It's time for principles based accounting ethics

Ethics And Code Of Conduct Paper

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Read "It's Time for Principles-Based Accounting Ethics" (attached) In 4-5 pages (12-pt type, double-spaced) answer the following questions:

Do you agree with the authors that a code of ethics should do more than establish minimum acceptable standards? Why or why not?
Describe the five cardinal virtues of professional accountants that the article's authors discuss.
We've talked about rules-based versus principles-based accounting standards. Should we have rules-based ethics standards? Why or why not? Should they tell you exactly what to do in specific ethical situations?
Read the AICPA Code of Professional Conduct (Links to an external site.) (pdf version) (attached) and summarize any TWO of the below contents of Part I of the Code of Conduct.
Introduction
1.100 Integrity and Objectivity
1.200 Independence
1.300 General Standards
1.310 Compliance with Standards
1.320 Accounting Principles
1.400 Acts Discreditable

It’s Time for Principles-Based Accounting Ethics

Albert D. Spalding Jr. • Alfonso Oddo

Published online: 6 January 2012

� Springer Science+Business Media B.V. 2012

Abstract The American Institute of certified public

accountants (AICPA) has promulgated a Code of Profes-

sional Conduct, which has served as the primary ethical

standard for public accountants in the United States for

more than 20 years. It is now out of date and needs to be

replaced with a code of ethics. Just as U.S. generally

accepted accounting principles are being migrated toward

‘‘principles-based accounting’’ as part of a convergence

with international financial reporting standards, a similar

process needs to occur with ethics. This article organizes

the primary rules of the AICPA Code around five essential

virtues: objectivity, integrity, inquisitiveness, loyalty, and

trustworthiness. These virtues correspond to the general

principles set forth in the Code of Ethics for Professional

Accountants of the International Federation of Accountants

(IFAC). From this virtue ethics perspective, various rules

of the AICPA Code are critiqued as being inadequate at

best, and poorly crafted at worst. The article concludes

with the proposition that principles-based ethics serves the

profession and the financial reporting process better than

the current rules-based approach.

Keywords Ethics � Accounting standards � Rules-based � Principles-based � International accounting

Introduction

The accounting profession in the United States and around the

world is in the process of harmonizing its financial reporting

standards (Benston et al. 2006). This process involves two

initiatives. First, the accounting standards within various

jurisdictions, such as the generally accepted accounting

principles (GAAP) used in the United States, are being con-

verged into international financial reporting standards (IFRS).

IFRS are also known as International GAAP (iGAAP). Sec-

ond, as part of this process, countries whose financial stan-

dards have generally been understood to have been ‘‘rules

based’’ are re-working those standards so that they are more

‘‘principles based’’. The United States is generally recognized

as a jurisdiction within which accounting standards are mostly

rules based (Bennett et al. 2006).

This harmonization of local financial reporting standards

is being coordinated under the auspices of the International

Accounting Standards Board (IASB). The IASB is currently

closely working with the U.S. Financial Accounting Stan-

dards Board (FASB) in an effort to achieve complete har-

monization of U.S. GAAP and iGAAP within the next few

years. This allows corporations and other entities to use the

same reporting standards that are used elsewhere, and will

make it easier for investors to compare the financial perfor-

mance of publicly traded corporations around the globe.

Before this harmonization process, U.S. GAAP has

emphasized, and relied on, rules-based standards (Nobes

2005). In part, this has been in response to the demand of

corporate managers and their auditors, who have sought

clear and precise guidance for the reporting of transactions.

This article was presented at the 16th Annual International Conference Promoting Business Ethics, Niagara University, October 2009, and reflects the comments and suggestions of conference

participants.

A. D. Spalding Jr. (&) Associate Professor of Legal Studies, Wayne State University,

School of Business Administration, Detroit,

Michigan 40202, USA

e-mail: aspalding@wayne.edu

A. Oddo

Professor of Accounting, Niagara University, College

of Business Administration, Niagara University,

NY 14109, USA

123

J Bus Ethics (2011) 99:49–59

DOI 10.1007/s10551-011-1166-5

This has had the advantage of providing clarity to

accounting professionals, as well as a precise standard of

care that has served in the defense of accountants and

managers when they have been sued by plaintiffs charging

them with accounting negligence.

Detailed accounting protocols have not served the pro-

fession or its stakeholders well in the long run. Corporate

managers have honed their skills at finding and using

loopholes and technical exceptions to complex rules, so

they have been able to finesse the rules and augment their

financial results. The result has been financial statements

that comply with the technical rules of GAAP, but do not

provide a fair representation of the corporation or other

economic entity. This, in turn, has served to camouflage

problems at reporting entities, until those problems become

so large that the entity itself is swallowed up by them.

And so the drive toward principles-based accounting

standards, as part of the convergence of U.S. GAAP and

iGAAP is, in part, an effort to improve financial reporting in

the United States and elsewhere. Principles-based account-

ing is intended to allow reporting standards to be more clo-

sely aligned with the objectives of financial reporting, such

as relevance and usefulness. They are intended to be based on

a carefully crafted and consistently applied conceptual

framework that minimizes exceptions and avoids loopholes.

An appropriate amount of implementation guidance is nec-

essary and expected, within the principles-based approach,

but a balance is sought between generalized and abstract

concepts, on one hand, and very specific, almost mechanical,

rules, on the other (Benston et al. 2006).

Along with the movement from rules-based accounting

standards to principles-based accounting standards, there is

an opportunity for the accounting profession in the United

States to improve its ethical standards. In fact, the AICPA

has committed to conforming its Code of Professional

Conduct to an international Code of Ethics for Professional

Accountants, but has yet to complete that project (AICPA

2008a). Just as academic research has served to enliven and

assist the discourse among accountants and their constitu-

ents in the area of convergence of financial reporting

standards (Fülbier et al. 2009), we offer some suggestions

to enhance the ethical standards of the accounting

profession.

The AICPA’s Code of Professional Conduct

The AICPA is the national professional organization of

certified public accountants in the United States. Its code of

conduct serves as the ethical standard for purposes of self-

regulation within the profession. The AICPA code consists

of a set of principles and a set of rules (AICPA 2008a).

Each will be discussed briefly in the following. It should be

noted, however, that the bylaws of the AICPA require that

members adhere to the rules, but not the principles.

Principles

The principles section sets forth the objectives of the code

in somewhat lofty, if not compulsory, language. It is sug-

gested, for example, that accountants should ‘‘exercise

sensitive professional and moral judgments in all their

activities,’’ and should seek to ‘‘continually demonstrate

their dedication to professional excellence.’’ Service to the

public trust ‘‘should not be subordinated to personal gain

an advantage,’’ and members should ‘‘maintain objectivity

and avoid conflicts of interest.’’ Other ideals, such as

competence, cooperation with other members of the pro-

fession, and self-governance, are also commended.

Although some of the text of the principles section includes

language that seems to be mandatory and authoritative,

such as the assertion that integrity requires AICPA mem-

bers to be honest and candid within the constraints of

confidentiality, the principles themselves are nonbinding.

Rules

There are eleven rules of the AICPA code, and most of the

rules are supported by interpretations. The AICPA also

provides short hypothetical ethics rulings that serve to pro-

vide additional interpretation. Some of the rules are rela-

tively brief, and can only be understood by reference to the

AICPA interpretations. Rule 101—Independence simply

requires that accountants maintain independence from their

clients when performing such attestation services as audits or

reviews. The AICPA interpretation 101-1, however, is a

complex and lengthy document that details such relation-

ships as immediate family and close relatives (for example,

grandparents are and domestic partners are included, but

aunts, uncles, cousins, and in-laws are not). It prescribes

those circumstances in which an accountant may own or hold

one share of stock in the firm’s attestation client, and when he

or she may not. Rule 101 is further bolstered by a separate

‘‘conceptual framework’’ document that prescribes proce-

dures for gauging independence in situations where the

interpretation provides insufficient guidance.

Rule 501—Acts Discreditable is another very short rule

backed up by various interpretations and rulings. The rule

simply requires that AICPA members not commit an act

‘‘discreditable to the profession.’’ The term ‘‘discreditable’’

is not defined, but the interpretations of Rule 501 provide

examples of such acts. For example, interpretation of 501-1

is a lengthy set of instructions pertaining to how accoun-

tants ought to respond requests by clients and former cli-

ents for records. The interpretation provides, among other

things, that client records prepared by an accountant should

50 A. D. Spalding Jr., A. Oddo

123

be provided to the client, unless there are fees due to the

accountant. Unfortunately, some accountants have from

time to time been tempted to increase their final fees

charged to a departing client, and then hold the client’s

records ransom. For all its detail, the interpretation 501-1

encourages, rather than discourages, this type of ‘‘dis-

creditable’’ behavior.

Other rules are poorly drafted. Rule 102—Integrity and

Objectivity, for example, mandates that AICPA members

‘‘shall be free of conflicts of interest.’’ In fact, accountants

face conflicts of interests nearly every day of their working

lives, and are required to navigate those conflicts in a way

that optimizes their professionalism. Unfortunately, the

AICPA code does not provide insight or guidance in regard

to this necessity. Similarly, the same rule prohibits mem-

bers from subordinating their judgment to others (except,

presumably, the requirements of the AICPA and other

authoritative bodies affecting the work of the accountant).

The idea of honesty is also clumsily addressed. Rule 102

establishes a very low ethical watermark by requiring that

AICPA members ‘‘not knowingly misrepresent facts.’’ Of

course, dishonesty and deceit is not limited to outright lies.

On its face, this rule leaves open the possibility of misleading

others by omission, deliberate vagueness, circumlocution, or

purposeful efforts to confuse without outright misrepresen-

tation. Oddly, Rule 502—Advertising sets a higher standard

than does Rule 102. There, accountants are prohibited from

advertising ‘‘in a manner that is false, misleading, or

deceptive.’’ As written, the code holds accountants to a

stricter standard of honesty in their advertisements than in

their work and other communications.

The AICPA code has come under other criticism as

well. Neill et al. (2005), for example, suggested that the

enforcement of the code was ineffective because it was

largely dependent on grievances filed by clients, former

clients, and other accountants. As a result, no compre-

hensive system is in place to assess whether members are

acting in compliance with the code. The lack of compliance

assessment by the AICPA (or third parties) not only

weakens the effectiveness of the code in transforming the

professional behavior of accountants but also deprives the

public from access to data regarding whether AICPA

members are complying with the code.

These criticisms remain relevant today. Through its

enforcement process, the AICPA investigates members

who are accused of violating the code and imposes sanc-

tions as it deems appropriate. Sanctions range from the

assignment of required ethics education, to a temporary

suspension of membership, to a termination of mem-

bership. If, for example, a member has been disciplined

by a governmental agency or other organization that

has oversight authority (such as the Securities and

Exchange Commission, or the Public Company Accounting

Oversight Board), the AICPA routinely takes action to

sanction that member by requiring ethics education or by

suspending membership. If a complaint is filed against the

member by a client, another accountant, or third party, the

AICPA joint ethics enforcement panel and joint trial board

will conduct an investigation to determine whether similar

sanctions should apply.

As Neill et al. (2005) observed, the AICPA maintains a

peer review process whereby accounting firms visit each

other and assess the quality of each other’s work. However,

the subject matter of this review process is limited to quality

control concerns in regard to compliance with technical

accounting standards. Ethical problems, and its risks of

potential ethics violations, are not explicitly addressed.

The IFAC Code of Ethics for Professional Accountants

The International Federation of Accountants (IFAC) includes

157 accounting organizations from 123 countries and juris-

dictions worldwide. IFAC develops and promotes high-

quality international accounting standards and facilitates

collaboration and cooperation among its member bodies.

The IFAC maintains an International Ethics Standards

Board for Accountants (IESBA) as an independent stan-

dard-setting board. The IESBA has recently established a

Code of Ethics for Professional Accountants (IESBA

2009). The IESBA develops ethical standards and guidance

for use by all professional accountants under a shared

standard-setting process involving the Public Interest

Oversight Board, which oversees the activities of the

IESBA, and the IESBA Consultative Advisory Group,

which provides public interest input into the development

of the code. Some jurisdictions may have requirements and

guidance that differ from those contained in the IFAC

code. Professional accountants in those jurisdictions are

required to comply with the more stringent requirements

and guidance unless prohibited by law or regulation.

The code contains three parts. Part A establishes fun-

damental principles of ethics for professional accountants

and provides a conceptual framework that professional

accountants shall apply to:

• Identify threats to compliance with the fundamental principles

• Evaluate the significance of the threats • Apply safeguards to eliminate or reduce threats

Safeguards are necessary when the professional accountant

determines that the threats are not at a level at which a rea-

sonable and informed third party would be likely to conclude,

weighing all the specific facts and circumstances available to

the professional accountant at that time, that compliance with

the fundamental principles is not compromised.

It’s Time for Principles-Based Accounting Ethics 51

123

Parts B and C of the code describe how the conceptual

framework applies in certain situations. They provide

examples of safeguards that may be appropriate to address

threats to compliance with the fundamental principles. They

also describe situations where safeguards are not available to

address the threats, and consequently, the circumstance or

relationship creating the threats should be avoided. Part B

applies to professional accountants in public practice. Part C

applies to professional accountants in business. Professional

accountants in public practice may also find Part C relevant

to their particular circumstances.

The IFAC code establishes ethical requirements for

professional accountants and provides a conceptual

framework for all professional accountants to ensure

compliance with five fundamental principles of profes-

sional ethics. Under the IFAC framework, all professional

accountants are required to identify threats to these fun-

damental principles and, if there are threats, apply safe-

guards to ensure that the principles are not compromised. A

member body of IFAC, such as the AICPA, may not apply

less stringent standards than those stated in the IFAC code.

Fundamental Principles

The IFAC code requires that a professional accountant

shall comply with the following fundamental principles:

Integrity To be straightforward and honest in all

professional and business relationships.

Objectivity To not allow bias, conflict of interest, or

undue influence of others to override

professional or business judgments.

Professional

competence

and due care

To maintain professional knowledge and

skill at the level required to ensure that a

client or employer receives competent

professional services based on current

developments in practice, legislation, and

techniques and act diligently and in

accordance with applicable technical

and professional standards.

Confidentiality To respect the confidentiality of infor-

mation acquired as a result of professional

and business relationships and, therefore,

not disclose any such information to

third parties without proper and specific

authority, unless there is a legal or

professional right or duty to disclose, nor

use the information for the personal

advantage of the professional accountant

or third parties.

Professional

behavior

To comply with relevant laws and

regulations and avoid any action that

discredits the profession.

Conceptual Framework Approach

The IFAC code establishes a conceptual framework that

requires a professional accountant to identify, evaluate, and

address threats to compliance with the fundamental prin-

ciples. The conceptual framework approach assists pro-

fessional accountants in complying with the ethical

requirements of the code and meeting their responsibility to

act in the public interest. It accommodates many variations

in circumstances that create threats to compliance with the

fundamental principles and can deter a professional

accountant from concluding that a situation is permitted if

it is not specifically prohibited.

When a professional accountant identifies threats to

compliance with the fundamental principles and, based on

an evaluation of those threats, determines that they are not

at an acceptable level, the professional accountant shall

determine whether appropriate safeguards are available and

can be applied to eliminate the threats or reduce them to an

acceptable level. In making that determination, the pro-

fessional accountant shall exercise professional judgment

and take into account whether a reasonable and informed

third party, weighing all the specific facts and circum-

stances available to the professional accountant at the time,

would be likely to conclude that the threats would be

eliminated or reduced to an acceptable level by the appli-

cation of the safeguards, such that compliance with the

fundamental principles is not compromised.

A professional accountant shall evaluate any threats to

compliance with the fundamental principles when the

professional accountant knows, or could reasonably be

expected to know, of circumstances or relationships that

may compromise compliance with the fundamental prin-

ciples. The following illustration outlines the conceptual

framework approach.

Conceptual Framework

Identify threats to

fundamental principles

Evaluate the threats

Apply safeguards to

eliminate or reduce threats

52 A. D. Spalding Jr., A. Oddo

123

Revised Code

The IESBA has issued a revised Code of Ethics for Pro-

fessional Accountants, clarifying the requirements for all

professional accountants and significantly strengthening

the independence requirements of auditors. The revised

code has been released following the consideration and

approval by the public interest oversight board (PIOB) of

due process and extensive public interest consultation. The

revised code, which is effective on January 1, 2011,

includes the following changes to strengthen independence

requirements:

• Extending the independence requirements for audits of listed entities to all public interest entities

• Requiring a cooling off period before certain members of the firm can join public interest audit clients in

certain specified positions

• Extending partner rotation requirements to all key audit partners

• Strengthening some of the provisions related to the provision of nonassurance services to audit clients

• Requiring a pre- or post-issuance review if total fees from a public interest audit client exceed 15% of the

total fees of the firm for two consecutive years

• Prohibiting key audit partners from being evaluated on or compensated for selling nonassurance services to

their audit clients

The revised code maintains the principles-based

approach supplemented by detailed requirements where

necessary, resulting in a code that is robust but also suffi-

ciently flexible to address the wide-ranging circumstances

encountered by professional accountants. The International

Federation of accountants’ statements of membership

obligations have as a central objective the convergence of a

country’s national code with the Code of Ethics for Pro-

fessional Accountants. Furthermore, the requirements

specify that member bodies should not apply less stringent

standards than those stated in the code.

Virtues as Ethical Principles

Both the AICPA and IFAC codes contain ethical standards,

but the content of the latter is more principles based than

that of the former. In regard to honesty, for example, Rule

102 of the AICPA code prohibits intentional misrepresen-

tation. This rule begs the interpretation of the extent to

which actions are ‘‘willful,’’ and the extent to which

actions constitute ‘‘misrepresentation.’’ The emphasis is on

the element of wrongdoing associated with behavior of the

accountant. To determine whether an accountant has vio-

lated Rule 102, it becomes necessary to examine whether a

specific statement made by the accountant constitutes a

willful misrepresentation.

Section 110 of the IFAC code, by comparison, brings

more focus to the character of the professional accountant

as a person. Honesty is associated with ‘‘straightforward-

ness.’’ Accountants are prohibited from being associated

with reports, returns, communications, or other information

that contains statements or information furnished reck-

lessly, or omits or obscures information in a way that

would be misleading. In other words, the emphasis is on

the accountant’s responsibility for the overall quality of his

or her work.

Each of these two codes also provides a different

approach to conflicts of interest. Rule 102 of the AICPA

code states that accountants shall be free of conflicts of

interest when rendering professional services. To make any

practical application of this part of Rule 102, the definition

of ‘‘conflict of interest’’ must be so circumscribed and

limited that it does not take into account the complexity of

commerce in the twenty-first century (or the even greater

complexity of the accounting discipline within a globalized

society). Some readers of the AICPA code, who are

mindful of the fact that auditors are usually compensated

by their own audit clients, may reasonably conclude that

the profession’s notion of conflict of interest is driven by its

own myopic manner of defining its code language.

The IFAC offers no pretense about the fact that

accountants are then faced by a myriad of real or potential

conflicts of interest in many circumstances. The IFAC code

does not prohibit the existence of conflicts of interest or

undue influence. Instead, it requires that accountants not

allow conflicts of interest, undue influence of others, or

even their own personal bias to override professional or

business judgments. This is a more realistic standard that

speaks to the professional accountant as a person, and

challenges the accountant to rise above the realities of such

conflicts.

Among the differences between the AICPA code and the

IFAC code is a greater emphasis, within the latter, on those

qualities and behavior patterns that characterize the ‘‘eth-

ical accountant.’’ Such virtues as honesty and integrity are

described in greater detail, and held out as the ideal ethical

standards to which accountants ought to aspire. The IFAC

code tends to point toward the highest levels of excellence

and professionalism, rather than to simply delineate mini-

mally acceptable ethical standards.

This emphasis on personal character is consistent with

the ‘‘virtue theory’’ approach to business and professional

ethics that has gained greater currency in recent years. As

Whetstone (2001) notes, moral philosophizing during the

last half century or so has tended to focus either on act-

oriented theories (such as the consequentialism of Ben-

tham’s utilitarianism and the deontology of Kant’s rational

It’s Time for Principles-Based Accounting Ethics 53

123

ethics) or on virtue-oriented theories. When applied, the

former focuses on normative rules, whereas the latter tends

to result in the articulation of ethically optimal habits and

characteristics. Whetstone suggests that both are important,

but that principles-based ethics (PBE) has the advantage of

emphasizing the promotion of virtuous judgment.

Dawson and Bartholomew (2003) expand on Whet-

stone’s approach by suggesting that an important role of

business ethics generally, and codes of conduct in particular,

is the promotion of those virtues that, in turn, foster human

flourishing. Bertland (2009) offers an additional insight by

taking into account the extent to which the advocacy of

virtues, and virtuous judgment, can not only promote human

flourishing in general but can also enhance the use of human

capabilities in particular. Indeed, some have argued that it is

the cultivation of character or virtue that is a precondition to

any reasonable expectation that rules would be respected

and understood as minimum standards of behavior (Arjoon

2000). That is, in part, because virtue ethics emphasizes both

behavior and motives, rather than behavior in isolation from

motives (Blackburn and McGhee 2004).

Here, we consider the implications of this emphasis on

virtue-oriented PBE on the professional ethics of accoun-

tants. We draw from traditional concepts of Aristotelian

virtue theory. As Graafland (2010) explains, virtues, under

this classical view, are habits of character that constitute a

‘‘golden mean’’ between the vices of deficiency, on one

hand, and excess on the other. For example, the Aristotelian

virtue of courage represents an optimal balance between its

deficiency (cowardice) and its excess (recklessness, boor-

ishness, or overconfidence). The proper roles of ethical

epistemology and the development of ethical protocols

(such as codes of conduct and codes of ethics) are to enhance

such virtues and move them to higher levels of excellence

and prudence. The intellectual project of virtue ethics is the

identification of the most desirable virtues, as well as the

development of disciplines and habits that will foster such

virtues. The bell curve in Fig. 1 depicts the optimization of

virtues and the block arrow represents the devel