AUDITINGCHAPTER 4Professional EthicsByDavid N. Ricchiute

GBW 8th ed., Ch. 42

TOPICSGeneral, professional ethics & collapse of Enron, AndersenAICPA Code of Professional ConductAICPA Rules of Conduct; SEC Independence RulesEthics enforcementPCAOB rules & AICPA practice monitoring system

GBW 8th ed., Ch. 43

GENERAL, PROFESSIONAL ETHICS

General ethics Study of ideal conduct, behaviorProfessional ethics Applies general ethics to choices,

consequences of a profession Does not, cannot require ideal

standards Enforces minimum standards

GBW 8th ed., Ch. 44

ETHICAL REASONINGOpinion

Personal opinion absent self interest; neither right nor wrong

“What do I think?”Self-interest

“What’s in it for me?”Consequence

“What’s in it for everyoneDuty

“What is my duty?”Character

“How will this reflect on me?”

GBW 8th ed., Ch. 45

ENRON, ANDERSEN FACTS

Enron Once ranked 7th on Fortune 500 Thousands of investors, retirees who

invested heavily in Enron lost millionsAndersen Big 5 auditor at the time

GBW 8th ed., Ch. 46

ENRONQuestionable Accounting

Deducting notes received for common stock from equityReporting inflated values for broadband assets & content-service businessesSpecial purpose entities (SPE) Enron off-loaded debt to SPEs Enron recorded gains on sales to SPEs

because not consolidated Chewco, with <3% at risk not consolidated

when should have been

GBW 8th ed., Ch. 47

ENRON QUOTEI am incredibly nervous that we will implode

in a wave of accounting scandals. My 8 years of Enron work history will be worth nothing on my resume, the business world will consider the past successes as nothing but an elaborate accounting hoax.

What form of ethical reasoning is this?

New York Times, 1/16/02, p. A6.

GBW 8th ed., Ch. 48

ANDERSENQuestionable Auditing

Did not issue qualified opinion for unconsolidated Enron subsidiary, Chewco

GBW 8th ed., Ch. 49

ANDERSEN QUOTEI have not spoken to the Practice Director. I do

not know if he knows how much we cannot support this. Where do we go from here? This is a big item and the team apparently does not want to go back to the client on this.

What form of ethical reasoning did the team use?

http://energycommerce.house.gov/107/News/04022002_527.htm

GBW 8th ed., Ch. 410

1980’S CONSULTING, AUDITING

Conflict Independence, objectivitySolutions Code Professional Conduct applies to

all professional activities Mandatory quality assurance program

GBW 8th ed., Ch. 411

21st CENTURY CONSULTING & AUDITING:

SEC concerns “Consulting . . . May shorten

distance between auditor, management”

Big 5 clients paying more for consulting than auditing

POB concerns Ratio accounting, auditing revenues

to consulting revenues dropping to 1.5:1

GBW 8th ed., Ch. 412

ETHICS VULNERABILITY RISK ASSESSMENTAssessment of risks bearing on

corporate ethicsSexual harassmentEnvironmental contaminationAntitrust infractionsImproper foreign paymentsFraudulent financial reporting

GBW 8th ed., Ch. 413

AICPA CODE OF PROFESSIONAL CONDUCT

Principles Framework for Rules of Conduct UnenforceableRules of Conduct Govern performance AICPA members

GBW 8th ed., Ch. 414

PRINCIPLES OF PROFESSIONAL CONDUCT 1

Responsibilities Use moral judgmentPublic interest Honor public trustIntegrity

GBW 8th ed., Ch. 415

PRINCIPLES OF PROFESSIONAL CONDUCT 2

Objectivity, independence Free of conflicts of interest Independence in fact & appearance

when auditingDue care Observe technical, ethical standards &

improveScope, nature of services Observe Code Professional Conduct

GBW 8th ed., Ch. 416

INTERPRETATIONS & ETHICS RULINGS

Interpret scope, applicability of Rules of ConductSummarize applicability of Rules of Conduct, Interpretations to detailed fact situations

GBW 8th ed., Ch. 417

AICPA RULES OF CONDUCT: Independence (101)

Applies to all practicing CPAs in audit, attest servicesAICPA interpretations affecting independence Litigation or intent to litigate by

management for deficiencies in work Litigation by auditor for fraud, deceit Other material litigation

GBW 8th ed., Ch. 418

SEC’s AUDITOR INDEPENDENCE ISSUESWhether a relationship or service Is prohibited by Sarbanes-Oxley Involves client who has hired former auditor

within 1 year Violates mandatory partner 5-year rotation

rule Audit committee pre-approval of services rule Compensates audit partner for

non-audit/attest services Fees not disclosed if for services

GBW 8th ed., Ch. 419

SEC FINANCIAL INDEPENDENCE RULES

No direct or material indirect financial relationshipJoint, material closely held business investment with clientLoan from client out of ordinary course of businessInvestment > 5% client’s equity securitiesNo business relationshipNo bookkeepingNo operating, supervising client’s information system

GBW 8th ed., Ch. 420

SEC OTHER INDEPENDENCE RULES

Not supplying actuarial advisory services for policy reservesNot supplying more than 40% internal audit hoursNo management functions or decision makingNo human resources or broker-dealer functionsNo legal services

GBW 8th ed., Ch. 421

AICPA RULES OF CONDUCT: Integrity, Objectivity (102)

In any service, AICPA member shall Be free of conflicts of interest

andShall not knowingly Misrepresent facts Subordinate judgment

GBW 8th ed., Ch. 422

AICPA RULES OF CONDUCT: General Standards (201)

AICPA member shall comply with standards for Professional competence Due professional care Planning & supervision Obtaining sufficient relevant data

GBW 8th ed., Ch. 423

AICPA RULES OF CONDUCT: Compliance, Principles (202, 203)

AICPA member shall Comply with standards promulgated by

designated bodiesAICPA member shall not, if false Express opinion in conformity with GAAP State unaware of material modifications

necessary to conform to GAAPIf GAAP misleading, AICPA member can describe necessary departure

GBW 8th ed., Ch. 424

GAAP HIERARCHYFASB Statements, APB opinions, ARB’sFASB Technical Bulletins, AICPA accounting, auditing guides, AICPA Statements of PositionAICPA accounting standards & practice bulletinsAICPA accounting interpretations, FASB implementation guides

GBW 8th ed., Ch. 425

AICPA RULES OF CONDUCT: Confidentiality (301)

AICPA member shall not Disclose confidential client

information without specific consent of client except under law or disciplinary body

GBW 8th ed., Ch. 426

AICPA RULES OF CONDUCT:Contingent Fees (302)

AICPA member shall not Perform any service for a contingent

fee for any audit, review or compilation client

Prepare tax return for contingent fee

GBW 8th ed., Ch. 427

AICPA RULES OF CONDUCT: Acts Discreditable (501)

3 Interpretations Working papers are accountant’s

property No discrimination based on race, color,

sex, age, national origin in hiring, promotion, salary, other employment practices

Nondisclosure CPA exam questions, solutions after May 1996

GBW 8th ed., Ch. 428

AICPA RULES OF CONDUCT: Advertising, Soliciting (502)

AICPA member shall not Obtain clients by false, misleading,

deceptive advertising Use coercion, overreaching, harassing

conduct in solicitation

GBW 8th ed., Ch. 429

AICPA RULES OF CONDUCT: Commissions, Referral Fees (503)

Prohibited commissions Audit, review Compilation Examination prospective statementsMust disclose permitted commissions & referral fees

GBW 8th ed., Ch. 430

AICPA RULES OF CONDUCT: Form of Practice, Name (505)

Form of organization must be permitted by state lawName shall not be misleadingMay not designate itself as “Members of AICPA” unless all partners, shareholders are members of institute

GBW 8th ed., Ch. 431

MOINTORING PUBLIC ACCOUNTING FIRMS

For all firms Quality control

Internal policies, procedures designed to assure consistent performance across engagements

Firms that audit public companies PCAOB Rules for Inspection & AICPA Center

for Public Company Audit FirmsFirms without public audit clients Peer review

AICPA Peer Review Program

GBW 8th ed., Ch. 432

ELEMENTS OF QUALITY CONTROL POLICIES

Independence, integrity, objectivityPersonnel managementAcceptance, continuance of clientsEngagement performanceMonitoring

GBW 8th ed., Ch. 433

PCAOB RULES Under authority of Sarbanes-OxleyRegular inspections Annually for firms auditing more than

100 public companiesSpecial inspections Every 3 years for firms whose public

audit clients number between 1 and 100

GBW 8th ed., Ch. 434

JOINT ETHICS ENFORCEMENT

3 Organizations enforce ethical conduct AICPA State societies of CPAs State boards of accountancyPenalties include Suspension Expulsion License revocation