Accounting ethics

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Ethics is an integral component of financial reports. Investors, creditors, and other analysts rely heavily on financial statements prepared by accountants and reviewed by auditors. The historical, present and future financial conditions of companies are represented therein, and this information needs to be credible for the company, and business world as a whole, to survive.

Contents

[edit] Background

Ethics in the business world is not a new phenomenon. However, recent publicity, mostly negative, has brought accounting to the front lines of business ethics. Due to the magnitude of impact on investors and the market, accountants and auditors are questioned whenever fraudulent activities occur within corporations. Major corporate scandals at Enron, WorldCom and Tyco International have only deepened the public’s lack of trust.

To ensure ethics, and therefore financial stability, professional accountants must make morally sound decisions. Ethics cannot be restricted to merely financial statements and records, but also to the decisions that companies may make and enforce.

For example, lack of ethics fueled abuses at WorldCom, Enron, and Adelphia Communications at the highest levels. Senior level management engaged in unethical accounting practices, allowing financial misrepresentations at each of these corporations, almost always under the influence of top management. During these times, Enron was being audited by Arthur Anderson, which approved the financial statements. In fact, when Arthur Anderson learned that Enron had falsified their data and numbers, and was being probed by the Securities and Exchange Commission (SEC), they began to shred all documents relating to their audit of Enron. In December 2001, Enron, a once-leading energy company, filed for bankruptcy, the largest in U.S. history. It used tactics such as off-the-books partnerships to hide their debt (~$1 billion) and inflate profits to raise their stock prices. Top Enron officers cashed out their own stock options while thousands of workers were left with empty retirement accounts. [1]

Worldcom follows a similar story. At the time, the external auditors for Worldcom were again Arthur Andersen. Under the direction of the company’s top executives, Worldcom used fraudulent accounting methods to artificially inflate their revenues during 1999 - 2002. The company’s stock went up and these top officials enjoyed hefty bonuses. However, in 2002, during an internal audit review, more than $3.8 billion of the fraud was uncovered. Following an SEC inquiry, it was discovered that the company’s assets had been inflated by $11 billion. [2]

In the case of Tyco, two top executives succeeded in stealing close to $600 million in company assets, claiming that this amount was approved by the company’s board of directors. They were eventually convicted on all but one of 30 counts in 2005 and are now in prison. [3]

Adelphia was a victim of internal corruption. Family members that held top positions in various divisions of Adelphia were charged with securities violations after it was disclosed that $100 million had been stolen and $2.3 billion worth of debt had been concealed via complicated cash-management systems. [4]

As a result of these infamous events, U.S. Congress passed the Sarbanes-Oxley Act of 2002 (a.k.a. Public Company Accounting Reform and Investor Protection Act of 2002). In essence, the legislation established or enhanced standards of conduct for public companies and accounting firms. The act provided three things:

The PCAOB was a new agency that stakeholders (U.S. Congress, corporations, and investors) hoped would help mitigate unethical accounting practices, under the supervision of the U.S. Securities and Exchange Commission (SEC).

[edit] Agencies

The U.S. Government, primarily Congress, has created various agencies to counteract unethical behavior, including unethical business practices. The various agencies work to ensure financial accounting is honest and reliable. Although all are separate entities, they often work cooperatively to maximize areas of coverage.

[edit] I. SEC

The United States Securities and Exchange Commission (SEC) is a five-member body appointed by the President of the United States and approved by the U.S. Senate. It was created by the Securities Exchange Act of 1934 as a consequence of the Stock Market Crash of 1929. It enforces the federal securities laws and regulations dealing with the securities industry and stock market. Primarily created to prevent corporate abuses relating to the sale of securities and corporate reporting, the SEC now administers six major laws [5] :

The SEC is composed of 4 main divisions [6]:

1. Corporation Finance Division

The Corporation Finance Division primarily oversees public disclosures made by public companies as well as the registration of company transactions. In order to achieve these goals, the SEC requires quarterly and annual reports to be submitted, as well as a statement of the year’s operations and success. To allow all individuals access to these reports, the SEC maintains an online database called EDGAR (Electronic Data Gathering, Analysis, and Retrieval System). EDGAR contains these forms and papers, as well as all other information filed with the SEC. This vital company information allows individuals to better evaluate companies and potential securities.

2. Trading and Markets Division

The Trading and Markets Division oversees self-regulatory organizations like NYSE, FINRA, MSRB, broker-dealer firms, and investment houses.

3. Investment Management Division

The Investment Management Division oversees investment companies and investment advisers, and also administers federal securities laws. They also assist in interpreting laws and regulations, as well as adapting SEC rules to new circumstances.

4. Enforcement Division

The Enforcement Division investigates violations of securities laws/regulations and brings actions against these violators.

[edit] II. PCAOB

The PCAOB was created by the Sarbanes-Oxley Act of 2002 as a non-profit corporation to oversee auditors of public companies. The PCAOB actually replaced the Public Oversight Board, which was dissolved in 2002, to act as a non-partisan oversight body. Allegations that auditors’ allegiance to clients had compromised their independence because of fees the firms were receiving led to a long list of powers, most importantly the ability to set standards relating to auditing, ethics, quality control and preparation of audit reports for the auditing industry. The PCAOB also has the power to inspect any registered public accounting firms at any time to review the firm’s adherence to policies. If the PCAOB uncovers anything it believes is unethical or illegal, it can investigate and impose sanctions upon either the firm as a whole or the individuals involved. Firms registered with the PCAOB are bound to abide by PCAOB's Ethics & Independence Standards which are composed of

  • AICPA Code of Professional Conduct Rule 101, and interpretations and rulings
  • Independence Standards Board]] (ISB) Standards numbers 1, 2, and 3, and ISB Interpretations 99.1, 00.1, and 00.2.
  • SEC Rules on Auditor Independence

On April 19th 2006, the PCAOB's Ethics and Independence Rules Concerning Independence, Tax Services and Contingent Fees were approved by the SEC. The seven approved rules primarily focus on tax and audit issues, but also discuss ethical responsibilities. Rule 3502, "Responsibility Not to Knowingly or Recklessly Contribute to Violations” allows the PCAOB to take legal actions against an individual that violates the professional standards and laws pertaining to the Sarbanes-Oxley Act and PCAOB Rules. [7]

Public trust has grown and auditing firms have enhanced the quality of audits performed under the strict guidelines set forth by the PCAOB.

[edit] III. FASB

The Financial Accounting Standards Boards (FASB) is a non-profit organization created in 1973 (replacing the Accounting Principles Boards) and the Committee on Accounting Procedures) for the purpose of generating Generally Accepted Accounting Principles (GAAP). Their goal is to establish and improve financial accounting standards and methods of reporting. The FASB is a seven-member board of accounting professionals, and though independent from the SEC, is a critical component of the SEC and its mission. Currently, the FASB is working closely with the International Accounting Standards Board to simplify the financial reporting process and require only one set of financial statements from companies that operate in both domestic and international markets. [8]

[edit] IV. AICPA

The American Institute of Certified Public Accountants (AICPA) (formerly known as the American Association of Public Accountants) was established in 1887. [9] It adopted the AICPA Code of Professional Conduct for its membership bodies that range from those within public accounting to the government sector and in education. [10] The Code consists of the rules and the principles that provide the framework for the rules. Together, they guide their members in performing professional responsibilities. To assist its members with understanding and meeting the ethical responsibilities set within the Code, the AICPA has established a Professional Ethics Executive Committee (PEEC). [11] PEEC holds quarterly meetings to discuss the standard-setting activities and ethical cases involving disciplinary actions against members that fail to comply with the rules. Ethical issues are also discussed within the Journal of Accountancy, which is a periodic publication of the AICPA. The Five Principles of Professional Conduct are: carrying out professional responsibilities; serving the public interest; acting with integrity, objectivity, and independence; and due care.

[edit] V. GAO

The U.S. Government Accountability Office, as the name suggests, works closely with the US Congress to ensure the proper accountability of federal public funds. The US Government Accountability Office has extensive literature on the ethical responsibility of corporations as well. From the GAO’s perspective, the recent accountability failures discussed earlier reflect poorly on US corporations and the accounting ethics they have in place. This can translate into reduced investment in US markets by foreign companies and individuals alike. According to the GAO, improvements have been seen in the two years since the S.O.X. Act was passed in 2002. [12]

[edit] VI. IESBA

International Ethics Standards Board for Accountants (IESBA) develops high-quality ethical standards to be used by its member bodies and accountants all over the world. IESBA works independently under the International Federation of Accountants (IFAC) and together they have developed a code of conduct, called the IFAC Code of Ethics for Professional Accountants. [13] Firms that prepare financial reports using the International Auditing and Assurance Standards have to adhere to these standards. Within the Code are five fundamental principles:

  • Integrity and honesty in all work
  • Maintaining objectivity in decision making
  • Staying professionally competent and acting with due care
  • Respecting client confidentiality
  • Maintaining a professional behavior

[edit] VII. Others

Various other organizations and agencies have set ethical standards in place. The Institute of Internal Auditors (IIA) has developed an Institute of Internal Auditors Code of Ethics for its members and other certified internal auditors. Likewise, the Institute of Management Accountants (IMA) has a standard for ethical conduct for professionals in the management accounting field.

[edit] Summary

Almost all authoritative accounting bodies, professional organizations and government agencies have guidelines that propagate codes of ethics that are both necessary and appropriate for the accounting profession. All accountants, because of the importance of their work, have a responsibility to all those that utilize their services, both directly and indirectly.

Cooperation seems to be key; many ethics-promoting organizations and boards utilize outside help on a constant basis to achieve their goals. This cooperation can not only improve accounting as a profession, but also maintain and raise the public’s confidence in the honesty and reliability of financial information. Both individuals and corporations must achieve the highest level of ethics and morality for the accounting profession to advance and evolve.

[edit] References

  1. ^ The Enron Story That Waited To Be Told
  2. ^ The WorldCom We Hardly Knew
  3. ^ Timeline of the Tyco International Scandal
  4. ^ The Corporate Scandal Sheet
  5. ^ Laws That Govern the Securities Industry
  6. ^ Divisions of the SEC
  7. ^ PCAOB Professional Standards and Rulemaking
  8. ^ Financial Accounting Standards Board
  9. ^ History of the AICPA
  10. ^ AICPA Code of Professional Conduct
  11. ^ Professional Ethics Executive Committee (PEEC)
  12. ^ Report to the Committee on Small Business and Entrepreneurship, U.S. Senate
  13. ^ International Ethics Standards Board of Accountants
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