Introduction: Ethical Issue
Auditors hold positions of trust in the society. However, over the years, auditors have been accused and, in some occasion, found guilty of failing to live up to these expectations. Therefore, this inability necessitated the enactment of laws that will support both accounting through strengthening firm’s internal controls and procedures and auditing through attestation of these internal controls. As such, this has strengthened the auditors’ position to uphold the social trust. Nonetheless, isolated cases have been observed where auditors have given the organization a clean bill of health yet such organization end up collapsing due to malpractices that were perpetrated but not reported by the auditor (Berglund & Kang, 2013). Therefore, are such instances Unintentional Bias or Dishonesty?
Critique of Ethical Situation
Selective perception bias is one of the approaches that explain the dilemma. According to this understanding, the auditor’s independence is undermining by the auditors’ involuntary tendency to safeguard their interest (Alexander, 2012). Primarily, this will be economic interest. Conceptually, every business objective is to sustain its sources of revenue thus ensuring its continuity. As such, the auditor involuntary tendency is to act in a manner that will safeguard these sources of income. Due to this involuntary tendency, such an auditor will not be willing to report malpractices due to the fear that when the malpractices are reported, the auditor will lose this source of revenue.
Once an unethical decision has been done, it paves the way for other unethical decisions to be carried out since the first unethical decision went unnoticed. With time, the cycle will pile a series of unethical decisions that lead to the eventual collapse of the organization. The understanding is based on the concept of Escalation of Commitment. Escalation of Commitment refers to the continuous tendency to invest in the losing course of action hoping that the events will turn out favorable (Milkman & Kelly, 2011). Suppose that such a client keeps the auditor, the effect of Escalation of Commitment is that the auditor will be ethically compromised to ever act in an ethical manner in future thus making the auditing process a mere routine. In addition, the client will not manage to undertake auditor rotation as a mean of improving the auditing process. Consequently, the client will be focused on concealing the malpractices and the previous audit covers up as opposed to improving on the effectiveness of the auditing process. As such, the firm will end up keeping the “compliant auditor” until such malpractices lead to the collapse of the organization or discovered by a whistleblower.
According to Moore, Loewenstein & Bazerman (2002) discounting of information bias refers to the tendency to be aware and concerned with the immediate consequences of their actions. Considering unethical decision, when the client requests the auditor to act unethically, the immediate action that the client may take, assuming the auditor declines the request, is termination of the engagement contract as a way to punish the auditor. On the other hand, if the auditor accepts the request, the auditor will improve their relationship with the client thus keeping this client. According to discounting of information bias, such an auditor will have opted to safeguard themselves from immediate consequence of their action by agreeing to act unethically but fail to foresee the possible effect of their action in the long term such as loss of reputation once the unethical action comes out.
Investors highly depend on information to make decisions in the financial markets. Information influences the operations of the financial markets. However, one of the major pieces of information that significantly affects the operations of the market is the end year published financial reports that a firm publishes. Therefore, once the financial reports have been manipulated, the manipulation affects the financial markets since the investors’ decisions will be based on manipulated information. As a result, this manipulation affects the efficiency in financial market operations. Since the investors are members of the society, when their decisions are manipulated, it means a large part of the society is manipulated thus leading to manipulated allocation of resources by the society.
Financial institutions are also highly and adversely affected by such a decision. When advancing credit to corporates, financial institutions will critically analyze the financial statement of the firm for a period of years in making their decisions (Kaplan Financial Knowledge Bank, n.d.). In essence, when the auditor allows misrepresentation of facts, it means that the decisions that were made were based on misrepresented data thus giving a false image of the firm outlook. Therefore, this will expose the financial institution to undisclosed risks. Such a trend is dangerous since the unethical decision by one firm may spread to another innocent party thus spreading the effect such a decision. Since the effect will be negative, it will have a wider negative effect on the society since it will ripple through to other firms thus affecting many society members.
Potential Outcomes: From an accounting perspective
A true and fair view of the firm must be represented in the financial statement that the reporting entity prepares, which makes it a fundamental trait of financial reporting. True means that the financial reports have been prepared as per the established requirements and do not contain any material misstatement that can mislead the user of this financial statement while fair means that the statements have been prepared faithfully without any element of doubt thus the statement does not only reflect the economic substance of transaction but also their legal form (True and Fair View of Financial Statements, n.d.). As such, from an accounting perspective, the ethical dilemma determines whether the financial statement present true and fair view of the firm or not.
Avoidance or prevention
Promoting ethical code of conduct among business executive is the primal channel to address the issue. Through promoting ethical practices, there are reduced chances that the management and the auditors will collude to conceal information or manipulate facts thus effectively eliminating financial reporting dishonesty. Strengthening corporate governance is another channel. Through this channel, the organization will adopt best practices such as the establishment of effective internal controls and procedures, the establishment of audit committee and strengthening the internal audit function among others (Biegelman & Bartow, 2012).
Unethical decisions are known to be carried out even after the legislation of various laws to eliminate such activities. However, there has been a debate whether the actions are deliberate or be Unintentional bias. Although the essay has pointed out that these decisions may be Unintentional bias, bias does not bar auditors from logical consideration of ethical requirements. Therefore, these are deliberate dishonest decision since the decisions are not reflexive in nature, they can be subject to critical evaluations. However, regardless of whether they are dishonest action or Unintentional bias, it is evident that these actions have a negative effect on end users of these financial statements since the action paint a false and unfair picture of the organization. Nonetheless, the essay has showed that the action can be prevented.
Alexander. (2012). Perception, cognitive biases and decision making - IWPRO21. Retrieved February 07, 2016, from http://www.iwpro21.com/organizational-behavior/perception-cognitive-biases-and-decision-making/
Berglund, N., & Kang, T. (2013, December). Does Social Trust Matter in Financial Reporting?: Evidence from Audit Pricing. Retrieved January, 2016, from https://www.uts.edu.au/sites/default/files/ACCconf14TKang.pdf
True and Fair View of Financial Statements | Audit Concept. (n.d.). Retrieved February 10, 2016, from http://accounting-simplified.com/audit/concepts/true-and-fair-view
Biegelman, M., & Bartow, J. (2012). Executive roadmap to fraud prevention and internal control creating a culture of compliance, second edition (2nd ed.). Hoboken, N.J.: John Wiley & Sons.
Kaplan Financial Knowledge Bank. (n.d.). ACCAPEDIA. Retrieved February 07, 2016, from http://kfknowledgebank.kaplan.co.uk/KFKB/Wiki Pages/The Users of Financial Statements.aspx? Mode=none
Milkman, K. L., & Kelly, T. F. (2011). ESCALATION OF COMMITMENT. Retrieved January, 2016, from http://opim.wharton.upenn.edu/~kmilkman/2011_10_23_escalation_FINAL.pdf
Moore, D., Loewenstein, G., & Bazerman, M. H. (2002). Why Good Accountants Do Bad Audits. Retrieved February 07, 2016, from https://hbr.org/2002/11/why-good-accountants-do-bad-audits