Love and a Question: What Should the CPA Do? Irene Mac, Elisa Montoya, and Hong-Yi Shih (October 24th, 2007)

Summary of the Case I nt h ec a s e , “ L o v ea n daQu e s t i o n : Wh a t Sh o u l dt h eCPADo ? ” T o d dDa v i si san e wg r a d u a t ewh oh a sp a s s e d his CPA examination and is working as a staff accountant for a small, but highly regarded CPA firm. Todd learns, during conversation over dinner with his wife Carrie that her current employer, Mrs. Cook, has not been ringing up cash sales and hence might be involved in a form of tax fraud. By not ringing up cash sales, a company does not recognize part of its revenue on its books and as a result not all of its r e v e n u es h o wsu po nc o mp a n y ’ sf i n a n c i al statements and tax returns. T o d d ’ sf i r md o e sn ob u s i n e s swi t hMr s . Co o k ’ sc o mp a n y, but Todd personally knows Mrs. Co o k ’ sa c c o u n t a n t , Harold Heywood, wh oh a sb e e np a r t n e r i n gwi t hMr . Co o k ’ sh u s b a n di na t l e a s t o n eb u s i n e s s . Todd is conflicted as to what to do with the information he has just learned because Carrie had worked long and hard hours to support the couple while he was in school and she had just found a position with her current employer that she enjoys. Should Todd keep what he knows to himself or go to the authorities? Perhaps Todd should speak to Mr. Heywood or someone at his CPA firm about the situation. In this paper, we will explore different scenarios for Todd based on the two moral doctrines. We will analyze the consequences of his actions in the different scenarios, and determine the best way for Todd to handle the situation. The two moral doctrines that are used to approach the dilemma faced by Todd are utilitarian ethics and categorical imperative.

Utilitarian Ethics Approach The utilitarian approach to ethics, originating from the Greek philosophers Epicurus and developed by Jeremy Bentham and John Stuart Mill, claims that human beings behave according to calculated consequences. The thinkers of this school believe that the consequences of an action should be either beneficial or harmful to all concerned parties;

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people calculate the overall utility (i.e. benefits or harms) resulting from each alternative and then choose the one that maximizes overall benefits. The morally right action is the one which generates the most benefits. Utilitarianism suggests that whichever method is used to solve the dilemma to achieve the maximum benefit does not matter. The method could be manipulation, telling the truth and/or lies, coercion, whatever it takes, as long as the maximum benefit is achieved. While contemplating which action he will take, Todd should thoroughly think through the different scenarios. It is difficult to measure the outcomes yet Todd must weigh the benefits and harms to all parties involved during his decision making process. Lastly, Todd should pick the action in which the greatest benefits can be achieved. Under the utilitarian approach, the utilities f r o me a c ho f T o d d ’ sactions are analyzed as follows. 1. Convince Carrie to Resign at Once Todd should understand that it would not be easy for Carrie to leave the company, especially when considering her bright future as an apprentice of Mrs. Cook. Ho we v e r ,Mr s .Co o k ’ sc u r r e n tpractice seems to suggest that she does not value ethical behavior in the workplace, particularly within her own company. T h el a c ko f a“ d o i ng-the-right-t h i n g ” c u l t u r ewo u l de v e n t u a l l ys h a d o w any great performance of a company. In addition, if it is proved that Mrs. Cook is hiding income and thus committing tax fraud, the Internal Revenue Service (IRS) would likely step in and investigate. The legal and tax liabilities will burden t h ec o mp a n y ’ sf i n a n c i a l p o s i t i o nand lead to troubles not only for Mrs. Cook but also for Carrie. Considering all of the above, resignation from the company may be the right decision for Carrie to make. Though temporarily suffering, she will eventually benefit in the long run from her decision to resign. 2. Advise Carrie to Re p o r t Mr s . Co o k ’ sPractice Di r e c t l yt ot h eCo mp a n y ’ sExternal Auditor as well as the IRS Based on the fact that Carrie is very loyal to Mrs. Cook and that she would never believe that Mrs. Cook is a racketeer, it is impossible for Carrie to report what Mrs. Cook asked her to do either to the outside auditor or to the IRS. This alternative is very difficult to execute. Ho we v e r , i f Ca r r i et a k e sT o d d ’ sadvice to take the action, the outcomes can be measured.

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First of all, though personal monetary reward should never become the motivation for disclosure, if this action leads to a collection of additional tax, Carrie could receive a monetary reward from the IRS (Verschoor, 2005). Carrie should disclose this matter based on the good it will do for the general public or investors. If Mrs. Cook is h i d i n gi n c o me ,Ca r r i e ’ sa c t i o nwi l l b ea b l et oprotect the interests of potential investors and strengthen the pub l i c ’ s confidence in the tax system. T h ep r e s s u r ef r o mt h ec o mp a n y ’ ss t a k e h o l d e r swi l l a l s of o r c et h ec o mp a n yt oi mp r o v e its internal controls over financial reporting, as well as its ethical standards. Un d e r t h i sa l t e r n a t i v e , Ca r r i e ’ sh a p p i n e s swi l l b es a crificed and the Cooks ’ financial situation may be ruined, but the benefits of the general public and potential investors will be optimized. 3. Discuss the Matter with Mr. Heywood Todd, as a professional courtesy, may want to discuss this matter with Mr. Heywood. However, there is not s u f f i c i e n ti n f o r ma t i o nf o rT o d dt od e t e r mi n ewh e t h e rMr .He y wo o dk n o wsa b o u tMr s .Co o k ’ sp r a c t i c eand how Mr. Heywood values ethical behaviors as a professional. Moreover, because of the business partnership between Mr. Heywood and Mr. Cook, Todd needs to consider the probable close friendship between Mr. Heywood and the Cooks. The lack of information makes the situation so complicated that the outcomes to each party are hard to measure. 4. Do Nothing Todd could ignore and walk away from the situation which stands in front of him. He has no actual evidence of wrongdoing and all his information about the situation is based on hearsay from his wife. Furthermore, Mrs. Cook is n o to n eo fh i sf i r m’ sc l i e n t sa n dh i sk n o wl e d g eabout her company is limited. It is possible that Mrs. Cook has a perfectly reasonable explanation for her actions or that Carrie misinterpreted the situation entirely. If Todd does nothing, Carrie wi l l s t i l l h a v eh e r j o bwi t hMr s . Co o k ’ sc o mp a n ywh e r es h es e e sareal future for herself, Mr. Heywood wo u l dk e e pp r a c t i c i n g , a n dMr s . Co o k ’ sc o mp a n ywo u l dc o n t i n u et oo p e r a t e , p e r h a p sf a l s e l yr e p o r t i n gi n c o met ot h e IRS and evading taxes. Even if Mrs. Cook was discovered committing tax fraud and Todd did nothing, no one would ever know he had information that might have been incriminating for her.

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However, if this were the case and Mr s . Co o k ’ sc o mp a n yis evading sales taxes, business income taxes, and personal income taxes, the general public and the government, which requires tax revenues from companies to serve t h ep u b l i c , ma yb eh u r t b yMr s . Co o k ’ sp r a c t i c eo f not paying her share of taxes. Moreover, the company would be undervalued based on its financial statements and tax returns. If Mrs. Cook ever wanted to sell her company, the p r o s p e c t i v eb u y e r wo u l db emi s i n f o r me da b o u t t h ec o mp a n y ’ sp e r f o r ma n c e . On the other hand, if it was discovered that Mr. Heywood was acting dishonestly and Todd had knowledge of the wrong doing, it would reflect badly on the entire profession and all accountants would be under scrutiny because o n ea c c o u n t a n t ’ sa c t i o nr e f l e c t o nt h eo t her members of the profession. The accounting profession as a whole would be viewed negatively as a result of Mr. He y wo o d ’ sd e c e p t i o n . Carrie would still likely beo u t o f aj o ba sMr s . Co o k ’ s c o mp a n y ’ sr e p u t a t i o nwo u l db er u i n e da n dthe company may go out of business.

Ka n t ’ sCategorical Imperative The Categorical imperative argues that the moral system is not based on subjective considerations; human beings must unconditionally perform actions to fulfill obligations. This school of morality was defined by Immanuel Kant (1785),a n df o r mu l a t e da s“ a c to n l ya c c o r d i n gt ot h a tma x i mwh e r e b yy o uc a na tt h es a met i mewi l l t h a ti ts h o u l d b e c o meau n i v e r s a l l a w” (p. 44). Examples of this morality are: -

The reason people do not kill is because people shall not kill, but not because killing cannot create the greatest overall happiness. People who kill are affected by their judgments about the benefit of killing; without those judgments, they innately know that killing will never be justified.

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T h ewo r d“ p r o mi s e ”i t s e l f i mp l i e st h eme a n i n go f “ k e e p i n gt h ep r o mi s e .”I f p e o p l ema k i n gp r o mi s e sh a v en o i n t e n t i o nt ok e e pt h ep r o mi s e s , t h e r es h o u l dn o t b es u c hat h i n ga s“ p r o mi s e .” Kant’ smoral philosophy assumes that every individual in the same situation will do the same thing,

unconditionally demanding performance of an action for its own sake. It maintains a concrete and practical method for

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evaluating particular actions of several distinct varieties. The morality emphasizes that the ethics decision should be made a priori; any additional analysis will disturb the original motivation of fulfilling obligations (Kemerling, n.d.). I na p p l y i n gKa n t ’ smo r a l d o c t r i n e ,t h eI n s t i t u t eo fMa n a g ement Accountants (IMA) provides the Statement of Et h i c a l Pr o f e s s i o n a l Pr a c t i c et or e s o l v eCa r r i e ’ se t h i c a l c o n f l i c t a sa ne mp l o y e eperforming accounting duties. Carrie is not advised to report the problem to any authorities before confirming that there is a clear violation of the law. It is also not appropriate for Carrie to communicate this matter with Todd because Todd is not currently employed or involved with any aspect of Mrs. Co o k ’ sc o mp a n y . According to the Statement, Carrie is encouraged to 1) initiate a confidential discussion with an IMA ethics counselor to clarify the ethical issue and obtain a better understanding of possible course, and 2) identify legal obligation and rights concerning the ethical conflict by consulting her own attorney. As for Todd, he has been taught that financial statements and tax returns are presumed to be accurate and reflect the fiscal reality of a company. Hi st h o u g h t c a nb eo n eo f t h eb e s t i l l u s t r a t i o n so f Ka n t ’ sc a t e g o r i c a l i mp e r a t i v e since if companies do not have the intention to retain the integrity in financial reporting; there should not be such a thing as “ financial statements. ” To resolve his conflict, Todd may want to approach and discuss his concerns with higher level management within his own firm. When speaking to management, Todd must be prepared to present the facts and disclose all that he knows. There will be a dilemma as Todd does not know all the facts –he only knows that Mrs. Cook had asked his wife not to ring up cash sales. This could be a problem as there are most likely more facts that should be known before he accuses Mrs. Cook of anything. Going to management before an external agency is strongly encouraged by the American Institute of Certified Public Accountants (AICPA). Management may be able to provide suggestions as to what Todd should do. It is always better to get a second opinion in general, especially from someone who is completely unbiased. If Todd does report the situation to the IRS, he could damage his reputation if it was found that there was no fraud being committed. When analyzing the different scenarios, Todd should think of his obligation to the profession and follow the AICPA Code of Professional Conduct.

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The AICPA Code of Professional Conduct was created to provide guidance and rules to all members of the AICPA. It consists of 1) Rules, which govern the performance of professional services by members, and 2) Principles that provide the framework for the Rules. According to the Code, the Pr i n c i p l e s“ g u i d eme mb e r si nt h ep e r f o r ma n ce of their professional responsibilities and express the basic tenets of ethical and professional conduct. ”They “ call for an unswerving commitment to honorable behavior, even at the sacrifice of personal advantage”( ETSe c t i o n5 1– Preamble .02). To apply the Code, Todd, as a CPA candidate, should uphold his obligations to the accounting profession. Regardless of any personal cost, the Code must be followed. Even though Todd is not directly working for Mrs. Cook, he is still committed to his career and should act accordingly. ET Section 53 –Ar t i c l eI I o f t h eCo d e , T h ePu b l i cI n t e r e s t s t a t e st h a t CPAs“ s h o u l da c c e p t t h eo b l i g a t i o nt oa c t i n a way that will serve the public interest, honor the public trust, and demonstrate co mmi t me n t t op r o f e s s i o n a l i s m. ” The c o n c e p t , t h o u g hp r o v i d e do n l yf o rCPAs ’ g u i d a n c e , is particularly applicable to all concerned parties in this case. Not only do Todd and Mr. Haywood have professional responsibilities to honor the public trust, but Carrie and Mrs. Cook should also consid e rt h ep u b l i c ’ si n t e r ests when conducting business. The Section also states that CPAs should "discharge their responsibilities with integrity, objectivity, due professional care, and a genuine interest in serving the public." If Mr. Heywood was aware that Mrs. Cook had asked Carrie to not ring up any cash sales, he should inform Mrs. Cook of her wrong doing and educate her on the consequences. If she let him know that she wasn't in fact going to report her cash sales, he would have to let her know that he has no other choice but to report her to the IRS and that he must terminate his current engagement with her. If Mr. Heywood has knowledge of what Mrs. Cook is doing and he does nothing about it, ET Section 501 - Acts Discreditable is applicable. "Member shall be considered to have committed an act discreditable to the profession when the member fails to correct an entity's financial statements that are materially false and misleading." Mr. Heywood would not only be violating the Code but he would also be committing an act of tax fraud according to the IRS.

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Conclusion Todd must decide what he is going to do with the little information that he has. Todd could convince Carrie to resign, advise Carrie to report Mrs. Cook's practice directly to the company's external auditor as well as the IRS, discuss the matter with Mr. Heywood, or do nothing. The IMA states that Carrie could initiate a confidential discussion with an IMA ethics counselor to clarify the ethical issue and obtain a better understanding of possible course of action, and identify legal obligation and rights concerning the ethical conflict by consulting her own attorney. The AICPA states that Todd should uphold his obligations to the accounting profession through integrity, objectivity, and due professional care. Todd could blow the whistle, reporting Mr. Heywood and Mrs. Cook, which is professionally and morally justifiable yet harmful to all concerned parties in this case. Although Todd is working for a CPA firm and does intend to become a CPA, he has not fulfilled the experience requirement and technically not yet a CPA. The AICPA Code of Professional Conduct for this reason is not necessarily applicable to his situation. Todd also does not have any authority or control over Mr. Heywood so he has no obligation to discuss or report his findings with Mr. Heywood, the company's external auditor, and/or any related authorities (AICPA, ET Section 91 - Applicability). Todd is also not advised to directly communicate Mrs. Cook's current practice with either Mr. Heywood or the company's external auditor because Todd is not currently engaged wi t hMr s . Co o k ’ sb u s i n e s s . After considering all of his options, Todd's best bet would be to do nothing. He is lacking information and accusing Mrs. Cook of tax evasion could be a career changing event. If Todd knew for a fact that Mrs. Cook was understating her revenue, he could report her to the IRS. Todd could approach Mr. Heywood and if he was an accessory, Todd could also report him to the IRS. Todd is unsure if Mrs. Cook is understating her revenue and if Mr. Heywood is an accessory; therefore he should do nothing. The AICPA Code of Conduct encourages discussion with management, which he could do, yet Todd is lacking information and Mrs. Cook is not a client of his firm, which also leads to Todd doing nothing. While some might think doing nothing is not the morally right thing to do, Todd must do nothing.

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References American Institute of Certified Public Accountants. AICPA Code of Professional Conduct. Retrieved October 5, 2007, from http://www.aicpa.org/about/code/index.htm Institute of Management Accountants. Resolution of ethical conflicts. In Statement of Ethical Professional Practice. Retrieved October 3, 2007, from http://www.imanet.org/about_ethics_statement.asp Kant, I (1785). Foundations of the Metaphysics of Morals, trans. Lewis White Beck. New York : Macmillan, c1969. 44 Kemerling, G (n.d.). Kant: The Moral Order. In Philosophy Pages. Retrieved October 5, 2007, from http://www.philosophypages.com/hy/5i.htm Verschoor, C. (2005, January). Is This the Age of Whistleblowers? Retrieved October 3, 2007, from http://www.imanet.org/pdf/2849.pdf

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