Ethical Dilemmas: Case Studies for Professional Accountants – Part 2 of 4

As previously noted (see Part 1), the Consultative Committee of Accountancy Bodies (CCAB) comprises the ICAEW, ACCA, ICAS and CIPFA in the UK and the Chartered Accountants Ireland. In December 2011, the CCAB published case studies on ethical issues encountered by professional accountants in business, professional accountants in public practice, professional accountants working as non-executive directors and professional accountants working in the voluntary sector. The purpose of these case studies is to provide guidance for resolving ethical problems and to encourage debate in these areas. CCAB welcomes feedback on the case studies and other ethics related issues.

The CCAB guidance on Ethical Dilemmas Case Studies for Professional Accountants in Public Practice illustrates how the ethical codes of the CCAB bodies can be applied by professional accountants working in public practice. These scenarios are not intended to cover every possible circumstance, but instead to outline key principles and processes that could be considered when attempting to identify, assess and resolve ethical problems in line with the ethical codes. Six case studies address the following matters:

·       Case Study 1 - Dealing with staff performance issues;

·       Case Study 2 - Improper accounting for sales;

·       Case Study 3 - Conflicting clients’ interests;

·       Case Study 4 - How much to disclose to the finance director;

·       Case Study 5 - Placing unreasonable expectations on a student;

·       Case Study 6 - Financial interest.

According to the guidance, a professional accountant in public practice “will want to act in the best interests of his or her clients. However, he or she also has a responsibility to act in the public interest, which will require objectivity to be exercised at all times (not only when providing assurances to third parties). The duties of the accountant in public practice who faces an ethical dilemma cannot be easily reconciled. On the one hand, it is good business practice to work closely with your clients; on the other hand, you will sometimes be expected to challenge their decisions, and even distance yourself from them.”

Ethical Dilemmas: Case Studies for Professional Accountants – Part 1 of 4

The Consultative Committee of Accountancy Bodies (CCAB) comprises the ICAEW, ACCA, ICAS and CIPFA in the UK and the Chartered Accountants Ireland. The Board of CCAB Ltd consists of five directors, senior members of the five member bodies. CCAB provides a forum whereby its member bodies can meet and act collectively on behalf of the accountancy profession in the UK to promote the public interest on matters within the sphere of the accountancy profession and its members.

In December 2011, the CCAB published case studies on ethical issues encountered by professional accountants in business, professional accountants in public practice, professional accountants working as non-executive directors and professional accountants working in the voluntary sector. The purpose of these case studies is to provide guidance for resolving ethical problems and to encourage debate in these areas. CCAB welcomes feedback on the case studies and other ethics related issues.

The case studies are compatible with the ethical codes of the CCAB member bodies, which are derived from the Code of Ethics for Professional Accountants issued by the International Ethics Standards Board for Accountants (IESBA). They illustrate the application of the “conceptual framework” approach to resolving ethical dilemmas. This approach focuses on safeguarding the fundamental principles of integrity, objectivity, professional competence and due care, confidentiality and professional behaviour.

The CCAB guidance on Ethical Dilemmas Case Studies for Professional Accountants in Business outlines key principles and processes that could be considered when attempting to identify, assess and resolve ethical problems in line with the ethical codes. Six case studies address the following matters:

·       Case Study 1 - Pressure to overstate stock valuation;

·       Case Study 2 - Pressure to participate in fraudulent activity;

·       Case Study 3 - Suspicion of false accounting;

·       Case Study 4 - Company restructure – working with limited resources;

·       Case Study 5 - Confidentiality when bidding for a contract; and

·       Case Study 6 - Non-disclosure to auditors.

Enhancing Professional Skepticism in Auditing

In February 2012, the Canadian Institute of Chartered Accountants (CICA) issued an Auditing and Assurance Bulletin on Enhancing Professional Skepticism. The Bulletin addresses how certain specific audit procedures required by Canadian Auditing Standards (CASs) can enhance professional skepticism. It is intended to help raise practitioners’ awareness in a timely manner of significant new or emerging issues or other noteworthy circumstances related to engagements addressed by the pronouncements of the Auditing and Assurance Standards Board (AASB). It is also meant to direct practitioners to relevant requirements, application and other explanatory material in the CICA Handbook – Assurance.

This Bulletin was issued in response to certain matters identified by practice inspectors and questions received by provincial practice advisors. In particular, this Bulletin addresses how to apply professional skepticism in accordance with CASs. It notes that: “CASs define professional skepticism as an attitude that includes a questioning mind, being alert to conditions that may indicate possible misstatement due to error or fraud, and a critical assessment of audit evidence (paragraph 13(I) of CAS 200).”

The Bulletin further states that: “Paragraph A19 of CAS 200, Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Canadian Auditing Standards, calls for the auditor to plan and perform the audit with professional skepticism in order to reduce the risks of:

• overlooking unusual circumstances;
• over generalizing when drawing conclusions from audit observations; and
• using inappropriate assumptions in determining the nature, timing and extent of the audit procedures and evaluating the results thereof.”

 

The topics covered by the Bulletin include the following: Overall auditor alertness; Risk assessment; Related parties; Accounting estimates; Inquiries of others; Accounting policies; External confirmations; Analytical procedures; Testing of journal entries; Evaluation of misstatements; Written representations; and Forming an opinion. After discussing these matters, it concludes that: “Auditors are encouraged to consider the matters discussed in this Bulletin, and continue to improve the application of professional skepticism in the audits they perform.”

 

For additional insight on professional skepticism, refer to Professional Judgment – Education Continued and the three-part series on Learning about Professional Skepticism (November 23, November 29 and November 30, 2011).

Using frameworks for the application and evaluation of auditors’ professional judgments

In response to concerns that a transition towards less precise accounting standards in the United States will increase auditor litigation exposure, regulators and accounting firms have developed and implemented frameworks for the application and evaluation of auditors’ professional judgments. Regulatory frameworks include, for example, the 2008 US Securities and Exchange Commission (SEC) Committee on Improvements to Financial Reporting (see previous posts on August 17, August 24 and August 30). Accounting firm frameworks include, for example, the 2011 KPMG monograph, Elevating Professional Judgment in Auditing: The KPMG Professional Judgment Framework (see previous posts on September 7, September 14 and September 20).

Recent research predicts and provides experimental evidence that such frameworks provide clarity to evaluators about the quality of auditors’ judgments. The research found that, when no direct signals of judgment quality are available, only auditors with recognized technical expertise in specific judgment tasks (an indirect signal of judgment quality) are insulated from the increase in litigation exposure arising from less precise standards.

When a direct signal of judgment quality is available (e.g., the auditor used a judgment framework when making specific judgments), there is no longer a relative increase in litigation exposure for auditors with general expertise compared to technical expertise. Nonetheless, when accounting standards are precise, the research found that the use of judgment frameworks may result in dysfunctional outcomes by reducing litigation exposure more for auditors with general expertise, not by improving the perceived quality of their judgments relative to auditors with technical expertise, but by signaling their lack of control over the events leading to the alleged material misstatement.

It is important to note that this research examines the signaling aspects of auditors’ use of a judgment framework, not whether and how professional judgment frameworks actually improve the quality of auditors’ professional judgments. Future research could examine auditors’ willingness and ability to use judgment frameworks and the downstream effects on their professional judgments, which preliminary evidence finds to be positive but to also depend on the economic substance of the transactions.

To learn more, read the April 2011 research article “Signaling the Quality of Auditors’ Professional Judgments: The Joint Effects of Accounting Standard Precision and Auditor Task Expertise” by Jonathan H. Grenier, PhD (Miami University), Bradley Pomeroy, PhD and Matthew Stern (both at University of Illinois at Urbana-Champaign). The paper is also available online at the Social Sciences Research Network.

Professional Judgment and Canadian Generally Accepted Auditing Standards – 1975

Thirty-seven years ago, in February 1975, the CICA’s Auditing Standards Committee proposed, subject to comments received following exposure, to publish the contents of an Exposure Draft as CICA Handbook: Section 5100 - Generally Accepted Auditing Standards. This Exposure Draft was a re-exposure of material previously included in a November 1973 Exposure Draft. At that time the Committee used wording closely following and, in most places, identical to that used in the AICPA Statement on Auditing Standards No. 1, Codification of Auditing Standards and Procedures.


The Introduction to the Exposure Draft stated: “Although the Committee’s intention remains, as a general principle, to use words closely following AICPA Statements (or other professional pronouncements) in cases where this is appropriate, consideration of responses received to the 1973 Exposure Draft indicated that several significant changes were desirable in this particular case. The November 1973 Exposure Draft contained two other Sections of background material, which have been eliminated. "Responsibilities and Functions of the Independent Auditor" required extensive changes and will be dealt with at a later date. The discussion previously included under the heading "The General Standards" related to ethical matters [emphasis added], which are within the jurisdiction of the provincial Institutes and Order. Accordingly, it is the Committee’s intention not to deal further with this topic in the Auditing Recommendations Section of the CICA Handbook, other than including the substance of the three November 1973 general standards as one general standard in paragraph 5100.02 in the interest of completeness.”

It is noteworthy that the Introduction also stated that concurrent with the issuance of this Exposure Draft as an Auditing Recommendation, the Committee would intend to amend the Introduction to Auditing Recommendations by inserting the following as a new paragraph in the "Application" section:

"Among the Recommendations issued, GENERALLY ACCEPTED AUDITING STANDARDS, Section 5100, constitute the basic professional standards with which, in the Committee’s view, the auditor should comply when reporting upon financial statements. In adhering to such basic standards the auditor should have regard to the specific Auditing Recommendations in the Handbook while exercising his professional judgment [emphasis added] as to what procedures are required for such adherence. In addition, the Handbook provides Recommendations with respect to unaudited financial statements, to which Generally Accepted Auditing Standards do not apply.”

Principles-based standards and the consequent role of professional judgment enhance the quality of Canadian financial reporting

The academic research provides preliminary confirmation of Ross Skinner’s (1995) hypothesis that Canada’s relatively principles-based GAAP yield higher accrual quality than the US’s relatively rules-based GAAP. These results stem from a comparison of the Dechow-Dichev (2002) measure of accrual quality for cross-listed Canadian firms reporting under both Canadian and US GAAP. However, the research documents lower accrual quality for Canadian firms reporting under US GAAP than for US firms, which are subject to stronger US oversight and greater litigation risk, reporting under US GAAP.

The latter results are consistent with stronger US oversight compensating for inferior accrual quality associated with rules-based GAAP. Consistent with the positive effect of Canada’s principles-based GAAP and the offsetting negative effect of Canada’s weaker oversight, the research found no overall difference in accrual quality between Canadian firms reporting under Canadian GAAP and US firms reporting under US GAAP.

Consistent with Skinner’s writings, the results imply that it is fallacious to attribute perceived deficiencies in Canadian financial reporting to the leeway allowed by principles-based GAAP without allowing for Canada’s oversight, which is relatively weak due largely to the absence of a national securities regulator. If anything, over the 1990-2002 sample period, principles-based standards and the consequent role of professional judgment enhance the quality of Canadian firms’ financial reporting.

To learn more, read the June 2004 article “Earnings Quality under Rules- vs. Principles-Based Accounting Standards: A Test of the Skinner Hypothesis” by Erin Webster and Daniel B. Thornton, Ph.D, FCA, (pictured here). Both are at Queen’s University School of Business in Kingston, Ontario, Canada.