THE INCREASING FOCUS ON ETHICS HAS CREATED
an opportunity for CPAs to help their companies
foster a corporate culture that promotes ethical decision
making. It also has encouraged more boards of directors to be
involved with hiring internal audit and other accounting
employees with financial reporting and control
CPAs NEED TO CONVEY THE CONCEPT OF AN ETHICAL corporate culture to a broad range of people including the board, management and other employees. They can do this by setting the tone and delivering the message that an ethical approach to decision making is important.
CPAs SHOULD PARTICIPATE IN DEVELOPING their company’s audit committee charter by offering input on internal controls and oversight of the accounting and financial reporting processes.
NPOs AND PRIVATE COMPANIES ALSO ARE REEXAMINING their approach to ethics as states consider applying elements of Sarbanes-Oxley to these entities. Even though they aren’t required to do so, a number of private companies are reviewing their ethics and compliance policies, especially those looking ahead to possible public offerings or sales to public companies.
|KAREN M. KROLL is a freelance business journalist.|
o secure her position as director of internal controls and audit with Comfort Systems USA Inc., CPA Melissa Frazier met with most of the executive management team as well as with members of the board of directors’ audit committee. “The audit committee hired me,” she says. “Officially, I report to them, although administratively I report to the CFO.” As with many internal audit directors, Frazier’s role includes helping the company’s accounting staff members understand how ethics apply to their day-to-day responsibilities.
Frazier’s experience with the $785 million provider of commercial and industrial heating and ventilation systems isn’t unique. Industry observers agree that because of their understanding of financial reporting and their view into operations, CPAs often are in the best position to take the lead in helping their companies develop a vigorous ethical culture. Thus many corporate boards—influenced by the Sarbanes-Oxley Act of 2002—are taking a more active role in ensuring companies implement and follow sound ethics policies.
Given that most ethical dilemmas in the workplace have a clear financial dimension, board members now are more involved in hiring internal audit and other accounting employees. “There has been, and will continue to be, increased interaction between the audit committee and an organization’s financial people,” says Curtis Verschoor, professor emeritus of accounting at DePaul University in Chicago. This article will show how the focus on ethical corporate behavior is affecting accountants in businesses as well as in not-for-profit organizations (NPOs). It also will review the changing relationship between accounting staff and boards of directors and identify some best practices CPAs can follow to foster a corporate culture that promotes ethical decision making.
A 2004 survey by the Conference Board showed CPAs how the increased focus on corporate ethics is reshaping the responsibilities of corporate boards—and CPAs—in companies around the globe. The New York-based research organization published Ethics Programs—The Role of the Board: A Global Study in February 2004. The survey examined the activities of boards of directors at 165 companies in the United States, Canada, Great Britain, India, Japan and Western Europe. (For details on survey results, see “ The Board’s Role in Ethics .” )
|U.S. Ethics Trends
Source: Ethics Programs—The Role of the Board: A Global Study, The Conference Board, New York City, www.conference-board.org , 2004 survey of 165 companies.
Several factors are behind the increased board involvement in ethics programs revealed in the survey. Clearly the shift is one result of the implosions at Enron, Adelphia Communications and other companies, as well as the passage of the Sarbanes-Oxley Act. Any company listed on the New York Stock Exchange must comply with the Sarbanes-Oxley requirement that audit committees establish procedures to handle complaints concerning accounting, internal controls and auditing matters.
Lawmakers in other countries also have been zeroing in on corporate governance and ethics. In April 2003 Japanese lawmakers amended their Commercial Code to allow companies with market capitalization of 500 million Japanese yen or more (about $4.8 million) to adopt a corporate governance style similar to that of the United States. Board members must be separate from day-to-day decision makers and a majority of directors must be independent.
In the United Kingdom lawmakers revised the Combined Code, which sets corporate governance standards. The changes included requirements that at least half of directors be independent and that audit committees be composed entirely of independent directors who are not executives of the company.
IMPACT ON CORPORATE CPAs
As they do their jobs, corporate CPAs can help convey the concept of an ethical corporate culture to a broad range of people, including the board of directors, other employees and the executive team, and help companies adopt procedures that allow an ethical culture to flourish. That includes participating in the development of audit committee charters, control procedures and the processes the company uses to issue information to interested outsiders.
It’s not appropriate for CPAs at all levels to volunteer for such tasks. Some responsibilities are better suited to accountants at the manager level or higher. But entry-level CPAs still can make a contribution and “should be aware of opportunities to play a supporting role,” says Chris Curtis, vice-president with the consulting firm Ashton Partners in Chicago. For instance, less senior CPAs can volunteer to research new FASB pronouncements and write a memo on how the company can implement them. Still, speaking up can be daunting for CPAs at any level. It’s important to recognize that if CPAs don’t accurately communicate the company’s financial results—positive or negative—they aren’t doing their jobs.
To be effective in their new roles, accountants have to operate in a new mode, says Sal Salibello, CPA, managing partner with Salibello & Broder LLP, New York. “Corporate accountants must become less timid. They can’t just perform a service function, but instead must report on and protect the assets of public shareholders.”
CPAs first have to help set the tone, and convey the message that an ethical approach to decisions and transactions is important. “As senior financial executives we constantly want to be on the record in public so our employees hear our message that ethics are important throughout our business, whether it be in financial reporting, compliance with regulations or honoring commitments,” says James Harris, CPA, executive vice-president and CFO of MedCath Corp., a Charlotte, North Carolina-based operator of 13 hospitals.
To accomplish this, accountants should offer their insight on how ethics apply within their organizations to people at all levels. When Frazier of Comfort Systems meets with coworkers at the company’s corporate headquarters and 45 field locations, she makes a point of describing how Comfort Systems applies its ethics policies to its day-to-day business. “CPAs are taking and should take a proactive role in explaining what an ethical corporate culture means: Here is what the law says and here’s what it means to us,” she says.
Frazier says one particularly thorny topic that prompts much discussion is materiality. She and her accounting colleagues regularly discuss which events are material to the company and should be disclosed, and when disclosure would only make the company’s financial reports more confusing.
For example, assume a company has $10 million in inventory, 90% of which is valued using the Lifo method. One division—the remaining 10%—uses the Fifo method. Management needs to determine whether the valuation differences resulting from the company’s using two inventory methods is material to the company’s overall financial statements. If not, disclosing the difference probably would only make the entity’s financial report more difficult to understand.
As Frazier’s experience illustrates, fostering an ethical culture requires going beyond what’s required to do your job. “You need to put the entity’s overall goals in the right perspective,” says Curtis of Aston Partners. “Ask, ‘Who are we here to serve?’ It’s not ourselves, but our community, customers and shareholders.”
CPAs should tailor their discussions to their intended audience, Curtis adds. For instance, in talking with employees charged with developing new business, they should bring up ethically precarious situations this group might encounter and the company’s approach to managing them. In some instances that might mean stating that the company forbids using bribes to win clients—even if offering bribes is an accepted way of doing business in some parts of the world. Curtis offers another example: Many salespeople who close large deals are, not surprisingly, excited to talk about them. To prevent information on material transactions from leaking out, CPAs should discuss with the sales staff the regulations governing the disclosure of material information to investors.
It’s also a good idea for CPAs who serve as CFOs, internal audit executives or similar senior managers to provide appropriate input to the nonfinancial staff when the company issues financial releases. One critical role is to caution against technical compliance with regulations that actually might mislead statement readers. For example, if the company’s selling an asset results in a one-time multi-million-dollar gain, the accounting staff should instruct the company’s public relations team not to mislead investors by hyping the one-time bump to the company’s bottom line.
WORKING WITH THE BOARD
In addition to networking with others in the company, CPAs need to develop their own relationships with both the board of directors and its audit committee. As a starting point, Salibello says corporate accountants should volunteer to participate in the development of the audit committee charter. Their input typically will concern internal controls and oversight of the organization’s accounting and financial reporting processes. Several points of control are key to a strong charter, he notes, including directives stating that the independent auditor report directly to the audit committee and that the committee annually examine a report by the independent auditors on the company’s internal control procedures.
The CFO in particular, along with employees at all levels in the accounting and finance departments, needs to develop strong relationships with the board. “The CFO is in a unique position to monitor ethical practices by other team members,” says Richard Sykes, CPA, vice-president of corporate services and CFO of Union Rescue Mission, a $45 million NPO in Los Angeles. CFOs must be able to alert the finance committee chairperson if ethically questionable situations arise. This might be the case, for example, if a director or primary fundraiser inflates donations to make it appear he or she has been extremely successful in raising money for the organization. One way a fundraiser might do this is to include in the donation tally an estimate of the amount a certain person is likely to donate without any documentation (such as a pledge letter) to support the estimate.
As Frazier’s hiring experience at Comfort Systems shows, the link between internal auditors and the board’s audit committee is tightening. “The internal auditor is part of management, but with a dotted-line relationship to the audit committee,” says Barbara Hackman Franklin, president and CEO of Washington, D.C-based Barbara Franklin Enterprises. Franklin also sits on the boards of Aetna Inc., Dow Chemical Co., GenVec Inc., MedImmune Inc. and Milacron Inc.
Internal auditors need to set up regular, private meetings with the audit committee to review any concerns or questionable behavior they may have uncovered. “I really believe in this process,” Franklin says, “and when I chair the committee, I always do this.” She also receives an annual report from the internal audit group providing an overview of the strength and effectiveness of the company’s internal controls and the level of independence, resources and clout the internal auditors have within the organization. “If resources look thin, the audit committee can take a stand and go back to management,” she says.
At Comfort Systems, Frazier regularly provides the audit committee with summaries of the resources available to her group, as well as background information on new personnel and an overview of the training classes the internal audit staff attends. But this isn’t the case at every company; Salibello says he still sees instances where the internal audit function reports only to the CEO. “Depending on how dominant the CEO is, he or she can try to inject him- or herself into the process,” he says. “In today’s climate there’s no good argument for this reporting relationship.”
Even CPAs who are not on the internal audit team should try to build relationships with the board and initiate discussions on how to handle situations that are ethically ambiguous. For instance, they should talk with board members about how the company recognizes revenue. “Educate your board or the audit committee on the ins and outs of accounting for your business,” says Curtis. The goal is to make sure the company’s revenue recognition policies match those of its peers, so investors can make comparisons more easily.
NPOs AND PRIVATE COMPANIES
Public companies aren’t the only organizations reexamining their approach to ethics and revamping relationships between board members and the accounting staff. Some NPOs, particularly larger ones, also are looking closely at these roles. In part this is a result of debates by regulators in New York, California and several other states on whether to apply elements of Sarbanes-Oxley to NPOs, says Sykes. Donors and board members also are more closely scrutinizing accounting policies at many larger NPOs.
Union Rescue Mission has incorporated some practices common to the corporate world. For instance, after the annual audit is complete, the external audit partner and Sykes review it with the mission’s finance and administrative committee, which is similar to the audit committee in the for-profit world. They discuss the scope of the audit, how well it went (or didn’t), the level of cooperation Syke’s staff provided and any improvements in internal controls the auditors recommend.
Then Sykes and the other staff employees leave, letting the outside auditor talk directly with committee members with “no minutes and no staff in attendance.” While this practice is becoming common in the corporate world, he says it’s just emerging in the NPO arena.
A number of private companies also are reviewing their ethics and compliance policies, and considering whether to implement the standards for public companies, even though they aren’t required to do so, says Cathy Fleming, a partner and chair of the corporate integrity and white-collar crime practice group of law firm Edwards & Angell LLP in New York. This is especially true for companies looking ahead to possible public offerings or sales to publicly held companies.
IN THE SPOTLIGHT
Even though accountants at many organizations are working diligently to review and improve their approach to ethics and compliance, not all companies are on board to the degree they need to be, says Jane Salter, CPA, a Tampa, Florida-based partner with Ernst & Young. “Some medium-sized public companies still have yet to get engaged. They think it’s just a weekend project.”
The many CPAs who are stepping up to today’s challenges are boosting their profiles within their organizations, as colleagues seek their input on the ethical dimensions of accounting rules and business transactions. “The role of CPAs has been elevated,” says Frazier of Comfort Systems. “They have a spotlight shining on them” and should step to center stage and be recognized.The Board’s Role in Ethics
T he involvement of corporate boards in establishing and ensuring compliance with ethics programs is growing. This was one of the more significant findings in the Conference Board survey of ethics policies. “Some 10 to 15 years ago, it would have been unthinkable for a director to be responsible for company ethics or compliance programs. It would have been considered micromanagement,” says Ronald Berenbeim, the study’s author and a principal researcher with the Conference Board.
That’s no longer the case. Today, 66% of U.S. companies and all Indian companies surveyed said their companies’ codes of ethics were established by board resolution. That’s up from an average of 21% of U.S. companies in 1987. Board members in all countries in the study are taking similar approaches to ensure their companies’ compliance with strong, effective corporate ethics programs, although the United States leads the effort. “What came through to an appreciable degree was the commonality of issues in all the regions we studied and an increasingly similar approach to dealing with them,” says Berenbeim.
For instance, more than half of all board members said they reviewed their company’s ethics programs regularly. Responses ranged from 54% in Japan to 78% in the United States. Similarly, about half said their boards reviewed their companies’ ethics training programs. In Western Europe the percentage of companies that said so was 42%; in the United States it was 61%.
One example of regional differences: In the United States, audit committees oversaw the ethics programs in more than three-quarters (77%) of companies, while in Japan an ethics committee was responsible in 63% of cases. In India, responsibility was fairly evenly split; the audit committee handled oversight in 40% of companies, ethics committees had responsibility in 30% and governance committees took charge in the remaining 30%.
Director independence was one area in which opinions and practices diverged. Both in and out of the United States executives questioned the prevailing American view that independence can be measured by the absence of conflicts of interest—such as business contracts—between directors and the companies on whose boards they serve.
The study found no evidence the current director independence requirements “afford shareholders sufficient assurance of an independently functioning board.” Rather, even supposedly independent directors often failed to question ideas and challenge assumptions.
Nonetheless, independent directors (as defined in the United States) made up the ethics oversight committees in 85% of U.S. companies responding to the survey. In Japan the result was almost the exact opposite: 82% of companies reported their ethics oversight committees consisted entirely of nonindependent directors. Western European companies were in the middle: 11% of ethics oversight committees had only nonindependent directors; 53% were a mix of independent and nonindependent; and 37% were composed only of independent directors.