Regulatory Ethics Financial Reporting & Audit

Presenting today Jill Schulz Senior Manager Audit Services T 303 813 4014 E jill.schulz@us.gt.com

Honesty/Ethics in professions Polls have shown that accountants are viewed as having relatively low ethical standards, ranging between funeral directors and building contractors.

Notorious audit failures

Recent high-profile regulatory actions for ethics violations In September, one of the large public accounting firms was fined over $9 million for "inappropriate client relationships" The SEC found that a senior partner on the engagement team for an unnamed New York-based public company, “maintained an improperly close friendship” with the company’s chief financial officer, thus violating rules that ensure objectivity and impartiality during audits. According to the SEC, the partner reportedly spent close to $100,000 in travel and entertainment expenses between 2012-2015 while socializing with the company’s chief financial officer and his family. Further, according to the SEC, the firm was aware of the expenses, but took no action.

Recent high-profile regulatory actions for ethics violations In another case, an audit partner who served on another audit team had a romantic relationship with the chief accounting officer of an SEC audit client of the firm. Another partner, though not relating with clients in an inappropriate manner, was charged with ethics violations nonetheless because he became aware of facts suggesting the improper relationship between the CAO and the other partner, yet failed to perform a reasonable inquiry or raise concerns internally within the accounting firm's U.S. independence group.

Recent high-profile regulatory actions for ethics violations The SEC said in a press release that this case marks the first time it has enforced actions against auditors failing to remain independent “due to close personal relationships between auditors and client personnel.”

Agenda What is ethics in the context of financial reporting and audit relationships? The regulatory environment and impact on non-audit services Private companies Public companies IFRS considerations

Regulatory ethics financial reporting & audit Philosophical considerations What are ethics as they relate to accounting? Why are ethics important with respect to financial reporting and auditing?

Ethics in the context of accountancy If: Ethics = moral values or knowing the difference between right and wrong and Accounting or accountancy is the measurement, processing, and communication of financial information about such as businesses and corporations.

Ethics in the context of accountancy Then: Ethics for accountants involves making good moral choices in terms of their potential impact to the measurement and communication of financial information. But accountants are human, and history has shown us that rules are necessary to establish minimum ethical standards for accountants and auditors. Thus, an extraordinary standard of ethics for accountants is needed: Obviously, in order to prevent willful ethics violations. But also to guard against inadvertent violations of ethics.

What society expects of accountants & auditors Accountants must be: Trustworthy Responsible Fair Professionals are expected to hold themselves to a higher standard of conduct than average for society.

Regulatory Environment AICPA SEC/Sarbanes Oxley IFRS With respect to ethics, much of the regulatory oversight for financial reporting and auditing devolves into maintaining independence and objectivity between auditors and their clients

Regulatory Environment AICPA Standards

Standards of conduct Principles: aspired level of conduct by practitioners Rules of Conduct: minimum level of conduct by professionals Substandard conduct

AICPA – Code of professional conduct Interpretations of the Rules of Conduct Interpretation of the rules of conduct by the AICPA Division of Professional Ethics. These offer guidance Ethical Principals Ideal standards of ethical conduct stated in philosophical terms. These are aspirational Rules of Conduct Minimum standards of ethical conduct stated as specific rules. These are enforceable

Ethical principals 1 Responsibilities: CPAs should act in a manner reflective of the reliance that society places in them. 2 3 4 5 6 Objectivity: In order to be independent, CPAs must be free of conflicts of interest. The public interest: Society expects CPAs to act selflessly on behalf of the public. Due Care: CPAs must perform competently. Integrity: CPAs should perform with objectivity and honesty. Scope and nature of services: CPAs in public practice should observe the Code of Professional Conduct.

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.

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

Financial interests Interpretations of Rule 101 prohibit covered members from owning any direct investments in audit clients. Covered member. All of the following: an individual on the attest engagement team. an individual in a position to influence the attest engagement. a partner, partner equivalent, or manager who provides more than 10 hours of non-attest services to the attest client within any fiscal year. Designation as covered member ends on the later of (i) the date that the firm signs the report on the financial statements for the fiscal year during which those services were provided or (ii) the date he or she no longer expects to provide 10 or more hours of non-attest services to the attest client on a recurring basis. a partner or partner equivalent in the office in which the lead attest engagement partner or partner equivalent primarily practices in connection with the attest engagement. the firm, including the firm’s employee benefit plans. an entity whose operating, financial, or accounting policies can be controlled by any of the individuals or entities described in items a–e or two or more such individuals or entities if they act together.

Litigation between CPA firm and client A lawsuit or intent to start a lawsuit between a CPA firm and its client, the ability of the CPA firm and client to remain objective is questionable. The interpretations regard such litigation as a violation of Rule 101.

Bookkeeping & other services The AICPA Code permits a CPA firm to do both bookkeeping and auditing for a non-public client.

Bookkeeping & other services Client must accept full responsibility for the financial statements. The CPA must not assume the role of employee or of management. The audit must conform to use of auditing standards. 1 2 3

Bookkeeping & other services AICPA rules do not allow audit firms to provide bookkeeping services to public company audit clients. Consulting and other non-audit services Unpaid fees

Other rules 102 – Integrity and objectivity 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

AICPA code Integrity and objectivity (Rule102 of the AICPA Code) – Conflicts of interests Conflicts of interests – occurs when CPA has a relationship with another person, entity, product, or service that could be viewed by his or her employer or other appropriate parties as impairing the CPA’s objectivity Disclosure and specific consent required Examples: Financial interest in entity bidding on contract with your employer Personal relationship with key person or officer in entity that is competing with your employer in competitive bidding situation

AICPA code Integrity and objectivity (Rule102 of the AICPA Code) – Acceptance of offering of gifts or entertainment Q: Would objectivity or integrity be considered to be impaired if a CPA offers or accepts gifts or entertainment from a customer or vendor of the CPA’s employer or a representative of the customer or vendor? A: Objectivity or integrity would be considered impaired unless the gift or the entertainment is “reasonable in the circumstances.” A CPA is expected to use judgment in determining whether a gift or entertainment is or is not reasonable in the circumstances.

AICPA code Integrity and objectivity (Rule102 of the AICPA Code) – Acceptance of offering of gifts or entertainment Factors to consider in determining whether a gift or entertainment is “reasonable in the circumstances” Nature of the gift or entertainment Occasion giving rise to the gift or entertainment Cost or value Nature, frequency, and value of other gifts and entertainment offered or accepted Whether the entertainment was associated with a business activity directly before, during, or after the entertainment Whether other clients, customers, or vendors also participated in the entertainment Individuals from the client, customer, or vendor and the employer who participated in the entertainment

Follow employer's policies and/or applicable laws/regulations AICPA code Integrity and objectivity (Rule102 of the AICPA Code) – Acceptance of offering of gifts or entertainment A CPA is presumed to lack integrity if he or she accepts or offers a gift or entertainment if he or she knew, or was reckless in not knowing, that the gift or the entertainment would violate the customer, vendor, or employer’s policies or applicable laws and regulations. Follow employer's policies and/or applicable laws/regulations

AICPA code ET Section 301 – Confidential client information Confidential client information – a CPA in public practice shall not disclose any confidential client information without the specific consent of the client. Does not relieve CPA from his/her professional obligation or to comply with a valid or enforceable subpoena or summons Need to determine whether the information is confidential or not (e.g., is it in the public domain, is it acceptable to disclose to third party)

Enforcement Action by AICPA Professional Ethics Division Action by a state board of accountancy Fair

AICPA code AICPA sanctions Automatic sanction follows regulatory sanction (generally results in suspension, termination, or expulsion) Sanction letter (admonishment, letter of recommended corrective action, suspension, terminated, or expulsion) requires agreement by both societies Ethics rule(s) violated Sanction(s) (e.g., CPE, work-product follow-up, etc.)

Regulatory Environment SEC Standards

Sarbanes-Oxley Act & 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.

Overview of independence The cans and can nots of providing non-audit services CAN Identify deficiencies/gaps Advise management's project team Provide examples Train on general requirements Evaluate work of management's specialists CAN NOT Design, customize or implement new policies, processes, controls or software Lead management's project team Identify and approve accounting entries Decide for management on policies, practices, etc.

Independence considerations for providing non-audit services SEC's overarching Independence Principles Create mutuality of interest Become an advocate Act as management or employee Audit your own work

Sarbanes-Oxley Act & SEC provisions addressing auditor independence Prohibited Services Bookkeeping and other accounting services Financial information systems design and implementation Appraisal or valuation services Actuarial services Internal audit outsourcing Management of human resource functions Broker, dealer, or investment adviser or investment banker services Legal and expert services unrelated to the audit Any other service that the PCAOB determines by regulation is impermissible

Permitted & prohibited services As long as the SEC's Overarching Principles are not violated, auditors are permitted to perform the following services for any SEC audit client (or affiliate): Tax consulting and compliance services (excluding contingent fees, aggressive tax positions, financial reporting applications and services to key officers or directors) Due diligence services (excluding contingent fees, success-based fees or corporate financing activities) Prohibited services for any SEC audit client or its affiliate that impair independence include the following: Management functions (e.g. SOX 404, loan staff, implementing accounting policies or controls, or reporting directly to audit committee or governing board) Human resources or management/ executive recruiting services (management function) Expert services (advocate) Legal services (advocate or management function) Incompatible functions (corporate finance or investment advisory services) Services creating mutuality of interest (e.g. contingent fees, success-based fees, or business relationships)

Regulatory environment Safeguards

Sarbanes-Oxley Act of 2002 Mandates that the PCAOB establish Auditing Standards to require: Work paper retention for 5 and 7 years CPA firms utilize a second-partner review and approval of audit reports Testing of companies’ internal controls, including reporting of test results

Sarbanes-Oxley Act of 2002 Corporate Governance Standards Prohibits most director and officer loans from the company New rules on director and officer trading of company stock (insider trading) Requires attorney whistleblowing

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.

Conflicts arising from employee 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.

Partner rotation The Sarbanes-Oxley Act requires that the lead and concurring audit partner rotate off the audit engagement after a period of five years.

Ownership interests SEC rules prohibit ownership in SEC rules on financial relationships take an engagement perspective. SEC rules prohibit ownership in audit clients by those persons who can influence the audit.

Other issues Engagement and payment of audit fees by management Shopping for accounting principals Engagement and payment of audit fees by management

International Financial Reporting Standards ("IFRS") & International Federation of Accountants ("IFAC") The International Ethics Standards Board for Accountants (IESBA) is a standard-setting body of IFAC. IESBA establishes and maintains the requirements in the IFAC code. That code uses a conceptual framework approach to evaluate ethical conduct. The code requires, in many situations, that professionals: Exercise judgment to identify and analyze threats to their independence, and Apply appropriate "safeguards " that eliminate those threats or reduce threats to an acceptable level.

International Financial Reporting Standards ("IFRS") & International Federation of Accountants ("IFAC") The code is comprehensive, addressing most of the same areas as the AICPA Code of Professional Conduct, such as objectivity, independence, due care and confidentiality. IFAC's conceptual framework approach suggests safeguards that may reduce threats in particular circumstances. Nevertheless, the IFAC code is not devoid of rules. In certain instances, the code states that no safeguards may be applied to reduce or eliminate a specific threat, thus prohibitions (that is, rules) are imposed. For example, an audit team member would not be able to apply safeguards to mitigate the self-interest threat created by accepting an expensive gift from a client. As a result, the IFAC code explicitly prohibits the auditor from accepting such a gift.

International Financial Reporting Standards ("IFRS") & International Federation of Accountants ("IFAC") Generally, the AICPA code is more restrictive than the IFAC code because it is more rules-based and because independence rules often convey what an accountant should not do. Despite the IFAC code's conceptual framework approach, both codes contain prohibitions that are intended to guard against the loss of independence. The AICPA code, for example, prohibits a member of the audit team from having a direct financial interest in the client. The IFAC code contains the same prohibition, which applies even if the auditor claims that safeguards, such as having another accountant check his or her work, would eliminate the threat to independence.

Closing Understand your role and responsibilities Identify the appropriate standards and framework Recognize potential conflicts and the related safeguards

Appendix: Comparative Matrix of Permitted Non-Audit Services; International Federation of Accountants ("IFAC") Code, American Institute of Certified Public Accountants ("AICPA") and the Securities and Exchange Commission ("SEC")

Permitted & prohibited non-audit services

Permitted & prohibited non-audit services

Permitted & prohibited non-audit services

Permitted & prohibited non-audit services

Permitted & prohibited non-audit services

Permitted & prohibited non-audit services