ETHICS IN ACCOUNTING

At least as far back as ancient Greece, when the Hippocratic oath was instituted for medical practitioners, a hallmark of a profession has been its claim to integrity. When the public thinks of the accounting profession, they usually think of certified public accountants (CPAs) who work in big national or regional firms that audit the financial statements of publicly listed companies. But many CPAs work in smaller partnerships, auditing or organizing the books and records of private companies and not-for-profit and governmental organizations. CPAs may also perform other services, most notably tax services. Some work as financial officers and management accountants in corporations, large and small, as well as governmental and not-for-profit institutions. In addition, many accountants who do not have a CPA designation perform services similar to some of the services—but not audits—performed by CPAs.

ROLE OF ETHICS IN THE WORK OF PUBLIC ACCOUNTANTS

As noted, only CPAs can audit the financial statements of publicly owned companies that have to report to the federal government's Securities and Exchange Commission (SEC). CPAs who audit the financial statements of an organization have a clear ethical responsibility to all those who use audited financial statements. But public accountants are in a peculiarly difficult position compared with those in the legal and medical professions, because the parties that rely on their work extend beyond the client (often a corporation) who pays them, to the business and financial community, including stockholders, investors, creditors, suppliers, customers, employees, and government regulators. These parties rely on the objectivity and integrity of CPAs to make sure that the financial statements fairly present in accordance with generally accepted accounting principles.

In the early days of the public accounting profession in the United States, many accountants came to the United States to audit new and growing enterprises on behalf of British investors. These auditors clearly knew to whom they owed their loyalties. They also brought with them strict principles that, when many of these auditors founded U.S.-based audit firms, influenced the formation of the accounting profession in the United States. Almost from the beginning, however, professional ethical standards were not left to the individual CPAs to determine.

To protect the public, states instituted educational standards and examinations, as well as admission standards for CPAs and the rescindment of professional licenses for breaches of professional standards. The American Association of Public Accountants formed an ethics committee in 1906 to develop ethics standards for its members. Its modern successor body, the American Institute of Certified Public Accountants (AICPA), is an organization of all state societies of CPAs. Its Professional Ethics Executive Committee (established in 1971) promulgates a code of professional conduct and investigates, threatens, and punishes AICPA members for infringements of the code.

Consequently, for much of the twentieth century the accounting and auditing profession was largely self-regulating, with a professional code of conduct and a mechanism for investigating and punishing those whose conduct fell below professional standards. A separate investigation might also be conducted by the state licensing organization (e.g., the Department of Education in New York State).

The federal legislation that ensued after the 1929 stock market crash (the Securities Act of 1933 and the Securities Exchange Act of 1934) set up a federal agency, the SEC, with broad powers of regulating public securities markets. All public companies are required by these acts to register with the SEC and to file annual audited financial statements. The SEC largely delegated accounting standard setting to the private sector but retained enforcement action. It may regulate the most powerful members of the profession who audit the financial statements filed with the SEC directly, by enforcement actions including bans on auditing or working for public companies; it can also ban trading in the securities of public companies. For the most part though, throughout the twentieth century, the audit profession continued to be self-regulating at the federal level, by agreement and cooperation between the SEC and the AICPA.

ETHICAL CONCERNS BEGINNING IN THE 1990S

During the 1990s the growth of management consulting by audit firms caused many observers to question whether those firms were sufficiently independent to conduct their audits of public companies in the interest of the investing public. Anecdotal evidence of an increasing willingness by auditors to agree with corporate management's dubious accounting treatments, strained the relationship between the profession and the SEC. Its chairman, Arthur Levitt, was so concerned about the growing threat to the integrity of financial reporting and hence to the operation of capital markets that he instituted a new regulatory body in 1997, the Independence Standards Board (ISB). The ISB attempted to shore up audit firms' independence from corporate management by instituting stricter regulation of professional conduct. Unfortunately, the board received little more than lip service from leading CPA firms and was abolished in 2001.

The corporate scandals of 2001–2002 resulted in major federal legislation and regulation not seen since the 1933 and 1934 securities acts, principally the Sarbanes-Oxley Act (SOX) of 2002. SOX transferred the regulation of accountants auditing the financial statements of public corporations from the AICPA to the Public Companies Accounting Oversight Board (PCAOB), a new private sector, not-for-profit body. The PCAOB is funded from fees paid by registrants. SOX requires accounting firms, including international firms and foreign firms that play a substantial role in the preparation of audit reports of U.S. public companies, to register with the PCAOB. As of November 2005 more than 1,500 firms were registered.

Section 103 of SOX directed the PCAOB to establish auditing and related attestation, quality control, ethics, and independence standards and rules for registered public accounting firms. To meet this requirement for ethical standards under rule 3500T, the board adopted the AICPA's Code of Professional Conduct Rule 102, and passed interpretations and rulings (as Section 191) as of April 16, 2003, as interim ethics standards, unless superseded or amended by the board. The board also adopted (under rule 3600T) the AICPA code of Professional Conduct Rule 101 as its interim Independence Standard, along with Standards 1, 2, and 3 and their interpretations issued by the ISB. It is the responsibility of users to determine if a particular rule has been amended or superseded.

AICPA CODE OF ETHICS

The AICPA Code of Ethics covers general principles as well as more explicit rules of conduct. It is based on six principles, which are translated into a set of specific rules that AICPA members must observe. The code is supported by interpretations and rulings that apply in specific circumstances. The overriding objective of the six principles is to commit members to honorable behavior, even at the sacrifice of personal advantage. The preamble states that by accepting membership in the institute "a CPA assumes an obligation of self-discipline above and beyond the requirements of laws and regulations."

The six principles to which the CPA must adhere are:

1. Commitment —to the public interest and honoring public trust
2. Integrity —sensitivity to professional and moral judgments
3. Objectivity —requires the CPA to be unbiased and impartial in assessing facts, making estimates and arriving at judgments
4. Independence —unbiased, impartial, and free of conflicts of interest (independence in fact and appearance) when providing auditing or other attestation serves. CPAs may not audit a company if they (or spouse or dependents) own stock in that company and/or have financial or employment relationships with the client (apart from financial interest in timely receipt of audit fees).
5. Confidentiality —information known to accounting professionals may not be disclosed to outsiders except when professional work papers are subpoenaed by a court. (Accountants do not have attorney-client privilege.)
6. Professional competence —exercising due care, including observing professional technical and ethical standards. Accounting professionals should undertake only tasks that they can complete with professional competence, and they must carry out their responsibilities with sufficient care and diligence, usually referred to as due care.

As the AICPA Code of Ethics has been adopted as the interim standard by the PCAOB, it governs behavior of all AICPA members, in all types of practice—auditing public companies, private companies, not-for-profit and governmental institutions, as well as attestation and tax practices. Accountants who are not members of the AICPA but who belong to other professional bodies are governed by similar codes of ethics. Those who are not members of any professional body are still subject to professional codes promulgated by state governments, for example, the New York State code.

In so far as the PCAOB amends their rules of ethics, however, there may be an increasing gulf between the demands made on registered firms by that board, and the requirements of the AICPA for CPA firms not involved in audit of public companies. For example, on November 23, 2005, the board proposed a change in rule 3502 from "Responsibility not to Cause Violations" (of tax shelter laws) to "Responsibility not to Knowingly or Recklessly Contribute to Violations." Unless the AICPA adopts the same higher standard, CPAs auditing public firms will in the future have to conform to higher ethical standards than those who do not.

ETHICS ENFORCEMENT

Enforcement varies with the type of accountant (CPA or non-CPA) and the type of practice (audit of publicly listed companies or not). For non-CPAs, state governments and professional societies may be responsible for ethics enforcement, but the penalty imposed by professional societies is limited to expulsion. CPAs face higher penalties.

Section 105 of SOX makes the PCAOB responsible for the enforcement of the professional standards for accountants auditing the financial statements of corporations issuing securities in public markets. The PCAOB adopted rules, approved by the SEC in May 2004, that allow it to investigate:

any acts or practices, or omissions to act, by registered public accounting firms and persons associated with such firms, or both, that may violate any provision of the Act, the rules of the Board, the provisions of the securities laws relating to the preparation and issuance of audit reports and the obligations and liabilities of accountants with respect thereto, including the rules of the Commission issued under the Act, or professional standards [italics added]

Registered firms must cooperate with PCAOB investigations, the results of which are private and not released to the public. If a potential breach of professional standards is found, though, the PCAOB may hold public hearings and may impose sanctions—including revoking a firm's registration, barring a person from participating in audits of public companies, and invoking fines and imposition of remedial measures, such as training, quality-control procedures, and appointment of independent monitors.

Following SOX the AICPA membership voted to permit the AICPA to sanction members without investigation, if the SEC, Internal Revenue Service, PCAOB, or a state board sanctioned the member. In addition, the institute will allow more public disclosure and transparency on disciplinary matters.

CPAs who do not audit the financial statements of publicly listed companies do not fall under the jurisdiction of the SEC and the PCAOB. Ethical standards for these CPAs are enforced by the state societies of CPAs (if they are members) and by individual state enforcement mechanisms of codes of ethics. For example, in New York State, the Office of the Professions of the Department of State Education investigates and prosecutes professional misconduct. Penalties include censure, reprimand, fines of up to $10,000 for each violation, suspension of license and, in severe cases, revocation of license. The state board deals with about thirty cases of all types of professional misconduct by CPAs per year, about nine of which involve breaches of professional duties. State societies of CPAs also have enforcement mechanisms for their codes of ethics, and violations can lead to public expulsion.

ETHICS FOR ACCOUNTANTS NOT IN PUBLIC PRACTICE

Not all accountants work as public auditors. Those who work for corporations as financial managers, management accountants, and internal auditors may be CPAs, but a significant number are not. Over time, these accountants and internal auditors have founded their own professional societies without state or federal legislation. These societies also promulgate professional standards ensuring all members are appropriately qualified to do the work required of them and that all members adhere to a code of conduct or ethics somewhat similar to those of the AICPA. Examples include the Institute of Management Accountants' Standards of Ethical Conduct, which apply to practitioners of management accounting and financial management in corporations and not-for-profit institutions, and the Institute of Internal Auditors' (IIA) Code of Ethics, which applies to all IIA members and to certified internal auditors.

see also Accounting

bibliography

American Institute of Certified Public Accountants. (2006, January). AICPA code of professional conduct. Retrieved February 20, 2006, from http://www.aicpa.org/about/code/index.html

Institute of Internal Auditors. (n.d.) Code of ethics. Retrieved February 20, 2006, from http://www.theiia.org/index.cfm?doc_id=604

Institute of Management Accountants. (n.d.). IMA's statement of ethical professional practice. Retrieved February 20, 2006, from http://www.imanet.org/ima/sec.asp?TRACKID=&CID=191&DID=323

New York State Education Department, Office of the Professions. (n.d.). Professional misconduct and discipline. Retrieved February 20, 2006, from http://www.op.nysed.gov/opd.htm

Public Company Accounting Oversight Board. (2005, February 15). Bylaws and rules of the Public Company Accounting Over-sight Board. Retrieved February 20, 2006, from http://www.pcaobus.org/Rules/Rules_of_the_Board/Bylaws.pdf

Jan Sweeney