Chapter 3

The Auditor’s Role in Society

Learning Objectives

1. Describe the contributions audit services make to society and

relationships among auditors, audit clients and the public.

2. Describe the different inputs to and influences on personal

ethics and morals.

3. Understand the role and contributions of professionals in

society.

4. Recognize the potential for ethical considerations and outcomes

in decisions and the decision-making models applicable to

ethical decisions.

5. Become familiar with external regulation and professional

standards governing the accounting profession’s conduct and

quality control.

Auditors as Professionals

Professionals

Make a living by providing services to others

Recipients of professional services have to trust the

professional because they do not have the knowledge

that would be needed to monitor the quality of work

Auditors

Are different from most professionals because their

services benefit the public but their compensation for

the services does not come from the public

Constituents of Auditors’ Services

The public and capital markets are the ultimate

beneficiaries

As owners of the company being audited, the

shareholder group is actually the client

The shareholders elect the Board of Directors to

oversee the company for them

As a committee of the Board of Directors, the Audit

Committee is a subset of the board of directors

The Audit Committee selects and hires the auditors,

oversees the auditor’s compensation, and interacts with

the auditors

Examples of Different Philosophies

What is right? It depends on the philosophical

underpinning…

Whatever creates the greatest good

Whatever is fundamentally “right,” regardless of

consequences

Whatever preserves the life of even one person

The decision made by a single ruler with ultimate

authority

The decision made by the group of people affected

Whatever the law requires

Theory of Moral Development

Pre-conventional level: completely self-

centered decisions

Conventional level: considers impacts

beyond personal consequences;

considers others

Post-conventional level: abstract

analysis of right and wrong

Food for thought

Accountants and auditors must behave at a

conventional level when performing their work. If

they were to behave in a post-conventional manner

they would apply abstract analysis and decide that

their preferences were “right.” If accountants and

auditors used personal preferences instead of

following the standards set according to due

process, financial statements would lose

comparability.

Ethical Orientation

Ethic of Rights

Business

Laws

Courts

United States culture

Ethic of Care

Family

Sports teams

Military

Pacific Rim and other cultures

Sociology of Professions

Entry and membership in the group

Regulation

Self regulation

Coordination with authorities

Individual characteristics

Taxonomic description

Technical expertise

Integrity

Believe their work is of value, important

Believe they make a contribution through their work

Social contract

Auditing is a Profession

A profession is an occupational group of individuals with a

collective identity

Body of knowledge: accounting and auditing

Community of peers: AICPA and other groups

Entry and Membership: CPA exam, continuing education

Regulation of the group: AICPA is internal; SEC, PCAOB, states

and courts are external

Individual Characteristics: competence, integrity

Social Contract: oversight of the quality of financial reporting

provided to the public in exchange for professional status

Decision Process for Moral Issues

Environment produces issues with moral components

Decision maker recognizes the moral issue or moral components. Moral

intensity affects whether the decision maker recognizes the moral

components.

Magnitude of the consequences

Social consensus

Probability of effect

Temporal immediacy

Proximity

Concentration of effect

Decision maker goes through a decision process to make a judgment

regarding the issue, and selects and carries out a behavior. This is done

using a decision model that considers ethical consequences.

Model for Making Ethics-Related Decisions

Determine the facts of the situation.

Identify the ethical issues and people involved. Who are the

stakeholders?

Identify the values related to the situation: honesty, loyalty,

compassion, integrity, etc. Identify any that conflict.

Identify alternative courses of action that are available.

Evaluate courses of action and match each with relevant

values.

Consider the consequences of viable courses of action

remaining.

Make the decision; take indicated action.

Value of Using an Ethics Decision Model

Supports considering ethics during the decision

making process

Does not guarantee a particular decision result

Moral dilemmas will still exist; this type of

decision model just helps provide a process for

addressing them

A moral dilemma is an ethics-related

situation for which there is no clear right or

wrong answer

AICPA Code of Conduct

Principles of Professional Conduct

Conceptual, ideal standards; not enforceable

Rules of Conduct

Threshold for minimum acceptable behavior

Stated in behavior-related language

Enforceable

Interpretations of the Rules of Conduct

Response when there are frequent questions about a rule

Departures must be justified in any disciplinary hearing

Rulings by the Professional Ethics Executive Committee

Rulings on individual cases; responses to specific factual circumstances

Justification for departures may be requested in any disciplinary

hearing

Principles

Responsibilities

Professional and moral judgment

Public interest

Integrity

Objectivity and Independence

Conflict of interest

Public practice; attest functions, independent in fact and

appearance

Due Care

Scope and Nature of Services

Observe the other principles in making these decisions

How AICPA Rules Use the Term “Public Practice”

What does it mean to be in public practice?

…covered in the definitions

Performance for a client by a member or a member’s firm,

while holding out as a CPA, of the professional services of

accounting, tax, personal financial planning, litigation support

and professional services for which standards are promulgated

by bodies designated by Council.

Council is the AICPA’s Council

For example, standards referred to are: SFAS, SAS, SSARS,

SSCS, SSAE – and now also IFRS and ISA

AICPA Code, Rules

Rule 101 - Independence

Rule 102 – Integrity and Objectivity

Be objective

Behave with integrity

Don’t misrepresent facts

Don’t subordinate judgment

Rule 201 – General Standards

Professional competence

Due professional care

Planning and supervision

Sufficient relevant data

Rule 202 – Follow the rules

Rule 203 - Financial statements have to be GAAP to issue a clean opinion

unless the exception applies

AICAP Code, Rules continued

Rule 301 - Confidential client information

Exceptions: subpoenas, practice monitoring, complaints regarding professional performance

Rule 302 - Contingent Fees

Rule 501 – Acts Discreditable

Rule 502 – Advertising & Other Forms of Solicitation

False, misleading, deceptive, coercion, overreaching, harassing

Rule 503 –

Can’t recommend anything to (attest) client if you get a fee for it

Can’t recommend anything an attest client does or sells to anyone if you get a fee from the attest client

If you are allowed to, and receive a commission, have to disclose it to the person to whom you make the recommendation

Referral fees; if you pay or receive a referral fee have to disclose it to the client

Rule 505 – Form of Practice and Name

Only an allowed organizational form

Name that is not misleading

All owners have to be AICPA members to say the firm is: “Member of AICPA”.

Definitions

The following terms have specific definitions for the

AICPA Code of Professional Conduct: Attest engagement Interpretation Professional services

Attest engagement team Key position Significant influence

Client Loan

Close relative Key position

Council Loan

Covered member Manager

Financial institution Member

Firm Normal lending procedures

Holding out Office

Immediate family Partner

Individual…position to influence Period of the…engagement

Institute Practice of public accounting

Conceptual Framework, AICPA Independence

ET 100.01…a member’s relationship with a client is

evaluated to determine whether it poses an

unacceptable risk to the member’s independence. Risk

is unacceptable if the relationship would compromise

(or would be perceived as compromising by an

informed third party having knowledge of all

relevant information) the member’s professional

judgment when rendering an attest service to the

client.

Independence

In fact and in appearance

General SEC guidelines communicate the essence of

independence

SEC General Standard of Auditor Independence

No mutual or conflicting interest with the audit client

Audit firm cannot audit its own work

Audit firm cannot act as management

Audit firm cannot be an advocate for the client

In 2001 SEC relaxed the group of people to whom

independence rules apply

AICPA Interpretation 101 of Rule 101

Independence shall be considered to be impaired

if:

A. During the period of the professional engagement a

covered member…

Definitions, Important for Covered Member

Individual: the person or the person’s immediate

family

Immediate family: spouse, spousal equivalent,

dependent (whether or not related)

Attest engagement team: Individuals participating in

the attest engagement, including those who perform

concurring and second partner reviews, regardless of

functional classification (audit, tax, consulting).

Excludes specialists and those performing clerical

tasks.

Definitions, Important for Covered Member

An individual in a position to influence the audit engagement;

Someone who

Evaluates the performance or recommends the compensation

of the attest engagement partner

Directly supervises or manages the attest engagement

partner (all the way up to firm’s chief executive)

Consults with the attest engagement team on technical or

industry-related issues specific to the attest engagement

Participates in or oversees quality control activities with

respect to this attest engagement (all the way up to the top

of the firm)

A Covered Member Is….

An individual on the engagement team

An individual in a position to influence the

engagement

A partner or manager who provides 10 or more

hours of nonattest services to the client

Another partner in the office of the lead attest

engagement partner

The firm, including the firm’s employee benefit plans

Any entities whose policies are controlled by any of

the people described above

AICPA Interpretation 101

Important terms:

Financial interest: direct financial interest, material indirect financial interest

Management role

Family: immediate, close

Period covered by the audit, period of the professional engagement

Financial interests that are problems:

Have direct or material indirect interest

Be a trustee or executor of an entity with a direct or material indirect interest

Have joint investment

Have a loan through other than normal lending procedures

Cannot own more than 5% of the client either together or in a group (even if it is

not material and indirect)

Applies to CPAs doing the audit and people who previously worked for the client;

Someone who worked for client and moves to audit firm can sever financial ties

Control positions/functions that are problems

Director

Officer

Management or equivalent

Promoter

Underwriter

Voting trustee

Pension or profit sharing trustee

Works in both directions

CPA performing those services for the client

Person in a client control position coming to work for the CPA firm and

auditing the period they perform the control function.

AICPA Interpretation 101 continued

Close Relatives

Close relative – only independence problems

When close relative is in a key position, or

Has a financial interest that is material to the close relative that the auditor knows about that can result in significant influence over the client

in a key position means…

Significant accounting function

Preparation of financial statements

Ability to exercise influence over the contents of the financial statements

Can influence an attest engagement that is not about the financial statements

Immediate Family, Close Relatives

Differences exist for independence issues when

immediate family and close relatives are involved

Covered member is expected to know everything about

immediate family

Financial interests and employment of immediate family

can cause independence problems

Employment of close relative in key position is visible, so

covered member knows about it

Finances of close relative can only be a problem if the

covered member has knowledge

Public Company Issues

Sarbanes Oxley 1 year cooling off period (Section 206, Conflicts of Interest)

Services that impair independence: SEC, SOX

Bookkeeping

Systems design and implementation

Appraisal or valuation services

Actuarial services

Internal audit outsourcing services

Management functions

Human resources

Broker-dealer, investment adviser, investment banking services

Legal services

Expert services unrelated to the audit

Note: Not all of these would be prohibited by AICPA rules

Fees paid to the audit firm for non-audit services must be disclosed in the proxy statement

Audit Committee Approvals

Under SOX

Audit committee hires the auditor, and as a

result, approves the audit service

Audit committee approves any other services

If a non-audit service is not prohibited it

must be approved in advance by the

client’s audit committee

Peer Review

AICPA

Peer Review Program (AICPA PRP)

National Peer Review Committee

Reviews the portion of a firm’s practice not inspected by

the PCAOB

PCAOB

Firm Registration

Inspections

International Code of Ethics

International Federation of Accountants

International Ethics Standards Board for Accountants

(IESBA)

Code of Ethics for Professional Accountants

Applicability of IESBA Code

CPAs must comply with the standards of

the applicable jurisdiction, or most

restrictive code

IESBA Code revised in July 2009,

effective January 1, 2011

CPA Exam coverage of IESBA Code could

begin effect January 2011

Structure of IESBA Code

Set up in 3 sections

Part A, General Application of the

IESBA Code

Part B, Professional Accountants in Public

Practice

Part C, Professional Accountants in

Business

Conceptual Framework, IESBA

Uses a Conceptual Framework approach

Identify threats to compliance with the

fundamental principles

Evaluate the significance of the threats

identified

Apply safeguards, when necessary to

eliminate threats or reduce them to an

acceptable level

Fundamental Principles, IESBA

Integrity

Objectivity

Professional Competence and Due

Care

Confidentiality

Professional Behavior

Threat Categories, IESBA

Self-interest threat

Self-review threat

Advocacy threat

Familiarity threat

Intimidation threat

Some of these look familiar – AICPA, SEC

Safeguards, IESBA

Safeguards created by the

profession, legislation or regulation

Safeguards in the work environment

Safeguards: Professional, Legislation, Regulation

Educational, training and experience requirements

for entry into the profession

Continuing professional development requirements

Corporate governance regulations

Professional standards

Professional or regulatory monitoring and

disciplinary procedures

External review by a legally empowered third

party

Other Safeguards

Safeguards to identify or deter

Effective, well-publicized compaint systems

Explicitly stated duty to report breaches of ethical

requirements

From the work environment

Presented in Parts B and C

These are the details of Parts B and C – what CPAs

should and shouldn’t do

AICPA, IESBA

An example of differences between the Codes:

Addressing familiarity threats, these examples are

not addressed directly in AICPA Code:

Long Association of Senior Personnel (Including Partner

Rotation) with a Client

Fees-Relative Size

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