Accounting Ethics: The Problem of Information

Accountancy Resources

Accounting Ethics: The Problem of Information

Accounting Author: Admin


Information is valuable:  Investors want the information to know how valuable their company shares are.; managers want the information to know how efficiently and effectively their employees are working; regulatory agencies want the information to know companies’ incomes and effects on the public.  When one party in a relationship (i.e. investor-manager, manager-employee, government-company) has more information than the other party, there is the potential for that party to misrepresent reality in order to financially gain at the expense of others (i.e. a manager makes his company appear more profitable so investors are happy, an employee makes his production seem greater to get a bonus, a company misclassifies expenses to reduce its tax liability).

The ultimate problem is that information is gathered within firms while the incentives are distributed beyond firms’ boundaries.  Since the accounting profession revolves around the financial process it is only natural that accountants play a crucial role in maintaining the informational balance in these relationships.  Accountants try to ensure that financial information is generated and communicated according to the standards of the practice so that the partners in business relationships have confidence that they are making well-informed decisions.

The principles of accounting seem clear:  Provide information that is relevant, reliable, comparable, and consistent.  Unfortunately, different parties find different things to be relevant, things that are the most cutting-edge and relevant are often less reliable and the business cycle is inherently inconsistent and businesses constantly change so two entities that were comparable in 2009 might not be in 2010.  Accordingly, the practice of accounting can be more flexible than we might prefer.

Accounting Scandal!

The tensions in business relationships and the desired qualities of accounting information generate a great deal of confusion about what constitutes ethical behavior in this field.  When confusion is coupled with dangerous incentives you have the opportunity for misuse.

The most obvious challenge to professional accounting ethics is self-interest. When an accountant or accounting firm is hired by a company to evaluate its financial statements, it naturally wants to please the client and continue to earn its business. When the audit reveals information that could be damaging to the client and its shareholders, this creates a clear ethical dilemma. Accountants are forced to choose between professional integrity and keeping the client happy.

Another challenge in maintaining rigorous accounting ethics can be the lavishes of corporate culture. It is not uncommon for accounting firm clients and accounting executives with lucrative business relationships to reward each other with expensive gifts, parties, and opportunities for luxury travel. Combine these cozy relationships with the legal flexibility of some creative accounting practices, and the temptation to compromise professional ethics may be a powerful one.

These challenges culminated in a number of accounting scandals in the early 2000s that were at the forefront of several high-profile corporate failures, including that of Arthur Andersen, one of the most prominent accounting firms in history, and corporate giants Enron and WorldCom.  While the incidents were embarrassing to the field of accounting, the attention inspired a renewed emphasis on accounting ethics.

The Modern State of Accounting Ethics

Professional codes of conduct aim to serve at least two important functions. One is to advance a uniform understanding of what constitutes ethical behavior in each profession and the second is to promote public confidence in those practicing these professions.  For example, three of the foremost U.S. professional accounting organizations, the American Institute of Certified Public Accountants (AICPA), the Institute of Internal Auditors (IIA), and the Institute of Management Accountants (IMA), have established ethical codes of conduct to which their members are expected to adhere.

While these organizations are diverse, they all require four common elements in their official codes of conduct for accounting professionals.

  • Competence – accountants must not accept assignments for which they do not have sufficient knowledge or experience to conduct the work proficiently.
  • Confidentiality – accountants are not to disclose a client’s confidential information to outsiders unless ordered to do so by court subpoena.
  • Integrity – accounting professionals are expected to adhere to a consistent set of moral and ethical principles with regard to their actions, methods, and outcomes across their entire practice.
  • Objectivity – members of these organizations are to avoid both actual and perceived conflicts of interest; which may cause clients, the business community, or the general public to lose faith in the accuracy of the accountant’s work.

Recognizing the crisis in public confidence in the accounting profession, the U.S. government enacted new legislation to encourage ethical accounting in 2002. The Sarbanes-Oxley Act attempted to curb unethical practices in several ways. In an effort to reduce the risks associated with financial reliance, the regulation limits the percentage of its fees each accounting firm can earn from any one client. It holds senior management accountable for the accuracy of financial reports, adds protection for whistle-blowers, and limits the role of outside accounting firms (for example, an accounting firm that performs much of the accounting entry for a client or provides significant consulting services for a client cannot also provide audit assurance services for that same client).

By addressing all aspects of unethical behavior (the causes, the effects, and the perceptions of), ongoing emphasis on professional codes of conduct and new regulations are helping to rebuild the public’s trust in financial information.