CASE 3THE AUDIT I.

CASE ABSTRACT This case deals with personal value conflicts within the context ofestablished organizational practices which run counter to statedpolicy. The case involves conflicts between professional and possiblypersonal values on the one hand and peer pressures to conform on theother."The Audit" is set in a national CPA firm. Sue, a newly hiredauditor, has been sent out on an audit where she discovers that theclient has been treating a large number of its workers as "independentcontractors." This practice saves the client the payroll taxes thatwould otherwise be due. In Sues professional judgment, this may beimproper and should be further investigated to see whether it shouldbe noted in the audit report. A conversation with her immediatesupervisor gives her no help.Co-workers put pressure on Sue to drop the matter. If she goes overthe head of the partner in charge of the audit, she will get them allin trouble as they have ignored the practice in prior years audits.They say that while they realize that it was probably wrong, they aresure their supervisor wants them to ignore it again this year. Theyencourage her to be a "team player."Clearly, Sue faces a dilemma. If she drops the issue she will beviolating her professional code of ethics. On the other hand, if shecontinues with the matter, she may well jeopardize her future with thefirm. Decision Date: No Date

II. CASE ISSUES AND SUBJECTS CPA Firm Ethics and Moral Relativism Corporate Culture

Personal Values vs. Group Norms Role Conflict Decision Making

Policies and Procedures Evaluation and Control

Whistle Blowing

Code of Ethic

Case 3The Audit III. STEPS COVERED IN STRATEGIC DECISION-MAKINGPROCESS (see Figure 1.5 on pages 20 and 21) Strategy FormulationStrategyImplementationEvaluation&Control Performance Strategic Posture Corpora te Governance External Factors Internal Fact ors S t r a t e g i c F a c t o r s R e v i e w M B O t r a t e g i c A l t e r n a t i v e s 1 3 5 8 O O X O O i C n o v = C e E a r m s e e d p h X i a = n C a s e s i z e d B A 4 6 1 B 5 A 7 2 & M i s s i o n S

IV. CASE OBJECTIVES A. To help students identify personal value conflicts which occur inthe work setting where the individual may be forced to choosebetween professional standards (or personal values) and group norms. B. To introduce the idea that small concessions to peer pressure maylead to larger concessions later on. C. To introduce the counter point that the act of disagreeing withones supervisors may also lead to unanticipated consequences. D. To focus on the ethical dilemma posed by a violation which isrelatively minor but which still appears to the central figure inthe case to be a violation of professional standards. E. Overall, to provide a vehicle for discussing the relationshipbetween personal values, group norms, and codes of ethics.

V. SUGGESTED CLASSROOM APPROACHES TO THE CASE A.This is an excellent value case for open-class discussion. We suggest that you require each student to write out a specificsolution to the employees dilemma. You can go back to thestudents individual solution after the class discussion. B. This is an excellent in-class exam case focusing on ethics indecision making. C. This is an excellent case for role playing followed by questioningby the students. D. This case can be placed anywhere in the course that you want todiscuss ethics or value oriented issues.

VI. DISCUSSION QUESTIONS

A. What would you do in this situation if you were Sue? B.Should Sue go over the head of the partner in charge of theaudit to upper management? What are the pros and cons of such adecision? Would this help or hinder her career at the CPA firm? C. What role does the group (co-workers) play in Sues choice?D. The case authors provided 11 excellent discussion questions and answers in the following Section VII - CASE AUTHORS TEACHING NOTE Discussion Questions and Answers.

VII. CASE AUTHORS TEACHING NOTE by John Kilpatrick, Gamewell Gantt, andGeorge Johnson* A. Teaching Objectives - These were listed in Section IV - CASEOBJECTIVESB. Discussion Questions and Answers 1. What are the responsibilities or obligations which the maincharacters in the case owe to themselves? This is the issue of personal integrity and the duty one owes tooneself. Students will inevitably be faced with pressures to bendtheir standards or to agree with and cooperate with policies andpractices which they find offensive ... all in the name of jobsecurity and/or promotion. In the words of the short story, howfar are you willing to go with this "kiss, kiss, grovel, grovel?" 2. What are the responsibilities or obligations which the maincharacters in the case owe to the organization? In our experience at this point questions of loyalty to theorganization inevitably come up. It is possible to introduce thenotion that "loyalty" is a two-way street and requires a certainlevel of trust, integrity, and reciprocity. The issue oforganizational culture also should be introduced. Organizationscan either encourage the moral high road from the top down ordiscourage compliance with company policies and community orprofessional standards. This may be done either by tacitlyapproving of actions which generate revenues but do not place theorganization in jeopardy, or by

actively encouraging disregardfor those same standards. It may be argued that an organizationgets the moral climate it deserves. The student should beencouraged to identify the stress which occurs between therespect for organizational values and the need to get alongwith peers and/or to advance ones own career. 3. What are the responsibilities or obligations which the maincharacters in the case owe to their profession? One of the distinguishing characteristics of professionals is thetendency to identify more with their chosen profession than withany particular organization. Another is the importance ofupholding the reputation and integrity of the profession byadhering to standards and practices which other members of theprofession have concluded are appropriate and important. In "TheAudit," questions of potential conflicts between company policyand practice, and professional standards are all evident. Howdoes a profession maintain its integrity and reputation with itsclients and the general public if members are not willing tomake difficult choices?The accounting profession is regulated by state licensing boardsand state statutes. Each state has its own code of ethics, whichis largely patterned upon the code of ethics of the professionsnational association, the American Institute of Certified PublicAccountants (the "AICPA"). Excerpts from relevant sections of the state of Idahos Code of Ethics for certified public accountants appear below: Rule 202 - Auditing Standards. A licensee shall not permit hisname to be associated with financial statements in such a manneras to imply that he is acting as an independent public accountantunless he has complied with the applicable generally acceptedauditing standards. Statements on Auditing Procedure issued bythe Institutes Auditing Standards Executive Committee are, forpurposes of this rule, considered to be interpretations of thegenerally accepted auditing standards, and departures from suchstatements (or other standards considered by the board to beapplicable in the circumstances) must be justified by those whodo not follow them.Rule 103 - Accounting Principles. A licensee shall not expressan opinion that financial statements are presented in conformitywith generally accepted accounting principles if such financialstatements contain any departure from such accounting principleswhich has a material effect on the financial statements taken asa whole, unless the licensee can demonstrate that by reason ofunusual

circumstances the financial statements would otherwisehave been misleading.Rule 301 - Confidential Client Information. A licensee shall notwithout the consent of his client disclose any confidentialinformation pertaining to his client obtained in the course ofperforming professional services.An accountant who violates the professions code of ethics can besubject to a number of possible sanctions including (1) publicand/or private reprimands, (2) license suspension, (3) licenserevocation, and/or (4) potential civil liability to the client and to third parties for damages in appropriate cases.In The Audit, Sue faces the likelihood of immediate adverserepercussions on the job if she continues to call objections tothe clients practice. She also faces the possibility of evenmore severe adverse professional consequences if she fails toobject and if she is later accused of violating the professionscode of ethics in having failed to pursue the matter further.Indeed, an auditor who has reason to suspect improper accountingpractices has an obligation to further investigate thequestionable practice. Failure to do so could result in aviolation of generally accepted auditing standards as well as thepresentation of financial statements that are not in accordancewith generally accepted accounting principles.This case is particularly difficult because Sues supervisors andthe partner in charge of the audit seem to be encouraging her toviolate the professions code of ethics and professionalstandards in order to retain the client. 4. What are the responsibilities or obligations which the maincharacters in the case owe to their peers? Most students will be able to identify with the peer pressureswhich are being exerted, or are anticipated, in the case. In ourexperience many students will underestimate the consequences ofattempting to change departmental practice or of disagreeing withones supervisor or of going further and engaging in some form of"whistle blowing." (For a discussion, see for example Near andMicelli, "Retaliation against whistle blowers: predictors andeffects" in the Journal of Applied Psychology (February, 1986):137-146. 5. What are the responsibilities or obligations which the maincharacters in the case owe to the business community? Edward T. Hall, a cultural anthropologist who has written anumber of books dealing with the practices of subcultures,suggests that employees operate in three cultures: the broadcommunity culture, the business culture of the

region or country,and that of the specific firm in which the individual works (E.T.Hall, The Silent Language, Doubleday-Anchor, 1973). The questionopens the door to a discussion of a number of "rules" of the U.S.business culture and, by way of comparison, those predominatingin other cultures. It also leads into questions of the type ofbusiness community--what are the rules of the game?--which theindividual student would like to see. To what extent does thistype of business community require that individuals exercise somedegree of "moral restraint?" 6. What are the responsibilities which the main characters in thecase owe to the broader community? This issue allows the issues identified above to be extended tothe local, regional, national, and global communities. While it may be counter-productive to try to get too much mileage out ofcases which are fairly narrowly focused, the students can beencouraged to recognize that none of the dilemmas exist in avacuum. This should be particularly appropriate at thecommunity level. What kind of community do they wish to live in,and in what ways is that issue dependent on the choices ofindividuals? To what extent are the choices of individualsswamped by policies and practices of major institutions,including those of business? At some point, everything isconnected to everything, as the ecologists are inclined to pointout. 7. What are the implications for the individual of each of theoptions? Discussion of this issue can be useful in getting the students toreally think through the significance and likely outcomes of thevarious choices. Students with work experience will probablykeep the discussion from becoming too naive. Our experience hasbeen that students are eager to explore the ramifications ofmoral and, to some, political choices. 8. How does an organization ensure that the policies which itdevelops will be followed by organization members? This, of course, is an issue for which there is no short or easyanswer. Research suggests that a number of characteristics andpractices are critical if organization members are going tocommit to organizational values. Among these are the fullsupport of top management, recognition and support forcompliance, censure for failure to comply, a

willingness to notreward behavior strictly on the basis of bottom-line performance,and effective communication of policies and the reasons for them. 9. What impact does an organizations reward system have on membersdecisions when confronted by ethical dilemmas? Specifically,what are the implications of asking for "ethical conduct" whilerewarding solely on the basis of narrowly defined (short-term) performance goals? This is simply an extension of the "reward structure" questionraised above. The students in colleges of business will havethoroughly absorbed the managers responsibility forprofitability. However, they may not have been challenged toconsider the trade-offs and conflicts which sometimes evolve fromthe pursuit of single or narrowly defined goals. 10. How does a group leader balance between the need to work withhis or her group and the need to provide strong leadership? Management and organization behavior classes focus attention onthe task/people dimensions and on the balance between being likedand being effective. This question addresses the ethicaldimensions of those conflicts: at what point does the groupleader make an issue of a breach of company policy? 11. What is the role of trust in these matters? What are the costsand benefits of using "administrative controls" vs. trustingemployees to act in good faith? It can be argued that the tendency in many American firms hasbeen to rely on administrative controls: the greater theperceived level of "misbehavior" the more tightly bureaucraticand rule-oriented the firm becomes. This line of argumentsuggests that frequently "misbehavior" is a symptom of some otherunderlying problem, which is only exacerbated by increasingautocratic or unilaterally designed and imposed controls. At theother end of the spectrum are firms which focus on developing anatmosphere of trust which, ideally, leads to a lessened need foradministrative controls. The goal is to have the employees"internalize" and identify with the objectives of theorganization. This of course presupposes a high level ofintegrity on the part of top management in particular. Mostfirms, and perhaps the values and management style of mostmanagers, lie somewhere in between these two extremes. Thisquestion

confronts the students with some of the practicalmanagerial issues which confront managers in attempting to setthe ethical tone for the firm. C. General Discussion Short cases provide a number of advantages to an instructor. Theycan easily be slipped into a course when the instructor or studentsneed a change, or when something planned does not work out. Sincethe text is only a page or two, students can be given time to readthe case in class with minimal lost time. Also, at times it seemsthat students today struggle with a steady diet of business ethics"essays." Short cases provide some relief and can be used on veryshort notice.Overall, we have found the interest level to be very high indiscussing issues such as are found in this brief case. Thediscussions tend to be lively and thought-provoking. Many studentshave indicated that these discussions have proven to be among themost stimulating and eye-opening of the semester.We have used "The Audit" for a number of pedagogical purposes. Thecase focuses very clearly on an example of the potential conflictsbetween group norms and personal and professional standards of thetype which the students will face as they begin their professionallives. The situation serves to highlight the importance of personalvalues, organizational culture, and the responsibilities ofmanagement in ensuring an environment in which personal andprofessional standards are respected.The cases have been used in a variety of courses: sophomore levellegal environment courses, junior or senior level management ororganization behavior, business and society or business ethics,marketing, purchasing;, and senior level accounting courses.These materials do not presuppose advanced work in philosophy or ethics. The intention, as noted above, is to present moral dilemmaswhich students will likely face, and to engage them in the exchangeof ideas and the comparing of values and insights. In the process itis hoped that students will better understand the nature of suchvalue conflicts and the relationship and importance of their ownvalues.For "The Audit," the instructor should be aware of the auditingstandards which require the noting of certain practices in the auditreport, as well as having some knowledge of the specific standardsdealing with the accounting for "independent contractors." A briefdiscussion of relevant auditing standards is included below for theinstructors use.Under the accounting

professions guidelines, independentaccountants are required to state whether or not they believe aclients financial statements "fairly present" the financialposition of the client at a given point in time. If the client in"The Audit" is improperly accounting for wages paid to some workersas payments to independent contractors when those workers are infact common law employees, the result would be an understatement ofthe clients payroll tax expenses and an understatement ofliabilities for potential back taxes, penalties, and interest. Thisis something that generally accepted auditing standards require theaccounting firm to call to the attention of management of theclient, and it could require a "qualified opinion" (i.e. disclosurein the financial statements) if management refused to modify itsstatements to reflect the correct expenses and liabilities involved.Moreover, under the professions guidelines, Sue, as a staffaccountant, would have an obligation to document the disagreementwith her supervisors as part of the working papers on the audit.Finally, the accounting professions code of ethics prohibits anaccountant from disclosing confidential information to thirdparties. Therefore, under the guidelines of the profession, atleast, Sue should not report the clients practice to the state orfederal government tax authorities.Not all of the above specialized knowledge concerning the positionof the accounting profession is necessary to use "The Audit" in non-accounting classes. The information is included in this teachingnote for use in upper level accounting classes where students mayhave had some exposure to the professions guidelines. It is alsoincluded to provide background information for instructors who maywish to use the case in general management courses which typicallyinclude a broad cross-section of business majors.It should be emphasized, however, that the case is intended toillustrate the discovery of facts which might lead a reasonableauditor to take further action. The relevant question is whether ornot Sue should continue to pursue the matter in light of thepressure from her peers and the partner in charge of the audit forher to "drop it." VIII. STUDENT PAPER Sue is in a difficult position, one with far-reaching consequences. Tomake it worse, she is feeling a great deal of pressure to do nothing,and the others involved are presenting what seems to be quite a fewarguments supporting their position.Several issues were raised to promote the "dont make waves" positionand to be a team player. Paul, the

partner in charge of the audit,brought up the point that others in the industry of the company inquestion followed the same practice. He further encouraged no actionby stating that to pursue the issue could mean the loss of the accountand hinted at negative repercussions for Sue if this were to happen.Sues co-workers, Bill and Mike, echoed the sentiment by urging Sue tobe a "team player." They pointed out that the practice had beenignored in the past. If Sue were to follow through, her co-workerscareers would be jeopardized. In addition, her relationship with hersuperiors would be so threatened, it could possibly force her to leavethe firm.The arguments for raising the issue were not many in the case itself(see Exhibit 1). The fact that the practice was wrong was confirmed.Despite evidence to the contrary, the firm endorses high ethicalstandards and highlights the ethical responsibilities of a CPA. Also,Sues conscience would bother her if she were to do nothing.The support for Sues speaking up is far greater than mentioned in thecase. If the authorities were to discover the understating of taxes,the company could be fined as well as forced to pay back taxes. Thiswould, in all likelihood, be a material amount. The stockholders relyon an auditors clean opinion to ensure that there is not a materialdeviation.If she were to overlook this situation, Sue could be expected tooverlook the next one. It seems as if once a person backs down, it iseasier to do so again. This step could have serious consequences forSues career as a CPA.As stated previously, Paul hinted at possible negative actions were Suenot to let the issue die. I question whether this is a type of firmone would want to work for anyway. To tailor an opinion because of therisk of losing a client is a very dangerous practice and a highlyunethical one. It defeats the entire concept of an auditorsindependence.All these factors are very significant in making the decision, but theone which most moves me to recommend pursuing the issue is Suesfeelings. If she does not feel comfortable with the situation, sheshould act on it. To deviate from ones own standards could lead to alifetime of regret. Because of this and the other reasons, Sue shouldfollow through on this issue.