governance, a values-based code of conduct reinforced by a responsible business culture,
and effective stakeholder engagement, transparency, and accountability.
According to the International Federation of Accountants (IFAC), “A growing number of
organizations go far beyond viewing ethical practices as a means to avoid penalties or
fines; they believe that corporate responsibility and ethical practices lead to sustainable
The decisions and behaviors of accountants should reinforce good governance and ethical
practices through diligent application of the rules and professional standards in
accounting and auditing and adherence to ethical standards such as those in the AICPA
Code and the Global Code of Ethics of IFAC. Moreover, enforcement of internal
controls; working with internal auditors; and communications with audit committees are
all steps that accountants can take to reinforce good governance and ethical practices. The
auditors’ review of the control environment establishes the basis to assess organizational
culture. The challenge in a global environment is the interaction of cultural variables with
these governance procedures. For example, in Asian cultures the emphasis on protecting
Accountants appointed to senior management positions, both in business and practice,
have a particular responsibility to provide ethical and trusted leadership. They are not
only expected to be technically competent but to also use their position of influence to
encourage ethical behavior and decision making throughout their organization.
Ethical behaviors by accountants are critical to enhance the trust placed by the end user in
the professional services offered by accounting firms. In the absence of trust, such
Ethical Obligations and Decision Making in Accounting, 4/e 19
Extended Discussion
In some jurisdictions, particularly in Europe and the U.S., aspects of business ethics are
typically reinforced by regulation, laws, and stock exchange listing rules. Examples of
regulatory and legislative approaches to business ethics and conduct include the US
Federal Sentencing Guidelines (1991), Section 406 of the Sarbanes Oxley Act of 2002,
UK Bribery Act (2010), and Clause 49 of the listing agreement of India’s stock exchange.
Significant progress has been made toward the global convergence of ethical standards by
professional accountants. The International Ethics Standards Board for Accountants
(IESBA) develops and issues, under its own authority, the Code of Ethics for
17. How do Gray’s accounting values establish a basis for financial reporting in
countries with different cultural systems?
Gray uses Hofstede’s values to identify four widely recognized accounting values that
can be used to define a country’s cultural foundation with respect to financial reporting:
2. Uniformity (consistency across companies in the use of accounting practices)
3. Conservatism (a cautious approach to measurement to deal better with the
4. Secrecy (preference for confidentiality and restrictions on disclosures) versus transparency
(open and public accountability).
Ethical Obligations and Decision Making in Accounting, 4/e 20
From an accounting perspective, high conservatism implies a tendency to defer the
recognition of assets and items that increase net income while reserving for possible
future declines in earnings. Within Hofstede’s framework, higher levels of conservatism
18.
What are the costs and benefits of establishing one set of accounting standards (i.e.,
IFRS) around the world? How do cultural factors, legal systems, and ethics
influence your answer? Apply a utilitarian approach in making the analysis.
The advantages of one set of accounting standards to be followed by all companies
around the world include the comparability of financial statements, irrespective of the
location of the company’s headquarters; global cost of capital; and its ability to raise
capital in world-wide markets, not just the home country. The disadvantages of one set of
accounting standards is the failure of one set of standards to be 100% compatible with the
Extended Discussion
Here is a more extensive list of advantages and disadvantages of adopting IFRS in the
U.S. Any utilitarian analysis starts with identifying these factors (benefits/harms) and
weighing each one’s importance (hard to do) – and then making a decision about the
overall net benefits of adoption.
Advantages
• Improved transparency. Investors, executives, and managers in different
countries should be able to better understand a foreign company’s or
multinational’s reports and statements.
Ethical Obligations and Decision Making in Accounting, 4/e 21
• Uniformity across international boundaries.
• Better management information, with more visibility into foreign
subsidiaries and more transparency.
• Improved communication among subsidiaries, as their accounting
converges in IFRS.
19.
The Institute of Chartered Accountants in England and Wales (ICAEW) has
adopted a code of ethics based on the IFAC Code. In commenting on the principles-
based approach used in these codes, the ICAEW states that a principles approach
“focuses on the spirit of the guidance and encourage responsibility and the exercise
of professional judgment, which are key elements of professions.” Explain how
factors underlying professional judgment that were discussed in Chapter 4 come
into play in the global environment.
In chapters 1 and 4 we noted that the principles in the AICPA Code are aspirational
statements and guide members in the performance of their professional duties; they
call for an unyielding commitment to honor the public interest, even at the sacrifice of
Ethical Obligations and Decision Making in Accounting, 4/e 22
Principles call for the exercise of professional judgment in conflicting cases by
asking: Am I doing what a person of integrity would do?
The IFAC Code sets out five fundamental principles, which guide members’ behavior:
• Integrity
• Objectivity
Members are responsible for assessing threats to complying with those principles and for
implementing safeguards where those threats are significant.
The ethics code relies on professional judgment. The rules can never be expected to cover
all situations encountered by accounting professionals. When the rules are unclear,
judgment must be used based on the principles in the code, basic ethical values such as
honesty, integrity, trust, and responsibility, and ethical reasoning used to think through
what should be done in a particular situation.
Professional judgment is influenced by personal behavioral traits (i.e., attitudes and
ethical values) as well as one’s knowledge of the accounting and auditing issues in
question. Theoretical models of ethical decision-making, such as that of Hunt and Vitell,
include personal values in their theory as one of several personal characteristics that
Ethical Obligations and Decision Making in Accounting, 4/e 23
The KPMG framework identifies five components of professional judgment that revolve
around one’s mindset. The components are: (1) clarify issues and objectives; (2) consider
alternatives; (3) gather and evaluate information; (4) reach conclusion; and (5) articulate
and document rationale. The framework recognizes that influences and biases might
affect the process as could one’s knowledge of professional standards. Judgments are
At the very center of the KPMG framework is “mindset.” Auditors should approach
matters objectively and independently, with inquiring and incisive minds. Professional
skepticism is required by auditing standards. It requires an objective attitude that includes
a questioning mind and critical assessment of audit evidence. In the previous example,
professional skepticism was sacrificed for expedience.
Professional skepticism is not the same as professional judgment, but it is an important
component of professional judgment. It is a frame of reference to guide audit decisions
and enhances ethical decision making.
Our intuitive judgments can fall prey to cognitive traps and biases that negatively
influence our judgments. Three common judgment traps are “group-think,” a rush to
solve a problems, and “judgment triggers.” Group-think finds a home in stage 3 of
Kohlberg’s model. We become influenced by the expectations of the group and,
20. Consider the practice of making “facilitating payments” to foreign officials and
others as part of doing business abroad in the context of the following statement:
International companies are confronted with a variety of decisions that create
ethical dilemmas for the decision makers. “Right–wrong” and “just–unjust” derive
their meaning and true value from the attitudes of a given culture. Some ethical
Ethical Obligations and Decision Making in Accounting, 4/e 24
standards are culture-specific, and we should not be surprised to find that an act
that is considered quite ethical in one culture may be looked upon with disregard in
another. Explain how culture interacts with the acceptability of making facilitating
payments in a country. Use rights theory and justice reasoning to analyze the ethics
of allowing facilitating payments such as under the FCPA in the United States and
prohibiting them as under the U.K. Bribery Act.
For legal purposes, a facilitating payment is distinguished from bribery; however, the
distinction is often blurred. Determining whether a payment is a facilitating one may
be difficult and depend on the circumstances. The value of the payment is not
immediately relevant; however, the greater the value, the higher are chances that it
will be a red flag for law enforcement. Small unofficial payments are customary and
even legal in some countries; nevertheless they may present a risk of liability
according to the laws of the host country. There also exists a slippery slope danger of
evolving into bribery payments.
21. One provision of the U.K. Bribery Act is that it applies to bribes that occur
anywhere in the world by non-U.K. companies that conduct any part of their
business in the United Kingdom. For example, the Bribery Act would cover a
company that has a few employees working in the United Kingdom or that simply
sells its goods or services in the United Kingdom. Evaluate this policy from an
Ethical Obligations and Decision Making in Accounting, 4/e 25
ethical perspective using ethical reasoning. In particular, do you think the policy is
fair? Is it right?
The U.K. Bribery Law is using rights theory and the categorical imperative to
determine that if a bribe or facilitating payments is wrong in one culture, then it is
wrong in all cultures. Is this fair? Is it ethical to not act consistently with one’s values
based on justifications for different actions in different situations? Being fair means
22. What is the purpose of having a two-tier system of boards of directors in
countries such as Germany? How does the dual-board approach ameliorate the
potential conflicts in the principal-agent relationship between investor and
manager?
The two-tier structure for board directors consists of a Management Board and the
Supervisory Board. The Management Board generally performs the duties and
responsibilities of senior management of a corporation. The group is charged with the
day-to-day managing of the corporation to benefit the various stakeholder groups. The
Supervisory Board appoints, supervises, and advises the members of the Management
23. In discussing the benefits of the Global Code of Ethics, Richard George,
chairperson of the International Ethics Standards Board for Accountants, said,
“Strong and clear independence standards are vital to investor trust in financial
reporting. The increase in trust and certainty that flow from familiarity with
standards, including a common understanding of what it means to be
independent when providing assurance services, will contribute immeasurably to
a reduction in barriers to international capital flows.” Explain the link between
auditor independence and facilitating international capital flows from the public
interest perspective.
Auditor independence is the foundation of trust that the public places in financial
reporting. Users of financial reports trust that auditors will act independently of
management and make objective judgments when evaluating the accuracy and
A common understanding of independence is important because it is not 100 percent
clear in all instances whether independence standards have been met. Independence is
a factual determination but difficult to assess. Therefore, the appearance of
independence is most important. This includes avoiding certain relationships with
clients and client management that might lead an observer to conclude that
independent thought cannot be exercised and objective judgment may be clouded.
Both the AICPA Code of Professional Conduct and IFAC Global Code of Ethics
establish a conceptual framework approach to independence that calls for assessing
Ethical Obligations and Decision Making in Accounting, 4/e 27
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
Undue Influence
A threat to replace the CPA or CPA firm because of a disagreement with
the client over the application of an accounting principle.
Interest Threat
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.
Self-Review Threat
A self-review threat occurs when a CPA reviews evidence during an attest engagement that is
based on her own or her firm’s nonattest work. An example would be preparing source
documents used to generate the client’s financial statements.
Advocacy Threat
Adverse Interest Threat
Ethical Obligations and Decision Making in Accounting, 4/e 28
Familiarity Threat
A familiarity threat occurs when a close relationship is formed between the CPA and an attest
Undue Influence Threat
An undue influence threat results from an attempt by the management of an attest client or other
interested parties to coerce the CPA or exercise excessive influence over the CPA.
Financial Self-Interest Threat
A financial self-interest threat occurs when there is a potential benefit to a CPA from a financial
interest in, or from some other financial relationship with, an attest client. It goes beyond simple
Management Participation Threat
A management participation threat occurs when a CPA takes on the role of client management or
otherwise performs management functions on behalf of an attest client.
Safeguards to Counteract Threats
Safeguards are controls that eliminate or reduce threats to independence. These range from
partial to complete prohibitions of the threatening circumstance to procedures that counteract the
potential influence of a threat. The nature and extent of the safeguards to be applied depend on
There are three broad categories of safeguards. The relative importance of a safeguard depends
on its appropriateness in light of the facts and circumstances.
1. Safeguards created by the profession, legislation, or regulation. For example, continuing
2. Safeguards implemented by the attest client, such as a tone at the top that emphasizes the
attest client’s commitment to fair financial reporting and a governance structure, such as
Ethical Obligations and Decision Making in Accounting, 4/e 29
24. What are the unique challenges to the global internal audit function?
Ever since the Sarbanes-Oxley Act was passed the internal audit function has increased in
importance. The Treadway Commission had already established that the internal audit
function should be independent of management and the internal auditors should have
direct and unrestricted access to the audit committee of the board of directors. SOX calls
The internal audit department plays a critical role in corporate governance. Given that
corporate governance systems vary on a global level, the role of internal auditors may be
different in different systems and cultures. For example, many European countries have a
A document prepared by Ernst & Young on the challenges of the global internal audit
function provides useful information on this issue.6
EY points out that the role of internal audit has changed with the evolving global
business environment including:
• Internal audit must recruit, train, and manage staff that can operate across a variety of
cultures and deal with multiple regulatory regimes.
• Internal audit departments must secure a strong position within their companies,
underpinned by trust and close relationships with staff in other business units and across
multiple countries.
Ethical Obligations and Decision Making in Accounting, 4/e 30
25. In this chapter, we discuss problems encountered by the PCAOB in gaining access
to inspect workpapers of auditors in U.S. international accounting firms that have
Chinese company clients that list their stock in the United States. Explain why these
problems exist from a cultural and legal perspective. How might shareholder
interests be compromised by the arrangement between the PCAOB and CSRC that
was struck in the Longtop Financial case discussed in this chapter?
Gray uses Hofstede’s values to identify accounting values of professional, uniformity,
conservatism, and secrecy. China shows a preference for statutory control and
compliance driven prescriptive legal requirements versus a preference for professional
judgment; uniformity and consistency across companies in the use of accounting
practices versus choice of accounting practice with perceived circumstances of individual
Ethical Obligations and Decision Making in Accounting, 4/e 31
thereby eliminating any claims that it had violated confidentiality in regards to its
Chinese client.
The SEC began investigating Longtop Financial Technologies of China for accounting
fraud in 2011 after Deloitte’s Chinese affiliate resigned as its auditor because of
significant problems in verifying its financial statement. Deloitte had served as Longtop’s
auditor since the company went public in the United States in 2007 through an initial
public offering and listed its shares on the NYSE.
The firm has resisted complying with the subpoena because it asserted that turning over
its work papers could violate Chinese law prohibiting the disclosure of “state secrets,”
which it says includes information about the “national economy and social development.”
Anyone convicted of a violation could be sentenced to a long prison term.
Ethical Obligations and Decision Making in Accounting, 4/e 32
about their bookkeeping and financial disclosures. From an ethical perspective, it is an
issue of trust and representational faithfulness in the financial reporting. Can foreign
investors trust the financial reports produced by accountants in China and audited by the
Big Four CPA firms to faithfully represent what it purports to represent thereby
enhancing the usefulness of such reports? Can we really trust that the CSRC turns over
all relevant information?
Recent Agreement between SEC and CSRC
On April 4, 2015, a legal settlement was reached between the SEC and the China
affiliates of the Big Four firms resolving the long-running dispute over access to audit
working papers related to U.S.-listed Chinese companies.7
It seems that each party obtained what they wanted: the SEC Commission will be able to
check audit working papers, the Big Four firms in China keep their clients, and
shareholders should gain more transparency in evaluating the companies’ performance.
Legal experts have described the settlement as a balanced outcome that benefits all major
parties.
For their part, the Big Four firms concerned – Deloitte Touche Tohmatsu, Ernst & Young
Hua Ming, KPMG Huazhen and PricewaterhouseCoopers Zhong Tian – issued a joint
statement welcoming the settlement.
Ethical Obligations and Decision Making in Accounting, 4/e 33
regulators can find a meaningful permanent reconciliation of the differences between
Chinese laws and U.S. listed entity rules and regulations.
Roy Lo, Hong Kong Managing Partner of ShineWing (HK) CPA and a member of the
Hong Kong Institute of CPAs. “I believe the settlement is positive in encouraging the
access to audit work papers in China [towards] achieving the completion of audit work
with a good balance of investors’ interests and confidentiality asserted by listed
companies.”