Auditing and Ethical Sensitivity
Gordon Cohn, Ph.D.
Assistant Professor of Accounting
Department of Economics
Brooklyn College of the City University of New York
(Forthcoming in the Outlook)


Auditing versus other Professions

Auditing is an ethically precarious profession. In other disciplines, the major responsibility is assisting the client. How this assistance affects the rest of society is not a major consideration. A lawyer, for example, pleads on behalf of a client's innocence even if she suspects that he is guilty. A doctor's primary concern is maintaining and improving health. Her focus is on benefitting the patient. Occasionally a doctor faces ethical dilemmas which affect other people. They include the appropriateness of abortions, mercy killing, or revealing private information. However, the physician's principal focus is the ethically neutral task of utilizing scientific knowledge for improved patient health. On the other hand, auditors confront more complicated professional issues. Although they are compensated by the client, their primary focus is to represent the public.

An ethical conflict exists when the duties toward one group are inconsistent with responsibilities to another [Finn (1988]). This definition describes the auditor. He frequently receives substantial client fees for both auditing and non auditing services. Yet, he is expected to provide an impartial endorsement of financial statements [Solomon (1990)]. Should an auditor elect to publicize a discovered impropriety, he runs the risk of violating confidentiality, facing litigation, and damaging clients' trust [Beach (1984), Ruland (1992)]. Alternatively, if he withholds general release of this information his actions can be considered legally negligent. He also has to fear the resultant loss of reputation from being overly lenient [Baiman (date)] The auditor's obligations have been described as a "Catch 22 " [Beach (1984)]. No decision strategy eradicates the auditor's potential for liability.

Management hires an auditor to verify the company's records in accordance with Generally Accepted Accounting Standards (GAAP) and Generally Accepted Auditing Standards (GAAS). This information is then relied upon by stockholders, creditors, investors, and government agencies. The auditor at every stage is simultaneously required to consider the welfare of these competing interest groups (Waples 1991).

The Public Trust Auditors

The public trusts that auditors perform their assignments proficiently. Ruland (1984) claims that the more public confidence, the more prima facie duty for accountants to be trustworthy. Th is based on Ross (1930) idea that if someone has high regard for another, the second person has a stronger moral obligation to treat the first person ethically. The following studies show that accountants are considered to be the trustworthy professionals.

Mendick (1990) contends that many surveys of public attitude toward professionals place CPAs at the top for integrity and objectivity. The AICPA (1989) presents results of a survey where businessman ranked accounting to be the most ethical of sixteen professions. The Dingell Committee (1986) claimed that the public expects that auditors will make reasonable efforts to detect corporate fraud should not go undetected. Chief Justice Burger in a Supreme Court decision [United States v. Arthur Young & Co. et al, 104 S. Ct. 1495, 465 U.S. 805 (1984), p. 1503] described the public's expectation of the accountant's performance. He said, "By certifying the public reports that collectively depict a corporation's financial status, the independent auditor assumes a public responsibility transcending any employment relationship with the client. The independent public accountant performing this special function owes ultimate allegiance to the corporation's creditors and stockholders, as well as to the investing public. This 'public watchdog' function demands that the accountant maintain total independence from the client at all times and requires complete fidelity and public trust."

Problems with Auditor Independence

Even though the accountant's responsibility to the public, there are several studies that question whether accountants uphold this responsibility. The challenges can be divided into two principal categories. One problem is concerned with lack of independence and the second with the inefficient functioning of accounting firms

The AICPA's rule on independence prevents auditors from being relatives to and maintaining any type of financial interest with clients. However, even it is obvious that auditing firms' aspirations to maximize the number of well-paying clients provides them considerable interest in their clients' financial successes. Firms have a strong stake in both patron retention and financial solvency. One can claim that the accountants' dependency on compensation from and gratitude to the client limits independence. Thus, it is possible to contend the degree public expectations of independence are unjustified.

In addition to the large fees received for auditing, other financial relationships place a strain on the auditor's ability to be independent. For the last several decades there has been considerable debate as to the extent that accounting firms should be allowed to simultaneously maintain contracts for both auditing and consulting services (MAS). Opponents have argued that the allowance of such relationships unnecessarily increases the already extensive financial dependency of the auditor on the client. On the other hand, proponents claim that the synergy between the two functions assists the accounting firm to produce improved services in both areas.

Klion (1978) attests that in the fifteen years of research -- much of which has been conducted by those biased toward the impropriety of MAS -- not a single instance has been discovered when MAS was responsible for accountants compromising values. Bartlett (1991) however, dismisses the significance of Klion's results for two reasons. Firstly, he notes that the AICPA's ambiguous and difficult to make operational Code of Ethics definition of independence could be one reason that no violations have been found. Secondly, he observes that considerable litigation against CPAs are settled out of court without an admission of liability or a discussion of grounds. However, if these cases could be examined, they might bring evidence against the auditor's claim of independence.

Furthermore, there is evidence that the public is becoming concerned regarding the loss of independence which results from the same firms performing both auditing services and MAS. Armstrong (1988) reports that the Dingell committee attempted to connect the deluge of audit failures with allowing accounting firms to engage in multiple activities. In addition, a recent poll under the auspices of the AICPA found that "members of the key publics think that performing certain management advisory services can impair objectivity and independence" (AICPA, 1986).

Shortcomings in Audit Firm Structure

Many people are aware of problems of independence which limit an auditor's ability to give a non-biased opinion regarding financial statements. But, auditors also encounter a more subtle and obscure obstacle to fulfilling the public's expectation for precise audits. Researchers describe how inappropriate organizational processes in auditing firms hamper effectiveness. Even intentions of the most idealistic auditors are limited by non supportive organizations.

The auditor is continually plagued with difficult cost benefit decisions regarding how much effort should be expended to determine the accuracy of presented data. As in all investigations, the quantity and quality of information which should be amassed require considerable individual discretion and judgement (Mautz and Sharaf 1961). However, the following illustrates the neglectful character of many of these examinations:

Kelley and Margheim (1990) examined the impact of time pressure on motivating dysfunctional auditor behavior. Audit firms use strict time budgets as a technical control for the pricing of engagements, allocation of resources, and ex post evaluation. However, these budgets have substantial shortcomings. The amount and quality of time that a staff member uses are often unobserved and not easily monitored. Individuals frequently work in isolation. Managers who are occupied with their own tasks have minimal opportunity for supervision (McNair, 1991).

Kelley and Margheim found that an "alarming number of under-reporting of audit time and audit quality reductions are occurring in practice [p. 22]." Over half of the auditors had reduced quality on a specific audit by such procedures as prematurely signing-off, reducing work and investigations below reasonable levels, and accepting weak client explanations. As a result of their study, Kelley and Margheim suggested that auditing firms improve their monitoring the extent of dysfunctional behaviors, de-emphasize time budget attainment pressures, and find mechanisms for improving time requirement estimations. McNair's (1991) article confirms Kelley and Margheim's results. She also mentioned problems due to surreptitiously shifting extra hours from time-consuming jobs to less demanding ones.

Bartlett (1991) and others claim that standards can be upheld only to the extent that auditors are educated and socialized to obediently follow the profession's regulations. However, Ponemon [1992] found that auditing firms' managers and overseers have ethical reasoning levels below comparable norms for college educated adults. "This means that the ethical values encouraged by firm management are inconsistent with higher levels of ethical reasoning [p. 254]." When confronting conflict partners and managers are more likely to conform to firm norms rather than to professional standards or moral principals. This weakens auditors' scrupulousness to insure faithful reporting.

Lastly, there is a common auditing firm practice which limits promotion of ethical behavior. Schlacter (1990) reports that disregard of ethical standards jeopardizes career opportunities. However, a reputation for highly principled behavior is not an important factor in determining career advancement. In addition, Montagna (1974) claims that overly individualistic behavior is considered a handicap in terms of audit firm promotion. Thus, while an auditor may not allow a client to perform an outright illegal falsification, he is hesitant to assertively encourage his client to adopt more truthful reporting. His principal professional concern is avoiding actions for which his client might be fined or reprimanded, more precise and responsible reporting is not the goal.

In summary, there are several of the ethical problems facing auditors. Auditors' maintaining an unbiased position is frequently compromised by the large fees they receive for engagements. In addition, this problem is often exasperated through additional fees being earned for non-auditing services. Furthermore, auditors' responsibility for providing unbiased opinions is increased due to the public placing auditors in high regard. Finally, structural shortcomings in audit firms make the above problems even more acute. Thus, it is imperative that the profession equips auditors with a strong ethical awareness in order to prepare them to successfully meet ethical challenges. A first step would be to encourage ethics courses in the accounting curriculum and encourage professors to incorporate ethics materials into their accounting courses.

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