The Institute of Management Accountants in its attempt to streamline accounting practices developed the Standards for Ethical Conduct for Management Accountants. Under this code of conduct, professional ethics in the practice of accounting has been perceived under pillars of competence, confidentiality, integrity and objectivity in the practice of accounting (IMA, 1983).
Accountants are tasked with the responsibility of stating the true financial position of organizations and provision of an environment of trust which is usually necessary in a market economy. Bodies such as the American Institute of Certified Public Accountants have developed a code of conduct and ethical guidelines applicable to financial professionals including accounting managers. Because of the possibility of financial statements being tampered with, accounting managers should overcome their personal interests and act as guardians of organizational interests by stating the truth, especially on the financial position of the company. In addition, the process of hiring and training should be strictly based on accountability, ethical and professional responsibilities (Leung and Cooper 1995, Schilt 1997, Dechow and Skinner 2000).
Need for Professional Ethics
Vast accounting literature is laden with accounting practices which have ethical implications, not withstanding the fact that managerial accounting deals in practices which have ethical implications. In such literature, the occurrence of unethical practices due to the decisions made by accounting practitioners take different forms ranging from managerial decisions such as volume of production and reimbursement of costs to accounting practices like cost allocations. The scope of practice may even widen to performance evaluation and other responsibilities which bestow immense responsibility in the hands of accounting managers, which they tend to misuse hence unethical practice (Leung and Cooper 1995). The advent of immense responsibilities also accrues with modern accounting managers as they carry vast responsibilities to the public, the organization, customers, creditors, shareholders, the business community and the government. While many authors of accounting literature focus on the occurrence of unethical practices, a smaller percentage focus on the need for ‘tamper proof’ policies or ethical practices (Revsine 1991). Therefore, the rising black marks and tainted image in the practice of accounting goes to extremes of questioning trust instilled in accounting managers and disputing their impartiality in offering expertise advice. Clearly, the fall of Enron further disrupts the already murky waters hence the need to combat the rising unethical trends (Naser and Pendlebury 1992).
Ethical Challenges Facing the Profession
Several ethical issues have been highlighted in managerial accounting research. According to a study by Sayre, Rankin, and Fargher (1998) which examined the impact of promotion incentives on accounting managers’ choices of investment, it was demonstrated that investment choices by accounting managers are driven by their own individual interests rather than the interests of the organization or the employers. In another study by Rogerson (1992) which investigated overhead contract allocation, findings suggested that companies have incentives for engagement in wasteful activity through padding direct use of labor on contracts whose revenues were cost based. Similarly, various research findings (Waller, 1988; Chow, et al, 1988; Nouri, 1994; Stevens, 2002) have shown that subordinate employees posses incentives which cause a misrepresentation of capabilities of production or human resource needs, especially when such a subordinate employee’s information is used as a primary tool to evaluate his or her performance.
In addition, several research findings have suggested that accounting managers use accounting gimmicks and managerial decisions to alter financial records to their own benefits e.g. maximization of compensation or performance enhancement (Healy and Whalen, 1999; Nelson et al, 2003). In addition, Dechow and Sloan (1991) also explored how managerial decisions are used to pursue the interests of accounting managers (i.e. through research and development spending declarations).
Professional Accountancy Bodies & Action Taken to Address Challenges and Enforcement of Codes of Ethics
The Institute of Internal Auditors (IIA), American Institute of Certified Public Accountants (AICPA), International Federation of Accountants (IFAC) and Institute of Management Accountants (IMA) are some of the major professional accountancy bodies which strive to enforce the code of ethics in managerial accounting. In addition, they also attempt to provide a solution to the ethical implications which are posed by unethical practices in management accounting. They use several approaches, for example providing ethics and values in their practice as part of their curriculum and examinations and enhancing accountability to the professional accounting code of ethics on the part of their members. Similarly, they stipulate a requirement for continued professional education for their members (IMA 1983, Conner 1986, Hamilton 2008). These professional accounting bodies have a core focus on the professional code of conduct due to the existing notion that accounting students are under motivation and the desire to earn professional credentials (Fox 1997, Hamilton 2008, Dechow and Skinner 2000).
Besides existence of professional bodies, the rising ethical concerns in managerial accounting are partly addressed by various statutory requirements in the United States. These statutory requirements focus on ethical behavior in the practice of accounting. For example, in Section 406, the Sarbanes-Oxley Act of 2002 stipulates a professional code of ethics for all accounting managers and senior executives (Schneider and Sollenberger 2003). Similarly, the United States Federal Sentencing Guidelines has a provision where corporate fraud cases are heard and offenders given a lesson by being sentenced. These provisions were further tightened by the 2004 revision through the requirement that corporate codes of ethics are designated to ensure their effectiveness in curbing unethical practices. The revision on this provision also stipulated the role of an ethics program is fundamentally formulated with the key objective that it will prevent and detect unethical practices such as fraud. In line with the Gold standard of business accreditation, the AACSB puts across the requirement that reasoning skills are parcel of the core learning goals in a professional accounting program. This also entails the requirement that professional accounting accreditation standards that management accounting trainees’ learning outcomes should include outcomes of learning which encompass ethical accountancy practices and should focus on the ethical standards of the accounting profession (Schneider and Sollenberger 2003, Hamilton 2008).
Schneider and Sollenberger (2003) address the steps to be taken to address ethical challenges and enforce professional accounting code of ethics. They suggest the kind of persons to teach ethical practices to accounting trainees. They suggested that though it is beneficial to use trained ethicists in training, training resources are scarce and should be increased. The need to use trained ethicists to curb this menace has also been mentioned by Dechow and Skinner. This is as a result of findings that the accounting professionals feel they are unqualified to teach ethical accounting practices in schools (Dechow and Skinner 2000).
The framework released by the International Federation of Accountants in 2006 seemed to be a relief to the ethical issues which were under-taught in the training of accountants. This framework focused on ethics and values such as threats, ethical decision making skills, whistle blowing, earnings management and a conflict of interests. According to Hamilton, “ethics should focus on absolutes and the need for fortitude when pressure comes with its demand for flexibility and compromise” (2008, p. 18). She suggests the use of six scandals in the accounting profession to examine fraud in managerial accounting. These include Enron, Health South, Sunbeam, WorldCom, Tyco, and cases of earnings management survey. This exposes the trainees and subjects them to critical thinking which makes them develop critical skills such as leadership skills, impartiality, critical thinking and integrity to act in cases of ethical dilemmas (Hamilton 2008).
Ethical Issues Faced by Accounting Managers, Monitoring Behavior and Effects on Companies
The ethical issues which accounting managers face usually emanate from decision making situations that are usually propagated by self or group interests rather than the interests of the organization. Such issues revolve around decisions regarding investment, cost allocation, production and the accounting manager’s estimation of judgment.
Allocation of costs– According to Sollenberger (2003, p. 4-19) managers tend to move overhead costs to cost-based products usually if the product pricing is partly cost based and partly market driven. In a similar perspective, Rogerson (1992) demonstrated that companies with contracts whose revenues are cost-based are likely to take part in unethical practices in terms of overhead cost-allocation. This is because these companies have the necessary incentives to engage in such practices which have ethical ramifications on the company.
In addition, Hilton et al. (2000, p. 375) asserted that “cost-plus contracts give incentives to the supplier of the good or service to seek as much reimbursement as possible and, therefore, to allocate as much cost as possible to the product for which reimbursement is possible.” This can be explained by an example of a producer who produces standard goods or products or price contracts which are fixed to his commercial customers and specialized-almost-similar goods to a higher cadre of customer under contracts with an extra cost. This occurs in order to increase revenues through the act of “shifting indirect costs away from fixed price commercial customers and to the cost –plus contracts” (Horngren et al. 2002, p. 535). In terms of the ethical ramifications on the company, it has been suggested that this approach does not contravene the GAAP (Generally Accepted Accounting Principles) and the ethical implications on the company are slightly nebulous.
Investment and Self Driven Interests- According to Sayre, Rankin, and Fargher , the investment choices of accounting managers are geared to serving the managers’ personal interests rather than the interests of the organization or the employer/owner of the organization. If participant-performance is rated based on ROI, ethical ramifications may ensue as a result of a conflict of interest (Schneider 1995). A return on investment which would tend to put the company in a beneficial position and minimizes the ROI of the participant can easily be a source of conflicts of interests between different quarters in the organization (Schenider 1995).
According to Horngren et al. (2002, p. 410),if performance is determined by the return on investment, then accounting managers of divisions which have earnings of 20% are likely to exhibit reluctance in investing in projects which have returns of 15% since this move is a likely to cause a reduction of their average return on investment.
Zimmerman (2000, p. 190), further suggests that “Managers have incentives to reject profitable projects whose ROIs are below the mean ROI for the division because accepting these projects lowers the division’s overall ROI.” This is further supported by Kaplan and Atkinson’s assertion that interventions which tend to reduce the divisional rate on investment are likely to maximize “the economic wealth of the corporation” (Kaplan and Atkinson 1998, p. 505). To further explain their point, Kaplan and Atkinson1998, p. 505 give the example of n investment whose ROI lies between a ROI of 22% (which is the current divisional ROI) and the divisions 15% capital cost and they come to the conclusion that in such an investment, the measure of the return on investment pushes the division manager towards investment refusal. This is because though the ROI exceeds the cost of capital, it “lowers the divisional ROI” (Kaplan and Atkinson 1998, p. 505).
Overproduction- Overproduction in organizations is partly supported by the fact that the decisions of accounting managers are likely to be inspired by manipulation approaches towards earnings. Therefore in this sense, the relationship between full (absorption) costing and variable costing is controversial (Horngren et al. 2002). In comparison with full costing, variable costing has had an upper hand as its proponents suggest that with absorption costing, there is susceptibility of manipulation of the net income by accounting managers. This occurs because of the ease with which unit costs can be decreased by heightening the current production because fixed overhead is a product of cost. The result is a decrease in the cost of goods sold which in turn produces a net income which is much higher (Horngren et al. 2002).
According to Zimmerman (2000, p. 496), accounting managers who get rewards on total profits compiled through full costing can heighten the reported profits by an increase in production with constant sales. Major criticisms of full costing therefore emanate from the fact that it builds inventories by creating incentives which favor overproduction on the part of the (Kaplan and Atkinson 1998). This is further supported by Horngren et al. (2002, p. 609) who pointed out that “if the company uses the absorption costing approach, a manager might be tempted to produce unneeded units just to increase reported operating income.” This profit manipulation gimmick is best explained by Kaplan and Atkinson (1998, p. 504) who highlighted an example where production was greatly increased by the accounting manager of the division in the second and the third quarter which caused excess production to pile as an inventory of finished goods. Since the rate of production was higher, it created an enabling environment for the periodic costs which were enabled to be soaked into inventory.
Estimation of Equivalent Units- Estimation of equivalent units usually entails an estimate which affects the profit reported in one way or another. As depicted in other ethical issues, if the information of a subordinate employee is used as a primary asset for performance evaluation the subordinate employee posses the necessary incentives to misrepresent the information. In the estimation of equivalent units, this is experimented through an estimation of the completion of the kind of work which ends in process inventory though a situation which is process costing. When the degree of completion is overestimated by an accounting manager, there is a likelihood that a lower cost will be obtained. This is achieved through spreading the costs through units which are equivalent and of a larger amount. His has the effect of reducing the cost of goods or services that are sold and the end result is an increase in profits (Corner 1986, Horngren et al.2002).
Similarly, Schneider and Sollenberger pointed out that “Estimating the stage of completion of the work in process is an area particularly susceptible to manipulation by production managers… managers might be motivated to overestimate the stage of completion… A higher estimate for the degree of completion of the work in process inventory results in a greater number of equivalent units of output for the period. This in turn generates a lower cost per equivalent unit” (Schneider and Sollenberger 2003, p. 5-16). In a perspective which is almost similar to Schneider and Sollenberger’s, Hilton et al. pointed out that overestimation of the degrees of completion and the ethical issue of estimation of equivalent units has ethical ramifications on accounting managers and the organizations as it is in total violation of ethical aspects of integrity and objectivity. This may compromise the activities of other players in the investment industry and may adversely affect careers of management accountants (Hilton et al. 2000).
According to Nouri (1994), disciplinary action should be used against professional accountants to demonstrate to trainees the implications of unethical practices. Using disciplinary actions levied against accountants to show students the consequences of illegal activity. Similarly, Hamilton (2008) cites the WorldCom and Enron cases among others as a representation of previous ethical failures. He says these failures should be used as a lesson to reduce the unethical practices in managerial accounting.
List of References
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Dechow, P. and Sloan, R.G. (1991) “Executive Incentives and the Horizon Problem: An Empirical Investigation”, Journal of Accounting and Economics, 14: 51-89
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