Ethical Obligations

Business

Quiz 4 :
Ethics and Professional Judgment in Accounting

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Quiz 4 :
Ethics and Professional Judgment in Accounting

1. Capital expenditures are expenses incurred for use over an extended period. For example, this can be the purchase of a building. On an income statement, capital expenditures will not be listed in full but rather depreciated over time. Advertising cost generally don't fall under capital expenditures because advertisements such as those on TV or magazines are viewed by the consumers within a short time frame. In this case, the advertisement was in the form of pre-installed software on computers, and software CDs sent out to consumers. The company probably treated these as assets because it believed the consumers response to the ad will be delayed, e.g. customers install software a year or two later. AICPA section 93-7 gives conditions when direct advertising cost may be capitalize. The company must be able to document that there are potential future benefit for its advertising. 2. The Kohlberg's moral development stages are listed below. Preconventional: • Stage 1: Obedience and punishment - morals are followed to avoid punishment • Stage 2: Self-interest - morals are pursued if there's a benefit. Conventional: • Stage 3: Norms - one considers how others may perceive their actions. • Stage 4: Social order - morals need to be followed to maintain order in society Postconventional: • Stage 5: Social contract - considers the overall cost benefit to society. • Stage 6: Universal ethics - absolute notion of following ethics The company may be pursuing it out of stage 2, self-interest. Capitalizing expenses make the company seem as if it was making a profit, this will give a favorable impression on the stock market. At stage 3, the company may believe that its action was not wrong because the advertisement may have future benefit. Thus, others may view it as an error. At stage 4, the company will be conservative and expense it directly. At the post-conventional. Stage 5, the company considers its effect on investors. Investors have a right to accurate financial statements and it's wrong to provide them anything less. At stage 6, the company will do it because they can't find strong reason to capitalize the cost. Thus, they have to follow moral guidance. 3. The auditor will be in violation of "due care". Due care requires the auditor to exercise professional judgment. They have to be skeptical of the client's claims until the client can provide them with "reasonable assurance", i.e. evidence, to back their claim. 4a. A round trip transaction is a method used to boost revenue. Basically, the company give money to its customers to buy its own products. E.g. company A gives customer B $100 to buy A's product. To unaware investors it will seem as A has an increased $100 in revenue, when it fact they purchased their own product. 4b. Please refer to the link in the citation. The three transactions are listed under "The Vendor Round-trip transaction". In the computer hardware scenario: • The online company incurred cost for hardware purchases. • The online company was given a 15% discount worth $37.5 million. • It agreed to forgo it in exchange for the hardware company purchasing $37.5 million worth of online services from the company. In essence, this "generated" $37.5 million of revenue for the company when in reality it was a discount on costs of hardware. 4c. The managers certified that their ad revenues were proper. If there was an honest purchase of ads by the computer hardware supplier, the managers should inform the auditor of such so that they be aware of it.

Auditors serve a public interest in providing attestation services of a company's financial records. Their service can serve as a seal of approval. Thus, they are responsible for the investors and the public. Auditors are required to be independent of the client that hired them. This leads to potential conflicts of interest may arise as the audit firm may wish to maintain its business relationship with its client. The AICPA proposes an independent rule to maintain an auditor's independence from the client. This requires reducing events or "threats" that can impair an auditor's judgment to her audit project.

1. The following summarizes the events in the case: • P is an auditor. • P is auditing BMC a medical center. • He heard from S confidential information regarding S's client company C. • Company C sells medical devices to BMC, these medical devices have failed. S should not have disclosed confidential information to P. Although this information is of relevance to P's client BMC. It is up to S's client to disclose the information. P's company should seek legal advice if they choose to disclose the issue or not. The best strategy for P is to convince S for his client company C to disclose the information to BMC. This is the most ethical method as it allows confidentiality to be maintained, and allows company C to come clean about their product's quality. 2. P's company may be liable for breach of confidentiality if P decides to disclose. 3. The Kohlberg's moral development stages are listed below. Preconventional: • Stage 1: Obedience and punishment - morals are followed to avoid punishment • Stage 2: Self-interest - morals are pursued if there's a benefit. Conventional: • Stage 3: Norms - one considers how others may perceive their actions. • Stage 4: Social order - morals need to be followed to maintain order in society Postconventional: • Stage 5: Social contract - considers the overall cost benefit to society. • Stage 6: Universal ethics - absolute notion of following ethics The pre-conventional level would prevent P's company from disclosing as they do not want to lose their client company C, and suffer from potential lawsuit. At the conventional level, confidentiality is law and it is expected of an audit form to obey the law. At the post-conventional level, the firm will decide whether it is beneficial to society, e.g. patients of BMC if they disclose this issue. At Stage 6 universal ethics, they may decide that the safety of the patient is far above legal liability and choose to disclose. 4. P's firm should seek legal advice. They are struggling to pick between confidentiality and the potential harm to BMC's patient's health. They may also suggest client C to disclose the product quality to their customers. If client C chooses to do so themselves, P's firm will not have to breach confidentiality.