AICPA Ethics Exam

Conflicts of Interest" interpretation (ET sec. 1.110) applicable to members in public practice

"A member or his or her firm may be faced with a conflict of interest when performing a professional service. In determining whether a professional service, relationship or matter would result in a conflict of interest, a member should use professional judgment, taking into account whether a reasonable and informed third party who is aware of the relevant information would conclude that a conflict of interest exists. A conflict of interest creates adverse interest and self-interest threats to the member's compliance with the 'Integrity and Objectivity Rule.'" Adverse interest threat. The threat that a member will not act with objectivity because the member's interests are opposed to the client's interests. [...] Self-interest threat. The threat that a member could benefit, financially or otherwise, from an interest in, or relationship with, a client or persons associated with the client. Other conflicts of interest may arise when two clients agree to merge or one client acquires another. Imagine that Company A wants to acquire Company B; both companies are your clients, and both ask your firm to perform services related to the acquisition. Were you to find yourself in this situation, you should apply the "Conflicts of Interest" interpretation, address any threats, and disclose the relationship to both companies. To provide professional services to both sides of this transaction, each party must agree to let your firm represent the other party. However, many CPA firms have policies in place that prohibit representing both sides in a merger or acquisition. In this scenario, you should first determine whether your firm has any such policy.

Integrity and Objectivity

"Integrity and Objectivity Rule" (ET sec. 1.100.001) "Integrity and Objectivity Rule" interpretation Applicable to members in business, the "Knowing Misrepresentations in the Preparation and Presentation of Information" interpretation (ET sec. 2.130.010) states (in part) the following: .05 Threats to compliance with the "Integrity and Objectivity Rule" [2.100.001] would not be at an acceptable level and could not be reduced to an acceptable level by the application of safeguards, and the member would be considered to have knowingly misrepresented facts in violation of the "Integrity and Objectivity Rule," if the member 1. makes, or permits or directs another to make, materially false and misleading entries in an entity's financial statements or records; 2. fails to correct an entity's financial statements or records that are materially false and misleading when the member has the authority to record the entries; or 3. signs, or permits or directs another to sign, a document containing materially false and misleading information. [Prior reference: paragraph .02 of ET section 102]. .06 Preparing or presenting information may require the exercise of discretion in making professional judgments. Preparing or presenting such information in compliance with the "Integrity and Objectivity Rule" [2.100.001] requires the member not to exercise such discretion with the intention of misleading. First, Sara should think about the following: 1. Comfort level. How comfortable would she be making a particular decision? If her decision became public knowledge, would she have any reservations about it? 2. Rules, regulations, and laws. Is the course of action she decides on consistent with the profession's codes of conduct and its regulatory and legal requirements? 3. Next steps. Having thought about these factors, it's time for Sara to decide. Remember that when dealing with complex ethical matters, there could be more than one reasonable and honorable solution. Let's see how Sara responds after she has mulled over the preceding considerations. -Comfort level: Don suggests providing Gerald, the donor, with financial statements that Sara has manipulated to make Helping Hands appear healthy. It would only be temporary, Don says. However, in removing the C.A. Transport liability from the charity's financial statements, Sara would be sharing a document she knows to be false. To give Gerald misleading financial information is to act in in bad faith. For these reasons, Sara would not feel comfortable doing as Don suggests. -Rules, regulations, and laws: Were Sara to doctor the financial statements, she would be in violation of AICPA's requirement that members maintain their integrity when performing professional services; this is because Sara would know that the statements were based on false information.(Note: The fact that Don is holding out hope that his friend Charles, the president of C.A. Transport, will waive the liability is irrelevant; it may be removed from the books only if and when Charles agrees to permanently waive the liability.) -Next steps: Sara decides that she must not misstate the financial statements as Don suggests. Under no circumstances should she subordinate her judgment to Don's and create false and misleading entries in the financial statements. To do so would represent a breach of her professional ethics; it also might subject her to disciplinary action by the AICPA and her state accountancy board and CPA society. This could threaten her ability to practice as a CPA. Exhibit: Excerpt from the "Knowing Misrepresentations in the Preparation and Presentation of Information" interpretation. .09 If the member knows or has reason to believe that the information with which he or she is associated is misleading, the member should apply appropriate safeguards to seek to resolve the matter, including the following: 1. Consulting the employing organization's policies and procedures (for example, an ethics or whistleblowing policy) regarding how such matters should be addressed internally 2. Discussing concerns that the information is misleading with the member's supervisor or the appropriate levels of management within the member's employing organization or those charged with governance and requesting such individuals to take appropriate action to resolve the matter. Such action may include the following: i. Having the information corrected ii. If the information has already been disclosed to the intended users, informing them of the correct information .10 If the member determines that appropriate action has not been taken and continues to have reason to believe that the information is misleading, threats to compliance with the "Integrity and Objectivity Rule" [2.100.001] would not be at an acceptable level. In such circumstances, the member, being alert to the requirements of the "Confidential Information Obtained From Employment or Volunteer Activities" interpretation [2.400.070], should consider one or more of the following safeguards: 1. Consulting with a relevant professional body 2. Consulting with the employing organization's internal auditor and external accountant 3. Determining whether any requirements exist to communicate to third parties, including users of the information, the organization's external accountant, or regulatory authorities 4. Consulting legal counsel regarding his or her responsibilities .11 If, after exhausting all feasible options, the member determines that appropriate action has not been taken and there is reason to believe that the information is still misleading, the member should refuse to be or to remain associated with the information. The member also should consider whether to continue a relationship with the employing organization. Pressure to breach the rules To achieve what they perceive as a "greater good" or to save jobs in an organization on the brink of failure, people are sometimes tempted to adjust financial statements. However, the code clearly states that you should not subordinate your judgment to that of another person. This rule applies even when that person is in a position of greater authority. In the course of your career, you could find yourself in a situation where you face pressure that threatens your compliance with the "Integrity and Objectivity Rule" when providing a professional service. Such pressure could be explicit or implicit; it could come from within your employing organization (such as a supervisor) or from outside (such as a vendor or customer). Sometimes pressure comes from yourself — for example, you need to meet your employer's internal or external targets and put pressure on yourself to achieve that goal. Regardless of the cause, you should not allow pressure to cause you to breach the "Integrity and Objectivity Rule." Likewise, you should pressure others when you know or have reason to know that doing so could cause someone else to breach ethics rules. The full text of the "Pressure to Breach the Rules" interpretation (ET sec. 2.170.010) appears in the appendix.

Professional and regulatory bodies

1. American Institute of Certified Public Accountants (AICPA)-In fulfilling its mission, the AICPA works with state CPA societies and state accountancy boards, giving priority to those areas where public reliance on CPA skills is most significant. -The AICPA Professional Ethics Executive Committee (PEEC) promulgates and enforces ethics and independence rules that apply to all members. 2. U.S. Securities and Exchange Commission (SEC)-Its mission is to improve the professional performance of public company auditors to ensure that financial statements are presented fairly and have credibility. 3. Public Company Accounting Oversight Board (PCAOB)-The Sarbanes-Oxley Act of 2002 created and authorized the PCAOB to establish auditing and related attestation, quality control, ethics, and independence standards for public company auditors. The SEC oversees the PCAOB's activities. 4. U.S. Government Accountability Office (GAO)-The GAO issues ethics and independence rules that apply to engagements performed under generally accepted government auditing standards (GAGAS). These governmental standards are published as Government Auditing Standards, commonly referred to as the "Yellow Book." 5. U.S. Department of Labor (DOL)-Auditors of employee benefit plans that file reports with the DOL should be aware of the DOL interpretive bulletin on independence. 6. U.S. Department of the Treasury/Internal Revenue Service (IRS)-The Internal Revenue Code (IRC) authorizes the Secretary of the Treasury to set rules and regulations necessary to enforce the U.S. tax laws. Treasury Department Circular No. 230 governs federal tax practice before the IRS by CPAs, enrolled agents, attorneys, and actuaries and the IRS Office of Professional Responsibility (OPR) that enforces these regulations. 7. State boards of accountancy-State boards of accountancy are charged with issuing CPA licenses and overseeing the ethical conduct of CPAs in 55 jurisdictions in the United States. It is critically important for CPAs to know their state board's requirements. If you are licensed by more than one state board or practice in other states under their mobility laws, you should familiarize yourself with each state's requirements. 8. International Federation of Accountants (IFAC)-The IFAC supports four independence standard-setting bodies that develop standards for auditing, education, ethics, and public sector financial reporting in the accounting profession globally. IFAC also promotes good ethical practices by encouraging professional accounting organizations throughout the world to adopt high ethical standards and helps foster meaningful debate on ethical issues that accountants face. The IFAC's International Ethics Standards Board for Accountants (IESBA) develops ethical standards and guidance for use by professional accountants. The IESBA ethical standards appear in the International Code of Ethics for Professional Accountants (including International Independence Standards) (IESBA code), which serves as a global benchmark for codes of ethics. Member bodies, such as the AICPA in the United States, agree to maintain ethics and other professional standards that meet this global benchmark. As a result, the IESBA code has influenced and will continue to influence the AICPA code. 9. Others-In addition, banking, and insurance regulators, such as the U.S. Federal Deposit Insurance Corporation (FDIC) and state insurance regulators, incorporate the AICPA, SEC, and PCAOB rules into their regulatory requirements. Finally, state CPA societies also have ethics codes (often, they adopt the AICPA code) that state society members agree to abide by.In some cases, you may be subject to rules of different bodies. For example, auditors of public companies need to comply with the independence rules of the AICPA, the SEC, and the PCAOB. If more than one rule applies to a situation, you should apply the most restrictive requirement. Although we will address many of these rules, this course focuses primarily on a CPA's obligations under the AICPA code.

Financial and employment relationships

1. Financial relationships In many respects, the SEC independence rules on financial relationships are similar to those of the AICPA, but some additional restrictions exist. The following shows examples of the additional restrictions. -Loan to or from client: Additional restrictions under SEC rules Only mortgages and similar loans related to a covered person's primary residence may be legacied. -Insurance Policy from client: Additional restrictions under SEC rules A covered person may have an insurance policy if ​ -the policy was obtained when the individual was not a covered person, and -the likelihood of the insurer becoming insolvent is remote. -Depository account with client Additional restrictions under SEC rules A covered person may not have an account that exceeds federal or state-insured limits. 2. Family relationships: In general, the SEC rules for immediate family are similar to those of the AICPA, although the AICPA provides more detailed guidance on how certain rules apply to a covered member's immediate family. Financial interests and close family members Under SEC rules, a covered person's close family member impairs a firm's independence if that member owns greater than 5% of the client's outstanding equity securities. A close family member is a spouse (or equivalent), dependent, parent, sibling, or nondependent child. In addition, the close family of any partner in the firm will impair a firm's independence if the family member controls the client. 3. Employment relationships: Various employment relationships — whether current, future or past — may impair independence under the SEC rules. AICPA and SEC rules are similar with respect to current or past employment with an audit client. In this next section, we will address future employment with an audit client where the SEC provisions are more stringent than AICPA rules. Future employment at audit client The following scenario shows how the SEC independence rules would apply to a situation in which a partner in a firm accepted an employment offer from an audit client. Katie, a partner at Lux CPAs, accepts an employment position at B Corporation, her audit client. She will become B Corporation's CFO, which is a financial reporting oversight role. To maintain the firm's independence, Lux and Katie must take certain actions, such as the following: -Lux should pay Katie in full for her capital balance in the firm. (Note: amounts that Lux owes Katie should be fixed and not be tied in any way to firm revenues or profitability.) -Lux must fully fund Katie's retirement account through a "rabbi trust" or similar vehicle. -Once she takes the CFO position, Katie should not influence Lux's operations or financial policies. Cooling-off provision As a member of the client's audit team, Katie is subject to another requirement referred to as the "cooling-off" provision. That is, she must observe a one-year "cooling-off period" before she can accept the CFO position at B Corp. Specifically, that means that Katie cannot become B Corp's CFO until at least one full audit cycle has lapsed since she last served as a member of the audit team.

The accounting profession

1. In Public Practice-public accounting practice 2. In Business-not for profit or private firm

CPAs in public practice

1. Outsourcing: The code requires taking certain actions when you outsource the performance of your services to "third-party service providers." The standards apply to all independent contractors that your firm uses. Prior to sharing confidential client information with the contractor, you are required to inform the client, preferably in writing, that you may be using a service provider when providing professional services to that client. When you use a service provider to render professional services to clients, you are responsible for overseeing the service provider's work and ensuring that all applicable professional standards are met. You are required to enter into a contractual agreement with the contractor to maintain the confidentiality of the client's information, including those who provide only administrative support services. You should also ensure that the service provider has appropriate procedures in place to prevent the unauthorized release of confidential client information. 2. Advertising and solicitations: Members in public practice may not advertise their services in a manner that is false, misleading, or deceptive. Solicitation using coercion, overreaching, or harassing conduct is prohibited. 3. Form of organization and firm name: You may practice public accounting only in a form of organization permitted by law or regulation that also conforms to the resolutions of the AICPA Council. Your firm name cannot be misleading. Names of past owners may be included in the firm name, even when the firm merges with another firm. You may designate your firm as a member of the AICPA only if all CPA owners are members of the AICPA. 4. Ownership in a separate business: It is not unusual for a member to own all or part of a separate business that performs accounting, consulting, or other professional services. Does the code apply to a separate business? If the member, either individually or with members of his or her firm, controls the separate business, as defined by GAAP, then the separate business (including all its owners and employees) is subject to the code. If the member does not control the separate business, then only the member (as an individual) must comply with the code.

Determining when the independence rules apply

10 or more hours on an attest client can have independence findings. When do the independence rules apply to you personally? Although some independence rules apply to all professionals in a firm, many rules apply only to certain professionals who are associated with certain of the firm's attest clients or engagements. We call these persons (or entities) covered members. When you are a covered member with respect to a client, you must observe a number of personal restrictions with respect to that client. Covered members This diagram and the descriptions that follow illustrate which persons or entities are covered members with respect to a particular attest client. Top: Firm A firm is a form of organization permitted by law or regulation that is engaged in the practice of public accounting. Nonattest partners (including partner equivalents) and managers A partner or manager who provides 10 or more hours of nonattest services to an attest client in any fiscal year. Note: Partner includes partner equivalents. A partner is a proprietor, shareholder, equity or nonequity partner, or any individual who assumes the risks and benefits of firm ownership or who is otherwise held out by the firm to be the equivalent of such. Partner equivalents are persons authorized to act on behalf of the firm without partner approval. For example, partner equivalents may sign audit reports or engage letters for the firm. Partners in the attest office Partners (and partner equivalents) who practice in the same office in which the lead engagement partner practices in connection with a client's attest engagement. Persons who can influence the engagement An individual in a position to influence the attest engagement is one who -evaluates the performance or recommends the compensation of the attest engagement partner; -directly supervises or manages the attest engagement partner, including all successively senior levels above that individual in the firm; -consults with the attest engagement team regarding technical or industry-related issues specific to the engagement; or -participates in or oversees quality control activities with respect to the specific attest engagement, including all successively senior levels in the firm. Attest engagement team Those individuals participating in the attest engagement, including those who perform concurring and engagement quality reviews. The attest engagement team includes all employees and contractors retained by the firm who participate in the attest engagement (whether they provide audit, tax, or management consulting services). The attest engagement team excludes specialists and individuals who perform only routine clerical functions. Controlled entity A controlled entity is any partnership, corporation, trust, joint venture, or pool whose operating, financial, or accounting policies can be controlled by one or more covered members (including the firm). To determine whether an entity or an individual can control another entity, use the definition of control provided by generally accepted accounting principles (GAAP) for consolidation purposes in FASB ASC 810.

Compliance with standards

An AICPA member who performs audit, review, management consulting, tax, or other professional services shall comply with standards created by bodies that the AICPA Council has designated as "official" standard setters. Appendix A of the code provides a list of those standard-setting bodies, which includes, among others, the following: -Financial Accounting Standards Board -Governmental Accounting Standards Board -Public Company Accounting Oversight Board -Accounting and Review Services Committee -Tax Executive Committee -Auditing Standards Board

Independence and you

AICPA independence standards — fundamental concepts: AICPA professional standards require independence — both in fact and appearance — for all attest engagements. Attest services often culminate in the accountant's expression of an opinion or some other form of assurance that the information being reported on — for example, a financial statement — is free of material misstatements. The investing public or other interested parties, such as creditors, financial analysts, and vendors, typically rely on the accountant's report. Therefore, the accountant should be unbiased in forming his or her judgments when performing attest services. Here is an excerpt from the AICPA Code of Professional Conduct 's definition of independence: 1. Independence. Consists of two elements, defined as follows:Independence of mind is the state of mind that permits a member to perform an attest service without being affected by influences that compromise professional judgment, thereby allowing an individual to act with integrity and exercise objectivity and professional skepticism. 2. Independence in appearance is the avoidance of circumstances that would cause a reasonable and informed third party who has knowledge of all relevant information, including the safeguards applied, to reasonably conclude that the integrity, objectivity, or professional skepticism of a firm or member of the attest engagement team is compromised. Attest client An attest client is an entity whose financial statements or other information is being audited, reviewed, or attested to. Attest engagements include the following: -Financial statement audits -Financial statement reviews -Audits of internal control over financial reporting (as required by Section 404 of the Sarbanes-Oxley Act of 2002) performed under PCAOB Auditing Standard (AS) 2201, An Audit of Internal Control Over Financial Reporting That Is Integrated with an Audit of Financial Statements1 -Other engagements performed under the AICPA Statements on Auditing Standards (SASs) or Statements on Standards for Attestation Engagements (SSAEs) An audit of a company's financial statements is a common example of an attest service. In this course, the terms attest client, audit client, and client are synonymous. 1 All PCAOB auditing standards can be found in AICPA PCAOB Standards and Related Rules. Firm A firm and its people are required to be independent during -the period of the professional engagement and, in some cases, -the period covered by the financial statements or other information to which the attest services relate. For example, your financial interests and relationships (such as stock interests, credit cards, or loans) may impair independence if they exist during the period of the professional engagement. That period begins when the firm is engaged to perform audit or other attest services and continues until the audit or attest relationship is terminated. If you have a business or employment relationship with an attest client during the period of the professional engagement or the period covered by the financial statements, independence may be impaired. Business and employment relationships can impact your independence if they exist during either period. Therefore, for a new audit client, the employment or business relationships you had with the client before your firm was engaged to provide attest services can impair your independence.

Confidential client information

AICPA members are privy to a great deal of confidential information about their clients. If you are in public practice, the code requires that you do not disclose any confidential information unless your client specifically allows you to do so. So, what is confidential client information? The code includes the following definition (see paragraph .09 of ET sec. 0.400, "Definitions"): [Confidential client information is] any information obtained from the client that is not available to the public. Information available to the public includes, but is not limited to, information -in a book, periodical, newspaper, or similar publication; -in a client document released by the client to the public or that has otherwise become a matter of public knowledge; -on publicly accessible websites, databases, online discussion forums, or other electronic media by which members of the public can access the information; -released or disclosed by the client or other third parties in media interviews, speeches, testimony in a public forum, presentations made at seminars or trade association meetings, panel discussions, earnings press release calls, investor calls, analyst sessions, investor conference presentations, or a similar public forum; -maintained by, or filed with, regulatory or governmental bodies available to the public; or -obtained from other public sources. Unless the particular client information is available to the public, such information should be considered confidential client information.

Consequences of ethical infractions

As auditors and accountants, CPAs play a key role in safeguarding the integrity of financial reporting. They also provide tax compliance and other advisory services that are valuable to the public. They serve the business community in many important ways. For these reasons, CPAs are subject to numerous ethical requirements and must be able to -identify ethical issues, -critically assess them, and -use professional judgment to arrive at a reasonable decision. None of this is easy. There are many hard choices to make, but it is extremely important to develop these skills. The stakes are very high. A single significant error in judgment could lead to investigation by the AICPA, your state accountancy board, or the SEC, to name just a few of the bodies charged with overseeing the profession. The results can be significant. For example, you could -lose your license to practice as a CPA, -be expelled from membership in the AICPA or a state CPA society, and -incur significant fines and steep legal liabilities.

Communicating independence matters

Auditors must comply with PCAOB Rule 3526, Communication with Audit Committees Concerning Independence, before accepting a new audit engagement and annually once they become the auditor. 1. When to Communicate-Prior to initial appointment as auditor and at least annually thereafter To whom 2. To Whom-The audit committee (or the board of directors or similar body if there is no audit committee) 3. What to communicate in writing-All relationships between the auditor and the client, including the auditor's and client's affiliates, that could reasonably be thought to bear on independenceA statement confirming that the firm is independent of the company 4. What to communicate verbally-Matters identified in the written communication 5. What to document-The substance of the discussion with the audit committee

Business relationships and other matters

Business relationships and other matters addressed in the SEC and PCAOB independence rules include audit partner rotation and compensation, fee issues, and indemnification of the auditor by the audit client. 1. Business relationships The SEC recently revised its rule on business relationships (Rule 2-01(c)(3)). The revised language now states, in part: Business relationships. An accountant is not independent if, at any point during the audit and professional engagement period, the accounting firm or any covered person in the firm has any direct or material indirect business relationship with an audit client, or with persons associated with the audit client in a decision-making capacity, such as an audit client's officers or directors that have the ability to affect decision-making at the entity under audit or beneficial owners (known through reasonable inquiry) of the audit client's equity securities where such beneficial owner has significant influence over the entity under audit... (emphasis added) Examples of prohibited business relationships The following are examples of prohibited relationships between a covered person (XX, CPAs), and an SEC audit client (G Corp., including G's officers, directors, and shareholders) able to exercise significant influence: -XX and G have a joint business venture to create a new software product. -XX and G have an agreement to co-market their consulting services. -G has a subcontracting arrangement with a director of XX to perform services for G's clients. Examples of permissible business relationships Firms and covered persons in firms may have the following business relationships with their firm's audit client: -The firm or covered person provides professional services to an audit client -The firm or covered person purchases goods or services from the client as a consumer in the ordinary course of business. 2. Other matters The SEC and PCAOB independence rules address the following additional matters that are not explicitly addressed in the AICPA independence rules: Audit partner rotation To prevent partners from becoming too familiar with their audit clients over time, lead and quality review partners on audit engagements are required to rotate off an engagement after five consecutive years of service to the client. After the partner leaves the engagement team, that partner must remain off the engagement for another five-year period. During this period, that partner should cease having contact with the client; the partner may, however, confer with the subsequent engagement team on a limited basis to assist with the transition. Other partners who make decisions on significant accounting, audit, or other reporting matters or who also have contact with the client's management and audit committee must rotate after seven years of continuous service to the client and then remain off the engagement for at least two years. Partners who consult with the engagement team only on technical accounting, auditing, or similar issues are not required to rotate. AICPA independence rules do not require partner rotation, but firms should apply the "Conceptual Framework for Independence" interpretation (ET sec. 1.210.010) to situations involving long association with an attest client. In addition, two "Frequently asked questions" provide nonauthoritative guidance. 3. Restrictions on certain types of compensation arrangements Partner compensation Another SEC rule restricts audit partners from having certain types of compensation arrangements with their firms. Specifically, audit partners serving on the audit engagement team may not be directly compensated for selling nonaudit services to their client. The SEC's rationale for this rule is as follows: We understand that some accounting firms offer their professionals cash bonuses and other financial incentives to sell products or services, other than audit, review, or attest services to their audit clients. Such compensation arrangements may create a financial or other self-interest that could constitute a threat to the accountant's objectivity. These arrangements also may detract from audit quality by incentivizing the audit partner to focus on selling nonaudit services rather than providing high quality audit services. We also question whether a reasonable investor with full knowledge of such incentive programs would believe that the accountant could function with the independence and objectivity that is necessary for him or her to maintain, both in fact and in appearance. We are concerned that an accountant might be viewed as compromising accounting judgments in order not to jeopardize the potential for increased income from the act of selling nonaudit services to the audit client. Note: The audit partner rotation and compensation rules do not apply to firms with fewer than 10 partners and fewer than 5 issuer audit clients. 4. Example: Fee-related issues Contingent Fees: Caron, CPAs, invites Anika to a Zoom meeting to discuss whether a proposed fee arrangement would be considered a contingent fee. Anika says the SEC believes that contingent fees create a mutuality of interests between the firm and the client that impairs independence. Caron asks whether having their fee determined by a federal agency would make any difference. Anika agrees this would not be treated as a contingent fee. As a public authority acting in the public interest, Caron's services would not influence the fee, so the fee arrangement would be permissible. Concentration of Fees: Caron has an opportunity to become the auditor of a group of companies that would contribute approximately 22% to the firm's total revenues. The firm calls Anika to ask whether that will impair independence. Anika says that historically, the SEC staff has raised questions regarding the independence of firms that earn more than 15% of their total revenues from one SEC audit client (or group of related clients). She said this is because a concentration of fees exceeding 15% of a firm's total revenues may cause the firm to be overly dependent on that client or group of related clients. She labelled this audit opportunity a "nonstarter." Unpaid Fees: Via email, Caron asks Anika, "The firm is about to start an audit but has not yet collected last year's fees from this client. Is this a problem?" Anika replies: According to the SEC rules, if an audit client does not pay its auditor's fees for an extended period, the unpaid fees give the firm a direct interest in the results of the client's operations. Generally, independence is impaired if prior-year professional services fees are not paid before the commencement of any engagement requiring independence. If the client commits to paying the fees in full, and the firm is reasonably assured that it will collect those fees before the current report is issued, Caron will be considered independent. Keep in mind, however, that if the client is filing a registration statement with the SEC, the fees must be paid before the engagement begins. Indemnification Clauses: In this consultation, Caron asks Anika whether the firm may enter into an indemnification agreement with an audit client that would provide Caron immunity from liability for the firm and its personnel's negligent acts. Anika says that Caron is not considered independent if it moves forward with that agreement. The SEC's position is more stringent than the AICPA independence rules, she explains, which permits auditors to be indemnified for costs and liabilities resulting from management's knowing misrepresentations.

Accounting principles

CPAs should not indicate that a company's financial data (for example, financial statements) are presented in conformity with generally accepted accounting principles (GAAP) if such information contains any departure from GAAP. An exception exists for data that justifiably departs from GAAP because not doing so would make the information misleading. This rule applies to letters and other communications that members in business send to their employer's auditors or to others, such as regulators and creditors. It also applies to members in public practice when they issue an opinion on a company's financial statements. Members may prepare or report on financial statements under frameworks besides U.S. GAAP, such as the GAAP of another country or other frameworks (for example, a framework prescribed by law or contract). The member should ensure that the basis of accounting (such as income tax-based financial statements) is clearly specified so that readers do not wrongly assume that the statements were prepared in accordance with U.S. GAAP. The following exhibit, "Accounting Principles Rule," states the rule that applies to members in business. Exhibit: "Accounting Principles Rule" (ET sec. 2.320.001). .01 A member shall not (1) express an opinion or state affirmatively that the financial statements or other financial data of any entity are presented in conformity with generally accepted accounting principles or (2) state that he or she is not aware of any material modifications that should be made to such statements or data in order for them to be in conformity with generally accepted accounting principles, if such statements or data contain any departure from an accounting principle promulgated by bodies designated by Council to establish such principles that has a material effect on the statements or data taken as a whole. If, however, the statements or data contain such a departure and the member can demonstrate that due to unusual circumstances the financial statements or data would otherwise have been misleading, the member can comply with the rule by describing the departure, its approximate effects, if practicable, and the reasons why compliance with the principle would result in a misleading statement.

Fee arrangements

Certain types of fee arrangements between a member and a firm's attest clients create threats to the member's compliance with the "Integrity and Objectivity Rule" (ET sec. 1.100.001). Fee arrangements are not addressed within the code's independence provisions. However, the concepts of independence and objectivity are similar and overlap, and the restrictions on fee arrangements largely relate to attest services, so we address them here. Firms also need to monitor their attest clients' payments for previously rendered services as outstanding fees may create threats to independence. 1. Contingent fees A contingent fee is defined as an arrangement in which either -no fee is charged unless a specified result is attained or -the amount of the fee depends on the results of your services. For example, suppose you performed a consulting engagement to help decrease a client's operating costs, and the fee was based on the amount of cost savings the client achieved. That fee arrangement would be considered a contingent fee. Your firm may not perform for a contingent fee any professional services for or receive such a fee from a client for whom you perform -an audit or review of a financial statement; -a compilation of a financial statement when you do not disclose a lack of independence in the report which you expect someone to rely on; or -an examination of prospective financial statements. The prohibition applies during the period in which you or your firm is engaged to perform any of the services listed above and the period covered by any historical financial statements involved in any of the above-listed services. 2. Permissible contingent fee arrangements Certain types of contingent fee arrangements are permitted under this rule: -Fees are not contingent if fixed by courts or other public authorities. -In tax matters, fees are not contingent if determined based on the results of judicial proceedings or the findings of governmental agencies. Question: When is a fee considered to be determined based on the findings of a governmental agency? Answer: If you can demonstrate a reasonable expectation that a government agency will consider the substance of the results of your services (for example, a tax credit application submitted to a municipality), the fee is not considered contingent and would be allowable. Examples of when a contingent fee may be accepted for tax work: -You represent a client in connection with a revenue agent's examination of the client's federal income tax return. -You file an amended state income tax return claiming a tax refund that is based on a tax issue that is the subject of a test case involving another taxpayer. -You represent a client in connection with obtaining a private letter ruling. 3. Commissions and referral fees Commissions and referral fees are prohibited when your firm provides one of the following services to the client involved in the transaction: -An audit or review of a financial statement -A compilation of a financial statement (you do not disclose a lack of independence in the report, which you expect user(s) to rely on) -An examination of prospective financial statements The following are examples of prohibited commission arrangements: -Your firm recommends your audit client's brokerage services to a third party. The client pays you a one-time commission (fee) for making the introduction. -Your firm recommends a colleague's insurance services to your review client, and you receive a fee based on a percentage of the insurance premiums received by your colleague. This prohibition applies during the period in which you are engaged to perform any of the services listed above and the period covered by any historical financial statements related to the services. The code makes an exception for fees that a member pays or receives in connection with referring a CPA's professional services. An excerpt from the code follows. Exhibit: "Commissions and Referral Fees Rule" (ET sec. 1.520.001) .04 Referral fees. Any member who accepts a referral fee for recommending or referring any service of a CPA to any person or entity or who pays a referral fee to obtain a client shall disclose such acceptance or payment to the client. Disclosure of permitted commission or referral fee When you are permitted to have a commission or referral fee, you must disclose the fee to your client or other relevant party in writing. Examples of permitted situations include the following: -You received a commission for recommending a social media company 's services to L Co, your tax (nonattest) client. Disclose the commission to L Co. -You paid a referral fee to M, Inc. for referring your firm's professional services to B Co. Disclose the commission to B Co. The code does not prescribe what your written disclosure should include (for example, the amount of the fee or other terms of the agreement). 4. Unpaid fees Does a client's failure to pay fees on a timely basis threaten your independence? The code states that unpaid fees may create undue influence, self-interest, or advocacy threats to your independence. If your attest client owes fees for professional services your firm provided more than one year prior to the date of the current-year attest report, independence is impaired. Threats are not at an acceptable level because your firm has a heightened interest in the client's continued viability. It does not matter whether the fees are billed or unbilled, or whether your firm converts your outstanding fees to a note receivable. (Note: if you do the latter, you will have a prohibited loan with your client.) If the client has not paid its fees for over one year as of the date of the attest report, the report may not be issued. There is one caveat, however. If your firm is confident that the client will pay the outstanding fees in full prior to release of your firm's report, your firm may commence the engagement.

IRS Circular No. 230

Circular No. 230 contains regulations that govern practice before the IRS. Subpart B of the Circular describes the duties and restrictions related to federal tax practice. The ethics requirements for Subpart B are as follows: -Return of client's records -Conflicting interests -Solicitation -Negotiation of taxpayer checks -Practice of law -Best practices for tax advisors -Standards with respect to tax returns and documents, affidavits, and other papers -Competence -Procedures to ensure compliance -Requirements for other written advice 1. Conflicting interests Previously you heard Harold and Linda discuss a potential conflict of interest. Both the AICPA and Circular No. 230 rules require that tax services be performed in an objective manner as described in the following example. Linda: I remember a conflict situation I had several years ago when I was providing services for a married couple that was breaking up. Both wanted me to continue to do work for them. I agreed because they both seemed so amicable, but I was sorry later when things got heated and they both started pointing fingers at me! I will never do that again. Harold: Right. These situations also come up with partnerships that split up. It depends on the specific facts and circumstances and whether we think we can continue to perform our services objectively. Do we reasonably believe we can provide competent and diligent representation to each of the affected clients? It's really a matter of professional judgment, but we also need to be practical and think about how the relationship between the parties could become adversarial — quickly. If we decide to move forward and perform services where a potential conflict exists, we must remember this: Circular No. 230 requires that each affected client waive the conflict and provide informed consent confirmed in writing. We are required to keep the consent from each directly interested party on file for at least three years. We had a divorced couple's returns audited last year and the IRS asked to see the consent forms. Excerpt from Circular No. 230, Section 10.29 a. Except as provided by paragraph (b) of this section, a practitioner shall not represent a client in his or her practice before the Internal Revenue Service if the representation involves a conflict of interest. A conflict of interest exists if: 1. the representation of one client will be directly adverse to another client; or 2. there is a significant risk that the representation of one or more clients will be materially limited by the practitioner's responsibilities to another client, a former client or a third person or by a personal interest of the practitioner.b. b. Notwithstanding the existence of a conflict of interest under paragraph (a) of this section, the practitioner may represent a client if: 1. the practitioner reasonably believes that the practitioner will be able to provide competent and diligent representation to each affected client; 2. the representation is not prohibited by law; and 3. each affected client gives informed consent, confirmed in writing. c. Copies of the written consents must be retained by the practitioner for at least 36 months from the date of the conclusion of the representation of the affected clients and the written consents must be provided to any officer or employee of IRS on request. (Approved by the Office of Management and Budget under Control No. 1545-1726.) 2. Solicitations The IRS rule on solicitations is similar to the AICPA rules, but there are a few more explicit requirements to be mindful of, for example, in terms of advertising our fees and advertising online and in social media. In both instances, the IRS rules are more prescribed than the AICPA's rules. See the following exhibit. A. Advertising and solicitation restrictions 1. A practitioner may not, with respect to any Internal Revenue Service matter, in any way use or participate in the use of any form of public communication or private solicitation containing a false, fraudulent, or coercive statement or claim; or a misleading or deceptive statement or claim. 2. A practitioner may not make, directly or indirectly, an uninvited written or oral solicitation of employment in matters related to the Internal Revenue Service if the solicitation violates Federal or State law or other applicable rule, e.g., attorneys are precluded from making a solicitation that is prohibited by conduct rules applicable to all attorneys in their State(s) of licensure. Any lawful solicitation made by or on behalf of a practitioner eligible to practice before the Internal Revenue Service must, nevertheless, clearly identify the solicitation as such and, if applicable, identify the source of the information used in choosing the recipient. B. Fee Information 1. (i) A practitioner may publish the availability of a written schedule of fees and disseminate the following fee information: (A) Fixed fees for specific routine services.(B) Hourly rates. (C) Range of fees for particular services. (D) Fee charged for an initial consultation. (ii) Any statement of fee information concerning matters in which costs may be incurred must include a statement disclosing whether clients will be responsible for such costs. 2. A practitioner may charge no more than the rate(s) published under paragraph (b)(1) of this section for at least 30 calendar days after the last date on which the schedule of fees was published. C. Communication of Fee Information Fee information may be communicated in professional lists, telephone directories, print media, mailings, and electronic mail, facsimile, hand delivered flyers, radio, television, and any other method. The method chosen, however, must not cause the communication to become untruthful, deceptive, or otherwise in violation of this part. A practitioner may not persist in attempting to contact a prospective client if the prospective client has made it known to the practitioner that he or she does not desire to be solicited. In the case of radio and television broadcasting, the broadcast must be recorded, and the practitioner must retain a recording of the actual transmission. In the case of direct mail and e-commerce communications, the practitioner must retain a copy of the actual communication, along with a list or other description of persons to whom the communication was mailed or otherwise distributed. The copy must be retained by the practitioner for a period of at least 36 months from the date of the last transmission or use. D. Improper Associations A practitioner may not, in matters related to the Internal Revenue Service, assist, or accept assistance from, any person or entity who, to the knowledge of the practitioner, obtains clients or otherwise practices in a manner forbidden under this section.

Competence

CPAs should assess professional competence by evaluating whether their education, experience, and judgment are adequate for the professional services they will perform. CPA practice has become more and more specialized, and CPAs should be honest in their self-assessments to avoid situations that put themselves and their clients or employers at risk. "Competence" interpretation (ET sec. 1.300.010) .01 Competence, in this context, means that the member or member's staff possess the appropriate technical qualifications to perform professional services and that the member, as required, supervises and evaluates the quality of work performed. Competence encompasses knowledge of the profession's standards, the techniques and technical subject matter involved, and the ability to exercise sound judgment in applying such knowledge in the performance of professional services. .02 A member's agreement to perform professional services implies that the member has the necessary competence to complete those services according to professional standards and to apply the member's knowledge and skill with reasonable care and diligence. However, the member does not assume a responsibility for infallibility of knowledge or judgment. .03 The member may have the knowledge required to complete the services in accordance with professional standards prior to performance. A normal part of providing professional services involves performing additional research or consulting with others to gain sufficient competence. .04 If a member is unable to gain sufficient competence, the member should suggest, in fairness to the client and public, the engagement of a competent person to perform the needed professional service, either independently or as an associate. [Prior reference: paragraph .02 of ET section 201]

Business relationships Part 1

Covered members in a firm can have a joint closely held investment with an attest client that affects independence. Because a firm is considered a covered member, the firm also must avoid having a joint closely held investment with an attest client (or person associated with an attest client) that is material to the firm. A firm may also have a "cooperative arrangement" with a client. The interpretation, which describes when a cooperative arrangement with an attest client impairs independence, are as follows: Exhibit: 265.010 Cooperative Arrangements With Attest Clients .01 If a member or his or her firm has a cooperative arrangement with an attest client, self-interest, familiarity, and undue influence threats to the member or his or her firm's compliance with the "Independence Rule" [1.200.001] may exist. Threats to compliance with the "Independence Rule" would not be at an acceptable level and could not be reduced to an acceptable level by the application of safeguards if, during the period of the professional engagement, the cooperative arrangement is material to the firm or attest client. Accordingly, independence would be impaired. .02 A cooperative arrangement exists when a member or the member's firm and an attest client jointly participate in a business activity. However, a cooperative arrangement would not exist when all of the following safeguards are met: 1. The participation of the firm and attest client are governed by separate agreements, arrangements, or understandings that do not create rights or obligations between the firm and attest client. 2. Neither the firm nor the attest client assumes responsibility for the other's activities or results. 3. Neither party has the authority to act as the other's representative or agent. .03 Examples of cooperative arrangements include the following: 1. Prime and subcontractor arrangements to provide services or products to a third party 2. Joint ventures to develop or market products or services 3. Arrangements to combine one or more of the firm's services or products with one or more of the attest client's services or products and market the package with references to both parties 4. Arrangements under which the firm acts as a distributor or marketer of the attest client's products or services or the attest client acts as the distributor or marketer of the firm's products or services .04 Refer to the "Contingent Fees Rule" [1.510.001] and the "Commissions and Referral Fees Rule" [1.520.001] for additional guidance. [Prior reference: paragraph .14 of ET section 101]

Other business relationships with attest clients

Executor or trustee At some point in your career, an attest client (typically a small, closely held business) may ask you to serve as an executor or trustee of the owner's will or trust. Eventually, the estate or trust holds or will hold stock in that client. Can you accept? Generally, this situation would not threaten independence — not yet, anyway. Although a covered member is prohibited from actually serving as an executor of an estate that has acquired or was committed to acquire a direct or indirect material financial interest in a client, merely being named as trustee or executor does not affect independence. However, problems will arise when the owner dies, and the investments pass to his or her estate. Now you have a problem; you are an executor of an estate that has a direct financial interest in a client. As executor, you are authorized to make all necessary decisions for the estate; even though you do not own the investments, they are treated as if they were yours and this impairs your independence.

Banking, insurance, and other regulators

FDIC If you audit financial institutions that take deposits from the public, you should be aware that certain agencies overseeing the industry have taken positions on auditor independence. The Federal Deposit Insurance Corporation (FDIC), at times in concert with other federal banking agencies, has issued policy statements addressing auditor independence. One important policy statement, which applies to all insured depository institutions (IDIs), prohibits many types of auditor indemnification or limitations of liability provisions in audit engagement letters. Look at the table in the following link: https://www.fdic.gov/regulations/examinations/supervisory/insights/siwin06/accounting_news.html 1. Part 363 of the FDIC regulations: Independent audit and reporting requirements Section 36 of the Federal Deposit Insurance Act and Part 363 of the FDIC's regulations impose annual audit and reporting requirements on IDIs with $500 million or more in consolidated total assets. An independent public accountant, auditor, or audit firm that provides audit and attest services to IDIs subject to Part 363 must comply with the independence standards and interpretations of the AICPA, the SEC, and the PCAOB. In February 2006, the federal banking agencies issued the Interagency Advisory on the Unsafe and Unsound Use of Limitation of Liability Provisions in External Audit Engagement Letters. Specifically -the advisory applies to financial statement audits and audits of internal control over financial reporting regardless of whether IDI is public or nonpublic; -under the advisory, the auditor may not form an agreement with its audit client in which the audit client will: -indemnify the auditor against third-party claims, -hold harmless or release the auditor from liability for claims by the client institution, or -limit the remedies available to the client institution for all IDIs, inclusion of any such provisions in an engagement letter represents noncompliance with the AICPA code's "Interpretations Under the Acts Discreditable Rule" (ET sec. 1.400.060); and -including any of the prohibited limitation of liability provisions set forth in the interagency advisory in an audit engagement letter is an act discreditable to the profession. 2. Other regulators Insurance The National Association of Insurance Commissioners' Model Audit Rule incorporates several aspects of the SEC's independence requirements, including the following: -Prohibitions on indemnity or other agreements to release an insurer's auditor from liability -Audit partner rotation (that is, lead audit engagement partner assigned to an insurance company engagement must rotate after five consecutive years of service) after which he or she must remain apart from the engagement for another five years -Restrictions on nonaudit services -Audit committee pre-approval of permitted nonaudit services and all audit and other attest services to be provided by the auditor -A one-year "cooling off" period during which partners and senior managers involved in the audit cannot become a member of the insurer's board, or the insurer's president, CEO, controller, CFO, CAO, or any equivalent position Individual state insurance commissions have the option of adopting the Model Audit Rule (or a variation of the rules), so it is important to check with the applicable state insurance commission. Commodity futures The Commodity Futures Trading Commission requires audits of futures commission merchants to be conducted in accordance with PCAOB independence standards applicable to audits of broker-dealers that are nonissuers (for example, they do not sell their company's securities to the public).

The AICPA "Conceptual Framework for Independence"

For many years, the AICPA code has employed the conceptual framework approach to analyzing threats to compliance with the independence rule. And, like the frameworks already described, members must employ the "Conceptual Framework for Independence" (ET sec. 1.210.010) (the framework) when evaluating matters that the independence interpretations do not specifically address. Here's a quick recap of the approach. First, you should identify threats to independence arising from particular circumstances and evaluate whether those threats are significant, meaning they are not at an acceptable level. Then, if threats are significant, you should consider whether "safeguards" could reduce or eliminate the threat to an acceptable level. If safeguards do not adequately reduce or eliminate a significant threat, independence would be impaired. The independence rules address many situations in which this is the case. In other words, a member of the audit team could never hold a financial interest in the client, because no safeguards (other than selling the investment or removing that person from the audit team) would eliminate that threat. Assume you are an audit manager whose friend just took a job as the assistant controller of an audit client. This set of circumstances is not addressed in the independence interpretations, so you would be required to evaluate whether threats to independence are significant. Most likely, you would work with your firm to determine whether threats are at an acceptable level and if not, which safeguards would be most appropriate. If the relationship is close, your firm will likely remove you from the team and ensure that you cannot influence the engagement. If the relationship is more distant or casual, the firm may have a professional who is independent of the engagement perform a secondary review of your work. The goal would be to eliminate the threat or at least reduce it to an acceptable level and maintain the firm's independence.

Other regulators

GAO independence rules- The Government Accountability Office (GAO) independence and ethics rules apply to auditors who perform attest services under generally accepted government auditing standards (GAGAS), which are described in the GAO publication, Government Auditing Standards (the Yellow Book). These standards apply both to auditors employed by the government and to auditors in public accounting and their firms, in addition to the AICPA code. 1. Ethical principles in government auditing The Yellow Book stresses five ethical principles: the public interest; integrity; objectivity; professional behavior; and the proper use of government information, resources, and position. The AICPA code is based on principles, including those addressing the public interest, integrity, objectivity, and professional behavior. The Yellow Book includes similar principles. A fifth principle — the proper use of government (including sensitive or classified) information, resources, and position — is not explicitly expressed in the AICPA code but would be expected of professionals under the AICPA principles of integrity and professional behavior. The fifth principle stresses that government information, resources, and positions should be used only for official purposes and not inappropriately for the auditor's personal gain or in a manner contrary to law or detrimental to the legitimate interests of the audited entity or the audit organization. Accountability to the public for the proper use and prudent management of government resources is an essential part of auditors' responsibilities and an important element of the public's expectations of auditors. 2. GAO independence principles and rules The Yellow Book establishes general standards and provides guidance for performing financial audits, attestation engagements, and performance audits. In all matters relating to audit work, both government auditors and public accounting firms and their professionals must be independent. Like the AICPA code and other rules, auditors must also avoid the appearance of impairment to their independence. GAS includes independence rules that apply to public accounting firms and governmental bodies. The rules that apply to one or the other group are not the same. Therefore, we will use the following naming convention to differentiate between the two: Naming convention -We will refer to public accounting firms as firms or audit firms, and to governmental organizations, such as municipalities, federal agencies, and similar bodies, as audit organizations. -When we discuss the entities audited by audit firms, we will use the terms client, audit client, or attest client. -To describe the entities audited by audit organizations (that is, governments), we will use the term audited entity. 3. Conceptual framework The GAO independence rules include a conceptual framework for assessing situations in which specific guidance does not exist in the Yellow Book. The framework is very similar to the one in the AICPA code in that auditors should apply the conceptual framework to​ -identify threats to independence; -evaluate the significance of the threats identified, both individually and in the aggregate; and -apply safeguards as necessary to eliminate the threats or reduce them to an acceptable level. Auditors should apply the framework approach at three levels: the firm, the engagement team, and the individual auditor. If no safeguards are available to eliminate an unacceptable threat or reduce it to an acceptable level, then independence would be considered impaired. 4. Threats to independence The following are some other examples of situations that may threaten your independence: -Brenda, your close friend, is a director of your firm's audit client (familiarity threat). -You have a direct financial interest that is not material to your net worth (self-interest threat). -You have deep-rooted beliefs that are inconsistent with the objectives of a program you are auditing (bias threat). -Your firm wishes to perform valuation advisory services for the client, but it is unclear whether those services would result in the audit team subsequently auditing its own work (self-review threat). -Management is pressuring the audit team to complete the audit in an unreasonable period of time (undue influence threat). -A partner in your firm serves on an advisory committee to the client's board of governors (management participation threat). 5. Using the conceptual framework for independence: Applying safeguards Example: GAO conceptual framework 2 Under the conceptual framework, once a threat to independence is identified, the auditor should determine whether the threat is significant. A threat is considered significant if it would compromise the auditor's professional judgment or even create the appearance that the auditor's judgment would be compromised. If the auditor thinks the threat is significant, the auditor is required to apply safeguards to eliminate the threat or reduce the threat to an acceptable level. By acceptable level, we mean the threat would no longer appear to threaten the auditor's professional judgment. 6. Government entities: External auditors The GAO's independence standards apply to auditors in government entities whether they report to third parties externally (external auditors), to senior management within the audited entity (internal auditors), or to both. An auditor's placement within a government body and the structure of the entity being audited can affect the auditor's independence. Some organizations are subject to constitutional or statutory safeguards that protect their independence. For example: -Governmental audit organization is at a different level of government than the audited entity (federal, state, or local); for example, U.S. auditors audit a New York state government program. -Governmental audit organization is within a different branch of government than the audited entity (for example, legislative auditors audit an executive branch program). 7. Internal auditor independence Some federal, state, and local government entities employ auditors to work for management. Alicia is an auditor in AB City where she performs internal audit functions in accordance with GAGAS.Alicia will be free from independence impairments if her audit organization (AB City) meets several criteria. They are that the audit organization -is accountable to the head of AB City or its governance board; -reports internal audit results both to the head of AB City and its governance board; -is located organizationally outside the staff or line-management function of the unit being audited; -has access to AB City's governance board; and -is sufficiently removed from political pressures to conduct audits and report its findings, opinions, and conclusions objectively without fear of political reprisal. 8. Nonaudit services The Yellow Book imposes requirements that the auditor must meet before agreeing to provide a nonaudit service to an audited entity (the client). These are similar to the AICPA independence requirements, although there are a few exceptions. Similarities include the following: - The auditor should determine whether providing the service would create a threat to independence, either by itself or in the aggregate if multiple services are provided. Critical to the determination is management's ability to effectively oversee the nonaudit service to be performed. -The auditor should determine that the client has designated an individual who possesses suitable skill, knowledge, or experience, and that the individual understands the services to be performed sufficiently to oversee them. -The auditor must not assume any management responsibilities. -The auditor should establish and document the understanding with the client's management or those charged with governance regarding the following: -Objectives of the nonaudit service -Services to be performed -Client's acceptance of its responsibilities -Auditor's responsibilities -Any limitations of the nonaudit service Also similar to AICPA independence rules, the Yellow Book differentiates nonaudit services from routine activities that auditors perform in conjunction with an audit (for example, providing advice or assistance to the entity on an informal basis as part of the audit). The following are examples of routine activities included in the Yellow Book: -Providing advice to the audited entity on an accounting matter as an ancillary part of the overall financial audit -Providing advice to the audited entity on routine business matters -Educating the audited entity about matters within the technical expertise of the auditors -Providing information to the audited entity that is readily available to the auditors, such as best practices and benchmarking studies Examples of activities that would not be considered routine activities (that is, they should be treated as nonaudit services) include the following: -Financial statement preparation -Cash-to-accrual conversions -Reconciliations One difference between the AICPA independence rules and the Yellow Book independence rules is that under the Yellow Book rules, the auditor should document why he or she concluded that the individual designated by the client to oversee the auditor's nonaudit services has suitable skills, knowledge, or experience to do so. AICPA rules do not require documentation, although they do require that the member conclude as such. A few other differences between the two sets of rules will be discussed in this section; however, overall, Yellow Book independence rules and AICPA independence rules are quite similar. The Yellow Book addresses several specific nonaudit services, including financial statement preparation, internal audit services, and valuation services, among others. Preparing accounting records and financial statements for an attest client Under the 2018 version of the Yellow Book, auditors are subject to more restrictive rules when they help prepare a client's financial statements or perform other permissible accounting or bookkeeping services. Example: Financial statement preparation Barta Accountancy audits BirdSaves, a not-for-profit organization. This year, BirdSaves asked Barta to help prepare its financial statements from the client's trial balance. Under the Yellow Book, Barta should conclude that significant threats to independence exist and apply safeguards to eliminate or reduce the threats to an acceptable level. Possible safeguards the firm could apply include the following: -The personnel performing the audit does not also work on the financial statements. -An independent party (from inside or outside the firm) performs a second review of the accounting or financial statement work. Assuming the firm is able to apply adequate safeguards, Barta should also document its evaluation of the threats and the safeguards applied. If Barta is unable to apply effective safeguards that reduce the threats to an acceptable level, the firm should not prepare the client's financial statements, as independence would be considered impaired. What if Barta scaled back its accounting services so that it was not preparing the financial statements in total? For example, Barta prepares account reconciliations that identify reconciling items for management's evaluation. In this case, the firm should evaluate threats to independence. If threats are significant, the firm should apply safeguards, as appropriate. Barta should document this assessment even if the firm concludes that threats are insignificant. GAO illustration: Nonaudit services Imagine you are on an engagement team that audits a small city. The client recently lost an accountant and asks your firm to perform some bookkeeping services until the city hires someone else. What do you think? Can your firm perform these services under the Yellow Book and still maintain its independence? Provide a detailed explanation. Consider whether you need to apply the conceptual framework to this situation. You would need more details to determine whether these services would be permitted. First, you should ensure that the services being requested are permissible under the Yellow Book. Assuming they are, if you would be preparing the city's financial statements, you should conclude that those services create a significant threat to your independence. If you are performing any other permissible bookkeeping service, or only preparing part of the financial statements, you must evaluate threats to your firm's independence. You should document your application of the conceptual framework, including (if applicable) the specific safeguards your firm applied to eliminate the threats or reduce the threats to an acceptable level, including your rationale about your conclusions and any actions taken.

Materiality

How large an investment is considered material? The independence rules do not establish a quantitative benchmark for materiality. You should use your judgment and consider both quantitative and qualitative factors. The following illustration shows how you should measure an indirect interest. Assume you are a limited partner in a partnership along with several other individuals. The partnership invests in many entities, including an audit client of your firm, and you are a covered member with respect to that client. Materiality is determined according to that portion of your investment that is invested in the client. To narrate this illustration, assume you invest $100,000 in a limited partnership that is not a client. The partnership spreads this $100,000 among several investments. If 1% of the partnership's assets are allocated to the client, your indirect investment is $1,000. It is this $1,000 investment, not the $100,000, that is compared to your net worth to determine materiality. However, here's an important distinction: if you supervised or participated in the limited partnership's investment decisions or were a general partner, then the financial interests held by the partnership would be ascribed to you personally and would be considered a direct financial interest in the client. In that case, even an immaterial investment in a client would impair independence. Interests held through mutual funds (or similar investment vehicles) Owning shares in a mutual fund or similar investment vehicle, such as an exchange traded fund ("fund"), creates a direct financial interest in the fund. If the fund is an attest client of your firm, and you are a covered member with respect to that fund client, any investment in the fund is a prohibited direct financial interest. However, the fund's underlying investments (for example, the companies issuing various stocks, bonds, and other investments that make up the fund's portfolio), are indirect financial interests. If any of those investments are in attest clients of your firm, you should consider the following: 1. Is the fund diversified? If a fund is diversified, ownership of 5% or less of the outstanding shares of the fund would not create a material indirect financial interest in the fund's underlying investments. (To determine whether a fund is diversified, refer to the fund's prospectus or Section 5(b)(1) of the Investment Company Act of 1940.) If you or your immediate family own more than 5% of the outstanding shares of a diversified fund, you should evaluate the fund's underlying investments to determine whether you have a material indirect financial interest in any of the fund's investments. 2. Is the fund nondiversified? If a fund is not diversified (for example, if it is a specialty or sector fund), you should evaluate the fund's underlying investments to determine whether you have a material indirect financial interest in any of the fund's underlying investments. Immediate family members As noted, if you are a covered member, the independence rules also apply to your immediate family (spouse or equivalent, and dependents), which generally includes rules on financial interests. If you are a covered member with respect to your firm's attest client, you cannot have a direct financial interest, such as a stock investment, in that client. With limited exceptions, your immediate family will also be prohibited from having investments in that same client. The 5% rule Certain financial relationships, due to their magnitude, are presumed to pose a greater threat to independence than others and therefore apply more broadly to persons other than covered members. For example, if any partner and professional employee in a firm owns financial interests in an attest client that constitute more than 5% of that client's outstanding equity, threats to independence are considered to impair independence. Unsolicited financial interests What happens if you obtain a financial interest in an attest client unexpectedly through a gift or an inheritance? To mitigate self-interest threats to independence, you should dispose of the financial interest as soon as practicable, generally within 30 days. If this is not possible, the threat will be reduced to an acceptable level if you do not participate in the attest engagement and the investment is immaterial to your net worth. Otherwise, independence is impaired. Loans with clients As a covered member, a loan to or from an attest client or the client's officer, director, or certain shareholders (associated persons) may raise self-interest threats to your independence. Loans with attest clients that are not financial institutions (and their associated persons) are generally prohibited. However, certain types of loans from an attest client that is a financial institution may be grandfathered or otherwise permitted. For these loans, threats to independence are at an acceptable level and do not impair your independence. 1. Permitted Loans: Permitted loans include the following: -car loans that are fully collateralized by the vehicle -certain small consumer loans (such as credit card accounts in which the balance is reduced each credit cycle to $10,000 or less) -loans that are fully collateralized by cash deposits at the same financial institution or by the cash surrender value of an insurance policy Covered members may obtain a permitted loan on normal terms and conditions from a financial institution attest client without impairing independence. Other types of loans impair independence unless they meet the criteria for a grandfathered loan. 2. Grandfathered Loans: Home mortgages, secured loans, and immaterial unsecured loans may qualify for "grandfathered" status, which means you may continue to have the loan with a financial institution that is an attest client under the rules. To be grandfathered, a loan must meet all the following safeguards: -You obtained the loan before you became a covered member; or -You obtained the loan before the financial institution you have your loan with became an attest client; or -You obtained the loan before May 31, 2002, and met the transitional requirements; and -The terms of the loan do not change after the loan has been grandfathered; -You obtained the loan on normal terms and conditions; and -You are making loan payments on a timely basis. Other financial relationships Other financial relationships with an attest client (for example, a checking account, brokerage account, lease arrangement, or insurance policy) can create self-interest or other threats to your compliance with the Independence Rule when you are a covered member. As with other personal interests, restrictions on your financial relationships also apply to those of your immediate family. 1. Lease Agreements: Summary of rule This rule uses a narrower version of covered member than most other rules in the code; "covered member" includes only persons on the attest engagement team and those who can influence the attest engagement. To enter into a new lease or renegotiate an existing lease requires the following safeguards: -The lease is on market terms and established at arm's length; -The lease is not material to any of the parties; and -The covered member complies with all lease terms, including timely payment under the lease terms. 2. Bank Deposit Accounts: Summary of rule A depository account with an attest client, such as a savings or checking account, impairs independence unless you meet one of the following conditions: -The balance is fully insured by the appropriate state or federal government deposit insurance agency (such as the Federal Deposit Insurance Corporation [FDIC]); -Uninsured amounts are not material to your net worth; or -If any uninsured amounts are material to your net worth, you reduce them to an immaterial amount within 30 days. 3. Brokerage Account: Summary of rule A brokerage account with an attest client will not impair independence if the following two safeguards are met: 1. You obtained the attest client's brokerage services under its normal terms, procedures, and requirements, and 2. Any assets that are subject to the risk of loss from the arrangement are immaterial to your net worth. In determining risk of loss, consider losses you would sustain if broker became insolvent or went bankrupt, or suffered losses due to fraud or other illegal acts. Do not consider potential losses arising from a market decline in the value of the assets. 4. Insurance Policy: Summary of rule An insurance policy obtained from an attest client is permissible if you purchased the policy under the insurer's normal terms, procedures, and requirements. If the policy offers an investing option and you can select the policy's underlying investments or supervise or participate in the investment decisions, any investment in an attest client would be a direct or indirect financial interest based on the specifics.

Joint closely held investments

If you are a covered member, a joint closely held investment with an attest client or persons associated with the client may create self-interest threats to independence. A joint closely held investment exists if you and the client (or the client's associated persons, such as an officer, director, or significant shareholder) individually or jointly control the investment. If a joint investment is material to your net worth, threats are considered to be at an unacceptable level and would impair independence. The following example helps illustrate the rule: Alistair, a partner of Mayfair CPAs, co-owns (50/50) an apartment building with Chongai, the CFO of Alistair's financial statement review client. The investment is material to Alistair and his spouse's net worth. In this case, threats to independence are significant and may not be sufficiently reduced by safeguards. Independence is considered impaired.

Key AICPA ethics provisions for tax services

Illustration — Exercising Due Professional Care SemperBarnes, LLP, is a midsized accounting practice with six offices. SemperBarnes' primary service offerings are accounting, auditing, tax, advisory, valuation, and litigation support services. The firm's client base is mainly privately held companies, but also includes not-for-profits, benefit plans, individuals, and a small number of public registrants. Harold Barnes, CPA, is a senior tax partner and co-founder of the firm. He is in charge of the firm's tax practice, including its quality control policies and procedures. He also serves as the firm's primary consultant on tax engagements. Today, Harold is following up on a review he did of a corporate tax return prepared by an engagement team led by David Thompson, CPA, and a junior partner who was recently admitted to the firm. Harold has asked David to join him in his office to discuss the return. Harold: David, thanks for coming by. I have reviewed the tax return you prepared for the Dunlop account and have some questions. In particular, I am curious about one of the calculations. I'm not sure I agree with your classification of certain items. David: I'm surprised to hear you say that. The client said they had the exact same transaction last year, so the staff pulled last year's work papers and modeled the calculation after that. We also researched the AICPA code to ensure there had been no recent decisions or rulings that would affect the calculations. There were none. Harold: Did you review and agree with the analysis used for the calculations on last year's return and do you feel that you reviewed enough of the underlying documents for this year's transaction to conclude that the same analysis should apply this year? David: We looked at some of the analysis and documents; but not absolutely everything though. I felt comfortable relying on last year's work; after all, you were the tax partner! Also, we felt it necessary to rely on last year's work due to the increasing demands on my time and the time of my staff. The client also confirmed that the transaction was the same as last year. Question Do you think David exercised due diligence in preparing the tax calculation? No, David should have reviewed last year's analysis and enough of the underlying documentation, obtaining assistance, if needed, with any technical issues. Correct. In addition to reviewing last year's return, David needed to review and agree with the analysis used for the calculations on last year's return. He also needed to review enough of the underlying documents for this year's transaction to conclude that the same analysis should apply this year. He should have sought technical assistance if needed. Harold: David, regardless of who worked on a job before you — even a very senior person like me — you need to exercise due care and check things out for yourself. Because the client is new to you, you should review the prior year return as well as the permanent file (for example, legal documents such as deeds, trusts, and incorporation documents, and any documents related to your review of the client's current year tax situation). In addition, just because the client believes that a transaction is identical to one they had in a prior year, it does not mean that for tax purposes it necessarily is. I know this client well. They would not try to mislead you, but they may leave something out that's relevant from a tax perspective. It's your job to dig in. Because you are new to the firm, let's talk a bit about the practice aids and research you and the staff used to prepare this return. Maybe you just need to get more attuned to the tools we have available and the way we generally do things. 1. Due professional care Establish facts by: -determining which facts are relevant, -evaluating reasonableness of assumptions or representations, -relating the applicable law to the facts, and -arriving at a conclusion based on law and facts. -Also, review prior-year tax returns; and (for new clients or as needed for existing client engagements) review the permanent file. 2. Competence Competence includes the following: -Complying with professional standards -Applying knowledge and skill with reasonable care and diligence -Having both the technical qualifications and the ability to supervise and evaluate the work of others -Knowing the profession's standards, the techniques, and the technical subject matter involved, and making sound judgment in applying such knowledge In some cases, even a person who is competent in the subject matter will need to perform additional research or consult with others. If a member is unable to gain sufficient competence through these means, the member should suggest, in fairness to the client and the public, the engagement of someone competent to perform the needed professional service, either independently or as an associate.

The NOCLAR standard

In 2016, the International Ethics Standards Board for Accountants (IESBA) issued a standard, Responding to Non-Compliance with Laws and Regulations (NOCLAR), which provides a framework to guide professional accountants on how best to act in the public interest when confronted with their client's or employer's actual or suspected noncompliance with laws or regulations. The standard became effective on July 15, 2017. NOCLAR is noncompliance committed by either a client or an employer, including the client's or employer's governance body, management, and employees. NOCLAR is further narrowed as follows: -The law or regulation directly affects material amounts and disclosures in a client's or employer's financial statements. -Compliance with the law or regulation is fundamental to the client's or employer's business and operations; such compliance is key to avoiding material penalties. NOCLAR does not include -clearly inconsequential matters, -personal misconduct unrelated to the company's business, or -misconduct by persons not included in the scope of NOCLAR. Examples of laws and regulations the standard addresses include those related to the following: Fraud, corruption, and bribery Money laundering, terrorist financing, and proceeds of crime Securities markets and trading Banking and other financial products and services Data protection Tax and pension liabilities and payments Environmental protection Public health and safety As adopted by IESBA, if a professional accountant concludes that a client or employer is committing NOCLAR violations, the accountant should disclose the matter to the appropriate members of his or her client's or employer's management. If, once told of the NOCLAR violations, those parties (for example, management and/or the board of directors) fail to address the violations, and the accountant believes there is a significant threat of substantial harm to the public, the accountant may conclude that it is in the public interest to disclose the matter to a governmental body (or other relevant public authority) for investigation. In other words, the NOCLAR standard provides an additional exception to the confidentiality rules that normally preclude such disclosure without the client or employer's consent.

AICPA-proposed NOCLAR standards

In March 2017, the AICPA proposed NOCLAR rules tailored to members in public practice and members in business (parts 1 and 2 of the code, respectively) that, while based on the IESBA standard, departed from it in significant ways. AICPA and state accountancy board rules and regulations generally prohibit disclosure of confidential information to an outside party without client or employer consent unless required by rule or law. Therefore, the AICPA proposal included no provision that would require the member to consider disclosing the NOCLAR to an outside body. The AICPA received comments on the proposal; some were critical of the expansion of responsibilities to nonauditors and members in business and others questioned why the AICPA did not propose a rule that conforms more closely to the IESBA rule. Due to the comments received, the Professional Ethics Executive Committee (PEEC) decided to study the issues further. The AICPA and the National Association of State Boards of Accountancy explored the confidentiality provision in the Uniform Accountancy Act, a model of rules and laws the state accountancy boards may adopt. In February 2021, the PEEC proposed new NOCLAR rules that significantly revised those proposed in March 2017. The 2021 proposed rules include the following: -Different requirements for members performing financial statement attest services for clients versus all other members in public practice -Exclusions for certain types of nonaudit services, such as forensic and investigative services -Clarification that the term client means the entity that engages the member to perform services -Indication that a member in business in a senior role at a company may report NOCLAR to an appropriate authority (unless prohibited by laws or regulations)

Financial interests and relationships

Independence is impaired if a covered member has or is committed to acquire a direct financial interest in an attest client. A direct financial interest is defined as a financial interest that is -owned directly by an individual or entity; -under the control of an individual or entity; or -beneficially owned through a(n) investment vehicle, estate, trust, or other intermediary and the beneficiary -controls the intermediary or -has the authority to supervise or participate in the intermediary's investment decisions. For a direct financial interest, there is no materiality threshold (that is, no safeguards reduce or mitigate the self-interest threats to independence to an acceptable level). If you are a covered member, any direct investment in the client, even a single share of stock, impairs your independence. Some argue that a small investment in a client could not possibly affect independence; however, this is an area in which the perception of having any interest, no matter how small, taints the appearance of your independence. What if you have an indirect financial interest in an attest client? For example, you hold interest in the client through another entity. In that case, you may consider whether the interest in the client is material to your net worth. If you have an indirect financial interest, you may consider the combined net worth of you and your immediate family. An indirect financial interest is defined as a financial interest beneficially owned through a(n) investment vehicle, estate, trust, or other intermediary if the beneficiary -does not control the intermediary and -has no authority to supervise or participate in the intermediary's investment decisions.

Business relationships Part 2

Let's discuss the threats that may arise when a firm (or a member of the firm) and the firm's attest client enter into a cooperative arrangement and where the lines are drawn. (Note: the term "member" is broader than "covered member" and includes all of the firm's professional personnel.) 1. Self Interest Threat-Profit-sharing ventures can create self-interest threats to a member's independence, particularly when the impact is material to the firm or member. Accordingly, the code states that if the arrangement is material to the firm or the client, independence is impaired. 2. Familiarity threat-Entering into a business arrangement with the client will likely increase familiarity threats as the client and firm (or member) develop a business strategy and work closely together. This may affect the firm's independence, particularly in appearance. 3. Undue Influence Threat-Entering into a cooperative arrangement with an attest client can also cause undue influence threats that allow an individual associated with the client to exert excessive influence over the member or the firm. If any of the aforementioned threats are not at an acceptable level, the firm must apply safeguards to eliminate the threat(s) or reduce them to an acceptable level. However, as noted, if a cooperative arrangement (for example, a joint venture to develop a new software with the client) is material to either the firm or the attest client, independence is impaired.

Independence and Your Firm

Nonattest services: Performing nonattest services (that is, consulting or tax services) for an attest client may raise self-review, management participation, or advocacy threats to independence. The AICPA Code of Professional Conduct (the code) lays out general and specific requirements designed to ensure threats are at an acceptable level and do not impair independence. Members should meet the general requirements described in the following section for each nonattest services engagement. If the code does not provide specific guidelines about the services the firm would provide, evaluate independence using the conceptual framework for independence. General requirements: Assume you are an audit partner in a firm that wants to provide a nonattest service to an attest client. First, you should determine if the proposed services are permissible under the code. If they are, you should apply the "General Requirements for Performing Nonattest Services" interpretation (ET sec. 1.295.040). The three general requirements are described in the following screens. General requirements: 1. Client responsibilities: Determine whether your client will agree to assume the following responsibilities: -Perform all management responsibilities -Oversee the services by designating an individual (preferably from senior management) with suitable skill, knowledge, or experience -Evaluate the adequacy and results of services -Accept responsibility for the results of the services Suitable skill, knowledge, or experience Management should designate an individual with suitable skill, knowledge, or experience to oversee the services your firm will perform. You should be satisfied that this person can fulfill all of the aforementioned responsibilities. However, this does not mean that the client's designee must match your firm's skills and knowledge or be able to duplicate the firm's services. In assessing whether an individual has suitable skill, knowledge, or experience to oversee a nonattest service, consider (among other things) whether the individual -knows the client's business, -knows the client's industry, and -has general business knowledge. 2. General requirements: Firm assumes no management responsibilities The second general requirement states that "the member does not assume management responsibilities when providing nonattest services" and should be satisfied that the client's designee will be able to meet all the previously listed responsibilities, make the significant judgments and decisions, and make an informed judgment on the results of your nonattest firm's services. If the client is unwilling or unable to assume these responsibilities, then your provision of the nonattest services creates an unacceptable management participation threat that impairs your independence. The following are some examples of activities that your firm should avoid because they are management responsibilities. 1. Authorize-Authorize, execute, or consummate a transaction exercising authority on behalf of a client. 2. Prepare-Prepare source documents (in electronic or other form) evidencing the occurrence of a transaction. 3. Take Custody-Take custody of client assets, data, or records. 4. Supervise-Supervise client employees as they perform their normal recurring activities. 5. Other- -Determine which of your firm's recommendations the client should implement. -Report to the board of directors on management's behalf. 3. General responsibilities: Establish understanding with client Before performing nonattest services, you are required to establish and document (in writing) your understanding with the client regarding -the objectives of the engagement, -the services to be performed, -the client's acceptance of its responsibilities, -the firm's responsibilities, and -any limitations of the engagement. Your firm's documentation may take any form you wish (for example, an engagement letter or a memo). The failure to prepare the required documentation generally would not impair independence, provided the understanding with the client had been established. However, the failure to document the understanding with the client would be considered a violation of the "Compliance with Standards Rule" (ET sec. 1.310.001). What happens when a nonattest client later becomes an attest client? Suppose you provided tax advisory services to a client during 20X4. Then, in 20X5, the client approaches you and asks if you would be able to audit its 20X4 financial statements. When performing tax services in 20X4, you did not document your understanding with the client. May you accept the attest engagement? Take a moment to reflect on this question. The answer is "yes," if: -You did, in fact, establish the required understanding with the client and comply with the other general requirements of the rules. -Upon acceptance of the attest engagement, you prepare documentation demonstrating your compliance with the general requirements during the period covered by the financial statements.

Nonaudit services

Nonaudit services generally include tax and consulting services, for example, bookkeeping, tax compliance, or valuation services. When your firm provides these services to an SEC audit client, the rules impose limits on the nature and scope of those services. Your firm may even be prohibited from providing certain types of services for the client. 1. More restrictive rules: SEC and PCAOB independence rules for nonaudit services tend to be stricter than the AICPA rules, especially for the following services: -Bookkeeping, accounting, and payroll services -Valuation, appraisal, and actuarial services -Tax services (personal tax services for financial executives and aggressive tax transactions) -Financial information systems design -Human resource services -Legal services -Internal audit -Temporary staffing services (Note: these services are viewed as acting as an employee, which violates an SEC principle.) Recall that an accounting firm should not audit its own work. The following services raise self-audit concerns: -Bookkeeping (including payroll) -Valuation, appraisal, and actuarial -Financial information systems design and implementation -Internal audit Therefore, unless an auditor reasonably concludes that the results of the services will not be subject to the accounting firm's audit procedures, performing these services will impair independence. SEC and PCAOB independence rules also require auditors to discuss independence with an audit client's audit committee and to have their services pre-approved by the audit committee. Bookkeeping services In addition to raising self-audit issues, certain aspects of bookkeeping services — for example, authorizing electronic payments — constitute management functions. For these reasons, bookkeeping services are strictly prohibited. The SEC prohibits -maintaining or preparing the audit client's accounting records; -preparing the audit client's financial statements that are filed with the SEC or form the basis of financial statements filed with the SEC; and -preparing or originating source data underlying the audit client's financial statements. To evaluate some of the other SEC and PCAOB rules regarding nonaudit services, we'll look at scenarios involving consultations between Julia — the quality control director at AB Accountants — and some of the firm's partners as they prepare to perform tax or advisory services for audit clients. Assume AB Accountants provides nonaudit services to its audit clients. Following are descriptions of certain nonaudit services that firm clients requested but that AB declined or modified to comply with the rules. 2. Other nonaudit services: Private client to become public Consider this scenario: AB provided bookkeeping assistance to its private audit client in 20X1, 20X2, and 20X3 under AICPA rules. The client plans to file an initial public offering (IPO) with the SEC in 20X4 and those financial statement periods will be included in the IPO filing. SEC rules do not permit firms to perform bookkeeping services during the professional engagement period, which includes the periods covered by the financial statements. Under a revised rule that went into effect in June 2021, AB must be independent under SEC and PCAOB rules with respect to the latest year included in the filing, that is, 20X3. In this case, the bookkeeping services performed that year would require the client to hire a new audit firm in connection with the public offering.

SEC and PCAOB Independence Rules

Organization and application of the SEC and PCAOB independence rules: 1. Applicability of SEC and PCAOB rules The independence rules that apply to you and your firm depend on the type of entity your firm is auditing. If your firm audits a privately held entity that is not subject to government oversight, then you will be required to follow the rules of the AICPA and your state accountancy board. If, however, your firm audits a company that files reports with the SEC, you must also comply with the SEC and, in some cases, the PCAOB independence rules. 2. Similarities and differences between AICPA and SEC rules Many SEC independence rules are substantially similar to the AICPA rules and therefore will not be addressed in this course. Rather, this section will focus on SEC and PCAOB rules that either supplement or are more restrictive than the AICPA rules. The exhibit below identifies the rules that are similar in substance. Similarities between AICPA and SEC independence rules -Application of SEC independence rules to a "covered person" (a term similar to AICPA's "covered member") -Definitions of key position and immediate and close family members and application of the rules to a covered person's family -Financial interests in client, including holdings in a client through a mutual fund and a prohibition against 5% or greater ownership in a client -Current or previous employment or other association in a management role with client 3. How the rules are organized SEC independence rules and guidance The SEC's independence rules and related guidance can be found in -Rule 2-01 of Regulation S-X -Office of the Chief Accountant: Application of the Commission's Rules on Auditor Independence, Frequently Asked Questions -Section 602 of the SEC Codification of Financial Reporting Policies SEC Rule 2-01 The primary source of authoritative literature on independence is SEC Rule 2-01, Qualifications of Accountants, of Regulation S-X. SEC Rule 2-01(b) establishes a general standard of independence and four fundamental principles against which the auditor's services to and relationships with the audit client should be weighed. Rule 2-01(b) The Commission will not recognize an accountant as independent, with respect to an audit client, if the accountant is not, or a reasonable investor with knowledge of all relevant facts and circumstances would conclude that the accountant is not, capable of exercising objective and impartial judgment on all issues encompassed within the accountant's engagement. In determining whether an accountant is independent, the Commission will consider all relevant circumstances, including all relationships between the accountant and the audit client, and not just those relating to reports filed with the Commission. Section 210.2-01, Qualifications of accountants Fundamental principles In considering the general standard, the SEC considers whether a relationship or the provision of a service -creates a mutual or conflicting interest between the auditor and the audit client; -places the auditor in the position of auditing his or her own work; -results in the auditor acting as management or an employee of the audit client; or -places the auditor in a position of being an advocate for the audit client. SEC Rule 2-01(c) reflects the application of the general standard to particular circumstances, such as the provision of nonaudit services and investments in clients. The rule does not purport to consider all circumstances that raise independence concerns; therefore, relationships and services are also subject to the general standard in SEC Rule 2-01(b). 4. Applying the rules SEC rules apply to audit clients, which by definition includes all of the audit client's affiliates. If A Inc. is the audit client, A's affiliates under SEC rules will include -a parent or subsidiary of A; -an entity that has significant influence over A (generally 20-50% equity interest in A) when A is material to the entity; -an entity that A has significant influence over (generally 20-50% equity interest in entity) when the entity is material to A; -an entity under common control with A when both the entity and A are each material to the controlling entity; and -an entity in an investment company complex when A is a part of that complex — for example, if A is an SEC-registered mutual fund, then all the other funds in that fund family and certain other entities (for example, banks or brokerage firms) will be affiliates of A. 5. PCAOB independence rules and guidance In April 2003, the PCAOB adopted the interim independence standards consisting of independence standards described in the AICPA's Code of Professional Conduct Rule 101, and interpretations and rulings thereunder, as in existence on April 16, 2003. PCAOB rules also require compliance with SEC Rule 2-01 and certain standards and interpretations adopted by the Independence Standards Board, which no longer exists. In all cases, auditors should apply the more restrictive rule or portion of the applicable rule. The PCAOB independence rules appear on its web site at https://pcaobus.org/oversight/standards/ethics-independence-rules. The PCAOB staff occasionally issue guidance on independence. For example, in 2019, the Board issued Staff Guidance: Rule 3526(b) Communications with Audit Committees Concerning Independence. See https://pcaob-assets.azureedge.net/pcaob-dev/docs/default-source/standards/documents/staff-guidance-rule-3526(b)-communications-audit-committee-concerning-independence.pdf?sfvrsn=77612794_0.

Ethics rules for tax practice

Professional ethics rules require you to comply with all professional standards set by bodies designated by the AICPA Council. Therefore, if you are performing audit, review, management consulting, tax, or other services, you must also refer to the applicable technical requirements in each area. In this course, we will cover the ethics rules for professionals who perform tax services for clients, including AICPA code provisions and related technical standards and regulatory standards set by the federal government. 1. Standard-setting bodies and regulators The primary rules of conduct for federal tax practice that apply to AICPA members are promulgated by the AICPA and the U.S. Treasury Department (via the IRS). Tax professionals may be subject to the rules of other regulators as well. 1A. AICPA Code of Professional Conduct Many rules and interpretations found in the AICPA Code of Professional Conduct (the code) apply to tax practice, including the following: -Due professional care -Competence -Contingent fees -Confidential client information -Independence (if your firm provides attest services to clients) -Records requests The AICPA Tax Executive Committee promulgates the Statements on Standards for Tax Services (SSTSs), which are enforceable under the "General Standards Rule" (ET sec. 1.300.001) and "Compliance with Standards Rule" (ET sec. 1.310.001) of the AICPA code. Federal tax law is codified in the Internal Revenue Code (IRC). Section 7805(a) of the IRC authorizes the Secretary of the Treasury to promulgate rules and regulations necessary to enforce the U.S. tax laws. Treasury Department Circular No. 230 is available at https://www.irs.gov/pub/irs-pdf/pcir230.pdf. Circular No. 230 governs federal tax practice before the IRS by CPAs, enrolled agents, attorneys, enrolled retirement plan agents, appraisers, and actuaries. Preparer penalty provisions appear in the IRC. The IRS director of the Office of Professional Responsibility (OPR), operating under the IRS Commissioner's office and the Treasury Department, may censure, suspend, or disbar a practitioner from practicing before the IRS if the practitioner is shown, among other things, to be incompetent or disreputable. In certain matters involving egregious behavior (for example, fraud or breach of trust), the IRS may immediately suspend a practitioner. The AICPA bylaws provide an "automatic" disciplinary provision, which allows it to impose disciplinary sanctions on a member found by the IRS (or another relevant regulator) to have committed a serious violation of the profession's standards. Example A six-month suspension by the IRS for nonpayment of taxes would result in a six-month suspension of AICPA membership without a hearing, which would also be subject to publication by the AICPA in the CPA letter or in another publication.

DOL independence rules

Professionals in public accounting who perform audits of employee benefit plans under the Employee Retirement Income Security Act (ERISA) must comply with the independence rules of the DOL in addition to the AICPA code. The DOL established broad independence requirements for employee benefit plan audits in the 1970s under Regulation 2509.75-9, Interpretive Bulletin Relating to Guidelines on Independence of Accountants Retained by Employee Benefit Plan. AICPA rules also apply to employee benefit plan attest clients (and in most cases, their nonclient or nonattest client sponsors), and the AICPA code states that you should comply with DOL rules when they apply to your firm's engagement. DOL rules are generally more restrictive than the AICPA rules, are silent on many issues, and also apply to the plan's sponsor, so it is important to know the DOL requirements and where these differences lie. The entirety of the DOL independence rules appears as follows: https://us.aicpa.org/content/dam/aicpa/interestareas/professionalethics/resources/tools/downloadabledocuments/dolindependenceinterpretivebulletin.pdf Example: Independence for benefit plan audits Sylvie is the newly hired quality control director at Fargo & Co., CPAs. She's researching independence matters for a benefit plan audit the firm may undertake. She notes that the DOL defines a member in much broader terms than the AICPA's covered member. The DOL's definition includes all owners, partners, or shareholders in the firm, all professional employees participating in the audit, and all professional employees located in an office of the firm participating in a significant portion of the audit. The bulletin also indicates that the DOL "will give appropriate consideration to all relevant circumstances, including evidence bearing on all relationships between the accountant or accounting firm and that of the plan sponsor or any affiliate thereof." Further, independence requirements apply not only to the benefit plan under audit but also to the plan's sponsor even if the sponsor is not a client. So, if the sponsor asks her firm to perform nonattest services, she will need to consider whether those services affect independence with respect to both the plan under audit and the plan's sponsor. Sylvie also accesses a publication by the AICPA Employee Benefit Plan Audit Quality Center called, "DOL and AICPA Independence Rule Comparison," which provides a side-by-side analysis of the rules and how they differ. https://us.aicpa.org/content/dam/aicpa/interestareas/employeebenefitplanauditquality/resources/accountingandauditingresourcecenters/auditorindependence/downloadabledocuments/dol-aicpa-independence-rule-comparison.pdf.

International independence standards

Professionals performing audit and other attest (assurance) services under international auditing standards must comply with ethics standards promulgated by the International Ethics Standards Board for Accountants (IESBA) and their local jurisdictions (for example, AICPA or another applicable code). The global ethics standards are found in the International Code of Ethics for Professional Accountants (including International Independence Standards) (IESBA code). When local and IESBA standards differ, the auditor should comply with the more restrictive rules. The IESBA code serves as the foundation for codes of ethics developed and enforced by member bodies of the International Federation of Accountants (IFAC), such as the AICPA, the Institute of Management Accountants (in the United States), Chartered Professional Accountants Canada, and other professional accountancy bodies throughout the world. The IESBA code is based on the conceptual framework approach, which requires a professional accountant to identify and evaluate threats to their compliance with the fundamental principles of the IESBA code to determine their significance. If threats are not at an acceptable level, safeguards should reduce threats to an acceptable level or eliminate them completely. 1. Comparing the AICPA and IESBA codes The IESBA and AICPA codes have many similarities, and, in some cases, applying the codes to the same fact pattern will yield similar results. The principles underlying each code are also similar, as are many of the requirements applicable to professional accountants in business. Like the AICPA code, the IESBA code describes how the conceptual framework applies in some specific situations. For example, both codes describe -how providing nonassurance services, such as valuations, to an audit client may threaten an accounting firm's independence; and -how receiving gifts or other inducements from a superior may threaten a corporate accountant's objectivity. -The IESBA code provides guidance for the more common, but certainly not all, practice situations. In all instances, IESBA requires a professional accountant to apply the conceptual framework approach to identify, evaluate, and address threats to compliance with the fundamental principles. -Like the AICPA code, the IESBA code considers some threats so significant that no safeguards can be applied to eliminate or reduce threats to an acceptable level. For example, an audit team member could not own stock in his or her client and apply safeguards to mitigate the threat to independence because the IESBA code prohibits audit team members from investing in their clients. In those cases, the threat to independence cannot be sufficiently reduced with safeguards. As mentioned, the codes address many of the same topical areas. However, some differences exist. For example, the AICPA code dictates how members in public practice may structure and name their accounting firms and describes several "discreditable acts" that violate the AICPA code; the IESBA code does not (although IESBA requires compliance with the fundamental principle of professional behavior). The IESBA code also contains an interpretation called "Noncompliance with Laws and Regulations" (NOCLAR) that does not appear in the AICPA code. (Note: The AICPA's Professional Ethics Executive Committee [PEEC] issued a proposal to include NOCLAR interpretations in the AICPA code in 2017 and 2021. The 2021 proposal is currently pending.)The IESBA code provides detailed guidance on certain independence matters that do not appear, or are addressed differently, in the AICPA code. One example is long association of senior personnel with a client, that is, partner rotation. PEEC developed two "Frequently Asked Questions" (nonauthoritative guidance) that address long association, and the issue is addressed in the conceptual framework. The IESBA code also imposes additional provisions that reflect the public's heightened interest in public interest entities (PIEs). PIEs are listed entities (for example, entities whose securities are listed on a recognized stock exchange) and entities whose auditors are required by law or regulation to comply with the same independence requirements as listed entities. Depending on the jurisdiction, PIEs may include certain banks or pension funds. A pending proposal to revise the definition of PIE will be discussed in this section under "Recent standard setting." The AICPA independence rules do not include stricter provisions for PIEs than for other types of attest clients, although this notion is included in the conceptual framework. However, the AICPA code requires members to comply with many more restrictive rules and regulations applicable to their engagements. For instance, if B Company lists its common stock on the New York Stock Exchange, it would be considered a PIE. A member auditing B Company who complies with the independence rules of the SEC and the PCAOB would be in compliance with the AICPA and the IESBA codes because the SEC and PCAOB rules are as stringent as the IESBA requirements. AICPA members and others subject to the AICPA code should pay attention to rules set by IESBA. As an IFAC "member body," the AICPA has agreed to consider adopting rules that are as stringent as the IESBA code; therefore, changes to the IESBA code can also result in changes to the AICPA code. 2. Recent standard setting IESBA recently made substantial revisions to the independence rules that apply to auditors providing nonassurance services (NAS) to clients and matters involving an auditor's fees with the effect of making the IESBA independence standards more stringent. Nonassurance services A few examples of the changes IESBA made recently to the independence provisions for NAS follow: -Before providing NAS to an audit client, a firm or network firm shall determine whether the provision of that service might create a self-review threat by evaluating whether there is a risk that the results of the services will affect the client's accounting records, internal controls, or financial statements. The key question is whether the audit team will evaluate or rely on the firm's judgments or activities undertaken in performing the NAS. -Also, when a firm or network firm provides multiple NAS to an audit client, the firm shall consider whether, in addition to the threats created by each service individually, the combined effect of the services creates or affects threats to independence. -A firm or network firm should not perform a service that advocates a particular tax treatment that the firm initially developed for the client when the significant purpose of that treatment is tax avoidance. However, if the firm is confident that the proposed treatment has a basis in applicable tax law or regulation that is likely to prevail, the NAS may be permissible. -A firm or network firm should not recommend a particular candidate for appointment, or advise on the terms of employment, remuneration, or related benefits, if that candidate would hold a senior management position in the company or serve on the company's board of directors. These revisions apply to all audit engagements. Other more restrictive rules, including those for accounting and bookkeeping, expert services, and communications with audit committees, apply solely to audits of PIEs. For example, firms may not perform any service for a public interest entity that might create a self-review threat to independence, even if the results of those services are immaterial to the entity's financial statements. Fees Changes to rules related to an auditor's fees include the following: -Recognition that when fees are negotiated with and paid by an audit client, this creates a self-interest threat and might also create an intimidation threat to independence -A new prohibition precluding firms from allowing NAS to influence the audit fee -Requirements relating to fee dependency and the proportion of fees paid by a client for nonaudit services to the audit fee -Requirements for sharing information about fees with those charged with governance and the public Like the changes to the NAS provisions, the independence rules for audits of PIEs are generally more restrictive, although the requirements have also become more stringent for audits of other "nonpublic interest entities." The following is an example: Assume your audit client — a private company — supplies 35% of your firm's total fees, and this situation continues over five consecutive years. Under the new rules, you must determine whether applying certain safeguards (specifically, a pre- or post-issuance review) would mitigate self-interest and possibly other threats to your firm's independence starting in that fifth year, and if so, apply that safeguard. (Note: The threshold for this requirement is 30%.) If the total fees from this engagement continue to exceed 30% each year, your firm must determine, each year, whether the pre- or post-issuance review continues to be a safeguard, and if so, apply that safeguard. If your firm continues to believe that applying the safeguard sufficiently mitigates threats to independence, this situation can continue indefinitely. Each year, you should document your evaluation and actions. To illustrate the application of fee dependency to a PIE: If your client is a PIE (for example, a large bank), the threshold drops to 15% of your firm's total revenue. You should determine whether a pre-issuance review that meets the objectives of an engagement quality review would mitigate threats to your independence starting in the second consecutive year of fee dependency. If the situation continues into a fifth year, your firm would be required to cease the audit relationship. The effective dates for both the NAS and fees provisions are periods beginning on or after December 15, 2022. Early application is permitted. Public interest entity IESBA proposed significant revisions to the definitions of PIE and listed entity; If an entity is a PIE, the auditor must meet more rigorous independence standards, for example, similar to the way in which auditors of SEC registrants must comply with stricter independence rules than auditors of privately held companies. There is an even greater emphasis on the perception of independence for audits of PIEs, so even immaterial relationships or services are often forbidden. The IESBA proposal has three elements: First, the board proposed a high-level list of PIE categories, which includes, for example, companies whose main function is to provide post-employment benefits, publicly traded companies, banks, and insurers. Second, IESBA expects that local standard-setters — like the AICPA — would refine these broad categories based on local preferences and guidance provided in the proposal, for example, a member body may narrow a category of PIE to exclude certain smaller entities. Third, firms would be required to consider whether additional clients should be treated as a PIE for independence purposes — today, they are only encouraged to do so.Comments on the proposal were due on May 3, 2021.

Employment and business relationships

Recall that for certain significant financial interests, the rules apply to all professionals in your firm. For example, if any partner or professional employee in the firm has a financial interest in an attest client exceeding 5% of the entity's outstanding equity securities, the self-interest threat to independence would not be at an acceptable level and would impair independence. Similarly, an unacceptable management participation threat would exist and impair independence if any partner or professional employee of a firm is employed or otherwise associated with an attest client during the period of the professional engagement or the period covered by the financial statements as a -director, officer, or employee; -promoter, underwriter, or voting trustee; or -trustee of any pension or profit-sharing trust of the client. Seeking employment with an attest client Assume you are on an attest engagement team or can influence an attest engagement and are interested in a position with the client. To mitigate undue influence and self-interest threats to independence, you must follow these safeguards: -Promptly report any employment negotiations with the client to the appropriate person in the firm. -Remove yourself from the engagement during negotiations (until you reject the employment offer or no longer seek employment with that client). Now assume that the client hires you. If you will be employed in a key position that will allow you to influence the client's financial statements or significant accounting records, several additional safeguards apply. First, you must disassociate from the firm as follows: -You should not be able to influence the firm's operations or financial policies. -You should not participate or appear to participate in the firm's business (for example, by having an office in the same building) or continue to provide professional services to the firm's clients. In addition, any amounts due to you for your interest in the firm and retirement benefits must be based on a fixed formula and may not be material to the firm. Former association with a client What threats to independence arise if a professional who has worked for an attest client comes to work for the firm that performs its audit or other attest engagement? Assume, as a former employee of XYZ Co., you take a job at Bennett CPAs, which performs XYZ's audit. Your employment at Bennett CPAs would impair the firm's independence if, during any period that included your time in XYZ's employ, you -participated in XYZ's attest engagement, or -were able to influence XYZ's attest engagement. Disassociation from client At a minimum, you must disassociate from XYZ before becoming a covered member by -disposing of any financial interests in XYZ; -collecting or repaying any loans to or from XYZ; -ceasing to participate in XYZ's benefit plans; -liquidating or transferring all vested benefits in XYZ's compensation and benefit plans; and -considering the application of the conceptual framework for independence standards to threats created by any other interests or relationships with XYZ.

Ethical decision-making model

Step 1 Recognize the ethical issue Step 2 Gather critical facts Step 3 Identify Stakeholders Step 4 Consider Alternatives Step 5 Consider the effect of Stakeholders Step 6 Consider your comfort level Step 7 Consider rules, regulations, and laws Step 8 Make a decision Step 9 Document efforts Step 10 Evaluate the outcome

Preparer penalties-Example

Tax practitioners should be aware of provisions in the IRC that can impose penalties on the practitioner in connection with preparing federal tax returns. In this next example, Harold is holding a training session on preparer penalties. Harold: It looks like everyone is here. Thanks for coming. As you know, today we are going to discuss the IRC preparer penalty provisions and, specifically, how to avoid them. I would like this to be a discussion and not a lecture. So, please ask questions. Linda: As long as you say that, would you mind by starting with a review of the basic penalty provisions? Harold: Section 6694 of the IRC contains the basic preparer penalty provisions that apply to all federal tax returns, not just income tax returns. These penalties apply to understatements due to "unreasonable positions," as well as to understatements due to willful or reckless conduct. Harold (continued): The penalty amounts are significant: the greater of $1,000 ($5,000 if the understatement is due to willful or reckless conduct) or half the income derived from preparing the return. Plus, a penalty under Section 6694 could lead to a referral to the IRS Office of Professional Responsibility, which means that your license to practice might be at risk. Therefore, this is an area to watch carefully. As of today, Section 6694(a) generally penalizes a tax return preparer if a client's tax liability was understated and it was due to one of the following situations: (1) a nondisclosed tax position for which there was not "substantial authority," or (2) a disclosed tax position for which there was not a reasonable basis. There is one situation where the penalty may be waived: if there was a reasonable cause for the understatement and the preparer acted in good faith. How do you know whether a position has substantial authority? This means the weight of the authorities supporting the tax treatment is substantial compared to the weight of the authorities supporting the contrary treatment. AICPA members also need to comply with the AICPA SSTSs, including SSTS No. 1, Tax Return Positions, which sets forth the level of support needed to take a tax return position. These standards are not the same as the standards in Section 6694; where federal or other requirements are more restrictive, members should apply the strictest standard. Harold: Obviously, no one in this firm would ever fall into this category of offenders, but the other preparer penalty under Section 6694(b) is referred to as the "willfulness penalty." It applies if: -any part of a client's underpayment can be attributed to a willful attempt to understate the client's tax liability or -where the preparer recklessly or deliberately disregarded the rules or regulations. If the preparer knew, or was reckless in not knowing, that a tax position was contrary to a rule or regulation, the penalty is the greater of $5,000, or half of the revenue derived from preparing the return. The IRS can also obtain an injunction that would prevent a preparer from practicing in the future if the preparer's conduct involved fraud or gross incompetence. The Section 6662 penalty provision, referred to as the "accuracy-related penalty," applies to taxpayers (clients). This penalty amounts to 20% of the portion of a client's underpayment if it can be attributed to: -the client's negligence or disregard of IRS rules and regulations, -substantial understatement of tax, or -substantial over- or under-valuation of certain assets or liabilities. For example, the IRS may penalize a client if the client substantially misstated a valuation like a client overstating the value of a painting she donated to a museum. However, as in the case of preparer penalties, if there are extenuating circumstances, the IRS may provide a waiver if the client had reasonable cause for the position and acted in good faith. Linda: Good faith and reasonable cause. What does that mean? Harold: It essentially means that the taxpayer displayed ordinary business care and prudence to determine the tax liability, but perhaps due to circumstances they could not control, they were unable to comply. These matters are very fact specific.

Acts discreditable to the profession

The "Acts Discreditable Rule" (ET sec. 2.400.001) applies to all AICPA members and broadly addresses professional conduct. In this context, to discredit means to harm the reputation of the profession and the people who practice it. Examples of discreditable acts include such things as misappropriation of client or employer funds, insider trading, or failing to comply with laws and regulations. The AICPA Professional Ethics Executive Committee has issued several interpretations of this rule. 1. Discrimination and Harassment: Being found guilty of violating any antidiscrimination laws. 2. Government Regulations: Failure to follow standards and procedures or other requirements in governmental or regulatory audits or attest services. 3. Preparation of Financial Statements: -Through negligence, making or permitting others to make materially false or misleading entries in the financial statements or accounting records -Failure to correct an entity's financial statements that are materially false and misleading when the member has the authority to record an entry -Signing (or permitting or directing another to sign) a document containing materially false and misleading information 4. Timely Filing of Tax Returns: Failure to timely file personal tax returns or those of the firm, or failure to remit payroll or other taxes in a timely manner. 5. Disclosure of employer's confidential information(including volunteer positions): Member should maintain the confidentiality of his or her employer's or firm's (employer) confidential information and should not use or disclose any confidential employer information obtained as a result of an employment relationship; for example, discussions with the employer's vendors, customers, or lenders.

Gifts and entertainment

The "Gifts and Entertainment" interpretation (ET sec. 2.120) applicable to members in business cites a possible self-interest threat plus two other threats to compliance with the code, as follows: Familiarity The threat that, due to a long or close relationship with a client, you will become too sympathetic to the client's interests or too accepting of the client's work or product. Undue Influence The threat that you will subordinate your judgment to that of an individual associated with the client or any relevant third party due to that individual's reputation or expertise, aggressive or dominant personality, or attempts to coerce or exercise excessive influence over you.

Affiliates of attest clients

The AICPA code requires members to be independent of attest clients as well as certain affiliates of "financial statement attest clients." For example, you may have an investment in a non-client (T Corp.) that controls or has significant influence over U Corp., your financial statement attest client. If T Corp. is an affiliate of U Corp., the same independence restrictions that apply to your relationships and interests with U Corp. (as your client) would also generally apply to your relationships and interests with T Corp., the affiliate. A financial statement attest client is an entity whose financial statements are audited, reviewed, or compiled (if the member's compilation report does not include a disclosure regarding lack of independence). The following are examples of affiliates of a firm's financial statement attest client ("client"): -An entity that your client controls (such as a subsidiary) -An entity that has significant influence over your client and the investment in your client is material to the entity -A sister entity of your client (under common control with your client) if your client and the sister entity are each material to the controlling entity -The sponsor of your employee benefit plan client Controls: The term control(s) follows the definition in FASB ASC 810, Consolidation, for commercial entities and FASB ASC 958-805-20 for not-for-profit entities. Significant Influence: The term significant influence follows the definition in FASB ASC 323-10-15.

Principles of Professional Conduct

The Principles of Professional Conduct (ET sec. 0.300) 1. Responsibilities-In carrying out your professional responsibilities, you should exercise sensitive professional and moral judgment. 2. Public Interest-You should act in a way that will serve the public interest, honor the public trust, and demonstrate your commitment to professionalism. 3. Integrity-To maintain and broaden public confidence, you should perform all professional responsibilities with the highest sense of integrity. 4. Objectivity and Independence-You should maintain objectivity and be free of conflicts of interest in discharging your professional duties. If you work for a public accounting firm that provides audit and other attestation services, you should be independent in fact and appearance. 5. Due Care- You should observe the profession's technical and ethical standards, strive continually to improve competence and the quality of services, and discharge professional responsibility to the best of your ability. When performing audits or other attest services, due care requires CPAs to exercise professional skepticism. 6. Scope and Nature of Services-As a member in public practice, you should observe the principles of the Code of Professional Conduct in determining the scope and nature of services to be performed. Rules of conduct 1. Part 1: Members in public practice: 1.100 — Integrity and Objectivity 1.200 — Independence 1.300 — General Standards 1.310 — Compliance with Standards 1.320 — Accounting Principles 1.400 — Acts Discreditable 1.500 — Fees and Other Types of Remuneration 1.600 — Advertising and Other Forms of Solicitation 1.700 — Confidential Information 1.800 — Form of Organization and Name 2. Part 2: Members in business: 2.100 — Integrity and Objectivity 2.300 — General Standards 2.310 — Compliance With Standards 2.320 — Accounting Principles2.400 — Acts Discreditable 3. Part 3: Other members (neither in public practice nor business) panel text: 3.400 — Acts Discreditable "Interpretations and Other Guidance" (ET sec. 0.100.020) Interpretations of the rules of conduct are adopted after exposure to the membership, state societies, state boards, and other interested parties. The interpretations of the rules of conduct, "Definitions" (0.400), "Application of the AICPA Code" (0.200.020), and "Citations" (0.200.030), provide guidelines about the scope and application of the rules but are not intended to limit such scope or application. A member who departs from the interpretations shall have the burden of justifying such departure in any disciplinary hearing.

Statements on Standards for Tax Services

The SSTSs are enforceable standards under the AICPA code ("General Standards Rule" and "Compliance with Standards Rule") that apply to all AICPA members providing tax services, whether in public practice or in private industry. These standards apply to work performed in foreign and domestic tax jurisdictions, at all levels of government (federal, state, and city), and complement other standards of tax practice. Note: To address significant changes in tax practice in recent years, the AICPA has initiated a project to update the SSTSs. The SSTSs are enforceable standards under the AICPA Code of Professional Conduct. Areas of focus will be -data security and privacy, -tax quality control, -taxpayer representation, -reliance on technology tools, and -document retention. A summary of each SSTS follows. 1. SSTS No. 1, Tax Return Positions The primary question addressed by SSTS No. 1, Tax Return Positions (TS sec. 100),2 is, "What standard must a member meet to recommend a tax return position and sign a tax return?" ​Nondisclosed tax positions Nondisclosed tax positions should comply with the tax return reporting standard of the applicable taxing authority. If no such standard exists or the taxing authority's standard is lower than the realistic possibility standard (that is, the member believes in good faith that the position has at least a realistic possibility of being sustained administratively or in the courts, if challenged), then the realistic possibility standard applies. Disclosed tax positions Disclosed tax positions should comply with the tax return reporting standard of the applicable taxing authority. If no such standard exists or the taxing authority's standard is lower than the reasonable basis standard, (that is, the member believes in good faith that there is a reasonable basis for the position), then the reasonable basis standard applies. When relevant, members should advise taxpayers of the disclosure requirements and how to avoid penalties through disclosure. Interpretation No. 1-1 Interpretation No. 1-1, "Reporting and Disclosure Standards' of SSTS No. 1, Tax Return Positions" (TS sec. 9100), states that the realistic possibility standard is met when the position is warranted under existing law, or it can be supported by a good faith argument; that is, it is based on a reasonable interpretation of the law. To determine whether the realistic possibility standard has been met, generally, you would do the following: -Establish relevant facts. -Distill relevant questions from the facts. -Research authoritative literature to answer those questions. -Conclude based on your research. Interpretation No. 1-2 Interpretation No. 1-2, " 'Tax Planning' of SSTS No. 1, Tax Return Positions" (TS sec. 9100), clarifies your responsibilities when you provide tax planning services, including those situations involving tax shelters. "Tax planning" includes: -prospective and completed transactions; -written and oral advice; -tax return positions; and -specific tax plans the member, taxpayer, or a third party developed. You should apply appropriate due diligence steps to the evaluation of third-party opinions. 2 All TS sections can be found in AICPA Professional Standards 2. SSTS No. 2, Answers to Questions on Return The primary question addressed by SSTS No. 2, Answers to Questions on Return (TS sec. 200), is, "May a member sign a tax return if one or more questions on the return have not been answered?" Before signing a return, a member should make a reasonable effort to obtain information from the taxpayer to answer all questions on a tax return. Discuss when reasonable grounds exist for omitting an answer to a question on a return.Not all questions are of equal importance; SSTS No. 2 provides guidelines on the types of matters that should be of concern to members. 3. SSTS No. 3, Certain Procedural Aspects of Preparing Returns The primary question addressed by SSTS No. 3, Certain Procedural Aspects of Preparing Returns (TS sec. 300), is, "Must a member examine or verify information provided to him or her by taxpayers or other third parties?" -Members may rely in good faith, without verification, on information provided by taxpayers or third parties unless the information appears to be incorrect, incomplete, or inconsistent with other information that is known to the member, including information related to another taxpayer. -If information appears to be lacking in some manner, members should make reasonable inquiries of the taxpayer. -If there is a specific requirement for a tax treatment (for example, maintaining books and records or substantiating documentation), then the member should inquire to determine if the requirement has been satisfied. -Prior tax returns of the taxpayer should be referred to whenever possible. 4. SSTS No. 4, Use of Estimates The primary question addressed by SSTS No. 4, Use of Estimates (TS sec. 400), is, "May a member rely on a taxpayer's estimates in preparing the taxpayer's return?" -Assuming it is not prohibited by statute or rule, you may use estimated information supplied by your client, provided: -it is not practical to obtain exact data and -the estimate appears reasonable. -In some cases, you should advise the client to disclose the reason an estimate was used (for example, Schedule K-1 for a partnership was not received in time). -The information in the return should not be presented in a manner that is misleading concerning the degree of factual accuracy. 5. SSTS No. 5, Departure From a Position Previously Concluded in an Administrative Proceeding or Court Decision The primary question addressed by SSTS No. 5, Departure from a Position Previously Concluded in an Administrative Proceeding or Court Decision (TS sec. 500), is, "May a member recommend a tax return position to a taxpayer that departs from a position determined in an administrative proceeding or court decision with regards to the taxpayer's prior return?" -Yes, unless the taxpayer was bound by the court decision or administrative proceeding to apply the same tax position in subsequent years. -The member must comply with SSTS No. 1. -SSTS No. 5 provides examples of circumstances in which it might be appropriate to recommend a different tax treatment to the taxpayer in a later year. 6. SSTS No. 6, Knowledge of Error: Return Preparation and Administrative Proceedings The primary question addressed by SSTS No. 6, Knowledge of Error: Return Preparation and Administrative Proceedings (TS sec. 600), is, "What should a member do if he or she discovers an error on a taxpayer's previously filed return or one that is subject to an administrative proceeding, or learns that a taxpayer has failed to file a required tax return?" -Upon becoming aware of an error, unless the error would have had only an insignificant effect on the taxpayer's liability, the member should act promptly to advise the taxpayer of the error, the potential consequences of the error, and recommend that the error be corrected. (Advice may be oral.) -If a member represents a taxpayer in an administrative proceeding that relates to the return that contains the error, the member should ask the taxpayer to agree to disclose the error to the taxing authority. -The taxpayer is responsible for deciding whether to act on the member's advice to correct the error. -If the taxpayer fails to act on the member's advice, the member should reconsider his or her ongoing association (employment or client relationship) with the taxpayer. Unless required under law or regulation or authorized by the taxpayer, the member may not disclose the taxpayer's failure to act to the taxing authority. 7. SSTS No. 7, Form and Content of Advice to Taxpayers The primary question addressed by SSTS No. 7, Form and Content of Advice to Taxpayers (TS sec. 700), is, "Does a member have a responsibility to communicate with a taxpayer when subsequent events affect the member's previous advice?" - Members are not obligated to communicate with a taxpayer about subsequent developments affecting previous advice unless he or she agreed to do so or is assisting the taxpayer with implementing the advice. -Members should use judgment in determining the form (for example, written or oral) and content of advice -Members should comply with the taxing authority's requirements when relevant (for example, when providing written federal tax advice). -Members' advice should comply with the standards in SSTS No. 1. -SSTS No. 7 provides factors members should consider in determining the most appropriate form of advice to provide to a taxpayer.

Identifying and evaluating conflicts of interest

The code states that you should take reasonable steps to identify circumstances that might create a conflict of interest before you take on a new professional service or relationship. In doing so, you should consider 1. the nature of the relevant interests and relationships between the parties involved, and 2. the nature of the service and its implication for relevant parties. Once you identify a potential or an actual conflict of interest, you should evaluate it by asking yourself some questions: 1. Are threats at an acceptable level? -If you determine that threats are insignificant — meaning they are at an acceptable level — then your evaluation is complete. Assume the defendant is a client you haven't provided services to in 10 years; this relationship is greatly weakened by the passage of time, so you conclude that threats are at an acceptable level. -If, on the other hand, you conclude that threats are significant — threats are not at an acceptable level — then you must apply safeguards that eliminate or sufficiently reduce the threats to an acceptable level. The code defines safeguardsas "[a]ctions or other measures that may eliminate a threat or reduce a threat to an acceptable level." 2. Have you disclosed the matter to appropriate parties? When a conflict of interest exists, you should disclose the nature of the conflict to the relevant parties and obtain their consent to move forward with the service or relationship. Note: When making this disclosure, you are required to maintain the confidentiality of your client or employer's information. 3. Do the relevant parties agree with your evaluation of conflict? If the relevant parties agree with your assessment of the conflict of interest, including any safeguards you are proposing, you may proceed with the services or relationship. If they do not agree, you should not proceed. Note: The "Integrity and Objectivity Rule" applies to all professional services you provide; however, if your engagement requires independence, you must also comply with the independence requirements of the "Independence Rule" (ET sec 1.200.001); that is, independence impairments under the code cannot be eliminated by disclosure and consent.

AICPA Code of Professional Conduct (the code)

The code's "General Standards Rule" (ET sec. 1.300.001)1 sets forth requirements for professional competence and due care, which are critical to a member's delivery of quality services. The general standards apply to all members who provide professional services, including members in business who work in private industry, government, and academia. .01 A member shall comply with the following standards and with any interpretations thereof by bodies designated by Council: 1. Professional Competence. Undertake only those professional services that the member or the member's firm can reasonably expect to be completed with professional competence. 2. Due Professional Care. Exercise due professional care in the performance of professional services. 3. Planning and Supervision. Adequately plan and supervise the performance of professional services. 4. Sufficient Relevant Data. Obtain sufficient relevant data to afford a reasonable basis for conclusions or recommendations in relation to any professional services performed.

Due care

The quest for excellence is the essence of due care (paragraph .02 of ET sec. 0.300.060). The standard of due care requires members to -discharge professional responsibilities with competence and diligence; -perform professional services to the best of one's abilities; and -serve the best interests of those for whom services are performed, consistent with the profession's responsibility to the public. What does exercising due care mean? Due care requires you to be diligent in performing professional services in a manner that is prompt, thorough, and consistent with the applicable technical and ethical standards. For example, performing an audit of a company's financial statements requires you to apply the technical auditing standards that specify the profession's standard of care for audit services. You will also apply your professional judgment, an important element of competence.

Confidential client information: Disclosures

There are a few exceptions to the "Confidential Client Information Rule" (ET sec. 1.700.001), as described in the following table.Confidential client information may be disclosed without client permission only in certain circumstances, as outlined by the code. The following are a few examples: 1. Comply with Standards: To comply with the requirements of other professional standards, for example, audit, review, or tax standards. (Your requirement to comply with these other standards always takes precedence over your responsibilities to maintain client confidentiality.) 2. Comply with Laws: To comply with a law or regulation. 3. Subpoena or Summons: To comply with a validly issued and enforceable subpoena or summons. 4. Ethics Investigation: To initiate a complaint with or respond to inquiries made in connection with an investigation or disciplinary proceeding by the AICPA, a CPA society, board of accountancy, or another professional or regulatory body. 5. Firm Sale or Merger: To sell your accounting practice to another firm or merge with another firm if you take appropriate precautions.

Breach of an independence interpretation

What are your responsibilities if you violate the independence rules or otherwise become aware of a violation? The code includes an interpretation that assists firms in evaluating and addressing the consequences of a violation or "breach" of an independence interpretation. Included are specific steps and actions you should take when you learn of the breach to help ensure that it is addressed properly. Note: Addressing the breach satisfactorily does not preclude the AICPA from investigating your conduct or taking enforcement action. 1. Firm policies and procedures First, to apply this interpretation, your firm must be compliant with QC section 10, A Firm's System of Quality Control (AICPA, Professional Standards). QC section 10 requires firms to have policies and procedures designed to provide it with reasonable assurance that the firm, its personnel, and others subject to independence requirements maintain independence as required. 2. What are my responsibilities? When you identify a breach, you should follow your firm's policies and procedures to promptly communicate that information to the appropriate individual in your firm. We will call her Nancy. Nancy should report the breach to those who need to take action, be satisfied that the interest or relationship that caused the breach has been terminated, suspended, or eliminated and address the consequences of the breach. To do this, Nancy should evaluate the significance of the breach and its effect on the attest engagement team's integrity, objectivity, and professional skepticism. The significance of the breach will depend on such things as: -The nature and duration of the breach -Whether other breaches affect the attest engagement -Whether an attest team member knew of the interest or relationship that caused the breach -Whether the individual who caused the breach is on the attest team Nancy should determine whether satisfactory action can be taken, for example, by -removing the relevant individual from the attest engagement team, -conducting an additional review of the attest work or re-performing using different personnel, and -recommending that the attest client engage another firm to review or re-perform the affected attest work. 3. Communicating with those charged with governance If Nancy determines that no action will satisfactorily address the breach, she should inform those charged with governance and take the steps to terminate the attest engagement, if possible, under law and regulation. Otherwise, Nancy should discuss the breach and the action(s) taken (or to be taken) with those charged with governance, including: -The significance of the breach, including its nature and duration -How the breach occurred and how it was identified -The action taken or proposed to be taken and her rationale for how the action will address the consequences of the breach and enable the firm to issue the attest report -The conclusion that (in her professional judgment) the integrity, objectivity, and professional skepticism of the attest engagement team has not been compromised and rationale -Any steps she has taken or proposes to take to reduce or avoid the risk of further breaches Nancy should obtain the concurrence of those charged with governance that action can be, or has been, taken to satisfactorily address the consequences of the breach. 4. Documentation Nancy should document the breach, the action(s) taken, key decisions, and all the matters discussed with those charged with governance and any discussions with a professional body, regulator, or oversight authority. If the attest engagement is continued, her conclusion should state that (in her professional judgment) the integrity, objectivity, and professional skepticism of the attest engagement team have not been compromised. Nancy should also document her rationale for why the action(s) taken satisfactorily addressed the consequences of the breach and allowed the firm to issue the attest report.

Providing multiple nonattest services to an attest client

What if your firm performs multiple nonattest services during the same period for an attest client? Your firm should evaluate its proposed services not only per engagement but also collectively to ensure that any significant threats are reduced to an acceptable level before the additional services are performed. An illustration:BTW CPAs is currently performing the following three nonattest services engagement for its client, C Corp., which is also an audit client: -Internal controls review and assessment -Tax valuations for owners' estate planning purposes -Corporate tax compliance and advisory Now, the client has asked whether BTW can install an "off-the-shelf" inventory control system. BTW believes the installation would comply with the independence rules. Similarly, BTW believes that each of the other engagements are fully compliant. Now, BTW must consider whether threats are still at an acceptable level collectively. Engagement 1, which is almost complete, was of a limited scope. The firm reviewed a small number of internal controls over financial reporting and recommended enhancements, with the client making the decisions about which enhancements to implement. BTW considered the threats for that engagement to be at an acceptable level due to the limited scope and management competency to determine which enhancements to select. Engagements 2 and 3 are ongoing and relate to corporate and personal tax reporting and planning. BTW determined that both create minimal threats to independence (that is, threats are at an acceptable level). The system installation relates to the client's inventory, which comprises a very small part of the business and is also considered to create only minimal threats, if any, because the client selected a commercial software package that BTW will install and configure as per the client's instructions. After considering the threats individually and in the aggregate, BTW concludes that threats are at an acceptable level, and that performing the additional nonattest service would not impair the firm's independence.

Code of Conduct

When something is "ethical," it is in accordance with the accepted principles of right and wrong governing the conduct of a person or the members of a profession.1 -In general, a code of professional conduct describes the basic tenets of ethical conduct in a profession, whether accounting, medicine, or engineering. Professions that serve the public interest adopt a code of conduct to help maintain public confidence in the profession. The AICPA Code of Professional Conduct (the code) 1. Membership in the AICPA is voluntary. By accepting membership, a member assumes an obligation of self-discipline above and beyond the requirements of laws and regulations. 2. The principles of the Code of Professional Conduct of the AICPA express the profession's recognition of its responsibilities to the public, to clients, and to colleagues. They guide members in the performance of their professional responsibilities and express the basic tenets of ethical and professional conduct. The principles call for an unswerving commitment to honorable behavior, even at the sacrifice of personal advantage. 3. The first two principles in the code, "Responsibilities" and "The Public Interest," say, in part, that "[m]embers of the AICPA have responsibilities to all those who use their professional services." The code also notes that "a distinguishing mark of a profession is acceptance of its responsibility to the public." The public interest is defined as "the collective well-being of the community of people and institutions the profession serves." 4. These principles also indicate, in part, that "members should exercise sensitive professional and moral judgments in all their activities." Members should also act in a manner that serves the public interest and honors the public trust that is bestowed upon them as a member of the accounting profession. Structure of the code 1. Preface-Applies to all members of the AICPA. The preface includes an overview of the code, describes the principles, structure and application of the code, sets forth the definitions, and provides information about changes to the code and nonauthoritative guidance. 2. Part 1-Applies to members in public practice. These members work in audit, tax, and consulting firms that provide professional services to clients. 3. Part 2- Applies to members in business. These members work in organizations in executive, staff, governance, advisory, or administrative capacities. 4. Part 3-The code is available online at https://pub.aicpa.org/codeofconduct/Ethics.aspx Members of the AICPA agree to comply with the code as a condition of membership, but the code applies to many non-AICPA members, too. Most state accountancy boards adopt the code or parts of the code under their laws or regulations, making the AICPA rules applicable to the CPAs who practice public accounting in those states and territories.

Conceptual framework

You will find the following three conceptual frameworks in the code: 1. Conceptual Framework for Members in Public Practice, which applies to all rules in Part 1 of the code (except independence). 2. Conceptual Framework for Independence, which applies to the independence rule, which is addressed in Part 1 of the code. 3. Conceptual Framework for Members in Business, which applies to all rules in Part 2 of the code. The conceptual framework includes the following key terms: 1. Threats. Relationships or circumstances that could compromise a member's compliance with the rules. These include adverse interest, advocacy, familiarity, management participation, self-interest, self-review, and undue influence. See the appendix "Conceptual Framework for Members in Public Practice" for detailed definitions of each threat. 2. Acceptable level. A level at which a reasonable and informed third party who is aware of the relevant information would be expected to conclude that a member's compliance with the rules is not compromised. 3. Safeguard. May partially or completely eliminate a threat or diminish the influence of a threat. To be effective, safeguards should eliminate the threat or reduce it to an acceptable level. See the appendix "Conceptual Framework for Members in Public Practice" for a full description and list of safeguards. You should use the following process when applying the framework 1. Identify threat(s) to compliance with one or more rules. 2. Evaluate whether the threat (or threats in the aggregate, if applicable) is significant. -If threat is not significant — Stop, no further consideration is needed. -If threat is significant — Proceed to next step. 3. Identify and apply safeguards.​ -If safeguard(s) would eliminate the threat or reduce the threat to an acceptable level, proceed with professional services and or engagement. -If safeguard(s) is not available or is insufficient (that is, it does not reduce threat(s) to an acceptable level), decline or discontinue professional service or resign from the engagement.

Relationships

Your family's interests, employment, and other relationships may create self-interest or familiarity threats to your independence because their interests are closely aligned to yours. In fact, the independence rules generally extend from a covered member to the covered member's immediate family (the covered member's spouse or equivalent and the people he or she supports financially, including children, parents, or even nonrelatives). For example, your spouse's investment would be treated as if it was yours — your interests are considered inseparable — even if you keep your finances and investments in separate accounts and with separate brokers. The exhibit below offers definitions from the code of spousal equivalent and dependent. 1. Spousal equivalent. In determining whether an individual is a spousal equivalent, one must look to the closeness of the bond between the covered member and the individual. Persons in domestic partnerships or common-law marriages, cohabitants, and others in close committed relationships that are in substance the equivalent of marriage generally meet this criterion. 2. Dependent. In general, a dependent is any individual for whom the covered member provides more than half of his or her financial support. Key positions Your immediate family's employment may create threats to your independence. For example, if you provide tax services throughout the year to your spouse's employer, and your spouse is the CEO of that company, the threats will be considered so significant that safeguards would not sufficiently reduce them to an acceptable level. Your independence would be considered impaired. However, not all your immediate family's employment creates such significant threats under the rules. Under what circumstances do threats become unacceptable? If your immediate family holds a key position, the rules indicate that threats are significant and impair your independence. The position is a key position if he or she -has primary responsibility for significant accounting functions that support material components of the financial statements; -has primary responsibility for preparing the financial statements; or -can exercise influence over the contents of the financial statements (for example, as a member of the board of directors, CEO, president, CFO, chief operating officer, general counsel, chief accounting officer, controller, director of internal audit, director of financial reporting, treasurer, or any equivalent position). In general, you should not rely solely on job titles to determine whether a position held by a covered member's spouse or dependent impairs independence; rather, you should consider the nature of the individual's responsibilities. Close relatives Your close relative's employment with or financial interest in an attest client may impair your independence, but not all covered members must apply this rule. The rule applies to you only if you fall into one of the following categories of covered member: -on the client's attest engagement team -able to influence the client's attest engagement -a partner in the office in which the lead attest engagement partner primarily practices in connection with the attest engagement Under the independence rules, close relatives include the following: -Nondependent children -Brothers and sisters -Parents You participate on the client's attest engagement team Your independence is impaired if you are aware that your close relative has a financial interest in the attest client that either -was material to your relative's net worth or -enables the relative to exercise significant influence over the attest client. You are able to influence the attest engagement or are a partner or partner equivalent in the office in which the lead attest engagement partner practices in connection with the engagement. Your independence is impaired if you are aware that your close relative has a financial interest in the attest client that -is material to your relative's net worth and -enables your relative to exercise significant influence over the attest client.