irvin t. nelson utah state university ethics in accounting: does it really matter?

Irvin T. NelsonUtah State University

Ethics in Accounting: Does It Really Matter?

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


• 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


• Bottom line:– The relationship between client and auditor in

the real world is rather “cozy”


“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


“When the FASB wants to increase financial statement truthfulness and fairness, the large firms have traditionally argued against any proposed rule change…


“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…


“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…


“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


• “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


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. Honesty2. Integrity3. Promise-keeping4. Fidelity5. 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

Principles

Life Experiences

Values

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.

[Allan Bloom, The Closing of the American Mind, New York, Simon and Schuster, Inc. 1987]

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


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.


“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…


“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


• 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.”

“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?

Educational Institutions have established ethics codes for their students, e.g. the U.S. Air Force Academy:

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

ACTIONS ADVANTAGES DISADVANTAGES

Alternative Courses of Action Available in Ethical Situations

NOT THINK ABOUT IT

GO ALONG & GET ALONG

PROTEST

Avoids the danger of getting into a zero-sum game with colleagues

Same as “not think about it”

Individual feels good about making effort to stop unethical behavior

The risk of going in the wrong direction

Same as “not to think about it” Individuals slowly conform… maybe to the wrong direction

Organization disregards protest & punishes protester



CONSCIENTIOUSLY OBJECT

LEAVE

Makes clear statement that one person feels that action is unethical

Person feels good about self for making effort to stop unethical behavior

Signals that organization will lose good people if unethical behavior continuesPerson who leaves may join a competitor, feels better because he/she did not cooperate with unethical behavior

Few organizations recognize individual rights to object

May hurt chances for rewards and advancement

Most people are replaceable and if replacement cooperates with unethical behavior, what is gained?



SECRETLY BLOW THE WHISTLE

PUBLICLY BLOW THE WHISTLE

SECRETLY THREATEN TO BLOW THE WHISTLE

Can be very effectiveIf whistle-blower remains secret, retaliation cannot occur

Can be effectiveWhistle-blower may be treated as a hero by many

Can be very effectiveWhen it works, organization is not hurt by bad publicity

- Feelings of cowardice - Creation of atmosphere of mistrust - What will whistle-blower do if confronted by firm - tell the truth or lie?

- 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

- Does not permit dialogue between upper&lower managers - Might prevent injured consumers or clients from receiving remedies



SABOTAGE

NEGOTIATE

Can be effective

Identity of saboteur might be protected

Individual action may lead to small-group consensus that will be more effective than individual action

Win-win solutions are possible

Sabotage is not dialogue

Retaliation might occur against the saboteur or against others

Innocent people may be fired

Does not work well in situations that are zero-sum, lose-win, in nature

Individual who perceives ethical problem may not know how to negotiate, my lose “cool”

irvin t. nelson utah state university ethics in accounting: does it really matter?

Documents

way of truth

solomon slide

ratliff slide

usual slide

plato slide

absence of truth

true impression slide

underlying reality slide