Members should use the aicpa conceptual framework for independence to

Chapter 03

Professional

Ethics

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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

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Ethical Dilemma

Gary Watson, a graduating business student at a small college, is currently interviewing for a job. Gary was invited by both Tilly Manufacturing Co. and Watson Supply Company to travel to a nearby city for an interview. Both companies have offered to pay Gary’s expenses. His total expenses for the trip were $96 for mileage on his car and $45 for meals. As he prepares the letters requesting reimbursement, he is considering asking for the total amount of the expenses from both employers. His rationale is that if he had taken separate trips, each employer would have had to pay that amount.

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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

Minimum standards for education and experience

Need for public confidence

CPA product is credibility

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Code of Professional Conduct

Designed to provide CPAs guidance and rules in the performance of professional responsibilities

Code consists of

Principles

Rules

Interpretations

Other guidance (definitions, pending revisions, etc.)

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AICPA Code of Professional Conduct Figure 3.1

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AICPA Code of Professional Conduct Figure 3.2

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Conceptual Frameworks

Purpose—Address situations not directly included in the Code of Professional Conduct

Overall approach—Consider the threats to compliance with requirements and available safeguards

Code includes 3 conceptual frameworks

For CPAs in public practice

1. Threats to code compliance

2. Threats to independence

CPAs in business

3. Threats to code compliance

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Conceptual Framework Threats

Adverse Interest—client litigation against CPA

Advocacy Threat—CPA endorses a client product

Familiarity—CPA’s close friend employed by client

Management Participation—CPA authorizes a client transaction

Self-Interest—CPA has financial interest in client

Self-Review—CPA makes accounting decisions for client

Undue Influence—CPA and firm threatened with dismissal from an engagement

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Conceptual Framework Safeguards

Created by profession, legislation, or regulation—continuing education requirements for independence and ethics

Implemented by the client—client tone at the top

Implemented by the firm—policies and procedures designed to implement and monitor engagement quality control

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Conceptual Framework Figure 3.5

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Principles of the Code

Responsibilities

The Public Interest

Integrity

Objectivity and Independence

Due Care

Scope and Nature of Services

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The Rules of the AICPA Code of Professional Conduct

RULES*

Independence

Integrity and Objectivity

General Standards

Compliance with Standards

Accounting Principles

Acts Discreditable

Contingent Fees

Commissions and Referral Fees

Advertising and Other Forms of Solicitation

Confidential Client Information

Form of Organization and Name

* In order discussed in text (Integrity and Objectivity precedes independence in Code).

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Independence

Independence of mind (actual independence)

Independence of appearance

Both are required

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AICPA Conceptual Framework for Independence

The AICPA Conceptual Framework for Independence is used to evaluate threats to independence. As with the earlier presented framework for the code, 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 lack of independence exists

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Threats to Independence

Adverse Interest— Litigation between client and CPA firm

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

Familiarity—Spouse holds a key position with client

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

Management Participation—CPA Serves as officer of client

Self-Review—CPA firm has provided consulting services that relate to financial statements

Undue Influence--Pressure from client to reduce audit procedures

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Independence Safeguards

Created by profession, legislation, or regulation—continuing education requirements

Implemented by attest client—effective board of director oversight

Implemented by CPA firm—stressing importance of independence in training programs

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Summary of Conceptual Framework Approach for Evaluating Threats to Independence Figure 3.7

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Individual vs. Firm Independence and Covered Members

Individual vs. Firm Independence

Not all individuals must be independent

The firm must be independent to perform attest services

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

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Independence Requirements for All Partners and Staff

No partner or professional employee may own more than 5% of attest client’s outstanding equity securities

Combination of all such persons may not own more than 5%

No partner or professional employee may be a director, officer, employee, promoter, trustee, etc. of a client

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Additional Independence Requirements for Covered Members

All direct financial interests are prohibited, regardless of amount

Material indirect financial interests are prohibited

Gifts from clients or management may impair independence

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Additional Financial Interest Independence Requirements for Covered Members

Direct Financial Interest Indirect Financial Interest
Example Investment in client, such as owning capital stock or providing a loan Investment in a mutual fund, which in turns owns capital stock of a client
Type allowed for individual CPA to retain independence None Immaterial
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Effects of CPA Relationships on Firm Independence Figure 3.9

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Effects of Interests of Family Members, Relatives and Friends Figure* 3.10

*Summary omits consideration of certain detailed factors that may affect independence. Consult independence rule and its interpretations for a detailed consideration of the effect on independence of family members and relatives.

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Key Position

An individual that

Has primary responsibility for significant accounting functions that support material components of the financial statements;

Has primary responsibility for the preparation of the financial statements; or

Has the ability to exercise influence over the contents of the financial statements, including being a member of the board, 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,

etc.

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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

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Integrity and Objectivity Rule

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

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General Standards Rule

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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Compliance with Standards Rule

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Accounting Principles Rule

Accounting Principles

Designates GAAP

The Statements and Interpretations of

FASB

GASB

FASAB

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Acts Discreditable Rule

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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Contingent Fees Rule

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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Commissions/Referral Fees and Advertising Rules

Commissions and Referral Fees Rule

As is the situation with contingent fees, such fees are only allowed for a nonattest client

Allowable commissions received must be disclosed to the client

Advertising Rule

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

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Confidential Client Information Rule

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

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Form of Organization Rule

Form of Organization and Name

Can practice in any legal business form

Allows fictitious names as long as not false, misleading, or deceptive, e.g., a sole proprietor practicing in a partnership name

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Alternative Practice Structures Figure 3.13

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Code of Professional Conduct: Applicability to Members in Business and Others

Members in business applicable rules

Integrity and Objectivity

General Standards

Compliance with Standards

Accounting Principles

Acts Discreditable

Others (primarily retired CPAs) applicable rule

Acts Discreditable

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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 1/4

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 2/4

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 3/4

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 4/4

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.