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Accounting Assignment

Open Posted By: highheaven1 Date: 16/10/2020 High School Case Study Writing

 Find a current accounting article. This article should be from a respectable source, ie Journal of Accountancy, CBA, Tax Advisor, etc. Provide a short fact synopsis about the article and analyze how the article relates to the class(PLEASE SEE THE ATTACHED POWERPOINTS TO SEE WHAT SUBJECTS I TOOK IN THIS CLASS). The assignment should not exceed three paragraphs. If I find the article does not relate to accounting, you will not receive credit. 

Category: Arts & Education Subjects: Education Deadline: 12 Hours Budget: $150 - $300 Pages: 3-6 Pages (Medium Assignment)

Attachment 1

Chapter 4 Ethics and Professional Judgment in Accounting

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Questions for Consideration

What are the underlying behavioral characteristics of good judgment?

What is the link between moral reasoning methods and making professional judgments?

How does cognitive dissonance influence professional judgment?

What is the role of professional judgment in making ethical decisions?

How does the AICPA Code address issues of professional judgment?

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Public Watchdog Function (1 of 2)

Public responsibility transcending any employment responsibility with the client

Ultimate allegiance to the corporation’s creditors and stockholders, as well as to the investing public

Accountant must maintain total independence from the client at all times and requires complete fidelity to the public trust

Overriding duty to put the interests of investors first

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Public Watchdog Function (2 of 2)

Need for professional skepticism in making professional judgments

Need for objectivity and due care in making judgments given the increasing complexity in financial reporting

Only profession where one’s public obligation supersedes that to a client

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Professional Judgment in Accounting (1 of 2)

Professional judgment is influenced by personal behavioral traits

Attitudes

Ethical values

Personal values link to ethical sensitivity and judgment

Ethical awareness of an ethical dilemma is a mediator of the personal factors and ethical judgment relationship

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Professional Judgment in Accounting (2 of 2)

Objectivity and due care are attitudes and behaviors that enable professional judgment

Professional skepticism is essential in making professional judgments; helps frame auditors’ mindset of independent thought

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KPMG Professional Judgment Framework (1 of 2)

Judgment is the process of reaching a decision or drawing a conclusion where there are a number of possible alternative solutions

Judgment occurs in a setting of uncertainty, risk, and often conflicts of interest

Components revolve around ones’ mindset

Clarify issues and objectives

Consider alternatives

Gather and evaluate information

Reach conclusion

Articulate and document rationale

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KPMG Professional Judgment Framework (2 of 2)

Prescriptive framework is used but pressures, time constraints, and limited capacity may cause deviations

Auditor should approach matters with objectivity and independence, with inquiring mind and critical assessment of audit evidence

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Link between KPMG Framework and Cognitive Processes (1 of 2)

Auditors need to use System 2 thought process

Ethical awareness

Application of ethical reasoning, ethical analysis of harms and benefits and stakeholder rights; and professional obligations

Judgments can fall prey to cognitive traps and biases that negatively influence judgments

Group-think

Rush to solve problems

Judgment triggers

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Link between KPMG Framework and Cognitive Processes (2 of 2)

Judgment triggers – can lead to accepting a solution before it is properly identified and evaluated

Availability tendency

Confirmation tendency

Overconfidence tendency

Anchoring tendency

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Public Interest in Accounting (1 of 2)

When professional judgment is compromised by taking shortcuts or allowing pressures and biases imposed by others to taint decision making, the public looses trust in the accounting profession

The profession must rebuild its reputation on its historical foundation of ethics and integrity

IFAC’s Policy Position Paper #4, A Public Interest Framework for the Accounting Profession

A distinguishing mark of the accounting profession is the acceptance of its responsibility to act in the public interest.

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Public Interest in Accounting (2 of 2)

International Ethics Standards Board for Accountants (IESBA) include integrity, objectivity, professional competence and due care, confidentiality, and compliance with laws and regulations

AICPA public interest includes clients, credit grantors, governments, employers, investors, the business and financial community, and others who rely on the objectivity and integrity of CPAs

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Professionalism versus Commercialism (1 of 2)

In 2013 PwC acquired the consulting giant Booz & Company.

In 2014 KPMG brought Zanett Commercial Solutions and in 2015 acquired all the assets of Beacon Partners, Inc.

Unlike audits that are conducted primarily to satisfy the public interest, consulting services satisfy the client’s interest and does not require independence from the client.

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Professionalism versus Commercialism (2 of 2)

Lynn Turner, former SEC chief accountant asked, “Are the auditors going to serve management, or are they going to serve the best interests of the investing public?”

As long as the appearance of independence has been tainted by the consulting relationship, the Independence standard would be compromised.

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Investigations of the Profession

High profile frauds in the 1970s, 1980s, 2000s

Congressional concern of auditors’ ethical and professional responsibilities

Themes of investigations

Nonaudit services impairing auditor independence

Management to report on internal controls

Prevention and detection of fraud

Role of audit committee and communication between them and auditors

Peer reviews/inspections

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Tread way Commission Report (2 of 2)

Established Committee of Sponsoring Organizations (COSO)

Need to change the corporate culture

Establish systems to prevent fraudulent reporting

Tone at the Top – sets ethical tone of organization

Importance of strong control environment

Internal auditors must have direct and unrestricted access to Audit Committee of BOD

COSO Enterprise Risk Management – Integrated Framework

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2007–2008 Financial Crisis (1 of 2)

Excessive risk taking

Mortgage meltdown

Moral Hazard – Incentive for risk taking -- to put own interests first especially when perceived sanctions for inappropriate behavior not enforced

Concern over independence, objectivity, and audit quality

Growing personal and business relationships between auditing firms, the client, and client management

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2007–2008 Financial Crisis (2 of 2)

Emphasis on marketing of professional services

Lehman Brothers

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Failure of Lehman Brothers (1 of 2)

Insufficient liquidity to meet its current obligations and loss of confidence of its lenders

CEO, CFOs, and external auditors all failed to meet professional responsibilities

Lehman used “Repo 105”, did not disclose its use

Shares dropped 94% over 8 months; U.S. refused to fund a solution for Lehman

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Failure of Lehman Brothers (2 of 2)

Auditors play a critical role in the proper functioning of public companies and financial markets

The public has every right to conclude that auditors who hold themselves out as independent will stand up to management and not succumb to pressure

External auditors need to recommit to their watchdog/gatekeeper function

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AICPA Revised Code: Independence for Members in Public Practice

Conceptual framework incorporates a “threats and safeguards” approach

New section on “Ethical Conflicts”

Violation of the rules for a CPA to permit others acting on his behalf to engage in behavior that would have been a violation for the CPA

When differences exist between AICPA and those of the licensing state board of accountancy, the CPA should follow the state board’s rules

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Conceptual Framework for Independence Standards

Independence required for audit and other attestation services; in fact and in appearance

AICPA uses risk based approach for analyzing threats using the following steps:

Identifying and evaluating threats to independence

Determining whether safeguards already eliminate or sufficiently mitigate identified threats and whether threats that have not yet been mitigated can be eliminated or sufficiently mitigated by safeguards

If no safeguards are available to eliminate an unacceptable threat or reduce it to an acceptable level, independence would be considered impaired

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Threats to Independence (1 of 2)

Independence must be in fact and appearance

Threats include:

Self review threat

Advocacy threat

Adverse interest threat

Familiarity threat

Undue influence threat

Financial self-interest threat

Management participation threat

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Threats to Independence (2 of 2)

Safeguards to counteract threats:

Safeguards created by the profession, legislation, or regulation

Safeguards implemented by the attest client

Safeguards implemented by the firm

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Exhibit 4.2 Examples of Threats to Independence

Threat Example
Self-Review Threat Preparing source documents used to generate the client’s financial statements.
Advocacy Threat Promoting the client’s securities as part of an initial public offering or representing a client in U.S. tax court.
Adverse Interest Threat Commencing, or the expressed intention to commence, litigation by either the client or the CPA against the other.
Familiarity Threat A CPA on the attest engagement team whose spouse is the client’s CEO.
Undue Influence Threat A threat to replace the CPA or CPA firm because of a disagreement with the client over the application of an accounting principle.
Financial Self-Interest Threat Having a loan from the client, from an officer or director of the client, or from an individual who owns 10 percent or more of the client’s outstanding equity securities.
Management Participation Threat Establishing and maintaining internal controls for the client.

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Safeguards

Source of the Safeguard Examples of Safeguards
Created by the profession, legislation, or regulation Professional resources, such as hotlines, for consultation on ethical issues.
Implemented by the client The client has personnel with suitable skill, knowledge, or experience who make managerial decisions about the delivery of professional services and makes use of third-party resources for consultation as needed. The tone at the top emphasizes the client’s commitment to fair financial reporting and compliance with the applicable laws, rules, regulations, and corporate governance policies. Policies and procedures are in place to achieve fair financial reporting and compliance with the applicable laws, rules, regulations, and corporate governance policies. Policies and procedures are in place to address ethical conduct. Policies are in place that bar the entity from hiring a firm to provide services that do not serve the public interest or that would cause the firm’s independence or objectivity to be considered impaired.
Implemented by the firm Policies and procedures addressing ethical conduct and compliance with laws and regulations.

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Financial Relationships that impair Independence

Direct or material indirect financial interest in a client

Loans to or from a client

Example: Alexander Grant and ESM: CPA accepted loans from a financial institution client.

Led to changes in independence rules to prohibit such loans and Permitted Loans

Automobiles loans collateralized by the car

Loans fully collateralized by cash deposits at the same financial institution (passbook loans)

Credit cards and overdraft accounts of $10,000 or less

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Other Relationships

Family Relationships

Immediate family members

Spouse or spouse equivalent, or dependents

Close relatives in financial sensitive position with the client or material financial interest

Parent, sibling, or nondependent child

Subject to independence rule if CPA knows member has material financial interest

Business Relationships

Partner or manager who provides more than 10 hours of non attest services to the attest client

Partnerships or joint ventures with attest client

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Employment or Association with Attest Clients

Independence may be impaired when a partner or professional employee leaves the firm and is subsequently employed by the client in a key position unless following met:

Amounts due to the former professional are not material to the firm

The former professional is not in a position to influence the accounting firm’s operations or financial policies

The former professional employee does not participate in or appear to participate in or is not associated with the firm once the relationship with the client begins

Participating in the firm may be continuing to consult for it or have one’s name included in firm literature

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Providing Non attest Services to an Attest Client

Certain lucrative non attest services create a conflict of interests

A CPA should not perform management functions or make management decisions for an attest client

Client must agree to perform the following functions:

Assume all management responsibilities

Designate competent overseer of these services

Evaluate adequacy and results of services performed

Accept responsibility for the results of the services

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Nontraditional Forms of Ownership

A traditional CPA firm may be acquired by a public company that will provide nonattest services to clients while, at the same time, a spin-off of the original firm provides the attest services.

Only firms that are majority owned by CPAs can perform attest services.

Concerns whether managers of the public companies (or alternative practice structures) may attempt to exert pressure over those in the CPA firm and cause ethical problems.

The appearance may be that the audit work could be tainted by the relationship.

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SEC Position on Independence

Emphasizes independence in fact and appearance in 3 ways:

Proscribing certain financial interests and business relationships with the audit client

Restricting certain nonauditing services to audit clients

Subjecting all auditor conduct to a general standard of independence

Three principles that underlie auditor independence:

An auditor cannot function in the role of management

An auditor cannot audit her own work

An auditor cannot serve in an advocacy role for her client

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General Standard of Independence

Judged by a reasonable investor with knowledge of all relevant facts and circumstances

Auditor must be capable of exercising objective and impartial judgment on all issues within the engagement

Principles

Situations which impair independence

Creates a mutual or conflicting interest between an accountant and his audit client

Places an accountant in the position of auditing his own work

Results in an accountant acting as management or employee of the audit client

Places an accountant in position of being an advocate for the audit client

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SEC Independence Actions Against Big 4 (1 of 2)

Deloitte

Violated independence rules when its consulting affiliate kept a business relationship with a trustee serving on boards/audit committees of three funds Deloitte audited

EY

PeopleSoft – joint sales, marketing, license fees and royalty with client (mutuality of interests)

KPMG

Violated independence rules by providing certain nonaudit services to affiliates of companies whose books KPMG was auditing

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SEC Independence Actions Against Big 4 (2 of 2)

PwC

Avon hired PwC for IT system; terminated project; did not write down full cost of project, approved by PwC

Pinnacle – PwC approved improper treatment of $8.5M as capital expenses and reserves

Cases raise red flags about consulting services and impairment of audit independence

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Insider Trading Cases (1 of 2)

Deloitte

Thomas P. Flanagan, former management advisory partner and vice chair

Traded in the securities of multiple clients (including Best Buy, Motorola, Sears, and Option Care) from information learned in his partner duties

Tipped his son, Patrick so he could also trade on that information

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Insider Trading Cases (2 of 2)

KPMG

Scott London, former partner of the KPMG’s Southern California’s regional audit practice

Leaked confidential information to Brian Shaw, about Skechers and Herbalife

Shaw repaid London with $50,000 in cash and a Rolex watch

Audit opinions signed by London on Skechers and Herbalife had to be withdrawn

Cases show the risk to audit independence when audit engagement team members trade on information that is not publicly available

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AICPA Code: Ethical Conflicts

Assess whether an ethical conflict exists

Ethical conflicts create challenges to ethical decision making because they present barriers to meeting the requirements of the rules of conduct

Consider whether any departures exist to the rules, laws, or regulations and how they will be justified in order to ensure that conflicts are resolved in a way that permits compliance with these requirement

Any unresolved conflicts can lead to a violation of the rules of conduct which should focus the CPA’s attention on any continuing relationship with the engagement team, specific assignment, client, firm, or employer

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Integrity and Objectivity (1 of 2)

Conflicts of interest for public practice occur when a professional service, relationship, or specific matter creates a situation that might impair objective judgment

A conflict of interest creates adverse and self-adverse threats to integrity and objectivity

Safeguards include

Implementing mechanisms to prevent disclosure or violation of confidentiality

Senior individual not involved in the engagement regularly reviewing safeguards

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Integrity and Objectivity (2 of 2)

Member of the firm not involved in the conflict review the work performed to assess whether key judgments and conclusions are appropriate, and

Consulting with third parties, such as professional body, legal counsel, or another CPA

The CPA should disclose the nature of the conflict to clients and obtain their consent to perform professional services

If consent is not received, then the CPA should either cease performing the services or take action to eliminate or reduce the threat to an acceptable level

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Subordination of Judgment (1 of 2)

Integrity rule prohibits a CPA from knowingly misrepresenting facts or subordinating one’s judgments when performing professional services for a client or employer

Addresses differences of opinion between a CPA accountant/auditor and that person’s supervisor or others in the organization including top management on material accounting issues

CPA should consider any threats to integrity and objectivity, and assess their significance whenever there is a material misrepresentation of fact

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Subordination of Judgment (2 of 2)

CPA should assess if threats are at an acceptable level; if not, evaluate significance of safeguards to prevent impairment to independence/objectivity

Follow prescribed process to protect against subordination of judgment (see Exhibit 3.13)

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AICPA Code: Conceptual Framework for Members in Business

The conceptual framework for members in business applies to integrity and objectivity, as well as other rules of conduct, but not independence

Threats

Adverse interest threat

Advocacy threat

Familiarity threat

Self-interest threat

Self-review threat

Undue influence threat

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Safeguards to Mitigate Risk

Safeguards include

Tone at the top

Policies, procedures, implementation, and monitoring addressing ethical conduct and compliance with laws and regulations

Internal policies and procedures for disclosure of interests and relationships

Whistle-blower hotlines

Internal auditors not allowed to audit areas where they have operational responsibilities

Policies for promotion, rewards and enforcement of a culture of high ethics and integrity

Use of third-party resources for consultation as needed.

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SOX: Nonaudit Services (1 of 2)

Financial information systems design and implementation

Appraisal or valuation services, fairness opinions, or contribution-in-kind reports

Actuarial services

Internal audit outsourcing services

Management functions or human resources

Broker or dealer services, investment adviser, or investment banking services

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SOX: Nonaudit Services (2 of 2)

Legal services and expert services unrelated to the audit

Any other service prohibited by BOD

Tax services must be preapproved by the audit committee

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Rules of Professional Practice (1 of 2)

The General Standards rule establishes requirements for competence, compliance with professional standards, and adherence to accounting principles

Acts Discreditable covers a broad number of actions that may bring discredit to the profession including

Discrimination and harassment

Solicitation or disclosure of CPA examination questions and answers

Failure of a CPA/CPA firm to file and pay taxes

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Rules of Professional Practice (2 of 2)

Negligence in preparation of financial statements or records

Standards relating to governmental accounting and auditing

Confidentiality of information gained through employment, except in specified situations

Records Request governing what is client-provided records, member-prepared records, member’s work products, and member’s working papers

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Contingent Fees, Commissions, and Referral Fees (1 of 2)

Contingent fees and commissions are permitted when performing advisory-type services for a nonattest client

Contingent fees are prohibited from an attest (audit) client

Prohibits acceptance of contingent fees if CPA or firm performs any of the following:

an audit or review of a financial statement

compilation of financial statement that third party may use

examination of prospective financial information

prepares original/amended tax return

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Contingent Fees, Commissions, and Referral Fees (2 of 2)

Permits acceptance of contingent fee based upon initiation by and findings of governmental agencies (i.e., IRS-initiated investigation of income taxes paid)

Commissions and Referral Fees

Rule is similar to that for contingent fees; cannot accept commissions or referral fees from audit client

Commissions and referral fees require disclosures by CPAs when recommending or referring a service or product to which the commission relates

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Advertising and Solicitation

Advertising and solicitation permitted

Requires that advertising not be false, deceptive or misleading

Imply ability to influence official bodies

Contain a representation that specific services will be performed for a stated fee, when such fees would be substantially increased

Prohibits solicitation by use of coercion, over-reaching, or harassing conduct

Contain any representation that would be likely to cause a reasonable person to misunderstand or be deceived

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Confidentiality

Confidential information

CPA should not disclose confidential client information without specific consent of the client

Internal whistle blowing allowed; external may violate confidentiality; consult legal counsel

Permitted disclosure of confidential client information

Response to validly issued subpoena or summons

Adherence to applicable laws and regulations (i.e., Dodd-Frank whistle-blowing provisions)

Compliance with peer review of CPA practice under PCAOB, AICPA, state CPA society, or board of accountancy authorization

Defense in an investigation of the CPA

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Concluding Thoughts (1 of 2)

Technical skills are important in accounting but so are ethical reasoning abilities

Virtue-based decision making is an important component because it depends on “practical wisdom,” or the ability to see the right thing to do in circumstances

The process in the Code is a conceptual framework to assess whether independence, integrity and objectivity may be compromised as a result of threats that exist

Safeguards can be put into place to reduce or eliminate such threats, although nothing can substitute for ethical intent and ethical action

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Concluding Thoughts (2 of 2)

The accounting profession is in danger of losing sight of its mandate to protect the public interest because of increased commercial tendencies

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Attachment 2

Chapter 5 Fraud in Financial Statements and Auditor Responsibilities

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Questions for Consideration

What are the red flags that are indicators of fraud may exist?

What are the auditor’s responsibilities to detect and report fraud?

What is the role of internal controls and risk assessment in preventing and detecting fraud?

Will the revised audit report provide any tangible benefits with respect to increasing its informational value, usefulness, and relevance to the investing public?

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Fraud in Financial Statements (1 of 2)

The primary responsibility for the prevention and detection of fraud rests with both those charged with governance of the entity and management.

An auditor conducting an audit in accordance with generally accepted auditing standards is responsible for obtaining reasonable assurance that the financial statements as a whole are free from material misstatements, whether by fraud or error.

An unavoidable risk exists that some material misstatements of the financial statements may not be detected, even though the audit was conducted in accordance with GAAS.

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Fraud in Financial Statements (2 of 2)

When the financial statements are materially misstated, the auditor should not give an unmodified or unqualified opinion but should modify the opinion as either qualified or adverse opinion.

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Fraudulent Financial Reporting

Involves either intentional misstatements or omissions of amounts or disclosures in order to deceive financial statement users

Deception – manipulation, falsification or alteration of accounting records or supporting documents

Misrepresentation in, or intentional omission from, events, transactions, or other significant information

Intentional misapplication of accounting principles

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Nature and Causes of Misstatements (1 of 2)

An inaccuracy in gathering or processing data from which financial statements are prepared

A difference between the amount, classification, or presentation of a reported financial statement element, account, or item in accordance with GAAP

The omission of a financial statement element, account, or item

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Nature and Causes of Misstatements (2 of 2)

A financial statement disclosure that is not presented in conformity with GAAP

The omission of information required to be disclosed in conformity with GAAP

An incorrect accounting estimate due to oversight, misrepresentation of facts, or fraud

Management’s judgments concerning an estimate or the selection or application of accounting policies that the auditor may consider unreasonable or inappropriate

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Error, Fraud and Illegal Acts

Error

Innocent mistake in math or application of GAAP

Innocent mistake in omission of information

Fraud

Deliberate decision made to deceive others through

Fraudulent financial reporting

Misappropriation of assets

Illegal Acts

Violations of laws or regulations

Bribery

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Illegal Acts

Assess the impact and materiality of the acts on the financial statements

Consult with legal counsel and other specialists

Report the acts to audit committee

Consider client’s remedial actions

Disciplinary actions

Controls to safeguard against recurrence

Reporting effects of the acts

If client does not take remedial actions necessary, the auditor should consider withdrawing from engagement

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Private Securities Litigation Reform Act (PSLRA) (1 of 2)

Additional requirements upon public companies and their auditors when

The illegal act has a material effect on financial statements

Senior management and the board have not taken appropriate remedial action

Failure to take remedial action may warrant departure from a standard audit report (or resignation of auditors)

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Private Securities Litigation Reform Act (PSLRA) (2 of 2)

When illegal act has material effect on the financial statements

Auditors must report act to the client

Client must inform Board of Directors which has one day to inform the SEC

If client does not inform the SEC

Auditors must furnish the report to the SEC within one day

Or resign from the engagement within one day

Ethical obligation of confidentiality is waived

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The Fraud Triangle (1 of 2)

Incentives/Pressures to Commit Fraud

Self-serving

Pressures to meet financial numbers

Financial distress

Home Problems

Opportunity

Employees who have access to assets such as cash and inventory

Internal controls to help safeguard assets

Segregation of duties

Reconciliations

Backdating stock options

Override internal controls by management

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The Fraud Triangle (2 of 2)

Rationalization

Explain away actions as acceptable

Perpetrators are often in denial

A good person may get caught up in the fraud

Other Rationalizations

Company had to make numbers

Fear losing job

I’m entitled since I’m underpaid

Link to GVV

One-time event

Loyalty

Expected/standard practice

Not your responsibility

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Fraud Risk Assessment (1 of 2)

AU-C240 requires the auditor to evaluate risk assessment during the audit

Evaluation of evidence about the potential client before accepting engagement

Communication with predecessor auditor

Reasons for firing or the reasons for no longer servicing client

Management’s and key accounting personnel’s integrity

Disagreement with management over accounting principles

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Fraud Risk Assessment (2 of 2)

Make inquiries about the risks of fraud and how they are addressed

Consider any unusual or unexpected relationships

Consider whether one or more fraud risk factors exist

Consider other information

Approach each engagement with a healthy dose of skepticism

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Internal Control Assessment

The risk that internal controls will not help prevent or detect a material misstatement is a critical evaluation to provide reasonable assurance

Components of internal control under the COSO framework

Control environment

Risk assessment

Control activities

Monitoring

Information and communication

Attention should be focused on areas of highest risk that a material weakness could exist in a particular area of the company’s internal control over financial reporting

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Enterprise Risk Management – Integrated Framework

Internal control enhanced with corporate governance and risk management

Aligning risk appetite and strategy

Enhancing risk response decisions

Reducing operational surprises and losses

Identifying and managing multiple and cross-enterprise risks

Seizing opportunities

Improving deployment of capital

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COSO Guidance on Monitoring Internal Control Systems (1 of 2)

Management should monitor controls to determine whether they are operating effectively and the need for redesign when risks change

Effective monitoring involves

Establishing a baseline for control effectiveness

Designing and executing monitoring procedures that are based on the significance of business risks relative to the entity’s objectives

Assessing and reporting results, including follow-up on corrective actions

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COSO Guidance on Monitoring Internal Control Systems (2 of 2)

Framework adopts the position that management should determine its risk appetite and align it with strategic objectives

ERM seems to place emphasis in the wrong areas by focusing on risk appetite

Emphasis needed on the ethical dimensions of making strategic decisions

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Audit Committee Responsibilities for Fraud Risk Assessment

Audit Committee should

Evaluate management’s identification of fraud risks

Implementation of antifraud measures

Creation of the appropriate tone at the top

Active oversight by the audit committee can help reinforce management’s commitment to create a culture with “zero tolerance” for fraud

Audit committee’s evaluation and oversight can serve as a deterrent to senior management engaging in fraudulent activity

Audit committee should encourage management to provide a mechanism for employees to report concerns about unethical behavior, suspected fraud, or violations of ethical codes or policies

©McGraw-Hill Education.

Auditor’s Communication with Those Charged with Governance (1 of 2)

AU-C 240 requires communication by auditors of evidence of fraud to appropriate level of management, even inconsequential or minor misappropriation

Fraud that causes a material misstatement should be reported directly to those charged with governance

Good governance principles suggest that

The auditor has access to the audit committee as necessary

The chair of the audit committee meet with the auditor periodically

The audit committee meets with the auditor without management at least annually

©McGraw-Hill Education.

Auditor’s Communication with Those Charged with Governance (2 of 2)

Auditors should communicate about accounting estimates

Nature of significant assumptions/degree of subjectivity/relative materiality

Communicate to management/those charged with governance risks due to fraud that have continuing control implications

©McGraw-Hill Education.

Management Representations and Financial Statement Certifications

Management responsible for preventing and detecting fraud

Management can override internal controls and create deceptive accounting

Management representation letters from CEO, CFO, and other appropriate officers (Section 302 of SOX)

Provides access to all known information bearing on fair presentation of financial statements

Confirms that management has performed an assessment of effectiveness of internal control over financial reporting

Concludes that effective internal controls have been maintained

Discloses any deficiencies in the design or operation of internal controls

©McGraw-Hill Education.

Audit Reports and Auditing Standards

Since 1926, the New York Stock Exchange has required an auditor’s report

The Securities Exchange Act of 1934 requires all public companies to have an independent auditor’s report in annual financial statements

The PCAOB oversees public companies audits since SOX in 2002

The AICPA Auditing Standards Board (ASB) oversees the audits of nonpublic companies

Independent auditors express or disclaim an opinion on whether an entity’s financial statements and related disclosures are presented in accordance with GAAP

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Audit Reports

Exhibit 5.5 (ASB) Unmodified Opinion for Non-Public Companies

Exhibit 5.6 (PCAOB)Unmodified or Unqualified Report for Public Companies

International Requirements

Section ISA 700 of the International Standards on Auditing allows the signature of the audit firm, the personal name of the auditor who directed the audit, or both

After December 15, 2016, the personal name of the auditor who directed the audit will ordinarily be required

Also, after December 15, 2016, the audit reports of public companies will include a “key audit matter” section

©McGraw-Hill Education.

Differences between ASB and PCAOB Unmodified Reports (1 of 2)

Title of Audit Report

ASB – Independent Auditor’s Report

PCAOB – Report of Independent Registered Audit Firm

Headings

ASB – Section headings

PCAOB – No headings

Management’s and Auditor’s Responsibilities

ASB – Detailed descriptions

PCAOB – Less detailed descriptions

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Differences between ASB and PCAOB Unmodified Reports (2 of 2)

Auditing Standards

ASB – GAAS

PCAOB – Standards of PCAOB

Internal Control over Financial Reporting

ASB – Not included in auditor’s report

PCAOB – Report on internal control included in an additional paragraph in the report

©McGraw-Hill Education.

Unmodified or Unqualified Audit Opinions

Financial statements “present fairly”

Financial position

Results of operations

Cash flows

Stockholders’ Equity

Optional additional paragraph

Emphasis-of-matter

Going concern

Consistent application of accounting principles

Litigation uncertainty

Other-matter

Supplemental information

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Modified or Qualified Audit Opinions (1 of 2)

Modifies the audit when

Based upon evidence financial statements are materially misstated, or

Unable to obtain sufficient appropriate evidence

Qualified

Concludes misstatements, individually or in the aggregate, are material but not pervasive to the financial statements, or

Unable to obtain sufficient appropriate audit evidence; possible effect on financial statements could be material but not pervasive

©McGraw-Hill Education.

Modified or Qualified Audit Opinions (2 of 2)

Adverse

Concludes that misstatements, individually or in the aggregate, are material and pervasive

Basis for Modifications

Separate paragraph describes matter giving rise to modification

Placed immediately before the opinion paragraph

Titled “Basis for (Qualified, Adverse, Disclaimer) Opinion

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Disclaimer/Withdrawal from the Engagement

Disclaimer

Unable to gather sufficient evidence to warrant the expression of an opinion on the statements as a whole

Withdrawal

If significant conflict exists with management or the auditor decides that management cannot be trusted, then a withdrawal may be justified

Trust issues are a matter of ethics

The auditor must consider whether the breakdown between management and the auditor has advanced to the point that any and all information provided by the client is suspect

Withdrawal triggers the filing of the SEC’s 8-K form by management

©McGraw-Hill Education.

Limitations of the Audit Report Reasonable Assurance

Reasonable Assurance

Due care

Relation of independence and client relationships

Not an absolute guarantee

Followed GAAS, gathering sufficient competent evidential matter

Failure to follow GAAS: allegation of negligence

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Limitations of the Audit Report Materiality

Magnitude of an omission or misstatement of accounting information that the judgment of reasonable person relying on the information would have been changed or influenced by the omission or misstatement

Judging Materiality

May not rely solely on a quantitative threshold as a “rule of thumb”

5% is a common materiality test

SEC wants qualitative matters to be considered as well

Unintended consequence of materiality is that it is subject to manipulation

An item may not be material and ignored even though it is wrong to produce financials with mistakes from an ethical (Rights Theory) perspective

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Limitations of the Audit Report Present Fairly

Present Fairly

Auditor’s assessment of fair presentation depends on whether

Accounting principles used have general acceptance

Accounting principles are appropriate

Financial statements are informative

Information presented is classified and summarized in a reasonable manner

Financial statements reflect the underlying transactions and events in a manner that is consistent with materiality and reflects economic substance

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Generally Accepted Auditing Standards (GAAS)

Auditing standards provide a measure of audit quality and the objectives to be achieved in an audit

Auditing standards differ from auditing procedures because the procedures are steps taken by the auditor during the course of the audit to comply with GAAS

The application of auditing standards entails making judgments with regard to the nature of audit evidence, sufficiency, competency, and reliability

Materiality considerations are important to assess whether the audit opinion should be modified

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GAAS (1 of 2)

General Standards

Adequate technical training and proficiency

Independence in mental attitude

Due care in the performance of the audit and preparation of the report

Standards of Field Work

Adequately plan the audit work and supervise assistants

Obtain a sufficient understanding of internal control to adequately plan the audit and determine the nature, timing, and extent of tests to be performed

©McGraw-Hill Education.

GAAS (2 of 2)

Gather sufficient competent evidential matter to provide a basis for an opinion

Standards of Reporting

The statements have been in conformity with GAAP

Accounting principles have been consistently applied

Adequate informative disclosures have been made

Expression of an opinion on statements taken as a whole, or indication that an opinion cannot be expressed

©McGraw-Hill Education.

Auditing Evidence

Consideration of the competency and sufficiency of evidence

Management representations are not a substitute for application of proper audit procedures

Audit risk and materiality considered together

Determination of nature, timing and extent of procedures

Evaluation of results of procedures

Assess risks of material misstatements due to fraud

Application of professional skepticism

Audit procedures – specific acts performed to gather evidence about specific assertions

©McGraw-Hill Education.

Professional Skepticism (1 of 2)

An important role in gathering audit evidence and evaluating usefulness

Auditor should exercise professional judgment and skepticism

Determining the nature, timing, and extent of audit procedures

Determining the sufficiency, competency, and relevancy of evidence

Evaluating management’s judgments and estimates

Considering fraud in the audit

Determining the conclusions based on the audit evidence obtained

©McGraw-Hill Education.

Professional Skepticism (2 of 2)

A state of mind and requires documentation to provide evidence that the audit was planned and performed in accordance with GAAS

Document the thought process, alternative views considered, judgments made, audit evidence gathered, and support for final conclusion

Document challenges to management’s views and assumptions

Document the basis for unusual, one-time transactions and related business rationale

Include a complete and comprehensive record of discussions with management

Document assessments of the reliability of the source of documents

Document professional skepticism in significant matters

©McGraw-Hill Education.

Challenges to Professional Skepticism

Motivated Blindness: Auditors may see what they want to see and easily miss contradictory information when it’s in their best interest to remain ignorant

Results over Efficiency: Link between skeptical judgment and action and how it relates to reward structure in auditing: rewarding results rather than high-quality decisions

Personality Traits: Diligence, thoroughness, objectivity and reliability are traits that influence level of professional skepticism

Levers: Accountability to reviewers and regulators serve as a lever that impacts skeptical judgment and skeptical action(PCAOB inspections)

©McGraw-Hill Education.

PCAOB Standards

Auditing Std No. 5 – audit of assessment of effectiveness of internal control over financial reporting

Auditing Std No. 7 – engagement quality review

Auditing Std No. 14 – requirements regarding the auditor’s evaluation of audit results and determination of whether the auditor has obtained sufficient appropriate audit evidence

Auditing Std No. 15 – requirements for designing and performing audit procedures to obtain sufficient appropriate audit evidence to support the opinion expressed in the auditor’s report

Auditing Std No. 16 – communications with audit committees on significant issues

©McGraw-Hill Education.

Audit Committee Communications

Significant accounting policies and practices

Critical accounting policies and practices

Critical accounting estimates

Significant unusual transactions

Quality of financial reporting information

Contentious issues with management/disagreements

Modifications to audit report

©McGraw-Hill Education.

Specific Items to Communicate: Quality of Financial Reporting

Qualitative aspects of accounting policies and procedures

Assessment of reasonableness of estimates in financial statements

Assessment of management’s disclosures re: critical policies/procedures

Whether presentation and disclosures are in conformity with applicable financial reporting framework

Management’s response to issues raised

Possibility of alternative treatments in financial statements

©McGraw-Hill Education.

Audit Deficiencies - SEC Actions (1 of 2)

Findings of a study of audit deficiencies for the Center for Audit Quality that resulted in sanctions from the SEC include

Failure to gather sufficient competent evidence

Failure to exercise due care

Insufficient level of professional skepticism

Failure to obtain adequate evidence related to management representations

Failure to express an appropriate audit opinion

©McGraw-Hill Education.

Audit Deficiencies - SEC Actions (2 of 2)

Satyam Case resulted in PwC being sanctioned due to a lack of due care and exercise of professional skepticism by accepting evidence provided by management that was less than persuasive.

PwC also failed to perform the necessary procedures and report likely illegal acts that had a material effect on the financial statements

©McGraw-Hill Education.

PCAOB Inspection Program

SOX authorized the PCAOB to inspect and set professional standards for public accounting firms

PCAOB enforcement proceedings are non-public unless

The parties consent to a public hearing

The board has imposed sanctions and the time to file an appeal with the SEC has expired

The SEC, on appeal, issues an order regarding the sanctions imposed

The process, including appeals, can take years to complete and the enforcement actions may not yet nor never be known to the public

©McGraw-Hill Education.

Inspections and Audit Deficiencies (1 of 2)

A significant issue addressed in many enforcement actions against audit firms is a lack of professional skepticism and due care

Examples that can inhibit professional skepticism

Incentives and pressures to build or maintain a long-term audit engagement

Incentives and pressures to avoid significant conflicts with management

Desire to achieve high client satisfaction ratings

Desire to keep audit costs low

Desire to cross-sell services to clients

©McGraw-Hill Education.

Inspections and Audit Deficiencies (2 of 2)

Deficiency rates of the Big-4 CPA firms range from 28 to 50 percent

In 2014, PCAOB said that the firms have shown real improvements in its internal control audits

©McGraw-Hill Education.

PCAOB Inspections of Chinese Firms (1 of 2)

Reluctance of foreign-based entities operating under the banner of a Big-4 CPA firm to cooperate with the PCAOB inspections of audits conducted by the foreign entities that list stocks on the U.S. exchanges

Chinese authorities find the disclosure about Chinese companies to non-Chinese regulators to be unacceptable

©McGraw-Hill Education.

PCAOB Inspections of Chinese Firms (2 of 2)

The dilemma for U.S. regulators is the growing number of Chinese companies listing stock in the U.S. that are found to have engaged in financial fraud

The contentious nature of relationship between PCAOB and Chinese audit firms raises questions about the quality, reliability, and trustworthiness of the audits and brings into question whether the best interests of U.S. investors are being adequately protected

©McGraw-Hill Education.

Concluding Thoughts

Financial statement fraud threatens the foundation of the financial reporting process and jeopardizes the integrity of the auditing function

The audit and evaluation of audit evidence must be controlled through an ethical approach that emphasizes objectivity, due care, and the exercise of professional skepticism

“Trust but verify” should be the mantra of a sound audit

Audit firms and auditors should recommit to the public interest ideal that is the foundation for the accounting profession

©McGraw-Hill Education.

Attachment 3

Organizational Ethics and Corporate Governance

Chapter 3

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Organizational Ethics, Ethical Culture, and Ethical Climate

Organizational Ethics

Generally accepted principles and standards that guide behavior in organizational contexts.

Ethical Culture

Explicit statement of values, beliefs and customs from top management

Organizational ethical climate

Moral atmosphere and level of ethics practiced within a company

Determined by leaders

Shared values, beliefs, goals, and problem-solving

Focuses on issues of right and wrong

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Establishing an Ethical Culture

Corporate culture is the shared beliefs of top managers in a company about how they should manage themselves and other employees, and how they should conduct business.

Tone at the top refers to the ethical environment that is created in the workplace by the organization’s leadership.

Corporate culture starts with an explicit statement of values, beliefs, and customs from top management.

A code of ethics serves as a guide to support ethical decision making.

It clarifies an organization’s mission, values, and principles, linking them with standards of professional conduct.

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Framework for Understanding Ethical Decision Making in Business

Ethical Issue Intensity

Importance of the issue to the individual, work group and/or organization (intensity) based on values, beliefs and norms involved and pressures in the workplace.

Individual Factors

Values of individuals

Organizational and social forces shape behavioral intentions and decision making

Organizational Factors

Organization’s values have a greater influence than a person’s own values.

Opportunity

Conditions that limit or permit ethical or unethical behavior

Business Ethics Intentions, Behavior, and Evaluations

Organizational ethical culture is shaped by effective leadership

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Ethical Leadership

Leaders of Good Character

Possess integrity, courage, and compassion

Careful and prudent

Decisions and actions inspire employees to act in an enhancing way

Virtues

Courage, temperance, wisdom, justice, optimism, integrity, humility, reverence and compassion

Role Models

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Key Markers of Highly Ethical Organizations

Humility

Zero tolerance for individual and collective destructive behaviors

Justice

Integrity

Trust

A focus on process

Structural reinforcement

Social responsibility

Values-driven organization that encourages openness, transparency, and provides supportive environment to voice values without fear of retribution or retaliation

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Ethical Dissonance Model

Interaction between the individual and the organization, based upon person-organization ethical fit at various stages of the contractual relationship in each potential ethical fit scenario

Four potential fit options:

High-High (high organization & high individual ethics)

Low-Low (low organization & low individual ethics)

High-Low (high organization & low individual ethics)

Low-High (low organization & high individual ethics)

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Seven Signs of Ethical Collapse

“Occurs when any organization has drifted from the basic principles of right and wrong” Marianne Jennings

Pressure to maintain numbers

Fear and silence

Young ‘uns and bigger than life CEO

Weak board of directors

Conflicts of interests overlooked or unaddressed

Innovation like no other company

Goodness in some areas atones for evil in others

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Pressure to Maintain Numbers and Fear of Reprisals

Ethical collapse occurs when there is an unreasonable and unrealistic obsession with meeting quantitative goals

“financial results at all costs”

Employees are reluctant to raise issues of ethical concern because they may be ignored, treated badly, transferred or worse

“kill the messenger syndrome”

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Loyalty to the Boss and Weak Board of Directors

Young people selected by the CEO for their position based on inexperience, possible conflicts of interest, and unlikelihood to question the boss' decisions

Weak board of directors characterizes virtually all of the companies with major accounting frauds in the early part of the 2000s

Culture of Conflicts

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Corporate Governance Structures and Relationships

Corporate governance is shaped by internal and external mechanisms.

Internal mechanisms help manage, direct, and monitor corporate activities to create sustainable stakeholder value.

Examples: independent board of directors, the audit committee, management, internal controls and the internal audit function

External mechanisms are intended to monitor the company’s activities, affairs, and performance to ensure that the interests of insiders (management, directors, and officers) are aligned with the interests of outsiders (shareholders and other stakeholders).

Examples: the financial markets, state and federal statutes, court decisions, and shareholder proposals

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Potential Agency Problems

Executive Compensation – compensation packages are tied to firm performance and stock option plans creating an incentive to manipulate earnings

Backdating stock options and improper disclosures

Clawbacks allow a recovery of compensation from CEOs and CFOs of public companies

“Say on pay” provisions provide shareholders a vote regarding the compensation of CEO and CFOs

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Stakeholder Orientation

Business Stakeholders

Investors and shareholders, creditors, employees, customers, suppliers, government agencies, communities and others

Have a “stake” or a claim in some aspect of a company’s products, operations, markets, industry and outcome

Stakeholder orientation is the degree to which an organization understands and addresses stakeholder demands. Consists of:

Generation of data about stakeholder groups and assessment of the firm’s effects on these groups

Distribution of this information throughout the firms

The responsiveness of the organization as a whole to this information

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Trust in Business

Trust means to be reliable and carry through words with deeds.

Trust becomes pervasive only if the organization’s values are followed and supported by top management.

Trust can be lost, even if once gained in the eyes of the public, if an organization no longer follows the guiding principles that helped to create its reputation for trust.

Credo is an aspirational statement that encourages employees to internalize the values of the company.

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Ethical and Legal Responsibilities of Officers and Directors

Directors and officers are deemed fiduciaries of the corporation as their relationship with the corporation and its shareholders is one of trust and confidence

Duty of Care – act in good faith, exercise the care that an ordinarily prudent person would exercise in a similar situation

Duty of Loyalty – act in the best interest of corporation; loyalty can be defined as faithfulness to one’s obligations and duties

Duty of Good Faith – requires an honesty of purpose that leads to caring for the well-being of the constituents of the fiduciary

Business Judgment Rule – expected to exercise due care and to use their best judgment in guiding corporate management, but they are not insurers of business success; honest mistakes and poor business decisions do not make them liable to the corporation for resulting damages

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Best Practices of Governance

Independent directors enhance governance accountability

Separation of the duties of CEO and board chair minimizes conflicts of interest

Separate meetings between the audit committee and external auditors strengthen control mechanisms

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Ethics in the Workplace

A code of conduct goes beyond what is legal for an organization and provides normative guidelines for ethical conduct. Support for ethical behavior from top management is a critical component of fostering an ethical climate.

Measures that should be taken to establish an ethical culture:

Clear policies on ethical conduct including a code of ethics

Ethics training program that instills a commitment to act ethically and explains the code provisions

A top level officer (Chief Ethics and Compliance Officer) to oversee ethics and compliance

Use internal auditors to investigate whether ethics policies are followed

Strong internal controls to prevent and detect unethical behaviors

Whistleblowing policies, including reporting outlets

Ethics hot line for anonymous tips

Ethics statement signed by employees

Enforce ethics policies fairly and take immediate action against violators

Reward ethical behavior and include in performance evaluation system

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Behavioral Indicators of Fraud

Living Beyond Means

Financial Difficulties

Unusual Close Association with Vendor/Client

Control Issues, Unwillingness to Share Duties

Wheeler-Dealer Attitudes

Divorce/Family Issues

Instability, Suspiciousness or Defensiveness

Addiction Problems

Complained about Inadequate Pay

Refusal to Take Vacations

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18

Financial Statement Fraud

Fraud schemes occur because an employee – usually top management – causes a misstatement or omission of material information in the organizations’ financial reports.

Methods include:

Revenue Overstatement

Recording gross, rather than net, revenue

Recording of revenues of other companies, acting as a ‘middleman’

Recording sales that never took place

Recording future sales in the current period

Recording sales of products that are out on consignment

Expense Understatement

Recording cost of sales as a non-operating expense

Capitalizing operating costs

Not recording some expense at all

Improper Asset Valuations

Manipulating reserves

Changing the useful lives of assets

Failing to take a write-down when needed

Manipulating estimates of fair market value

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Why does Financial Statement Fraud Occur?

Situational pressure

Perceived opportunity

Rationalization

A culture is created and tone at the top established that presents the image of a company willing to do whatever it takes to paint a rosy picture about financial results.

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Liability for False Certifications

SEC’s increased focus on identifying and penalizing misstatements in public company financials

Analyzing patterns of internal control problems even absent a restatement of the financials

Quality Services Group Inc. (QSGI) CEO and CFO held responsible for alleged misrepresentations in public disclosures about the company’s internal controls environment

Signed Form 10-Ks with management reports on internal controls that falsely omitted issues

Signed certifications in which they falsely represented that they had evaluated the management report on internal controls and disclosed all significant deficiencies to auditors

Transparency with the company’s audit committee and with external auditors regarding evaluations of the company’s internal controls and whether it protects the company, its investors, and its officers

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Has SOX Accomplished its Intended Goal?

Section 302 requires CEO and CFO to certify financial statements contain no material misstatements

Helps protect the public against fraudulent financial statements

Very few defendants have been charged with false certification, and fewer still have been convicted

Richard Scrushy, former HealthSouth Corporation CEO

Indicted but found not guilty on false certification

Weston L. Smith, CFO, pleaded guilty in scandal, sentenced to 27 months in prison

CFO of DVI pleaded guilty to mail fraud and false certification, sentenced to 30 months in prison

SEC increasingly is pursuing claims against CFOs by alleging that the CFOs subordinates violated securities laws and the CFO either certified the resulting reports or failed to implement adequate internal safeguards

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Audit Committee

Independent directors with one having financial expertise

Oversight of financial reporting

Internal audit function

External auditors

CEO and CFO financial statement certification process

Review formal announcements of earnings, significant financial reporting judgments, internal controls and risk management procedures, whistleblower and compliance program, external auditor’s independence and objectivity and effectiveness of audit process

Seen as the one body that should be able to prevent identified fraudulent financial reporting

Committee should meet separately with the senior executives, the internal auditors, and the external auditors

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Internal Auditors

Monitor corporate governance activities and compliance with organization policies

Review effectiveness of the organization’s code of ethics and whistle-blower provisions

“Eyes and ears” of audit committee

Assess audit committee effectiveness and compliance with regulations

Oversee internal controls and risk management processes

Assurance on how effectively the organization assesses and manages its risk

Assurance on data security and privacy controls

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External Auditors

An obligation to the public interest that underlies their corporate governance responsibilities

Protect the interests of shareholders

Conduct audits independent of any influence of management or the company

Communicate effectively with the audit committee: accounting policies and procedures, estimates by management; quality of financial reporting; potential violations of laws

Ensures accountability for financial reporting process

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Internal Controls

Prevent and detect errors and fraud

Asset misappropriations

Materially false and misleading financial reports

Inadequate disclosures

Ensure management policies are followed

Ethical systems built into corporate governance

Can be overridden by top management

Do what CEO says, not what he does

Creates cynical attitude

Managers need to “walk the talk” of ethics

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Internal Control Weaknesses

Internal control includes all of the processes and procedures that management puts in place to help make sure that its assets are protected and that company activities are conducted in accordance with the organization’s policies and procedures.

An effective system of internal controls is critical to establish an ethical corporate culture that should be supported by the tone at the top.

An internal control system, no matter how well conceived and operated, can provide only reasonable - not absolute – assurance to management and the board of directors regarding achievement of an entity’s objectives.

Management override of internal controls may be a problem.

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Whistleblowing

Employees (former or current) who report suspected violations to persons or organizations that may be able to effect action

Illegal

Immoral

Illegitimate

Four elements:

The whistleblower

The whistleblowing act or complaint

The party to whom the complaint is made

The organization involved with the complaint

“Organizational Dissidence” – similar to civil disobedience

Whistleblower laws protects employees who provide information on a fraud against retaliation

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Morality of Whistleblowing

Organizational policies should be designed to encourage moral autonomy, individual responsibility, and organizational support for whistleblowers

Moral agency is important for the determination of moral behavior

Autonomy means to act according to reasons and motives that are taken as one’s own and not the product of policies, laws, etc.

If pressure exists in an organization not to report wrongdoing, a rational, moral person will withstand such pressure, even with perceived retaliation, because it is a moral requirement to do so

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Morality of Whistleblowing (continued)

Michael Davis considers whistleblowing to be morally required when it is required at all; a moral obligation to prevent serious harm to others if it can be done with little cost to the individual

Application of a rule utilitarian perspective could lead to the conclusion that a categorical imperative exists to do whatever it takes to stop fraudulent behavior regardless of whether the action might bring more harm than good to the stakeholders

DeGeorge thinks “corporations have a moral obligation not to harm.” His criteria for when whistleblowing is morally permitted includes

Firm’s actions will do serious and considerable harm to others

Whistleblowing is justifiable once the employee reports it to her supervisor and makes her moral concerns known

Absent any action by the supervisor, the employee should take the matter all the way up to the board

Documented evidence must exist that would convince a reasonable and impartial observer that one’s view of the situation is correct and that serious harm may occur

The employee must reasonably believe that going public will create the necessary change to protect the public and is worth the risk to oneself

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Rights and Duties

Whistleblowers hope and believe their speaking out will achieve correction of what they perceive as the organizational wrongdoing

“Retaliatory climate” in the organization is the primary barrier to blowing the whistle on corporate wrongdoing

When organizations establish an ethical culture and anonymous channels to report wrongdoing, it creates an environment that supports whistleblowing and whistle-blowers while controlling for possible retaliation

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Compliance Function

Organization’s ethics officer

Ensures that the organization is in compliance with the laws and regulations, including SEC securities laws, SOX, and Dodd Frank

May report to the audit committee, CEO, or general counsel

Official member of the c-suite

Addresses existing requirements and anticipates regulatory changes and their likely impact

Ethics and Compliance Officer Association (ECOA)

Ethics officer plays a critical role in helping create a positive ethical tone in organizations

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Dodd-Frank Wall Street Reform and Consumer Protection Act

2010 passage of Dodd-Frank established benefits for whistleblowers who aid in recovery of $1M or more and they can receive 10-30% of the recovery

Defines a whistleblower as any individual who voluntarily provides information to the SEC relating to a violation of federal securities laws, is ongoing or is about to occur

Voluntarily means the whistleblower has not provided the information previously to the government, a self-regulatory organization, or the PCAOB

Concern: Will whistleblowers go external rather than internal with the information in order to receive an award (“bounty hunter”)?

Employees have a loyalty obligation to their employers, but loyalty should not be used to mask one’s ethical obligation to maintain integrity and protect the public interest

Whistleblowing in conformity with Dodd-Frank rules sets aside confidentiality requirement

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Internal Accountants’ Eligibility

Internal accountants, including compliance and internal auditors, are excluded from receiving whistleblower awards under Dodd-Frank because pre-existing legal duty and job responsibilities to report suspicion of illegal acts and fraud to management.

Under the following circumstances, internal accountants are eligible to become Dodd-Frank whistleblowers:

Disclosure to the SEC is needed to prevent “substantial injury” to the financial interest of an entity or its investors

The whistleblower “reasonably believes” the entity is impeding investigation of the misconduct (e.g., destroying evidence or improperly influencing witnesses)

The whistleblower has first reported the violation internally and at least 120 days have passed with no action.

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External Auditor Eligibility

Whistleblower rules allow the auditor or an employee associated with the auditor to make a whistleblower submission alleging that the firm failed to assess, investigate or report wrongdoing in accordance with Section 10A, or that the firm failed to follow other professional standards.

Concerns about permitting CPAs to obtain monetary rewards for blowing the whistle on their own firms’ performance of services for clients create significant problems including

Undermining the ethical obligations of CPAs not to divulge confidential client information

Harming the quality of external audits because client management might restrict access to client information for fear the financial incentive for whistleblowing could lead to report client-specific information to the SEC

Overriding the firms’ internal reporting mechanisms for audit-related disagreements

Incentivizing an individual to bypass existing programs to report disagreements including hotlines

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Integrity Considerations

It is the integrity standard that establishes the basis for moral action of auditors and avoids subordinating judgment

Reporting procedures for accountants and auditors under the AICPA Code (Exhibit 3.11)

The CPA should seek legal advice when difference of opinion exists on how best to handle disagreements with the client and the firm refuses to make the required adjustments.

The auditor should consider whether the relationship with the organization should be terminated including possibly resigning one’s position

Resignation from the audit firm does not negate the auditor’s disclosure responsibilities to the SEC

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Accountants’ Obligations for Whistleblowing

Dodd-Frank contains provisions to encourage accountants and auditors to report corporate wrongdoing, and Section 10A of the SEC 1934 Act requires reporting of fraud

Whistleblowing in accounting is a duty when it is motivated by a desire to protect the public, confidentiality obligation not withstanding

Process in deciding to report fraud

Whether the violations have a material effect on the financial statements

Has management or BOD taken remedial action?

If not, auditor must report to BOD. The board has one business to inform the SEC and provide copy to external auditor

If auditing firm does not receive a copy within one business day

Provide a copy of its own report to the SEC within one business day, or

Resign from the engagement and provide copy of report to the SEC within one business day of resigning

The process must be handled through the client’s internal compliance system before external auditors turn to whistleblowing

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Attachment 4

Chapter 2

Cognitive Processes and Ethical Decision Making in Accounting

Questions for Consideration

What is the role of virtue in auditors’ ethical decision making?

What would you do if your attitudes and beliefs conflict with your intended behavior?

Ethical Judgment

“Every act is to be judged by the intention of the agent.”

~ (Unknown author)

Ethical judgment is not enough, the decision maker must carry through with the ethical action.

Kohlberg’s Stages of Moral Development

Lawrence Kohlberg’s six stages of moral development are divided into three levels of moral reasoning

Level 1 – Preconventional

Level 2 – Conventional

Level 3 - Postconventional

Kohlberg’s Model

Suggests that people continue to change their decision priorities over time and with additional education and experience.

Individual’s moral development can be influenced by corporate culture, especially ethics training.

Stage sequence is universal, same in all cultures (counter to Hofstede’s cultural dimensions).

Level 1 - Preconventional

Rules are seen as something external imposed on one’s self

Individual is very self-centered

Stage 1 – Obedience to rules; avoidance of punishment

Stage 2 – Satisfying one’s own needs (egoism); follow rules only if they satisfy one’s needs

Level 2 - Conventional

Individual becomes aware of the interests of others and one’s duty to society

Personal responsibility is an important consideration in decision-making.

Stage 3 – Fairness to others; commitment to loyalty in the relationship

Stage 4 – Law and order; one’s duty to society, respect for authority, maintaining social order

Level 3 - Postconventional

Individual recognizes there must be a society wide basis for cooperation

Orientation to principles that shape whatever laws and role systems a society may have

Stage 5 – Social contracts; upholding the basic rights, values, and legal contracts of society

Stage 6 – Universal ethical principles that everyone should follow, Kohlberg believed this stage rarely existed; Kant’s categorical imperative

fits right in

Ethical Domain in Accounting and Auditing

Four key constituent groups of accountants and auditors’ domain are the:

1) Client organization that hires and pays for accounting services

2) Accounting firm that employs the practitioner

3) Accounting profession including various regulatory bodies

4) General public who rely on the attestation and representation of the accounting firm

Accountants Ethical Behavior

Accounting profession has professional standards to encourage ethical behavior

These standards, an individual’s attitudes and beliefs, and ethical reasoning capacity influence professional judgment and ethical decision making

Post conventional reasoning is the ethical position to take even though it may go against corporate culture of, “go along to get along”

Components of Rest’s Model

Moral Sensitivity – ability to identify what is moral and amoral.

Moral Judgment – ability to reason through several courses of actions and making the right decision when forced with an ethical dilemma.

Moral Motivation – influences that affect an individual’s willingness to place ethical values ahead of nonethical values.

Moral Character – having one’s ethical intentions match actions taken.

Components Interact

All processes must take place for moral behavior to occur.

This framework is not a linear decision making model, the processes instead work through sequence of “feed-back” and “feed-forward” loops.

Individual accuracy at one level does not necessarily mean accuracy at all levels

Moral failure can occur when there is a deficiency in any one component.

Cognitive Dissonance

Inconsistency between our thoughts, beliefs, or attitudes and behavior creates the need to resolve contradictory or conflicting beliefs, values, and perceptions.

Only occurs when we are “attached” to our attitudes and beliefs.

How we think we should behave is different from how we decide to behave.

Supporting Courage to Act

Courage to withstand pressures that challenge one’s commitment to act in an ethical manner

Supportive environment in the organization

Ethical top must be set by top management

Professional Judgment in Auditing

Judgment exercised with due care, objectivity, and integrity within the framework provided by applicable professional standards, by experienced and knowledgeable people.

Application of professional standards.

Principles of AICPA Code

Circular 230

PCAOB

Firm’s internal standards

Libby and Thorne: Virtues Important for Auditing

Intellectual virtues: indirectly influence individual’s intentions to exercise professional judgment

Most important: integrity, truthful, independent, objective, dependable, principled, and healthily skeptical

Instrumental virtues: directly influence individual’s actions

Most important: diligent, alert, careful, resourceful, consultative, persistent, and courageous

16

Linda Thorne’s Integrated Model of Ethical Decision Making

Whistle blowing illustrated

Diem-Thi Le’s, senior auditor at Defense Contract Audit Agency (DCAA), audit opinion was changed by branch manager

DCAA violated whistleblower act

Le was ultimately put under whistleblower protection and now trains auditors

Example shows the difficulty of transitioning from knowing what the right thing to do is and actually doing it

Behavioral Ethics

Kahneman’s two distinct modes of decision making:

System 1: intuitive system of processing info; fast, automatic, effortless, and emotional decision processes

System 2: slower, conscious, effortful, explicit, and a more reasoned decision process

Integrated Decision-Making Model

 1. Identify the ethical and professional issues (ethical sensitivity)

• What are the ethical and professional issues in this case (i.e., GAAP and GAAS)?

• Who are the stakeholders?

• Which ethical standards apply (i.e., AICPA Code Principles, IMA Ethical Standards, and IFAC standards)

2. Identify and evaluate alternative courses of action (ethical judgment)

• What can and cannot be done in resolving the conflict under professional standards?

• Which ethical reasoning methods apply to help reason through alternatives (i.e., rights theory, utilitarianism, justice, and virtue)?

3. Reflect on the core professional values, ethics, and attitudes to help carry through with ethical action (ethical intent)

• Consider how virtue considerations (i.e., moral virtues: intellectual and instrumental)

motivate ethical actions.

• Consider how IES 446 standards (i.e., independence, objectivity, integrity, professional skepticism) motivate ethical actions and behaviors.

4. Take action (ethical behavior)

• Decide on a course of action consistent with one’s professional obligations.

• How can virtue considerations support turning ethical intent into ethical action?

• What steps can I take to strengthen my position and argument?

Comprehensive Ethical Decision-Making Model

Frame the ethical issue

Gather all the facts

Identify the stakeholders and obligations

Identify the accounting and auditing issues

Identify the operational issues

Model (cont’d)

Identify the relevant accounting ethics standards in the situation

List all the possible alternatives of what you can or cannot do

Compare and weigh the alternatives

Decide on a course of action

Reflect on your decision

Concluding Thoughts

Requirements of Ethical Decision Making:

Ethical intent

Moral reasoning skills

Decision making process

Identifying issues

Analyze ethical issues

Affects of alternative courses of action

Courage to act

Ethical Intention

Ethical Behavior

Sensitivity

Prescriptive

Reasoning

Ethical

Motivation

Ethical Character

Virtue

Perception

Moral Virtue

Understanding

Instrumental Virtue

Moral Development

Identification of

Dilemma

Ethical Judgment

Ethical Intention Ethical Behavior Sensitivity Prescriptive Reasoning Ethical Motivation Ethical Character Virtue Perception Moral Virtue Understanding Instrumental Virtue Moral Development Identification of Dilemma Ethical Judgment

An Ethical Decision Making Model

Frame the ethical

issue

Gather all the facts

List the relevant

accounting ethics

standards

Identify stakeholders

and obligations

Identify operational

issues

Identify technical

accounting issues

issues

List all possible

alternatives

Compare and weigh

alternatives

Decide on a course

of action

Reflect on

how

alternative courses of

action affect

others

Reflect on your

decision

Attachment 5

Chapter 1

Ethical Reasoning:

Implications for Accounting

Accounting and the Public Interest

Honoring public trust

Acting with integrity in performance of professional services

Being independent of clients

Making decisions objectively

Exercising due care in the performance of services

AICPA Code of Conduct

The code is divided into two sections:

Principles: are Aspirational statements that form the foundation for the Code’s enforceable Rules of Professional Conduct. Principles are expectations but are not legally binding. The principles of professional conduct include:

Responsibilities

Public Interest

Integrity

Objectivity and Independence

Due Care

Nature and Scope of Services

Rules: enforceable applications of the Principles

Overriding responsibility of CPAs

Exercise sensitive professional and moral judgments in all activities.

Recognize the primacy of a CPA’s responsibility to the public as the way to best serve the clients’ and employers’ interest.

Continued improvement in the level of competency and quality of services

Virtue and Ethical Obligations of CPAs

Aristotle’s Virtues

Trustworthiness, benevolence, altruism

Honesty, integrity

Impartiality, open-mindedness

Reliability, dependability, faithfulness

Trustworthiness

Ethical Standards for CPAs

Integrity

Truthfulness, non-deception

Objectivity, independence

Loyalty (confidentiality)

Due care (competence and prudence)

Rights Principles

IS ALL LYING WRONG???

WHAT ABOUT IN ACCOUNTING?

AUDIT, TAX & PRIVATE INDUSTRY.

WHAT ABOUT IN BUSINESS?

Justice

JUSTICE “WHAT SOMEONE DESERVES”?

WHAT S FAIR TO ME OR TO SOCIETY?

Virtues in Accounting Practice

Ethical obligations to clients, employers, government, and public at large

Perform services

Without bias

Avoid conflicts of interests

Independence

Integrity

Acting with Integrity

Act out of moral principle, not expediency

Never let loyalty cloud good judgment and ethical decision-making

Moral Point of View

Emphasizes practical reason and rational choice

Deliberation precede choice of action

Reason

Thought

Voluntary

Ends do not justify the means

Personal Integrity

Essential characteristic for CPA

Learn to be ethical

By practice

Exercising virtues

Enable to lead life of excellence

Institute of Management Accountants (IMA)

Principles

Honesty

Fairness

Objectivity

Responsibility

Standards

Confidence

Confidentiality

Integrity

Credibility

Resolution of Ethical Conduct

Discuss issue with immediate supervisor or higher authority.

Clarify ethical issues with an IMA Ethics Counselor or other impartial advisor

Consult attorney.

DigitPrint

Outsourcing business for high-speed digital printing

$2 million in venture capital

$200,000 net income for 1st year

$1 million unrecorded accrued expenses

Income becomes $800,000 loss

DigitPrint

IMA Standards

Integrity, inform Higgins, seek outside counsel

Utilitarianism

Greatest benefit to the public, company, and employees

Rights Theory

Venture capitalist (and Higgins) have ethical right to know

Justice

Virtue of integrity and not subordinate judgment

What to DO?

Take concerns to Higgins

Whistle-blowing

Confidentiality

Right to do versus the Right thing to do