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Professional EthicsProfessional Ethics

Chapter 4Chapter 4

Key Topics in Chapter 4Key Topics in Chapter 4

AICPA Code of Professional ConductAICPA Code of Professional Conduct Rule 101, IndependenceRule 101, Independence Rules 301, 302, 501, 503Rules 301, 302, 501, 503

Sarbanes-Oxley Act and SEC Provisions Addressing Sarbanes-Oxley Act and SEC Provisions Addressing Auditor IndependenceAuditor Independence

Special Need for Ethical Conduct Special Need for Ethical Conduct in Professionsin Professions

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

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

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

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

Trustworthiness and a strong sense of ethicsTrustworthiness and a strong sense of ethicsare assets of the CPA.are assets of the CPA.

Trustworthiness and a strong sense of ethicsTrustworthiness and a strong sense of ethicsare assets of the CPA.are assets of the CPA.

AICPA Code of Professional ConductAICPA Code of Professional Conduct

PrinciplesPrinciplesPrinciplesPrinciplesIdeal standards of ethical conductIdeal standards of ethical conduct

stated in philosophical terms.stated in philosophical terms.They are not enforceableThey are not enforceable..

Ideal standards of ethical conductIdeal standards of ethical conductstated in philosophical terms.stated in philosophical terms.

They are not enforceableThey are not enforceable..

Rules ofRules ofconductconduct

Rules ofRules ofconductconduct

Minimum standards of ethicalMinimum standards of ethicalconduct stated as specific rules.conduct stated as specific rules.

They are enforceableThey are enforceable..

Minimum standards of ethicalMinimum standards of ethicalconduct stated as specific rules.conduct stated as specific rules.

They are enforceableThey are enforceable..

InterpretationsInterpretationsof the rulesof the rulesof conductof conduct

InterpretationsInterpretationsof the rulesof the rulesof conductof conduct

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

They are not enforceable, but aThey are not enforceable, but apractitioner must justify departurepractitioner must justify departure..

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

They are not enforceable, but aThey are not enforceable, but apractitioner must justify departurepractitioner must justify departure..

AICPA Code of Professional ConductAICPA Code of Professional Conduct

EthicalEthicalrulingsrulings

EthicalEthicalrulingsrulings

Published explanations and answersPublished explanations and answersto questions about the rules ofto questions about the rules of

conduct submitted to the AICPA byconduct submitted to the AICPA bypractitioners and others interestedpractitioners and others interested

in ethical requirements.in ethical requirements.They are not enforceable, but aThey are not enforceable, but a

practitioner must justify departurepractitioner must justify departure..

Published explanations and answersPublished explanations and answersto questions about the rules ofto questions about the rules of

conduct submitted to the AICPA byconduct submitted to the AICPA bypractitioners and others interestedpractitioners and others interested

in ethical requirements.in ethical requirements.They are not enforceable, but aThey are not enforceable, but a

practitioner must justify departurepractitioner must justify departure..

Who Falls Under the AICPA Rules Who Falls Under the AICPA Rules of Conduct (Code)?of Conduct (Code)?

Technically, members of the AICPA.Technically, members of the AICPA.

However, state and federal courts have However, state and federal courts have held that all practicing CPAs must follow held that all practicing CPAs must follow ethical standards, as set forth in the ethical standards, as set forth in the Code of Professional Conduct.Code of Professional Conduct.

Standards of ConductStandards of Conduct

PrinciplesPrinciples

Rules ofRules ofconductconduct

SubstandardSubstandardconductconduct

Ideal conductIdeal conductby practitionersby practitioners

Minimum levelMinimum levelof conduct byof conduct bypractitionerspractitioners

IndependenceIndependence

The value of auditing depends heavily on the The value of auditing depends heavily on the public’s perception of the independence of auditors.public’s perception of the independence of auditors.

The value of auditing depends heavily on the The value of auditing depends heavily on the public’s perception of the independence of auditors.public’s perception of the independence of auditors.

• Independence in fact, means the member must be unbiased and objective mentally – it is a state of mind.

•Independence in in appearance means that knowledgeable users of financial statements must believe the auditor is independent – avoiding observable conflicts of interest

AICPA Rules of ConductAICPA Rules of Conduct

Rule 101 – IndependenceRule 101 – IndependenceRule 101 – IndependenceRule 101 – Independence

A member in public practice shall beA member in public practice shall beindependent in the performance ofindependent in the performance ofprofessional services as required byprofessional services as required bystandards promulgated by bodiesstandards promulgated by bodiesdesignated by Council.designated by Council.

A member in public practice shall beA member in public practice shall beindependent in the performance ofindependent in the performance ofprofessional services as required byprofessional services as required bystandards promulgated by bodiesstandards promulgated by bodiesdesignated by Council.designated by Council.

Financial InterestsFinancial Interests

Interpretations of Rule 101 prohibitInterpretations of Rule 101 prohibitcovered members from owning anycovered members from owning anydirect investments in audit clients.direct investments in audit clients.

Interpretations of Rule 101 prohibitInterpretations of Rule 101 prohibitcovered members from owning anycovered members from owning anydirect investments in audit clients.direct investments in audit clients.

Covered membersCovered membersCovered membersCovered members

Direct versus indirect financial interestDirect versus indirect financial interestDirect versus indirect financial interestDirect versus indirect financial interest

Material or immaterialMaterial or immaterialMaterial or immaterialMaterial or immaterial

Engagement Based ApproachEngagement Based Approach

Covered members are persons in a position with the Covered members are persons in a position with the potential to influence audit decisions, including:potential to influence audit decisions, including:

1.1. Individuals on engagement team.Individuals on engagement team.

2.2. Individuals who supervise or evaluate the Individuals who supervise or evaluate the engagement partner.engagement partner.

3.3. Partners who provide non-attest services to the Partners who provide non-attest services to the client.client.

4.4. Refer to p. 86 of chapter for others.Refer to p. 86 of chapter for others.

Prohibited Activities by Covered Prohibited Activities by Covered MembersMembers

Members cannot:Members cannot: Have Have a direct or a direct or material indirectmaterial indirect investment in the investment in the

audit client.audit client. Be a Be a director, officer, manager, or employeedirector, officer, manager, or employee of the of the

client.client. Participate in Participate in joint business venturesjoint business ventures with the client. with the client.

Have Have loansloans to or from the client. to or from the client.

Automobile loans and leasesAutomobile loans and leases

Collateralized loans Collateralized loans

Credit cards and cash advancesCredit cards and cash advances

Related FinancialRelated FinancialInterests IssuesInterests Issues

Former practitionersFormer practitioners Normal lending proceduresNormal lending procedures Financial interests and employmentFinancial interests and employment of immediate and close familyof immediate and close family Joint investor or investeeJoint investor or investee relationship with clientrelationship with client Director, officer, management,Director, officer, management, or employee of a companyor employee of a company

Former practitionersFormer practitioners Normal lending proceduresNormal lending procedures Financial interests and employmentFinancial interests and employment of immediate and close familyof immediate and close family Joint investor or investeeJoint investor or investee relationship with clientrelationship with client Director, officer, management,Director, officer, management, or employee of a companyor employee of a company

Litigation Between CPA FirmLitigation Between CPA Firmand Clientand Client

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

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

BookkeepingBookkeeping

The AICPA The AICPA CodeCode permits a CPA firmpermits a CPA firmto do both bookkeeping and auditingto do both bookkeeping and auditingfor the same client.for the same client.

• See p. 89.See p. 89.• Note that SOX takes a differentNote that SOX takes a different position with publicly traded (SEC)position with publicly traded (SEC) clients, p. 83.clients, p. 83.

The AICPA The AICPA CodeCode permits a CPA firmpermits a CPA firmto do both bookkeeping and auditingto do both bookkeeping and auditingfor the same client.for the same client.

• See p. 89.See p. 89.• Note that SOX takes a differentNote that SOX takes a different position with publicly traded (SEC)position with publicly traded (SEC) clients, p. 83.clients, p. 83.

Other Services and Unpaid FeesOther Services and Unpaid Fees

Consulting and other nonaudit servicesConsulting and other nonaudit services• Must avoid performing management functionsMust avoid performing management functions

Note that SOX takes a differentNote that SOX takes a different position with publicly traded (SEC)position with publicly traded (SEC) clients, p. 83clients, p. 83

Consulting and other nonaudit servicesConsulting and other nonaudit services• Must avoid performing management functionsMust avoid performing management functions

Note that SOX takes a differentNote that SOX takes a different position with publicly traded (SEC)position with publicly traded (SEC) clients, p. 83clients, p. 83

Unpaid feesUnpaid fees• Can cause a conflict of interest if theyCan cause a conflict of interest if they relate to professional services providedrelate to professional services provided more than one year prior to the date ofmore than one year prior to the date of

the reportthe report

Unpaid feesUnpaid fees• Can cause a conflict of interest if theyCan cause a conflict of interest if they relate to professional services providedrelate to professional services provided more than one year prior to the date ofmore than one year prior to the date of

the reportthe report

Rule 301 – Confidential client informationRule 301 – Confidential client information

Generally, a member may not disclose any Generally, a member may not disclose any confidential client information without the confidential client information without the specific consent of the client.specific consent of the client.

Exceptions:Exceptions: Obligations related to technical standardsObligations related to technical standards Subpoena or summonsSubpoena or summons Peer reviewPeer review Response to ethics divisionResponse to ethics division

Rule 302 – Contingent feesRule 302 – Contingent fees

Contingent fees for any professional services are Contingent fees for any professional services are generally prohibited whengenerally prohibited when

(1) a member (or firm) performs:(1) a member (or firm) performs:(a)(a) an audit or review of financial statements; oran audit or review of financial statements; or

(b)(b) a compilation of a financial statement a compilation of a financial statement (see text)(see text) (c)(c) an examination of prospective financial an examination of prospective financial information; orinformation; or

(2) Prepare an original or amended tax return or claim for (2) Prepare an original or amended tax return or claim for a tax refund for a contingent fee for any client.a tax refund for a contingent fee for any client.

Rule 501 – Acts discreditableRule 501 – Acts discreditable

A member shall not commit an act discreditable to the profession, including:

Retention of client records.Retention of client records. Discrimination and harassment in employment practices.Discrimination and harassment in employment practices. Failure to follow standards and/or procedures or other Failure to follow standards and/or procedures or other

requirements in governmental audits.requirements in governmental audits. Negligence in the preparation of financial statements or records.Negligence in the preparation of financial statements or records. Failure to follow requirements of governmental bodies, Failure to follow requirements of governmental bodies,

commissions, or other regulatory agencies in performing attest or commissions, or other regulatory agencies in performing attest or similar services.similar services.

Solicitation or disclosure of CPA examination questions and Solicitation or disclosure of CPA examination questions and answers.answers.

Failure to file tax return or pay tax liability.Failure to file tax return or pay tax liability.

Rule 503 – Commissions and referral feesRule 503 – Commissions and referral fees

Commissions are not allowed when a member or the Commissions are not allowed when a member or the member's firm also performs for that client:member's firm also performs for that client: An audit or review of financial statements; orAn audit or review of financial statements; or A compilation of a financial statement (see text) ; orA compilation of a financial statement (see text) ; or An examination of prospective financial information.An examination of prospective financial information.

Disclosure of permitted commissions or referral fees.Disclosure of permitted commissions or referral fees.

Other AICPA Rules of ConductOther AICPA Rules of Conduct

102 – Integrity and objectivity102 – Integrity and objectivity201 – General standards201 – General standards202 – Compliance with standards202 – Compliance with standards203 – Accounting principles203 – Accounting principles502 – Advertising and other forms502 – Advertising and other forms

of solicitationof solicitation505 – Form of organization and name505 – Form of organization and name

102 – Integrity and objectivity102 – Integrity and objectivity201 – General standards201 – General standards202 – Compliance with standards202 – Compliance with standards203 – Accounting principles203 – Accounting principles502 – Advertising and other forms502 – Advertising and other forms

of solicitationof solicitation505 – Form of organization and name505 – Form of organization and name

Enforcement mechanisms for the Enforcement mechanisms for the rules of conductrules of conduct

Action by AICPA:Action by AICPA:• Remedial or corrective actionRemedial or corrective action• Expulsion and notification to that effect inExpulsion and notification to that effect in the the CPA NewsletterCPA Newsletter

Action by AICPA:Action by AICPA:• Remedial or corrective actionRemedial or corrective action• Expulsion and notification to that effect inExpulsion and notification to that effect in the the CPA NewsletterCPA Newsletter

Action by a state Board of Accountancy:Action by a state Board of Accountancy:• Varies by state, but license may be Varies by state, but license may be revoked. revoked.

Action by a state Board of Accountancy:Action by a state Board of Accountancy:• Varies by state, but license may be Varies by state, but license may be revoked. revoked.

Sarbanes-Oxley Act and SEC Sarbanes-Oxley Act and SEC Provisions Addressing Auditor Provisions Addressing Auditor IndependenceIndependence

The SEC adopted rules strengthening auditorThe SEC adopted rules strengthening auditorindependence in January 2003 Consistent withindependence in January 2003 Consistent withthe requirements of the Sarbanes-Oxley Act.the requirements of the Sarbanes-Oxley Act.

The SEC adopted rules strengthening auditorThe SEC adopted rules strengthening auditorindependence in January 2003 Consistent withindependence in January 2003 Consistent withthe requirements of the Sarbanes-Oxley Act.the requirements of the Sarbanes-Oxley Act.

The Sarbanes-Oxley Act and the revised SECThe Sarbanes-Oxley Act and the revised SECrules further restrict, but do not completelyrules further restrict, but do not completelyeliminate the type of nonaudit serviceseliminate the type of nonaudit servicesthat can be provided to the public.that can be provided to the public.

The Sarbanes-Oxley Act and the revised SECThe Sarbanes-Oxley Act and the revised SECrules further restrict, but do not completelyrules further restrict, but do not completelyeliminate the type of nonaudit serviceseliminate the type of nonaudit servicesthat can be provided to the public.that can be provided to the public.

Who Falls Under the SEC Provisions Who Falls Under the SEC Provisions for Auditor Independence?for Auditor Independence?

Auditors of publicly traded Auditors of publicly traded companies.companies.

Sarbanes-Oxley Act and SEC Sarbanes-Oxley Act and SEC Provisions Addressing Auditor Provisions Addressing Auditor IndependenceIndependence

1. Bookkeeping and other accounting services1. Bookkeeping and other accounting services2. Financial information systems design and implementation2. Financial information systems design and implementation3. Appraisal or valuation services3. Appraisal or valuation services4. Actuarial services4. Actuarial services5. Internal audit outsourcing5. Internal audit outsourcing6. Management of human resource functions6. Management of human resource functions7. Broker or dealer or investment adviser7. Broker or dealer or investment adviser or investment banker servicesor investment banker services8. Legal and expert services unrelated to the audit8. Legal and expert services unrelated to the audit9. Any other service that the PCAOB determines9. Any other service that the PCAOB determines by regulation is impermissibleby regulation is impermissible

1. Bookkeeping and other accounting services1. Bookkeeping and other accounting services2. Financial information systems design and implementation2. Financial information systems design and implementation3. Appraisal or valuation services3. Appraisal or valuation services4. Actuarial services4. Actuarial services5. Internal audit outsourcing5. Internal audit outsourcing6. Management of human resource functions6. Management of human resource functions7. Broker or dealer or investment adviser7. Broker or dealer or investment adviser or investment banker servicesor investment banker services8. Legal and expert services unrelated to the audit8. Legal and expert services unrelated to the audit9. Any other service that the PCAOB determines9. Any other service that the PCAOB determines by regulation is impermissibleby regulation is impermissible

Prohibited ServicesProhibited Services

Audit CommitteesAudit Committees

An audit committee is a selected numberAn audit committee is a selected numberof members of a company’s board of directorsof members of a company’s board of directorswhose responsibilities include helpingwhose responsibilities include helpingauditors remain independent of management.auditors remain independent of management.Duties include:Duties include:

• Pre-approval of all audit and nonaudit servicesPre-approval of all audit and nonaudit services• Oversight of auditors workOversight of auditors work• Resolution of disagreements between managementResolution of disagreements between management and auditorsand auditors

An audit committee is a selected numberAn audit committee is a selected numberof members of a company’s board of directorsof members of a company’s board of directorswhose responsibilities include helpingwhose responsibilities include helpingauditors remain independent of management.auditors remain independent of management.Duties include:Duties include:

• Pre-approval of all audit and nonaudit servicesPre-approval of all audit and nonaudit services• Oversight of auditors workOversight of auditors work• Resolution of disagreements between managementResolution of disagreements between management and auditorsand auditors

Audit CommitteesAudit Committees

The Sarbanes-Oxley Act requires that allThe Sarbanes-Oxley Act requires that allmembers of the audit committeemembers of the audit committeebe independent.be independent.

The Sarbanes-Oxley Act requires that allThe Sarbanes-Oxley Act requires that allmembers of the audit committeemembers of the audit committeebe independent.be independent.

Companies must disclose whether or notCompanies must disclose whether or notthe audit committee includes at leastthe audit committee includes at leastone financial expert.one financial expert.

Companies must disclose whether or notCompanies must disclose whether or notthe audit committee includes at leastthe audit committee includes at leastone financial expert.one financial expert.

Conflicts Arising from Conflicts Arising from Employment RelationshipsEmployment Relationships

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

• Chief Executive OfficerChief Executive Officer• Chief Financial OfficerChief Financial Officer• Chief Accounting OfficerChief Accounting Officer• Equivalent positions to the aboveEquivalent positions to the above

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

• Chief Executive OfficerChief Executive Officer• Chief Financial OfficerChief Financial Officer• Chief Accounting OfficerChief Accounting Officer• Equivalent positions to the aboveEquivalent positions to the above

Partner RotationPartner Rotation

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

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

Ownership InterestsOwnership Interests

SEC rules adopted in 2000 on financialSEC rules adopted in 2000 on financialrelationships narrow the restrictions onrelationships narrow the restrictions onownership in clients to those personsownership in clients to those personswho can influence the audit.who can influence the audit.

• Members of the engagement teamMembers of the engagement team• Those in a position to influence audit Those in a position to influence audit engagementengagement• Partners and managers providing Partners and managers providing

>10 hrs of non-audit svcs. to client>10 hrs of non-audit svcs. to client• Partners in the office of the partner Partners in the office of the partner primarily responsible for engagementprimarily responsible for engagement

SEC rules adopted in 2000 on financialSEC rules adopted in 2000 on financialrelationships narrow the restrictions onrelationships narrow the restrictions onownership in clients to those personsownership in clients to those personswho can influence the audit.who can influence the audit.

• Members of the engagement teamMembers of the engagement team• Those in a position to influence audit Those in a position to influence audit engagementengagement• Partners and managers providing Partners and managers providing

>10 hrs of non-audit svcs. to client>10 hrs of non-audit svcs. to client• Partners in the office of the partner Partners in the office of the partner primarily responsible for engagementprimarily responsible for engagement