AICPAs Code of Professional Conduct Rule 101 and 102: Independence and Integrity/Objectivity How both coincide with

an auditors morality, ethical behavior, and conflict of interest. By Krystal Smith ACCT 612

When you think of auditing, you can paint a negative image in your head. Auditing can be a very touchy topic, especially when referring to big businesses. However, the main issues when dealing with auditing are the independence and integrity that auditors should have. In this paper, I will be talking about how unethical behavior first started, the moral instability within the accounting profession, the different views on how auditors should maintain independency and integrity, what companies should do when they come up against unethical concerns, and the future of accounting once independency, integrity, moral judgment, and objectivity is intact. Under the American Institute of Certified Public Accountants (AICPA) Code of Professional Conduct, Rule 101 discusses independence. It states, A member in public practice shall be independent in the performance of professional services as required by standards promulgated by bodies designated by council. This means that once you have accepted an audit, you have to make sure that you as the auditor comply with the rules of the accountancy. Rule 102, discusses integrity and objectivity. It states, In the performance of any professional service, a member shall maintain objectivity and integrity, shall be free of conflicts of interest, and shall not knowingly misrepresent facts or subordinate his or her judgment to others. This

means that as an auditor you must sustain your morality at all times and if you shall come up against a situation that you feel is an awkward situation, you should excuse yourself. You should make sure that the confidentiality and competence are on your priorities list. These two rules may seem like they arent that hard to follow, but you will be surprise to see how many auditors fail to abide by them both. To understand integrity, competence, objectivity, confidentiality, and independency, you must understand ethics and moral judgment. In an article written by Domenec Mele, he discuss that the most important aspect of accounting is character. Accountants must determine the

significance of each situation with practical judgment and wisdom. Practical judgment and wisdom is made up of habits and personality, which forms virtues and values. When you connect all of these together, you will start to understand why having all of them helps you conduct an audit better. In order to become a good auditor, these aspects in your life should be in your nature. They should be things that you do on a daily basis. When doing an audit you should be completely unbiased and moral sensitive. Once you become less and less involved with your roots in ethical behavior, your performance as an auditor starts to show. According to the AICPA, independence is considered to be weakened if during the period of the professional engagement, a covered member had or was committed to acquire any direct or material indirect financial interest in the client. Was a trustee of any trust or executor or administrator of any estate. Had a joint closely held investment that was material to the covered member. During the period of the professional engagement, a partner or professional employee of the firm, his or her immediate family, or any group of such persons acting together owned more than five percent of a clients outstanding equity securities or other ownership interests. During the period covered by the financial statements or during the period of the professional engagement, a firm, or partner or professional employee of the firm was simultaneously associated with the client as a director, officer, or employee, or in any capacity equivalent to that of a member of management; promoter, underwriter, or voting trustee; or trustee for any pension or profit-sharing trust of the client. When referring to integrity and objectivity weakness, it states that, a member shall be considered to have knowingly misrepresented facts in violation of the preparation of financial statements or records when he or she knowingly makes or permits or directs another to make materially false and misleading entries. Fails to correct an entitys financial statements or

records that are materially false and misleading when he or she has the authority to record an entry. Signs or permits or directs another to sign a document containing materially false and misleading information. This is where the conflict of interest begins. A conflict of interest may occur if a member performs a professional service for a client or employer and the member or his or her firm has a relationship with another person, entity, product, or service that could, in the members professional judgment, be viewed by the client, employer, or other appropriate parties as impairing the members objectivity. If the member believes that the professional service can be performed with objectivity, and the relationship is disclosed to and consent is obtained from such client, employer, or other appropriate parties, the rule shall not operate to prohibit the performance of the professional service. Colin Boyd article was about the structural origins of conflicts of interest in the accounting profession. In the article, Boyd discusses that the conflict of interest didnt start with Enron, it started way before then. In the beginning of the 20th century, most professional public accountants worked in public practice accounting firms that provided tax and accounting services to businesses, other organizations, and to small proportion of private individuals whose financial affairs were complex. The scope of most firms was local, with operations typically confined to one office servicing one town or city, and its surroundings. Larger accounting firms operated as partnerships rather than as sole proprietorships. In countries with a federal structure, the regulation of professional accountants and the organization of their professional institutes took place at the regional level. In other countries, they operated at the national level. Accountants were perceived by the public to be sold and conservative professional, with a reputation of good ethical integrity. Due to a geographical change, businesses had to merge nationally which increased the degree of concentration of the industry. Once the profession went

global, only four accounting firms held ground. There were pressures on labor inputs which led to the strategy of horizontal integration. Auditing, at first, was a very unattractive occupation to be a career path until the 1980s when it became intense. Accountants started to realize that auditing allowed them to view clients business systems operations and correct them where needed. This increased high margins. Accountants started viewing themselves as legal business advisors rather than just auditors. This horizontal integration which was cross subsidization across product lines enabled the accounting firms to ease the low price/low cost production of the audit. However, this strategy also led to commercial tension that pressured the ability to provide audit services independently of their growing commercial interests. This led to the growth of non-audit business. Audits share of revenues started to decline, which caused the accounting firms to focus on their other services. Those who had the power and dominance of the auditing units started to become weak, while the power of the consulting units started to grow stronger. Of course this led to even more political friction amongst the accounting firms. If the firms had a policy of sharing of total profits across all partners, no matter which unit they worked in, then the partners in the high margin areas probably disliked having to share their profits with the audit partners. Fighting between audit partners and consulting partners over internal power and about profit sharing was the origin of the splitting away. This is when the Enron scandal began. Since the audit services wasnt bringing in the money and the consulting services was, accounting firms started taking clients that they did audits for and consulting services for, Which gave the accountants double fees, or one fee outweighing the other. This increased the concern of independency and questioned the improper bookkeeping. In the Enron case, the consulting services started to outweigh the auditing

services. Enron started getting over compensated for non-audit services they sold to their clients, and this is where the conflict of interest started to rise and become the auditors main focus instead of following the profession code of conduct on independence. Outside people could see how the accounting profession was starting to lose its ethical background, but inside there still were some unresolved issues that werent being addressed and remained uncorrected and unrecognized. Authors Sally Gunz and John McCutchen wrote an article on unresolved ethical issues in auditing. While authors Don Finn, Lawrence Chonko, and Shelby Hunt wrote an article on ethical problems in public accounting: the view from the top. Both articles discuss the nature of ethical issues, how they occur, why they occur, and what to do about them. Finn, Chonko, and Hunt states, that ethical problem occur only when an individual interacts with other people. Ethical conflict occurs when people perceive that their duties toward one group are inconsistent with their duties and responsibilities toward some other group. They then must attempt to resolve these opposing obligations. By doing this, the individual gets confused and overwhelmed by what they feel is right and what they believe in. If the individual clients are asking for specific duties that the individual must compromise their own responsibilities, then it causes moral pressure amongst them both. Gunz and McCutcheon states, that the auditor must have and been seen to have an objective mind untainted by self interest. They then explain that an audit is the process in which a competent independent person accumulates and evaluates evidence about quantifiable information related to a specific economic entity for the purpose of determining and reporting on the degree of correspondence between the quantifiable informations and established criteria. Along with independence that means taking an unbiased viewpoint in the performance of audit

tests, the evaluation of the results, and the issuance of the audit report. Auditors have an ethical obligation to the clients on behalf on whom they are employed. Legally the client is defined as variously the shareholders or as the board of directors. It is for these classes of persons that the audit is primarily performed. The auditor also has a wider duty to ensure the publication of a fair and appropriate set of financial statements and in doing so becomes the servant not only to the client but to the economics and financial structure of the licensing jurisdiction. Because the auditor is a servant to different user groups with distinct and sometimes competing interests, the auditor is placed in a situation where there will always be conflict. Finn, Chonko, and Hunt states, that top management sets the ethical tone for an organization. If top management is the ones that are compromising the moral principles within the company, how the employees are suppose to follow and support the law. Most of the ethical problems that are occurring within these organizations are involving the financial statement alterations, fee problems, and client pressure to alter tax reportings. These include overstated company earnings and financial condition, falsification of corporate records, lying, covering up practices, improperly applying accounting principles, and false disclosures. There will always be unresolved ethical issues if the top management is ignoring them and not forcing their company to abide by them. It all starts with the top. Once the top people throw the ethical and moral values out the window, the entire company will follow. It takes a strong foundation for an organization to succeed. If the organization is weak from the start, the company will collapse significantly. According to author Steven Wallman, accounting and financial reporting are key players to the success of our capital formation process; and accountants along with others such as lawyers and underwriters, are the gatekeepers of our financial market sentiments. He claims that

the main touchstones of accounting information are relevance or usefulness and the need to enhance the utility of financial statements. When it comes to auditing, the main touchstone is reliability. Independence is part of the essence that underlies the success of our public accounting system. It helps provide the objectivity that permits the profession to perform its attestation and monitoring functions effectively. He believes that out current approach to independence should be modified to becoming more comprehensive and comprehensible, which leads to becoming more effective. Accountants should consider different ways to resolve ethical conflict. They should discuss such problems with the immediate superior except when it appears that the superior is involved, in which case the problem should be presented initially to the next higher managerial level. If satisfactory resolution cannot be achieved when the problem in initially presented, a submission of the issues should be presented to the next higher managerial level. They should clarify relevant concepts by confidential discussion with an objective advisor to obtain an understanding of possible courses of action. Finally, if the ethical conflict still exists after exhausting all levels of internal review, the accountant may have no other recourse on significant matters than to resign from the organization and to submit an informative memorandum to an appropriate representative of the organization. In conclusion, I believe that when one enters in the career path of accounting they should already have the mind frame of being independent and truthful. It all begins with how you were taught as a child. Whats right from wrong and whats good and bad is where it starts. Your moral judgment all depends on what you feel inside. If there is one doubt in your mind, or you get that gut feeling, then you should probably go with your instincts. I believe that auditing can be the most stressful occupation because you arent just going in, doing paperwork, and then

receiving a check. You have to understand the businesses background, look at all their financial statements and documentation, and then give an opinion about those documents. Where the issue would come up with me is the overall conflict. I understand as an auditor you should maintain independence and I have no problem with being independent because I like to work alone, however, I wouldnt want any of my clients to get upset with me because I gave an opinion that they didnt agree with. I would want them to keep asking for my services, but I guess thats where you should draw the line, and not take the same client more than once. I dont understand how accountants can get involved with conflict of interest cases. I dont see how money can be the cause of why you would compromise your morality. Your moral judgment is what gets you through life obstacles. I have a guilty conscience, so I know I wouldnt take extra money for services that the client wants me to do. Even if I didnt have a guilty conscience, it is immoral and unprofessional to take more than what you worked for. It would be hard for me to not befriend my client, since I am such a friendly person, but I wouldnt want my client to get the wrong impression. This is why I cant see myself becoming an auditor. You have to be well trained to deal with that type of surrounding. All the authors that I wrote about discussed different views on what independence is in accounting, and why it is so important to follow. After the Enron situation, I think more accounting professionals are aware of the consequences if their independency is compromised, however, I dont think that businesses will stop placing accounting professionals in situations where there will be conflict of interest or integrity problems. The future development of the profession would appear to lie in the hands of external regulators and legislators, implying that the fundament of any profession, self regulation, is forever lost to the accounting profession.

References: Wallman, Steven M H. (1996). The future of accounting, Part III: Reliability and auditor independence. Accounting Horizons, 10(4), 76-97. Retrieved August 3, 2010, from ABI/INFORM Global. (Document ID: 10551512). Gunz, Sally, & McCutcheon, John. (1991). Some Unresolved Ethical Issues in Auditing. Journal of Business Ethics, 10(10), 777. Retrieved August 3, 2010, from ABI/INFORM Global. (Document ID: 572586). Boyd, C. (2004). THE STRUCTURAL ORIGINS OF CONFLICTS OF INTEREST IN THE ACCOUNTING PROFESSION. Business Ethics Quarterly, 14(3), 377-398. Retrieved from Business Source Complete database. Nelson, M. (2006). AMELIORATING CONFLICTS OF INTEREST IN AUDITING: EFFECTS OF RECENT REFORMS ON AUDITORS AND THEIR CLIENTS. Academy of Management Review, 31(1), 30-42. Retrieved from Business Source Complete database. Bazerman, M., Moore, D., Tetlock, P., & Tanlu, L. (2006). REPORTS OF SOLVING THE CONFLICTS OF INTEREST IN AUDITING ARE HIGHLY EXAGGERATED. Academy of Management Review, 31(1), 43-49. Retrieved from Business Source Complete database. Standards Of Ethical Conduct For Management Accountants. (1989). Management Accounting, 70(7), 40. Retrieved August 3, 2010, from ABI/INFORM Global. (Document ID: 652590). Mel, D. (2005). Ethical Education in Accounting: Integrating Rules, Values and Virtues. Journal of Business Ethics, 57(1), 97-109. doi:10.1007/s10551-004-3829-y. Finn, D., Chonko, L., & Hunt, S. (1988). Ethical Problems in Public Accounting: The View from the Top. Journal of Business Ethics, 7(8), 605-615. Retrieved from Business Source Complete database. 2010. http://www.wiley.com/college/kieso/0471363049/dt/protool/Ethics/aicpa/et102.htm 2010. http://www.aicpa.org/Research/Standards/CodeofConduct/Pages/sec100.aspx