Saturday, April 4, 2009

THE AUDIT

THE AUDIT

I. CASE ABSTRACT

This case deals with personal value conflicts within the context of established organizational practices which run counter to stated policy. The case involves conflicts between professional and possibly personal values on the one hand and peer pressures to conform on the other.

"The Audit" is set in a national CPA firm. Sue, a newly hired auditor, has been sent out on an audit where she discovers that the client has been treating a large number of its workers as "independent contractors." This practice saves the client the payroll taxes that would otherwise be due. In Sue’s professional judgment, this may be improper and should be further investigated to see whether it should be noted in the audit report. A conversation with her immediate supervisor gives her no help.

Co-workers put pressure on Sue to drop the matter. If she goes over the head of the partner in charge of the audit, she will get them all in trouble as they have ignored the practice in prior years’ audits. They say that while they realize that it was probably wrong, they are sure their supervisor wants them to ignore it again this year. They encourage her to be a "team player."

Clearly, Sue faces a dilemma. If she drops the issue she will be violating her professional code of ethics. On the other hand, if she continues with the matter, she may well jeopardize her future with the firm.

Decision Date: No Date

II. CASE ISSUES AND SUBJECTS

CPA Firm Ethics and Moral Relativism
Personal Values vs. Group Norms Corporate Culture
Role Conflict Decision Making
Policies and Procedures Evaluation and Control
Whistle Blowing Code of Ethics

III. STEPS COVERED IN STRATEGIC DECISION-MAKING PROCESS
(see Figure 1.5 on pages 20 and 21)

IV. CASE OBJECTIVES

A. To help students identify personal value conflicts which occur in the work setting where the individual may be forced to choose between professional standards (or personal values) and group norms.

B. To introduce the idea that small concessions to peer pressure may lead to larger concessions later on.

C. To introduce the counter point that the act of disagreeing with one’s supervisors may also lead to unanticipated consequences.

D. To focus on the ethical dilemma posed by a violation which is relatively minor but which still appears to the central figure in the case to be a violation of professional standards.

E. Overall, to provide a vehicle for discussing the relationship between personal values, group norms, and codes of ethics.


V. SUGGESTED CLASSROOM APPROACHES TO THE CASE

A. This is an excellent value case for open-class discussion.
• We suggest that you require each student to write out a specific solution to the employee’s dilemma. You can go back to the student’s individual solution after the class discussion.

B. This is an excellent in-class exam case focusing on ethics in decision making.

C. This is an excellent case for role playing followed by questioning by the students.

D. This case can be placed anywhere in the course that you want to discuss ethics or value oriented issues.

VI. DISCUSSION QUESTIONS

A. What would you do in this situation if you were Sue?

B. Should Sue go over the head of the partner in charge of the audit to upper management? What are the pros and cons of such a decision?

• Would this help or hinder her career at the CPA firm?

C. What role does the group (co-workers) play in Sue’s choice?

D. The case authors provided 11 excellent discussion questions and answers in the following Section VII - CASE AUTHORS’ TEACHING NOTE - Discussion Questions and Answers.

VII. CASE AUTHORS’ TEACHING NOTE by John Kilpatrick, Gamewell Gantt, and George Johnson*

A. Teaching Objectives - These were listed in Section IV - CASE OBJECTIVES

B. Discussion Questions and Answers

1. What are the responsibilities or obligations which the main characters in the case owe to themselves?

This is the issue of personal integrity and the duty one owes to oneself. Students will inevitably be faced with pressures to bend their standards or to agree with and cooperate with policies and practices which they find offensive ... all in the name of job security and/or promotion. In the words of the short story, how far are you willing to go with this "kiss, kiss, grovel, grovel?"

2. What are the responsibilities or obligations which the main characters in the case owe to the organization?

In our experience at this point questions of loyalty to the organization inevitably come up. It is possible to introduce the notion that "loyalty" is a two-way street and requires a certain level of trust, integrity, and reciprocity. The issue of organizational culture also should be introduced. Organizations can either encourage the moral “high road” from the top down or discourage compliance with company policies and community or professional standards. This may be done either by tacitly approving of actions which generate revenues but do not place the organization in jeopardy, or by actively encouraging disregard for those same standards. It may be argued that an organization gets the moral climate it deserves. The student should be encouraged to identify the stress which occurs between the respect for organizational values and the need to get along with peers and/or to advance one’s own career.
___________
*Reprinted by permission of the authors

3. What are the responsibilities or obligations which the main characters in the case owe to their profession?

One of the distinguishing characteristics of professionals is the tendency to identify more with their chosen profession than with any particular organization. Another is the importance of upholding the reputation and integrity of the profession by adhering to standards and practices which other members of the profession have concluded are appropriate and important. In "The Audit," questions of potential conflicts between company policy and practice, and professional standards are all evident. How does a profession maintain its integrity and reputation with its clients and the general public if members are not willing to make difficult choices?

The accounting profession is regulated by state licensing boards and state statutes. Each state has its own code of ethics, which is largely patterned upon the code of ethics of the profession’s national association, the American Institute of Certified Public Accountants (the "AICPA").

Excerpts from relevant sections of the state of Idaho’s Code of Ethics for certified public accountants appear below:

Rule 202 - Auditing Standards. A licensee shall not permit his name to be associated with financial statements in such a manner as to imply that he is acting as an independent public accountant unless he has complied with the applicable generally accepted auditing standards. Statements on Auditing Procedure issued by the Institute’s Auditing Standards Executive Committee are, for purposes of this rule, considered to be interpretations of the generally accepted auditing standards, and departures from such statements (or other standards considered by the board to be applicable in the circumstances) must be justified by those who do not follow them.

Rule 103 - Accounting Principles. A licensee shall not express an opinion that financial statements are presented in conformity with generally accepted accounting principles if such financial statements contain any departure from such accounting principles which has a material effect on the financial statements taken as a whole, unless the licensee can demonstrate that by reason of unusual circumstances the financial statements would otherwise have been misleading.

Rule 301 - Confidential Client Information. A licensee shall not without the consent of his client disclose any confidential information pertaining to his client obtained in the course of performing professional services.

An accountant who violates the profession’s code of ethics can be subject to a number of possible sanctions including (1) public and/or private reprimands, (2) license suspension, (3) license revocation, and/or (4) potential civil liability to the client and to third parties for damages in appropriate cases.

In “The Audit,” Sue faces the likelihood of immediate adverse repercussions on the job if she continues to call objections to the client’s practice. She also faces the possibility of even more severe adverse professional consequences if she fails to object and if she is later accused of violating the profession’s code of ethics in having failed to pursue the matter further. Indeed, an auditor who has reason to suspect improper accounting practices has an obligation to further investigate the questionable practice. Failure to do so could result in a violation of generally accepted auditing standards as well as the presentation of financial statements that are not in accordance with generally accepted accounting principles.

This case is particularly difficult because Sue’s supervisors and the partner in charge of the audit seem to be encouraging her to violate the profession’s code of ethics and professional standards in order to retain the client.

4. What are the responsibilities or obligations which the main characters in the case owe to their peers?

Most students will be able to identify with the peer pressures which are being exerted, or are anticipated, in the case. In our experience many students will underestimate the consequences of attempting to change departmental practice or of disagreeing with one’s supervisor or of going further and engaging in some form of "whistle blowing." (For a discussion, see for example Near and Micelli, "Retaliation against whistle blowers: predictors and effects" in the Journal of Applied Psychology (February, 1986): 137-146.

5. What are the responsibilities or obligations which the main characters in the case owe to the business community?

Edward T. Hall, a cultural anthropologist who has written a number of books dealing with the practices of sub-cultures, suggests that employees operate in three cultures: the broad community culture, the business culture of the region or country, and that of the specific firm in which the individual works (E.T. Hall, The Silent Language, Doubleday-Anchor, 1973). The question opens the door to a discussion of a number of "rules" of the U.S. business culture and, by way of comparison, those predominating in other cultures. It also leads into questions of the type of business community--what are the rules of the game?--which the individual student would like to see. To what extent does this type of business community require that individuals exercise some degree of "moral restraint?"

6. What are the responsibilities which the main characters in the case owe to the broader community?

This issue allows the issues identified above to be extended to the local, regional, national, and global communities. While it may be counter-productive to try to get too much mileage out of cases which are fairly narrowly focused, the students can be encouraged to recognize that none of the dilemmas exist in a vacuum. This should be particularly appropriate at the community level. What kind of community do they wish to live in, and in what ways is that issue dependent on the choices of individuals? To what extent are the choices of individuals swamped by policies and practices of major institutions, including those of business? At some point, everything is connected to everything, as the ecologists are inclined to point out.
7. What are the implications for the individual of each of the options?

Discussion of this issue can be useful in getting the students to really think through the significance and likely outcomes of the various choices. Students with work experience will probably keep the discussion from becoming too naive. Our experience has been that students are eager to explore the ramifications of moral and, to some, political choices.

8. How does an organization ensure that the policies which it develops will be followed by organization members?

This, of course, is an issue for which there is no short or easy answer. Research suggests that a number of characteristics and practices are critical if organization members are going to commit to organizational values. Among these are the full support of top management, recognition and support for compliance, censure for failure to comply, a willingness to not reward behavior strictly on the basis of bottom-line performance, and effective communication of policies and the reasons for them.

9. What impact does an organization’s reward system have on member’s decisions when confronted by ethical dilemmas? Specifically, what are the implications of asking for "ethical conduct" while rewarding solely on the basis of narrowly defined (short-term) performance goals?

This is simply an extension of the "reward structure" question raised above. The students in colleges of business will have thoroughly absorbed the manager’s responsibility for profitability. However, they may not have been challenged to consider the trade-offs and conflicts which sometimes evolve from the pursuit of single or narrowly defined goals.

10. How does a group leader balance between the need to work with his or her group and the need to provide strong leadership?

Management and organization behavior classes focus attention on the task/people dimensions and on the balance between being liked and being effective. This question addresses the ethical dimensions of those conflicts: at what point does the group leader make an issue of a breach of company policy?

11. What is the role of trust in these matters? What are the costs and benefits of using "administrative controls" vs. trusting employees to act in good faith?

It can be argued that the tendency in many American firms has been to rely on administrative controls: the greater the perceived level of "misbehavior" the more tightly bureaucratic and rule-oriented the firm becomes. This line of argument suggests that frequently "misbehavior" is a symptom of some other underlying problem, which is only exacerbated by increasing autocratic or unilaterally designed and imposed controls. At the other end of the spectrum are firms which focus on developing an atmosphere of trust which, ideally, leads to a lessened need for administrative controls. The goal is to have the employees "internalize" and identify with the objectives of the organization. This of course presupposes a high level of integrity on the part of top management in particular. Most firms, and perhaps the values and management style of most managers, lie somewhere in between these two extremes. This question confronts the students with some of the practical managerial issues which confront managers in attempting to set the ethical tone for the firm.

C. General Discussion

Short cases provide a number of advantages to an instructor. They can easily be slipped into a course when the instructor or students need a change, or when something planned does not work out. Since the text is only a page or two, students can be given time to read the case in class with minimal lost time. Also, at times it seems that students today struggle with a steady diet of business ethics "essays." Short cases provide some relief and can be used on very short notice.

Overall, we have found the interest level to be very high in discussing issues such as are found in this brief case. The discussions tend to be lively and thought-provoking. Many students have indicated that these discussions have proven to be among the most stimulating and eye-opening of the semester.

We have used "The Audit" for a number of pedagogical purposes. The case focuses very clearly on an example of the potential conflicts between group norms and personal and professional standards of the type which the students will face as they begin their professional lives. The situation serves to highlight the importance of personal values, organizational culture, and the responsibilities of management in ensuring an environment in which personal and professional standards are respected.

The cases have been used in a variety of courses: sophomore level legal environment courses, junior or senior level management or organization behavior, business and society or business ethics, marketing, purchasing;, and senior level accounting courses.

These materials do not presuppose advanced work in philosophy or ethics. The intention, as noted above, is to present moral dilemmas which students will likely face, and to engage them in the exchange of ideas and the comparing of values and insights. In the process it is hoped that students will better understand the nature of such value conflicts and the relationship and importance of their own values.

For "The Audit," the instructor should be aware of the auditing standards which require the noting of certain practices in the audit report, as well as having some knowledge of the specific standards dealing with the accounting for "independent contractors." A brief discussion of relevant auditing standards is included below for the instructor’s use.

Under the accounting profession’s guidelines, independent accountants are required to state whether or not they believe a client’s financial statements "fairly present" the financial position of the client at a given point in time. If the client in "The Audit" is improperly accounting for wages paid to some workers as payments to independent contractors when those workers are in fact common law employees, the result would be an understatement of the client’s payroll tax expenses and an understatement of liabilities for potential back taxes, penalties, and interest. This is something that generally accepted auditing standards require the accounting firm to call to the attention of management of the client, and it could require a "qualified opinion" (i.e. disclosure in the financial statements) if management refused to modify its statements to reflect the correct expenses and liabilities involved.

Moreover, under the profession’s guidelines, Sue, as a staff accountant, would have an obligation to document the disagreement with her supervisors as part of the working papers on the audit.

Finally, the accounting profession’s code of ethics prohibits an accountant from disclosing confidential information to third parties. Therefore, under the guidelines of the profession, at least, Sue should not report the client’s practice to the state or federal government tax authorities.

Not all of the above specialized knowledge concerning the position of the accounting profession is necessary to use "The Audit" in non-accounting classes. The information is included in this teaching note for use in upper level accounting classes where students may have had some exposure to the profession’s guidelines. It is also included to provide background information for instructors who may wish to use the case in general management courses which typically include a broad cross-section of business majors.

It should be emphasized, however, that the case is intended to illustrate the discovery of facts which might lead a reasonable auditor to take further action. The relevant question is whether or not Sue should continue to pursue the matter in light of the pressure from her peers and the partner in charge of the audit for her to "drop it."

VIII. STUDENT PAPER

Sue is in a difficult position, one with far-reaching consequences. To make it worse, she is feeling a great deal of pressure to do nothing, and the others involved are presenting what seems to be quite a few arguments supporting their position.

Several issues were raised to promote the "don’t make waves" position and to be a team player. Paul, the partner in charge of the audit, brought up the point that others in the industry of the company in question followed the same practice. He further encouraged no action by stating that to pursue the issue could mean the loss of the account and hinted at negative repercussions for Sue if this were to happen.

Sue’s co-workers, Bill and Mike, echoed the sentiment by urging Sue to be a "team player." They pointed out that the practice had been ignored in the past. If Sue were to follow through, her co-workers’ careers would be jeopardized. In addition, her relationship with her superiors would be so threatened, it could possibly force her to leave the firm.

The arguments for raising the issue were not many in the case itself (see Exhibit 1). The fact that the practice was wrong was confirmed. Despite evidence to the contrary, the firm endorses high ethical standards and highlights the ethical responsibilities of a CPA. Also, Sue’s conscience would bother her if she were to do nothing.

The support for Sue’s speaking up is far greater than mentioned in the case. If the authorities were to discover the understating of taxes, the company could be fined as well as forced to pay back taxes. This would, in all likelihood, be a material amount. The stockholders rely on an auditor’s clean opinion to ensure that there is not a material deviation.

If she were to overlook this situation, Sue could be expected to overlook the next one. It seems as if once a person backs down, it is easier to do so again. This step could have serious consequences for Sue’s career as a CPA.

As stated previously, Paul hinted at possible negative actions were Sue not to let the issue die. I question whether this is a type of firm one would want to work for anyway. To tailor an opinion because of the risk of losing a client is a very dangerous practice and a highly unethical one. It defeats the entire concept of an auditor’s independence.

All these factors are very significant in making the decision, but the one which most moves me to recommend pursuing the issue is Sue’s feelings. If she does not feel comfortable with the situation, she should act on it. To deviate from one’s own standards could lead to a lifetime of regret. Because of this and the other reasons, Sue should follow through on this issue.


EXHIBIT 1

PROS AND CONS OF PURSUING THE ISSUE


Do Not Pursue Issue Do Pursue Issue


- better relationship with superiors - impact on conscience
- better relationship with co-workers - make a firm statement
about her beliefs
Pros - wouldn't risk losing account - act in manner firm
preached
- wouldn't risk losing job - doubtful if you would
- other professionals would follow want to stay with a
same practice firm that did not
practice what they
preach


- firm's members confirmed practice - damage relationship with
was not correct co-workers
- potential liability - damage relationship with
- bothered conscience - might cause firm to lose
- firm members might expect her to an account
Cons overlook other issues in the - damage her future with
future - possible damage to
- would not act in a manner that the co-workers' careers
firm "preached"
- once you back down it is easier to
do it again



IX. EFAS, IFAS and SFAS EXHIBITS - Were inappropriate for this case.

X. FINANCIAL ANALYSIS - Was inappropriate for this case.

No comments:

Post a Comment