Discussion ethical - Assignment Essays

Please read the case paragraphs and power point slides, answer the following questions:

case 2-1. Explain what Barbara should do if she reasons at each of the stages of Kohlberg’s model. (no less than 150 words)

case 3-2. Assume you have decided to report the fraud. What would your first step be? That is, to whom would you report the fraud and why? (no less than 150 words)

Case 2-1 A Team Player? (a GVV case)

Barbara is working on the audit of a client with a group of five other staff-level employees. After the inventory audit was completed, Diane, a member of the group, asks to meet with the other employees. She points out that she now realizes a deficiency exists in the client’s inventory system whereby a small number of items were double counted. The amounts are relatively minor and the rest of the inventory observation went smoothly. Barbara suggests to Diane that they bring the matter to Jessica, the senior in charge of the engagement. Diane does not want to do it because she is the one responsible for the oversight. Three of the other four staff members agree with Diane. Haley is the only one, along with Barbara, who wants to inform Jessica.

After an extended discussion of the matter, the group votes and decides not to inform Jessica. Still, Barbara does not feel right about it. She wonders: What if Jessica finds out another way? What if the deficiency is more serious than Diane has said? What if it portends other problems with the client? She decides to raise all these issues but is rebuked by the others who remind her that the team is already behind on its work and any additional audit procedures would increase the time spent on the audit and make them all look incompetent. They remind Barbara that Jessica is a stickler for keeping to the budget and any overages cannot be billed to the client.

Explain what Barbara should do if she reasons at each of the stages of Kohlberg’s model.

(no less than 150 words)

Case 3-2 Rite Aid Inventory Surplus Fraud

Occupational fraud comes in many shapes and sizes. The $12.9 million dollar fraud and kickback scheme at Rite Aid is one such case.

In February 2015, Jay Findling, a New Jersey businessman, pleaded guilty to charges of conspiracy to commit wire fraud.

Former vice president, Timothy Foster, pleaded guilty to making false statements to authorities. On November 16, 2016, Foster was sentenced to five years in prison and Findling, four years. Findling and Foster were ordered to jointly pay $8,034,183 in restitution. Findling also forfeited and turned over an additional $11.6 million to the government at the time he entered his guilty plea. In sentencing Foster, U.S. Middle District Judge John E. Jones III expressed his astonishment that in one instance at Rite-Aid headquarters, Foster took a multimillion dollar cash pay-off from Findling, then stuffed the money into a bag and flew home on Rite Aid’s corporate jet.

The charges relate to a nine-year conspiracy to defraud Rite Aid by lying to the company about the sale of surplus inventory to a company owned by Findling when it was sold to third parties for greater amounts. Findling would then kick back a portion of his profits to Foster. Foster’s lawyer told Justice Jones that, even though they conned the company, the efforts of Foster and Finding still earned Rite Aid over $ 100 million “instead of having warehouses filled with unwanted merchandise.” Assistant U.S. Attorney Kim Daniel focused on the abuse of trust by Foster and persistent lies to the feds.

“The con didn’t affect some faceless corporation, Daniel said, “but harmed Rite Aid’s 89,000 employees and its stockholders.” Findling’s attorney, Kevin Buchan, characterized his client as “a good man who made a bad decision.” “He succumbed to the pressure. That’s why he did what he did and that’s why he’s here,” Buchan said during sentencing.

Findling admitted he established a bank account under the name “Rite Aid Salvage Liquidation” and used it to collect the payments from the real buyers of the surplus Rite Aid inventory. After the payments were received, Findling would send lesser amounts dictated by Foster to Rite Aid for the goods, thus inducing Rite Aid to believe the inventory had been purchased by J. Finn Industries, not the real buyers. The government alleged Findling received at least $127.7 million from the real buyers of the surplus inventory but, with Foster’s help, only provided $98.6 million of that amount to Rite Aid, leaving Findling approximately $29.1 million in profits from the scheme. The government also alleged that Finding kicked back approximately $5.7 million of the $29.1 million to Foster.

Assume you are the Director of Internal at Rite Aid and discover the surplus inventory scheme. Explain the steps you would take to determine whether you would blow the whistle on the scheme by applying the requirements of Exhibit 3.15 on subordination of judgment. In that regard, answer the following questions.

Assume you have decided to report the fraud. What would your first step be? That is, to whom would you report the fraud and why?

(no less than 150 words)

Cognitive Processes and Ethical Decision Making in Accounting

Chapter 0

© 2023 McGraw Hill, LLC. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw Hill, LLC.

Because learning changes everything.®

Learning Objectives

L O 2-1: Analyze the thought processes involved in, and the impact cognitive biases have on, making decisions and taking ethical action.

L O 2-2: Describe Kohlberg’s stages of moral development.

L O 2-3: Explain Rest’s Model and how its components influence ethical decision making.

L O 2-4: Describe the link between organizational culture, ethical climate, ethical leadership, and ethical decision making.

L O 2-5: Distinguish between Equity, Diversity, and Inclusion.

L O 2-6: Apply both the Integrated Ethical Decision-Making Model and the Giving Voices to Values Methodology to a case study.

Chapter Organization

Access the text alternative for slide images.

Learning Objective 1
Analyze the thought processes involved in, and the impact cognitive biases have on, making decisions and taking ethical action.
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Behavioral Ethics
Behavioral ethics emphasizes how individuals actually make decisions and the impact our cognitive biases have on those decisions.
Kahneman’s suggests two distinct modes of decision making:
System 1 thinking is an intuitive system of processing information.
Fast, automatic, effortless, and emotional.
System 2 thinking is a reasoned decision process.
Slower, conscious, effortful, and explicitly.
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Cognitive Biases
Understanding unconscious biases that people may have is an important first step to preventing unethical behavior.
Where these bias’s come from.
Types of Biases.
Incrementalism.
Situational Factors.
Cognitive Dissonance.
Bystander Effect.
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Theories About the World
Deterministic Bias.
Hindsight Bias.
Attribution Bias.
Framing Bias.
All of the above biases contribute to underestimating the risk associated with the decisions being made.
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Theories About Other People
Ethnocentrism
Thinking of ourselves and those most similar to us as better than others.
US versus Them Mentality.
Our nation is better than any other nation.
Our Baseball team is better than any other team.
People who think and act like me are better than those that don’t.
Stereotypes
Derived from ethnocentrism.
People often attribute negative attributes to those not similar to themselves.
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Theories About Ourselves
Overconfidence/Superiority Bias.
Oversimplification Bias.
Loss Aversion Bias.
Authoritative Bias.
Conformity Bias/ Group Think.
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Incrementalism
The Slippery Slope.
Once you agree to do something unethical and or illegal once it is more likely you will do it again.
Your past actions can be used against you in the future.
Often times presented as a ‘one time’ request or as being ‘immaterial’.
There is no concept of materiality when it comes to fraud.
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Situational Factors
Time Pressure
People tend to cut corners when under a deadline.

Transparency
The importance of Internal Controls – People do not respect what you do not inspect.
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Leon Festinger
Recognized the limitation of philosophical reasoning approaches integrated into decision making models.
How we think we should behave is different from how we decide to behave.
Coined term of Cognitive Dissonance in 19 56.
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Cognitive Dissonance
Inconsistency between our thoughts, beliefs, or attitudes and behavior creates the need to resolve contradictory or conflicting beliefs, values, and perceptions.
Only occurs when we are “attached” to our attitudes and beliefs.
How we think we should behave is different from how we decide to behave.
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Bystander Effect
Tendency not to report wrongdoing or try and help someone in need thinking others will.
The New York City Subway Incident.
The Harvey Weinstein Case.
Countless other incidents of Sexual Harassment in the workplace.
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Learning Objective 2
Describe Kohlberg’s stages of moral development.
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Kohlberg and Cognitive Development
Psychologist.
20 years of research.
Moral reasoning processes becomes more complex and sophisticated with development.
Higher stages are consistent with philosophical theories of rights and justice.
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Heinz and the Drug
Heinz’s wife has a rare cancer.
A radium drug could help.
Druggist charged 10 times what drug cost ($200 cost; $2,000 for small dose of drug).
Heinz could only get together $1,000.
Druggist would make no exceptions to price of drug.
What should Heinz do?
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Sample Responses to the Heinz Dilemma
Egoism: Steal the drug, depending on how much Heinz likes his wife and how much risk to stealing.
Ends justify the means: Steal the drug, due to loving the wife so much and cannot watch her die.
Act Utilitarianism: Weigh the costs and benefits of alternative actions.
Rule Utilitarianism; justice: Do not steal the drug, since stealing is against the law.
Rights: Right to life above all else (Constitutionally: life, liberty, and the pursuit of happiness).
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Kohlberg’s Stages of Moral Development
Lawrence Kohlberg’s six stages of moral development are divided into three levels of moral reasoning.
Level 1 – Preconventional.
Level 2 – Conventional.
Level 3 – Postconventional.
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Level 1 – Preconventional
Rules are seen as something external imposed on one’s self.
Individual is very self-centered.
Stage 1 – Obedience to rules; avoidance of punishment.
Stage 2 – Satisfying one’s own needs (egoism); follow rules only if they satisfy one’s needs.
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Level 2 – Conventional
Individual becomes aware of the interests of others and one’s duty to society.
Personal responsibility is an important consideration in decision making.
Stage 3 – Fairness to others; commitment to loyalty in the relationship.
Stage 4 – Law and order; one’s duty to society, respect for authority, maintaining social order.
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Level 3 – Postconventional
Individual recognizes there must be a society wide basis for cooperation.
Orientation to principles that shape whatever laws and role systems a society may have.
Stage 5 – Social contracts; upholding the basic rights, values, and legal contracts of society.
Stage 6 – Universal ethical principles that everyone should follow, Kohlberg believed this stage rarely existed; Kant’s categorical imperative.
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Characteristics of Kohlberg’s Model
Kohlberg maintains that his stage sequence is universal.
Same in all cultures.
Stages refer not to specific beliefs, but underlying modes of reasoning.
Suggests that people continue to change their decision priorities over time and with additional education and experience.
Individual’s moral development can be influenced by corporate culture, especially ethics training.
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Learning Objective 3
Explain Rest’s Model and how its components influence ethical decision making.
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Moral Reasoning and Moral Behavior
Moral judgment is the single most influential factor of a person’s moral behavior.
Morality requires.
Person’s actions be rational.
Motivated by purpose or intent.
Carried out with autonomous free will.

Rest’s Model of Morality
James Rest’s model of ethical action is based upon the presumption that an individual’s behavior is related to her/his level of moral development. He breaks down the ethical decision-making process into four major components.
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Components of Rest’s Model
Moral Sensitivity – ability to identify what is moral and amoral.
Moral Judgment – ability to reason through several courses of actions and making the right decision when faced with an ethical dilemma.
Moral Motivation – influences that affect an individual’s willingness to place ethical values ahead of non-ethical values.
Moral Character – having one’s ethical intentions match actions taken.
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Moral Intent
Critical component of ethical decision making.
Internalization of virtues.
Acting in accordance with principles.
One must want to make the ethical decision.
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Components Interact
All processes must take place for moral behavior to occur.
This framework is not a linear decision-making model, the processes instead work through sequence of “feed-back” and “feed-forward” loops.
Moral failure can occur when there is a deficiency in any one component.
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Libby and Thorne: Virtues Important for Auditing
Intellectual virtues: indirectly influence individual’s intentions to exercise professional judgment.
Most important: integrity, truthful, independent, objective, dependable, principled, and healthily skeptical.
Instrumental virtues: directly influence individual’s actions.
Most important: diligent, alert, careful, resourceful, consultative, persistent, and courageous.
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Linda Thorne’s Integrated Model of Ethical Decision Making

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Learning Objective 4
Describe the link between organizational culture, ethical climate, ethical leadership, and ethical decision making.
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Organizational Ethics, Ethical Culture, and Ethical Climate
Organizational Ethics
Generally accepted principles and standards that guide behavior in organizational contexts.
Ethical Culture
Explicit statement of values, beliefs and customs from top management. It is typically found in the Company’s Code of Ethics.
Organizational ethical climate
Moral atmosphere and level of ethics practiced within a company.
Importance placed on E D I.
Determined by leaders.
Shared values, beliefs, goals, and problem-solving.
Focuses on issues of right and wrong.
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Establishing an Ethical Culture
Corporate culture is the shared beliefs of top managers in a company about how they should manage themselves and other employees, and how they should conduct business.
Tone at the top refers to the ethical environment that is created in the workplace by the organization’s leadership.
Corporate culture starts with an explicit statement of values, beliefs, and customs from top management.
Creating a culture which actively promotes an inclusive work environment that values diversity is essential.
A code of ethics serves as a guide to support ethical decision making.
It clarifies an organization’s mission, values, and principles, linking them with standards of professional conduct.
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Ethical Leadership: Tone at the Top
Leaders of Good Character
Possess integrity, courage, and compassion.
Careful and prudent.
Decisions and actions inspire employees to act in an enhancing way.
Virtues
Courage, temperance, wisdom, justice, optimism, integrity, humility, reverence and compassion.
Role Models
Employees follow the actions of their leaders over written codes of conduct.
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Key Markers of Highly Ethical Organizations
Humility.
Zero tolerance for individual and collective destructive behaviors.
Justice.
Integrity.
Focus on Equity, Diversity and Inclusion.
Trust.
A focus on process.
Structural reinforcement.
Social responsibility.
Values-driven organization that encourages openness, transparency, and provides supportive environment to voice values without fear of retribution or retaliation.
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Learning Objective 5
Distinguish between Equity, Diversity, and Inclusion.
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Equity, Diversion, and Inclusion (E D I)
E D I means to give each person the same opportunity, accepting people from different races, genders, religions, and nationalities.
E D I policies should promote ethical behavior and tear down biases.
Promote justice and fairness.
Virtues of caring, kindness and empathy.
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Deloitte Survey: How to Create a Culture of Belonging
25% identified fostering an environment where workers feel they are treated fairly and can bring their authentic selves to work (feeling comfortable) as the biggest driver of belonging.
31% identified having a sense of community and identifying with a defined team (feeling connected) was the biggest driver.
44% identified feeling aligned to the organization’s purpose, mission, and values and being valued for their individual contributions (feeling their contributions matter) was the biggest driver of belonging at work.
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Deloitte Survey: Value of E D I efforts in the Workplace
72 % indicated that fostering a sense of belonging at work is important.
93% indicated that a strong sense of belonging drives organizational performance.
Unfortunately, only 13% indicated that they were ready to address / make the changes necessary to foster belonging in their organizations.
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Better Up Survey: Importance of E D I Efforts
Workplace belonging can lead to:
a 56% increase in job performance;
a 50% reduction in the risk of turnover;
And, a 75% decrease in the number of employees calling in sick.
One single incidence of a micro-exclusion can result in a 25% reduction in productivity.
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Factors that Influence Ethical Decision Making
Individual Factors
Values of individuals.
Organizational and social forces shape behavioral intentions and decision making.
Organizational Factors
Organization’s values have a greater influence than a person’s own values.
Ethical Dissonance
The Organizational to Individual Fit.
Opportunity
Conditions that limit or permit ethical or unethical behavior.
Business Ethics Intentions, Behavior, and Evaluations.
Organizational ethical culture is shaped by effective leadership.
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Organizational Influence on Ethical Decision Making
The Jones-Hiltebeitel model looks at the role of one’s personal code of conduct in ethical behavior within an organization.
When one’s personal code is insufficient to make the necessary moral decision, the individual will look at professional and organizational influences to resolve the conflict.
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Ethical Dissonance Model
Interaction between the individual and the organization, based upon person-organization ethical fit at various stages of the contractual relationship in each potential ethical fit scenario.
Four potential fit options:
High-High (high organization & high individual ethics).
Low-Low (low organization & low individual ethics).
High-Low (high organization & low individual ethics).
Low-High (low organization & high individual ethics).
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Ethical Dissonance Model 2

High Organization Ethics
&
Low Individual Ethics
High Organizational Ethics
&
High Individual Ethics

Low Organizational Ethics
&
Low Individual Ethics
Low Organizational Ethics
&
High Individual Ethics

Learning Objective 6
Apply both the Integrated Ethical Decision-Making Model and the Giving Voices to Values Methodology to a case study.
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Accountants Ethical Behavior
Accounting profession has professional standards to encourage ethical behavior.
These standards, an individual’s attitudes and beliefs, and ethical reasoning capacity influence professional judgment and ethical decision making.
Post conventional reasoning is the ethical position to take even though it may go against corporate culture of, “go along to get along”.
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Ethical Domain in Accounting and Auditing
Four key constituent groups of accountants and auditors’ domain are the:
Client organization that hires and pays for accounting services.
Accounting firm that employs the practitioner.
Accounting profession including various regulatory bodies.
General public who rely on the attestation and representation of the accounting firm.
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Empirical Studies
Studies have shown that:
Ethical reasoning may be an important determinant of professional judgment.
Unethical and dysfunctional audit behavior may be systematically related to the auditor’s level of ethical reasoning.
Ethical reasoning may be an important cognitive characteristic that may affect individual judgment and behavior.
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Ethical Decision-Making Models
Consciously thinking about and analyzing what one has done (or is doing).
A systematic process to organize the various elements of ethical reasoning and professional judgment.
Evaluate stakeholder interests.
Analyze the relevant operational and accounting issues.
Identify alternative courses of action.
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Integrated Ethical Decision-Making Process
Identify the ethical and professional issues (ethical sensitivity).
Identify and evaluate alternative courses of action (ethical judgment).
Reflect on the moral intensity of the situation and virtues that enable ethical action to occur (ethical intent).
Take action (ethical behavior).
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Ace Manufacturing
Three stockholders: Smith, Williams, & Jones.
Jones hires son Paul to manage the office.
Paul is given complete control over payroll, approves disbursements, signs checks, reconciles G/L cash to bank statement.
Paul hires Larry Davis to help with accounting.
While Paul is on medical leave, Davis finds $10,000 total in payments over payroll amount to Paul in January and February.
What should Davis do?
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Application of Decision-Making Model to Ace Manufacturing 1
Identify the ethical and professional issues (ethical sensitivity).
G A A P – Potential fraud, misstated F/S, incorrect taxable income.
Stakeholders – owners, Paul, Davis, I R S, banks.
Ethical/professional standards – objectivity, integrity, due care.
Identify and evaluate alternative courses of action (ethical judgment).
Legal issues – G A A P, fraudulent F/S, tax understatement.
Alternatives/ethical analysis – do nothing, confront Paul, report to Jones or all the owners. Rule utilitarianism and rights argue for informing other partners who have a right to know, although Paul can be approached first under the theory he has a right to correct the matter.
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Application of Decision-Making Model to Ace Manufacturing 2
Use Ethical Reasoning to evaluate the alternative courses of action.
Will Davis be responsible for getting Paul in trouble?
What is the right thing to do?
Can Davis trust Paul again?
Davis needs to maintain Integrity and avoid cognitive dissonance.
Take action (ethical behavior).
Have courage, insist on correction to accounting, give Paul an opportunity to explain.
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Giving Voice to Values
Behavioral ethics approach with an emphasis on developing the capacity to effectively express one’s values in a way that positively influences others.
Finding levers to effectively voice and enact one’s values.
Ask to think about the arguments others might make that create barriers to expressing one’s values in workplace.
Ask to think how best to counteract these “reasons and rationalizations”.
Used post-decision making (already decided what to do).
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G V V Questions
How you get it done effectively and efficiently?
What do you need to say, to whom, and in what sequence?
What will the objectives or pushback be, and, then.
What will you say next?
What data and examples do you need to support your point of view?
G V V relies on developing arguments, action plans, and rehearsing how to voice/enact moral values.
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Reasons and Rationalizations
Expected or Standard Practice – “Everyone does this”.
Materiality – “The impact is not material. It doesn’t really hurt anyone”.
Locus of Responsibility – “This is not my responsibility; I’m just following orders”.
Locus of Loyalty – “This is not fair to the client, but I don’t want to hurt my reports/team/boss/company”.
Isolated Incident – “This is a one-time request”.
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4 – Step G V V Process
What are the main arguments you are trying to counter? That is, what are the reasons and rationalization you need to address?
What’s at stake for the key parties, including those with whom you disagree?
What levers can you use to influences those with whom you disagree?
What is your most powerful and persuasive response to the reasons and rationalizations you need to address?
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Ace Manufacturing Analysis with G V V 1
What are the main arguments to counter or reasons and rationalizations to address?
No one hurt, private company, sympathy card, materiality, not being compensated properly, isolated incidents, Jones has approved, will pay back.
What’s at stake for the key parties?
Reputations, embarrassment, right to know, loss of job, ability to obtain loan.
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Ace Manufacturing Analysis with G V V 2
What levers can you use to influence those with whom you disagree?
Ask for supporting documents for coding of expenses, harm to company and embarrassment to dad, long-term effects, telling all the owners.
What is your most powerful and persuasive response to the reasons and rationalizations?
Verifying that vendor is not paid twice, using money for personal use is stealing and no materiality test, challenges Jones about knowing, owners need (have a right) to know.
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Concluding Thoughts/Key Issues
“The road to success is littered with failures, but the lessons learned are crucial in plotting your course to success.” Kristi Loucks.
Kohlberg’s model of moral development.
Rest’s model of ethical decision-making.
Cognitive development.
Issues of moral intensity and virtue in Integrated Decision-Making mode.
Behavioral ethics.
Moral reasoning skills.
Giving Voice to Values.
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Video Links

Ethics Relationships.

Baby Lab.

Personal
Behavior.

Case 2-10 WorldCom.

Cynthia Cooper interview.

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Organizational Ethics and Corporate Governance

Chapter 03

Because learning changes everything.®

Learning Objectives

L O 3-1: Describe the causes of fraud, detection methods, and preventative controls.

L O 3-2: Describe the signs that an organization has collapsed ethically.

L O 3-3: Discuss compliance, integrity, and employee views about ethics in the workplace.

L O 3-4: Describe the scope and role of corporate governance systems in the ethical decision-making process.

L O 3-5: Explain the models of corporate governance and ethical expectations of organizations.

L O 3-6: Explain how the provisions of the Sarbanes-Oxley Act relate to corporate governance, including relationships with key parties.

L O 3-7: Discuss whistleblowing procedures under Dodd-Frank and concerns about the program.

Fraud in Organizations
Fraud can be defined as a deliberate misrepresentation to gain an advantage over another party. Fraud comes in many different forms, including fraud in financial statements, the misappropriation of assets (theft) and subsequent cover-up, and disclosure fraud.
Fraud is not the same as an error, which can occur innocently. Fraud is a purposeful act to mislead others.
A common element of fraud is it leads to (material) misrepresentation of the financial statements.
3

How Fraud is Detected
According to the ACFE study of Occupational Fraud, the most common method of detection was a “tip,” (43%).
In organizations with hotlines, 49% come from a tip but declines to 31% percent in organizations with no hotline.
Internal audit was next with 15% followed by management review (12%).
The results indicate the need for strong internal controls and an effective audit committee.
4

Fraud Detection Methods

Detection Method
Percentage Reported
Median Loss

Tip
43%
$145,000

Internal Audit
15%
$100,000

Management Review
12%
$100,000

Other
6%
N/A

By Accident
5%
$200,000

Account Reconciliation
4%
$81,000

Document Examination
3%
$101,000

External Audit
4%
$150,000

Red Flag Warnings of Fraud
Individual behavioral traits/warning signs include living beyond one’s means (42%) and financial difficulties (26%).
The question is how can the anti-fraud controls identify these behavioral indicators of fraud?
Red flags might show up through internal and external relationships.
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Frequency of Anti-Fraud Controls 1
Internal controls do not guarantee protection against fraud, however
They can help to both mitigate losses and deter some potential fraudsters.
With 43 percent of frauds being detected by tips, hotlines should play an essential role in organizations’ anti-fraud programs.
However, only 64% had a hotline mechanism in place and 13% provided rewards for whistleblowers.
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Frequency of Anti-Fraud Controls 2

Anti-Fraud Control
Percentage Reported

External Audit of Financial Statements
83%

Code of Conduct
81%

Internal Audit Department
79%

Management Certification of Financial Statements
73%

External Audit of Internal Controls over Financial Reporting
68%

Management Review
65%

Hotline
64%

Independent Audit Committee
62%

Behavioral Indicators of Fraud

Behavioral Indicators of Fraud
Percentage Reported

Living Beyond Means
42%

Financial Difficulties
26%

Unusually Close Association with Vendor/Customer
19%

Control Issues, Unwillingness to Share Duties
15%

No Behavioral Red Flags
15%

“Wheeler-dealer” Attitude
13%

Irritability, Suspiciousness, or Defensiveness
13%

Divorce/Family Problems
12%

Financial Statement Fraud
A variety of factors discourage the reporting of fraud:
Poor tone at the top.
Dominating and intimidating personalities.
Mistrust.
Excessive team loyalty.
Management does not want to hear about problems.
A lack of sound policies and procedures.
Perception that wrongdoing will not be addressed if misconduct is reported.
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Why Employees Don’t Come Forward
Fear of the unknown.
Fear that the report will not be handled anonymously or confidentially.
Fear that the reporter’s identity will be revealed to others in the organization.
Concern that the person perpetrating the misconduct will not be held responsible.
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Possible Consequences of Reporting Fraud
Retaliation by co-workers.
Termination.
Future reputation.
Impact on others.
Results of investigation determine that the misconduct is unsubstantiated.
Emotional cost of whistleblowing.
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How Financial Statement Fraud Occurs
Revenue Overstatement
Recording gross, rather than net, revenue.
Recording of revenues of other companies, acting as a ‘middleman.’
Recording sales that never took place.
Recording future sales in the current period.
Recording sales of products that are out on consignment.
Expense Understatement
Recording cost of sales as a non-operating expense.
Capitalizing operating costs.
Not recording some expense at all.
Improper Asset Valuations
Manipulating reserves.
Changing the useful lives of assets.
Failing to take a write-down when needed.
Manipulating estimates of fair market value.
13

Why Does Financial Statement Fraud Occur
Situational pressure
May prompt an otherwise honest person to commit fraud.
Typically occurs as a result of immediate pressure within the internal or external environment.
Perceived opportunity
The opportunity to commit fraud and conceal it must exist.
Rationalization
People who commit financial statement fraud are able to rationalize the act.
Being able to justify the act makes it possible.
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Seven Signs of Ethical Collapse
“Occurs when any organization has drifted from the basic principles of right and wrong” Marianne Jennings
Pressure to maintain numbers.
Fear and silence.
Bigger than life C E O.
Weak board of directors.
Conflicts of interests overlooked or unaddressed.
Innovation like no other company.
Goodness in some areas atones for evil in others.
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Pressure to Maintain Numbers and Fear of Reprisals
Ethical collapse occurs when there is an unreasonable and unrealistic obsession with meeting quantitative goals
“Financial results at all costs.”
Companies manipulate earnings to meet financial analyst expectations.
Those who report wrongdoing are ignored.
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Fear of Reprisals
A culture of fear and silence can easily mask ethical problems.
Employees may be reluctant to raise issues of ethical concern because they may be ignored, treated badly, transferred, or worse.
The whistleblowing process in many organizations does not work because there is no hotline to report anonymously.
The whistleblowing process does not work because allegations are not taken seriously.
A “kill the messenger syndrome” exists when the organization does not want to hear about wrongdoings, so it responds negatively to the messenger.
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Loyalty to the Boss and Weak Board of Directors
Young people selected by the C E O for their position based on inexperience, possible conflicts of interest, and unlikelihood to question the boss’s decisions.
Weak board of directors exists because of conflicts of interest arise from relationships between board members and the company/top management.
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Ethics in the Workplace
A code of conduct goes beyond what is legal for an organization and provides normative guidelines for ethical conduct. Support for ethical behavior from top management is a critical component of fostering an ethical climate.
Measures that should be taken to establish an ethical culture:
Clear policies on ethical conduct including a code of ethics.
Ethics training program that instills a commitment to act ethically and explains the code provisions.
A top-level officer (Chief Ethics and Compliance Officer) to oversee ethics and compliance.
Use internal auditors to investigate whether ethics policies are followed.
Strong internal controls to prevent and detect unethical behaviors.
Whistleblowing policies, including reporting outlets.
Ethics hotline for anonymous tips.
Ethics statement signed by employees.
Enforce ethics policies fairly and take immediate action against violators.
Reward ethical behavior and include in performance evaluation system.
19

K P M G Integrity Survey
Employees asked what they would do if they observed a violation of their organization’s standards of conduct:
78% would notify their supervisor or another manager.
54% would try resolving the matter directly.
53% would call the ethics or compliance hotline.
26% would notify someone outside the organization.
23% would look the other way or do nothing.
75% would inform their supervisor.
20

Employee Perception About Ethics in the Workplace
When organizations prioritize integrity, employees are:
Less likely to feel pressure to violate ethics standards;
Less likely to observe misconduct;
More likely to report misconduct they observe; and,
Less likely to experience retaliation for reporting.
21

Using Social Media to Criticize the Employer
Employees sometimes feel inclined to post negative comments about their employer outline.
When those comments are solely made by the individual with no input from others, the N L R B treats it as a “personal gripe” and it’s not protected speech.
When others comment on the posting, it is protected because it is deemed to be a “concerted effort,” — that is, more representative of the group, not one’s individual feelings.
22

Ethical and Legal Responsibilities of Officers and Directors
Directors and officers are fiduciaries of the corporation as their relationship with the corporation and its shareholders is one of trust and confidence.
Duty of Care – act in good faith, exercise the care that an ordinarily prudent person would exercise in a similar situation.
Duty of Loyalty – act in the best interest of corporation’ loyalty can be defined as faithfulness to one’s obligations and duties.
23

Role of Corporate Governance Systems
Maximize shareholder wealth
Problems of agency costs.
Executive compensation packages/stock options.
Represent all stakeholders
Investors, creditors, employees and other interests considered.
Stewardship Function
Fiduciary duty of managers.
More consistent with stakeholder views.
24

Corporate Governance Oversight and Regulation
Independent directors
Executive versus nonexecutive directors.
Audit committee responsibilities.
Oversee financial reporting
Work with internal and external auditors.
Monitor internal controls.
25

Key Audit Committee Responsibilities
Meet at least annually with the independent auditor and review the audit report describing independent auditor’s internal quality control procedures.
Discuss all relationships between the independent auditor and the company to enable assessment of the auditor’s independence.
Discuss earnings press releases and financial information and earnings guidance given to analysts and rating agencies.
Discuss policies with respect to risk assessment and risk management.
Meet separately, from time to time, with management, with internal auditors, and with independent auditors.
Review with the independent auditor any audit problems or difficulties and management’s response to such issues.
Report regularly to the board of directors.
Evaluate work of the audit committee annually.
26

Corporate Social Responsibilities
Refers to the ethical expectations that society has for business.
Ethical responsibilities are those things that we ought to, or should do, even if we prefer not to.
Corporations have an ethical responsibility to prevent harm.
Sexual harassment.
Other forms of discrimination.
Workplace safety.
27

Sustainability
Forerunner of conscious capitalism.
Sustainability describes the ability to maintain various systems and processes.
Environment.
Social responsibilities.
Social equality.
Economic.
28

Triple Bottom Line
The three “Ps”
People.
Planet.
Profit.
Describing the scope of reporting in three broad areas affecting society:
Economic including financial reporting.
Ecological including the environment.
Social including social responsibility.
29

Economic Model of C S R
Businesses’ sole social responsibility is to fulfill the economic functions they were designed to serve.
Managers must work to further the owners’ interests.
Dominant model of C S R: “managerial capitalism.”
Places shareholders at the center of the corporation.
Ethical responsibility is to serve those shareholders.
Argued for by Milton Friedman as the one and only social responsibility of business.
Increase profits by pursuing profits without deception while playing within the rules.
30

Stakeholder Model of C S R
Business Stakeholders.
Investors and shareholders, creditors, employees, customers, suppliers, government agencies, communities and others.
Have a “stake” or a claim in some aspect of a company’s products, operations, markets, industry, and outcome.
Stakeholder orientation is the degree to which an organization understands and addresses stakeholder demands, consists of:
Generation of data about stakeholder groups and assessment of the firm’s effects on these groups.
Distribution of this information throughout the firms.
The responsiveness of the organization to this information.
31

Example of Good C S R?: The Case of the Ford Pinto
Subcompact car.
Unsafe gas tanks could burst into flames.
Initial ethical legalism defense.
Risk/cost benefit analysis.
Too costly to replace the fuel tanks.
Compliance with law versus ethical behavior – met all safety requirements.
Utilitarian reasoning.
Focus on costs and benefits.
Ignores rights of various stakeholders.
Ignores cost of potential lawsuits.
32

Corporate Governance Structures and Relationships: Sarbanes Oxley
Section 301
Independent audit committee.
Receive whistleblower complaints.
Section 302
Certification of financial statements by C E O & C F O.
Section 404
External auditor report on management assessment of effectiveness of internal controls.
33

Sarbanes-Oxley Act
Section 406
Code of ethics for financial officers.
Section 806
Prohibits retaliation against whisteblowers.
Section 906
Written statement by the C E O and C F O about compliance with S E C reporting requirements.
Financial statements present, in all material respects, the financial condition and results of operations.
34

Liability for False Certifications
S E C’s increased focus on identifying and penalizing misstatements in public company financials.
Analyzing patterns of internal control problems even absent a restatement of the financials.
Quality Services Group Inc. (Q S G I) C E O and C F O held responsible for alleged misrepresentations in public disclosures about the company’s internal controls environment.
Signed Form 10-Ks with management reports on internal controls that falsely omitted issues.
Signed certifications in which they falsely represented that they had evaluated the management report on internal controls and disclosed all significant deficiencies to auditors.
Transparency with the company’s audit committee and with external auditors regarding evaluations of the company’s internal controls and whether it protects the company, its investors, and its officers.
35

Internal Control Relationships
With internal auditors.
Should have direct and unrestricted access to the audit committee.
Audit committee.
Financial statement certification process.
Establish disclosure controls.
Responsible for channeling employees to submit confidential concerns over accounting and auditing matters.
Whistleblower hotline.
36

Audit Committee
Independent directors with one having financial expertise.
Oversight of financial reporting.
Internal audit function.
External auditors.
C E O and C F O financial statement certification process.
Review formal announcements of earnings, significant financial reporting judgments, internal controls and risk management procedures, whistleblower and compliance program, external auditor’s independence and objectivity and effectiveness of audit process.
Seen as the one body that should be able to prevent identified fraudulent financial reporting.
Committee should meet separately with the senior executives, the internal auditors, and the external auditors.
37

Internal Auditors
Monitor corporate governance activities and compliance with organization policies.
Review effectiveness of the organization’s code of ethics and whistle-blower provisions.
“Eyes and ears” of audit committee.
Assess audit committee effectiveness and compliance with regulations.
Oversee internal controls and risk management processes.
Assurance on how effectively the organization assesses and manages its risk.
Assurance on data security and privacy controls.
38

External Auditors
An obligation to the public interest that underlies their corporate governance responsibilities.
Protect the interests of shareholders.
Conduct audits independent of any influence of management or the company.
Communicate effectively with the audit committee: accounting policies and procedures, estimates by management, quality of financial reporting, potential violations of laws.
Ensure accountability for financial reporting process.
39

Internal Controls
Prevent and detect errors and fraud.
Asset misappropriations.
Materially false and misleading financial reports.
Inadequate disclosures.
Ensure management policies are followed.
Ethical systems built into corporate governance.
Can be overridden by top management.
Do what C E O says, not what he does.
Creates cynical attitude.
Managers need to “walk the talk” of ethics.
40

C O S O Internal Control – Integrated Framework
Emphasizes roles of B O D, management, internal auditors, and personnel.
Designed to provide reasonable assurance.
Effectiveness and efficiency of operations.
Reliability of financial reporting.
Compliance with laws and regulations.
Framework.
Control environment: ethics of the organization.
Risk assessment.
Control activities.
Monitoring.
Information and communication.
41

Internal Control Weaknesses
Internal control includes all of the processes and procedures that management puts in place to help make sure that its assets are protected and that company activities are conducted in accordance with the organization’s policies and procedures.
An effective system of internal controls is critical to establish an ethical corporate culture that should be supported by the tone at the top.
An internal control system, no matter how well conceived and operated, can provide only reasonable – not absolute – assurance to management and the board of directors regarding achievement of an entity’s objectives.
Management override of internal controls may be a problem.
42

Whistleblowing
Employees (former or current) who report suspected violations to persons or organizations that may be able to effect action.
Illegal.
Immoral.
Illegitimate.
Four elements:
The whistleblower.
The whistleblowing act or complaint.
The party to whom the complaint is made.
The organization involved with the complaint.
“Organizational Dissidence” – similar to civil disobedience.
Whistleblower laws protects employees who provide information on a fraud against retaliation.
43

Morality of Whisteblowing 1
Organizational policies should be designed to encourage moral autonomy, individual responsibility, and organizational support for whistleblowers.
Moral agency is important for the determination of moral behavior.
Autonomy means to act according to reasons and motives that are taken as one’s own and not the product of policies, laws, etc.
If pressure exists in an organization not to report wrongdoing, a rational, moral person will withstand such pressure, even with perceived retaliation, because it is a moral requirement to do so.
44

Morality of Whisteblowing 2
Michael Davis considers whistleblowing to be morally required when it is required at all; a moral obligation to prevent serious harm to others if it can be done with little cost to the individual.
Application of a rule utilitarian perspective could lead to the conclusion that a categorical imperative exists to do whatever it takes to stop fraudulent behavior regardless of whether the action might bring more harm than good to the stakeholders.
DeGeorge thinks “corporations have a moral obligation not to harm.” His criteria for when whistleblowing is morally permitted include:
Firm’s actions will do serious and considerable harm to others.
Whistleblowing is justifiable once the employee reports it to her supervisor and makes her moral concerns known.
Absent any action by the supervisor, the employee should take the matter all the way up to the board.
Documented evidence must exist that would convince a reasonable and impartial observer that one’s view of the situation is correct and that serious harm may occur.
The employee must reasonably believe that going public will create the necessary change to protect the public and is worth the risk to oneself.
45

Rights and Duties
Whistleblowers hope and believe their speaking out will achieve correction of what they perceive as the organizational wrongdoing.
“Retaliatory climate” in the organization is the primary barrier to blowing the whistle on corporate wrongdoing.
When organizations establish an ethical culture and anonymous channels to report wrongdoing, it creates an environment that supports whistleblowing and whistle-blowers while controlling for possible retaliation.
46

Exhibit 3.12 Whisteblower Reporting Mechanisms

Mechanism
Percentage Reported

Telephone Hotline
33%

Email
33%

Web-based/online form
32%

Mailed letter/form
12%

Other
9%

Fax
1%

Exhibit 3.13 To Whom Did Whisteblowers Initially Report?

Reporting method
Percentage Reported

Direct supervisor
28%

Other
15%

Fraud investigation team
14%

Internal audit
12%

Executive
11%

Coworker
10%

Law Enforcement or regulator
7%

Owner
7%

Board or audit committee
6%

Human resources
6%

In-house counsel
4%

External audit
1%

Menendez v Halliburton, Inc.
Menendez was the Director of Technical Accounting Research and Training.
Only months before that Halliburton had settled with the S E C after a two-year accounting probe.
Menendez realized the company was violating very basic accounting revenue recognition rules.
Accountants were counting the full value of the equipment right away as revenue, even before it had assembled the equipment, customer could walk away until delivery, and Halliburton was liable for loss on damaged equipment.
Menendez tried to get Halliburton to change accounting method, but no action was taken.
He then spoke to the S E C and was told to go to the audit committee.
Halliburton’s general counsel circulated Menendez’s complaints to the C F O, K P M G, other top executives and accounting department.
He was stripped of his responsibilities and became a pariah at the firm.
Appeals court panel ruled that Menendez had been retaliated against for blowing the whistle.
49

Compliance Function
Organization’s ethics officer.
Ensures that the organization is in compliance with the laws and regulations, including S E C securities laws, S O X, and Dodd Frank.
May report to the audit committee, C E O, or general counsel.
Official member of the c-suite.
Addresses existing requirements and anticipates regulatory changes and their likely impact.
Ethics and Compliance Officer Association (E C O A).
Ethics officer plays a critical role in helping create a positive ethical tone in organizations.
50

Dodd-Frank Wall Street Reform and Consumer Protection Act
2010 passage of Dodd-Frank established benefits for whistleblowers who aid in recovery of $1M or more and they can receive 10-30% of the recovery.
Defines a whistleblower as any individual who voluntarily provides information to the S E C relating to a violation of federal securities laws, is ongoing or is about to occur.
Voluntarily means the whistleblower has not provided the information previously to the government, a self-regulatory organization, or the P C A O B.
Concern: Will whistleblowers go external rather than internal with the information in order to receive an award (“bounty hunter”)?
Employees have a loyalty obligation to their employers, but loyalty should not be used to mask one’s ethical obligation to maintain integrity and protect the public interest.
Whistleblowing in conformity with Dodd-Frank rules sets aside confidentiality requirement.
51

Internal Accountants’ Eligibility
Internal accountants, including compliance and internal auditors, are excluded from receiving whistleblower awards under Dodd-Frank because of pre-existing legal duty and job responsibilities to report suspicion of illegal acts and fraud to management.
Under the following circumstances, internal accountants are eligible to become Dodd-Frank whistleblowers:
Disclosure to the S E C is needed to prevent “substantial injury” to the financial interest of an entity or its investors.
The whistleblower “reasonably believes” the entity is impeding investigation of the misconduct (for example, destroying evidence or improperly influencing witnesses).
The whistleblower has first reported the violation internally and at least 120 days have passed with no action.
52

External Auditor Eligibility
Whistleblower rules allow the auditor or an employee associated with the auditor to make a whistleblower submission alleging that the firm failed to assess, investigate or report wrongdoing in accordance with Section 10A, or that the firm failed to follow other professional standards.
Concerns about permitting C P As to obtain monetary rewards for blowing the whistle on their own firms’ performance of services for clients create significant problems including:
Undermining the ethical obligations of CPAs not to divulge confidential client information.
Harming the quality of external audits because client management might restrict access to client information for fear the financial incentive for whistleblowing could lead to report client-specific information to the S E C.
Overriding the firms’ internal reporting mechanisms for audit-related disagreements.
Incentivizing an individual to bypass existing programs to report disagreements including hotlines.
53

Integrity Considerations
It is the integrity standard that establishes the basis for moral action of auditors and avoids subordinating judgment.
Reporting procedures for accountants and auditors under the A I C P A Code (Exhibit 3.11).
The C P A should seek legal advice when difference of opinion exists on how best to handle disagreements with the client and the firm refuses to make the required adjustments.
The auditor should consider whether the relationship with the organization should be terminated including possibly resigning one’s position.
Resignation from the audit firm does not negate the auditor’s disclosure responsibilities to the S E C.
54

Accountants’ Obligations for Whisteblowing
Dodd-Frank contains provisions to encourage accountants and auditors to report corporate wrongdoing, and Section 10A of the S E C 19 34 Act requires reporting of fraud.
Whistleblowing in accounting is a duty when it is motivated by a desire to protect the public, confidentiality obligation not withstanding.
Process in deciding to report fraud.
Whether the violations have a material effect on the financial statements.
Has management or B O D taken remedial action?
If not, auditor must report to B O D. The board has one business to inform the S E C and provide copy to external auditor.
If auditing firm does not receive a copy within one business day.
Provide a copy of its own report to the S E C within one business day, or
Resign from the engagement and provide copy of report to the S E C within one business day of resigning.
The process must be handled through the client’s internal compliance system before external auditors turn to whistleblowing.
55

Whisteblowing Payouts
June 4, 2020, $50 million whistleblower award.
Largest ever rewarded to one whistleblower.
Since its inception in 2011, S E C’s whistleblower program has paid more than $175 million to whistleblowers.
Whistleblowing program is the right thing to do to protect the public interest, but concerns are:
A self-interested and opportunistic person may be induced to reveal company information to the S E C, with inadequate safeguards as to the quality of information provided.
Permitting compliance officers to become whistleblowers solely on the passage of time rather than case-specific considerations can erode corporate culture and trust in compliance officials who may subvert the objectives of preventing, detecting, and remediating corporate misconduct on an enterprise-wide basis.
56

Whisteblowers and Confidential Information
Erhart v. BofI Holdings.
Clarifies that employer confidentiality agreements do not supersede federal whistleblower rights.
Signals that retaliatory lawsuits against whistleblowers are unlikely to succeed.
Provides guidance to corporate whistleblowers concerning the use of company documents to blow the whistle.
57

Conclusion: Creating an Ethical Culture
Creating an ethical culture is a necessary but insufficient condition to ensure that ethical behavior occurs.
Individuals within the organization may attempt to subvert the systems and pressure others to look the other way or go along with wrongdoing under the guise of being a team player or accepting a one-time fix to a perceived problem.
In these situations, outlets should exist for employees to voice their values when they believe unethical or fraudulent behavior has occurred.
58

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