Chapter 8

Discreditable Acts: Discrimination, Deceit, and Disclosure

Your friends think that you are Clark Kent by day, with a touch of Superman by night. Strangers simply think you're crazy.

After earning your CPA license at a public accounting firm, you joined a commercial bank as a loan analyst. At work, you are called the Picasso of Pro Formas as a compliment to your meticulous cash flow spreadsheets. However, once the sun goes down, your inner Jekyll turns into Mr. Hyde. Late at night, friends and colleagues alike are shocked to see you cruising around town in a retrofitted funeral hearse adorned in neon lettering with the phrase Accounting Stud Magnet. They also were mortified when you screamed, “Hey hotty” in the bank's dimly lit parking lot, apparently unaware that you were shouting toward the darkened silhouette of the bank's CFO.

You readily admit that onlookers consider you to be vulgar and more than a little wacky. However, you never even considered that your actions might jeopardize your professional license as a CPA.

According to the Code of Conduct and various state accountancy laws, an accountant should not commit acts that are discreditable to the profession or demonstrate a lack of moral character. Could your conduct result in the revocation of your CPA license? Or, are you merely engaging in offensive, yet constitutionally protected, acts of private expression?

This chapter will explore the Code of Conduct and state accountancy rules that govern discreditable acts, moral character, and related duties concerning truthful financial reporting.

DISCREDITABLE ACTS UNDER THE CODE OF CONDUCT

Specific Acts That Are Discreditable

The Acts Discreditable Rule forbids accountants from committing acts that discredit the profession of accounting.1 This rule enumerates various categories of disreputable acts, including noncompliance with antidiscrimination rules, the failure to file tax returns, the refusal to return client records, and deceptive and false financial reporting. Each of these acts will now be discussed.

Failure to Comply with Antidiscrimination Rules

Protected Categories of Individuals

According to the Code of Conduct, accountants are presumed to have committed a discreditable act if a court concludes that they “violated any of the antidiscrimination laws of the United States or any state or municipality thereof, including those relating to sexual or other forms of harassment.”2

The Civil Rights Act of 1964 is the landmark federal law that first prohibited the most pernicious forms of discrimination, including racial segregation in school, work, and public facilities. This act broadly prohibits discrimination based on race, color, religion, sex, or national origin. The Age Discrimination in Employment Act of 1967 was enacted shortly thereafter to protect workers and job applicants who are age 40 or older from unfair treatment.

As society has evolved, additional federal antidiscrimination laws have been enacted. The Americans with Disabilities Act, for instance, requires employers to provide reasonable accommodations for qualified workers and job applicants who have physical or mental disabilities. Laws that prevent discrimination based on sexual orientation remain controversial, but they are gaining wider acceptance.3

Criticisms of the Prohibition Against Discrimination

Although the Code of Conduct's strong stance against discrimination is laudable, two practical questions remain unanswered.

The first issue is: Are the Code of Conduct's antidiscrimination rules too strict?

Some have argued that the accounting profession only should enforce antidiscrimination rules in cases involving serious misconduct. A Maryland court, for instance, ruled that a nightclub offering Skirt and Gown Night discounts to patrons wearing these apparel items was engaged in an illegal “discriminatory subterfuge” against men. If the owner of this nightclub was a CPA, would you have wanted this marketing promotion to cost him his CPA license?

Accounting professor Robert McGee provocatively suggests that the Code's antidiscrimination provisions are so all-encompassing that an accounting firm that sponsors college scholarships for minority students might even be committing a discreditable act by discriminating against nonminorities.4

A second important question is: Why does the Code of Conduct classify violations of antidiscrimination laws as discreditable acts, but not expressly condemn other serious violations of the law? An accountant who, for example, embezzles funds from a charity caring for pediatric cancer patients surely brings shame on the accounting profession. However, the Code of Conduct does not explicitly state whether embezzlement and other financial crimes are discreditable acts.

The Laws Prohibiting Sexual Harassment

The Code of Conduct expressly classifies sexual harassment as a discreditable act. Sexual harassment occurs when a person makes an unwelcome sexual advance or physically touches another person in an inappropriate manner.

Like many social interactions, proper conduct in a workplace requires judgment and due caution. Hugging a colleague who just got married might be appropriate, for example, but hugging them for finishing a work project on time probably is objectionable.

From a legal standpoint, sexual harassment occurs only if conduct is so pervasive and offensive that it impairs a person's work performance. Harassment is judged based on whether a person of normal sensitivities would find conduct offensive.

Sexual harassment commonly is classified into two subcategories called quid pro quo harassment and hostile work environment harassment.

Quid Pro Quo Harassment

Sexual harassment is labeled quid pro quo harassment if a person uses coercion to gain sexual favors in return for a work-related benefit, such as a promotion, pay raise, or ongoing job retention. Quid pro quo is a Latin phrase that refers to a bargain in which a person demands something of value in exchange for giving up something else of value. In short, it means this for that.

In identifying whether sexual harassment is present, it is irrelevant whether the people involved are of the same sex or the opposite sex. It also is irrelevant whether the harasser is an employer, a supervisor, a colleague, or a subordinate.

Hostile Work Environment Harassment

The second category of sexual harassment is known as hostile work environment harassment. A hostile work environment may be created if repeated, offensive comments about gender or sexual orientation seriously impair employees from performing workplace duties. These comments can constitute sexual harassment even if they are not directed at anyone in particular.

Because the legal standard for establishing sexual harassment gives workers wide latitude, many companies have stricter codes of conduct than the law requires. As a result, it is prudent to always be cautious, especially when touching others or working with people who are especially sensitive.

Failure to Comply with Personal Tax Responsibilities

Accountants have a duty to respect the tax law in their personal lives as well as their professional lives. As a result, accountants commit a discreditable act if:

  • They do not file their personal tax returns on time
  • Their accounting firm does not file its tax returns on time
  • They collect taxes on behalf of others, such as payroll taxes and employee income tax withholdings, but do not remit these funds to the tax authorities

False Financial Reporting

It may be alright to be “careless in love,” as singer Taylor Swift confesses, but carelessness distinctly is unacceptable in the financial reporting process. According to the Code of Conduct, accountants who facilitate false financial reporting commit a discreditable act. Thus:

  • An accountant should never record materially false entries in a company's books
  • An accountant should never permit someone under his or her supervision to record materially false entries in a company's books
  • An accountant should never fail to correct a materially false entry in a company's books
  • An accountant should never sign a document that is materially false
  • An accountant should never direct or allow someone else to sign a materially false document5

Failure to Follow Rules of Governmental Regulatory Bodies

Certain client engagements require accountants to apply auditing procedures or financial reporting rules that differ from ordinary GAAS or GAAP. For instance, government regulators often require specialized financial reports in evaluating rate increase requests submitted by insurance companies and utilities.

When accountants accept an engagement that must meet the specialized mandates of a governmental body, but then fail to comply with these rules, their conduct generally constitutes a discreditable act.

Improper Limitations on Malpractice Liability

No one likes to get sued, and accountants become easy targets for malpractice lawsuits when client companies issue erroneous financial statements or go bankrupt.

To fend off burdensome lawsuits, accounting firms often insist that clients agree to bear, or at least share, an accountant's costs of defending, settling, and satisfying malpractice claims. Agreements that shield an accountant from potential liability are known as indemnification agreements or Limitation of Liability provisions.

Although agreements that spare accountants from bearing full financial responsibility for their misdeeds generally are legally permissible, certain government bodies ban these agreements in specialized circumstances. If an accountant violates such a governmental prohibition, the accountant commits a discreditable act.

Misrepresenting Professional Qualifications and Experience

Accountants should never make untrue statements about their qualifications, experience, or credentials to practice accounting. Also, in accordance with the Advertising and Other Forms of Solicitation Rule, accountants should never provide unrealistic fee estimates, exaggerate the likelihood of achieving a favorable result, or imply an ability to influence government bodies or officials.6

State accountancy laws typically contain similar prohibitions. For example, Texas prohibits “false, fraudulent, misleading or deceptive statement or claims,” including “untrue comparisons with other accountants” and “self-laudatory statements that are not based on verifiable facts.”7

Figure 8-1

In a related mandate called the Form of Organization and Name Rule, a CPA firm's name must not be deceptive or misleading. A CPA firm may use a trade name, such as Tax and Wealth Advisors or KPMG, or it may use the names of one or more co-owners of the firm, such as Ernst and Young.

CPA firms may have non-CPAs as owners in most jurisdictions. However, only CPAs generally may be included in the firm's name, and appropriate precautions must ensure that the public does not mistakenly confuse a non-CPA to be a CPA.

The CPAs included in a firm name do not have to be currently in practice. To maintain brand recognition, a CPA firm name may continue to include a retired co-owner's name. Samuel Price, for instance, was a British accountant in the mid-19th century, and his name still lives on as the namesake of Price Waterhouse Coopers.8

Improper Disclosure of CPA Exam Questions

To keep the database of CPA exam questions confidential, the CPA Examiners insists that exam candidates not discuss or disclose the content of their exams. To reinforce this ethical mandate, the Code of Conduct makes it a discreditable act for someone to solicit or knowingly disclose questions and answers from past CPA exams without the examiners' permission.

Failure to Return Client Records

In romantic relationships, it is often said that “breakin' up is hard to do.” The same is true in professional relationships, especially when a client wants the benefits of an accountant's hard work but refuses to pay outstanding fees owed.

To help resolve client disputes, the Code of Conduct provides four principal rules concerning record retention:

  • An accountant always must return client-prepared records upon request.
  • An accountant must return accountant-prepared records, unless the client has not paid outstanding fees owed for services relating to those records. Accountant-prepared records mean adjusting and other bookkeeping entries that commonly are journalized by an accountant and directly affect or update client-prepared records.
  • An accountant must return work product, unless the client has not paid outstanding fees owed for services relating to that work product. Work product means the final document, such as a tax return or SEC filing, that an accountant was hired to create.
  • An accountant does not have to provide working papers to a client. Working papers are documents that reflect an accountant's own thought process and analysis. Examples include the design of an audit program, analytical tests such as ratio calculations, and statistical audit sampling results.

These rules are subject to two qualifications. By agreement, parties may alter the Code of Conduct's standard record-transmittal rules. Also, if the rules established by the Code of Conduct conflict with rules established by governing state law, an accountant must comply with whichever rules are most favorable to the client.

An accountant may charge a reasonable fee for the time and expense of retrieving and delivering documents and may insist on receiving these fees in advance of delivery.

Failure to Protect Confidential Client Information

Accountants commit a discreditable act when they disclose confidential client information. This topic is discussed in a later chapter.

Other Discreditable Acts

In addition to the specifically enumerated categories of disreputable acts discussed earlier, the Code of Conduct acknowledges that it “cannot address all relationships or circumstances that may arise.” Thus, when questionable or novel situations arise, accountants must carefully evaluate the propriety of their behavior. A subjective belief that conduct is appropriate is insufficient. Rather, accountants are required to view their actions from the perspective of “a reasonable and informed third party.”9

The Discreditable to the Profession Standard

The Code of Conduct, like most professional ethics codes, does not prohibit all discreditable acts. Rather, it only proscribes acts that are discreditable “to the profession.”

This raises the philosophical question: Can accountants' private activities subject them to discipline for discrediting the profession of accounting? Or, should a person only be held responsible for acts that occur while performing services as an accountant?

Several commentators have suggested that harm to the profession arises only when the public's faith in the professional integrity of accountants is undermined. Therefore, they contend, only misconduct while performing professional activities potentially should be considered to be a discreditable act to the profession.

Others adopt the broader view that any egregious misconduct by an accountant potentially is discreditable to the profession, regardless of whether the act occurs in connection with work activities. According to this view, accountants who commit domestic violence or evade child support obligations could potentially have their license to practice accounting suspended or revoked.

As for the AICPA's view, it has sidestepped this controversy and not provided official guidance on whether private misconduct can cost a CPA the right to practice public accounting.10 The Institute of Internal Auditors, however, has addressed this problem. Its ethics code clearly states that its members “shall not knowingly be a party to any illegal activity, or engage in acts that are discreditable to the profession of internal auditing or to the organization.”11

The Duty to Report Others' Misconduct

As a child, you might have gotten called a derogatory name like tattletale, snitch, or rat for reporting others' misconduct to a teacher or parent. As an adult member of a profession, however, it is reasonable to ponder the extent of your responsibilities to report others who disgrace your profession. Indeed, if you see others committing a discreditable act but nonetheless remain silent, have you committed a discreditable act?

Several professional organizations unequivocally require their members to report others' misconduct to organization officials. For example, the Financial Executive Institute's Code of Ethics states that its members must “report known or suspected violations of this Code in accordance with the FEI Rules of Procedure.”12 Thus, presumably, members of this organization who fail to report violators put their own professional standing in jeopardy. The Code of Conduct for accountants does not expressly address this issue.

DISCREDITABLE ACTS IN TAX PRACTICE

For many accountants, assisting clients regarding tax matters is an important part of their professional activities. Professional tax practice involves a variety of tasks, including communicating with the IRS concerning client rights and liabilities, representing taxpayers at IRS meetings and hearings, and submitting tax returns and related documents. To be eligible to practice before the IRS, a financial professional generally must be a licensed CPA, Enrolled Agent, or an attorney, and must maintain a “good reputation” that comports with strict ethical standards.

Broadly, to practice before the IRS, a person must not have committed discreditable acts, such as those discussed earlier regarding the Code of Conduct. In addition, IRS rules specifically state that the following discreditable acts, among others, can terminate a person's eligibility to engage in tax practice:

  • A tax practitioner misappropriated a client's tax refund check or deposited it into the accountant's own bank account
  • A tax practitioner charged an excessive, or unconscionable, fee for representing clients in connection with tax disputes
  • A tax practitioner committed a tax-related criminal offense or an offense involving dishonesty or breach of trust
  • A tax practitioner knowingly gave false or misleading information in connection with a federal tax matter
  • A tax practitioner refused to return client-prepared records that a client needed to comply with its tax reporting obligation, even if the client owed unpaid accounting fees
  • A tax practitioner attempted to influence IRS employees through intimidation or by offering inducements
  • A tax practitioner used abusive language or other contemptuous conduct in connection with practice before the IRS
  • A tax practitioner engaged in a pattern of providing false or incompetent opinions in federal tax law matters13

THE DUTY TO POSSESS SOUND MORAL CHARACTER

The Nature of Moral Character

State laws customarily require CPAs to possess sound moral character both when they apply for licensure and throughout their careers. But, what exactly does moral character mean in this context?

One viewpoint is that moral character deficiencies should disqualify a person from practicing public accounting only if they closely relate to the functions and duties of being a CPA. According to Ohio accountancy law, for instance, good moral character is “the combination of personal traits of honesty, integrity, attention to duty, forthrightness, and self-restraint that enables a person to discharge the duties of the accounting profession fully and faithfully.”14 The Uniform Accountancy Act's Model Rules similarly narrows its focus to only acts of misbehavior in which an essential element is “fraud, dishonesty, deceit, or any other conduct which evidences any unfitness of the applicant to practice public accountancy.”15

Limiting the definitional scope of moral character to only those infirmities that reflect a person's fitness and competence as an accountant seems reasonable. As one court declared, “It is axiomatic that the right of an individual to engage in one of the common occupations is among the several fundamental liberties” protected by the Constitution.16

Nonetheless, some jurisdictions define lapses in moral character by a CPA more expansively to also encompass criminal activities that may be unrelated to the practice of accounting. For instance, North Dakota's Accountancy Law states that a person's CPA license may be revoked or suspended upon “conviction of a felony, or of any crime an element of which is dishonesty or fraud,” and Texas, requires a CPA to possess “good moral character as demonstrated by a lack of history of dishonest or felonious acts.”17,18

Few would defend CPA Timothy Deegan's right to keep his CPA license after he was jailed in 2014 for heinous crimes, including kidnapping, human trafficking, and terrorizing women. However, a key policy question remains: Should all felonies, such as those involving the illegal possession of certain drugs or the sale of liquor to minors, disqualify a person from ever practicing accounting, even if they do not involve professional fitness or competence?19

To ensure that licensing authorities become aware of lapses in moral character, most locales require CPAs to promptly report specified criminal convictions and malpractice judgments to the licensing authorities. In addition, many states require courts and malpractice insurers to inform state authorities about these types of professional misconduct.

Figure 8-2

THE ETHICS OF FULL DISCLOSURE

“One morning, I shot an elephant in my pajamas. How he got in my pajamas, I don't know.”20 As this humorous movie quip reflects, imprecise statements are abundant in everyday conversations and, usually, harmless. However, in professions such as accounting, imprecise or misleading communications potentially can be devastating.

The title of the Jay-Z song “Show Me What You Got” aptly describes the accounting profession's commitment to full disclosure. Since accounting systems were first developed centuries ago, the accounting profession has maintained a steadfast commitment to financial presentations that are “clear, concise, comparable, relevant and reliable.”21 This duty applies to all financial communications, including SEC filings, financial statement footnotes, and other supplemental financial statement disclosures. Let's explore what it means, from an accounting perspective, to “show what you got.”

The Duty to Present Material Facts

All accountants learn early in their studies that a box of paper clips technically is an asset, but that the materiality principle allows companies to immediately expense minor supplies purchases. Accountants only have a duty to ensure that financial statements are materially correct. A standard audit report, for instance, provides assurance that material misstatements are not present because accountants only have a duty to ensure that financial statements are materially correct.

Sometimes, the materiality of an item hinges on its absolute size, or perhaps its relative size. For example, a $13,000 Allowance for Uncollectible Accounts may or may not be material in absolute size, but it surely would be material in relation to Accounts Receivable of, say, $20,000.

Materiality, however, fundamentally is a qualitative measure, not a quantitative measure. The accounting profession defines the concept of materiality as follows:

The omission or misstatement of an item in a financial report is material if, in the light of surrounding circumstances, the magnitude of the item is such that it is probable that the judgment of a reasonable person relying upon the report would have been changed or influenced by the inclusion or correction of the item.22

By adopting this view, the FASB “rejected a formulaic approach to discharging ‘the onerous duty of making materiality decisions’ in favor of an approach that takes into account all the relevant considerations.”23 The U.S. Supreme Court echoed this sentiment, stating that an item is material if there is a substantial likelihood that it would be “important” to a “reasonable investor.”

When would a quantitatively small item nonetheless be important to investors? The SEC provides the following nonexclusive list of possible situations:24

  • The misstatement masks a change in earnings or other trends
  • The misstatement hides a company's failure to meet analysts' consensus expectations
  • The misstatement changes a loss into a profit or a profit into a loss
  • The misstatement concerns a segment or other portion of a company's business that performs a significant role in the company's operations or profitability
  • The misstatement affects whether a company is in compliance with regulatory requirements
  • The misstatement affects whether a company is in compliance with loan covenants or other contractual requirements
  • The misstatement has the effect of increasing management's incentive-based compensation
  • The misstatement involves concealment of an unlawful transaction
  • The misstatement arises from an item capable of precise measurement

The Duty to Not Obscure Important Information

If you ever walked into an ice cream store that offers, say, 31 flavors, you may have experienced firsthand the feeling of information overload. Information overload arises when people receive so much data that they procrastinate or never make a decision.

The principle of less is more can apply to accounting information as well as to displays of ice cream. When important disclosures are obscured by too much surrounding data, investors may refrain from making decisions or, worse yet, make wrong decisions.

The IFAC Code expressly adopts this principle. It states that an accountant should not knowingly be associated with an accounting presentation that “omits or obscures information required to be included where such omission or obscurity would be misleading.”25 As a 16th-century French Renaissance writer evocatively once stated this notion, communications should be “simple, natural speech, the same on paper as in the mouth; a speech succulent and sinewy, brief and compressed”26

The Duty to Place Facts in Context

As British Poet Laureate Alfred Tennyson said over two centuries ago, “a lie that is half-truth is the darkest of all lies.” All businesspeople have a legal duty to be truthful in their dealings with others, but members of a profession have a greater responsibility than to merely comply with the law. Under GAAP, accountants must consider the context in which the public will read financial statements and make suitable disclosures that provide the full context for understanding these statements. Omitting material information is just as unethical as actively misstating information.

To illustrate, assume that a company traditionally has used the FIFO inventory method, but it changed this year to the weighted-average method. The company's reported earnings per share nominally rose from $8 last year to $9 this year. However, if the company had continued to apply the FIFO method, its reported earnings per share would have dropped to $6. Under GAAP, management must place its reported earnings in context by highlighting how the change in inventory methods affected its financial results.27

The Duty to Apply GAAP

The Accounting Principles Rule

The Accounting Principles Rule states that, as a general rule, financial statements should be presented in accordance with generally accepted accounting principles, or GAAP. Financial statements conform to GAAP if they comply with rules established by the Financial Accounting Standards Board or, when applicable, the International Accounting Standards Board.28 If statements or other financial data do not satisfy GAAP, an accountant should never:

  1. (1) express an opinion or state affirmatively that the financial statements or other financial data of any entity are presented in conformity with generally accepted accounting principles or (2) state that he or she is not aware of any material modifications that should be made to such statements or data in order for them to be in conformity with generally accepted accounting principles29

Modifications to the Accounting Principles Rule

Notwithstanding the Accounting Principles Rule, there are several situations in which financial statements or data do not have to conform to GAAP.

The Use of Non-GAAP Measures

The large fast-food chains recognized long ago that consumers appreciate the benefits of uniform and predictable menu offerings. Similarly, to ensure consistency and ease of use, the accounting profession traditionally has insisted that public-company financial statement presentations uniformly should conform to GAAP.

Despite the advantages of standardization, however, some publicly held companies have argued that they need the flexibility to customize their GAAP-based accounting reports to reflect unique situations. To illustrate this issue, consider the quandary that fruit grower Dole Foods faced. About a century ago, Dole Foods got a sweet deal when it purchased substantially the entire Hawaiian island of Lanai at a mere cost of just over $1 million. Although Dole's island purchase subsequently generated juicy appreciation of half a billion dollars, GAAP forced Dole to report this land on its books at its trivial historical cost, not market value. If Dole wanted to inform investors about its tropical triumph, could it ethically have supplemented its GAAP-based balance sheet with an additional pro forma schedule displaying the market value of its Hawaii land?

Historically, the answer has been no. Many commentators objected to the use of non-GAAP presentations, claiming that they might confuse the investing public. Also, they worried that poorly performing companies would use alternative non-GAAP presentations to distract readers from harsh economic realities. The essence of this GAAP-only viewpoint was expressed in a classic movie song performed by comedian Groucho Marx:

I don't know what they have to say

It makes no difference anyway…

When you've changed it or condensed it

I'm against it!30

Despite these concerns, the SEC recognizes that non-GAAP financial measures can be beneficial. For instance, if an unusual gain or loss item is unlikely to ever happen again, the SEC believes that readers benefit from having nonrecurring items highlighted. Consequently, the SEC has blessed the presentation of supplemental non-GAAP measures in public-company reports as long as three conditions are met. These three requirements are that GAAP-based results are prominently displayed, non-GAAP information is reconciled to the corresponding GAAP measure, and the overall presentation is not misleading.31

Notwithstanding its customary receptiveness to non-GAAP measures, the SEC sometimes gets a bit queasy. For example, when the coupon marketing company Groupon submitted its Initial Public Offering for SEC approval in 2011, the company wanted to impress investors, but its GAAP-based results were a disappointing operating loss of $413 million. As a result, Groupon also presented a non-GAAP concoction that it called Adjusted Consolidated Segment Operating Income. Basically, this customized earnings measure started with Net Income and then added back most of Groupon's expenses. As any accountant knows, when you remove nearly all expenses from net income, you essentially are just left with Revenues! The SEC was stunned by the brazenness of this supposedly net earnings measure roughly equaling Gross Revenues, and it summarily refused to approve Groupon's filing. As one Groupon critic observed, “If a company makes up its own accounting terms, run from that stock.”32

The Duty to Disregard GAAP Rules

It sometimes is said that “rules are made to be broken.” Imagine that a flat tire has caused a school bus filled with children to cross over into your opposing lane of traffic. To avert a potentially disastrous collision, you deliberately steered away from the bus, hitting the back of a parked police vehicle. Although there are clear rules against ramming into police cars, no one would dispute that your decision to break that rule was a wise choice.

Like breaking traffic rules, members of the accounting profession similarly are excused on rare occasions to break GAAP rules. According to the Accounting Principles Rule, accountants deliberately should ignore GAAP in preparing financial statements if they “can demonstrate that due to unusual circumstances the financial statements or data would otherwise have been misleading.” To fully justify a so-called Departure from GAAP, an accountant must fully describe the nature of the departure, the approximate effects of the departure, and the reasons why compliance with an established principle would mislead financial statement users.33

Our judicial system similarly concurs with the Code of Conduct's perspective on departures from GAAP. When adherence to specific accounting pronouncements conflicts with the broader goal of truthful financial reporting, the judicial system consistently has insisted that full and fair disclosure is of preeminent importance. One court articulated this view as follows:

GAAS and GAAP are monumental and commendable codifications of customs and practices within the profession of certified professional accountancy.…[Nonetheless,] neither GAAP nor GAAS is now, or may ever be, so comprehensive as to afford a predictable and repeatable standard of professional responsibility in all conceivable situations.34

In a landmark court case involving Continental Vending Machine Corporation, a jury and an appellate court reached a similar conclusion, which has come to be known as the Continental Vending doctrine. In that case, three auditors argued that they were not guilty of criminal fraud because they had crafted a footnote that achieved literal compliance with GAAP. Nonetheless, they were found guilty because the footnote was “designed to conceal…shocking facts”35 in order to create a “materially misleading impression in the minds of shareholders.”36

Duties Concerning Accounting Frameworks Other Than GAAP

Although publicly traded companies are required to submit GAAP-based financial statements to the SEC, smaller businesses sometimes find the labyrinthine rules of GAAP to be unwieldy and costly to execute. As a result, smaller companies sometimes bypass the use of GAAP and prepare statements using less cumbersome accounting frameworks. These frameworks commonly are referred to as other comprehensive bases of accounting. The most common of these other comprehensive bases are

  • Financial statements that reflect the cash receipts and disbursements basis of accounting, or are a widely accepted hybrid variation that selectively applies cash basis accounting for some items but accrual accounting for other items, such as depreciation
  • Financial statements that apply tax accounting rules
  • Financial statements that conform to requirements imposed by a governmental regulatory agency or rate-setting body

Before selecting a non-GAAP accounting framework, firms should give careful consideration to whether intended readers, such as lenders and regulators, will willingly accept the presentation framework selected.

Also, accountants involved in preparing or disseminating non-GAAP statements should make sure that readers do not mistakenly assume that statements conform to GAAP. Commonly, such statements bear a conspicuous legend that says: NOT PREPARED ACCORDING TO GAAP.

Duties Concerning Nonfactual Presentations

We live in a world where future events fascinate us. Hardcore sports fans contentiously debate who will advance to the Super Bowl or the World Cup, and political junkies hotly debate who the Presidential candidates will be years ahead of an upcoming election. Still others contemplate their future by engrossing themselves in movies about time travel to futuristic destinations.

Accountants, though, are trained to read “T” accounts, not tea leaves, and the objectivity principle all but compels accountants to focus on facts, not fortune-telling. As the Justin Timberlake song “Mirrors” reminds us, “Yesterday is history [but] tomorrow's a mystery.” It may surprise you, therefore, that accountants ethically are allowed, or indeed compelled, to gaze into the mysteries of the future in several circumstances.

First, many routine bookkeeping entries require estimates of the future. For example, depreciation is based on an asset's estimated future salvage value, Bad Debt Expense is based on predictions of customer defaults, and Warranty Expense reflects anticipated repair costs. Pension Expense is especially problematic for accountants because it depends on myriad estimates, including forecasts of employee turnover, employee longevity, and expected investment returns on pension plan assets.

Second, accountants have to record numerous assets at fair value, which is the price that market participants would agree on in a hypothetical orderly transaction. This too may require estimates about future profitability, cash flows, and market behavior.

Third, the budgeting process inevitably requires management accountants to forecast factors such as sales, costs, future product introductions, and capacity utilization. Budgeting likewise requires government accountants to predict future economic activity to anticipate tax collections and related expenditures. In fact, in applying fund accounting, certain government departments are required to journalize predicted accounting events and prepare a comprehensive set of budgetary records.

In addition, accountants sometimes are asked to prepare an examination of prospective financial statements. Financial statements prepared based on conditions that are likely to exist are referred to as financial forecasts. In contrast, statements that are based on a hypothetical action that might occur, but is not necessarily likely, are referred to as financial projections. Both types of examinations are considered to be attest engagements because an accountant attests, or opines, about the reasonableness of the presentation and the assumptions underlying it.37

Finally, forensic accountants involved in litigation-related services often have to compute damages based on estimates of lost future profits. This might occur, for instance, when an accident victim suffers a career-ending injury or a business competitor wrongfully misappropriates a client's trade secrets.

EXERCISES

General Principles

  1. Accounting ethicist Robert McGee has written, “There is no such thing as ‘the profession.’ It does not exist as a living, breathing person. Therefore, it is impossible to discredit it, since it is impossible to discredit something that does not exist.” Do you agree?
  2. The IFAC Code of Ethics prohibits professional accountants from engaging in marketing promotions that “bring the profession into disrepute.” This prohibition encompasses “disparaging remarks…to the work of others.”
    1. Do you believe that such a provision should be part of a professional code of conduct?
    2. The AICPA Code of Conduct does not have a similar provision. Can you think of reasons why such a provision is not in effect in the United States?
  3. According to police reports, a Gainesville, Florida, CPA was arrested for engaging in sexual assault. This story generated substantial publicity, especially in northern Florida. Despite the heinous nature of these crimes, there is no evidence whatsoever that the tax accounting services performed by him or staff members at his tax preparation service are substandard.
    1. Should this CPA's professional license be suspended or revoked?
    2. Assume that he is convicted or pleads guilty to these crimes. Would your answer be different?
  4. In a landmark U.S. Supreme Court case, Price Waterhouse, CPAs v. Hopkins, a senior accountant was denied a promotion to partner at a major CPA firm because, according to one evaluation, she needed to “walk more femininely, talk more femininely, dress more femininely, wear make-up, have her hair styled, and wear jewelry.” Others expressed more general criticisms that she was rude, impatient, and excessively demanding. When Ms. Hopkins sued under Title VII of the Civil Rights Act of 1964, the CPA firm defended its actions, claiming that Ms. Hopkins's overly aggressive personality gave it sufficient grounds for denying her a promotion. Did the CPA firm commit sex discrimination?
  5. To gain an advantage over its rivals, Rushtalent, Inc., a local corporation, interviews candidates for its accounting department as early as possible in the campus recruiting process. Once it has identified suitable candidates, it makes them generous job offers that expire two weeks after the date on which these offers are made. The company is “infamous” on campus for never extending the deadline on these offers. As a result, students have to make employment decisions with this company before they have had a chance to interview with, and possibly receive offers from, other recruiters. The head of Rushtalent, Inc.'s accounting department formulated this job offer policy, and she is a member of the AICPA. Is she committing a discreditable act?
  6. A staff accountant with a large corporation wrote a book in which he proudly admits that, as tax deadlines approached, he “popped illegal amphetamines” and “frankly was stoned” when he was preparing the company's tax returns. He claims that his use of unprescribed drugs enhanced his ability to get his tasks completed. Were this accountant's actions discreditable under the Code of Conduct? Were his statements discreditable?
  7. Various disciplinary committees are considering whether the following three accountants committed discreditable acts:
    • The first accountant is an Enrolled Agent who deposited a client's tax refund check into her own account and spent it on a personal vacation to a tropical resort
    • The second accountant is a management accountant who created an online video in which an IRS agent is portrayed wearing a clown suit and saying nonsensical ramblings
    • The third accountant stated in a television interview that “rich folks pay way too much tax and create all the jobs…our progressive tax system should be changed to a regressive rate structure to give needed help to the rich.”

    Which of these accountants committed an act that is discreditable to the accounting profession?

    Discrimination

  8. An unmarried, gay couple recently attempted to rent an apartment from a landlord who happens to be a CPA. The CPA told them that they would make “wonderful tenants,” but she could not rent to them because of her “deep religious convictions.” The prospective tenants sued the CPA, and the court held that the CPA violated applicable antidiscrimination laws. Did the CPA violate the Code of Conduct?
  9. The head of the accounting department at a midsize corporation refuses to promote workers of Portuguese heritage with solid performance records because he does not believe that they “ever are management material.” This same accountant also was videotaped destroying documents that had been subpoenaed by the SEC in a securities fraud investigation. Which of these acts clearly is presumed to be a discreditable act under the Acts Discreditable Rule of the Code of Conduct?
  10. During late-night tax preparation sessions at work, one of your male colleagues talks incessantly about how his gay-dar alerts him to which of your colleagues is gay. He also makes degrading comments about women frequently and talks about how all women “can be bought with a cheap shot of tequila.”

    You are a heterosexual man who respects women and individuals with differing sexual preferences as equals and finds these comments to be extremely disturbing. However, this obnoxious colleague never has directly confronted you or made negative comments about you to others.

    Does his conduct constitute sexual harassment?

  11. A partner at a major CPA firm once confided that “it's simple…we like to hire pretty women. Our clients generally are middle-aged men and they enjoy being around pretty women.”
    1. Did this partner admit to a discreditable act?
    2. Would your answer be the same if the partner simply had said that they like to hire “good-looking people” because when “our people look good, we look good”?
    3. If you are a member of the AICPA, do you have a duty to report this act to appropriate AICPA officials?
  12. A CPA owns a car rental agency. She will only rent cars to individuals who are age 25 or older. A recent college graduate who works as an accountant for a major corporation attempted to rent a car from this agency, but was turned down because of his age. Has the CPA who owns this car rental agency committed an act that is “discreditable” under the Code of Conduct as a violation of an antidiscrimination law?
  13. A CPA firm has a policy of mandatory retirement as of January 1 for “all general partners who reached the age of 60 during the preceding calendar year.” On January 1, each such retiring partner receives a cash payment equal to his or her share of the partnership's owners' equity. Does this CPA firm's policy constitute a discreditable act under the Code of Conduct?
  14. A small chain of dry cleaners hired you to determine its costs of cleaning blouses and shirts. After careful study, you determined that, due to higher labor costs, blouses require 20% more time to clean than shirts, but all other costs are the same.

    Despite this modest cost difference, you observed that women are less price-sensitive to dry cleaning prices. As a result, you recommended that your client charge $7 to clean a woman's blouse, but only $4 to clean a man's shirt.

    Have you committed a discriminatory act that likely violates the Code of Conduct?

    Disclosures of CPA Exam Questions

  15. While working as a new employee at the Defense Contracting Audit Agency, you noticed that a fellow employee was studying intensely for the Financial Accounting section of the CPA exam. You planned to sit for that exam section in two months, and your colleague was sitting for that exam section next Thursday.

    On Thursday evening, you phoned your friend to see how she was doing after the exam. She thanked you for being considerate and told you that she was emotionally drained. Nonetheless, she then kept you on the phone for 15 minutes, telling you about the “nasty” Statement of Cash Flows and Consolidation problems she encountered.

    Did either of you commit a discreditable act under the Code of Conduct?

    Record Retention

  16. A former client has demanded that you “turn over everything immediately” relating to a client engagement that ended two months ago. The client has paid all outstanding fees. Do you have a duty to “turn over everything”?
  17. A former client has demanded that you “turn over everything immediately” relating to a client engagement that ended one year ago. You previously did so at no charge, but the client sustained a fire loss and has requested that you “turn over everything immediately” again. The client has paid all of your previously billed fees. What are your duties?
  18. Your supervisor at work deliberately falsified how an illegal kickback payment the company made to a government official was reported. When others in your department went to lunch at a nearby restaurant, you had the opportunity to correct these schedules, but you did not do so. Have you committed a discreditable act?

    Moral Character

  19. Marilyn Greenen, a Washington State CPA, kept her ex-husband on her employer-provided health insurance policy, knowing that he no longer was a qualified family member entitled to coverage. Her employer later discovered her intentional misrepresentation, and the Washington State Board of Accountancy fined and disciplined her. In Washington, a CPA can be disciplined for “dishonesty, fraud, or negligence while representing oneself as a CPA” and for “acts of fiscal dishonesty.” Greenen appealed the Board's decision. Who should prevail in this appeal?

    Accounting Disclosures

  20. You are a CPA who provides bookkeeping services to a small home remodeling company. This client principally uses its financial statements only for internal decision making. Recently, however, to obtain short-term trade credit, it agreed to submit unaudited annual financial statements to a new raw drywall supplier. By coincidence, the owner of this drywall company and you attend a weekly ballroom dancing class with your spouses. As a result, you decided to deliver a package containing your client's unaudited statements to the owner of this drywall company at your weekly class.

    The financial statements are simply titled Financial Statements and do not indicate whether or not they are audited. Should you take any actions before you hand-deliver your client's financial statements to its supplier?

  21. A standard unqualified audit opinion states that financial statements “present fairly” a company's results “in accordance with generally accepted accounting principles.” Does following GAAP necessarily “present fairly” a company's operating results? What should a company do if following GAAP does not “present fairly” its operating results?
  22. Why was the Continental Vending case so important to the accounting profession?
  23. Could a difference of less than one-tenth of a percent in a company's Sales ever be considered material? In what circumstances?
  24. When a person buys a house, a lender customarily places the public on notice about its mortgage rights in the house by filing various mortgage documents in the local county government's records office.
    1. You have always been curious to find out how your friend was able to purchase a house at such a young age. Out of curiosity, you have thought about visiting the government records office to find out how much your friend borrowed on a mortgage loan to afford that house. Also, you are curious if your friend was able to buy the house on his own or if he had help from a friendly mortgage cosigner, such as his parents. Is it ethical to visit the county records office to review the public record for documents relating to your friend's house and mortgage?
    2. If these records are readily available on the Internet, would you access these records online?
  25. As a student at a state university, you have always wondered how much the Dean of your school earns.
    1. Should the salaries of administrative officials at state universities be publicly disclosed?
    2. Is it ethical to look up the Dean's salary if it is publicly available?
    3. One of your finance professors is, at best, a rather mediocre instructor. As one of your friends said, “If her pay got reduced by one thousand dollars for every bad joke she tells, she'd be broke.” Is it ethical to look up your professor's salary if it is publicly available?
    4. How would you feel if a new law made disclosure of your salary publicly available?
  26. “One who speaks a portion of the truth to deceive you is a craftsman of destruction.” Can you identify an advertisement that gave you only a portion of the truth? Would you have preferred that the advertisement told a bold lie rather than a lie that had elements of truth? Why or why not?
  27. Your financial planning client is a wealthy entrepreneur who owns a diverse collection of businesses and real estate holdings. This client is concerned with the market value of his assets and has no desire to read financial statements based on GAAP. As your client put it, “You accountants make me write down the reported value of my buildings every year due to depreciation, but thankfully, my buildings keep going up and up in value.”

    Is it a discreditable act for you to prepare market-value-based personal financial statements for your client?

    Reporting Based on “Nonfacts”

  28. In a lawsuit filed by the Estate of Michael Jackson on behalf of his children, the plaintiffs' accounting expert had to forecast the lost earnings that resulted from his death. What factors would you have had to consider in reaching your opinion?

    Comprehensive Problems

  29. A health insurance company sold insurance policies that allow policyholders to obtain services from selected hospitals. The policies fully disclosed the names of these hospitals. However, the insurance company did not mention that the hospitals did not have the capability to perform certain costly procedures, such as heart bypass operations. As a result, if a policyholder one day developed a severe heart blockage, the patient would not have insurance coverage to pay for such a heart bypass procedure.
    1. If the insurance company, to save money, deliberately selected hospitals that lack the capability of performing heart bypass operations, was its disclosure of the names of the hospitals available to patients adequate?
    2. If the insurance company did not deliberately select hospitals that lack the capability of performing heart bypass operations, but it knew that these hospitals were smaller regional hospitals that were likely to lack certain advanced capabilities, was its disclosure of the names of the hospitals available to patients adequate?
    3. If the insurance company deliberated selected low-cost hospitals that lack certain capabilities and passed these reduced costs along to policyholders, did the insurance companies act unethically?
  30. An international banana grower owns a large plantation in a Latin American country. Due to political upheaval in that country, the government of that country might expropriate land ownership for itself. The company has not adjusted the reported value of this land on its financial statements.

    Should the banana grower's auditor insist on any adjustment to how this land is reported?

Notes

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