Ethical Obligations and Decision Making in Accounting, 4e 1

Ethical Obligations and Decision Making in Accounting, 4/e 1 © 2017 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.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.During the audit, Diane, a member of the group, points out that she identified a deficiency in the client’s inventory system that she did not discover during the physical observation of the client’s inventory. The deficiency was relatively minor, and perhaps that is why it was not detected at the time. 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 who identified the deficiency and she is the one who should have detected it at the time of the observation. 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.Questions 1.Discuss these issues from the perspective of Kohlberg’s model of moral development. How does this relate to the established norms of the work group as you see it?Diane and the ones who did not want to take the matter to Jessica, the senior, are reasoning at the preconventional levels of avoiding punishment and satisfying one’s own needs. They want to avoid having more work to do or receiving a low evaluation from missing a mistake (Diane) or going over the time budget. Barbara and Haley are reasoning at the conventional and, possibly, postconventional levels. They want to be fair to the firm, the client, and the public, and know that they are following audit standards (law and order). It is possible that they are reasoning at level 5, social contract. They fully understand the social contract CPAs undertake to protect the public interest in financial markets. Barbara understands that the deficiency could be more serious than the group of staff auditors understands or that the deficiency could portend other problems. It could also portend problems with internal control deficiencies over financial reporting, which is the most cited deficiency of audit firms by the PCAOB.Often groups want to have a clear cut leader or work by majority rule. However, ethics does not go along well with majority rule. If a group decides by majority rule to rob someone, it does not make the theft right or ethical. Barbara should tell Jessica about the deficiency.

2.Assume you are in Barbara’s position. What would you do and why? Consider the

following in answering the question:

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Ethical Obligations and Decision Making in Accounting, 4/e 2 © 2017 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.•How can you best express your point of view effectively?•What do you need to say, to whom, and in what sequence?•What do you expect the objections or push-back will be and, then, what would you say next?Barbara should explain to the other team members that she feels compelled to go on and tell Jessica. She can say that she understands their concerns and will take all the blame for not finding the deficiency sooner. She also can state that telling Jessica will show their integrity, due diligence, and professional objectivity by not ignoring information that could impact the conclusion of the audit.Barbara can also solicit the help of Haley who supports Barbara’s point of view. There is strength in numbers so going together to talk to Jessica should enhance Barbara’s position and its legitimacy in the eyes of Jessica.Diane and the other team members may still push back against Barbara telling Jessica.Diane and the other team members may feel that they will still be blamed and be assigned even more work to do. They may be fearful of receiving low evaluations.Barbara should then go talk to Jessica and explain in detail why Jessica or the manager or partner may need to know about the deficiency. Jessica may at first be mad that the deficiency is just coming out as the audit is nearing completion. She may not want to go over the budget, which could affect her promotion to manager. Jessica may play the “loyalty to the team” card or say just ignore it this one time in trying to convince Barbara to let the deficiency go. She may emphasize that it is not material to the audit as well.If Jessica does not want to listen or does not believe Barbara, Barbara should document her concerns in the workpapers. Will Jessica allow the work papers to go forward with Barbara’s concerns? Should Barbara consider going to the manager or the partner?Standard practice is to go to the immediate supervisor, not jump over reporting lines.SOX and Dodd Frank laws are trying to protect whistleblowers and to get financial statement corrections done quickly. Most public accounting firms have a reporting mechanism similar to ethics hotlines in public companies, so that Barbara might employ that mechanism to report the error without going over Jessica’s head.

Ethical Obligations and Decision Making in Accounting, 4/e 1 © 2017 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.Case 2-2 FDA Liability Concerns (a GVV case) Gregory and Alex started a small business based on a secret-recipe salad dressing that got rave reviews. Gregory runs the business end and makes all final operational decisions. Alex runs the creative side of the business.Alex’s salad dressing was a jalapeno vinaigrette that went great with barbeque or burgers. He got so many requests for the recipe and a local restaurant asked to use it as the house special, that Alex decided to bottle and market the dressing to the big box stores. Whole Foods and Trader Joe’s carried the dressing; sales were increasing every month. As the business grew, Gregory and Alex hired Michael, a college friend and CPA, to be the CFO of the company.Michael’s first suggestion was to do a five-year strategic plan with expanding product lines and taking the company public or selling it within five to seven years. Gregory and Alex weren’t sure about wanting to go public and losing control, but expanding the product lines was appealing.Michael also wanted to contain costs and increase profit margins.At Alex’s insistence, they called a meeting with Michael to discuss his plans. “Michael, we hired you to take care of the accounting and the financial details,” Alex said. “We don’t understand profit margins. On containing costs, the best ingredients must be used to ensure the quality of the dressing. We must meet all FDA requirements for food safety and containment of food borne bacteria, such as listeria or e coli, as you develop cost systems.” “Of course,” Michael responded. “I will put processes in place to meet the FDA requirements.” At the next quarterly meeting of the officers, Alex wanted an update on the FDA processes and the latest inspection. He was concerned whether Michael understood the importance of full compliance.“Michael,” Alex said, “the FDA inspector and I had a discussion while he was here. He wanted to make sure I understood the processes and the liabilities of the company if foodborne bacteria are traced to our products. Are we doing everything by the book and reserving some liabilities for any future recalls?” Michael assured Alex and Gregory that everything was being done by the book and the accounting was following standard practices. Over the next 18 months, the FDA inspectors came and Michael reported everything was fine.After the next inspection, there was some listeria found in the product. The FDA insisted on a recall of batch 57839. Alex wanted to recall all the product to make sure that all batches were safe.“A total recall is too expensive and would mean that the product could be off the shelves for three to four weeks. It would be hard to regain our shelf advantage and we would lose market share,” Michael explained.

Ethical Obligations and Decision Making in Accounting, 4/e 2 © 2017 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.Alex seemed irritated and turned to Gregory for support, but he was silent. He then walked over to where Michael was sitting and said, “Michael, nothing is more important than our reputation.Our promise and mission is to provide great-tasting dressing made with the freshest, best, organic products. A total recall will show that we stand by our mission and promise. I know we would have some losses, but don’t we have a liability reserve for recall, like a warranty reserve?” “The reserve will not cover the entire expense of a recall,” Michael said. “It will be too expensive to do a total recall and will cause a huge loss for the quarter. In the next six months, we will need to renew a bank loan; a loss will hurt our renewal loan rate and terms. You know I have been working to get the company primed to go public as well.” Alex offered that he didn’t care about going public. He didn’t start the business to be profitable.Gregory, on the other hand, indicated he thought going public was a great idea and would provide needed funds on a continuous basis.Alex told Michael that he needed to see all the FDA inspection reports. He asked, “What is the FDA requiring to be done to address the issue of listeria?” “I’m handling it, Alex,” Michael said. “Don’t worry about it. Just keep making new salad dressings so that we can stay competitive.” “Well, Michael, just answer what the FDA is asking for.” “Just to sterilize some of our equipment, but it shouldn’t be too bad.” “Michael, it’s more than that,” Alex responded. “The FDA contacted me directly and asked me to meet with them in three days to discuss our plans to meet the FDA requirements and standards. We will be fined for not addressing issues found in prior inspections. I want to see the past inspection reports so I can better understand the scope of the problem.” “Listen, Alex,” Michael said. “I just completed a cost–benefit analysis of fixing all the problems identified by the FDA and found the costs outweighed the benefits. We’re better off paying whatever fines they impose and move on.” “Michael, I don’t care about cost–benefit analysis. I care about my reputation and that of the company. Bring me all the inspection reports tomorrow.” The three of them met the following day. As Alex reviewed the past inspection reports, he realized that he had relied on Michael too much and his assurances that all was well with the FDA. In fact, the FDA had repeatedly noted that more sterilization of the equipment was needed and that storage of the products and ingredients needed additional care. Alex began to wonder whether Michael should stay on with the company. He also was concerned about the fact that Gregory had been largely silent during the discussions. He wondered whether Gregory was putting profits ahead of safety and the reputation of the company.Questions