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ACCT 742: Advanced Auditing

Professional Ethics

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What Are Ethics?

Ethics can be defined broadly as a set of moral principles or values.

Each of us has such a set of values. We may or may not have considered

them explicitly.

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Need for Ethics

Ethical behavior is necessary for a society to function in an orderly manner.

The need for ethics in society is sufficiently important that many commonly held ethical values are incorporated into laws.

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Why People Act Unethically

The person’s ethical standards are different from those of society as a whole.

The person chooses to act selfishly.

In many instances, both reasons exist.

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Ethical Dilemmas

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

behavior.

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Rationalizing Unethical Behavior

Everybody does it. If it’s legal, it’s ethical. Likelihood of discovery and

consequences

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Resolving Ethical Dilemmas

1. Obtain the relevant facts.

2. Identify the ethical issues from the facts.

3. Determine who is affected.

4. Identify the alternatives available to the person who must resolve the dilemma.

5. Identify the likely consequence of each alternative.

6. Decide the appropriate action

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Relevant Facts – An Example

A staff person has been informed that he will work hours without recording them as hours worked.

Firm policy prohibits this practice.

Another staff person has stated that this is common practice in the firm.

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Ethical Issue

Is it ethical for the staff person to work hours and not record them as hours worked in this situation?

Who is affected?

How are they affected?

What alternatives does the staff person have?

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Special Need for Ethical Conduct in Professions

Our society has attached a special meaning to the term professional.

A professional is expected to conduct himself or herself at a higher level than most other members of society.

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CPAs Encouraged to Conduct Themselves at a High Level

GAAS &Interpretations

CPAExamination

Continuingeducation

requirements

Legal Liability

Division of CPA firms

Code ofProfessional

Conduct

QualityControl

Peerreview

Conductof CPA firmpersonnel

PCAOB andSEC

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Code of Professional Conduct

PrinciplesPrinciplesIdeal standards of ethical conduct

stated in philosophical terms.They are not enforceable.

Ideal standards of ethical conductstated in philosophical terms.

They are not enforceable.

Rules ofconduct

Rules ofconduct

Minimum standards of ethicalconduct stated as specific rules.

They are enforceable.

Minimum standards of ethicalconduct stated as specific rules.

They are enforceable.

Interpretationsof the rulesof conduct

Interpretationsof the rulesof conduct

Interpretation of the rules of conduct bythe AICPA Division of Professional Ethics.

They are not enforceable, but apractitioner must justify departure.

Interpretation of the rules of conduct bythe AICPA Division of Professional Ethics.

They are not enforceable, but apractitioner must justify departure.

Ethicalrulings

Ethicalrulings

Published explanations and answers to questionsabout the rules of conduct submitted to the AICPA by

practitioners and others interested in ethicalrequirements. They are not enforceable, but a

practitioner must justify departure.

Published explanations and answers to questionsabout the rules of conduct submitted to the AICPA by

practitioners and others interested in ethicalrequirements. They are not enforceable, but a

practitioner must justify departure.

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Ethical Principles1. Responsibilities: Professionals should exercise sensitive

and moral judgments in all their activities.2. The public interest: Members should accept the

obligation to act in a way that will serve and honor the public.

3. Integrity: Members should perform all responsibilities with integrity to maintain public confidence.

4. Objectivity and independence: Members should be objective, independent, and free of conflicts of interest.

5. Due care: Members should observe the profession’s standards and strive to improve competence.

6. Scope and nature of services: A member in public practice should observe the Code of Professional Conduct.

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Standards of Conduct

Principles

Rules ofconduct

Substandardconduct

Ideal conductby practitioners

Minimum levelof conduct bypractitioners

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Independence

The value of auditing depends heavily on the public’s perception of the independence of auditors. Independence in fact Independence in appearance

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Sarbanes-Oxley Act and SEC Provisions Addressing Auditor Independence

The SEC adopted rules strengthening auditor independence in January 2003 consistent with the requirements of the Sarbanes-Oxley Act.

The Sarbanes-Oxley Act and the revised SEC rules further restrict, but do not completely eliminate the type of non-audit services that can be provided to the public.

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Sarbanes-Oxley Act and SEC Provisions Addressing Auditor Independence: Services Prohibited

1. Bookkeeping and other accounting services

2. Financial information systems design and implementation

3. Appraisal or valuation services

4. Actuarial services

5. Internal audit outsourcing

6. Management of human resource functions

7. Broker or dealer or investment adviser or investment banker services

8. Legal and expert services unrelated to the audit

9. Any other service that the PCAOB determines by regulation is impermissible

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Audit Committees An audit committee is a selected number of

members of a company’s board of directors whose responsibilities include helping auditors remain independent of management.

Most audit committees are made up of three to five or sometimes as many as seven directors who are not a part of company management.

The Sarbanes-Oxley Act requires that all members of the audit committee be independent.

Companies must disclose whether or not the audit committee includes at least one financial expert.

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Conflicts Arising from Employment Relationships

The SEC has added a one year “cooling off” period before a member of the audit engagement team can work for the client in certain key management positions.

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Partner Rotation

The Sarbanes-Oxley Act requires thatthe lead and concurring audit partnerrotate off the audit engagement after a period of five years.

The Sarbanes-Oxley Act requires thatthe lead and concurring audit partnerrotate off the audit engagement after a period of five years.

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Ownership Interests SEC rules adopted in 2000 on financial

relationships narrow the restrictions on ownership in clients to those persons who can influence the audit (covered persons and their immediate family including:

a. Members of the audit engagement teamb. Those in a position to influence the audit

engagement in the firm chain of commandc. Partners and managers who provide more than

10 hours of non-audit services to the clientd. Partners in the office of the partner primarily

responsible for the audit engagement

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Covered Members – Persons in a position to influence an attest engagement

1. Individual on the attest engagement team

2. An individual in a position to influence the attest engagement, such as individuals who supervise or evaluate the engagement partner

3. A partner or manager who provides non-attest services to the client

4. A partner in the office of the partner responsible for the attest engagement

5. The firm and its employee benefit plans

6. An entity that can be controlled by any of the covered members listed above or by two or more of the covered individuals or entities operating together

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Independence Standards Board

It was dissolved in July 2001.It was dissolved in July 2001.

ISB pronouncements and interpretationsremain enforceable unless they conflictwith the independence rulingsissued by the SEC.

ISB pronouncements and interpretationsremain enforceable unless they conflictwith the independence rulingsissued by the SEC.

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Apply the AICPA Code rules and interpretations

on independence and explain their importance.

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Rules of Conduct

Rule 101 – Independence A member in public practice shall be

independent in the performance of professional services as required by standards promulgated by bodies designated by Council.

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Financial Interests

Interpretations of Rule 101 prohibit covered members from owning any direct investments in audit clients. Direct versus indirect financial interest

Material or immaterial

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Interpretations of Rule 101: Related Financial Interests Issues

Former practitioners Normal lending procedures Financial interests and employment

of immediate and close family members

Joint investor or investee relationship with client

Director, officer, management, or employee of a company

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Litigation Between CPA Firmand Client

A lawsuit or intent to start a lawsuitbetween a CPA firm and its client is aviolation of Rule 101 for the current audit.

A lawsuit or intent to start a lawsuitbetween a CPA firm and its client is aviolation of Rule 101 for the current audit.

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Bookkeeping and Other Services

The AICPA Code permits a CPA firmto do both bookkeeping and auditingfor the same non-public client.

The AICPA Code permits a CPA firmto do both bookkeeping and auditingfor the same non-public client.

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Bookkeeping and Other Services (Non-public companies)

1. Client must accept full responsibility for the financial statements.

1. Client must accept full responsibility for the financial statements.

2. The CPA must not assume the role of employee or of management.

2. The CPA must not assume the role of employee or of management.

3. The audit must conform to GASS.3. The audit must conform to GASS.

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Bookkeeping and Other Services

The SEC does not allow audit firmsto provide bookkeeping servicesto public company audit clients.

The SEC does not allow audit firmsto provide bookkeeping servicesto public company audit clients.

Consulting and other nonaudit servicesConsulting and other nonaudit services

Unpaid feesUnpaid fees

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Understand the requirements of other rules under the AICPA

Code.

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Other Rules of Conduct

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

505 – Form of organization and name

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

505 – Form of organization and name

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Describe the enforcement

mechanisms for the rules of conduct.

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Enforcement

Action by AICPA Professional Ethics Division

Action by a state Board of Accountancy