Ethical Guidance Issues by Auditors - Essay Example

Running Head: Auditors do not need detailed ethical guidance Auditors do not need detailed ethical guidance of the ofthe institution] Auditors do not need detailed ethical guidance Auditors and the audit profession have enjoyed the reputation 'f maintaining high ethical standards. Since 2000, there has been a focus on the issue and many books have been written on the subject. Indicators now exist, however, which may portend an ethical crisis. Accounting and auditing associations have responded to this potential crisis by adopting and updating codes 'f ethics which provide rules and principles to guide members via a conservative "Code-implied" model 'f ethical decision making. The AICPA Code 'f Professional Conduct (Code) was revised in 1988 and approved by the membership to consist 'f two sections: principles and rules. Interpretations 'f the rules and rulings issued by the AICPA to answer specific questions regarding members' ethical conduct supplement the principles and rules and, in combination, provide guidance to auditors making decisions about ethical dilemmas. The model 'f the decision-making process implied by the combination 'f these Code elements is conservative, however, and may not fully capture all the actual influences on auditors' decisions. This study proposes and tests an alternative model in comparison with the AICPA Code-implied model. (Jeffrey 2004, 553-579) Alternative Models 'f Ethical Decision Making When faced with an ethical dilemma, an auditor must gather and analyze data from many sources. It is likely that auditors gather and analyze these data in many different ways. One benefit 'f a model 'f auditors' ethical decision making is that the model elements can be identified and tested to better understand how and why the decisions are made. In this section the decision model implied by the AICPA Code is delineated and compared with other existing models. (Martin 2007, 5-14) Professional Code-Implied Model Numerous professional accounting, financial, and auditing organizations have separately adopted codes 'f ethics. Most practicing internal, public, and governmental auditors are associated with one or more 'f these organizations and have voluntarily submitted to the respective codes 'f conduct which restrict activities beyond the legal statutes binding the general citizenry. Comparisons 'f these codes indicate that there are significant common components across many 'f them, but also that omissions and potential conflicts exist Unlike most other codes, the AICPA Code provides specific guidance in using both rules and principles to conservatively resolve conflicts. The chairman 'f the committee drafting the restructured Code described the application 'f principles in the following manner: 'guided by the basic principles in the Standards of Professional Conduct, members must exercise professional and moral judgments in all their activities. Within the added principles section 'f the AICPA Code, members are called 10 an "unswerving commitment to honourable behaviour, even at the sacrifice 'f personal advantage" (AICPA 1988). This description 'f the AICPA Code implies an exceptionally conservative decision model. According to the Code-implied model, an accountant or auditor must be aware 'f the principles, rules, interpretations, and rulings promulgated by the AICPA. When facing an ethical dilemma, an auditor compares the dilemma situation with these elements 'f the Code and makes a decision to avoid any possible violation. To follow this decision model without exception would lead to increasingly conservative decisions in which the gray area calling for auditor judgment is reduced. That is, when an ethical dilemma situation is addressed within the Code each new level 'f guidance adds restrictions which require auditors to follow promulgated rules and principles without deviation. This model is illustrated in figure 1 and discussed below. At the legal level, CPAs are constrained from complete decision-making freedom. For example, a CPA might be serving a client who is involved in merger negotiations. When the merger proposal is made public, the price 'f the client's stock will rise substantially. An auditor is constrained by insider trading laws (LEGAL level) from investing in the stock to make a personal profit. Even when not legally constrained from investing in the client, Rule 101 'f the Code (RULE level) restricts investment in clients' stock. The PRINCIPLES level further restricts the auditor's ethical decision-making freedom. A Code principle states that a CPA will not engage in activities that could hinder public confidence in the profession. For example, if loans from a bank to partners 'f the audit firm would be beneficial to the partners but would cause other business leaders to question the CPAs' integrity, then such loans should not be consummated even if not constrained by legal sanctions or specific Code rules. The Code-implied model requires unswerving commitment to the LEGAL, RULE, and PRINCIPLE levels 'f self-constraint. Personal self-interest considerations as well as concerns for other parties such as family, friends, or colleagues are not appropriate reasons to swerve from the conservative decision rules. According to the Code-implied model, auditors always make conservative ethical decisions to avoid breaking laws, rules, or principles. Application 'f the model, however, is not straightforward in all situations. (Brown 2007, 39-71) For example, some auditors have willingly incurred legal liability in order not to disclose confidential client information. On the other hand, auditors have disclosed confidential information obtained via an audit when it was considered necessary in order to protect investors from harmful decisions based on erroneous data. One objective 'f this study is to better determine the situations in which auditors consider it appropriate to violate the Code-implied model. Other models 'f ethical decision making provide a means 'f identifying non-Code factors influencing auditors. Alternative Models 'f Ethical Decision Making Researchers in philosophy, psychology, economics, management, and accounting have begun to examine components 'f ethical decision making within models that describe the decision process. Before making an ethical judgment, auditors must gather, evaluate, and combine numerous professional and situational variables. (Hussey 2001, 169-178) The decision models in the literature attempt to explain what variables influence the decision maker, how the variables are valued, and how conflicting value judgments are reconciled. Specific models considered in this section include the agency model and three cognitive-psychology based models. The Agency Model. The basic agency model separates the ownership function (principal) from the function 'f a delegated decision maker (agent), recognizing that the best interest 'f the agent may be in conflict with that 'f the principal. Agency problems exist in all organizations and result in monitoring costs to be borne by the principal in order to control the agent (Jensen and Meckling 1976; Walts and Zimmerman 1986). A technical solution to the agency problem is to contract an optimal agreement clearly stating the agent's required actions. In situations 'f professional service, however, problems 'f moral hazard (the agent acting contrary to the interest 'f the principal) and information asymmetry (the principal not certain 'f the agent's actions) cannot be completely resolved through a contract agreement (Young and Jaworski 1988). DeJong and Smith (1984) conclude that auditors, as agents, may maximize personal utility by balancing short-term benefits with longer-term costs such as potential litigation or loss 'f reputation. Noreen (1988) extends agency theory to the economics 'f ethics. For those individuals who act unethically in self-interest, without conscience and without being readily observable, agency theory is applicable. Noreen extends this application 'f agency theory to show that the agents would be better off economically if it were possible to mutually agree to restrain opportunistic behaviour via agreements such as ethical codes 'f conduct. Because short-term violations 'f such an agreement would not be observable, it is necessary for members 'f a profession such as auditing to internalize sanctions for unethical behaviour. In the long run, it is 'f significant economic benefit to the profession for members to internalize sanctions and thereby avoid more costly external sanctions in situations when those parties using and paying for audit services subsequently determine unethical behaviour has occurred. Additional considerations 'f internalized ethical standards have been recognized in several cognitive-based ethical models. (Kaplan 2001, 40-45) Cognitive-Based Ethical Models. Academics and practitioners have directed increased attention to both theoretical and empirical examinations 'f ethical decision making. The primary model on which the remainder 'f this study is based is the Rest (1986a) four-component model for individual ethical decision making and behaviour. Another model (Trevino 1986) was offered as an alternative model to consider individual and situational variables. In this study, the Trevino "Interactionist Model 'f Ethical Decision Making in Organizations" is considered a complimentary extension 'f the Rest four-component model. A third issue-contingent model has been proposed by Jones (1991) and adds a new set 'f variables collectively referred to as "moral intensity," which further explains ethical decision making as internalized by individuals performing within an organization or profession. Each 'f these models includes recognition 'f an individual decision maker's stage 'f cognitive moral development as defined by Kohlberg (1984). References Brown, Phil; Stocks, Morris; Wilder, W. 2007. Ethical Exemplification and the AICPA Code 'f Professional Conduct: An Empirical Investigation 'f Auditor and Public Perceptions. Journal 'f Business Ethics, Mar2007, Vol. 71 Issue 1, p39-71 DeJong, D. V., and J. M. Smith. 1984. The determination 'f audit responsibilities: An application 'f agency theory. Auditing: A Journal 'f Practice &. Theory (Fall): 20-34. Hussey, Roger; Lan, George., 2001. An Examination 'f Auditor Independence Issues from the Perspectives 'f U.K. Finance Directors. Journal 'f Business Ethics, Part 2, Vol. 32 Issue 2, p169-178 Jeffrey, Cynthia; Dilla, William; Weatherholt, Nancy. 2004. The Impact 'f Ethical Development And Cultural Constructs On Auditor Judgments: A Study 'f Auditors In Taiwan. Business Ethics Quarterly, Vol. 14 Issue 3, p553-579 Jensen, M., and W. Meckling. 1976. The theory 'f the firm: Managerial behavior, agency costs, and ownership structure. Journal 'f Financial Economics (October): 305-360. Jones, T. M. 1991. Ethical decision making by individuals in organizations: An issue-contingent model. Academy 'f Management Review (April): 366-395. Kaplan, Steven E.; Whitecotton, Stacey M. 2001. An Examination 'f Auditors' Reporting Intentions When Another Auditor Is Offered Client Employment. Auditing, Vol. 20 Issue 1, p45 Kohlberg, L.. 1984. Essays on Moral Development. Volume II. The Psychology 'f Moral Development. New York: Harper and Row. Martin, Roger., 2007. Through the Ethics Looking Glass: Another View 'f the World 'f Auditors and Ethics. Journal 'f Business Ethics, Vol. 70 Issue 1, p5-14 Noreen, E. 1988. The economics 'f ethics: A new perspective on agency theory. Accounting Organizations and Society (June): 359-370. Rest, J. R.. 1986a. Moral Development: Advances in Research and Theory. New York: Praeger Publishers. Trevino, L. K. 1986. Ethical decision making in organizations: A person-situation interactionist model. Academy 'f Management Review (July): 601-617. Young, M., and R. Jaworski. 1988. Goal congruence, information asymmetry and dysfunctional behavior: An empirical study. Unpublished manuscript. Read More