Accounting Chapter 8 Homework Such Policies And Procedures

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whistleblowers believed internal whistleblowing would be ineffective. The desire to use

internal channels to report wrongdoing puts the ball in the court of companies to develop

ethical systems to facilitate such reporting.

In public accounting, organizational commitment is heavily emphasized through

identification with the ethical systems, quality controls, and firm leadership. Commitment

accounting profession as the outermost layer. An auditor can think of her professional

identity as her affinity for and identification with the audit profession. Within the

profession are public accounting firms. Auditors can be committed to the firm and the

profession, neither one, or one or the other. Individuals also vary in their commitment to

colleagues within the organization. At the center of these potentially conflicting layers of

to exhibit greater reporting intentions. However, the locus of commitment and likelihood

of reporting were not significantly related, although locus of commitment and

perseverance of reporting are significantly related. Thus, it would appear that the longer

an individual persists in attempting to resolve an issue, the more likely one’s commitment

to a colleague versus the organization becomes an influencing factor in determining

performance history. Senior auditors were more likely to report a manager’s ethical

violation when they perceived personal costs of disclosure were low or when personal

responsibility for reporting was perceived to be high.

Brennan and Kelly studied some of the factors that influence propensity or willingness to

blow the whistle among trainee auditors. The factors studied include audit firm

internal reporting has not resolved the differences between the auditor and firm

management.

Miceli et al. studied the whistleblower intentions of internal auditing directors and found

those directors less likely to report incidents of wrongdoing “when they did not feel

compelled morally or by role prescription to do so.” The authors note that these feelings

of moral compunction and role prescriptions form the basis of the moral intensity of the

situation.

Whistleblowing can be perceived as an effective response to an organization’s failure to

establish accountability mechanisms internally. For auditors, the act of whistleblowing is

internally required when differences exist on accounting issues with management because

of their compliance obligations. External auditors have a similar obligation and additional

reporting requirements to the SEC under Section 10(A) of the Securities Exchange Act of

1934, as discussed in Chapter 3.

12. Evaluate the moral intensity of the issues faced by Diem-Thi Le in her

whistleblowing experience at DCAA.

Moral intensity is a construct that relates to issues in terms of their perceived moral

significance. Individuals’ perceptions of moral intensity should impact their recognition

of issues as posing moral dilemmas and should also affect ethical judgments and

behavioral intentions regarding issues. Moral intensity dimensions are associated with

individuals’ ethical decisions. Social consensus and seriousness of consequences are

Diem-Thi Le encountered a situation where her supervisor changed her audit opinion on

contractor accounting systems from deficient to acceptable and even changed her

working papers to reflect the same. This is a highly unusual situation and on that tested

her willingness to maintain integrity and speak out about these wrongful acts by her

supervisors, as she did.

The moral intensity of the situation was felt by Le who knew her supervisors were not

supporting her professional judgments and even making them look quite different by

changing work papers and audit conclusions. She realized her job was on the line and the

moral intensity was high. She also realized that she could not stand idly by while work

Ethical Obligations and Decision Making in Accounting, 4/e 18

auditing practices worked in her favor as the Committee was sensitive to her allegations

and had no trouble accepting her claims and charges of abuse of authority and retaliation

against her.

In reflecting on the incident in an interview with the Orange County Register, Le

admitted to struggling with her conscience for weeks, trying through sleepless nights to

get the courage to report the bad audits. She said, “I got to live with myself when I look

13. How does organizational dissonance influence ethical leadership and decision

making?

Leaders who lead ethically are role models, communicating the importance of ethical

standards, holding their employees accountable to those standards, and — crucially —

designing environments in which others work and live. As described below, ethical

leadership has been shown to cause a host of positive outcomes, and to reduce the risk of

many negative outcomes. Leadership may therefore be the most important lever in an

ethical system designed to support ethical conduct.

Ethical Dissonance Model – Chapter 3

High

Organizational

Ethics

Low Personal High

Of the four potential fit options, two possess high person-organization fit: (1) high

organizational ethics, high individual ethics (High-High), and (2) low organizational

ethics, low individual ethics (Low-Low); and two possess low person-organization fit: (1)

high organizational ethics, low individual ethics (High-Low) and (2) low organizational

ethics, high individual ethics (Low-High). In two of the fit options (High-High and Low-

Low), no ethical dissonance exists. Person-organization fit is optimal, and the

14. Why do you think studies show that no single factor has a bigger impact on the

ethicality of a firm’s culture than the personal examples set by firm leaders?

High Organizational

Low Personal Ethics

High Organizational

High Personal Ethics

Low Organizational

Low Personal Ethics

Low Organizational

High Personal Ethics

Ethical Obligations and Decision Making in Accounting, 4/e 20

Personal examples greatly influence the ethicality of firm culture because those in

leadership roles set the tone for the behavior of others in the organization. The

personalities and values of ethical leaders represent the unique character of an

organization and provides the context for action in it and by it. Organizations are a

collective of individuals with different personalities and ethical values that need to be

meshed with organizational goals and ethical standards to create an ethical culture.

When managers are unethical, employees will emulate the bad behavior. Eventually, the

unethical environment will hinder business. For example, if managers take credit for

subordinates’ work, some employees will start to imitate the behavior. Honest employees

will begin to protect themselves by hiding their work from their colleagues and

supervisors. The resulting lack of teamwork and collaboration will limit the company’s

potential. In contrast, if managers model ethical behavior for employees and reward good

behavior, the positive corporate culture will instill how ethical behavior makes good

business sense and helps everyone succeed.

If a company’s culture rewards employees who pursue personal advantage rather than

focus on contributing to the performance of the entire team, employees might overstep

ethical boundaries to get ahead. For example, suppose a manager rewards top performers

without analyzing how they achieved their results. Some employees might use unethical

Ethical Obligations and Decision Making in Accounting, 4/e 21

15. Audit firms are expected to establish and maintain a system of quality control.

PCAOB inspections often cite the lack of quality controls as a deficiency of audit

firms. What role does leadership play in developing the kind of quality control

system that supports ethical decision making in audits?

Firm leadership needs to ensure that a system of quality controls is in place to deal with

audit issues and any differences of opinion between auditors and top management.

Quality controls establish procedures to support ethical decision making in a variety of

ways. The quality controls should be designed to ensure the audit is conducted in

accordance with generally accepted auditing standards, which includes making ethical

judgments on contentious accounting and auditing issues; the exercise of due care in the

conduct of the audit; the exercise of professional skepticism in making judgments and in

evaluating audit evidence and drawing conclusions about management’s representations;

and assessing the risk of material misstatements in the financial statements. A critical

Ethical Obligations and Decision Making in Accounting, 4/e 22

should establish policies and procedures designed to provide it with reasonable assurance that the

firm; its personnel; and, when applicable, others subject to independence requirements (including

network firm personnel) maintain independence when required by relevant ethical requirements.

Such policies and procedures should enable the firm to:

Such policies and procedures should require:

• Engagement partners to provide the firm with relevant information about client engagements,

including the scope of services, to enable the firm to evaluate the overall effect, if any, on

independence requirements;

• The firm of circumstances and relationships that create a threat to independence so that

appropriate action can be taken; and

• The accumulation and communication of relevant information to appropriate personnel so that

16. Explain how the circumstances under each of the following might reflect failed

leadership by auditors and the audit firm:

• Under-reporting of time on an engagement

Under-reporting of time might occur in a situation where an auditor fails to get work

completed on a timely basis and firm leadership pressures him to speed up and/or accepts

that he will do work on his own time and not charge it to the client. It can reflect failed

leadership because the firm should not promote or accept such a policy. It creates an

Ethical Obligations and Decision Making in Accounting, 4/e 23

• Premature sign-off on audit procedures

The premature sign-off on audit procedures might occur in a situation where the firm is

behind schedule and decides to reduce or eliminate some audit procedures that would

otherwise be required. A good example is where an auditor reviews insurance contracts to

verify that the accounting for premiums is correct. The audit program may have called for

• Accepting weak client explanations for accounting

Client explanations are an integral part of the evidence gathered to assess management’s

representations and is a critical component of exercising an appropriate level of

professional skepticism. The only reason to accept weak client explanations is because of

a conflict between the requirements of an audit conducted in accordance with generally

17. What is the role of leadership in auditor assessments of the likelihood of fraud in the

context of the fraud triangle?

First, let’s review the components of the fraud triangle.5 The pressure, or incentive, to

commit fraud is the reason why a person commits fraud. There are several reasons a

Ethical Obligations and Decision Making in Accounting, 4/e 24

performance, wanting to meet or exceed financial analysts’ earnings expectations, and

greed, among others. The reason the employee commits the fraud can change over time.

The opportunity to commit fraud is the circumstances that allow fraud to occur, and is the

only condition over which the company has complete control. For example, an employee

who is in a position that gives her the ability to add vendors and write checks realizes she

has the opportunity to write checks to a ghost vendor. Opportunities to commit fraud are

more commonly present in organizations that have poor internal controls because it

Rationalization of committing fraud is the most difficult condition to observe because it

takes place in the mind of the perpetrator. Rationalization has to do with justifying the

fraud. Since many fraudsters view themselves as honest, ordinary people and not as

criminals, they have to come up with some reasoning to make the act of committing fraud

more acceptable to them. Some common rationalization statements are “I’ll just take this

money now and pay it back later,” “No one will notice,” or “I deserve this after all these

years with this company.” Some fraudsters rationalize behavior by reframing their

definition of wrongdoing to exclude one’s own actions.

18. Bruns and Merchant found that managers did not agree on the types of earnings

management activities that are acceptable. Refer to the definitions of

earnings management in Chapter 7. Explain how leadership traits influence how

managers might perceive the acceptability of earnings management.

First, reviewing the definitions of earnings management, Schipper defines it as a

“purposeful intervention in the external reporting process, with the intent of obtaining

some private gain (as opposed to, say, merely facilitating the neutral operation of the

process).” Leaders need to judge the intent of management in this case, which is not

always easy to do. One sign to look for are what management is trying to accomplish

Healy and Wahlen define earnings management as “when managers use judgment in

financial reporting and in structuring transactions to alter financial reports to either

mislead some stakeholders about the underlying economic performance of the company,

or to influence contractual outcomes that depend on reported accounting numbers.” Here,

the motivation is important but needs to be evaluated in the context of making

professional judgments. For example, is the intent of structuring the transactions to gain a

competitive advantage or reflect the form of a transaction rather than its economic

Dechow and Skinner note the difficulty of operationalizing earnings management based

on the reported accounting numbers because they center on managerial intent, which is

unobservable. Dechow and Skinner offer their own view that a distinction should be

made between making choices in determining earnings that may comprise aggressive, but

acceptable, accounting estimates and judgments, as compared to fraudulent accounting

practices that are clearly intended to deceive others. The key here is how can a leader

determine whether the accounting is aggressive, but acceptable, as opposed to intended to

deceive another party? An ethical leader should err on the side of caution and question

Ethical Obligations and Decision Making in Accounting, 4/e 26

“cook the books.” He criticizes Schipper, Healy and Wahlen, and Dechow and Skinner

for taking “unnecessarily negative view[s] of earnings management.” McKee contends

that a more positive definition is needed that portrays managers’ motives in a positive

light rather than the negative view adopted by others.

We have already stated in Chapter 7 that we disagree with McKee’s notion that earnings

management is acceptable when it is designed to smooth net income over time. Any

intervention in the financial reporting process not justified by the accounting rules is, we

19. Moral legitimacy refers to the generalized perception or assumption of observers

that the actions of an entity are desirable, proper, or appropriate within some

socially constructed system of norms, values, and beliefs. Explain how moral

legitimacy might be applied to assess the actions of audit firms.

If legitimacy is interpreted descriptively, it refers to people’s beliefs about political

authority and, sometimes, political obligations. In his sociology, Max Weber put forward

a very influential account of legitimacy that excludes any recourse to normative criteria.

According to Weber, that a political regime is legitimate means that its participants have

certain beliefs or faith in regard to it: “the basis of every system of authority, and

correspondingly of every kind of willingness to obey, is a belief, a belief by virtue of

which persons exercising authority are lent prestige”. Weber distinguishes among three

main sources of legitimacy, understood as both the acceptance of authority and of the

need to obey its commands. People may have faith in a particular political or social order

Ethical Obligations and Decision Making in Accounting, 4/e 27

includes to assess management’s stewardship role and fiduciary obligations of the board

of directors.

Question #19 provides an opportunity to review the writings of the philosopher Alasdair

MacIntyre that were discussed in Chapter 1. MacIntyre states that the exercise of virtue

requires “a capacity to judge and to do the right thing in the right place at the right time in

the right way”. Judgment is exercised not through a routinizable application of the rules,

At the heart of the virtue approach to ethics is the idea of “community.” A person’s

character traits are not developed in isolation, but within and by the communities to

which he belongs, such as the Principles in the AICPA Code that pertain to standards of

acceptable behavior in the accounting profession (its community).

MacIntyre relates virtues to the internal rewards of a practice (i.e., the accounting

profession). He differentiates between the external rewards of a practice (such as money,

fame, and power) and the internal rewards, which relate to the intrinsic value of a

particular practice. MacIntyre points out that every practice requires a certain kind of

relationship between those who participate in it. The virtues are the standards of

excellence (i.e., AICPA Code principles) that characterize relationships within the

Mintz points out that the accounting profession is a practice with inherent virtues that

enable accountants to meet their ethical obligations to clients, employers, the

government, and the public at large. For instance, for auditors to render an objective

opinion of a client’s financial statements, they must be committed to perform such

services without bias and to avoid conflicts of interest. Impartiality is an essential virtue

for judges in our judicial system. CPAs render judgments on the fairness of financial

20. The American writer, Robert McKee, is quoted as saying, “True character is revealed

in the choices a human being makes under pressure.” Explain what you think this

means in the context of moral intensity and ethical leadership of organizations.

Ethical Obligations and Decision Making in Accounting, 4/e 28

Robert McKee is famously known for his statement that: True character is revealed in the

choices a human being makes under pressure – the greater the pressure, the deeper the

revelation, the truer the choice to the character’s essential nature.8 When we think about

this statement we can see more clearly what makes for an ethical leader. An ethical leader

is one whose character is revealed through decision making informed by virtues such as

honesty, trustworthiness, respect, fairness, empathy, responsibility, and accountability.

These are endearing values in accounting and underlie its public interest ideal.

McKee’s characterization has particular meaning in accounting because accountants and

auditors are frequently under pressure by superiors and others in management of a client

or the firm to go along with what the client wants. The way in which an

accountant/auditor handles the pressure reveals true character. Of course, the way in

which the accountant/auditor handles the pressure depends in part on the culture of the

organization and pressures imposed by one’s own supervisor and firm management.

The more intense the issue, the greater the moral challenge. The more intense the issue

the greater the need for judgment and decision making informed by virtues that help to

build an ethical culture in an organization and establish the leader as one who believes in

ethics; models such behavior; and builds the system to support ethical decision making.