procedures designed to reduce the opportunity for fraud and to provide reasonable assurance that its objectives will be accomplished.. Specific internal control procedures are tailored to meet the individual needs of particular businesses. For example, banks use vaults to protect cash, but universities have little use for this type of equipment. Chapter 6 discusses internal control procedures in more detail. At this point, simply recognize that accountants are aware of the need to reduce opportunities for unethical and criminal activities. Few individuals think of themselves as dishonest, so they develop rationalizations to justify their misconduct. Cressey found a significant number of embezzlers who contended they were only “borrowing the money,” even after being convicted and sentenced to jail. Common rationalizations include peer pressure, loyalty to unscrupulous superiors, family needs, revenge, and a sense of entitlement. To avoid involvement in ethical misconduct, accountants must develop a strong sense of personal responsibility. They cannot allow themselves to blame other people or unfair circumstances for their problems. They must learn to hold themselves personally accountable for their actions. Ethical misconduct is a serious offense in the accounting profession. A single mistake can destroy an accounting career. If you commit a white-collar crime, you normally lose the opportunity to hold a white-collar job. Second chances are rarely granted; it is extremely important that you learn how to recognize and avoid the common features of ethical misconduct. To help you prepare for the real-world situations you are likely to encounter, we include ethical dilemmas in the end-of-chapter materials. When working with these dilemmas, try to identify the (1) secret, (2) opportunity, and (3) rationalization associated with the particular ethical situation described. If you are not an ethical person, accounting is not the career for you. 6 American Institute of Certified Public Accountants, Inc. (AICPA), Code of Professional Conduct (New York: AICPA, 1992). 7 D. R. Cressey, Other People’s Money (Montclair, NJ: Paterson Smith, 1973). | |||||||||||
