Chapter 03 Professional Ethics McGraw-Hill/Irwin Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.

Steps in Resolving an Ethical Dilemma Identify the problem Identify possible courses of action Identify any constraints relating to the decision Analyze the likely effects of the possible courses of action Select the best course of action 3-2 2 2

Need for Professional Ethics Responsibility to serve the public CPA is representative of the public Complex body of knowledge Abundance of authoritative pronouncements Standards of Admission to the Profession Min. standards for education and experience Need for public confidence CPA product is credibility 3-3

Code of Professional Conduct Designed to provide a framework for expanding professional services and responding to changes in the profession Two sections Principles Rules Additional guidance Interpretations Ethics Rulings 3-4

AICPA Professional Ethics 3-5

Principles of the Code Responsibilities The Public Interest Integrity Objectivity and Independence Due Care Scope and Nature of Services 3-6

The Rules of the AICPA Code of Professional Conduct Rule Title 101 Independence 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 504 (Deleted) 505 Form of Organization and Name 3-7 3 3

Independence Independence of mind (actual independence) Independence of appearance Both are required. 3-8

AICPA Conceptual Framework for Independence The AICPA Conceptual Framework for Independence is used to evaluate threats to independence. When a threat arises, the approach considers Whether the Code directly addresses the threat If the Code does not directly address the threat, the auditor considers whether adequate safeguards exist to eliminate the threat to independence The perspective used throughout is whether a reasonable person, aware of all the relevant facts would conclude that an unacceptable risk of non-independence exists. 3-9

Threats to Independence (and an example of each) CPA financial and other personal matters Financial Self-Interest of CPA—CPA owns stock in the client Adverse Interest— Litigation between client and CPA firm Undue Influence--Pressure from client to reduce audit procedures Interests of relatives and friends Familiarity—Spouse holds a key position with client CPA Performance of nonattest services Self-Review—CPA firm has provided consulting services that relate to audit Advocacy of client—CPA promotes client securities as part of an initial public offering Management Participation—CPA Serves as officer of client 3-10

Independence Safeguards Created by profession, legislation or regulation (e.g., education requirements) Implemented by attest client (e.g., effective board of director oversight) Put in place by CPA firm (e.g., stressing importance of independence) 3-11

Summary of Conceptual Framework Approach for Evaluating Threats to Independence (Figure 3.4) 3-12

Covered Members Interpretation 1 of Rule 101 is particularly important for understanding independence. It relies in part on the concept of a “covered member.” Covered Members include Staff working on the attest engagement An individual who may influence the attest engagement A partner in the office in which the partner in charge of the attest engagement primarily practices Partners or managers that provide a specified amount of nonattest services to client The public accounting firm and its employee benefit plan Any entity controlled by one or more of the above 3-13

Interpretation 101-1 States That Independence is Impaired if a Member: Section Has direct or material indirect financial interest, loan, or joint business invest- ment; trustee or administrator of estate or trust that has such interest Applies to: Covered Members B. Owns 5% or more of client’s outstanding equity or other ownership interest All Partners and Professional Staff C. Simultaneously associated with client as director, officer, employee, etc. All Partners and Professional Staff 3-14

Financial Interests from Interpretation 101-1 Direct Indirect Example Investment in client, such as owning capital stock or providing a loan Investment in a mutual fund, which in turns owns capital tock of a client Type allowed for individual CPA to retain independence None Immaterial 3-15

Figure 3.5 – The effects of partner and professional staff relationships on firm independence* 3-16

Figure 3.6 Effects of Interests of Family Members, Relatives and Friends 3-17

Consulting Services Prohibited by the Sarbanes-Oxley Act Bookkeeping Financial systems design and Implementation Appraisal or valuation services Actuarial services Internal audit outsourcing Management functions or human resource services Investment services Legal services and expert services Certain tax services 3-18

Rule 102 Rule 102 – Integrity and Objectivity Applies to all members of the AICPA and to all services provided by CPAs Violations Makes, or permits or directs another to make, materially incorrect entries in a client’s financial statements or records Fails to correct financial statements that are materially false or misleading when member has such authority Signs, or permits or directs another to sign, a document containing materially false and misleading information 3-19

Rule 201 Rule 201 – General Standards Apply to all CPA services Member shall comply with following standards: Professional competence Due Professional Care Planning and Supervision Sufficient Relevant Data 3-20

Rule 202 Standards Technical Body Standards Auditing Standards Board (ASB) Management Consulting Services Executive Committee (MCSEC) Accounting and Review Services Committee (ARSC) ASB, MCSEC, and ARSC FASB, GASB and FASAC Standards Statements on Auditing Standards Statements on Standards for Consulting Services Statements on Standards for Accounting and Review Services Statements on Standards for Attestation Engagements FASB, GASB and FASAC Statements and related Interpretations 3-21 5 5

Rule 203 Accounting Principles Designates GAAP The Statements and Interpretations of FASB GASB FASAB 3-22

Rule 301 Confidential Client Information A member in public practice shall not disclose any confidential client information without the specific consent of the client. Auditors cannot directly disclose illegal acts by the client unless they have a legal duty to do so Confidential but not privileged communications with client 3-23

Rule 302 – Allowable Contingent Fees Allowable for clients for which the CPA provides none of the following services: An audit or review of financial statements A compilation of financial statements expected to be used by a third party and does not disclose a lack of independence An examination of prospective financial information Contingent fees are not allowed to prepare an original or amended tax return or claim for tax refund (Note: All tax contingent fees are prohibited under PCAOB Standards) 3-24

Rule 501 Retaining client records may be considered an act discreditable to the profession Rules: Client prepared records—should always be returned to the client. Client records prepared by the CPA (e.g. payroll records)—should be provided to client, except they may be withheld if they are incomplete or fees are due for them. Supporting records (e.g., adjusting entries)—should be provided to client, but may be withheld if fees are due for them. CPA working papers (e.g., audit programs)—CPA’s property and need not be provided to client , unless required by law. 3-25

Rules 502, 503, 505 Rule 502 – Advertising May advertise as long as it is not false, misleading or deceptive Rule 503 – Commissions Allowable commissions received must be disclosed to the client Rule 505 – Form of Organization & Name Can practice in any legal business form Allows fictitious names as long as not false, misleading or deceptive 3-26

Figure 3.9 – Alternative Practice Structures 3-27

IIA Code of Ethics--Principles Internal auditors are expected to apply & uphold the following principles:    Integrity. The integrity of internal auditors establishes trust and thus provides the basis for reliance on their judgment.  Objectivity. Internal auditors exhibit the highest level of professional objectivity in gathering, evaluating, and communi- cating information about the activity or process being examined. Internal auditors make a balanced assessment of all the relevant circumstances and are not unduly influenced by their own interests or by others in forming judgments.   Confidentiality. Internal auditors respect the value and ownership of information they receive and do not disclose information without appropriate authority unless there is a legal or professional obliga- tion to do so.   Competency. Internal auditors apply the knowledge, skills, and experience needed in the performance of internal auditing services.  3-28

IIA Code of Ethics— Rules of Conduct 1. Integrity;  Internal auditors: 1. Shall perform their work with honesty, diligence, and responsibility.  2. Shall observe the law and make disclosures expected by the law and the profession.  3. Shall not knowingly be a party to any illegal activity, or engage in acts that are discreditable to the profession of internal auditing or to the organization.  4. Shall respect and contribute to the legitimate and ethical objectives of the organization.   3-29

IIA Code of Ethics— Rules of Conduct 2. Objectivity;  Internal Auditors: 1. Shall not participate in any activity or relationship that may impair or be presumed to impair their unbiased assessment. This participation includes those activities or relationships that may be in conflict with the interests of the organization.  2. Shall not accept anything that may impair or be presumed to impair their professional judgment.  3. Shall disclose all material facts known to them that, if not disclosed, may distort the reporting of activities under review.  3-30

IIA Code of Ethics— Rules of Conduct 3. Confidentiality; Internal auditors: 1. Shall be prudent in the use and protection of information acquired in the course of their duties.   2. Shall not use information for any personal gain or in any manner that would be contrary to the law or detrimental to the legitimate and ethical objectives of the organization. 3-31

IIA Code of Ethics— Rules of Conduct 4. Competency; Internal auditors  1. Shall engage only in those services for which they have the necessary knowledge, skills, and experience.  2. Shall perform internal auditing services in accordance with the Standards for the Professional Practice of Internal Auditing.  3. Shall continually improve their proficiency and the effectiveness and quality of their services.  3-32