Chapter 2
Ethical Principles and Reasoning
DISTINGUISHING ETHICAL BEHAVIOR FROM LEGAL BEHAVIOR
For thousands of years, philosophers have debated whether it is more important to have an ethical society or a law-abiding society. In 500 BC, Confucius expressed the widely-accepted view that “the best government is one that rules through rites and the people's natural morality, rather than by using…coercion.”
Laws represent society's consensus about how citizens must, at minimum, behave. In contrast, ethical precepts focus on how people should behave. Although these two concepts often overlap, there can be stark differences between complying with the law and adhering to what is morally right.
Figure 2-1 How Law and Ethics Intersect.
It is not illegal to cheat on a college test, for instance, but it certainly is unethical. Conversely, it is illegal to drive above the posted speed limit, but it is not unethical if you are driving a bleeding neighbor to the hospital.
When people fail to adhere to laws, they are subject to criminal sanctions such as imprisonment. Ethics, on the other hand, is prescriptive for how we ought to behave, not coercive. Thus, the punishment for unethical behavior is a heaviness of heart and a conflicted conscience.
The interplay of law and ethics can be illustrated by the plight of movie stars Halle Berry and Jennifer Garner. These actresses repeatedly have decried the conduct of paparazzi who frighten their children by popping out of bushes to photograph the children near school. To these actresses' dismay, Constitutional protections for the freedom of the press make it impossible for our legal system to fully protect these children. However, moral outrage and societal pressure have filled this void, successfully persuading these intrusive photographers to respect children's privacy. As former Supreme Court Justice Potter Stewart once opined, “Ethics is knowing the difference between what you have a right to do and what is right to do.”
THE UNIVERSALITY OF ETHICAL RULES
Do all countries and cultures agree on the same ethical principles? Or, do ethical precepts vary among societies and evolve over time? These two opposing views are known as ethical absolutism and ethical relativism.
Ethical Absolutism
According to ethical absolutism, ethical rules are universal and immutable. As one indicator of global consensus, the United Nations adopted The Universal Declaration of Human Rights to recognize a “common understanding” of the “inherent dignity…of all members of the human family.” This declaration embraces universal respect for thirty “human rights and fundamental freedoms,” including broad rights to equality, justice, and freedom of expression, as well as more specific rights, such as equal pay for equal work, parental control of their children's education, and protection against unemployment. This declaration was enacted in 1948 without a single dissenting vote, and it has remained intact ever since.1
Moreover, as further evidence of ethical absolutism, supporters point out that the Golden Rule of “Do unto others as you would have others do unto you” has been firmly entrenched in all major world religions and societies for many centuries.
Ethical Relativism
Ethical relativism, in contrast, asserts that rules of morality evolve over time and vary among cultures, religions, and political structures. Several illustrations demonstrate the variations in ethical viewpoints among cultural groups.
The Issue of Gay Rights
Stark differences persist around the world about whether gay rights are a moral imperative. In many Western societies, the notion of equal rights for all, regardless of sexual preference, increasingly is embraced. In contrast, prior to the 2014 Winter Olympics, Russia provocatively enacted laws authorizing the arrest of gay tourists.2 Uganda recently went even further, imposing jail sentences on clergymen who conduct gay marriage ceremonies and life imprisonment on those who engage in homosexual acts.3
The Issue of Gender Equality
Views on gender equality also vary widely among cultures. Many Americans reflexively disparage countries that permit gender-based discrimination, but few realize that widespread support for gender equality is a relatively recent phenomenon in their own country. For example, American women were not guaranteed the Constitutional right to vote until 1920,4 and until the mid-1800s, married women desiring to retain control of their wealth nonetheless were generally compelled to transfer their personal earnings and assets to their husbands.5
The Issue of Freedom of Contract
Freedom of contract and the enforceability of agreements generally are regarded as important values in most societies because commerce enables economies to flourish. However, many countries view certain kinds of contracts as violating widely held notions of morality. Consider, for instance, how various societies view contracts for the sale of human organs. Some countries condemn the commercial trade in organs as violations of human dignity that inevitably exploit the poor. Others, however, espouse the contrary view that society benefits when individuals in need of cash are permitted to voluntarily sell their organs to buyers in failing health.
Reaching a consensus about the proper balance between saving lives and preserving the sanctity of one's own body has remained elusive. China, India, and the Philippines, for instance, once allowed the sale of human organs, but later enacted legal prohibitions in response to changing societal views. Iran, normally not considered a paradigm of personal freedom, presently is the only country that permits its citizens to openly sell their organs.
The Issue of Charging Interest
As a final illustration, cultures differ widely on whether lenders should be allowed to charge interest on loans. Centuries ago, Aristotle generally was a strong proponent of free market transactions, but he abhorred the concept of interest and those who charged interest. As Aristotle once wrote, “Money was intended to be used in exchange but not to increase at interest…the birth of money from money…is most unnatural.” Aristotle also believed that lenders who had “a sordid love of gain” were outcasts who should be ostracized along with “those who ply sordid trades [and] pimps…”6
Shakespeare likewise expressed the distaste of many in Elizabethan England for the tactics used by lenders to recover interest. In the Shakespearian play Merchant of Venice, for example, lender Shylock reminds a borrower that, if he defaults in repaying amounts due, Shylock will repossess a “pound of [his] fair flesh, to be cut off and taken in what part of your body pleaseth me.”
The morality of charging interest remains controversial, even in modern times. Many Western societies condemn lenders who charge excessively high interest rates and have enacted usury laws to deter such conduct. Elsewhere, Islamic countries apply the moral principle of riba, which prohibits the payment of interest altogether. In accordance with Islamic accounting principles, for example, a sale is void if the amount that a seller will collect on deferred payments increases or accrues over time.7
All these views contrast with the free market perspective articulated by philosopher Jeremy Bentham in the late 18th century:
No man of ripe years and of sound mind, acting freely, and with his eyes open, ought to be hindered, with a view to his advantage, from making such bargain, in the way of obtaining money, as he thinks fit: nor [shall] anybody [be] hindered from supplying him, upon any terms he thinks proper to accede to.8
Ethical Absolutism versus Relativism
Most ethicists disparage the notion that ethical values ebb and flow as the norms of a particular society change. Rather, they contend, societies may diverge in how they apply moral principles, but the core underlying principles themselves are universal. For example, virtually all societies agree on the right of privacy, but Europeans generally favor a stricter application of this principle to marketers' use of personal data gathered from observing individuals' internet searches. All societies likewise agree on the right to justice, but only some believe that juries, rather than judges, are better at imparting justice. Nonetheless, it is indisputable that cultural norms, or at least their implementation, differ among societies on a diverse set of business issues, such as scientific experimentation on animals and child labor protection.
Some members of the accounting profession have acknowledged that disagreements among countries and cultures about whether a particular business practice is ethical make it challenging to implement a uniform global set of professional standards. As one critic of the IFAC Code observed, “differing cultures and levels of economic development are likely to cause professionals in many countries to find some part of international guidelines [to be] antithetical to the social and economic environment in which they work.”9
AN INTRODUCTION TO THE AICPA CODE
An Overview
The AICPA Code is comprised of a Principles section and three substantive sections. These latter sections primarily govern the conduct of Members in Public Practice and Members in Business, but a third section covers All Members, including those who are retired or temporarily unemployed.
The Principles section presents the AICPA Code's broad framework.10 These Principles are advisory in nature and do not subject violators to disciplinary action. In contrast, violations of the Code's later sections can result in disciplinary action. Individuals accused of violating these later sections have the burden of justifying their conduct to the AICPA Disciplinary Committee.
The Core Principles of Professional Conduct
This chapter will now examine the Principles section of the Code of Conduct.11
The Code of Conduct identifies six principles that are applicable to all members of the accounting profession. These six principles are the Responsibilities Principle, the Public Interest Principle, the Integrity Principle, the Objectivity and Independence Principle, the Due Care Principle, and the Scope and Nature of Services Principle.12
Responsibilities
The Responsibilities Principle states:
In carrying out their responsibilities as professionals, members should exercise sensitive professional and moral judgments in all their activities.
An occupation typically is considered to be a profession if its members require extensive formal education, possess specialized skills, make a lifetime commitment to continual self-improvement, exercise independent judgment, and possess a dedication that rarely ends when the office door shuts at the close of a workday. Most professions also require their members to pass a rigorous exam and comply with state licensing mandates.
| PRINCIPLE | CORE CONCEPT |
| First | Adhere to professionalism |
| Second | Serve the public interest |
| Third | Act with integrity |
| Fourth | Be objective and free of conflicts of interest |
| Fifth | Act with due care |
| Sixth | Possess adequate training and skill |
Figure 2-2 The Six Principles of the AICPA Code.
For centuries, there were only three widely recognized professions: medicine, law, and divinity. Over time, other occupations, such as architecture, pharmacy, nursing, engineering, and teaching, established themselves as professions. Accounting has only comparatively recently been considered a profession.
Accounting is not only a profession; it is a unique profession. Unlike other professionals, accountants largely operate through self-governance. The Financial Accounting Standards Board, or FASB, and the Governmental Accounting Standards Board, or GASB, are nongovernmental entities that establish the detailed rules that comprise generally accepted accounting principles, or GAAP. The AICPA's Auditing Standards Board similarly establishes the rules that comprise generally accepted auditing standards, or GAAS, for audits of nonpublic companies.
State regulators traditionally have deferred to these private rule-making bodies, and the SEC, a federal agency, historically has recognized the FASB's rules as authoritative.13 In the aftermath of scandals that rocked our financial markets, however, the federal government changed the regulatory landscape by enacting the Sarbanes-Oxley Act, which created the Public Company Accounting Oversight Board (PCAOB) to oversee audits of companies traded on stock exchanges. By creating the PCAOB, Congress “ended more than 100 years of self-regulation at the federal level by the public company audit profession.”14
The Public Interest
The Public Interest Principle states:
Members should accept the obligation to act in a way that will serve the public interest, honor the public trust, and demonstrate commitment to professionalism.
Do members of a profession owe a duty only to their clients, or do they also owe a duty to the broader society? This issue long has been debated, with various professions reaching different conclusions.
The Viewpoint of Other Professions
In the legal profession, attorneys explicitly are required to act with a single-minded dedication to their clients' best interests. For example, criminal defense attorneys must strive to obtain a Not Guilty verdict, even if their client is indeed guilty and a danger to society. Similarly, tax attorneys are subject to disciplinary sanctions if they voluntarily inform the IRS about a client who filed a false tax return.
In the medical field, pharmacists and doctors likewise must consider only their patients' well-being. These professionals must inform their patients about the most effective drugs and medical procedures, without regard to the added costs that Medicare and others may incur.
In the engineering profession, the tension between serving clients and serving the public has evolved over time. During 1912, the profession's Code of Ethics required an engineer to make “the protection of a client's or employer's interests his first professional obligation.”15
However, by 1947, the profession enacted a more expansive set of duties that required an engineer to “discharge his duties with fidelity to the public, his employers, and clients, with fairness and impartiality to all.”16 Thus, this revised Code of Ethics recognized that engineers have a dual obligation to public as well as private-sector interests.
More recently, some might say that the engineering profession completed its transformation from a caterpillar to a majestic butterfly. According to a 1974 Canon of Ethics revision, engineers “shall hold paramount the safety, health, and welfare of the public in the performance of their professional duties.”17
The Viewpoint of the Accounting Profession
How does the accounting profession balance its twin responsibilities to serve both private and public interests? Like the modern-day engineering profession, the accounting profession generally believes that the broader public interest takes precedence over a client's parochial interests because “…credit grantors, governments, employers, investors, the business and financial community, and others…rely on the objectivity and integrity of certified public accountants to maintain the orderly functioning of commerce…” “This reliance imposes a public interest responsibility on…[accountants for] the collective well-being of the community of people and institutions that the profession serves.”
Accordingly, in performing an audit, an accountant acts as a public guardian that is beholden solely to readers of financial statements. This duty to the public reigns supreme, even though a client selects and pays for its auditor's services. A similar duty applies to accountants in tax practice. If a client insists on claiming an impermissible tax deduction, an accountant's foremost duty is to the governmental taxing authority, not the client.
Despite the public's preeminence, it is not always a simple task to determine what the “public interest” is. To illustrate this dilemma, assume that your audit client currently has insufficient funds to meet its pension obligations. Upon introducing its new product line, however, this client will likely obtain sufficient funds. Should you insist that your client disclose this temporary shortfall in liquidity in its public financial statements?
If the company discloses its lack of funds, experienced workers will depart, which will curb the company's efforts to innovate and cause large losses to investors, suppliers, and distributors. All levels of government will suffer too as laid-off workers draw unemployment and other social welfare benefits.
On the other hand, if an auditor does not disclose the company's liquidity problems, the investing public's faith in the reliability of financial reports will suffer, harming capital formation over the long run.
In balancing these considerations, the accounting profession has concluded that timely, truthful financial disclosures are essential to an efficient market economy, even if narrow constituencies are adversely affected in the short run. As former Supreme Court Justice Brandeis once said, “Sunlight is…the best of disinfectants.”18
Integrity
The Integrity Principle states:
To maintain and broaden public confidence, members should perform all professional responsibilities with the highest sense of integrity.
In Star Wars, a Jedi Knight proclaims: “Let there be truth between your heart and the Force. All else is transitory.”19 Integrity is the character trait of being forthright and truthful, even when others exert contrary pressures. As one country rock tune expresses this principle, you can't be a “puppet on a string…you've got to stand for something or you'll fall for anything.”20
Accountants must always display honest and straightforward behavior, without subordinating their judgment to others. Integrity also requires compliance with the spirit of a rule, and not just its formal articulation. Reliance on technicalities and loopholes as a subterfuge for avoiding ethical conduct violates the fundamental principle of integrity.21
Billionaire investor Warren Buffett profoundly once stated the importance of integrity as follows:
Somebody once said that in looking for people to hire, you look for three qualities: integrity, intelligence, and energy. And if you don't have the first, the other two will kill you. You think about it; it's true. If you hire somebody without [integrity], you really want them to be dumb and lazy.
Objectivity and Independence
The Objectivity and Independence Principle states:
A member should maintain objectivity and be free of conflicts of interest in discharging professional responsibilities. A member in public practice should be independent in fact and appearance when providing auditing and other attestation services.
The public unhesitatingly can rely on financial statements only if members of the accounting profession approach their tasks with impartiality. As a result, the Code of Conduct implores accountants in public practice to always approach their work with objectivity, free of biases that impair intellectual honesty. In addition, accountants must avoid any conduct that might cause a skeptic to doubt their impartiality.
Former KPMG audit partner Scott London, who pleaded guilty in 2013 to insider stock trading, provides an extreme illustration of what not to do. According to a wiretapped phone conversation recorded by the FBI, London told his co-conspirator, “…when I know that it's gonna start happening, what you do is you start just buying in small blocks, right, so it doesn't draw attention and then, you know, then it doesn't look unusual at all.”23 Although London's Los Angeles office overlooked the famed Hollywood sign, this was not dialogue from a bad movie. London's misconduct was reckless reality, not fanciful fiction.
To quote Warren Buffett once again, “It takes twenty years to build a reputation and five minutes to ruin it. If you think about that, you'll do things differently.” In the case of disgraced auditor London, it took thirty years for him to rise to the top of his profession, but only a few moments for it all to come crashing down.
It is easy to grasp why an outside auditor must adhere to high standards of objectivity and avoid even the appearance of a conflict of interest. However, should this same standard apply to industry accountants who perform accounting services solely for their employer?
According to the Code of Conduct, management accountants unavoidably have a conflict of interest in performing their job duties because their entire livelihoods inextricably are linked to their employers' continuing prosperity. As a result, it would be impossible and nonsensical to expect management accountants to remain free of conflicts of interest in performing job duties for their employer. Nonetheless, apart from this narrow exception, all accountants must maintain objectivity in their professional activities.
Due Care and the Scope and Nature of Services
The Due Care Principle states:
A member should observe the profession's technical and ethical standards, strive continually to improve competence and the quality of services, and discharge professional responsibility to the best of the member's ability.
Furthermore, an allied concept, the Scope and Nature of Services Principle, states:
A member in public practice should observe the Principles of the Code of Professional Conduct in determining the scope and nature of services to be provided.
In summary, these two principles allow accountants to accept a client assignment only if they have the training, skills, and time to perform the task with a high level of professional excellence.
No one, of course, can possibly be an expert at everything. Accordingly, it is acceptable for accountants to commit to a task as long as competent mentors and resources are available to fill in gaps in their knowledge. It is also acceptable to delegate tasks to others, as long as a professional assignment is properly planned and adequately supervised.
Ultimately, accountants are the sole judge of whether they have the professional competence to perform a task with due care.
THE DEVELOPMENT OF MORAL REASONING
Psychologist Lawrence Kohlberg's pioneering research observed that people sequentially reach more advanced levels of ethical reasoning over time due to training and life experience. Kohlberg's Stages of Moral Development model identifies six different stages of moral reasoning, which he grouped into three paired sets, referred to as Levels One, Two, and Three.24
Kohlberg's Stages of Moral Development
Level One: Focus on Self
At Level One of moral development, individuals only are concerned with their own punishment and rewards. This level is called the Pre-Conventional Level, and it is divided into two stages.
Stage One typically is associated with young children. Before reaching adolescence, children often make decisions based on whether their conduct will result in punishment. Young children act obediently solely out of fear of punishment or disapproval from an authority figure, such as a parent or teacher.
At Stage Two, people still focus on their self-interest, but they begin to notice that that punishment varies according to the severity of a person's misconduct. To illustrate, imagine that a young child is thinking about hitting another child who lives nearby. At Stage One, the child simply acts, or refrains from acting, based on the likelihood of receiving swift punishment. At Stage Two, however, children notice that malicious actions result in severe punishment, but well-intentioned acts, such as acting out of self-defense or to protect a nearby child from bullying, result in little or no punishment.
Individuals at Stage Two also realize that cooperative behavior today creates an implicit exchange that earns rewards in the future. For instance, a child at Level Two might agree to perform chores for a parent not out of a fear of punishment, but out of a desire to secure a future reward, such as a later weekend curfew.
Although Level One often is associated with children, many adults exhibit Level One development as well. Because individuals at Level One exclusively focus on themselves, rather than the welfare of their employer, customers, or subordinates, they are poor candidates for leadership positions within an organization. They also need to work in environments where rigid rules of behavior are imposed and sanctions are swiftly enforced.
Level Two: Focus on Group Expectations
At Level Two, known as the Conventional Level, people shift from acting out of a fear of punishment to behaving out of a desire to please others. Like the preceding level, Level Two is comprised of two stages, called Stage Three and Stage Four.
Stage Three is reached when individuals make moral decisions based on the expectations of others in their immediate social sphere, such as friends and family members. For example, people at this stage might refrain from drunk driving or cheating on a test principally out of a concern that getting caught or arrested would humiliate their families.
At Stage Four, people broaden the scope of the sphere that influences their decisions to encompass society as a whole. Typically, at this level of development, people recognize that laws are important expressions of societal values and that one should abide by laws.
This level is called the Conventional Level because individuals typically exhibit this level of development, with some never reaching this level and comparatively few progressing beyond it to the next level.
| LEVEL | FOCUSES ON: | STAGE | DESCRIPTION |
| 1 | Self | 1 | Act purely out of self-interest. Will disobey rules as long as they can avoid punishment |
| 2 | Still act in self-interest, but understand that others also have desires and that punishment is proportionate to the severity of misconduct | ||
| 2 | Group Expectations | 3 | Aim to please others in close proximity, such as family and friends |
| 4 | Aim to please others in broader society by complying with laws | ||
| 3 | Inner Principles | 5 | Recognize that some laws reasonably can be challenged and changed |
| 6 | Adhere to inner conscience, even if that may violate a law |
Figure 2-4 Kohlberg's Stages of Moral Development.
Level Three: Focus on Inner Principles
Level Three, called the Post-Conventional Level, involves the development of higher-order values and principles. This level, too, includes a pair of stages.
At Stage Five, individuals understand that laws reflect a majority consensus, but that reasonable people can formulate differing opinions about whether a law should be changed or obeyed. Individuals at this stage intellectually question the social values underlying certain laws and believe in pursuing needed changes through democratic processes.
The final stage, Stage Six, is achieved when individuals behave in accordance with their own moral reasoning about abstract concepts, such as integrity and justice, without regard to the dictates of the law. At this stage, people have the ability to “step into the shoes” of others to evaluate rules from alternative perspectives. They also have fully formed consciences that enable them to reject conventional societal rules, despite knowing that their disobedience could result in penalties or imprisonment.
Acts of civil disobedience that violated racial segregation laws of the early 1900s exemplify Stage Six conduct. For example, if a black child was extremely thirsty but the only drinking fountain nearby legally was labeled For Whites Only, a black parent who prioritized her child's health and comfort in disregard of the law engaged in Stage Six conduct.
Based on his observations, Kohlberg concluded that few people consistently exhibit Stage Six behavior.
Applying Kohlberg's Six Stages to the Accounting Profession
Advanced ethical reasoning is critical in the accounting profession because accountants often have to discern the right or just decision in circumstances where rules are ill-defined or simply absent. Industry accountants must not subordinate their judgments to their superiors, outside auditors must not subordinate their judgments to their clients, and tax professionals surely must reach fair and just determinations when a void exists in tax rules.
Various empirical studies have examined the ethical reasoning processes of accounting professionals working in public accounting firms. Using a widely accepted standardized test, one study found that moral development levels typically increase as accountants transition from junior-level staff members into senior-level staff positions with greater supervisory responsibilities.
Disturbingly, however, the stage of moral development attained by accountants drops off significantly once they become managers and partners.25 It is unclear if this drop-off is due to a socialization process that discourages managers and partners from developing more advanced reasoning. Other possible explanations are that staff members with higher-stage moral development often are denied promotions to become managers and partners, or their personalities predispose them to leave the public accounting profession before becoming managers and partners.
Criticisms of Kohlberg's Approach
Some researchers, such as Kohlberg's colleague Carol Gilligan, have criticized Kohlberg for emphasizing abstract, justice-based reasoning as the dominant element of higher-stage moral development. Gilligan has contended that at advanced levels, women commonly are less focused than men are on theoretical notions of justice. Instead, she believes, women generally are more oriented toward fostering interpersonal relationships and acting compassionately toward society's most vulnerable members.26 Accordingly, Gilligan contends that Kohlberg's emphasis on justice-based factors results in his model systematically underestimating the degree to which women exhibit advanced moral development. As one commentator summarized this difference between the sexes, “men are more willing to take a bullet to preserve their country's liberties and freedom, while women are more likely to sacrifice for their loved ones.” Gilligan's hypothesis that women have a greater propensity to be nurturing and compassionate has been dubbed the ethics of care.
Despite the plausibility of Gilligan's contention, subsequent investigations, including research by Gilligan herself, have shown few gender-based differences in moral reasoning between male and female managers and professionals.27 As a result, Kohlberg's model remains a useful model for assessing whether individuals are suitable candidates for leadership positions in the business, government, and nonprofit sectors.
MAKING ETHICAL DECISIONS
Rest's Four-Component Model of Ethical Decision Making
Kohlberg's protégé, psychologist James Rest, developed a four-step action plan for making and implementing ethical decisions. This approach is known as Rest's Four-Component Model.
The First Step: Moral Sensitivity
The first step in ethical decision making is to recognize that an issue involving morality is present in a particular situation. For example, assume that you have noticed that a work colleague brings her children to her office when the company is closed so they can complete school homework projects using company printers and supplies. Some might consider this unauthorized use of company property to raise a moral issue. Others might be glad to see children diligently doing their schoolwork and not perceive a moral issue to even be present.
To enhance your moral sensitivity, try to view actions from different perspectives, and openly discuss issues with others who may have differing viewpoints.
The Second Step: Moral Judgment
Once a moral issue has been identified, the second step is to decide whether the conduct is right or wrong. For example, you might decide that a colleague's use of company property is acceptable because the company's owner is family oriented, and the property used is of minor value. Alternatively, you might decide that the use of company property without express permission is wrong.
To improve your moral judgments, try to think about how other cultures and communities evaluate right and wrong. Also, consider whether certain models of thought, such as cost–benefit analysis, might aid your determination.
The Third Step: Moral Intent
After determining what the morally correct outcome is, the third step is to formulate the actions that you are prepared to initiate to achieve this outcome. If incentive systems such as cash bonuses or promotions are in place to reward adherence to moral actions, this step is relatively easy. However, in many cases, action might be met with disapproval that might adversely affect your career advancement, friendships, or financial well-being. In these situations, you must weigh the potential costs of acting against the benefits of preserving the status quo.
For example, assume that you have decided that your colleague's use of company resources for her children's homework projects is wrong. If you inform the company's owner, you might receive praise, or even a promotion, for your diligence. On the other hand, fellow workers who can influence your career advancement and work assignments may ostracize you for informing on your colleague.
Before establishing a course of action, restrain your emotions, identify the obstacles that lie ahead, and be pragmatic about what you can, or cannot, accomplish.
The Fourth Step: Moral Character
The final step is to muster the moral character to implement intended actions. This requires persistence, energy, belief in your strategic plan, and the mental toughness to overcome opposition.
For example, if you are concerned about a colleague using company resources for her personal benefit, locate others who share your concern and can corroborate your observations. Also, have the fortitude to do the right thing, even in the face of adversity.
The Accounting Profession's Models of Ethical Decision Making
The Code of Conduct has developed a general framework for accounting professionals to use in resolving ethical conflicts.28 Global CPA firm KPMG has expressed this framework succinctly using the acronym CARE:
- Consider all the facts,
- Assess the available alternative courses of action,
- Review the ethical issues,
- Evaluate the consequences of each alternative course of action.
Is Ethical Decision Making Truly Rational?
The decision-making approaches discussed thus far have assumed that people spend substantial time and effort in evaluating ethical dilemmas. Modern researchers believe, however, that many ethical decisions are made quickly based on automatic gut feelings to conserve our limited time and effort. For instance, Daniel Kahneman, a Nobel Prize-winning economist, contends that our brains engage in dual processing. He conceptualizes our brains as using System 1 for making rapid, intuitive decisions and System 2 for mental activities that require deliberative, controlled analysis, such as preparing a bond amortization schedule.
Please refer to Figure 2-6. Professor Kahneman illustrates these two thought systems by posing the following question: How much longer is the bottom line than the top line?
Figure 2-6 Which Line Is Longer?
Your brain's System 1 tells you that the bottom line is longer than the top one. However, careful System 2 analysis, aided by a ruler or straight edge, proves that both lines are exactly the same in length.29
To improve our ethical decision making, some psychologists believe that we need to tame the emotional dog of System 1 to prevent it from dominating the rational tail of System 2. That is, sound decisions require us to at times override our reflexive, intuitive responses and make the effort to use deliberative analysis.30
EXERCISES
Legality versus Ethicality
- Determine whether the following are legal, ethical, both, or neither:
- After graduating from college, you now have the opportunity to work as an unpaid assistant to a famous Hollywood director during the production of his new film. You are excited to accept this opportunity because you will gain invaluable experience and connections in the movie industry. A friend, however, recently questioned whether your unpaid endeavor will violate minimum wage or other labor laws.
- A bank headquartered in Dallas, Texas, recently hired three new employees from across the country to join its Real Estate Credit Analysis Department. At the time that the bank hired these employees, it knew that it would retain only one of these employees after “trying them out” for one month. The bank also knew that, under Texas law, employment contracts are terminable at will by an employer. The employees moved to Dallas and signed one-year apartment leases in the expectation that their jobs would be ongoing.
- When new consumer electronic devices are introduced for sale, an investment fund buys one at the earliest possible moment and then has engineers break it open. These engineers then advise the investment fund about the names of the suppliers who provide the component parts. The investment bank uses this information to increase its investments in these supplier companies in anticipation of them reporting greater sales.
- You use a prescription asthma inhaler when asthma attacks impair your breathing. It is against the law for you to share prescription items with others because only doctors can prescribe medicines and direct the use of medical devices. Nonetheless, when a companion recently suffered an asthma attack, you shared your inhaler with her.
- Metered parking spaces in the entertainment district of a Colorado ski resort town have posted signs that only permit “Two hour parking per day.” The purpose of these signs is to give all tourists a reasonable opportunity to dine in the entertainment district, where parking spaces are scarce during the peak ski season. During the past summer, you wanted to eat while watching a soccer match at a sports bar in this district. Because the soccer match was expected to last over two hours, you parked in one space for two hours and then drove your car to park in an adjacent metered parking space for the remainder of the game.
- A CPA firm wants to gain a competitive recruiting advantage over its peers. Its lead recruiter has started giving $2,000 signing bonuses to brilliant 18-year-old high school graduates who plan to major in accounting during their upcoming college years. In return for these bonuses, students must agree that, if they decide to join the accounting profession on graduation, they must accept employment with this CPA firm. This CPA firm is highly reputable, and social media sites confirm that it pays its employees “top dollar.” If bonus recipients attend information sessions for other CPA firms or interviews with other firms while in college, their offer of guaranteed employment with this firm terminates. Is this CPA firm's policy legal? Or ethical?
- The University of Michigan Consumer Sentiment survey is a widely watched index that serves as a barometer of economic activity. Within seconds after this index's monthly public release, stock markets routinely move significantly. Unknown to the general public, the University of Michigan was collecting a minimum of a million dollars annually for releasing the headline results to select investment firms before the general public announcement occurred. Was this legal? Or ethical?
- Under Chapter 7 bankruptcy rules, most debts are cancelled when an insolvent individual with a modest income successfully petitions for bankruptcy. A person is entitled to obtain a discharge from debts every seven years. After debt discharge, creditors are barred from exercising their right to ever enforce outstanding debts owed by bankrupt debtors. Is filing bankruptcy ethical?
Ethical Absolutism and Relativism
- To treat chickens more humanely, Californians voted by popular referendum to enact a law requiring minimum cage sizes for egg-laying chickens. Other large egg-producing states, such as Iowa, Nebraska, and Alabama, have not enacted such laws.
- Is the minimum size of an egg-laying hen's cage an ethical issue?
- Supporters of this law refer to themselves as “animal rights advocates.” Should animals have rights? Which ones?
- Is the difference in laws between California and egg-producing states evidence of ethical relativism?
- California also enacted a law that provides that all eggs sold in California must be laid by hens living in cages that meet or exceed California's standards. Does California have the right to try to impose its ethical views on other states' citizens? Was California's motive for enacting this law solely attributable to ethical concerns?
- Because eggs are an inexpensive source of protein, an increase in the price of eggs would primarily affect low-income consumers. Does the fact that an increase in the price of eggs might harm low-income members of society affect your viewpoint?
- Wide variations exist around the world in the permissibility and implementation of the death penalty. Some countries ban it altogether, some countries permit it but rarely implement it, and some countries use it regularly. Even within the United States, similar differences exist, with some states banning it and some states allowing it.
- Is this an example of ethical absolutism or ethical relativism?
- What countries would you expect to apply the death penalty most frequently?
Principles of Accounting Ethics
- Which of the six principles in the AICPA Code of Professional Conduct is the most important?
- A CPA needs to satisfy state continuing education requirements each year to preserve her license to practice. Due to procrastination, she waited until the last minute to fulfill this requirement. She is a busy controller for a growing company and knows that the course administrators take attendance only at the start of the morning session and the start of the afternoon session. She goes to each sign-in period and then immediately leaves to go back to the office, skipping the program. What principles of the Code of Professional Conduct did she violate?
Applying Ethics to Accounting Problems
- You enjoyed your job in the real estate accounting department of Forever Twelve, Inc., a large publicly traded retail clothing chain, until recently.
Last month, your company signed a 10-year nonrenewable lease with a major regional shopping mall. As part of the deal, Forever Twelve, Inc. agreed to invest $500,000 to immediately upgrade the interior of the store. This upgrade will include installing LED lighting, marble floors with gold inlays, bathrooms, and dressing rooms. In return, the mall's landlord agreed to give your company an “incentive payment” equal to 40% of the value of the upgrades, payable immediately.
According to construction industry estimates, these upgrades have an average useful life of 15 years. You remember from your business law course that these items are classified as “fixtures” and must remain affixed to the property when a tenant vacates the premises.
The head of the real estate accounting department has told you to record the 40% incentive payment as an immediate $200,000 revenue. Then, you are supposed to “depreciate the net out-of pocket cost” of $300,000 on a straight-line basis over 15 years.
You have no background at all in real estate accounting, so you asked your boss two questions: “Isn't the $200,000 a cost rebate rather than income?” and “Are you sure that 15 years is the correct depreciation period?” In response, your boss told you, “Look, this company is aggressive in its accounting and aggressive in firing people. Just do it.”
You did a little research, but could not definitively find the answers to your questions.
- Do you doubt the accuracy of the accounting policy posed by your boss? Why?
- Under the AICPA Code, what principles would you violate if you follow the accounting directive of your boss?
Kohlberg's Stages of Moral Development
- As the head of Zendog Corporation's tax department, you faced an interesting dilemma. Due to substance abuse problems, an officer–shareholder of this closely held company had become disruptive and untrustworthy. To alleviate this problem, the company terminated this officer's employment contract and repurchased his shares at a premium price above market value.
When a company enters into a treasury stock buyback of its own shares, the amount disbursed to a shareholder is viewed as an ownership distribution, not as an expense. However, an argument can be made that at least a portion of the buyback was a necessary expense because the buyback was a necessary cost of keeping the company running smoothly.
You have to decide whether to deduct some or all of this payment as a deductible tax expense on the company's corporate tax return. You have had various thoughts, listed here. Using Kohlberg's model, identify the stage of moral development associated with each of the following viewpoints you have considered:
- It is inappropriate to deduct this payment because doing so would violate our tax laws.
- It is appropriate to deduct this payment because the tax rules governing stock buybacks did not contemplate circumstances such as this one in which the purpose of the buyback was to get rid of an officer–shareholder whose corporate decisions were harming company profitability.
- It is proper to claim this deduction because the risk of IRS detection is infinitely small.
- Because the applicable tax rules are uncertain in this unique situation, a good faith argument can be made in favor of claiming the deduction, and the IRS is unlikely to ever impose severe penalties if the claimed deduction is detected and challenged.
- I am uncertain about the right decision, and I have to respect the wishes of senior management, all of whom want me to claim this deduction.
- I am going to claim this deduction, and if the IRS denies our right to this deduction, I am going have our general counsel fight for it in federal tax court because the broad policies of the matching principle permit deduction of this payment as an ordinary and necessary expense.
- NBC medical television reporter, Dr. Nancy Snyderman, agreed to a voluntary quarantine after returning from an area of Africa where there was an Ebola epidemic. There was no evidence that she was infected with Ebola, but she announced on national television that, as an act of prudence, she would voluntarily quarantine herself at home for 21 days. If a person has contracted Ebola, this is the typical incubation period for patients to manifest Ebola symptoms, such as a high fever, fatigue, and vomiting.
Despite her public assurances, Dr. Snyderman violated her quarantine by venturing outside her home to pick up food from a favorite restaurant. Ebola potentially can be contracted from contact with an infected person's bodily fluids, such as sweat or saliva. If Ebola is contracted, patients face a major risk of death.
- What level of moral development did Dr. Snyderman exhibit when she publicly announced her self-imposed quarantine?
- What level of moral development did Dr. Snyderman exhibit when she violated her self-imposed quarantine?
- Was it ethical for Dr. Snyderman to venture outside her home in violation of her self-imposed quarantine? Is it relevant that Dr. Snyderman did not break any laws by venturing out of her home?
- Assume that privacy laws prevent doctors from disclosing the names of patients who may have contracted a serious, contagious disease. If a doctor nonetheless discloses the identity of such a patient to enable others to get potentially lifesaving treatment, what level of moral development would the doctor be exhibiting?
- Do you venture outside your home when you have a contagious respiratory disease, such as flu? If so, although the magnitude of the harm that such an action may cause is quite different from the potential harm caused by venturing outside with Ebola, is your conduct in principle any different than Dr. Snyderman's?
- What are the odds that a contagious person infected with flu will infect others? Do you know those odds when you venture outside with flu? Is there a probability of infecting others that you believe is acceptable?
- In the 1960s, most civil rights attorneys were men and most nurses were women. Do these facts support Kohlberg's views on higher-level moral development or Gilligan's views?
Comprehensive Problems
- In Star Wars, Grand Master Luke Skywalker modified the Jedi Code as follows on reestablishing the Jedi Order in the Galaxy:
- Jedi are the guardians of peace in the galaxy.
- Jedi use their powers to defend and to protect.
- Jedi respect all life, in any form.
- Jedi serve others rather than ruling over them, for the good of the galaxy.
- Jedi seek to improve themselves through knowledge and training.
Match each of these five axioms to a counterpart principle in the AICPA Code of Professional Conduct, selecting from among the Responsibilities Principle, the Public Interest Principle, and the Due Care Principle.
- You never thought you would be selected for an internship, but you did succeed. You, along with your classmate Olya Kvalevcka, were spending the summer together, completing the final weeks of your coveted internships with PrizeWaterhome, CPAs. The only problem was that the firm intimated that, due to a slowdown in business, it would only give a permanent job offer to one of you.
While waiting in a partner's office, you happened to see Olya's resume on his desk. The resume was sitting plainly in front you, so you began to kill time looking at it. Upon reading it, you noticed that Olya had misrepresented several things about herself. She stated that she was the Beta Alpha Psi vice-president, but she was only the vice-president in charge of guest speakers, not the overall vice-president. She also said that she was Professor Salcedo's teaching assistant, but you knew that this was false because you were Professor Salcedo's teaching assistant…and he only employs one! Finally, her resume says that she was selected as the “top student in Intermediate Financial Accounting” and you have never heard of that award.
You could barely sleep last night, thinking about whether you should tell someone in authority at PrizeWaterhome about these lies. What should you do?
- Three shots rang out, striking Al and his son Jeff. Neither died…yet. It'd be just a matter of time.
As the sight of splattered crimson dominated the senses, all I could think of was, “What journal entries might be needed?”
The facts, as I later came to discover them:
Al Parsons and his equal partner, brother Lou, for over 30 years successfully had operated the Celebrity Loan Company on a quiet street in Beverly Hills, California. Catering to the famous but financially troubled, Celebrity Loan Company quickly became known as the “pawnbroker to the stars.”
Al and his son Jeff were shot on December 11, Year 1. Al died within 20 minutes, while Jeff languished in Mercy Hospital until his eventual demise on January 10, Year 2. The culprit was a disgruntled patron of Celebrity Loan Company.
Al's medical bills were modest, but Jeff's medical bills eventually reached $688,000 at the time of his death. On December 31, Jeff's medical bills were $200,000.
Celebrity Loan Company's financial problems were just beginning.
Lou submitted the medical claims for Jeff to the company's insurer, but the claim properly was denied by the insurance company on December 17, Year 1. The insurer's reason was that the loan company's accident insurance policy expressly stated that “all claims that appropriately are, or should be, covered by workers' compensation insurance are hereby not recoverable under this policy agreement.” The insurance claims representative was correct. Jeff's injuries clearly fell within the scope of workers' compensation insurance because these injuries occurred on the job in Jeff's employment capacity.
The loan company did not carry workers' compensation insurance on Jeff because its accountant inaccurately told Lou that workers' compensation insurance was not needed for a child employed in the family business. Lou and his accountant have been friends for many years. Lou's accountant, a CPA, admits that he told Lou that workers' compensation insurance was unnecessary, and he was wrong. The accountant points out, though, that he gave this advice while chatting during a break from their weekly poker game.
As business partners, Al and Lou had entered into an agreement, called a buy–sell agreement, to establish the price that the surviving partner would be required to pay to the other's estate on his death. The buy–sell agreement between the two equal partners sets the buyout price as follows:
“Upon the death of one partner, the surviving partner agrees to purchase the deceased partner's interest for an amount equal to 100% of the deceased partner's Capital Account, as stated in the Company's balance sheet as of the close of the month in which one partner dies. This balance sheet shall be prepared in accordance with generally accepted accounting principles.”
The partnership agreement elsewhere defines the phrase “Capital Account” to mean a particular partner's share of the loan company's owners' equity.
Lou received the company's December 31, Year 1 financial statement from the accountant on February 12, Year 2, and paid the buyout price for Al's partnership share shortly thereafter. The balance sheet, as prepared by the accountant, did not reflect any reduction in owners' equity for the liability owed to the hospital for Jeff's medical bills incurred by Jeff while on the job.
Later on, Lou got expert financial advice that the company accountant should have reflected the company's liability for Jeff's medical bills on the company's December 31, Year 1, balance sheet, but the accountant failed to do so.
As a result of the accountant's alleged error, Lou claims that he paid too much money to buy out his partner. Lou now wants the accountant to reimburse him for the amount of this overpayment.
- When the accountant advised Lou about whether Celebrity Loan Company was required to maintain a workers' compensation policy, both parties were at a poker game. Did the accountant have a duty to give accurate advice on this topic?
- Assume that the accountant was not an expert in workers' compensation insurance issues, but he wanted to help out Lou, who was his client and friend. Did the accountant violate any principles of the AICPA's Code of Professional Conduct? Which ones?
- Assume that the accountant gave this advice to Lou and never billed Lou for the accountant's services. Would your answers be different?
- Do you believe that the accountant has an ethical duty to reimburse Lou?
- How much do you believe that the accountant should pay to Lou?