Chapter 4 Professional Ethics

The AICPA Code of Professional Conduct states that a CPA shall not disclose any confidential client information obtained in the course of a professional engagement except with the consent of the client. In which one of the following situations would disclosure by a CPA be in violation of the Code?

1. Disclosing confidential information to another accountant interested in purchasing the CPA's practice

Rationalizing Unethical Behavior

1. Everybody does it 2. If it's legal, it's ethical 3. Likelihood of discovery and consequences

Conceptual Framework for rules of Conduct

1. Identify threats. When a member encounters a relationship or circumstance that is not specifically addressed by a rule or interpretation, the member should evaluate whether the relationship or circumstance creates a threat to following the rule. 2. Evaluate the significance of the threat. In evaluating the significance of a threat, the member should determine whether the threat is at an acceptable level. A threat is at an acceptable level when a reasonable and informed third party who is aware of the relevant information would be expected to conclude that the threat would not compromise the member's compliance with the rules. 3. Identify and apply safeguards. If the member concludes that the threat is not at an acceptable level, the member should apply safeguards to eliminate the threat or reduce it to an acceptable level.

Resolving Ethical Dilemmas

1. Obtain the relevant facts. 2. Identify the ethical issues from the facts. 3. Determine who is affected by the outcome of the dilemma and how each person or group is affected. 4. Identify the alternatives available to the person who must resolve the dilemma. 5. Identify the likely consequence of each alternative. 6. Decide the appropriate action.

In which one of the following situations would a CPA be in violation of the AICPA Code of Professional Conduct in determining the audit fee?

1. a fee based on whether the CPA's report on the client's financial statements results in the approval of a bank loan

Which of the following is not a provision of the Sarbanes-Oxley Act of 2002?

2. Audit documentation must be maintained for five years

According to the profession's ethical standards, which of the following events may justify a departure from GAAP?

3. I and III

Independence rule

A member in public practice shall be independent in the performance of professional services as required by standards promulgated by bodies designated by Council.

Contingent Fees Rule

A member in public practice shall not (1) Perform for a contingent fee any professional services for, or receive such a fee from, a client for whom the member or member's firm performs: (a) an audit or review of a financial statement; or (b) a compilation of a financial statement when the member expects, or reasonably might expect, that a third party will use the financial statement and the member's compilation report does not disclose a lack of independence; or (c) an examination of prospective financial information; or (2) Prepare an original or amended tax return or claim for a tax refund for a contingent fee for any client.

Confidential Client Information rule

A member in public practice shall not disclose any confidential client information without the specific consent of the client.

Commissions and referral Fees rule

A member in public practice shall not for a commission recommend or refer to a client any product or service, or for a commission recommend or refer any product or service to be supplied by a client, or receive a commission, when the member or the member's firm also performs for that client: (a) an audit or review of a financial statement; or (b) a compilation of a financial statement when the member expects, or reasonably might expect, that a third party will use the financial statement and the member's compilation report does not disclose a lack of independence; or (c) an examination of prospective financial information

Advertising and Other Forms of Solicitation rule

A member in public practice shall not seek to obtain clients by advertising or other forms of solicitation in a manner that is false, misleading, or deceptive. Solicitation by the use of coercion, over-reaching, or harassing conduct is prohibited.

Form of Organization and Name Rule

A member may practice public accounting only in a form of organization permitted by law or regulation whose characteristics conform to resolutions of Council. A member shall not practice public accounting under a firm name that is misleading. Names of one or more past partners may be included in the firm name of a successor organization. A firm may not designate itself as "Members of the American Institute of Certified Public Accountants" unless all of its CPA owners are members of the Institute.

General Standards Rule

A member shall comply with the following standards and with any interpretations thereof by bodies designated by Council: professional competence, due professional care, planning and supervision, sufficient relevant data

Accounting Principles Rule

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 GAAP 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 GAAP, 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.

Acts Discreditable rule

A member shall not commit an act discreditable to the profession.

Compliance with Standards Rule

A member who performs auditing, review, compilation, management consulting, tax, or other professional services shall comply with standards promulgated by bodies designated by Council.

LO8 Describe the enforcement mechanisms for CPA conduct.

Action by AICPA professional ethics Division Action by a State Board of Accountancy PCAOB enforcement actions

LO 2 Resolve ethical dilemmas using an ethical framework

An ethical dilemma is a situation a person faces in which a decision must be made about the appropriate behavior.

Related Financial Interest Issues

Any of these relationships between a CPA and the client could affect independence: Loans, other than normal lending procedures Employment of immediate and close family members Joint closely held investments with clients Director, officer, management, or employee of a company

Covered members

Any person who is in a position to influence an attest engagement.

LO6 Understand Sarbanes-Oxley Act and other SEC and PCAOB independence requirements and additional factors that influence auditor independence.

Auditors of public companies must also comply with the independence requirements of the Sarbanes-Oxley Act, the PCAOB, and the SEC. Sarbanes-Oxley and the SEC restrict the nonaudit services that can be provided to publicly held companies. Sarbanes-Oxley also requires that an audit committee of the public company be responsible for the appointment, compensation, and oversight of the auditor. Sarbanes-Oxley, the PCAOB, and the SEC have more stringent rules concerning independence than the Code. This is in response to the scandals that preceded the passing of Sarbanes-Oxley.

Action by a State Board of Accountancy

Because each state grants the individual practitioner a license to practice as a CPA, a significant breach of a state Board of Accountancy's code of conduct can result in the loss of the CPA certificate and the license to practice. Although it rarely happens, the loss removes the practitioner from public accounting

Rules of conduct

Because the rules of conduct are enforceable, they are stated in more precise language than the section on principles. Because of their enforceability, many practitioners refer to the rules as the AICPA Code of Professional Conduct. When practitioners conduct themselves at the minimum level in Figure 4-3, this does not imply unsatisfactory conduct. The profession has presumably set the standards sufficiently high to make the minimum conduct satisfactory.

Difference Between Cpa Firms and Other professionals

CPA firms are usually engaged by management for private companies and the audit committee for public companies, and are paid by the company issuing the financial statements, but the primary beneficiaries of the audit are financial statement users

Why is there a special need for professional conduct by CPAs? How does this differ from the need for special conduct in other professions

CPAs have high standards and conduct to live by in this profession. Their relationship with their clients are totally different from those in other professions. The CPAs conduct makes an impression and should help to give the company an image in the business marketplace. The quality of work that they produce should be a good quality and not reflect any form of unethical behavior. CPAs must be unbiased and competent to perform duties that they are given.

There are also rules concerning the following issues:

Conflicts arising from employment relationships Partner rotation Ownership interestsShopping for accounting principles ("opinion shopping") Engagement and payment of audit fees by management All of the Sarbanes-Oxley independence rules are intended to improve the appearance of independence as well as independence in fact.

2. Explain the rule on contingent fees. Why is this rule necessary?

Contingent Fees rule A member in public practice shall not (1) Perform for a contingent fee any professional services for, or receive such a fee from, a client for whom the member or member's firm performs: (a) an audit or review of a financial statement; or (b) a compilation of a financial statement when the member expects, or reasonably might expect, that a third party will use the financial statement and the member's compilation report does not disclose a lack of independence; or (c) an examination of prospective financial information; or (2) Prepare an original or amended tax return or claim for a tax refund for a contingent fee for any client. The prohibition in (1) above applies during the period in which the member or the member's firm is engaged to perform any of the services listed above and the period covered by any historical financial statements involved in any such listed services Necessary: To help CPAs maintain objectivity in conducting audits or other attestation services, basing fees on the outcome of engagements is prohibited

LO1 Distinguish ethical from unethical behavior in personal and professional contexts.

Ethics can be defined broadly as a set of moral principles or values. Most people define unethical behavior as conduct that differs from what they believe is appropriate given the circumstances. Each of us decides for ourselves what we consider unethical behavior, both for ourselves and others. It is important to understand what causes people to act in a manner that we decide is unethical.

Integrity and Objectivity rule

In the performance of any professional service, a member shall maintain objectivity and integrity, shall be free of conflicts of interest, and shall not knowingly misrepresent facts or subordinate his or her judgment to others.

Independence consists of two components: independence of mind and independence in appearance.

Independence of mind reflects the auditor's state of mind that permits the audit to be performed with an unbiased attitude. Independence of mind is often referred to as being independent in fact. Independence in appearance is the result of others' interpretations of this independence. If auditors are independent in fact but users believe them to be advocates for the client, most of the value of the audit function is lost.

Distinguish between independence of mind and independence in appearance. Identify an activity that may not affect independence of mind but is likely to affect independence in appearance.

Independence of mind reflects the auditor's state of mind that permits the audit to be performed with an unbiased attitude. Independence in appearance is the result of others' interpretations of this independence. If auditors are independent in fact but users believe them to be advocates for the client, most of the value of the audit function is lost. Activities: 1) Ownership of a financial interest in the audited client 2) Directorship or officer of an audit client 3) Performance of management advisory or bookeeping or accounitng services for the same company 4) Dependence upon a client for a large percentage of audit fees 5) Engagement of the CPA and payament of audit fees by management

Material or Immaterial

Materiality affects whether ownership is a violation of independence only for indirect ownership. Materiality must be considered in relation to the member person's wealth and income

1. Identify the circumstances under which a CPA can disclose confidential information without client permission.

Members in public practice should not disclose confidential client informationwithout the consent of the client. The four exceptions to the confidentialityrequirement are:1. Obligations related to technical standards 2. Subpoena or summons or compliance with laws and regulations 3. Participation in peer review 4. Response to AICPA Ethics Division

LO 3 Explain the importance of ethical conduct for the accounting profession.

Our society has attached a special meaning to the term professional. Professionals are expected to conduct themselves at a higher level than most other members of society.

Financial Interests of Close Relatives

Ownership interests of close family members, defined as a parent, sibling, or nondependent child, do not normally impair independence unless the member knows or has reason to believe the ownership interest is material to the close relative or enables the close relative to exercise significant influence over the attest client

A CPA's retention of client records as a means of enforcing payment of an overdue audit fee is an action that is

Prohibited under the AICPA rules of conduct

LO 4 Describe the purpose and content of the AICPA Code of Professional Conduct.

Responsibilities - In carrying out their responsibilities as professionals, members should exercise sensitive professional and moral judgments in all their activities The public Interest -Members should accept the obligation to act in a way that will serve the public interest, honor the public trust, and demonstrate a commitment to professionalism. Integrity -To maintain and broaden public confidence, members should perform all professional responsibilities with the highest sense of integrity. Objectivity and Independence - A member should maintain objectivity and be free of conflicts of interest in discharging professional responsibilities. A member in public practice should be independent in fact and appearance when providing auditing and other attestation services. Due Care - A member should observe the profession's technical and ethical standards, strive continually to improve competence and quality of services, and discharge professional responsibility to the best of the member's ability. Scope and Nature of Services - A member in public practice should observe the principles of the Code of Professional Conduct in determining the scope and nature of services to be provided.

Safeguards

Safeguards fall into three broad categories: 1. Safeguards created by the profession, legislation, or regulation. 2. Safeguards implemented by the client. 3. Safeguards implemented by the firm, including policies and procedures to implement professional and regulatory requirements.

Which of the following services can be offered to public company audit clients under SEC requirements and the Sarbanes-Oxley Act?

Tax planning not involving tax shelters

Financial interests

The AICPA Code prohibits covered members from owning any stock or other direct investment in audit clients regardless of materiality because it is potentially damaging to actual audit independence (independence of mind), and it certainly is likely to affect users' perceptions of the auditors' independence (independence in appearance

Nonaudit services

The Sarbanes-Oxley Act and SEC rules restrict, but do not completely eliminate, the types of nonaudit services that can be provided to publicly held audit clients. The following nine services are prohibited: 1. Bookkeeping and other accounting services 2. Financial information systems design and implementation 3. Appraisal or valuation services 4. Actuarial services 5. Internal audit outsourcing 6. Management or human resource functions 7. Broker, dealer, investment adviser, or investment banker services 8. Legal and expert services unrelated to the audit 9. Any other service that the PCAOB determines by regulation is impermissible

2. Explain the role of the audit committee in enhancing auditor independence

The audit committee must preapprove all audit and nonaudit services, and is responsible for oversight of the work of the auditor, including resolution of disagreements involving financial reporting between management and the auditor. Auditors are responsible for communicating all significant matters identified during the audit to the audit committee. For public companies, PCAOB rules require a CPA firm, before its selection as the company's auditor, to describe in writing and document its discussions with the audit committee about all relationships between the firm and the company, including executives in financial reporting positions, to determine whether there is any impairment of the CPA firm's independence. If selected as the auditor, these communications are to be made at least annually.

What is the meaning of the rule that requires the auditor be independent?

The auditor must be without bias with respect to the client under audit

Explain the conceptual framework for the Rules of Conduct and how it should be applied.

The conceptual framework for the Rules of Conduct is designed to assist members in situations where the interpretations of the rules do not address a threat to compliance with the rules. Using the conceptual​ framework, the member identifies​ threats, evaluates the significance of the​ threat, and identifies and applies safeguards to eliminate the threat or reduce it to an acceptable level. The rules for members in public practice apply to attestation services and, unless stated otherwise, apply to all services provided by CPA firms such as taxes and management services. The most notable exception is the Independence Rule, which requires independence only when the AICPA has established independence requirements through its rule-setting bodies, such as the Auditing Standards Board. The AICPA requires independence only for attestation engagements.

Action by AICPA professional ethics Division

The division's investigations result from information obtained primarily from complaints of practitioners or other individuals, state societies of CPAs, or governmental agencies. A member can be automatically sanctioned without an investigation if the member has been disciplined by governmental agencies or other organizations that have been granted the authority to regulate accountants, such as the SEC and PCAOB.

Suppose that you share a ride to a client with another audit staff member. Your colleague proposes that you both submit mileage reimbursement requests for each day of the audit even though you share rides. Explain the six-step approach to resolving an ethical dilemma and apply it to this situation.

The following is the six-step approach to resolving an ethical dilemma: 1. Obtain the relevant facts 2. Identify the ethical issues from the facts. 3. Determine who is affected by the outcome of the dilemma and how each person orgroup is affected. 4. Identify the alternatives available to the person who must resolve the dilemma. 5. Identify the likely consequence of each alternative. 6. Decide the appropriate action. Step 1 involves obtaining the relevant facts. In this case, a colleague has proposed thateach staff person submit a mileage reimbursement request, even when they shared a ride. Step 2 involves identifying the ethical issues from the facts. In this case, most would consider itunethical to request mileage when it has not been incurred, although some may argue that eachstaff person could have driven separately and requested mileage. Step 3 involves determiningwho is affected. In this case, the two staff members, the firm, and the client are affected. Steps 4 and 5 involve identifying the alternatives and consequences. If the mileage is requested, the staff person will receive extra compensation and the firm would overpay for travel expenses and theywould then overbill their client for those expenses. However, if the firm learns of this action, itcould issue punishment up to termination from the firm. Step 6 involves deciding the appropriateaction. Most people would say the appropriate action is not to request mileage unless it hasactually been incurred, considering both what is ethical and the possible consequences.

direct financial interest

The ownership of stock or other equity shares and debt securities by members or their immediate family is called a direct financial interest

What is the purpose of the Principles of Professional Conduct? Identify the six principles.

The principles are designed to guide members in the performance of their professional responsibilities and in meeting the basic requirements of ethical and professional conduct. My own words: It helps members to perform ethically and professionally in their profession and improve their performance in a responsible manner. Responsibilities Public Interest Integrity Objectivity and Independence Due Care Scope and Nature

Principles of Professional Conduct

The section of the AICPA Code dealing with principles of professional conduct includes a general discussion of characteristics required of a CPA. The principles section consists of two main parts: a list of six ethical principles and a discussion of those principles. The principles indicate the profession's responsibilities to the public, clients, and professional colleagues. The principles are designed to guide members in the performance of their professional responsibilities and in meeting the basic requirements of ethical and professional conduct.

LO5 Apply the AICPA Code rules and interpretations on independence and explain their importance

The value of auditing depends heavily on the public's perception of the independence of auditors.

Threats to Compliance

Threats to compliance with the rules fall into seven broad categories: adverse interest, advocacy, familiarity, management participation, self- interest, self-review, and undue influence.

PCAOB enforcement actions

When violations are found, the PCAOB can impose appropriate sanctions, including suspension or revocation of a firm's registration, suspension or barring of an individual from associating with a registered public accounting firm, and monetary penalties. The PCAOB may also require improvements in the firm's quality control, additional training, or other remedial measures.

The concept of materiality would be least important to an auditor when considering the

effects of a direct financial interest in the client on the CPA's independence

An indirect financial interest

exists when there is a close, but not a direct, ownership relationship between the auditor and the client

An auditor strives to achieve independence in appearance to

maintain an unbiased mental attitude

Audit committee—

selected members of a client's board of directors whose responsibilities include helping auditors to remain independent of management

Six Core Ethical Values

trustworthiness, respect, responsibility, fairness, caring, citizenship

Audit committee

—selected members of a client's board of directors whose responsibilities include helping auditors to remain independent of management