HOW TO IMPROVE ETHICS

Table of Contents:

There may be several ways to improve the ethics of auditors: regulation, audit firm, clients, and education. Regulation can play a significant role in shaping and improving ethics. For example, giving responsibility for the company’s relationship with its auditor to an independent audit committee rather than management profoundly and positively impacts the independence of auditors (Copeland 2005). As illustrated earlier, the code of ethics established by IESBA lay out clearly the path to upholding high ethical standards: the conceptual framework. Auditors need to identify, evaluate, and address possible threats by understanding circumstances, exercising professional judgment, remaining alert to new information, and using a reasonable third-party test. Moriarity (2000) shows that the adoption of the Code of Professional Conduct in 1988 by the AICPA increased the number of sanctions for substandard professional service and the use of education as a means of remediating deficiencies in professional service. The profession has also achieved more uniform enforcement of the Code. These results suggest that the Code helps improve self-regulation in the accounting profession. Davidson and Stevens (2013) conducted experiments to examine whether a code of ethics can improve manager behavior and investor confidence. They find that a code of ethics only improves manager return behavior and investor confidence when it incorporates a public certification choice by the manager.

Auditing firms and the auditing profession have a major role to play in encouraging ethical behavior within the accounting and auditing profession. Leaders have a responsibility to shape the culture of the firm, set the appropriate “tone at the top,” and behave as a role model for the values the firm espouses. As stated in the International Standards on Quality Control (ISQC), setting the tone includes the following elements:

• establish the firm's objectives, priorities, and values
• communicate regularly
• update the firm's quality assurance manual
• hold people accountable
• develop staff competence and reward quality work
• improve continually
• set an example (provide staff with a role model in the positive example set by partners in their day-to-day behavior. For example, if a policy emphasizes the need for quality work, a staff member should not be criticized for legitimately exceeding the budgeted time).

The organization, evaluation, promotion, and compensation structures of the firm should be designed to support and encourage competent and ethical performance by partners and other professionals. These structures should help to mitigate the natural bias or loss of objectivity that can result from close association by an individual partner or office with an important client. Finally, individual professionals must have the courage to fulfill their responsibility to represent the public interest, even when doing so may have personal consequences. That is the ultimate test of a professional to do the right thing for their client (the public), regardless of the personal consequences. In other words, professional accountants should be encouraged to have “moral courage,” a sixth fundamental ethics principle proposed by the Institute of Chartered Accountants of Scotland (ICAS) as discussed in Chapter 2.

Corporate clients can greatly affect the ethical behavior of the accounting profession. The leadership and personal behavior of management, and ultimately the members of the board of directors, are critical to creating an ethical corporate culture. In addition to setting a good personal example for ethical behavior and setting the right tone at the top, companies can provide education on the ethical essentials of their business, and set up employee codes of conduct; for example, employees may be required to take a training course and pass a test of their knowledge of the code. They also provide a system, often through third-party organizations, for employees to provide confidential information about potential violations of ethical standards, regulations, or laws. Audit committees of the board of directors review these compliance systems and reports, as well as meeting in private sessions with internal and external auditors and key accounting personnel, can greatly improve employees’ ethical behavior. Establishing a “whistleblower” program or hotline and providing protections to the whistleblowers will also enhance ethical behavior.

Lastly, university education can help students learn ethical standards and form better moral values. After all, the path to becoming a professional is through education. Some may argue that ethics cannot be effectively taught, because our moral foundations are built very early in life, long before entering university. However, it is not impossible for people to change after being taught properly.

In summary, ethical standards are important in building the profession’s reputation. Building a high audit reputation can deter managerial fraud and improve financial reporting quality, and thus install capital market trust. The professionals who have high moral values are more ethical, are more intrinsically motivated, and can provide betterquality services. Losing reputation could have a detrimental impact on the profession. However, to protect reputations from deteriorating, individual auditors may conceal fraud to cover up prior mistakes. Moreover, ethics are personal traits and can be hard to implement. Therefore, ethics and reputation alone are not sufficient to ensure high-quality audits. Audit regulations and legal liabilities are other important mechanisms to establish audit accountability.

End-of- chapter question

What are professional ethics and what are the key steps to apply in order to comply with the fundamental principles as specified in the conceptual framework?

Notes

1. Chapter 7 reviews key methods of measuring audit quality in the auditing literature. Chapters 3 to 6 discuss the accountability mechanisms to ensure high audit quality.
2. This "race-to-the-bottom" phenomenon is a good example of the social reality construction. See Chapter 2 on critical perspectives literature.
3. Source (last accessed on December 5, 2019): www.ifac.org/global-knowledge-gateway/ethics/discussion/international-code-ethics-professional-accountants-key.
4. Formally, top management nominated the auditor and the final appointment of the auditor was approved by shareholders via the voting of their common shares. The Sarbanes-Oxley Act imposes new guidelines in the hiring of the auditor of publicly traded firms. Publicly traded firms are required to have audit committees and the audit committee is directly responsible for the appointment, compensation, and oversight of the work of the public accounting firm conducting the audit.
5. Sources of demand for audits are discussed in Chapter 2 as well as Chapter 9. Weber et al. (2008) will be discussed in more detail in Chapter 9.
6. This is consistent with the auditor's primary role in the 19th century as explained in Chapter 1.
7. Recall that the traditional audit risk model specifies audit risk = inherent risk x control risk x detection risk. When inherent risks decrease, detection risk can be higher to maintain the same level of audit risk. Reducing the amount of substantive testing will increase detection risk.
8. This can be an example of a lack of "moral courage," a sixth fundamental ethics principle proposed by ICAS, as discussed in Chapter 2.