MODULE B- PROFESSIONAL ETHICS

Government Accountability Office (GAO) Independence Requirements

-Many state agencies and local municipalities use public accounting firms to perform audits required by government charters, laws, or contractual obligations (usually as part of a grant). During these audits, the public accounting firm is required to follow all GAO standards included in the Government Auditing Standards manual (also called the Yellow Book ; see Module D ). These standards require the auditor to be independent with respect to the government entity. -These standards differ from the SEC, AICPA, and Sarbanes-Oxley requirements in the following ways. Nonaudit services are allowed providing that the audit organization does not perform management functions, make management decisions, or audit its own work. However, the audit organization must employ the following safeguards: -(1) Personnel who provide nonaudit services are prohibited from planning, conducting, or reviewing audit work related to the nonaudit services. -(2) The audit organization may not reduce the scope or extent of work performed on the audit because a member of the firm performed the nonaudit work. The extent of the audit work may be reduced by an amount consistent with a reduction had the nonaudit been performed by another public accounting firm. -(3) The audit organization must document its reasons that the nonaudit services do not affect the firm's independence. -(4) The audit organization must document an understanding with the client regarding the objectives, scope, and work product for the nonaudit service. -(5) The audit organization must have established policies and procedures to ensure that effects of nonaudit services on the present and future audits are considered. -(6) The audit organization must communicate to the government entity any situation in which the nonaudit service would prohibit it from performing the audit. -(7) When subjected to a peer review, the audit organization must identify all nonaudit services provided to the audited entity

AICPA Code of Professional Conduct Confidential Client Information Rule 1.700

A member in public practice shall not disclose any confidential information without the specific consent of the client. (1.700.001) Confidential information is any information that is not available to the public (or in the public domain). As Scott London in this module's opening vignette was well aware, such information should not be disclosed to outside parties unless demanded by a court or an administrative body having subpoena or summons power. Privileged information is information that cannot even be demanded by a court. Common-law privilege exists for husband-wife and attorney- client relationships. While physician-patient and priest-penitent relationships have obtained the privilege through state statutes, no accountant-client privilege exists under federal law, and no state-created privilege has been recognized in federal courts. In all recognized privilege relationships, the professional person is obligated to observe the privilege, which can be waived only by the client, patient, or penitent. (These persons are said to be the holders of the privilege. ) The rules of privileged and confidential communication are based on the belief that they facilitate a free flow of information between parties to the relationship. The nature of accounting services makes it necessary for the accountant to have access to information about salaries, products, contracts, merger or divestment plans, tax matters, and other information required for the best possible professional work. Managers would be less likely to reveal such information if they could not trust the accountant to keep it confidential. If accountants were to reveal such information, the resulting reduction of the information flow might be undesirable, so no accountant should break the confidentiality rule without a good reason. Difficult problems arise over auditors' obligations to "blow the whistle" about clients' shady or illegal practices. For all practical purposes, information is not considered confidential if its disclosure is necessary to prevent financial statements from being misleading. If a client refuses to accept an auditors' report that has been modified because of the inability to obtain sufficient appropriate evidence about a suspected illegal act, failure to account for or disclose properly a material amount connected with an illegal act, or inability to estimate amounts involved in an illegal act, the public accounting firm should withdraw from the engagement and give the reasons in writing to the board of directors. In such an extreme case, the withdrawal amounts to whistleblowing, but the action results from the client's decision not to disclose the information. Auditors are not, in general, legally obligated to blow the whistle on clients. However, circumstances in which auditors are legally justified in making disclosures to a regulatory agency or a third party may exist. Such circumstances include when (1) a client has intentionally and without authorization associated or involved a CPA in its misleading conduct (e.g., used the CPA's name on financial statements), (2) a client has distributed misleading draft financial statements prepared by a CPA for internal use only, or (3) a client prepares and distributes in an annual report or prospectus misleading information for which the CPA has not assumed any responsibility. In addition, the Private Securities Litigation Reform Act of 1995 imposed another reporting requirement in connection with clients' illegal acts (see Module C ). The Confdential Client Information Rule possibly provides accountants with the most difculties and may be the most violated procedure. First, in its strictest interpretation, the principle of confdentiality applies to the communication of information to anyone who is not involved in the audit except as noted by the rule. Over lunch or after hours, however, you might fnd auditors discussing the day's work with other members of the frm or company. Second, CPAs should not view the Confdential Client Information Rule as an excuse for inaction when action may be appropriate to right a wrongful act committed or about to be committed by a client. In some cases, auditors' inaction may be viewed as part of a conspiracy or willingness to be an accessory to a wrong. A useful initial course of action is to consult an attorney about possible legal pitfalls of both whistleblowing and silence. •Exceptions: -To remain in compliance with standards -If work papers are subpoenaed by court -As part of a PCAOB peer or quality review of practice -As part of an ethics violation investigation by a state board of accountancy

Familiarity Threat

An immediate family member may not hold a position of influence (key position) in an audit client. The close family member's defnition comes into play in connection with (1) ownership or control of an audit client or (2) employment with an audit client. An example of (1) is the impairment of the public accounting frm's independence when a close family member of a covered person in the frm owns a material investment in an audit client or is in a position to exert signifcant infuence over an audit client. An example of (2) is the impairment of the public accounting frm's independence when a close family member works in an accounting or fnancial reporting role at an audit client or was in such a role during any period covered by an audit for which the person in the frm is a covered person. (Neither an immediate family member nor a close family member can work in a capacity such as a member of the board of directors, chief executive officer, president, chief financial officer, chief operating officer, general counsel, chief accounting officer, controller, director of internal audit, director of financial reporting, treasurer, or vice president of marketing.) Independence problems do not end when owners (partners, shareholders) and professional employees retire, resign, or otherwise leave a public accounting frm. A former owner or professional can cause independence to be impaired if a relationship continues with a client of the former frm. However, the problems are solved and independence is not impaired if (l) the person's retirement benefts are fxed, (2) the person is no longer active in the public accounting frm (sometimes retired owners remain "active"), and (3) the former owner is not held out to be associated with the public accounting frm. In addition to the preceding considerations, the public accounting frm must ensure that appropriate consideration is given to any increase in risks that may exist due to the former partner's or professional's knowledge of the frm's audit plan and procedures. The frm must consider the following: -The interaction with the former partner or professional. -The ability of audit team members to manage the interaction with the former partner or professional employee. -Modification of the engagement procedures. -The appropriateness of the review to determine that an appropriate level of skepticism was maintained.

Financial Self-Interest Threat

Any direct financial interest (e.g., ownership of common or preferred stock) is prohibited. This requirement is the strictest one in the code. There are no exceptions; indirect financial interests, on the other hand, are allowed up to the point of materiality (with reference to the member's wealth). This provision permits members to have some limited business transactions with clients so long as they do not reach material proportions. Other provisions define certain specific types of prohibited and allowed indirect financial interests. Immediate family members are subject to the same provisions that prescribe the acceptable actions of the covered person. Like the covered person, an immediate family member may not have a direct financial or material indirect financial interest in a client. We already understand that a covered member cannot have a financial relationship with a client. However, suppose the client is an investor in another company and the covered member has invested in that company. Has independence been impaired? If the covered member's investment is a direct or materially indirect financial interest in a nonclient investee, independence is considered to be impaired. The reasoning for the basic rule is that the client investor, through its ability to influence a nonclient investee, can increase or decrease the CPA's financial stake in the investee by an amount material to the CPA, and therefore, the CPA may not appear to be independent. If the investment by the client is not material to the nonclient (i.e., there does not appear to be any influence over the investee), then independence is not impaired unless the covered member's investment allows the member to exercise significant influence over the nonclient. Material cooperative arrangements with clients (i.e., joint participation in a business activity) also impair independence. Examples include joint ventures to develop or market products or to market a package of client and CPA services or one party working to market the products or services of the other. Most loans to or from audit clients are prohibited: "Independence is considered impaired if a covered member has a loan from a client, officer, director, or any individual owning 10 percent or more of a client." Similarly, independence is impaired if there are unpaid fees or a note receivable arising from unpaid fees from the client outstanding for more than a year. The only loans permitted are "grandfathered loans" and "other permitted loans." Grandfathered loans are those loans that were obtained either (1) before the independence rules changed (but met the requirements of the Independence Rule in effect at that time) or (2) from a financial institution before it became a client for services requiring independence. These grandfathered loans must at all times be current under all of their terms, and the terms shall not be renegotiated. The specific types of loans that are grandfathered are home mortgages, loans not material to the CPA's net worth, and secured loans for which the collateral value must exceed the balance of the loan at all times. Other permitted loans include: -Auto loans and leases collateralized by the automobile. -Insurance policy loans based on policy surrender value. -Loans collateralized by cash deposits at the same financial institution. -Credit card balances and cash advances of $10,000 or less. Ethics rules do not cover all circumstances in which the appearance of independence might be questioned. It is the member's responsibility to determine whether the personal and business relationships would lead a reasonable person aware of all the relevant facts to conclude that there is an unacceptable threat to the member's and the firm's independence.

Adverse interest and undue influence threats

-Conditions can arise when a public accounting frm and a client move into an adversary relationship instead of the cooperative relationship needed in an attest or audit engagement. Public accounting frm independence is considered impaired when the frm is involved in threatened or actual litigation involving an audit. Such cases may be rare, but the AICPA has provided auditors a way out of the difcult audit situation by this rule requiring them to declare "nonindependence" and the ability to give only a disclaimer on fnancial statements or other information. Essentially, the CPA-client relationship ends and the litigation begins a new relationship. -Occasionally, the public accounting frm may find that it is a defendant in a lawsuit initiated by a third party or parties. Normally, this type of litigation is not considered to adversely impact the independence of the public accounting frm. However, sometimes these lawsuits result in claims from the client's management that existing problems are the result of audit defciencies or claims from the auditor that defciencies are the result of fraud or deceit on the part of management. When such cross-claims are threatened or fled, independence may be impaired.

The International Federation of Accountants (IFAC)

-For audits of multinational companies, auditors must follow the guidelines promulgated by the IFAC. IFAC's International Ethics Standards Board for Accountants is responsible for the Code of Ethics for Professional Accountants (IESBA Code), which is the code of conduct that governs the audits of multinational companies. Although there are differences between the IESBA Code and the AICPA Code of Professional Conduct used to govern the audits of U.S. companies (which will be described later in this module), the codes are actually quite similar. -In general, a CPA should always comply with the more restrictive standard that is applicable on a particular audit engagement. Not surprisingly, with the dramatic increase in audits of multinational companies by public accounting firms from the United States, the importance of the IESBA Code has increased. Indeed, the AICPA has just completed a convergence and codification project designed to align the AICPA and IESBA codes and simplify the overall structure of the AICPA Code.

Other AICPA Rules of Conduct

-Integrity and objectivity rule -general standards rule -compliance with standards rule -accounting principles rule -confidential client information rule -fees and other types of remuneration -acts discreditable rule -advertising and other forms of solicitation rule -form of organization and name rule

Advocacy and Management Participation Threats

In addition to prohibitions against financial relationships with clients, a covered member is prohibited from acting in the capacity of a manager, employee, promoter, or trustee of a client. Generally, independence is impaired if the public accounting firm even appears to investors to be working in the capacity of management at the client. The client management (including its board of directors and audit committee) must understand that they are responsible for establishing and maintaining internal control and directing the internal audit function, if any.The board of directors and/or audit committee (i.e., those charged with governance) must understand their roles and responsibilities with regard to extended audit services including the establishment of guidelines for both management and the public accounting firm to follow in carrying out these responsibilities and monitoring how well the respective responsibilities have been met. In addition to the guidance discussed in the previous paragraphs, the following additional activities would impair independence: -Performing ongoing monitoring or control activities. -Determining which, if any, recommendations for improving internal control should be implemented. -Reporting to the board of directors or audit committee on behalf of management or the individual responsible for the internal audit function. -Authorizing, executing, or consummating transactions or otherwise exercising authority on behalf of the client. -Preparing source documents for transactions. -Having custody of assets. -Approving or being responsible for the overall internal audit work plan including the determination of the internal audit risk and scope project priorities and the frequency of performance of audit procedures. -Performing forensic accounting services, litigation support work, or any other service in which it appears that the CPA is taking an advocacy position on the client's behalf. Although performing tax compliance work would not normally impair independence, certain tax work in which an advocacy position is required does (e.g., representing a client in court to resolve a tax dispute). -Being connected with the client as an employee or in any capacity equivalent to a member of client management (for example, being listed as an employee in client directories or other client publications, permitting himself or herself to be referred to by title or description as supervising or being in charge of the client's internal audit function, or using the client's letterhead or internal correspondence forms in communications). Although this list is not all-inclusive, a prohibited activity is one that would force the CPA to act either in the capacity of management or as an advocate for management. As noted, independence is ordinarily impaired if a CPA serves on an organization's board of directors. However, members can be honorary directors of organizations such as charity hospitals, fund drives, symphony orchestra societies, and similar not-for-proft organizations so long as (1) the position is purely honorary, (2) the CPA is identifed as an honorary director on letterheads and other literature, (3) the only form of participation is the use of the CPA's name, and (4) the CPA does not vote with the board or participate in management functions. When all of these criteria have been satisfed, the CPA/board member can perform audit and attest services because the appearances of independence will have been preserved.

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. (1.100.001 and 2.100.001) -The Integrity and Objectivity Rule applies not only to CPAs in public practice but also to CPAs working in business. The rule requires integrity and objectivity in all types of professional work—tax practice and consulting practice as well as audit practice for public accountants—and all types of accounting work performed by CPAs employed in corporations, not-for-profit organizations, governments, and individual practices. The rule holds CPAs to the highest of standards of maintaining their integrity and objectivity at all times. In addition to integrity and objectivity, this rule emphasizes (1) being free from conflicts of interest between CPAs and others, (2) representing facts truthfully in reports and discussions, and (3) not letting other people dictate or influence the CPA's judgment and professional decisions. Conflicts of interest refer to the need to avoid having business interests in which the accountant's personal financial relationships or the accountant's relationships with other clients might tempt the accountant to fail to serve the best interests of a client or the public. Some examples of conflicts of interest are those in which the CPA: -Is engaged to perform litigation support services for a plaintiff in a lawsuit fled against a client. -Recommends that a client makes an investment in a business in which the CPA has a financial interest. -Performs management consulting for a client and has a financial or managerial interest in a major competitor. The phrases "shall not knowingly misrepresent facts" and "shall not subordinate his or her judgment to others" emphasize conditions people ordinarily identify with the concepts of integrity and objectivity. Accountants who know about a client's fraudulent tax return, about false journal entries, about material misrepresentations in fnancial statements, and yet do nothing have violated both the spirit and the letter of the Integrity and Objectivity Rule. The prohibition of misrepresentations in financial statements applies to the management accountants who prepare companies' statements. Business CPAs should not subordinate their professional judgment to superiors who try to produce materially misleading fnancial statements and fool their external auditors. They must be candid and not knowingly misrepresent facts or fail to disclose material facts when dealing with their employer's external auditor. They also cannot have conficts of interest in their jobs and their outside business interests that are not disclosed to their employers and approved. The importance of integrity and objectivity for business CPAs cannot be overemphasized. Too often, CPAs relate the Code of Professional Conduct only to CPAs in public practice. In fact, one of the objectives of the recodifcation of the AICPA Code of Conduct is to emphasize the importance of business CPAs adhering to ethics rules that relate to them. The Integrity and Objectivity Rule has two other applications. One concerns serving as a client advocate, which occurs frequently in taxation and rate regulation practice as well as in supporting clients' positions in FASB and SEC proceedings. Client advocacy in support or advancement of client positions is acceptable only so long as the member acts with integrity, maintains objectivity, and does not subordinate judgment to others. (Accountants-as-advocates do not adopt the same attitude as defense attorneys in a courtroom.) The other application is directed specifcally to your college professors: They are supposed to maintain integrity and objectivity, be free of conficts of interest, and not knowingly misrepresent facts to students

general ethics

In this definition, you can detect three key elements about ethics. First, ethics involves questions requiring reflective choice ( decision problems ). Second, ethics involves guides of right and wrong ( moral principles ). And third, ethics is concerned with the consequences ( good or bad ) of decisions.

Self-Review Threat

Independence is impaired if the public accounting firm performs the bookkeeping or makes accounting or management decisions for a company whose management does not know enough about the financial statements to take primary responsibility for them. The problem in this situation is the appearance of the public accounting firm having both prepared the financial statements or other information and provided the auditors' report or other attestation on its own work. In the final analysis, the management must be able to say, "These are our financial statements (or other information); we made the choices of accounting principles; we take primary responsibility for them." The auditors cannot authorize transactions, control assets, sign checks or reports, prepare source documents, supervise the client's personnel, or serve as the client's registrar, transfer agent, or general counsel.

Disclosures about Fees

The SEC believes that investors who use financial statements and auditors' reports can be enlightened with information about auditors' fee arrangements with clients. Hence, SEC rules require that companies (not auditors) disclose the following in proxy statements delivered to their shareholders: -Total audit fees paid to the public accounting firm for the annual audit and the reviews of quarterly financial information. -Total fees paid to the public accounting firm for tax and other advisory work (over and above the audit fees). -Whether the audit committee or the board of directors considered the public accounting firm's advisory work to be compatible with maintaining the auditor's independence. -The percentage of the audit hours performed by persons other than the principal auditor's full-time, permanent employees, if greater than 50% of the total audit hours. (This disclosure refers to "leased employees" in an "alternative practice structure" arrangement.)

Non-audit Services

The SEC is very concerned about the fact and appearance of independence when public accounting firms perform consulting services for audit clients. A major issue in the Enron case was that more than half of the fee it paid to Arthur Andersen was for consulting services. This fact exacerbated the concern that auditors would allow a client's improper financial reporting for the sake of preserving lucrative fees from other services. The SEC's concern in this regard is controversial, but the PCAOB has reinforced it. The SEC and PCAOB independence rules prohibit or place restrictions on the following types of nonaudit services provided to audit clients: -Bookkeeping or other services related to the audit client's accounting records or financial statements (including maintaining or preparing the accounting records, preparing the financial statements, or preparing or originating source data underlying the financial statements except in emergency situations). -Financial information systems design and implementation (including operating or supervising the client's information system, designing or implementing a hardware or software system that generates information that is significant to the client's financial statements unless the audit client's management takes full and complete responsibility for all design, implementation, internal control, and management decisions about the hardware and software). -Appraisal or valuation services or fairness opinions (including any such services material to the financial statements when the auditor might audit the results of the public accounting firm's own work, but the public accounting firm's valuation experts may audit actuarial calculations, perform tax-oriented valuations, and perform nonfinancial valuations for audit clients). -Actuarial services (including determination of actuarial liabilities unless the audit client management first uses its own actuaries and accepts responsibility for significant actuarial methods and assumptions). -Internal audit services (including those related to the client's internal accounting controls, financial systems, or financial statements). -Management functions (including acting temporarily or permanently as a director, officer, or employee of an audit client, or performing any decision-making, supervisory, or ongoing monitoring function for the audit client). -Human resources (including all aspects of executive search activities, reference checking, status and compensation determination, and hiring advice). -Broker-dealer services (including acting as a broker-dealer, promoter, or underwriter on behalf of an audit client; making investment decisions or otherwise having discretionary authority over investments; executing a transaction to buy or sell investments; or having custody of assets). --Legal services (including any service under circumstances in which the person providing the service must be admitted to practice before the courts of a U.S. jurisdiction). -Expert services (including providing expert opinions or other services to an audit client or legal representative of an audit client for the purpose of advocating the audit client's interests in litigation, regulatory, or administrative investigations or proceedings; the auditor may perform internal investigations at the direction of the audit committee or its legal counsel). -Any service performed for an audit client where the auditor is paid a contingent fee or commission. -Tax services that are based on judicial proceedings or aggressive interpretations of tax law. -Planning or opining on the tax consequence of a transaction. -Tax services for key company executives. The PCAOB's Rule 3526 ( Communication with Audit Committees Concerning Independence ) requires public accounting firms to discuss any independence issues with the audit committee (or those charged with governance) prior to accepting an initial engagement. This discussion must be documented (usually in the engagement administrative file workpapers).

Consequences of Violating the Code of Professional Conduct

Unethical behavior by an auditor can have financial implications (e.g., fines, lawsuits) and reputation implications that may be difficult to remedy. Quality control practices and disciplinary proceedings provide the mechanisms of self-regulation. Self-regulation refers to the quality control reviews and disciplinary actions conducted by fellow CPAs—professional peers. self-regulatory discipline -AICPA -state societies of CPAs public regulation discipline -state board of accountancy -SEC -PCAOB -IRS

The Imperative Principle

directs a decision maker to act according to the requirements of moral rules and principles. -Strict versions of the imperative principle maintain that a decision should be made without trying to predict whether an action will create the greatest balance of good over evil. -Rather, ethics in the imperative sense is a function of moral rules and principles and as such does not involve a situation-specific calculation of the consequences. The philosopher Immanuel Kant (1724-1804) was perhaps the foremost advocate of the imperative school. Kant maintained that reason and the strict duty to be consistent should govern our actions. He believed that individuals should act only as they think everyone should act all of the time. This law of conduct (in moral philosophy) is known as Kant's categorical imperative , meaning that it specifies an unconditional obligation. One such maxim (rule), for example, is "Lying is wrong." The general objection to the imperative principle is the belief that so-called universal rules always turn out to have exceptions. The general response to this objection is that if the rule is stated properly to include the exceptional cases, the principle is still valid. The problem with this response, however, is that human experience is complicated, and extremely complex universal rules would have to be constructed to try to cover all possible cases. As it relates to your work as an audit professional, this principle would lead you to follow the code of professional conduct to the letter of the law. This, of course, is what you must do to avoid being sanctioned by the profession.

U.S. Securities and Exchange Commission (SEC)

has federal statutory authority to regulate the public accounting profession for the purposes of (1) protecting the reliability and integrity of the financial statements of public companies and (2) promoting investor confidence in financial statements and the securities markets. -The SEC's jurisdiction covers only issuers that are required by federal securities laws to file financial statements audited by independent accountants. In addition to the duties outlined earlier, the passage of the Sarbanes-Oxley Act in 2002 requires the SEC to oversee the PCAOB.

Ethics

that branch of philosophy which is the systematic study of reflective choice, of the standards of right and wrong by which it is to be guided, and of the goods toward which it may ultimately be directed. - Wheelwright, 1959

ethical problem

•A problem situation exists when an individual must make a choice among alternative actions and the right choice is not absolutely clear. •An ethical problem situation may be described as one in which the choice of alternative actions affects the well-being of other persons. •More often, there is a conflict between what we should do and what we want to do.

An Emphasis on Independence

As you will soon learn, the AICPA Code of Professional Conduct (the Code) is crystal clear about the importance of independence. The responsibilities principle requires auditors to maintain independence in mental attitude; that is, auditors are expected to be unbiased and impartial with respect to all professional judgments and to the fnancial statements they audit. This "state of mind" is often referred to as the auditor's possessing independence in fact . It is important for auditors not only to be unbiased but also to appear to be unbiased. Independence in appearance relates to fnancial statement users' perceptions of auditors' independence. For example, even if the auditors do not have any direct or indirect fnancial interest or obligation with the audit client, they must ensure that no part of their behavior or actions appears to affect their independence in the opinion of the public. Simply stated, audit quality and the value of the profession depend on independence. If an auditor's independence is doubted, users of audited fnancial statements are likely to question the motives of the public accounting frm in completing the audit, greatly diminishing the value of the audit. As a result of its importance, public accounting frms now spend a substantial amount of time making sure they maintain their independence at all times. •Independence Rule (1.200) -A member in public practice shall be independent in the performance of professional services as required by standards promulgated by bodies designated by Council. -Independence can be violated by -Financial interest in client; -Managerial connection with the client; -American Institute of Certified Public Accountants -independence rule -adverse interest and undue influence threat -advocacy and management participation threats -familiarity threat -financial self-interest threat -self-review threat -other threats -SEC and PCAOB independence rules -nonaudit services -disclosures about fees -other effects of Sarbanes-Oxley on Auditor Independence -Government accountability office (GAO) independence requirements

Self-Regulatory Discipline

-AICPA -State Societies of CPAs Individual persons (not accounting firms) are subject to the rules of conduct of state CPA societies and the AICPA only if they choose to join these organizations. The AICPA and most of the state societies have entered into a Joint Ethics Enforcement Program through which the AICPA can refer complaints against CPAs to state societies or state societies can refer them to the AICPA. Both organizations have ethics committees to hear complaints. They can (1) acquit an accused CPA, (2) find the CPA in violation of rules and issue a letter of required corrective action, or (3) refer serious cases to an AICPA trial board. The letter of required corrective action ordinarily admonishes the CPA and requires specific continuing education courses to bring the CPA up to date in technical areas. The trial board panel has the power to (1) acquit the CPA, (2) admonish the CPA, (3) suspend the CPA's membership in the state society and the AICPA for up to two years, or (4) expel the CPA from the state society and the AICPA. The AICPA bylaws (not the Code of Professional Conduct) provide for automatic expulsion of CPAs judged to have committed a felony, failed to file their tax returns, or aided in the preparation of a false and fraudulent income tax return. The trial board panels are required to publish the names of the CPAs disciplined in their proceedings The expulsion penalty, while severe, does not prevent a CPA from continuing to practice accounting. Membership in the AICPA and state societies, while beneficial, is not required. However, a CPA must have a valid state license in order to practice. Most state boards of accountancy are the agencies that can suspend or revoke the license to practice.

Public Regulation Discipline

-State Boards of Accountancy -SEC -PCAOB -IRS State boards of accountancy are government agencies consisting of CPA and non-CPA officeholders. In most states, the state board of accountancy issues licenses to practice accounting in their jurisdictions. Most state laws require a license to use the designation CPA or certified public accountant and limit the attest (audit) function to license holders only. State boards have rules of conduct and trial board panels. They can admonish a license holder; perhaps more importantly, most can suspend or revoke the license to practice. Suspension and revocation are severe penalties because a person no longer can use the CPA title and cannot sign auditors' reports. When candidates have successfully passed the CPA examination and are ready to become CPAs, some state boards administer an ethics examination or require taking an ethics course intended to familiarize new CPAs with the state rules. The SEC and the PCAOB also conduct public disciplinary actions. Their authority comes from their rules of practice, of which Rule 102(e) provides that the SEC can deny, temporarily or permanently, the privilege of practice before the SEC to any person found to have engaged in unethical or improper professional conduct. When conducting a "Rule 102(e) proceeding," the SEC acts in a quasi-judicial role as an administrative agency. The SEC penalty bars an accountant from signing any documents filed by an SEC-registered company. The penalty effectively stops the accountant's SEC practice. In a few severe cases, Rule 102(e) proceedings have resulted in settlements barring not only the individual accountant but also her or his accounting firm or certain of its practice offices from accepting new SEC clients for a period of time. The PCAOB's Division of Enforcement and Investigations (DEI) handles disciplinary actions involving accountants (and their firms) who are engaged to audit public companies (also known as "issuers"). The DEI's role is to identify matters (often from tips) for further investigation, conduct an investigation, and recommend disciplinary proceedings (if considered necessary). Common investigations include violations of the PCAOB's Auditing Standards , independence violations, and failures to cooperate with inspections/investigations. If violations are found, the DEI makes recommendations for sanctions to the Board. The Board may decide to suspend or permanently bar an accountant from auditing any public companies, suspend or revoke an accounting firm's registration, appoint a monitor to oversee a firm's practice, impose monetary penalties, require additional continuing professional education, or impose other sanctions permitted under PCAOB rules.

American Institute of Certified Public Accountants (AICPA) Independence rule

-The PEEC makes independence rules for CPAs that are applicable not only for audits of issuers but also for all other audits (audits of non-issuers, not-for-profit organizations, and government units) and attestation engagements. Independence is required for both audit and attestation engagements, including reviews of financial statements. The Independence Rule, now discussed in detail, is derived from the AICPA Code of Professional Conduct's objectivity and independence principle. -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. (1.200.001) -The Independence Rule itself has very little substantive content. Instead, it incorporates PEEC interpretations that are explained in the following paragraphs. The fundamental thrust of these interpretations is that auditors preserve independence , the mental attitude and appearance that auditors are not influenced by others in making judgments and decisions, by (1) avoiding financial connections that make it appear that the auditor's wealth depends on the outcome of the audit and (2) avoiding managerial connections that make it appear that the auditors are involved in management decisions for the audit client (thus auditing their own work). -Essentially, covered members are prohibited from having any financial interest in clients that could affect their audit judgment ( independence in fact ) or would appear to others to have an influence on their judgment ( independence in appearance ). In addition, immediate family members are under the same restrictions as the auditor. Again, the appearance of independence would be jeopardized if the auditor's child owned stock in a client. Similarly, if a close relative or immediate family member worked for a client in a position that could influence the audit (e.g., a controller), independence in appearance, if not in fact, is impaired.

Ethical Codes of Conduct

-U.S. Securities and Exchange Commission (SEC) -Public Company Accounting Oversight Board (PCAOB) -The International Federation of Accountants (IFAC) -American Institute of CPAs (AICPA) and their Professional Ethics Executive Committee (PEEC) -applicable state society of CPAs -applicable state board of accountancy

Virtue Ethics

-can be traced not only to the Greek philosophers Aristotle and Plato (his Republic discusses the Four Cardinal Virtues: wisdom, justice, fortitude, and temperance), but also to Buddhist ethical tradition. -Rather than a focus on following rules or weighing outcomes, it emphasizes the role of one's character in the decision-making process. -Questions that may be asked include, "What action will help me become my ideal self?" or, "What action would I be the proudest of?"

AICPA Code of Professional Conduct Fees and Other Types of Remuneration Rule 1.500 (1 of 2)

-contingent fees -commission and referral fees

The Principle of Utilitarianism

-emphasizes examining the consequences of action rather than following some rules. -The criterion of producing the greater good is made an explicit part of the decision process. -The principle is very useful, but be sure to notice that it does not specify the values that enable you to determine the good or evil of an action. -In act-utilitarianism , the center of attention is the individual act as it is affected by the specific circumstances of a situation. -The general difficulty with act-utilitarianism is that it seems to permit too many exceptions to well-established rules. -By focusing attention on individual acts, the long-run effect of setting examples for other people appears to be ignored. -If an act-utilitarian decision is to break a moral rule, the decision's success usually depends on everyone else's adherence to the rule, which is highly unlikely in auditing. -Rule-utilitarianism , on the other hand, emphasizes the centrality of rules for ethical behavior while still maintaining the criterion of the greatest universal good. This kind of utilitarianism means that decision makers must first determine the rules that will promote the greatest general good for the largest number of people. The initial question is not which action has the greatest utility but which rule.

The Generalization Argument

-may be considered a judicious combination of the imperative and utilitarian principles. -Basically considers the consequences of a decision made by similar persons acting under similar circumstances. -A more everyday expression of the argument is this question: "What would happen if everyone acted in that certain way?" -If the answer to the question is that the consequences would be undesirable, the conclusion, according to the generalization test, is that the way of acting is unethical and should not be done.

The Public Company Accounting Oversight Board (PCAOB)

-responsible for setting standards for public accounting firms and to oversee quality control, ethics, and independence issues for accounting professionals who audit the financial statements of issuers. -The final authority for all matters related to the audits of issuers remains with the SEC. As a result, the SEC must approve all PCAOB proposed rules and standards before they are final. Also, even though the PCAOB has authority over the audits of only public entities, it would be a mistake to believe that the PCAOB's influence ends there. Indeed, several states (e.g., California) have passed legislation that incorporates PCAOB rules into state law applicable to audits of all companies, both public and private.

The Professional Ethics Executive Committee (PEEC) of the American Institute of CPAs (AICPA)

-the AICPA committee that makes and enforces all rules of conduct for CPAs (i.e., the AICPA Code of Professional Conduct) who are AICPA members. -You might think that if you were not in public accounting and not a member of the AICPA, the rules would not apply. However, state and federal court proceedings and disciplinary bodies have consistently upheld that CPAs must adhere to professional ethical standards even if they are not members of the AICPA. Furthermore, most states incorporate the AICPA Code of Professional Conduct into their own accounting statutes

An Ethical Decision Process

1.Define all facts and circumstances 2.Identify stakeholders 3.Identify stakeholders' rights and obligations in general and to each other 4.Identify alternatives and consequences 5.Choose superior alternative with respect to consequences and/or rules In the earlier definition of ethics, one of the key elements was reflective choice . This involves engaging in an important sequence of events beginning with the recognition of a decision problem. Collection of evidence, in the ethics context, refers to thinking about rules of behavior and outcomes of alternative actions. The process ends with analyzing the situation and taking an action. Ethical decision problems almost always involve projecting yourself into the future to live with your decisions. Professional ethics decisions usually turn on these questions: "What written and unwritten rules govern my behavior?" and "What are the possible consequences of my choices—whom will my decision affect?" Principles of ethics can help you think about these two questions in real situations A good way to approach ethical decision problems is to think through several steps: (1) Define all facts and circumstances known at the time that you need to make the decision. They are the "who, what, where, when, and how" dimensions of the situation. Identify the actor who needs to decide what to do. (a) Because ethical decision problems are defined in terms of their effects on people, identify the people involved in the situation or affected by it. These are the "stakeholders"; be careful not to expand the number of stakeholders beyond the bounds of reasonable analysis. (b)Identify and describe the stakeholders' rights and responsibilities in general and to each other (2) Specify the actor's major alternative decision actions and their consequences (good, bad, short-run, long-run). (3) The actor must choose among the alternative actions.

AICPA Code of Professional Conduct Advertising and Other Forms of Solicitation Rule 1.600

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, overreaching, or harassing conduct is prohibited. (1.600.001) Advertising consists of messages designed to attract business that are broadcast widely to an undifferentiated audience (e.g., print, radio, television, billboards). Advertising is permitted with only a few limitations. The current rule applies only to CPAs practicing public accounting and relates to their efforts to obtain clients. The guidelines basically prohibit false, misleading, and deceptive messages: -Advertising may not create false or unjustified expectations of favorable results. -Advertising may not imply the ability to influence any court, tribunal, regulatory agency, or similar body or official. -Advertising may not contain a fee estimate when the CPA knows it is likely to be substantially increased unless the client is notified. -Advertising may not contain any other representation likely to cause a reasonable person to misunderstand or be deceived. Solicitation generally refers to direct contact (e.g., in person, mail, telephone) with a specific potential client. In regard to solicitation, Rule 502 basically prohibits extreme bad behavior (coercion, overreaching, or harassing conduct). Many CPAs abhor solicitation, and many state boards of accountancy try to prohibit direct, uninvited approaches to prospective clients, especially when the client already has a CPA. Nevertheless, the U.S. Supreme Court has struck down state solicitation prohibitions, declaring them to be an infringement of personal and business rights to free speech and due process CPAs sometimes hire marketing firms to obtain clients. The AICPA permits such arrangements but warns that all such "practice development" activity is subject to the Advertising and Other Forms of Solicitation Rule because members cannot do through others things what they are prohibited from doing themselves.

AICPA Code of Professional Conduct Form of Organization and Name Rule 1.800

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 owners may be included in the firm name of a successor organization. A firm may not designate itself as "Member of the American Institute of Certified Public Accountants" unless all of its CPA owners are members of the Institute. (1.800.001) The Form of Organization and Name Rule allows CPAs to practice public accounting in any form of organization permitted by a state board of accountancy and authorized by law. Organization forms include sole proprietorship, partnership, limited partnership, limited liability partnership (LLP), professional corporation (PC), limited liability corporation (LLC), and ordinary corporation (Inc.). You may have noticed that the large international accounting firms now place LLP after their firm names. Many small accounting firms include PC in their names. CPAs in public practice cannot use misleading firm names. For example, suppose CPAs Stone and Thompson, who are not in partnership, agree to share expenses for office support, advertising, and continuing education. They cannot put up a sign that states "Stone & Thompson CPAs" because this name suggests a partnership where there is none. A member who practices public accounting also can participate in the operation of another business organization (e.g., a consulting or tax preparation firm) that offers professional services of the types offered by public accounting firms. If this business is permitted to practice public accounting under state law, the member also is considered to be in the practice of public accounting in it and must observe all rules of conduct. CPAs who work in alternative practice structures occupy an odd position. They can prepare compiled (unaudited) financial statements, which is considered a form of public accounting practice. In such a case, CPA employees of the alternative practice structure (e.g., "PublicCo") must take fnal responsibility for the accountants' compilation report and must sign it with their own personal names (not the name of PublicCo). The last paragraph of the Form of Organization and Name Rule permits a mixed accounting organization consisting of CPA and non-CPA owners to designate itself "Members of the AICPA" if all of the CPA owners are actually AICPA members. However, the AICPA Council limits this privilege of organizational form by expressing certain requirements for ownership and control, especially regarding non-CPAs who have ownership interests in an organization that practices public accounting. (See the Council Resolution provisions in the feature " Form of Organization and Name ." The purpose of the Council Resolution is to conform the operations of an accounting organization as closely as possible to the traditional accounting frm and to ensure control of professional services in the hands of CPAs.).

AICPA Code of Professional Conduct General Standards Rule 1.300

A member shall comply with the following standards and with any interpretations thereof by bodies designated by Council: (A) Professional competence. Undertake only those professional services that the member or the member's firm can reasonably expect to be completed with professional competence. (B) Due professional care. Exercise due care in the performance of professional services. (C) Planning and supervision. Adequately plan and supervise the performance of professional services. (D) Sufficient relevant data. Obtain sufficient relevant data to afford a reasonable basis for conclusions or recommendations in relation to any professional services performed. (1.300.001 and 2.300.001) The General Standards Rule is a comprehensive statement of general standards that accountants are expected to observe in all areas of practice. This is the rule that enforces the various series of professional standards. The AICPA Council has authorized the following agencies, boards, and committees to issue enforceable standards under this rule: -Public Company Accounting Oversight Board (PCAOB). -Auditing Standards Board. -Accounting and Review Services Committee. -Tax Executive Committee. -Management Consulting Services Executive Committee The General Standards Rule effectively prohibits the acceptance of any engagement that the CPA cannot complete in a competent manner. Such engagements may involve audits that require specialized industry knowledge or technical expertise the practitioner does not possess. Practitioners are allowed to accept an engagement if, through education, hiring of additional staff, or contracting with auditors' specialists, the practitioners can obtain the required knowledge prior to the conclusion of the engagement. As a result, a practitioner can accept an engagement for which he or she does not possess knowledge as long as this knowledge can be obtained prior to the conclusion of the engagement. This rule covers all areas of public accounting practice except personal financial planning and business valuation. Of course, a CPA may have to do some research to learn more about a unique problem or technique and may need to engage a colleague as a consultant

AICPA Code of Professional Conduct Accounting Principles Rule 1.320

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. (1.320.001 and 2.320.001) •If financial statements contain material departure from the applicable financial reporting principle, CPA shall not: -State that the financial statement is in conformity with GAAP; -State that he is not aware of any material modification to be made to the financial statements in order for it to be in conformity with GAAP; The AICPA Council has designated three rule-making bodies to pronounce accounting principles under the Accounting Principles Rule. The Financial Accounting Standards Board (FASB) is designated to pronounce standards in general, the Governmental Accounting Standards Board (GASB) has the responsibility to pronounce accounting standards for state and local government entities, and the Federal Accounting Standards Advisory Board (FASAB) is charged with respect to statements of federal accounting standards. The Accounting Principles Rule requires adherence to official pronouncements unless such adherence would be misleading. The consequences of misleading statements to outside decision makers would be financial harm, so presumably the greater good would be realized by explaining a departure and thereby "breaking the rule of officially promulgated accounting principles." Such an instance occurs in very rare situations, and the burden of proving that following pronouncements would be misleading is the responsibility of the auditor. CPAs in business also can be subject to the Accounting Principles Rule. These accountants produce and certify financial statements and sign written management representation letters for their external auditors. They also present financial statements to regulatory authorities and creditors. Business accountants generally "report" that the company's fnancial statements conform to GAAP, and this report is taken as an expression of opinion (or negative assurance) of the type governed by the Accounting Principles Rule. The result is that accountants who present fnancial statements containing any undisclosed departures from ofcial pronouncements face disciplinary action for violating the rule.

AICPA Code of Professional Conduct Acts Discreditable Rule 1.400

A member shall not commit an act discreditable to the profession. (1.400.001, 2.400.001, and 3.400.001) -may be called the moral clause of the code, but it is only occasionally the basis for disciplinary action. Penalties normally are invoked automatically under the AICPA bylaws, which provide for expulsion of members found by a court to have committed any fraud, filed false tax returns, been convicted of any criminal offense, or found by the AICPA Trial Board to have been guilty of an act discreditable to the profession. AICPA interpretations have determined the following to be discreditable acts: -Withholding a client's books and records and important documentation when the client has requested his or her return. -Being found guilty by a court or administrative agency as having violated employment anti-discrimination laws, including ones related to sexual and other forms of harassment. -Failing to follow government audit standards and guides in governmental audits when the client or the government agency expects such standards to be followed. -Failure to follow the requirements of governmental bodies, commissions, or other regulatory bodies including the PCAOB. -Soliciting or disclosing CPA Examination questions and answers from the CPA Examination. -Failing to file tax returns or remit payroll and other taxes collected for others (e.g., employee taxes withheld). -Making, or permitting others to make, false and misleading entries in records and financial statements. This last item is specifically applicable to all CPAs, whether in public practice, in business, between jobs, or in retirement. Any management accountant who participates in the production of false and misleading financial statements commits a discreditable act.

AICPA Code of Professional Conduct Compliance with Standards Rule 1.310

A member who performs auditing, review, compilation, management consulting, tax, or other professional services shall comply with standards promulgated by bodies designated by Council. (1.310.001 and 2.31.001) The Compliance with Standards Rule requires adherence to duly promulgated technical standards in all areas of professional service. These areas include the ones cited in the rule: auditing, review and compilation (unaudited financial statements), consulting, tax, or "other" professional services. The "bodies designated by Council" are the Auditing Standards Board, the Accounting and Review Services Committee, the Tax Executive Committee, and the Consulting Services Executive Committee. The practical effect of this rule is to make noncompliance with technical standards (in addition to the general standards) subject to disciplinary proceedings. Therefore, failure to follow auditing standards, accounting and review standards, tax standards, and consulting standards is a violation of the Compliance with Standards Rule.

AICPA Code of Professional Conduct: Six Principles

Back in 2014, the PEEC completed a project to completely recodify the AICPA's ethics standards in an effort to increase its accessibility and usefulness to members. The code is structured into topical areas and now refects a "conceptual framework" type of approach. Importantly, the recodifed standards closely follow the IESBA ethical standards. The AICPA Code of Professional Conduct contains four parts. The frst section, referred to as the Preface, includes a discussion of the Principles of Professional Conduct, a set of six positive essays expressing the profession's high ideals: (I) Responsibilities. In carrying out their responsibilities as professionals, members should exercise sensitive professional and moral judgments in all of their activities. (II) 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 commitment to professionalism. (III) Integrity. To maintain and broaden public confidence, members should perform all professional responsibilities with the highest sense of integrity. (IV) 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. (V) 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. (VI) 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. Although the frst section of the AICPA Code of Professional Conduct embodies principles to which CPAs should adhere, they are very general in nature, and thus are difcult, if not impossible, to enforce on their own. The three remaining parts contain enforceable rules that were derived from the six Principles of Professional Conduct. Part 1 applies to members practicing public accounting; Part 2 does the same for those CPAs working in business; and Part 3 applies to all other members, including those who are retired or are between jobs. The PEEC also publishes interpretations of the Code of Professional Conduct, which are detailed explanations of specifc rules necessary to help members understand particular applications. Finally, the PEEC also publishes "rulings" on the applicability of rules in specifc situations

contingent fees

Contingent Fees: Those fees based on a particular finding or outcome •Not permitted for attestation engagements •Not contingent if -Fixed by courts. -Based on hours worked or services provided. •Allowed for non-attestation (tax, consulting, litigation support) engagements 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 the 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. (1.510.001) A contingent fee is a fee established for the performance of any service in an arrangement in which no fee will be charged unless a specific finding or result is attained or the fee otherwise depends on the result of the service. (Fees are not contingent if they are fxed by a court or other public authority or, in tax matters, determined as a result of the fndings of judicial proceedings or the fndings of government agencies; nor are fees contingent when they are based on the complexity or time required for the work.) CPAs can charge contingent fees for work such as representing a client in an IRS tax audit and certain other tax matters, achieving goals in a consulting service engagement, or helping a person obtain a bank loan in a fnancial planning engagement. However, the PCAOB has issued an independence rule that prohibits all contingent fees for audit clients of registered public accounting frms. CPAs are allowed to receive contingent fees except from clients for whom the CPAs perform attest services when users of fnancial information may be relying on the CPAs' work. The prohibitions in items 1(a), 1(b), and 1(c) all refer to attest engagements in which independence is required. Acceptance of contingent fee arrangements during the period in which the member or the member's frm is engaged to perform any of these attestations or during the period covered by any historical fnancial statements involved in any of these engagements is considered an impairment of independence. Contingent fees are also prohibited in connection with the everyday tax practice of preparing original or amended tax returns. This prohibition arose from an interesting conflict of government agencies. The Federal Trade Commission (FTC) wanted to see contingent fees permitted, but the IRS objected on the grounds that such fees might induce accountants and clients to "play the audit lottery"—understate tax improperly in the hope of escaping audit. The IRS asserted that if the AICPA permitted such contingent fees, the IRS would make its own rules prohibiting them. The FTC agreed that the AICPA rule could contain this prohibition.

SEC and PCAOB independence rules

Prior to the issuance of Sarbanes-Oxley in 2002, the SEC accepted most of the independence rules established by the PEEC. However, the SEC became concerned about the public accounting profession's emphasis on consulting fees and the resulting effect on public accounting firm independence. In fact, the SEC issued a comprehensive independence rule in November 2000. The rule is based upon two premises: (1) independence in fact is a mental state of objectivity and lack of bias and (2) independence in appearance depends on whether a reasonable investor, with knowledge of all relevant facts and circumstances, can conclude that the auditor is not capable of exercising objective and impartial judgment. Hence, an auditor's independence depends on auditors both having the proper mental state and passing the appearance test In a preface to the rule, the SEC stated four principles for determining whether a public accounting firm is independent of an audit client, factors the SEC will first consider when making independence determinations in controversial cases. Auditors are not independent if they have a relationship that: -Creates a mutual or conflicting interest between the public accounting firm and the audit client. -Places the public accounting firm in the position of auditing its own work. -Results in the public accounting firm personnel acting as management or employees of the audit client. -Places the public accounting firm in a position of being an advocate for the audit client. The SEC independence rules relating to financial relationships are very similar to the AICPA Code of Professional Conduct Rule 101 Interpretations explained earlier. The most significant categories addressed by the SEC rules are in the areas of financial and employment relationships, nonaudit services (e.g., taxation, consulting), and disclosure of fees.

Other Effects of Sarbanes-Oxley on Auditor Independence

Sarbanes-Oxley required the SEC to modify its position on auditor independence in several ways. Perhaps the most important change in independence arises from the changing role of the audit committee. -While auditors must always be vigilant in establishing and monitoring their own independence to ensure that they are in fact independent of their clients, Sarbanes-Oxley has placed the responsibility for the determination of independence in appearance at the door of the audit committee. -This is particularly evident by the fact that the audit committee bears the responsibility for determining the scope of services provided by the auditor and reviewing independence issues prior to the appointment of the auditor. -The audit committee may do this on a case-by-case basis or may establish a set of policies and procedures that establish acceptable and unacceptable services. In addition, Sarbanes-Oxley limits the engagement partners and concurring audit partners on an engagement to five-year terms, after which they must rotate off the engagement. Other partners associated with the engagement are limited to seven-year terms with that client. Partners also are deemed as not independent if they receive compensation that is based on selling services to an audit client other than audits, reviews, or attestations. In the past, it was not unusual for a member of an audit team, usually a manager or higher, to leave the public accounting firm to take a financial management position with a client. Under the rules established by Sarbanes-Oxley, a public accounting firm cannot perform an audit of a company in which an individual with financial reporting oversight responsibilities was a member of the audit engagement team for the audit period, up to the audit date.

AICPA Code of Conduct Conceptual Framework

When a questionable practice or relationship arises, the CPA must evaluate whether the practice or relationship poses an unacceptable risk to a CPAs' independence. Because there is not a rule or interpretation for every ethical dilemma a CPA might face, the PEEC adopted a Conceptual Framework ( Exhibit B.3 ) that CPAs can use when facing a situation that is not explicitly covered in the Code of Conduct. The Conceptual Framework uses a three-step risk-based approach that involves (1) identifying and evaluating threats to independence, (2) determining whether safeguards eliminate or sufficiently mitigate the identified threats, and (3) determining whether independence is impaired. Identified threats to independence include the following: (1) Adverse interest threat. CPAs acting in opposition to clients (e.g., through litigation). (2) Undue influence threat. Attempts to coerce or otherwise influence the CPA member (e.g., significant gifts or threats to replace the auditor over an accounting principles disagreement). (3) Advocacy threat. CPAs promoting a client's interests or position. (4) Management participation threat. CPAs taking on the role of client management or otherwise performing management functions. (5) Familiarity threat. CPAs becoming too sympathetic to client interests because of long- standing or close relationships. (6) Self-interest threat. CPAs having a financial relationship with a client. (7) Self-review threat. CPAs reviewing their own work.

ethical behavior

You can find three standard philosophical answers to this question: Ethical behavior is that which (1) produces the greatest good, and/or (2) conforms to moral rules and principles, and/or (3) best demonstrates the virtues you value most. The most difficult problem situations arise when two or more rules conflict or when a rule and the criterion of "greatest good" conflict. However, as a professional auditor, you must always conform to the code of ethical behavior that applies to your jurisdiction or face the possibility of being formally sanctioned by the profession. Why does an individual or group need a code of ethical conduct? A code makes explicit some of the criteria for conduct unique to the profession. Codes of professional ethics provide guidance in addressing situations that may not be specifically available in general ethics theories. An individual is better able to know what the profession expects when a code exists. From the viewpoint of the organized profession, a code is a public declaration of principled conduct and a means of facilitating enforcement of standards of conduct. Once again, you can see the value of ethical behavior. Remember that accounting is the only business discipline that is considered a profession similar to those of doctors and lawyers. As a student of auditing, you must commit yourself to knowing and understanding the AICPA Code of Professional Conduct.

Commissions and Referral Fees

•Commissions: Receiving fees for recommending the products or services of clients or third parties (non-CPA) -Permitted for non-attestation, if disclosed -Prohibited for attestation engagements §Cannot earn commission by referring product/service to the attestation service client; §Cannot earn commission by referring attestation service client's product/service to a third party; •Referrals: Receiving fees for recommending the services of CPAs -Permitted for any engagement, if disclosed (A) prohibited commissions A member in public practice shall not recommend or refer to a client any product or service for a commission, or recommend or refer any product or service to be supplied by a client for a commission, or receive a commission, when the member or the member's frm also performs for that client: (a)an audit or review of a fnancial statement; or (b) a compilation of a fnancial statement when the member expects, or reasonably might expect, that a third party will use the fnancial statement and the member's compilation report does not disclose a lack of independence; or (c) an examination of prospective fnancial information. This prohibition applies during the period in which the member is engaged to perform any of the services listed above and the period covered by any historical fnancial statements involved in such listed services. B. Disclosure of Permitted Commission A member in public practice who is not prohibited by this rule from performing services for, or receiving a commission from, and who is paid or expects to be paid a commission, shall disclose that fact to any person or entity to whom the member recommends or refers a product or service to which the commission relates. C. 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. (1.520.001) A commission is generally defined as a percentage-based fee charged for professional services in connection with executing a transaction or performing some other business activity. Examples are insurance sales commissions, real estate sales commissions, and securities sales commissions. A CPA can earn commissions except in connection with any client for whom the CPA performs attestation services. Commissions are permitted provided that the engagement does not involve attestation of the types cited in part A of the rule. This permission is tempered by the requirement that the CPA must disclose to clients an arrangement to receive a commission. Most of the commission fee activity takes place in connection with personal financial planning services. CPAs often recommend insurance and investments to individuals and families. Some critics point out that clients cannot always trust commission agents (e.g., insurance salespersons, securities brokers) to have clients' best interests in mind when the agents' own compensation depends on clients' buying the product that produces commissions Referral fees are fees (1) a CPA receives for recommending another CPA's services or (2) a CPA pays to obtain a client. Referral involves the practice of sending business to another CPA and paying other CPAs or outside agencies for drumming up business. Some CPAs have hired services that solicit clients on their behalf, paying a fixed or percentage fee. Many CPAs frown on these arrangements, but they are permitted. However, CPAs must disclose such fees to clients.

Who is a Covered Member? (AICPA)

•Independence Rule applies to Covered members, which include (AICPA) -All individuals participating in an engagement. -An individual in a position to influence the engagement. -A partner or manager who provides nonattest services to an attest client. -A partner in the office where engagement partner practices. -The firm's benefit plan. -An entity that can be controlled by any person considered a member. Covered members - Broadly defined, any individual who might be in a position to compromise the integrity of an audit. In the AICPA Code of Professional Conduct, the term is defined as any individual, among others, who is (1) on the audit engagement team, (2) in a position to influence the audit engagement, (3) a partner or manager of a nonaudit client service team, or (4) a partner from the local office of the public accounting firm. As you can imagine, the application of these defnitions by professionals in practice can be difcult. As a result, an important role of the PEEC is to provide interpretations of the formal rules. For most practical purposes, the people who are prohibited from having fnancial and managerial relationships with the client are the audit engagement team, the people in the chain of command, the covered persons in the public accounting frm, their close family members, and immediate family members.

AICPA Code of Professional Conduct

•Principles -Ideal standards of ethical conduct. •Rules of Conduct -Minimum standards of ethical conduct stated as specific rules •Interpretations -Interpretations of the rules by the AICPA division of professional ethics •Ethical Rulings -Published explanations and answers to questions about Rules of Conduct

International Ethics Standards Board for Accountants (IESBA) Code

•The IESBA Code must be followed by auditors whenever an audit engagement is completed for a multinational client. •The importance has increased dramatically in recent years with the globalization of companies and their audits. •There are some differences between the IESBA Code and the AICPA Code of Ethics, but the codes are quite similar. •Given the increased importance of the international standards, the AICPA revised its Code of Conduct to better align (converge) the two codes.

Philosophical principles in ethics

•The Imperative Principle -focus on adherence to rules; -disregard the consequence; •The Principle of Utilitarianism -focus on producing the greater good; -What constitutes "greater good" depends on personal judgment •The Generalization Argument -Consider consequence of the decision by other people under similar situation; -What would happen if everyone else act in certain way? -If undesirable, then the action is unethical; •Virtue Ethics -Will the action help to build my character? -Will I be proud of the action?