Professional Ethics

Chapter 03

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

3-2

Steps in Resolving an Ethical Dilemma

Identify the problem

Identify possible courses of action

Identify any constraints relating to the

decision

Analyze the likely effects of the possible

courses of action

Select the best course of action

3-3

Need for Professional Ethics

Responsibility to serve the public

CPA is representative of the public

Complex body of knowledge

Abundance of authoritative pronouncements

Standards of Admission to the Profession

Min. standards for education and experience

Need for public confidence

CPA product is credibility

3-4

Code of Professional Conduct

Designed to provide a framework for

expanding professional services and

responding to changes in the profession

Two sections

Principles

Rules

Additional guidance

Interpretations

Ethics Rulings

3-5

AICPA Professional Ethics

3-6

Principles of the Code

Responsibilities

The Public Interest

Integrity

Objectivity and Independence

Due Care

Scope and Nature of Services

3-7

The Rules of the AICPA Code of

Professional Conduct

Rule Title

101 Independence

102 Integrity and Objectivity

201 General Standards

202 Compliance with Standards

203 Accounting Principles

301 Confidential Client Information

302 Contingent Fees

501 Acts Discreditable

502 Advertising and Other Forms of Solicitation

503 Commissions and Referral Fees

504 (Deleted)

505 Form of Organization and Name

3-8

Independence

Independence of mind (actual

independence)

Independence of appearance

Both are required.

3-9

AICPA Conceptual Framework

for Independence The AICPA Conceptual Framework for

Independence is used to evaluate threats to independence. When a threat arises, the approach considers Whether the Code directly addresses the threat

If the Code does not directly address the threat, the auditor considers whether adequate safeguards exist to eliminate the threat to independence

The perspective used throughout is whether a reasonable person, aware of all the relevant facts would conclude that an unacceptable risk of non-independence exists.

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Threats to Independence

(and an example of each) CPA financial and other personal matters

Financial Self-Interest of CPA—CPA owns stock in the client

Adverse Interest— Litigation between client and CPA firm

Undue Influence--Pressure from client to reduce audit procedures

Interests of relatives and friends Familiarity—Spouse holds a key position with client

CPA Performance of nonattest services Self-Review—CPA firm has provided consulting services that

relate to audit

Advocacy of client—CPA promotes client securities as part of an initial public offering

Management Participation—CPA Serves as officer of client

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Independence Safeguards

Created by profession, legislation or

regulation (e.g., education requirements)

Implemented by attest client (e.g.,

effective board of director oversight)

Put in place by CPA firm (e.g., stressing

importance of independence)

3-12

Summary of Conceptual Framework Approach for

Evaluating Threats to Independence (Figure 3.4)

3-13

Covered Members Interpretation 1 of Rule 101 is particularly important for

understanding independence. It relies in part on the concept of a ―covered member.‖

Covered Members include

Staff working on the attest engagement

An individual who may influence the attest engagement

A partner in the office in which the partner in charge of the attest engagement primarily practices

Partners or managers that provide a specified amount of nonattest services to client

The public accounting firm and its employee benefit plan

Any entity controlled by one or more of the above

3-14

Interpretation 101-1 States That

Independence is Impaired if a Member:

A.

Section Has direct or material indirect financial

interest, loan, or joint business invest-

ment; trustee or administrator of estate

or trust that has such interest

Applies to:

Covered Members

B. Owns 5% or more of client’s outstanding

equity or other ownership interest

All Partners and

Professional Staff

C. Simultaneously associated with client as

director, officer, employee, etc.

All Partners and

Professional Staff

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Financial Interests from

Interpretation 101-1

Direct Indirect

Example Investment in client,

such as owning

capital stock or

providing a loan

Investment in a

mutual fund, which

in turns owns

capital tock of a

client

Type allowed

for individual

CPA to retain

independence

None

Immaterial

3-16

Figure 3.5 – The effects of partner and professional staff

relationships on firm independence*

3-17

Figure 3.6 Effects of Interests of Family Members,

Relatives and Friends

3-18

Consulting Services Prohibited by

the Sarbanes-Oxley Act

Bookkeeping

Financial systems design and Implementation

Appraisal or valuation services

Actuarial services

Internal audit outsourcing

Management functions or human resource services

Investment services

Legal services and expert services

Certain tax services

3-19

Rule 102

Rule 102 – Integrity and Objectivity

Applies to all members of the AICPA and to all

services provided by CPAs

Violations • Makes, or permits or directs another to make, materially

incorrect entries in a client’s financial statements or records

• Fails to correct financial statements that are materially false

or misleading when member has such authority

• Signs, or permits or directs another to sign, a document

containing materially false and misleading information

3-20

Rule 201

Rule 201 – General Standards

Apply to all CPA services

Member shall comply with following

standards:

• Professional competence

• Due Professional Care

• Planning and Supervision

• Sufficient Relevant Data

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Rule 202 Standards

Technical Body Auditing Standards Board

(ASB)

Management Consulting

Services Executive

Committee (MCSEC)

Accounting and Review

Services Committee (ARSC)

ASB, MCSEC, and ARSC

FASB, GASB and FASAC

Standards Statements on Auditing

Standards

Statements on Standards for Consulting Services

Statements on Standards for Accounting and Review Services

Statements on Standards for Attestation Engagements

FASB, GASB and FASAC Statements and related Interpretations

3-22

Rule 203

Accounting Principles

Designates GAAP

The Statements and Interpretations of

• FASB

• GASB

• FASAB

3-23

Rule 301

Confidential Client Information

A member in public practice shall not disclose

any confidential client information without the

specific consent of the client.

Auditors cannot directly disclose illegal acts

by the client unless they have a legal duty to

do so

Confidential but not privileged

communications with client

3-24

Rule 302 –

Allowable Contingent Fees

Allowable for clients for which the CPA provides none of the following services: An audit or review of financial statements

A compilation of financial statements expected to be used by a third party and does not disclose a lack of independence

An examination of prospective financial information

Contingent fees are not allowed to prepare an original or amended tax return or claim for tax refund (Note: All tax contingent fees are prohibited under PCAOB Standards)

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Rule 501 Retaining client records may be considered an

act discreditable to the profession

Rules: Client prepared records—should always be returned to the

client.

Client records prepared by the CPA (e.g. payroll records)—should be provided to client, except they may be withheld if they are incomplete or fees are due for them.

Supporting records (e.g., adjusting entries)—should be provided to client, but may be withheld if fees are due for them.

CPA working papers (e.g., audit programs)—CPA’s property and need not be provided to client , unless required by law.

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Rules 502, 503, 505

Rule 502 – Advertising

May advertise as long as it is not false, misleading or

deceptive

Rule 503 – Commissions

Allowable commissions received must be disclosed to

the client

Rule 505 – Form of Organization & Name

Can practice in any legal business form

Allows fictitious names as long as not false,

misleading or deceptive

3-27

Figure 3.9 –

Alternative Practice Structures

3-28

IIA Code of Ethics--Principles

Internal auditors are expected to apply & uphold the following principles:

Integrity. The integrity of internal auditors establishes trust and thus provides the basis for reliance on their judgment.

Objectivity. Internal auditors exhibit the highest level of professional objectivity in gathering, evaluating, and communi- cating information about the activity or process being examined. Internal auditors make a balanced assessment of all the relevant circumstances and are not unduly influenced by their own interests or by others in forming judgments.

Confidentiality. Internal auditors respect the value and ownership of information they receive and do not disclose information without appropriate authority unless there is a legal or professional obliga- tion to do so.

Competency. Internal auditors apply the knowledge, skills, and experience needed in the performance of internal auditing services.

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IIA Code of Ethics—

Rules of Conduct

1. Integrity; Internal auditors:

1. Shall perform their work with honesty, diligence, and responsibility.

2. Shall observe the law and make disclosures expected by the law and the profession.

3. Shall not knowingly be a party to any illegal activity, or engage in acts that are discreditable to the profession of internal auditing or to the organization.

4. Shall respect and contribute to the legitimate and ethical objectives of the organization.

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IIA Code of Ethics—

Rules of Conduct

2. Objectivity; Internal Auditors:

1. Shall not participate in any activity or relationship that may impair or be presumed to impair their unbiased assessment. This participation includes those activities or relationships that may be in conflict with the interests of the organization.

2. Shall not accept anything that may impair or be presumed to impair their professional judgment.

3. Shall disclose all material facts known to them that, if not disclosed, may distort the reporting of activities under review.

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IIA Code of Ethics—

Rules of Conduct

3. Confidentiality; Internal auditors:

1. Shall be prudent in the use and protection of information acquired in the course of their duties.

2. Shall not use information for any personal gain or in any manner that would be contrary to the law or detrimental to the legitimate and ethical objectives of the organization.

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IIA Code of Ethics—

Rules of Conduct

4. Competency; Internal auditors

1. Shall engage only in those services for which they have the necessary knowledge, skills, and experience.

2. Shall perform internal auditing services in accordance with the Standards for the Professional Practice of Internal Auditing.

3. Shall continually improve their proficiency and the effectiveness and quality of their services.