THE ROLE OF PROFESSIONAL ETHICS IN ACCOUNTING AND AUDIT
AC793 summer class
Accounting is a valuable knowledge and taking an important role in market economy. In recent years, every transaction cannot exist without relying on accounting. Accounting is an organized process of identifying, recording, measuring, verifying information regarding financial situation and operation profitability. Accounting knowledge is fundamental construction for financial and monetary systems of various countries and plays an important role to “oversee” to create the responsiveness and interpretation in economy. The high portfolio of fraud in which accountants and auditors, management level or executive level are involved, lead to the public confidence decreasing about honesty and trust of professional accountants. The main issues in accounting profession is official auditors have the exclusive advantage of legal audit and the responsiveness from public for this exclusive advantage. Via its special features, the profession as objectivity, integrity, keeping public interest protect the exclusive benefit. More and more criticisms on relationship between these features and professional behavior arise during the past 20 years. In a 20th century, the main concern related to ethical issues and ethics on accounting jobs but this claim is challenged by regulators, lawyers, investors, and stockholders.
Definitions and Discussion
Ethics refers to a system of behavior that is related to the standard of behavioral error. The term encompasses the following concepts: (1) ethical standards of conduct, (2) moral responsibility, our conscience and (3) moral identity, or the ability of someone to behave correctly and wrongly. Its common synonyms are moralities, principles, virtues and goodness. People live on the world have own a set of principles but sometimes we will ignore them. Philosophers, religious institutions and other groups or personnel defined ideal ethical values by various methods. The examples of real ethical values are determined at education level, including rules, religious teaching, ethical principles in commerce for individual, industrial groups and professional ethics regulations in organizations. Ethics has become a complex issue in the multicultural world in which we live today.
2-2 Professional ethics
The formation of accounting ethics is an integral part of the formation of professional ethics. The formation of professional ethics is closely related to the social division of labor, a historical development process. The formation of professional ethics is the same as the formation of a certain class of morality. It has deep economic roots and is a product of certain social and economic relations. Because professional ethics is the ethical norms and requirements in people’s professional life defense. Therefore, the formation of professional ethics is linked to the division of labor in dark gray production and various professional activities. The generation of professional ethics is much later than social morality.
The concept of professional ethics is broad and narrow. The broad sense of professional ethics refers to the code of conduct that practitioners should follow in their professional activities, which covers the relationship between employees and clients, occupations and employees, and occupations and occupations. The narrow sense of professional ethics refers to the professional code of conduct and norms that should be followed in certain professional activities, reflect certain occupational characteristics, and adjust certain occupational relationships. Different professional personnel form special occupational relationships in specific professional activities, including the relationship between professional subjects and professional service objects, the relationship between professional groups, the relationship between people within the same professional group, and the relationship between professional workers, professional groups and the state.
Most of the companies will formulate their own standards and principles for professional ethics. The main goal of formulating behavioral standards is that ethical responsibilities are defined to the group, industry, and society. Common features in the mentioned jobs are including:
1- Required to achieve certain qualification to enter the job
2- Master in technology and professional knowledge
3- Responsibility in providing the services to society
4- The need to achieve acceptability and society trust
Ethical principles in these jobs are behavioral norms. People should know what they should do and they should not do in various economic (Duska et al., 2006). The key focus of professional rules is the norms. These norms are issued based on the accepted values and are described by some terms as good, bad, false and true.
Max Weber divided ethics into three sections:
1- Ethics in family and private life
2- Ethics in economic life
3- Ethics in politics and social relations
Thus, professional ethics in accounting and audit is the subset of business ethics and business ethics is the subset of morality in economic life (Bayat, 2008)
2-3 Accounting and audit profession
There are different reason arising for producing accounting and audit. Accounting is produced to meet the objective needs of social production practice and economic management and develops with the development of production. The reasons for the audit include the relationship of economic responsibility, the separation of the two powers, and the owner of the property cannot directly supervision.
Accounting and audit due to effective role in business are considered by various communities from the past. This profession dates back to the early human being civilization. Indeed, when trading was started, people were paying attention to record the transactions and reporting. In ancient civilizations, regulators will govern tax and assets of government. In 3700 years before and in ancient civilization of Sumerians, there was a comprehensive financial system recording agriculture basic information like the amount of grains, livestock and also the estates of government. In ancient civilizations of Egypt, the cash inflows and outflow of government were kept carefully. In the 13, 14 centuries and alone with the growth of industry, trading and banking, considerable progress was made in holding the accounts. At the end, in 1800, both balance sheet and profit and loss statement were common. After the industrial revolution, it is popular that the manufacturing operation of capital markets.
2-4 Ethics in accounting and auditing
2-4-1 The Enron Collapse
In a 20th century, astonish scandal of financial fraud and collapse of one of world great companies as Enron indicated that current regulations are not adequate in professional responsibilities. Professional accountants besides learning the technical regulations should be dedicated to follow professional ethics. Enron set up in 1985 through merging of Houston Natural Gas and Internorth, it became the first nationwide natural gas pipeline network company. After that, the firm’s main business area changed to unregulated energy trading markets from original the regulated transportation of natural gas. The business found out that it could earn more money in buying and selling financial contracts linked to the value of energy assets (and to other economic variables) than in actual ownership of physical assets.
Until late 2001, almost all business economists and observers – including some from Wall Street – believed it is an outstanding success to change main business. Economists reached that conclusion from Enron’s annual report in which revenues grew from under $10 billion in the early 1990s to $139 billion in 2001 and Enron as a new business star ranked fifth on the Fortune 500. Similar as many other firms, Enron believed that the Internet presented a new future in business world. In late 1990s, Enron started to purchase companies in Internet industry, such as on-line marketers and service providers (a fiber optic communications network), and also put a lot of money on developing a new market for trading broadband communications capacity. A series aggressive purchasing on the time of markets near the peak of the boom and Enron paid high prices. Instead of paying cash, Enron took on a heavy debt load to finance. When the Internet dream broke in 2000, revenues from these investments dried up, but the debt remained.
It is common for businesses to pay certain prices after bad investments. However, in Enron case, it was worse when the company response to its financial problems. Instead of disclosing its real financial condition to the public (required by the law), Enron manipulate its accounts. Enron transferred their own business losses and almost no residual value assets to undisclosed partnerships and “special purpose entities.” Simply speaking, the firm’s public annual report falsified that losses were occurring to the independent entities but not to Enron. However, SPEs were only apparently independent firms that had made an agreement with Enron to accept its losses but were in fact accounting tricks created and entirely controlled by Enron’s management. In addition, Enron appears to have falsified bank loans account as energy derivatives trades to conceal the public that the company is in indebtedness. Those accounting fair tale lasting for almost 2 years, then had been exposed to the truth – profits were overstated over 80%. After that, Enron was collapsed quickly.
2-4-2 The Role of Arthur Andersen in Enron Scandal
Enron had a long relationship with its outside auditor Arthur Andersen (AA) since 1985. Arthur Andersen was an international firm of 36,000 employees but dismissed after the collapse of Enron. During two companies 16 years business relationship, AA not only provided Enron external auditing but also provided internal auditing and consulting services. Until 2001, according to Enron past four years annual reports, Enron overstated its profits by $568 million in total which it had taken up 20 percent of Enron’s earnings. Andersen auditors helped Enron to cheat this earnings to the public through manipulate and falsified accounts. On June 15, 2002, Andersen was admitted that they were shredding audit documents of Enron. (Arthur Andersen v. United State, 2005)
There are four aspects that Arthur Andersen(AA) had an important contribution on Enron collapsed. Firstly, Andersen never disclosed their unethical behavior when they falsified and manipulated financial accounts. Because of Enron was one of AA’s major clients, there was downward pressure on auditing fees. Andersen faced considerable pressure to maintain the audit fees in relatively low level. The company believes that the audit opinion given by the accounting company is only like the goods on the market. In order to secure AA’s own financial interest, AA participated the cheat game with Enron together on several years annual reports. It is unethical action but also break the law. To try to save AA’s important client and also AA attracted by financial interest for their own, AA act in illegal way. From ethical aspects, AA broke integrity and acted not objectivity, they should stop this fraud at the beginning stage.
Secondly, Arthur Andersen placed increased emphasis on performing consulting services for audit clients. It was violating accounting and auditing standards because there were conflicts of interests among these services. This conflict of responsibilities of AA didn’t follow auditing standards and were illegal. Enron were paying Andersen more for consulting than for the financial statement audit. As a result, the business risks to the AA when there are disagreements with the client about financial statement will increase.
In addition to unambiguous responsibilities, the fact of AA violated the principal of independency also existed because there were close relationships and interest conflicts between AA’s employees and Enron’s executives. The audit partner, David Duncan, who was in charge of the Enron account and was a close personal friend of Enron’s chief accounting officer. Meanwhile, there were many management-levels of Enron from AA. For example, in 2000, seven AA auditors joined Enron (Jennings, 2009, p.355). In additional, there are many permanent offices at Enron available to AA employees, and also many AA employees kept close relationships with the staff in Enron. All of these facts affected the independence of auditors from AA.
Fourthly, SEC experience the most difficulties to process Enron case. After Enron collapsed, AA destroyed many audit papers and documents. The SEC hardly to know the truth and collect evidence during investigation of Enron. AA’s in-house counsel advised destroyed of documents (Jennings, 2009, p.358). It is both unethical and illegal behavior.
2-4-3 Factors contributed to unethical behaviors
Enron’s culture contributed much to the ethic scandal. Enron was a harsh and condescending company, who emphasized competition and financial goals. For example, it had a rating system which required that 20 percent of all the employees had to be rated as below requirements every year and then were encouraged to leave Enron (Jennings, 2009, p. 288). Although Enron hoped this rating system could have encouraged employees to work hard, actually, the system brought more harm to Enron than benefits.
Firstly, Enron’s competitive environments and rigorous performance evaluation standards caused a culture of deception. Since employees were nervous about losing their jobs, they only focused on their own. They ignored the ethical standards, and only focused on the achievement of their financial goal. After a few employees began cheating on their works, the only way to beat these persons was to cheat more. Gradually, no persons felt shame about cheating because they had no other choices and all their co-workers surrounding them were cheating. This caused a culture of deception. Employees were measured on their abilities to cheat. In such an environment, the people who never cheated were regarded as odd. For example, Margaret Ceconi, a former employee in Enron Energy Service, once wrote a memo to record the truth of accounting situation in Enron. Later, she was questioned on employee morale (Jennings, 2009, p.290).
Secondly, this competitive environment contributed to the covering of the errors and cheating because employees tended to be uncooperative and seldom communicated with each other. The employees were unwilling to ask questions because asking questions was regarded as humiliating. Besides that, they were also less willing to share resources and information because they competed with each other. So, in Enron, no persons asking questions as well as no one want to answer questions. Because of this working environment, few employees at Enron actually understood their jobs. As a result, they just tried to hide errors and made their work looked good. Additionally, they ignored the errors and cheatings of others. Even if they had doubts for other people’s work, they would not say anything. Because they thought if others were not actually wrong, the person who mentioned questions would be laugh at. So, employees at Enron were quiet.
Additionally, the culture of Enron emphasized too much on the financial goals. The person who can achieve the budget numbers would be the hero of the company. Both executives and most of employees focused on making profits for themselves through making good financial numbers instead of a real increase of the company’s economic value. Enron also was concerned less about the needs, values, desires and also the well-being of the employees. From the ethical aspect, employers should respond to their employees and keep the goal of benefiting them. In such a company, ethical standards were just window dressing. No one followed them. For example, the conflict of interest policy was waived to let the officers of Enron served as officers in off-the-book entities.
Fourthly, Enron tried to keep quiet for those people involved. Employees were discouraged from expressing doubts about the financial condition of the company as well as decisions made by the executives. In these years when it committed fraud in its financial statement, Enron hurt both people inside and outside of Enron, who doubted Enron’s financial conditions. For example, John Olson got fired because he suggested his client not to invest money in Enron since he doubted of Enron cash flow and the ability of making money. Here is another example, a former staff named Clayton was fired in November 2001 because he posted his comments about “overstating profits” in an employee chat room (Jennings, 2009, p. 291). Therefore, there were lots of pressure from Enron to staff to express their true opinions about company financial status. Employees had to secure their jobs first and ignored unethical things or illegal things happened in company, even they knew it was not right.
This pressure created a good environment to Enron’s scandal. At Enron, both executives and most of employees behaved unethically when they encountered conflicts of interests. They were greedy and self-interested.
The word “partnerships” in Enron collapse has brought in somewhat controversial in accounting. Big companies are looking more profitable than it actually was, but accounting firms assist in the profit crime which erosion of the public confidence. Consequently, billions of dollars in market value evaporation. Investor suffered huge losses.
In order to establish public confidence again, the U.S. Congress passed the Sarbanes-Oxley Act on July 30, 2002. The law promulgated four fundamental changes in the relationship between auditors and public companies.
First of all, regulators limited the auditor’s ability to provide consulting services to audit clients. The law separating consulting and accounting work, dividing investment banking from analysts and making disclosure of stock holdings and investment banking ties more prominent in research reports, potentially term limiting auditor contracts for individual companies, requiring outside entities be incorporated into financial disclosure statements so as not to understates liabilities and overstates earnings, and encourages diversity by employees with 401Ks.
Second, the responsibility of hiring auditor switched from management team to independent directors in the company’s audit committee. To make sure governance of company is effective and commit to fair and accurate financial disclosure, the company’s audit committee has the responsibility to oversight. In that regard, the relationship between the company’s auditor and its independent audit committee is key.
Third, both management and the auditor are responsible for reporting the effectiveness of the company’s internal control over financial reporting. That responsibility is required by the Sarbanes-Oxley Act. In order to make sure they will execute responsibility, PCAOB issued an auditing standard to regulate this area of the auditor’s responsibilities.
At last, the Public Company Accounting Oversight Board (PCAOB) set up the Sarbanes-Oxley Act. It ended long period of self-regulation by accounting profession. That is a good way for accounting practice which improved the quality by making examination recommendations instead of by taking punishment actions. That is also good for auditing firm or an individual auditor to act in a good faith and to establish a good image to the public and the clients.
2-5 Fundamental principles of ethics
After experience a series financial scandals, the International Ethics Standards Board for Accountants (IESBA) issued a rewritten Code of Ethics for Professional Accountants in June 2005. The particular changing on new Code is addressing auditor’s independence. To establish a conceptual framework to make sure all professional accountants will act compliance with the five fundamental principles of ethics:
2-5-1 Integrity—A professional accountant should be having strong moral principles and honest in all professional and business relationships (IESBA Code of Ethics 110.1).
2-5-2 Objectivity—A professional accountant should act in fairness, unbiased or independent from others perceptions to maintain professional or business judgments (IESBA Code of Ethics 120.1).
2-5-3 Professional Competence and Due Care— To ensure customers received competent professional services, it is required a professional accountant can provide professional knowledge and skill at the related. A professional accountant should follow applicable technical and professional standards to act diligently when providing professional services (IESBA Code of Ethics 130.1).
2-5-4 Confidentiality—A professional accountant should respect client organizational and business information as required that information should not disclose to any third parties without client proper authority unless there is a legal or professional right or duty to disclose. A professional accountant should not take advantages of confidential information to gain personal financial interest or other benefits (IESBA Code of Ethics 140.1).
2-5-5 Professional Behavior—A professional accountant should act comply with relevant laws and regulations requirements and should avoid any dishonest and untruthful action (IESBA Code of Ethics 150.1).
The strengthening of the awareness of accounting professional ethics plays a vital role in the overall development of the business. If accounting staff do not have accounting professional ethics, then the impact of trust on the public cannot be ignored. In accounting and auditing, professional ethics is a tool to measure the good or bad behavior, and also it is a guideline to help accountants have a good professional ethical habit, to determine the professional accountant responsibility to individual, investors, and the public. The reality is that now we communicate with each other based on trust which cannot without ethics. Also, we cannot have a good contact with environment and the world. In other words, as we are involved with small works, or when we participate in a simple dialogue or when we consider social life and professional responsibilities, we need ethical principles. Professional behavior regulation and ethics in accounting and auditing is an attempt to respond these needs.
From the ideology and behavioral performance of accounting practitioners, we can see that the level of professional ethics of employees directly affects the efficiency of work and the response. From the perspective of accounting practitioners, it is necessary to strengthen their own self-discipline and their own understanding of the relevant legal provisions of professional ethics; from the perspective of laws and regulations, the legal department needs to repair its laws and regulations on professional ethics, and promote the improvement of professional ethics To everyone, make it a norm for professional staff to restrain themselves; from the perspective of the enterprise system, it is necessary to develop a system of professional ethics that conforms to its own development, and strengthen its supervision, and regulate the laws of employees . In addition to affecting oneself, the cultivation of accounting professional ethics also affects the healthy operation of the entire enterprise and even has a certain impact on the rights and interests of the people. Therefore, it is necessary to strengthen the cultivation of accounting professional ethics.
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