Chapter 4 Professional Ethics Code of Professional Conduct online handout Independence is the big issue

Handout

Auditors Work for Banking Clients, Not Investors:  Resistance to Disclosing Subprime Poison Repurchase Risk "Auditors Aren’t Forcing Full Repurchase Risk Exposure Disclosure," by Francine McKenna, re:TheAuditors, September 27, 2010 ---

AICPA Principles v Rules

Weston Conceptually, what is the difference between a principle and a rule?

AICPA’s Code of Professional Conduct principles Ideal standards of ethical conduct in philosophical terms Principles are not enforceable rules of conduct establish minimum standards of acceptable conduct rules are enforceable

Speed Limits California has a "Basic Speed Law." This law means that you may never drive faster than is safe for current conditions. For example, if you are driving 45 mph in a 55 mph speed zone during a dense fog, you could be cited for driving "too fast for conditions.“ Regardless of the posted speed limit, your speed should depend on: The number and speed of other vehicles on the road. Whether the road surface is smooth, rough, graveled, wet, dry, wide, or narrow. Bicyclists or pedestrians walking on the road’s edge or crossing the street. Whether it is raining, foggy, snowing, windy, or dusty.

Monica What are the six principles guiding the Code of Professional Conduct?

Table 4-2 Page 86 (90)

responsibilities public interest in carrying out their responsibilities as professionals, members should exercise sensitive professional and moral judgments in all their activities public interest members should accept the obligation to act in a way that will serve the public interest, honor the public trust, and demonstrate a commitment to professionalism

objectivity and independence integrity to maintain and broaden public confidence, members should perform all professional responsibilities with the highest sense of integrity objectivity and independence A member should maintain objectivity and be free of conflicts of interest in discharging professional responsibilities. A member in public practice should be independent in fact and appearance when providing auditing and other attestation services.

scope and nature of services due care A member should observe the profession’s technical and ethical standards, strive continually to improve competence and the quality of services, and discharge professional responsibilities to the best of the member’s ability scope and nature of services observe the Principles of the Code of Professional Conduct in determining the scope and nature of services to be provided

Vikki How do the AICPA’s ethical principles define “Objectivity and Independence?”

our definition of Independence A member should maintain objectivity and be free of conflicts of interest in discharging professional responsibilities. A member should be independent in fact and appearance when providing auditing and other attestation services.

Sources AICPA, SEC & PCAOB are consistent

SEC guiding principles not in Code of Professional Conduct Independence in fact Independence in appearance Auditors are not independent if relationships Create mutual or conflicting interests with client Audit their own work Act as management or employee of the client Be an advocate for the client

SEC prohibited service Bookkeeping and accounting services Financial info system design & implementation Appraisal or valuation services Actuarial services Internal audit outsourcing Management or HR functions Broker, investment advisor, investment banking Legal services

auditors INDEPENDENCE DAY

Independence Independence implies an impartiality that recognizes an obligation to be fair not only to management and those charged with governance of an entity but also users of the financial statements who may rely upon the independent auditor’s report. Independence enhances the auditor’s ability to act with integrity, to be objective, and to maintain an attitude of professional skepticism.

AICPA Code of Professional Conduct Rules Table of Contents

Threats to compliance with rules Framework p. 86 (90) Threats (to independence) Acceptable level Safeguards Not an acceptable level apply safeguards Some threats cannot be reduced to an acceptable level by the application of safeguards

Framework p. 87 (91) Types of Threats Adverse interest Advocacy threat Familiarity threats Management participation threat Self-interest threat (a financial interest). Self review threat Undue influence threat

Rachel How might you evaluate the risk that a member might not be sufficiently independent?

2. Evaluate significance of threat Page 86 (90) Definitions 0.400 .01 Acceptable Level … is a level at which a reasonable and informed third party who is aware of the relevant information would be expected to conclude that the threat would not compromise the member’s compliance with the rules.

HANDOUNT .. Covered member Direct financial interest or material indirect financial interest in the audit client Trustee of trust or executor of estate … Loans to or from the client Joint investments with the client (or client’s Mgmt) Prof Employee - Member of group owning > 5% Prof Employee - Director or any capacity equivalent to management

.. Covered member Direct financial interest or material indirect financial interest in the audit client Trustee of trust or executor of estate … Loans to or from the client Joint investments with the client (or client’s Mgmt) Prof Employee - Member of group owning > 5% Prof Employee - Director or any capacity equivalent to management Covered members Group of Prof Emp Prof Employees

Period of the engagement .. Covered member Direct financial interest or material indirect financial interest in the audit client Trustee of trust or executor of estate … Loans to or from the client Joint investments with the client (or client’s Mgmt) Prof Employee - Member of group owning > 5% Prof Employee - Director or any capacity equivalent to management Period of the engagement Period covered by Fin State

Period of the Prof Engagement Covered Member Period of the Prof Engagement Direct financial interest or material indirect financial interest in the Trustee of trust or executor of estate … Loans to or from the client Joint investments with the client (or client’s Mgmt) Prof Employee - Member of group owning > 5% Period Covered by the Financial Statements Period of the Professional Engagement Director or any capacity equivalent to management

Professional Employee Covered Member handout Professional Employee Covered Member

Group > 5% equity Professional Employee Material Immediate family Covered member Not material Material Close Relative Not material NOT Covered member

Preface 0.400 Definitions .31 Member .12 Covered Member Professional Employee .13 Direct Financial Interest .22 Indirect Financial Interest .26 Joint Closely Held Investments .39 Period covered by the Financial Statements .39 Period of the Professional Engagement

Part 1 Members in Public Practice 1.240.010 Financial Interests Can Not be reduced to an Acceptable Level of Risk .01 A covered member had … a direct financial interest in the attest client during the period of the professional engagement .02 A covered member had a material indirect interest in the attest client during the period of the professional engagement .03 A partner or professional employee, his or her immediate family, or any group of such persons acting together owned more than 5% of an attest client’s outstanding equity securities during the period of the professional engagement

Part 1 Members in Public Practice 1.240.030 Mutual Funds ??? be reduced to an Acceptable Level of Risk .01 A covered member who owns shares in a mutual fund has a direct financial interest in the mutual fund However, whether the individual investments in the mutual fund are considered to be the covered member’s direct financial interest or indirect financial interests depends on the proportion of the mutual fund’s outstanding shares that the covered member owns and whether the mutual fund is diversified.

Part 1 Members in Public Practice 1.245.010 Trustee or Executor Can Not be reduced to an Acceptable Level of Risk .02 A covered member serves as the trustee of executor during the period of the professional engagement covered member has authority to make investment decisions the trust or estate owned .. More than 10% of the attest client’s outstanding equity … OR the value of the trust or estate’s holdings in the attest client exceeds 10% of the total assets of the trust or estate …

Part 1 Members in Public Practice 1.260.010 Loans, Leases Can Not be reduced to an Acceptable Level of Risk .01 A covered member has a loan to or from an attest client, any officer or director of the attest client or any individual owning 10% or more of the attest client’s outstanding equity

Can Not be reduced to an Acceptable Level of Risk Part 1 Members in Public Practice 1.265.020 Joint Closely Held Investments Can Not be reduced to an Acceptable Level of Risk .01 If A covered member holds a material joint closely held investment during the period of the professional engagement.

Part 1 Members in Public Practice 1.275.005 Employment or Association Can Not be reduced to an Acceptable Level of Risk .01 … serving as a director, an officer, an employee, …. Or any capacity equivalent to that or a member of management of an attest client during the period covered by the financial statements or the period of the professional engagement .02 If a partner or professional employee of the firm is employed of associated with an attest client ..

Preface 0.400 Definitions .12 Covered Member .19 Immediate Family .08 Close Relative Professional Employee Group of Professional Employees .39 Period of the Professional Engagement Period Covered by the Financial State

covered member

Edreese which members of the accounting firm are included in the phrase covered member ?

Covered member Individuals attest engagement team Individuals in a position to influence the engagement Partner or manager providing > 10 hrs non-audit work Partners in same office as engagement partner The firm and its employee benefit plan Any entity controlled by covered members

Position to influence the engagement Supervisor through firm’s Managing Partner Anyone who evaluates the engagement partner Provides Quality Control for engagement

immediate family can impair independence Individuals on attest engagement team Individuals in a position to influence the engagement Partner or manager providing > 10 hrs non-audit work Partners in same office as engagement partner And their immediate family

Ryan Who is included in the phrase Immediate Family ?

Immediate family spouse or spousal equivalent dependents

Matt what is a direct financial interest ? what is a material indirect financial interest ?

indirect financial interest investments in mutual funds investments by “Close Relatives” p. 91 (95)

Bella How much is material? To whom does it need to be material?

Annika Who is included in the phrase Close Relative ?

Close Relative (.0400.08) Spouse or spousal equivalent Dependents Parent Non dependent child Sibling

financial interests

financial interests direct financial interest or material indirect financial interest in the client trustee (executor) of a trust (estate) with a direct or material indirect financial interest in the client loans from or to the client or any of its officers, directors, or principal shareholders except for some secured loans joint investments with the client or any of its officers, directors, or principal shareholders

let’s talk about audit staff

Lindsey are all staff in the SLO office prohibited from owning stock in the client ? what about their spouses ?

Sophia what about their parents ?

Simran are all staff assigned to the engagement prohibited from investing in a diversified mutual fund that owns stock in the client ?

let’s talk about managers

Mikayla are all “audit” managers in the engagement office prohibited from owning stock in the client? what if the amount is immaterial ? what about their spouses ?

Mark in addition to audit managers in the ‘in a position to influence the engagement’ are there any other managers in the engagement office who might be prohibited from owning of stock in the client ? what about their spouses ?

let’s talk about partners

Wendy are all partners in the firm prohibited from owning any stock in a client ? what if the amount is immaterial ? what about their children ?

Ian what about partners in the Phoenix office ? (this is a San Luis Obispo client)

Benjamin a tax partner has provided tax advisory work for the audit client Her sister owns stock in the client

critical periods of time

critical periods of time financial interests positions equivalent to being a member of management

critical periods of time period covered by the financial statements period of the professional engagement

1/1/17 12/31/17 1/28/18 3/11/18 3/15/18 period covered by financial state engagement opinion

financial interest the period covered by the financial statements the period of the professional engagement 1/1/17 12/31/17 1/28/18 3/15/18 period covered by financial state engagement opinion

any management capacity the period covered by the financial statements the period of the professional engagement 1/1/17 12/31/17 1/28/18 3/15/18 period covered by financial state engagement opinion

Selin a staff person owns stock in client, they will be assigned to the engagement, can they sell their stock before the audit begins without jeopardizing the accounting firm’s independence ?

a staff person owns stock in client, they will be assigned to the engagement, can they sell their stock before the audit begins without jeopardizing the accounting firm’s independence ? 1/1/17 12/31/17 1/28/18 3/15/18 period covered by financial state engagement opinion

Kevin the engagement partner owns stock in the client, can they sell their stock before the audit begins without jeopardizing the accounting firm’s independence?

the engagement partner owns stock in the client, can they sell their stock before the audit begins without jeopardizing the accounting firm’s independence? 1/1/17 12/31/17 1/28/18 3/15/18 period covered by financial state engagement opinion

Greg can a partner (in the engagement office) resign her position on the client’s board of directors before the audit begins without jeopardizing the accounting firm’s independence

can a partner (in the engagement office) resign her position on the client’s board of directors before the audit begins without jeopardizing the accounting firm’s independence 1/1/17 12/31/17 1/28/18 3/15/18 period covered by financial state engagement opinion

positions equivalent to being management connected with the client .... in any capacity equivalent to that of a member of management or of an employee trustee for any pension fund or profit sharing trust of the client

Exhibit

other relationships to the client

Independence is impaired if parent, sibling or nondependent child (also includes immediate family) Independence is impaired if a close relative of: Anyone on the engagement team Anyone in position to influence the engagement All partners in the engage partner’s office Holds a key position with the client Holds a financial interest in the client that is material to the relative (member must know) Holds a financial interest that enables the relative to exercise significant influence over the client

Key positions 0.400.27 Primary responsibility for significant accounting functions that support material components of the financial statements Primary responsibility for preparing fin state Ability to exercise influence over fin state Board of Directors CEO CFO, COO, CAO Controller, treasurer, Dir Internal Audit

Other Rules of Conduct Table 4-4 p. 104 (108)

1.300 general standards professional competence due professional care planning and supervision sufficient relevant date

1.320.030 Departures from GAAP if, however, the statements contain a departure and the member can demonstrate that due to unusual circumstances the financial statements would otherwise be misleading, the member can comply with this rule by describing the departure. approximate effects and the reasons why compliance with the principle would result in a misleading statement

1.400.700 confidential client information A member shall not disclose any confidential client information without the specific consent of the client. This rule does not Affect the members obligation to comply with a validly issued subpoena or summons prohibit review of a member’s practice under AICPA authorization prohibit review of a member’s practice under state society authorization preclude a member from responding to any inquiry made by a recognized disciplinary body

1.510.100 contingent fees A contingent fee is an arrangement in which no fee will be charged unless a specific finding or result is attained, or in which the amount of the fee is otherwise dependent upon the finding or result ... A member’s fee may vary depending on the complexity of the services rendered. Members may not provide services for a contingent fee to clients whose financial statements they audit or review whose financial statements they compile if they expect a third party will use the financial statements for whom they examine prospective financial information

1.520.001 commissions and referral fees For audit clients ………… shall not for a commission recommend or refer to a client any product or service,

Assign the accounts receivable project

Part 1 Members in Public Practice 1.200 Independence Rule .15 A member serves as an officer or a director of the attest client … accepts responsibility for designing, implementing or maintaining internal controls for the attest client … or member’s firm relies excessively from a single client … hires, supervises, or terminates the attest client’s employees

Part 1 Members in Public Practice 1.200 Independence Rule .16 A member has a direct financial interest or material indirect interest in the attest client … has a loan from the attest client, an officer or director of the the attest client, or an individual who owns 10% or more of attest client’s outstanding equity securities … or member’s firm relies excessively from a single client … or member’s firm has a material joint venture or other material joint business arrangement with the attest client