Ethics in Accounting

Abstract

Accounting deals with the rules that govern the collecting, classifying, and summarizing of financial information about a given firm, and ethics is concerned with recording, reporting, and analyzing that information honestly so that it reflects true market values. Ethics in accounting focuses on adhering to accurate and honest accounting practices, and scholars have identified a number of approaches and social norms, that seek to explain how accountants make ethical decisions. Because employers and the public expect new accountants to already be trained in ethical behavior, the federal government and professional accounting organizations have accepted responsibility for setting guidelines for ethics in accounting.

Overview

The accounting profession depends on the ability of its client base and relevant stakeholders to trust the information that accountants provide about their firms. A series of scandals in the early years of the twenty-first century focused global attention on the ethics of accounting and led to an increased emphasis on teaching ethics to accounting students. In the United States, a number of states now require that accounting students be trained in the ethics of accounting before they are licensed as Certified Public Accountants.

Once in the workplace, however, new accountants are faced with ethical decisions that may determine the course of their entire careers. Just as business executives depend on accountants to provide them with information about the financial health of their firms, governments depend on that information to produce information about the health of the economy as a whole. Accountants who do not behave ethically may find themselves facing criminal charges that lead to heavy fines and prison terms.

While ethical behaviors are closely related to morals, the two words are not always synonymous. Morals govern personal rather than professional behavior (Mastracchio, Jiménez-Angueira & Toth, 2015). The modern Occupy Movement, which has been partially a response to corporate greed and unethical business behavior, has ignited a spark around the world with a grassroots movement dedicated to demanding more ethical behavior.

In the United States, there are fifty-five jurisdictions that license CPAs, and thirty-five of those jurisdictions require CPAs to complete either a stand-alone ethics course or prove ethical knowledge through an ethics examination. California, Illinois, Maryland, Texas, Indiana, and West Virginia require that CPAs present evidence of a stand-alone ethics course in order to be certified. California has gone further than any other state in promoting ethics in accounting, mandating ten units of ethics courses and requiring that at least three of those units be taken in accounting ethics. The American Institute of Certified Public Accountants has increased pressure on states to establish strict ethics accounting standards.

In order to explain ethical decision making in accounting, scholars have identified such approaches as egoism, universalism, utilitarianism, and social norms that differ according to the goals involved in each, focusing variously on the interests of employers, society, and customs. The most common approach is utilitarianism, which considers consequences paramount to decision making. In the late 1980s, scholars began focusing on cognitive-based models, paying close attention to psychological theories developed by Lawrence Kohlberg, who was the first to identify the stages of moral development.

Rest (1986) generated the Defining Issues Test (DIT), which depends on the concept of virtue for making ethical decisions. Rest’s four models occur in sequence, beginning with the recognition that an ethical situation has occurred and considering possible actions and effects. Second, a desired course of action is decided on after examining all sides of the issue. Third, steps that must be taken in order to resolve the issue are identified. Last, the selected steps are put into practice. Martinov-Bennie and Mladenovic (2015) suggest that Rest’s models do not pay sufficient attention to the moral intensity involved in decision making in accounting.

Beginning in the 1990s and increasing significantly in the early years of the twenty-first century, the entire globe was plagued with a number of accounting scandals that shook the profession to its core. Names of companies and individuals such as Adelphia, AIG, Bernie Madoff, Dynergy, Enron, Fannie Mae, Freddie Mac, Global Crossing, Rite Aid, Tyco, and WorldCom became as well known for their unethical behaviors as for the products and services they provided. Accounting students were required to study such scandals to learn how accounting frauds were perpetrated and the consequences suffered in each instance.

Some accounting scandals have come to light as the result of auditors discovering firms engaging in such practices as misrepresenting revenues or losses, but others are discovered by outside agencies, such as the Securities and Exchange Commission. Whistleblowers have also played a role in uncovering accounting sandals. Sherron Watkins was responsible for blowing the whistle on Enron, a giant energy company whose unethical practices bankrupted the company and led to a twenty-four-year prison sentence for CEO Jeff Skilling. Former CEO Ken Lay died before he could begin serving time.

Cynthia Cooper opened the gate for the WorldCom scandal in which investors lost $180 billion. CEO Bernie Ebbers was sentenced to twenty-five years in prison after company auditors discovered fraud amounting to $3.8 billion. One of the first whistleblowers to receive national attention was James Alderson, a former CFO at North Valley Hospital. Alderson filed a lawsuit in 1993 under the False Claims Act against HCA, the owner of North Valley Hospital, accusing them of defrauding the government of Medicare and Medicaid payments by keeping separate sets of books. The federal government joined Alderson’s suit in 1998, and in 2001 HCA was forced to pay $745 million in civil damages, 95 million in criminal fines, and $881 to settle other charges.

In 2004, the collapse of the accounting firm Arthur Anderson after the public learned of frauds carried out by partners and managers resulted in a $457 million class-action lawsuit and mounting public concern over ethics in accounting. David Costello, the president of the National Association of the State Boards of Accounting, and 160 charter members founded the NASBA Center for the Public Trust (CPT). In 2013, the group established the CPT Ethics Pilot Program, which provides online presentations, narrations, images, videos, and polls for use by teachers of accounting certification programs. The CPT online certification program is an eight-hour course composed of separate sections, and students are required to take a test after completing each section. In order to pass, at least 80 percent of all questions must be answered correctly.

Further Insights

The federal government has attempted to promote ethics in accounting through a series of laws. In 2002, Congress passed the Sarbanes-Oxley Act (SOX), which required American publicly traded companies to monitor accounting practices internally. Responsibility for honest reporting was assigned to CEOs and CFOs, who could face stiff punishment if convicted of unethical behaviors. SOX also established the Public Company Accounting Oversight Board to monitor ethics in auditing and accounting. The act banned auditors from being hired to provide non-auditing services to the companies they audit. SOX was not well received among American businesses, and it was dubbed "quack corporate governance" by its critics (Romano, 2005).

In 2010, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act, which significantly expanded the efforts made in SOX to ensure accountability of Big Business in the United States. Elements of Dodd-Frank included stricter standards for the accounting profession, more emphasis on peer reviews, and better methods for identifying accounting fraud (Carlino, 2011). Increased attention meant that the pressure on accountants was increased even as firms demanded that auditing costs be reduced.

Recognizing the need, software developers responded by creating a plethora of applications for auditors that were designed to uncover unethical accounting behaviors and make the work of accountants easier. SOX has continued to be controversial, and Republicans and Big Business have attempted to mitigate what they see as interference in the market. In 2014, Congress passed the Jumpstart Our Business Startups Act, which allowed exemptions of new companies reporting revenues of less than $1 billion from the provisions of both Dodd-Frank and SOX.

In an effort to monitor itself, the accounting profession has created a number of state, national, and international organizations that attempt to establish guidelines for ethics in accounting. The United States has historically enforced accounting standards more stringent than those of other countries, but efforts to globalize accounting standards in the twenty-first century has led to some relaxing of those standards. The International Association for Accounting Education and Research (IAAER) was founded in 1984 to establish global standards for teaching professional ethics, and organizations such as the International Federation of Accountants (IFAC) continue to offer guidance for establishing ethical standards for accountants and auditors and for ensuring that accounting students are trained in making ethical decisions.

In 1986, the American Accounting Association’s Committee on Future Structure, Content, and Scope of Accounting Education launched a campaign to improve ethics training in accounting programs in the United States. In 2008, the National Association of State Boards of Accountancy announced that it was revising Rules 5-1 and 5-2 of the Uniform Accounting Act to mandate that all accounting students take three semester hours of professional ethics classes.

In 2002, the American Institute of CPAs began providing an Ethics Tree for accountants to use when determining the proper professional behavior, suggesting that accountants trust their instincts when discussing situations with management and treat all responses with "the necessary degree of professional skepticism" (AICPA, 2015). Accountants are encouraged to document all elements of the ethical situation, including questions asked and responses received in light of professional and legal standards. Based on the information as a whole, accountants are then advised to determine whether employment should continue and whether the situation needs to be reported to non-company accountants, regulatory agencies, banks, lending institutions, owners, investors, boards, and/or other stakeholders (AICPA, 2015).

Issues

The alarming number of high-profile accounting scandals led Wall Street to attempt to shift some of the blame for unethical behaviors to colleges and universities, insisting that they had failed to adequately train accountants in the ethics of the profession. In the 1960s and 1970s, most training programs for accountants had spent only limited time on teaching ethics, offering students a few case studies of firms that had violated ethics laws and been charged with violations. In 1979, however, the Association to Advance Collegiate Schools of Business (AACSB) added an ethics requirement for business majors. A decade later, the organization began mandating ethics training in accounting and demanded that ethics education be integrated across the business curriculum.

As new scandals erupted, more schools added ethics to the curriculum. In 1990, the Academy of Management’s Social Studies Issues in Management Section conducted a study of ethics training for accountants, finding that one in three schools accredited under the Association of Advance Collegiate Schools of Business offered no stand-alone courses dedicated to the ethics of business and society (Martinov-Bennie & Mladenovic, 2015). Only half of the accredited schools had assigned full-time faculty members to teach ethics. In other schools, ethics was taught by professors from other fields, particularly philosophy.

The debate over how ethics should be taught to accounting students has been intense, and researchers have devoted significant effort to analyzing efforts of colleges and universities to prepare new accountants to meet the demands of a profession that is in the global spotlight. Scholars suggest that ethics training should focus on the need for honesty, fairness, and justice as universal and inviolate concepts (Thomas, 2012). In a 2012 study, (Ethics and Accounting), Thomas found that education was a major factor in sensitizing accounting students to ethical questions. The study indicated that fourth-year students were more attuned to deliberate reasoning than first-year students and that first-year accounting students were more aware of different levels of decision making than were first-year business students.

A 2015 study by Martinov-Bennie and Mladenovic suggested that ethical sensitivity of accounting students was greatest when the teaching of ethics was integrated throughout the curriculum. They were surprised to find that the students who exhibited the most sophisticated levels of ethical judgments were those who had not been exposed to frameworks that discussed the various viewpoints on ethics in accounting. Some studies have revealed that student accountants who are repeatedly exposed to ethics are better equipped to make ethical decisions on the job and in their personal lives (Lau, 2010). Overall, studies have demonstrated that the best ethics training for accountants is both cumulative and integrative. However, benefits from a single course dedicated solely to ethics are considered highly significant. The emphasis on accounting in ethics has led to an overall finding that accounting students express less tolerance for unethical behavior on the job than either business majors or non-business majors.

Since 2004, the AACSB has suggested that all ethics courses cover business responsibility, ethical decision making, ethics in leadership, and corporate government leadership (Martinov-Bennie & Mladenovic, 2015). In 2005, the Education Committee of the National Association of the State Boards of Accounting began recommending that all accounting programs include three semester hours of accounting ethics and three semester hours of business ethics. The backlash forced NASBA to backtrack, reducing the recommendation to only three semester hours of ethics training that could be taught in a stand-alone course or integrated into the existing curriculum. Asuza Pacific University, a private Methodist school located near Los Angeles, has gone further than most schools, establishing an endowed chair ($8.6 million) in ethical auditing within the Timothy Leung School of Accounting and providing a master’s degree in ethical auditing. John Thornton was recruited from Washington State University to head up the program, which covers ethics from the ancient Greeks and the biblical period to modern philosophies of ethics. Methods for teaching ethics in college classrooms include written and video ethics cases, group learning, case studies, role-playing, film, and multimedia presentations (Thomas, 2012). These methods may be used in stand-alone ethics classes and incorporated into other accounting and business classes.

The increased emphasis on ethics in accounting has not completely stopped firms from engaging in illegal practices, but it has made it more likely that such practices will be made public. In 2005, Refco, a commodities trading company, was engaged in a scandal when it was reported that its CEO and Chairman of the Board had prevented auditors and investors from learning about $340 million in bad debts. Three years later, it was learned that Lehman Brothers had engaged in off-balance sheet accounting. The National Business Ethics Society reported that between 2007 and 2013, incidences of unethical business behavior declined from 55 percent to 41 percent. However, more than one in four American firms is still believed to engage in some form of unethical behavior (Mastracchio et al., 2015).

Terms & Concepts

Dodd-Frank Wall Street Reform and Consumer Protection Act: Congressional act passed in 2010 that authorizes the federal government to engage in oversight of U.S. businesses in order ensure transparency and accountability.

Egoism: Approach to accounting ethics in which the chief goals are maximizing the benefits of decision makers while minimizing costs of business operations.

Great Recession: The worst economic crisis since the Great Depression, the Great Recession began in December 2007 after the collapse of the housing market, resulting in the loss of 7.5 million jobs and an unemployment rate of 10 percent. It was declared officially over in June 2009.

Occupy Wall Street: Social movement that began in 2011 on social media sites and spread throughout the developed world as individuals objected to rising poverty and increased corporate greed.

Sarbanes-Oxley Act (SOX): Controversial federal legislation passed in 2002 to increase accountability in business accounting. SOX also created the Public Company Accounting Oversight Board.

Social Norms: Approach to accounting ethics based on the theories of American philosopher John Rawls that defines ethical behaviors according to accepted norms of justice and fairness.

Universalism: Approach to accounting ethics based on the theories of German philosopher Immanuel Kant that suggests that behaviors should be based not on consequences but on principles.

Utilitarianism: Approach to accounting ethics derived from the political theories of Utilitarians such as Jeremy Bentham that call for practices that promote the greatest societal good.

Bibliography

American Institute of CPAs. (2015). Ethics tree. Retrieved December 15, 2015 from http://www.aicpa.org/InterestAreas/BusinessIndustryAndGovernment/Resources/ProfessionalDevelopment/EthicsDecisionTree/Pages/default.aspx

Carlino, B. (2011). The 21st century audit. Accounting Today, 25(4), 1–35.

Chawla, S. K., Khan, Z. U., Jackson, R. E., & Gray III, A. W. (2015). Evaluating ethics education for accounting students. Management Accounting Quarterly, 16(2), 16–25. Retrieved November 19, 2015 from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=103066534&site=ehost-live

Lau, C. L. L. (2010). A step forward: Ethics education matters! Journal of Business Ethics, 92(4), 565–584.

Martinov-Bennie, N., & Mladenovic, R. (2015). Investigation of the impact of an ethical framework and an integrated ethics education on accounting students’ ethical sensitivity and judgment. Journal of Business Ethics, 127(1), 189–203. Retrieved November 19, 2015 from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=101148513&site=ehost-live

Mastracchio Jr., N. J., Jiménez-Angueira, C., & Toth, I. (2015). The state of ethics in business and the accounting profession. CPA Journal, 85(3), 48–52. Retrieved November 19, 2015 from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=101708408&site=ehost-live

Meymandi, A. R., Rajabdoory, H., & Asoodeh, Z. (2015). The reasons of considering ethics in accounting job. International Journal of Management, Accounting, and Economics, 2(2), 136–143. Retrieved November 19, 2015 from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=101708408&site=ehost-live

Rest, J. R. (1986). Moral development: Advances in research and theory. New York, NY: Praeger.

Romano, Roberta. (2005). The Sarbanes-Oxley act and the making of quack corporate governance. Yale Law Journal, 114, 1521–1612.

Thomas, S. (2012). Ethics and accounting education. Issues in Accounting Education, 27(2), 399–418.

Suggested Reading

Chambers, D, Hermanson, D. K., & Payne, J. L. (2010). Did Sarbanes-Oxley lead to better financial reporting? CPA Journal, 80(9), 24–27. Retrieved January 3, 2016, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=59799797&site=ehost-live

Cooper, B. J., et al. (2008). Ethics education for accounting students: A toolkit approach. Accounting Education: An International Journal, 17(4), 405-430. Retrieved March 22, 2015 from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=ehh&AN=35581904&site=ehost-live

Gill, M. (2009). Accountants’ truth: Knowledge and ethics in the financial world. New York, NY: Oxford University Press.

Goldberg, S., & Bettinghaus, B. Everyday ethics: Tougher than you think. Strategic Finance, 97(6), 46–53. Retrieved November 19, 2015 from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=103029682&site=ehost-live

Stem, Robert. (2012). Understanding moral obligation: Kant, Hegel, Kierkegaard. Cambridge, UK: Cambridge University Press.