Reaction Paper on Ethical Issues in Accounting

“Accountants and the accountancy profession exist as a means of public service; the
distinction which separates a profession from a mere means of livelihood is that the
profession is accountable to standards of the public interest, and beyond the
compensation paid by clients”

--Robert H. Montgomery, describing ethics in accounting

Accounting ethics is primarily a field of applied ethics, the study of moral values and
judgement as they apply to accountancy. It is an example of professional ethics are thought in
accounting courses at higher education institutions as well as by companies training accountants
and auditors. Due to the diverse range of accounting services and recent corporate collapse,
attention has been drawn to ethical standards accepted within the accounting profession. These
collapses resulted in a widespread disregard for the reputation of the accounting profession. To
combat the criticism and prevent fraudulent accounting, various accounting organizations and
governments have developed regulations and remedies for improved ethics among the
accounting profession.
The nature of the work carried out by accountants and auditors requires a high level
of ethics. Shareholders, potential shareholders, and other users of the financial statements rely
heavily on the yearly financial statements of a company as they can use this information to make
an informed decision about investment. They rely on the opinion of the accountants who
prepared the statements as well as the auditors that verified it, to present a true and fair view of
the company. Knowledge of ethics can help accountants and auditors to overcome ethical
dilemmas, allowing for the right choice that, although it may not benefit the company, will
benefit the public who relies on the accountant/auditor’s reporting.
Accounting ethics has been deemed difficult to control as accountants and auditors
must consider the interest of the public while ensuring that they remained employed by the
company they are auditing. They must consider how to best apply accounting standards even
when faced with issues that could cause a company to face a significant loss or even be
discontinued. Due to several accounting scandals within the profession, critics of accountants
have stated that when asked by a client “what does two plus two equals?” the accountant would
be likely to respond “what would you like it to be?”. This thought process along with other
criticisms of the profession’s issues with conflict of interest have led to various increased
standards of professionalism while stressing ethics in the work environment. The role of
accountants is critical to society. Accountants serve as financial reporters in the capital markets
and owe their primary obligation to the public interest. The information they provide is crucial in
aiding managers, investors and others in making critical economic decisions. Accordingly, ethical
improprieties by accountants can be detrimental to society, resulting in distrust by the public and
disruption of efficient capital market operations.

We have written two cases regarding accounting issues:

Case 1
Pedro Santos is the controller of a corporation whose stock is not listed on a national
stock exchange. The company has just received a patent on a product that is expected to yield
substantial profits in a year or two. At the moment, however, the company is experiencing
financial difficulties; and because of inadequate working capital, it is on the verge of defaulting
on a note held by its bank.
At the end of the most recent fiscal year, the company’s president instructed Santos
not to record several invoices as accounts payable. Santos objected since the invoices
represented bona fide liabilities. However, the president insisted that the invoices not to be
recorded until after year-end, at which time it was expected that additional financing could be
obtained. After several very strenuous objections – expressed to both the president and other
members of senior management – Santos finally complied with the president’s instructions.
What can you say about the action of Pedro Santos?
If the new product fails to yield substantial profits and the company becomes insolvent, can
Santos’ action can be justified by the fact that he was following orders from a superior?

Reaction
In this case MR. Santos did not act in an ethical manner. In complying with the
president’s instruction to omit liabilities from the company’s financial statement he was direct
violation of the IMA’S Standards of Ethical Conduct for Management Accountants. He violated
both the ‘integrity’ and objectivity guidelines on the code of the ethical conduct. The fact that
the president ordered the omission of the liabilities is immaterial
Santos’ action can’t be justified. In dealing with similar situations, the SEC has
consistently ruled that “corporate officers cannot escape culpability by asserting that they acted
as a ‘good soldier’ and cannot rely upon the fact that the violate conduct may have been
condoned or ordered by their corporate superior. Thus, Santos not only acted unethically, but he
could be held legally liable if insolvency occurs and litigation is brought against the company by
creditors or others. It is important that student understand this point early in the course, since it
is widely assumed that “good soldiers” are justified by the fact that they are just following the
orders. In the case at hand, Santos should have resigned rather than become a party to the
fraudulent misrepresentation of the company’s financial statement

Case 2
Mayora, Inc., operates a chain of department stores located in the northwest. The
first store began operation in 1965, and the company has steadily grown to its present size of 44
stores. Two years ago, the board of directors of Mayora approved a large-scale remodeling of its
stores to attract a more upscale clientele. Before finalizing these plans, two stores were
remodeled as a test. Lisa Perez assistant controller, was asked to oversee the financial reporting
for these test store, and she and other management personnel were offered bonuses based on
the sales growth and profitability of these stores. While completing the financial report, Perez
discovered a sizable inventory of outdated goods that should have been discounted for sale
returned to the manufacturer. She discussed the situation with her management colleagues the
consensus was to ignore reporting this inventory as obsolete, since reporting it would diminish
the financial result and their bonuses.

Reaction
Failure to report the obsolete nature of the inventory would violate the standard of
ethical conduct as competence, integrity and objectivity.
As discussed above, the ethical course of action would be for Perez to insist on
writing down the obsolete inventory. This would not, however be an easy thong to do. Apart
from adversely affecting her own compensation, the ethical action may anger her colleagues and
make her very unpopular. Taking the ethical action would require considerable courage and self-
assurance.