Ethics, Trust and Auditing

Conceptualising a Tripartite Framework

A professional

A profession has three important attributes: “the provision of an important service, the possession of special knowledge requiring higher education, and the existence of an organisation” (Bayles, 1986: 27). These attributes enable professional auditors to have an important role in society. Knowledge and expertise give them the privilege to exert a certain amount of control, as investors, banks, employees, governing authorities and others rely on their final opinion to feel reassured that financial statements show a true and fair view. Professionals are also “largely autonomous when acting professionally and self-regulating as a group” (Brein, 1998: 391). A major component of self-regulation for professional auditors is the establishment of a code of ethics by their affiliate professional body. Unfortunately, this important status has been tainted by a litany of scandals that have surfaced over the past years, such as Enron, WorldCom, Adelphia, Global Crossing, Parmalat, and the demise of Arthur Anderson. Inevitably the public is losing trust in the auditing profession, previously held so high by society in general. The European Commission has also intervened and is introducing various measures to reaffirm this lost trust, which on the other hand is infringing on the ability of auditors for self-regulation.

It is vital that the profession itself regains this lost trust and rebuilds its reputation on its historical foundation of ethics and integrity (Copeland, 2005). The following sections will initially revisit the roots and examine the origins of the profession, followed by a reflection on the failings of the profession and finally exploring on ways how to rebuild the trust in auditors which is vital for a sound economic environment. The latter involves an attempt to construct a strategy based on developing a professional culture promoting trustworthiness based on the reaffirmation of the profession’s code of ethics and positive individual ethical values.

The function of auditing

Auditing as we know it today can be traced as far back as the period of the industrial revolution, when the management of a company was transferred from the owners to third party managers. This necessitated the services of an independent auditor to detect any possible errors or fraud (Basu, 2009), thus ensuring that shareholders’ interests were protected. In the mid nineteenth century, audits were initially performed by the individual shareholders, and therefore principals acted as auditors. It soon became clear that they did not have the skills required, and expert auditors were appointed to act on behalf of the shareholders (ICAEW, 2005). The demand for auditing as a service has been explained in various ways amongst which are: the “Policeman Theory”, “Lending Credibility Theory”, “Theory of inspired Confidence” and the “Agency Theory” (Schilder et al.,1999). An underlying factor common to all theories is the prominence of ethical behaviour, independence, expertise, and trust.

Advancement in technology and increased globalisation widened the rift between owners and managers. This naturally brought with it the increase in importance of auditing to the economy. However over the years auditing seems to have lost this important function of gatekeepers. Instead of improving the efficiency of markets by ensuring that financial statements are trustworthy, auditors are nowadays often viewed as enablers “for their clients’ efforts to mould financial statements to present pretty pictures that aren’t true” (Miller & Bahnson, 2004:14). This was made possible amongst other reasons by hiding behind rule-based principles, rather than following principle-based accounting and auditing practices. In the UK, audit guidelines are not as prescriptive as in the U.S. and the focus is on financial statements to show a ‘true and fair’ view. Nevertheless the UK also had its fair share of scandals, such as Equitable Life, Independent Insurance, and BCCI amongst others (Walsh, 2002).

The Future – A tripartite framework

Easing out of this inept situation will involve a strategy agreed upon by individual auditors and standard setters. A potential strategy encompasses the reinforcement of the code of ethics, the recognition of socially beneficial ethical principles and a conscious effort to re-establish trust. Audit firms have to engage and encourage a positive ethical climate, which defines “an employee’s beliefs of what is viewed as ethically correct behaviour within the organisation” (Kelly et al., 1989: 331). The perceived ethical climate will help individual auditors to identify situations that might involve ethical decision making. The ethical climate will also aid the individual to understand, evaluate, and resolve exposure to any ethical issue encountered (Barnett & Vaicys, 2000).

Auditors and professional accountants have a sound international code of ethics established by the International Ethics Standards Board for Accountants (IESBA), wherein the conceptual framework is set on the ethical principles of integrity, objectivity, professional competence and due care, confidentiality, and professional behaviour. The code of ethics therefore makes clear what is considered to be acceptable behaviour to the profession. Existence and awareness is however not enough, audit firms and standard setters have to comprehensively engage in increasing the knowledge base of professional staff. This can be achieved by increasing the awareness and knowledge content of the code of ethics by giving regular formal training to audit professionals, and by introducing audit aids such as checklists and audit program steps on all engagements (Pflugrath et al., 2007), amongst other measures. Thus setting aside the unfounded ideas that the code of ethics is just a marketing stunt and a necessity imposed upon by the affiliate professional body or law. Yet auditors occasionally encounter complex ethical dilemmas and the code of ethics in “their universalised form, cannot cover all eventualities” (Preuss, 1998: 500). In these situations auditors tend to fall on technical knowledge and solutions. However this can lead to the pitfall mentioned previously, and auditors will try to solve their difficulties by adopting a rule based stance to a possibly tricky situation, which is not always the right solution to the issue at hand.

The IESBA code of ethics also specifies that a professional accountant is duty bound to act in the public interest. Furthermore, specifying that a professional accountant’s responsibility should not be focused solely on the needs of an individual client, but shall act in the public interest (IESBA, 2013). This concept should be encouraged by professional bodies and adopted by audit firms, amplifying it to include the moral development of professional staff, through the conscious awareness and adoption of moral ethical theories. A compound model of moral ethics is being suggested invoking ethical ideas of ‘Utilitarian Benefits’ advocated by Jeremy Bentham, ‘Personal Virtues’ encouraged by Plato and ‘Universal Rules’ set by Kant. Utilitarian beliefs emphasize the importance of the greatest good to the greatest number of people (Duska & Duska, 2003). As described by Preuss (1998) utilitarianism is applicable within the accounting context as it tends to link self-interest with moral behaviour and a company’s actions are invariably self-interested. Additionally the weighing of benefit and harm is comparable to profit and loss accounting and therefore likely to be easily understood by auditors. “Virtues are dispositional properties that enable accountants to meet their ethical obligations to employers, clients and the public at large. For instance, in order for an accountant to act objectively in performing professional services, such as auditing the financial statements of a client, the accountant must have the inclination to be impartial and open-minded” (Mintz, 1995: 251). Finally the universal rules set by Kant emphasize actions that will result in the greater good for society. These actions revert to the principle -based foundation of accounting and auditing (Satava et al., 2006), which if followed will steer the professional’s ethical decision making towards the greater good and away from any possibility of self-interest motivated actions.

The concepts of trust and ethics are strongly linked, so much so that ethics is an essential element of trust. Rotter (1967: 444) defined trust as “an expectancy held by an individual or a group that a word, promise, verbal or written statement of another individual or group can be relied upon”. The above mentioned efforts towards establishing a positive ethical climate will definitely aid in restoring trust in the auditing profession. This process will be complete if auditors consciously strive to regain the trust that has been lost. This can be achieved if audit firms visibly engage in trust building activities in addition to their daily professional duty. Efforts have to be directed towards reaffirming the profession’s independence in fact and appearance and restoring their reputation. Emphasis has to be directed towards highlighting their technical capabilities, focusing on offering service quality, and promoting research. Auditors should also consider widening their service base to include other assurance services in addition to auditing, such as sustainability reporting. This would ensure that as a profession they are still relevant, without compromising their independence and capabilities.

Change

Invariably auditors have to change their practices and focus again on the basic principles of the auditing profession. The fundamental ethical principles advocated by the IESBA of: integrity, objectivity, professional competence and due care, confidentiality, and professional behaviour, have to act as a foundation for setting an ethical background. Next comes the establishment of an ethical framework which involves setting “norms and principles that serve as guidance for individual actions” (Barlaup et al., 2009: 187). The end result would be trust earned and developed outside regulation, involving leadership and not just processes to be followed.

This article won ‘Best academic essay’ in the Joint Professions for Good and Institute for Business Ethics Writing Awards on how to put ethics and the ‘public good’ back at the heart of the financial auditing process in light of recent scandals and regulatory reform.

References

  • Barlaup K., Dronen H. I. and Stuart I. (2009), ‘Restoring trust in auditing: Ethical Discernment and the Adelphia Scandal’, Managerial Auditing Journal, 24 (2): 183-203.

  • Barnett T. & Vaicys C., ‘The Moderating Effect of Individuals’ Perceptions of Ethical Work Climate on Ethical Judgements and Behavioural Intentions’, Journal of Business Ethics, 27 (4): 351-362

  • Basu S.K. (2009) Fundamentals of Auditing, Dorling Kindersley (India) Pvt. Ltd.

  • Bayles M. D. (1986) ‘Professional Power and Self-Regulation’, Business & Professional Ethics Journal, 5 (2): 26-46

  • Brien A. (1998) ‘Professional Ethics and the Culture of Trust’, Journal of Business Ethics, 17 (4): 391-409

  • Copeland J. E. (2005) ‘Ethics as an Imperative’, Accounting Horizons, 19 (1): 35-43

  • Duska R. F. & Duska B. S. (2003) Accounting Ethics: Foundation of Business Ethics, Blackwell Publishing Ltd., Oxford UK

  • ICAEW (2005) ‘Audit Quality – Agency Theory and the Role of Audit’, Institute of Chartered Accountants in England & Wales

  • International Ethics Standards Board for Accountants (2013), Handbook of the Code of Ethics for Professional Accountants; IFAC

  • Kelley S.W., Skinner S. J. & Ferrell O.C. (1989) ‘Opportunistic Behaviour in Marketing Research Organisations’, Journal of Business Research, 18: 327-340.

  • Miller P. B.W. & Bahnson P. R. (2004) ‘Audit Revolution: From Compliance to Adding Value’, Accounting Today, pp. 14 &17.

  • Mintz S.M. (1995) ‘ Virtue Ethics and Accounting Education’, Issues in Accounting Education, 10(2) 1995: 247-267

  • Pflugrath G., Martinov B. N. & Chen L. (2007), ‘The Impact of Codes of Ethics and Experience on Auditor Judgements’, Managerial Auditing Journal, 22 (6):566-589.

  • Preuss L. (1998), ‘On Ethical Theory in Auditing’, Managerial Auditing Journal, 13(9): 500-508

  • Rezaee Z. (2004) ‘Restoring Public Trust in the Accounting Profession by Developing Anti-fraud Education, Programs, and Auditing’, Managerial Auditing Journal, 19(1): 134-148

  • Rotter J.B. (1971) ‘Generalised Expectancies for Interpersonal Trust’, American Psychologist, 26(5): 443-452

  • Satava D., Caldwell C. & Richards L. (2006) ‘Ethics and the Auditing Culture: Rethinking the Foundation of Accounting and Auditing’, Journal of Business Ethics, 10(2): 271-284

  • Schilder A., Dassen R. & Wallage P. (1999) Principles of Auditing – An International Perspective, McGraw-Hill Higher Education.

  • Walsh C. (2002) ‘Now audit fears hit UK: But Hewitt let Big Four Carry on Regardless Accountancy Rules’ The Observer, pp.A3

0.00 avg. rating (0% score) - 0 votes