Chapter 2 - Before You Go
An audit staff person has been with the firm for only 6 months. Her spouse works for an audit client in an accounting position and makes material accounting decisions in the corporate accounting office. Are there safeguards that can be implemented to preserve the audit firm's independence? Explain.
Covered members must also be aware of potential conflicts of interest that may be raised by the activities of immediate family members and close relatives. An immediate family member cannot work for an attest client in a key position, such as the spouse making material decisions in the corporate accounting office. Given the relationship of the staff person to someone in a key position with an audit client, either the CPA firm would need to resign the audit engagement or the other individual would need to not be employed by the CPA firm.
Do EC professionals exist in public accounting firms? Explain.
EC professionals exist in public accounting firms since the people who practice accounting rely on a profession's responsibility and concern for the public interest
Self-Review Threat
If a CPA does not appropriately evaluate a previous judgment made by or services performed by an individual in the CPA's firm and that CPA relies on the work in forming a judgment as part of an engagement. If a CPA performs accounting services for a private company client and that work needs to be evaluated by the CPA's firm in the course of an attest engagement
Undue Influence Threat
If a CPA subordinates his or her judgment to an individual associated with a 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 the CPA . If a client threatens to dismiss a firm from the engagement or if a client continues to disagree with the client on an accounting or tax matter
Self-Interest Threat
If a CPA were to benefit, financially or otherwise, from an interest in or relationship with, a client or person associated with the client
What is the basis for determining that a threat is at an acceptable level after the application of safeguards?
If the CPA evaluates identified threats both individually and in aggregate, the CPA should determine if the threat is at an acceptable level for a reasonable and informed third party who is aware of the circumstances would conclude if a CPA is in compliance with the rules of the Code. (This is the third party rule.)
Explain how SOX significantly changed the audit environment for auditors.
SOX made it illegal for auditors to provide certain nonattest services to clients, and it changed the regulation of the auditing profession. It also significantly changed the audit environment by imposing increased penalties for management of public companies who engage in fraudulent financial reporting
What is the purpose of the AICPA ethical principles? Explain their enforceability.
The AICPA ethical principles provide guidance to all its members with respect to performance of their professional responsibilities. The principles are designed to provide the framework for the rules that govern the member's performance. The principles are not enforceable.
What is the purpose of the AICPA ethical rules? Explain their enforceability.
The Code rules establish minimum standards of acceptable conduct in a CPA's professional services. The AICPA's bylaws require members adhere to the rules of conduct. The rules are enforceable and members must be prepared to justify departures from the rules of conduct.
What is proportionate liability under the Private Securities Reform Act of 1995?
The Reform Act instituted a system of proportionate liability whereby defendants who are not found to have "knowingly committed a violation" of securities laws are liable based on the defendant's percentage of responsibility. This was intended to reduce the coercive pressure for innocent parties to settle meritless claims out of court rather than risk exposing themselves to liability for a grossly disproportionate share of the damages in a case. Defendants who "knowingly committed a violation" continue to be jointly and severally liable for all damages that may be assessed.
What transactions are covered by the Securities Act of 1933?
The Securities Act of 1933 allows "any person" purchasing or otherwise acquiring the securities to sue when the financial statements are materially misstated. The Act makes the auditor liable for losses to third parties resulting from ordinary negligence, as well as from fraud and gross negligence, to the effective date of the registration statement.
When evaluating whether an engagement was completed with due professional care, how might a state board of accountancy judge the due care that was used in completing an engagement?
The due care standard expects CPAs to exercise the professional care that would be expected of other CPAs performing the same work. Hence, a State Board of Accountancy would refer to professional standards to judge evaluate whether works was completed with due care.
Threats of Compliance with the AICPA Code of Professional Conduct
1. Adverse Interest 2. Advocacy Threat, 3. Familiarity, 4. Management Participation, 5. Self-Interest Threat, 6. Self-Review, 7. Undue Influence
After work, can a member of an audit team discuss confidential information about a client's business with his or her spouse, who works for the client's competitor? Has the member violated the AICPA Code of Professional Conduct? Explain your reasoning.
A CPA cannot disclose confidential client information to someone outside of the accounting firm without the permission of the client. After work, a CPA should not disclose information about an engagement to spouse. This situation becomes a more significant violation of the Code of Professional Conduct because the spouse works for a competitor of the client.
primary situations in which a CPA may be liable to his or her client.
A CPA may be liable to a client a) for a breach of contract under contract law, and b) for damages under a tort law action.
Integrity and objectivity
A member shall be free of conflicts of interest, and shall not knowingly misrepresent facts or subordinate his or her judgment to others. For example, an auditor should not subordinate his or her judgment to that of the client.
A partner works on the audit engagement of XYZ Company. After her husband died from a heart attack, she has had dinner a couple of times with a major shareholder in XYZ Company. The shareholder is not part of management. What are the implications if the personal relationship becomes serious between the partner and the shareholder?
A person who has more than a 5% direct investment in an audit client is considered a covered member, and therefore the major shareholder would need to sell enough shares so as to not be an owner of more than 5% of the audit client's company. Alternatively, the CPA firm would need to resign the audit engagement of the client.
Do the rules of conduct on accounting principles prevent a CPA from preparing financial statements for a client on a cash basis of accounting, which is not GAAP? Explain your reasoning.
CPAs often prepare financial statements for small businesses on a cash basis of accounting or a federal income tax basis of accounting. In these situations, the client's financial statements, and the CPA's report thereon, should not purport that the financial statements are in accordance with GAAP, and the financial statements and the CPA's report should clarify the financial reporting framework used.
Explain the concept of the CPI professional and how it applies to auditors.
CPI professionals are commonly defined by the level of expertise they possess, or their high level of skill. A professional relates to a profession's responsibility and concern for the public interest. These individuals are often recognized by a specialized body of knowledge, a formal education process, standards governing admission to the profession, a code of ethics, recognized status indicated by a license, a public interest in the work that practitioners perform and by the recognition by practitioners of an obligation to society
Explain why accepting an engagement on a contingent fee arrangement impairs independence.
The rule on confidential client information allows a CPA to comply with a validly issued and enforceable subpoena or summons, or allows a CPA to comply with applicable laws and government regulations.
due care defense as it applies to an audit
Under a due care defense, the auditor's documentation should provide evidence that the audit was performed in accordance with auditing standards generally accepted in the United States. The due care defense is also a primary defense against tort actions, along with contributory negligence.
foreseeable third party
not a primary beneficiary, yet the auditor should have known that this type of user would use the financial statement. For example, financial statements have only been used for borrowing by the owner of a private business. The owner is 70 years old and uses the financial statement in selling the business. Given this information, the buyer of the business would be a foreseeable third party.
Appearance of independence
observable and subject to enforcement under the AICPA Rules of Conduct. It addresses a number of potential conflicts of interest that can be observed or factually determined by others.
foreseen third party
one that is not a primary beneficiary but the type of users is known to the auditor. For example, the client borrows from a bank that it has not borrowed from before, using the audited financial statements. When the previous engagement was completed the bank was not known to the auditor.
two types of engagements that would be covered by the general standards in the AICPA Code of Professional Conduct.
tax services and consulting engagements
plaintiff's burden of proof under common law
the plaintiff must prove the following when suing an auditor: The auditor owed a duty of care to the plaintiff, The auditor breached the duty by failing to act with due care (negligence), The auditor's negligence was the proximate cause of the plaintiff's damage, and The plaintiff had actual damages. A key issue is whether the auditor owed a duty of care to the plaintiff.
Familiarity
when a CPA has a long or close relationship with a client, a CPA will become too sympathetic to the client's interests or too accepting of a client's work or product
Advocacy Threat
when a CPA promotes a client's interests or position to the point that the CPA's objectivity or independence is compromised
An audit manager in another office from the audit client has quality control responsibilities in the same region as the audit engagement. Is the audit manager a covered member?
Managers with consultation, oversight, or review responsibilities related to the engagement are covered members due to the fact that the audit manager has quality control responsibilities over the region of the audit client
Management Participation Threat
if a CPA takes on the role of client management or otherwise assume management responsibilities
Assume that you have been the tax manager on the tax engagement of XYZ Company. Your spouse has just been offered the job of chief financial officer for XYZ Company. Is there a threat to ethical behavior? What would be an appropriate safeguard, if any, that might be applied if your spouse accepts the position with XYZ Company?
If your spouse accepts employment as a CFO of an audit company client, this situation presents a familiarity threat, possibly a self-interest threat, possibly a management participation threat and possibly an undue influence threat. Unfortunately your spouse may need to decline the offer from this or any client company as part of their management, or you may need to leave the CPA firm's employment or the CPA firm will need to resign the client engagement to safeguard against this threat.
The conditions of auditor liability under Rule 10(b)-5 of the 1934 Securities Exchange Act. What were the findings under this section as they related to the Hochfelder case?
In this case, an auditor is no longer liable to third parties under Section 10(b) and Rule 10b-5 of the 1934 Act for ordinary negligence. That is, the auditor has no liability in the absence of any intent to deceive or defraud (legally called scienter)
What is the purpose of the AICPA ethical interpretations? Explain their enforceability.
Interpretations provide additional guidance regarding the scope and applicability of the rules of conduct. A member who departs from the interpretations shall have the burden of justifying such departure in any disciplinary hearing.
Adverse Threat
a CPA will not act with objectivity because a CPA's interests are opposed to the client's interests.
types of activities that impair the appearance of independence for an CPA firm
an auditor (or immediate family member) having an ownership interest in an attest client, participating in a joint venture with an attest client, having litigation threatened by an attest client, or having a loan from an attest client
