This blog is written by Mr. Abdullah Saleem, Associate Audit and Assurance Services.
Deadly Ethical Sins and Safeguards
An ethical conflict (also known as an ethical dilemma) is when two ethical principles demand opposite results in the same situation. In order to resolve the conflict a choice must be made that by definition will leave at least one of the ethical principles compromised.
A key reason behind many ethical conflicts is a conflict of interest between taking decisions in one’s own self-interest versus making decisions in the best interest of a client. For example an auditor has a moral obligation to earn money to feed, clothe and house his family. To purely satisfy this obligation they may take decisions that are not in the best interest of a client.
An ethical conflict may arise with confidential information that an accountant encounters, for example on the discovery of a fraud. The defrauded party has suffered in some way and the auditor is aware of this. The auditor’s primary responsibility is to provide an opinion on whether the financial statements provide a true and fair view not to report fraud to the plaintiff. It is normally the choice of the company how to proceed (unless crimes such as terrorism or money laundering are involved).
Rules-based and principles-based approaches to ethical conflicts
When accountants are faced with an ethical conflict they need to know what to do. If there is a threat to their compliance with the fundamental principles of the ethical code, how should they ensure their compliance and deal with the threat?
There are two possible approaches that the professional accountancy bodies could take, a rules based approach and a principles-based approach.
- A rules-based approach is to identify each possible ethical problem or ethical dilemma that could arise in the work of an accountant, and specify what the accountant must do in each situation.
- A principles-based approach is to specify the principles that should be applied when trying to resolve an ethical problem, offer some general guidelines, but leave it to the judgment of the accountant to apply the principles sensibly in each particular situation.
The nature of a principles-based approach
The recommended approach to resolving ethical problems, which will be considered in more detail later, is based on the following steps:
- Identify threats: To compliance with the fundamental principles. Accountants have an obligation to identify any threat to their compliance with the fundamental principles, when it could reasonably be expected that they should be able to identify it.
- Evaluate the threat: Qualitative factors as well as quantitative factors should be considered in the assessment of a threat to compliance. Insignificant threats may be ignored but others should be dealt with.
- Respond to the threat: If it is ‘not insignificant’, the accountant should apply appropriate safeguards, if he can, to eliminate the threat or reduce the threat to an insignificant level.
- Take action: If suitable safeguards cannot be applied, more drastic action will be needed, such as refusing to carry out a professional service, ending the relationship with a client or resigning from the job.
Nature of ethical threats
Threats to compliance with the fundamental ethical principles are grouped into five broad categories:
- Self-interest threats, or conflicts of interest: These occur when the personal interests of the professional accountant, or a close family member, are (or could be) affected by the accountant’s decisions or actions.
- Self-review threats: This type of threat occurs when a professional accountant is responsible for reviewing some work or a judgment that he was responsible for originally. An extreme example would be a situation where a professional accountant prepares the annual financial statements for a corporate client and then is appointed to do the audit.
- Advocacy threats: This type of threat can occur when an accountant promotes the point of view of a client, for example by acting as a professional witness in a legal dispute. Acting as an advocate for the client can reach the point where the objectivity of the accountant is compromised.
- Familiarity threats: A familiarity threat arises from knowing someone very well, possibly through a long association in business. The risk is that an accountant might become too familiar with a client and therefore becomes more sympathetic to the client and more willing to accept the client’s point of view.
- Intimidation threats: A professional accountant might find that his objectivity and independence is threatened by intimidation, either real or imagined.
- These threats to compliance with the fundamental ethical principles apply to firms of accountants in their dealings with clients as well as to individual accountants.
Nature of ethical safeguards
When there are threats to compliance with the fundamental ethical principles, the accountant should assess the safeguards against the threat. There might already be safeguards in place that eliminate the possibility that the risk will ever materialize, or that reduce the risk to an acceptable level. If the safeguards that exist are not sufficient, the accountant should try to introduce new safeguards to eliminate or reduce the risk to an insignificant level.
Ethical safeguards can be grouped into two broad categories:
- Safeguards created externally, by legislation, regulation or the accountancy profession
- Safeguards established within the work environment.