1. Professional Liability and the Need for Quality Auditor Judgments and Ethical Decisions

2. Learning Objectives Articulate a framework for professional decisions
Define ethics and ethical theories
Identify the two parts of the AICPA Code of Professional Conduct
Describe the AICPA (and IESBA) principles of professional conduct
Discuss each of the rules of conduct of the AICPA, as well as the PCAOB & SEC’s independence rules
Describe the enforcement procedures for the Code of Professional Conduct
Describe monitoring of public accounting firms

3. The Audit Process I. Making client acceptance and continuance decision
Chapter 1
II. Performing risk assessment
Chapters 3, 7 and 9-13
III. Obtaining evidence about internal control operating effectiveness
Chapters 8-13 and 16
IV. Obtaining substantive evidence about accounts, disclosures and assertions
Chapters 8-13 and 16
V. Completing the audit and making reporting decisions
Chapters 14 and 15
The auditing profession, regulation, corporate governance, and audit quality
Chapters 1 and 2
Professional liability and the need for quality auditor judgments and ethical decisions
Chapter 4
Audit opinion formulation process and a framework for obtaining audit evidence
Chapters 5 and 6

4. Professional Judgment Framework
The importance of making judgments in accounting and auditing continues to increase for a variety of reasons:
The increase in size, complexity and activities of businesses
The increasing complexity of accounting standards
The move toward principles-based accounting standards
The continual monitoring of performance and increased regulation
Professional judgment framework, E&Y Foundation

5. Professional Judgment Framework
Benefits that can result from using a framework:
Consistency and confidence in decision making
Enhanced ability to consider alternatives
The ability to better discuss issues with others
Improved ability to reach a well-supported outcome
A mechanism for improved documentation
Enhanced risk management
Better communication when consulting with others
Professional judgment framework, E&Y Foundation

6. Overview of the Professional Judgment Framework
Track, organize and evaluate considerations:
Define the issue
Gather the facts
Perform the analysis
Make the judgment
Document the judgment
Professional judgment framework, E&Y Foundation

7. Overview of the Professional Judgment Framework
Overarching considerations:
Manage any bias
Consider the risk of material misstatement
Consider the involvement of others
Maintain professional skepticism
Professional judgment framework, E&Y Foundation

8. Professional Judgment Framework
Common biases in decision making:
Availability/interference
Confirmatory trap
Overconfidence
Anchoring
Groupthink
Motivated reasoning
Professional judgment framework, E&Y Foundation

9. Professional Judgment Framework
Common techniques to reduce the effect of bias and facilitate professional skepticism include:
Delaying final judgment
Generating alternatives
Reframing
Counterfactual
Documenting reasons and counter reasons
Professional judgment framework, E&Y Foundation

10. KPMG Audit Judgment Framework
Mindset
Clarify Issues and Objectives
Consider
Alternatives
Evaluate Information
Reach Conclusions
Articulate and Document Rationale

11. Ethics Defined
The term ethics in the philosophical sense refers to the set of moral standards for right or wrong that a person, a group, or a society develops.
Each person, group, or society uses moral reasoning to decide whether or not an action is ethical, i.e., to make an ethical decision.

12. Ethical Theories
Ethical decisions are guided by ethical theories, which can be explained by simple maxims:
The utilitarian theory
The rights theory
The golden rule
Kant’s categorical
The professional ethics

13. A Framework for Ethical Decision Making
In applying ethical theories, the use of a checklist or a framework can be helpful.
What are the relevant facts?
What is the ethical issue/decision?
What alternative courses of action are available?
What are the consequences of alternative actions?
What is the appropriate action?

14. Professional Ethics
Professional ethics differ from general/individual ethics in that they emphasize right and wrong behavior for members of a profession. They are much more specific.
Why do most professions have a code of ethics?
Professions have a responsibility to provide quality service.
The body of knowledge in a profession is complex.
The public relies on the profession.
Professions assume self-discipline beyond the requirements of law.

15. The IESBA Code of Ethics
The IESBA Code of Ethics require accountants to adhere to five fundamental principles:
Integrity
Objectivity
Professional Competence and Due Care
Confidentiality
Professional Behavior

16. AICPA Code of Professional Conduct
The AICPA Code of Professional Conduct has two sections:
Principles. Principles are goals or ideal professional and ethical conduct by CPAs. They are not enforceable.
Rules. Rules reflect the principles. They are the min. standards of the profession & are enforceable.
The bylaws of the AICPA give authority to the Professional Ethics Executive Committee to interpret the rules and issue rulings (enforceable).

17. AICPA Code of Professional Conduct
In June 2014, the Professional Ethics Executive Committee (PEEC) adopted a revised Code, with an effective date of December 15, 2014, to converge the Code with the International Ethics Standards Board (IESBA) Code. The revised code is a codification of the existing principles, rules, interpretations, and rulings.
Additionally, the Code includes two conceptual frameworks (effective 2015) that members can use when facing circumstances not explicitly addressed by the Code.

18. Principles of the Code of Professional Conduct
CPA’s responsibilities ( )
Members should exercise sensitive professional and moral judgments in all activities
The public interest ( )
Act in a way that will serve the public interest, honor the public trust, and demonstrate commitment to professionalism
Integrity ( )
Perform all professional responsibilities with the highest sense of honesty and candidness

19. Principles of the Code of Professional Conduct
Objectivity and independence ( )
Be impartial and free of conflicts of interest in discharging responsibilities
Due care ( )
Observe the profession’s technical and ethical standards, strive to improve competence and quality of service, and discharge professional responsibilities to the best of ability
Scope and nature of service ( )
Observe the principles of the Code of Professional Conduct in determining the nature and the scope of services to be provided

20. Rules of the Code of Professional Conduct
AICPA members are responsible for compliance with the Rules of the Code of Professional Conduct, including interpretations and rulings.
AICPA members are also responsible for compliance with the rules by all persons associated with them in the practice of public accounting, and by all persons who act on their behalf.
The rules do not cover all conditions that might occur; CPAs must look to the frameworks.

21. Integrity and Objectivity (1.100.001)
In the performance of any professional service, a member in public practice shall:
maintain objectivity and integrity
be free of conflicts of interest
not knowingly misrepresent facts or subordinate his or her judgment to others

22. Independence ( )
Independence is required for all audit, review, and other attest engagements.
Independence rule applies only to covered members and their immediate families (with exceptions):
An individual on the attest engagement team
An individual in a position to influence the attest engagement, or
A partner in the office in which the lead attest engagement partner primarily practices in connection with the attest engagement

23. Independence – Financial Interest (1.240.010)
Independence is considered impaired if during the period of the professional engagement:
a covered member had or was committed to acquire any direct or material indirect financial interest in the client;
a covered member was a trustee of any trust or executor or administrator of any estate if such trust or estate had or was committed to acquire ...;
a partner or professional employee of the firm, his or her immediate family, or together, had more than a 5 percent ownership interest in a client.

24. Direct and Indirect Financial Interest - Definition
A direct financial interest is:
Owned directly by an individual or entity; or
Under the control of an individual or entity; or
Beneficially owned through an intermediary (e.g., an investment vehicle, estate, trust) when beneficiary:
Controls the intermediary; or
Has the authority to supervise or participate in the intermediary’s investment decisions.
An Indirect financial interest is:
beneficially owned but the beneficiary neither controls the intermediary nor has the authority to supervise or participate in the intermediary’s investment decisions.

25. Independence – Loans, Leases, and Guarantees (1.260.010)
Independence is considered impaired if during the period of professional engagement a covered member had any loan to or from the client or any officer, director, or a stockholder with more than a 10% ownership interest, except as specifically permitted.
Permitted Loans:
Unsecured loans not material to covered member’s net worth
Fully collateralized automobile loans and leases and mortgages
Loans fully collateralized by cash surrender value of an insurance policy or by cash deposits at the financial institution
Credit cards and overdraft reserve accounts that are reduced to $10,000 or less on a current basis

26. Independence – Joint Closely Held Investments (1.265.020)
Independence is considered impaired if during the period of the professional engagement a covered member had any joint, closely held investment that was material to the covered member’s net worth.

27. Independence – Simultaneous Employment or Association
Independence is considered impaired if:
During the period covered by the financial statements or during the period of the professional engagement
a firm, or partner or professional employee of the firm was simultaneously associated with the client as a(n)
director, officer, or employee, or a member of management;
promoter, underwriter, or voting trustee; or
trustee for any pension or profit-sharing trust of the client.

28. Effects of a CPA’s Relatives on Independence
Type of Relative
Immediate relatives (spouse, spousal equivalent and dependents)
Effect on Independence
Independence rules are the same as for the CPA
Would affect independence if close relative
is employed by the client in a key or audit sensitive position, or
has a financial interest that
is material to the relative or
enables relative to exercise significant influence over client
Close Relatives (e.g., nondependent children, stepchildren, brothers, sisters, grandparents, parents, parents-in-law)
Remote Relatives
Ordinarily would not affect independence

29. The SEC’s Independence Rules
In 2000, the SEC issued independence rules that mandated an engagement team model and emphasized independence in appearance.
Those rules prohibited relationships or services that
Create a mutual or conflicting interest
Place the auditor in the position of auditing his/her own work
Result in the auditor acting as a client’s management or employee, or
Place the auditor in the position of acting as the client’s advocate

30. Sarbanes-Oxley Act and SEC’s Independence Rules of 2003
Section 201 of the Act, Services Outside the Scope of Practice of Auditors, prohibits nine services (SEC issued rules on 1-8):
Bookkeeping or other services related to accounting records of audit clients
Financial information systems design and implementation
Appraisal/Valuation services, fairness opinions or contribution-in-kind reports
Actuarial services
Internal audit services
Management functions or human resources
Broker or dealer, investment advisory or investment banking services
Legal services or expert services unrelated to the audit
Any other service that the Board (PCAOB) determines is impermissible
Other services have to be approved by client’s BOD in advance.

31. Sarbanes-Oxley Act and the SEC’s Independence Rules
In addition to revising rules for provision of non-audit services, and requiring that the audit committee pre-approve all audit and non-audit services the auditor provides, in January 2003 the SEC issued new rules that
Require rotation of lead and concurring Partners after no more than five years
Prohibit accounting firms from auditing a client which employs one of the client’s former auditors within the one-year period preceding the audit
Prohibit partners from earning compensation from selling non-attest services to an audit client

32. General Standard ( )
A member shall comply with the following standards:
Professional competence
Due professional care
Planning and supervision
Sufficient relevant data

33. Compliance With Standards (1.300.001)
A member who performs professional services shall comply with the standards promulgated by bodies designated by the council.

34. Accounting Principles (1.320.001)
A member shall not:
affirm that financial data or statements are in conformity with GAAP, or
state that he or she is not aware of any material modifications that should be made for the financial statements to be in conformity with GAAP,
if such data or statements contain any departures from GAAP

35. Acts Discreditable ( )
A member shall not commit an act discreditable to the profession.
Discreditable acts include:
Retention of client records (not CPA’s work paper) by a CPA after a demand is made for them
Violation of any anti-discriminatory laws of the US, a state, or municipality
Soliciting or knowingly disclosing CPA exam questions or answers

36. Contingent Fees (1.510.001) A member in public practice shall not:
Performs for a contingent fee
an audit or review of financial statements
a compilation of financial statements that are expected to be used by a third party and the compilation report does not disclose a lack of independence
an examination of prospective financial information
Prepare an original or amended tax return or claim for a tax refund for a contingent fee for any client

37. Commissions and Referral Fees (1.520.001)
A member in public practice who is engaged to perform attestation services in Contingent Fees rule is prohibited:
from recommending or referring for a commission any product or service to a client,
from recommending or referring for a commission any product or service to be supplied by a client, or
from receiving a commission
Permitted commissions and fees must be disclosed.

38. Advertising and Other Forms of Solicitation (1.600.001)
A member in public practice shall not seek to obtain clients by advertising, or other forms of solicitation, in a manner that is false, misleading, or deceptive.
Advertising is false, misleading, or deceptive if it:
creates false expectations of favorable results
implies the ability to influence any court, tribunal, regulatory agency, or similar body or official
contains a representation about fee or fee range that is substantially lower than the fee likely to be charged
contains a representation that is likely to cause a reasonable person to misunderstand or be deceived

39. Confidential Client Information (1.700.001)
A member in public practice shall not disclose any confidential information without the specific consent of the client.
Confidentiality rule does not apply:
when court ordered subpoenas or summons exist
in examination of work papers as part of ethics division inquiry or quality review
In addition, confidentiality rule does not relieve members of their duties under Compliance with Standards rule and Accounting Principles rule.

40. Form of Organization and Name (1.800.001)
A member may practice public accounting only in the form of organization permitted by state law or regulation, or a professional corporation whose characteristics conform to resolutions of the council.
A member shall not practice under a firm name that is misleading.
A firm may not designate itself as members of AICPA unless all of its CPA owners are members.

41. Enforcement of the Code of Ethics
Enforcement of ethics potentially involves four groups:
State Board of Accountancy
grants the license to practice public accounting
can impose penalties for violation of the code
typically has adopted the AICPA rules of conduct or a set of similar ones
Securities and Exchange Commission
rules may differ significantly from those of AICPA
can impose penalties for violating SEC rules

42. Enforcement of the Code of Ethics
AICPA Professional Ethics Division
interprets and enforces Code of Professional Conduct
investigates complaints and other information that comes to its attention
if violation is found, member may be required to take CE courses and submit future work for Division review
if violation is severe, the member is referred to the Joint Trial Board
AICPA Joint Trial Board
conducts hearing of charges brought by the Ethics Division and/or state societies
can suspend or dismiss violators from AICPA member

43. Monitoring Public Accounting Firms
For all firms
Quality control – policies and procedures a firm establishes to ensure consistent performance in conformity with professional standards
Firms with public audit clients
PCAOB Rules for Inspection & AICPA Center for Public Company Audit Firms
Firms without public audit clients
Practice monitoring (peer review)