Ethics in Accounting: Does It Really Matter?
Irvin T. Nelson
Utah State University
What is the purpose of
accounting?
To provide information to decision
makers
What are the desired
characteristics of information?
•
•
•
•
Timeliness
Understandability
Reliability
Truthfulness
What is truth?
• Fair
– Not misleading
• Unbiased
– Not predisposed in a particular direction
• Representational faithfulness
– Conveys an accurate impression of the
underlying reality
What is Truth?
• “Oh say, what is truth? ‘Tis the fairest gem
that the riches of worlds can produce… ‘Tis
an aim for the noblest desire.” – John
Jaques
What is Truth?
• “Truth is a correspondence between what
we think and what is real.” -- Plato
What is Truth?
• “Truth is knowledge of things as they are,
and as they were, and as they are to come.”
– Joseph Smith, Jr.
What is Truth?
• “To tell the truth, rightly understood, is not
just to state the facts, but to convey a true
impression.” – Robert Lewis Stevenson
Forms of Lying
•
•
•
•
•
Saying something that is not so
Overstatement/exaggeration
Understatement
Withholding relevant information
What do these have in common?
– They all fail to convey a true impression
What is the relationship between
truth and CPAs?
“The auditor’s job is to determine what is
and what is not true, then to assure that
what is true is properly communicated to
the stakeholders.” – Richard L. Ratliff
What is the relationship between
truth and CPAs?
• What has been the function of the CPA profession
in society?
• Historically, it has been looked upon as the
“watchdog of business,” the “trustworthy
guardians of truth.”
• Even the Academy Awards hired Price Waterhouse
to tally the votes for the Oscars. Why? Because
their integrity was unquestionable. The public
perceived that the integrity and independence of
CPAs was beyond reproach, beyond question.
What happens in the absence of
truth?
• Stock market crash of 1929
– Led to the Great Depression
• Audit failures in the 1980s
• Enron, World Com, etc.
– Damaging public confidence in capital markets
– Cost to the economy is not measurable but may
be larger than 9/11 and Iraq combined…
What are the implications to
CPAs?
• “When a societal institution fails to fill the
function expected or demanded by society,
it is done for.” – Thomas D. Hubbard
• Hence, the CPA profession is rightly
concerned over its tarnished reputation.
• Unfortunately, its reaction to the scandals
has not addressed the real problems…
What Stands In the Way of
Truth?
•
•
•
•
Greed
Gaming Mentality
Incorrect conception of business
Tinkering with little changes will not solve
the problem
– Tweak peer review
– Spin off consulting, etc.
– Business as usual
What Stands In the Way of
Truth?
“The very conception of the corporation as a
‘legal fiction’ defined in terms of
obligations to its stockholders implies that
corporations are not moral or morally
responsible agencies.” – Robert C. Solomon
What Social Systems are
Supposed to Ensure Truth?
• Securities Acts of 1933 and 1934
• Independent Auditors
• Why do you think Congress passed those
acts?
What Social Systems are
Supposed to Ensure Truth?
• The middle word in CPA is “public”…
• Does this imply auditors have a duty to the
public?
• Or does it mean auditors’ first duty is to the
public?
• Or does it mean auditors’ only duty is to the
public?
Only THREE things protect the
public from lies:
• Competence
• Independence
• Ethics
There is no substitute for
competence
• No matter how independent and ethical you may
be, if you don’t know what you’re doing, the
public will not be protected
• Many audit failures in the past have been caused
by a lack of competence
• However, competence by itself is dangerous. In
the absence of independence and ethics,
competence only increases the ability to figure out
how to get away with doing the wrong thing!
Competence is Necessary but Not
Sufficient
• True independence, and/or
• Unimpeachable ethics are also needed
Independence is Problematic
• Independence is more than not owning
stock in the company being audited, not
dating people employed by the company
being audited, etc.
• It means not having a conflict of interest
• But auditors always have a financial and
psychological interest in the companies they
audit
Independence is Problematic
• In theory, auditors are hired by the board
• In practice, auditors are hired by
management
• There is essentially no auditor rotation
• “You don’t want to be the one who lost the
account.”
– Barry Minkow, ZZZ Best
Independence is Problematic
• Bottom line:
– The relationship between client and auditor in
the real world is rather “cozy”
Independence is Problematic
“The interviewer asked me why I wanted to be an
auditor. I told him I had wanted to be an FBI
Agent when I was young and that I viewed
auditing as a similar type of activity; digging and
analyzing evidence and ferreting out what’s true.
He looked at me like I didn’t know what I was
talking about.” – Jeffrey T. Doyle
Independence is Problematic
“When the FASB wants to increase financial
statement truthfulness and fairness, the large firms
have traditionally argued against any proposed
rule change…
Independence is Problematic
“The firms have partner groups that discuss FASB
proposals and submit responses in behalf of the
firm. Individual partners are not free to express a
position different from that taken by the firm. Of
course, before the firm position is adopted, the
responsible partner group listens carefully to the
opinions of their clients and, for some unexplained
reason, always seems to end up advocating the
same position as their clients…
Independence is Problematic
“During my career, I have had many discussions
with leading partners of what were once the Big 8
firms. These partners are all men and women
whom I respect, but in 40 years of such
conversations, I don't recall a single case where
the partner agreed with the position that I felt was
right…
Independence is Problematic
“They seemed unable to discuss a topic with
intellectual honesty, based on what would lead to
more truthful financial statements. Instead, they
always recited the ‘party line’ advocated by the
firm’s clients and seemed oblivious to the ‘error of
their ways.’ They behaved more like cheerleaders
for their clients than they did ‘watchdogs of the
public interest.’ ”
– A. Tom Nelson
In the Absence of De Facto
Independence…
Then there’s only one remaining thing
protecting the public:
ETHICS!
Something Has Gone Wrong
• “Trust is the accountant’s stock in trade.
That’s all we have to sell.”
– Richard L. Ratliff
• AICPA Surveys
– Before Enron, CPAs ranked a step above clergy
in public trust
– After Enron, CPAs ranked a step below used
car salesmen in trust
Something Has Gone Wrong
• “My heart breaks, and I'm embarrassed for our
profession right now.”
– Irv Nelson, after hearing Arthur Andersen partners
defend their audit of Enron by saying they didn’t do
anything wrong because they followed GAAP
Something Has Gone Wrong
When former SEC chairman Aurthur Levitt
testified before the Senate Hearing on the Collapse
of Enron (January 24, 2002) he decried the
“culture of gamesmanship” in which the objective
is not to ensure the reality of the numbers but
rather to try to get away with as much as possible.
Management Accounting
Examples
• Manipulating Earnings
– Smoothing
– Playing with bad debt reserves, asset lives,
inventory adjustments, timing of write offs
– Playing with timing of revenues
• Hiding Debt
– Leases
– Special Purpose Entities
Auditing Examples
• Allowing clients to “get away with”
accounting treatments the purpose of which
is to lie / distort / manipulate
• Holding GAAP as the ultimate standard,
instead of truth
• Failing to follow substance over form
• Advising clients how to structure
transactions so as to “get around the rules”
Something to think about…
As the FASB moves away from rules-based
standards towards principles-based
standards, ethics will become increasingly
important…
What are Ethics?
• Perhaps one of the problems is that we have
a flawed conception of ethics.
• Some view ethics as adherence to a set of
rules (“code of ethics”)
• Like the rules of a game (“gaming ethics”)
• If it’s not against the rules, it’s OK
• Others view ethics as flexible; what’s right
for some might not be right for others…
Models of Ethics:
• Relativism
• There is no such thing as right and wrong; it all
depends on the situation
• There is no such thing as truth; it all depends on
your point of view
• List the stakeholders, consider their competing
claims
• Objective: the most good for the most people
Models of Ethics:
• Principles-based Ethics
• “Virtue Ethics” – based on Aristotle
• There is such a thing as right and wrong
• Our duty is to figure out what’s right and do it
because it’s right (not because of an analysis of
the relative social good of various choices)
• Objective: live a life of virtue and integrity
Definitions:
•
•
•
•
•
Principles
Values
Pseudo-values
Ethical Behavior
Integrity
Principles
•
•
•
•
Universal truths
What IS right and wrong
Exist independent of any person or group
Do not vary between cultures, time periods
Can We Agree on Universal
Principles?
•
Dr. James W. Brackner proposed 10
values that seem to be universal across all
cultures:
1.
2.
3.
4.
5.
Honesty
Integrity
Promise-keeping
Fidelity
Fairness
Can We Agree on Universal
Principles?
6. Caring for Others
7. Respect for Others
8. Responsible Citizenship
9. Pursuit of Excellence
10. Accountability
May these be considered examples of correct
principles?
Principles
• People cannot see principles perfectly
• We view principles through the lens of our
experiences
• Colored and distorted to some degree
• Thus, we don’t live our lives on principles;
we have to translate them into VALUES
Values
Life
Experiences
Principles
Values
• How each person decides what he/she
THINKS is right and wrong
• Core beliefs upon which we live our lives
• Do vary between individuals and cultures
• Because each person’s lens is different
• May or may not be based on correct
principles
• Making choices in accordance with values
leads to self-esteem
What Is Ethical Behavior?
• To be ethical, a choice must be in
accordance with one’s values, AND
• Those values must be based upon correct
principles
• Neither is sufficient; both are necessary
What Is Ethical Behavior?
• "What ought to be?"
• The choice that is more right, more good,
and more just than the others
What Is Integrity?
• When a person consistently makes ethical
choices across a wide range of situations,
over a lifetime, that person has “integrity.”
Everyone must answer the
following question:
“What is my highest aspiration?”
–
–
–
–
–
Wealth
Power
Knowledge
Popularity/fame
Integrity
“Be on guard; if integrity is secondary to any
of the alternatives, it will be sacrificed in
situations in which a choice must be made.
Such situations inevitably occur in every
person’s life.”
-- Dr. L. Murphy Smith, in testimony to U.S. House of
Representatives Subcommittee on Commerce, Trade, and
Consumer Protection hearing on accounting scandals, July
26, 2002
American Institute of CPAs Code of
Professional Conduct, Principles
Article I:
In carrying out their responsibilities as
professionals, members should exercise
sensitive professional and moral
judgments in all their activities.
Pseudo-Values
Beliefs professed but not lived
Enron’s Values Statement,
included in 2000 annual report:
•
•
•
•
Excellence
Communication
Respect
Integrity
Pseudo-Values
• When values are not lived, emotional
dissonance results
• Two possible responses:
• Elevate behavior to level of values, or
• Use thinking errors
Thinking Errors
• Excuses we tell ourselves to make us feel
better about our unethical behavior
• Examples:
•
•
•
•
•
Rationalization (it’s OK because…)
Justification (I deserve it…)
Minimization (it’s not so bad…)
Blame Shifting (don’t blame me…)
Sincere delusion (it’s only this once…)
Look for the Thinking Errors:
Management Accounting
“We work for management. Our job is to make
management look good.”
“Our obligation is to our shareholders. Anything
we do to make the stock price go up is ethical.”
“Every good accountant knows where to find it.”
“You’re not being a team player.”
“You’ve got to stop thinking like a CPA and start
thinking like a management accountant.”
“You WILL make this journal entry.”
Look for the Thinking Errors:
Public Accounting
“We followed GAAP.”
“Enron didn’t do anything illegal.”
“If you want more transparency, you need to
change the rules. Don’t blame us.”
“Those partnership documents are incredibly
complex and 80 pages long.”
“We couldn’t force Enron to put it on the balance
sheet because we can’t break the rules.”
“Our capital markets are the most efficient in the
world.”
Three Choices:
• Blind loyalty
• Exit
• Voice
In his best-seller, The Closing of
the American Mind, Allan Bloom says
that the eternal conflict between good
and evil has been replaced with “I’m
okay, you’re okay.” Students unthinkingly
embrace a blind tolerance in which they
consider it “moral” never to think they
are right because that means someone
else is wrong.
Should Universities Teach
Principles and Values?
“Professional accounting education must not
only emphasize the needed skills and
knowledge, it must also instill the ethical
standards and the commitment of a
professional.”
– Bedford Committee Report, 1986
Should Universities Teach
Principles and Values?
University education should support the
development of intellectual skills, which include
the ability “to identify ethical issues and apply a
value-based reasoning system to ethical
questions,” and also general knowledge, which
includes “experience in making value judgments.”
-- Perspectives on Education: Capabilities for
Success in the Accounting Profession (1989),
white paper jointly authored by the “Big Eight.”
Should we teach values?
The National Commission on Fraudulent
Financial Reporting (Treadway Commission)
recommended that [accounting] curricula
should integrate the development of ethical
values with the acquisition of knowledge and
skills. In a keynote speech to the American
Accounting Association, John Burton, Dean of
the Columbia University Business School
stated that a declining influence of social
institutions has increased the role educators
must play in shaping values.
Should Universities Teach
Principles and Values?
“High quality corporate reporting requires people
of integrity, a spirit of transparency and a culture
of accountability. The values of quality, integrity,
transparency, and accountability should be
integrated throughout the curriculum… People of
integrity are essential because transparency can
only occur when individuals try to “do the right
thing…
Should Universities Teach
Principles and Values?
“All business students must understand that
personal integrity is not a choice. It is an
obligation for those who serve the public interest.
The profession is best served by academic
experiences that require compliance with
reasonable standards of conduct. Faculty
members should not tolerate actions that
demonstrate a lack of integrity.”
– PricewaterhouseCoopers white paper, March 2003
Should values
be taught?
Teddy
Roosevelt
said, “To
educate a
person in
mind and not
in morals is to
educate a
menace to
society.”
If we want to
produce people
who share the
values of a
democratic
culture, they
must be taught
those values
and not be left
to acquire
them by
chance.
Cal Thomas, The
Death of Ethics in
America
Not Everyone Agrees…
Sellers and Milam (1979) examined accounting student
perceptions of professional ethics and concluded,
“(Accounting) students are better in a moral/ethical sense
than they are given credit for,” and
“There is less need for the addition to curriculum of
courses in professional ethics than many educators
would have us believe.”
Sellers and Milam further concluded that the CPA code of
ethics was all that was needed and that “additional
courses in professional ethics are not necessary.”
What do profs think?
In a survey of college faculty, 187 professors responded to
several statements about teaching ethics:
1. The importance of ethics and personal integrity
should be stressed in the courses I teach. 4.75
2. The basis for ethics and personal integrity
should be discussed (e.g. benefit to society
as a whole, moral and religious foundations
of society, etc.)
4.11
Note: Scores are based on a scale from
1: Strongly Agree to 5: Strongly Disagree
In an issue of Management Accounting,
James W. Brackner stated: “The universities
are responding with an increased emphasis
on ethical training for decision making. For
the most part, however, they ignore the
teaching of values. For moral or ethical
education to have meaning there must be
agreement on the values that are considered
‘right.’ ”
“Until about 50 years ago, it was commonly
accepted that universities were to provide
students not only with knowledge and skills,
but also moral guidance based on the
essentials of the Western tradition.”
Geoffrey Lantos
Should Universities Teach
Principles and Values?
• In the early years of American University
education, moral values were an important
part of the curriculum
• In the last 50 years this has been replaced
by relativism
• There is an extreme reluctance to talk about
right and wrong for fear of offending
• What is the result?
In a recent Wall Street Journal
article, Psychology professor
Steven Davis says that cheating by
high school students has increased
from about 20 percent in the 1940’s
to 75 percent today.
“Students say cheating in high school is
for grades, cheating in college is for a
career.”
If students lack ethics in high school and
college, then there should be little surprise
that they lack ethics in their careers. Greed
and over-reaching ambition often end in
disastrous personal consequences.
Convicted inside trader, Dennis Levine, in
a Fortune magazine article wrote:
“I have painful memories of Sarah
learning to walk in a prison visiting
room, and of Adam pleading with a
guard who wouldn’t let him bring in a
Mickey Mouse coloring book.”
Educational Institutions
have established ethics
codes for their students,
e.g. the U.S. Air Force
Academy:
“We Will Not Lie, Steal Or Cheat, Nor
Tolerate Among Us Anyone Who Does”
-- Which do you think is the harder part:
Line 1 or Line 2?
Why?
What Happened to the Young
Auditors at Andersen?
• The firm owns you
• Team player – lose individual identity
• Culture: “We’re here to help Enron
succeed”
• Desensitization from ignoring conscience
• Principles fell like dominoes
– Integrity fell first, knocking down others
– Truth, fairness, empathy then fell
“We, as individuals, become the resultant
sum of each ethical confrontational event as
experienced from the beginning of our
careers. Simply stated, if we have
conditioned ourselves to blink at the small
decision opportunities at the beginning of
our careers, then we will precondition
ourselves to also blink at the more
important decision opportunities later.”
-- Roger M. Boisjoly, Morton Thiokol engineer who strongly argued
against Space Shuttle Challenger launch at 29 degrees F, in the face of
tremendous management pressure
Implications
• Strength of financial markets
• Health (survival?) of accounting profession
• Bigger implications than these???
Implications
• Before the American Republic, a common
belief was that where there was liberty,
anarchy would result because people are
unable to govern themselves. Yet
Americans were free and well behaved.
How could this be?
Implications
• The great English writer, G.K. Chesterson,
observed that America was the only nation
in the world founded on a creed. He said
that creed was set forth with dogmatic and
even theological lucidity in the Declaration
of Independence.
Declaration of
Independence
The second paragraph of
America's founding document
states:
"We hold these truths to be
self-evident, that all men are
created equal, that they are
endowed by their Creator with
certain unalienable rights, that
among these are life, liberty
and the pursuit of happiness."
Implications
“A society teeters on the brink of disaster
when its people lack moral character. No
nation survives for long without citizens
who share common values such as courage,
devotion to duty, respect for other people’s
lives and property, and a willingness to
sacrifice personal interests for a greater
cause.” – L. Murphy Smith
Can you make a difference?
It all boils down to personal choices
Alternative Courses of Action
Available in Ethical Situations
ACTIONS
NOT THINK
ABOUT IT
GO ALONG &
GET ALONG
PROTEST
ADVANTAGES
DISADVANTAGES
Avoids the danger of
getting into a zero-sum
game with colleagues
The risk of going in the
wrong direction
Same as “not think
about it”
Same as “not to think
about it”
Individuals slowly
conform… maybe to the
wrong direction
Individual feels good
about making effort to
stop unethical
behavior
Organization disregards
protest & punishes
protester
Alternative Courses of Action
Available in Ethical Situations
ACTIONS
CONSCIENTIOUSLY
OBJECT
 LEAVE
ADVANTAGES
DISADVANTAGES
Makes clear statement
that one person feels
that action is unethical
Person feels good
about self for making
effort to stop unethical
behavior
Few organizations
recognize individual
rights to object
Signals that
organization will lose
good people if unethical
behavior continues
Person who leaves may
join a competitor, feels
better because he/she
did not cooperate with
unethical behavior
Most people are
replaceable and if
replacement
cooperates with
unethical behavior,
what is gained?
May hurt chances for
rewards and
advancement
Alternative Courses of Action
Available in Ethical Situations
ACTIONS
SECRETLY BLOW
THE WHISTLE
PUBLICLY BLOW
THE WHISTLE
SECRETLY
THREATEN TO
BLOW THE
WHISTLE
ADVANTAGES
DISADVANTAGES
Can be very effective
If whistle-blower
remains secret,
retaliation cannot
occur
- Feelings of cowardice
- Creation of atmosphere of
mistrust
- What will whistle-blower do
if confronted by firm - tell the
truth or lie?
Can be effective
Whistle-blower may
be treated as a hero
by many
- Organization may attack the
whistle-blower
- It is difficult to interact with
those one is criticizing
- It may be difficult to work
with those who hold a
grudge
Can be very effective
When it works,
organization is not
hurt by bad publicity
- Does not permit dialogue
between upper&lower
managers
- Might prevent injured
consumers or clients from
receiving remedies
Alternative Courses of Action
Available in Ethical Situations
ACTIONS
SABOTAGE
ADVANTAGES
Can be effective
Identity of saboteur
might be protected
DISADVANTAGES
Sabotage is not dialogue
Retaliation might occur
against the saboteur or
against others
Innocent people may be
fired
NEGOTIATE
Individual action may
lead to small-group
consensus that will be
more effective than
individual action
Win-win solutions are
possible
Does not work well in
situations that are zerosum, lose-win, in nature
Individual who perceives
ethical problem may not
know how to negotiate, my
lose “cool”