Why Integrity in Accounting is Essential
Oct 07, 2020 | By Michael Whitmire
When engineers and architects design a building or a bridge, the components must hold together as an integral whole to support the weight of the structure. If the foundation lacks structural integrity, the whole thing may collapse or become unusable, like the Leaning Tower of Pisa.
I think of accounting as the foundation of business. Like a building with a weak foundation, a lack of integrity in accounting can cause the entire business to fall in like a house of cards. And, similar to the collapse of a building, that crash can destroy the lives of innocent people, who just happened to be in the wrong place at the wrong time.
That’s precisely what happened when Enron imploded in 2002 and 4,500 employees lost their jobs. Another 24,000 lost up to $1 billion from their retirement plans. That massive collapse happened because “the smartest guys in the room created the illusion of a prosperous company” for their own personal gain. Enron’s problems even spilled over to its auditing firm, Arthur Andersen. The downfall of that venerable accounting firm tainted the reputations of thousands of accountants who had nothing to do with Enron, but were working for the wrong firm at the wrong time.
What does integrity mean?
The Business Dictionary defines integrity as:
- Strict adherence to a moral code, reflected in transparent honesty and complete harmony in what one things, says, and does.
- State of a system where it is performing its intended functions without being degraded or impaired by changes or disruptions in its internal or external environments.
Integrity isn’t just following the rules, but acting in a way that’s wholly consistent with the intent of those rules. Integrity means openly and honestly aligning your conduct with the foundation of an internal code of ethics. It also means being willing to admit defeat or failure when things don’t work out. It means being candid and coming clean when you make a mistake.
What is the difference between objectivity and integrity?
Objectivity means freedom from bias, judgment, or prejudice. It means making decisions based on the facts at hand, and not on one’s preferences or opinions. Integrity includes all of that, but it goes deeper than just being free from conflicts of interest. Someone with integrity also adheres steadfastly to a central code of ethics.
What is the importance of integrity in accounting?
Accounting is the foundation that business owners, executives, investors, and other stakeholders depend on to make decisions. If that foundation lacks integrity, that can spell disaster. That’s what happened recently with German payments processor, Wirecard, who apparently fabricated about $2 billion in assets. In late 2019, Wirecard had a plan to take over Deutsche Bank. Seven months later, they filed for insolvency when the fraud came to light.
Like most providers of professional services, accountants have standards that govern their practice. The code of professional conduct for the American Institute of Certified Public Accountants (AICPA) says integrity “is the quality from which the public trust derives and the benchmark against which a member must ultimately test all decisions.” That code of ethics also reminds certified public accountants that the public relies “on the objectivity and integrity of members to maintain the orderly functioning of commerce.”
CPAs who audit public companies must additionally follow standards from the Public Companies Accounting Oversight Board (PCAOB), which also include rules on integrity and objectivity.These codes of conduct and rules are in addition to the accounting standards we have to follow.
Integrity is what the public expects from the accounting profession to keep the engine of commerce running smoothly. Like air, accounting ethics are most noticeable when absent.
Integrity is also essential for building strong accounting firms and accounting teams. The best and brightest will take their talent elsewhere if they can’t trust team members to be accountable and to act from a foundation of integrity. Some may leave public accounting altogether if they encounter a toxic work environment that lacks integrity.
Integrity in accounting is especially vital for small business owners, who may see accounting as a cost with only dubious benefits. So they may try to handle their bookkeeping themselves, or hire a low cost provider, who may or may not be competent. Saving a few bucks now may cost more in the long run when you need a professional accountant to clean up the mess, or when the IRS audits your tax returns.
Why are integrity, honesty and transparency essential in financial reporting?
Our investment markets and our entire financial system all depend on integrity, honesty and transparency in financial reporting. Honesty means that the reporting of transactions reflects the total reality of what happened. Transparency means there’s no attempt at deceit for personal gain.
Integrity means that the accounting practices of a company adhere to a consistent set of principles such as GAAP or IFRS. When everyone follows the same accounting principles, stakeholders have greater faith that the story those financial statements tell is trustworthy.
That story has to be consistent with all the other information that analysts sift through. Research by Baruch Lev indicates that only 5% of the stock prices for public companies comes from financial information published by those companies. If the reporting doesn’t jibe with the other information to comprise a consistent, integral whole, the market may punish that company.
Investors and stakeholders — which also include vendors and employees — need to know that they can trust the numbers, and that the foundation of that business isn’t going to collapse without warning. If stakeholders can’t trust the integrity of the financial statements, they may take their business relationships elsewhere. Trustworthiness is a key indicator from the public that your integrity is intact.
Ways to improve integrity in accounting
Sarbanes-Oxley was passed 2002, ostensibly to prevent the kinds of financial shenanigans that led to the failures of Enron, WorldCom, Global Crossing, Tyco, and Arthur Andersen. But laws don’t always compensate for a lack of integrity. Unethical businesses are always finding ways to cook the books.
Every accounting scandal begins with one or two people who decide that the short-term benefits of bending the rules far outweigh any possible long-term reputation damage. But so far, all of our laws about financial reporting, SEC regulations, and professional codes of ethics have proven less-than-effective in deterring bad actors. The best solution I can come up with is to model integrity aggressively so that it becomes the norm, not an exception.
Demonstrate integrity in all you do. Perfect integrity may be an ideal that we all strive for. But like a muscle,the more you exercise it, the stronger it gets. Don’t take shortcuts or the easy way out, but be willing to admit your mistakes and failings.
Talk about integrity. When you and your team discuss integrity and the importance of ethics and the importance of integrity frequently, that keeps everyone on the same page. It won’t feel awkward to say no when someone wants to push the ethical boundaries “just this once” (it’s never just once).
Call out lapses of integrity when you see them. Even if (and especially if) it’s you. This helps people around you recognize that something isn’t OK, and that someone has crossed a line they shouldn’t.
Use integrity as a benchmark for decisions. It’s not enough to just follow the GAAP. The accounting must also reflect the reality of what happened.
Consider integrity in hiring and firing decisions. Someone who lacks integrity makes a terrible team member, and a poor example of accountability. It’s best to just show these people the door.
Behave with transparency. Integrity means that your thoughts, words, and actions reflect your inner code of ethics. Springing a “gotcha” moment on someone is never a good way to get the best effort out of your team. Instead, treat others as you wish to be treated.
To build something that will endure, you need to first build a solid foundation, which must form an integral part of that structure. This applies equally to skyscrapers and to professions. Integrity in accounting is essential for ensuring that the accounting profession will exist long after we’re all gone.