Chapter 19Professional

Conduct, Independence,

and Quality Control

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Ethics and Professional Conduct

Ethics

Professionalism

Refers to a system or code of conduct based on moral duties and obligations that indicate how an individual should

interact with others in society

Refers to the conduct, aims, or qualities that characterize or mark a profession or professional person

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Theories of Ethical Behavior

UtilitarianismA subset of

Consequentialism

Rights-Based Approach

Justice-Based Approach

Recognizes that decision making involves trade-offs between the benefits and burdens

of alternative actions and focuses on consequences and on individuals affected

Assumes that individuals have certain rights and other individuals have a duty to

respect those rights when making decisions

Is concerned with issues such as equity, fairness, and impartiality

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Standards for Auditor Professionalism

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Three Categories of Standards for Ethics/Independence/Quality Control

Figure 19-1 in your text is not the way I organize my thinking about these standards. I view them as three categories:– Work on US private companies

AICPA (Code of Professional Conduct; Statement on Quality Control Standards No. 8)

– Work on US public companies SEC Rule 2-01; PCAOB Rules 3520 thru 3524; AS 7

– Work on companies outside the US that do not register with the US SEC

IFAC Handbook of the Code of Ethics for Professional Accountants

3 categories of standards (continued)

Here is how the text authors generally present the information in Chapter 19, to try to reduce unnecessary detail– Independence rules at the individual person

level are discussed re the AICPA Code– Independence rules at the CPA firm level are

discussed re the SEC rules– Quality control is discussed re the PCAOB rules– Discussion of peer review (AICPA)– Discussion of inspections (PCAOB)

The AICPA Codeof Professional Conduct:

A Comprehensive Framework for AuditorsPrinciples of Professional

Conduct

Rules of Conduct

Interpretations of Rules of Conduct

Rulings by the Professional Ethics

Executive Committee (PEEC)

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The AICPA Code ofProfessional Conduct:

A Comprehensive Framework for Auditors

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Principles of Professional Conduct

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Rules of ConductLO# 7

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Independence

Financial Statement Reviews

Financial Statement

Audits

Other Attest Services as defined by

SSAEs

Rule 101 A member in public practice shall be independent in the

performance of professional services as required by standards promulgated by bodies designated by Council.

Interpretation 101-1 “Covered members” must be independent.

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Covered Members

1. An individual on the attest engagement team

2. An individual in a position to influence the attest engagement

3. A partner or manager who provides nonattest services to the attest client beginning once he or she provides 10 hours of nonattest services

4. A partner in the office in which the lead attest engagement partner primarily practices in connection with the attest engagement

5. The firm, including the firm’s employee benefit plan

6. An entity whose operating, financial, or accounting policies can be controlled by any of the individuals or entities described above or by two or more such individuals or entities if they act together

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Prohibited Financial Relationships

Results when a covered member has a financial interest in an attest client, such

as ownership of stock or a loan to or from the client

Results when a covered member has a financial interest in an entity that is associated with an attest client, for

example an investment in a mutual fund that owns the client’s stock

Direct

Exception: Certain types of personal loans from financial institutions who are clients are permitted

Material Indirect

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Prohibited Business Relationships

Rule 101 and relevant interpretations essentially indicate that the independence of a

CPA is impaired if the CPA performs a managerial or other significant role for a

client’s organization during the time period covered by an attest engagement.

Interpretation 101-2 indicates that a firm’s independence will be considered to be

impaired with respect to a client if a partner or professional employee leaves the firm

and is subsequently employed by a client in a key position unless a number of

conditions are met.

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Effect of Family Relationships

A covered member’s immediate family (spouse, spousal equivalent, or dependent) is subject to

Rule 101 and its interpretations and rulings.

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Effect of Family RelationshipsTwo major situations with close relatives that can impair

independence:

1. A close relative has a financial interest in the client that is material to the close relative, and the CPA participating in the engagement is aware of the interest.

2. An individual participating in the engagement has a close relative who could exercise significant influence over the financial or accounting policies of the client.

Close relatives include nondependent children, brothers, sisters, parents, grandparents, parents-in-law, and their respective

spouses.

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Effect of Actual orThreatened Litigation

The commencement of litigation by management alleging deficiencies in audit work for the client would

be considered to impair independence.

An expressed intention by management to commence litigation against the CPA alleging deficiencies in audit

work would also impair independence if the auditor concluded that it is probable that such a claim will be

filed.

The commencement of litigation by the CPA against management alleging management fraud or deceit

would be considered to impair independence.

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Provision of Nonaudit Services

AICPA Code of Professional Conduct restricts somewhat the types of nonaudit services that

can be provided to attest clients.

SEC has more restrictive independence rules for audits of public companies.

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SEC Independence Requirements for Audits of Public Companies

The SEC’s rules are predicated on three basic principles of auditor objectivity and

independence:

1.An auditor should not audit his or her own work.

2.An auditor should not function in the role of management.

3.An auditor should not serve in an advocacy role for his or her client.

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SEC Independence Requirements for Auditsof Public Companies

Bookkeeping

Financial Information

Systems Design and

Implementation

Appraisal or Valuation Services

Actuarial Services

Internal Auditing

Outsourcing Services

Management Functions or

Human Resources

Broker or Dealer

Legal Services

Expert Services

Categories of Generally Prohibited Nonaudit Services

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SEC “revolving door” and “cross selling” rules from SarBox (inspired by Enron/Andersen)

Partners are limited to five consecutive years.

Partners are limited to five consecutive years.

A one year “cooling off” period is required if you

work on audit of a company to leave CPA firm and join company in a “financial reporting

oversight role”.

A one year “cooling off” period is required if you

work on audit of a company to leave CPA firm and join company in a “financial reporting

oversight role”.

A firm is not independent if an audit partner’s compensation

is based on selling engagements to that

client for services other than audit, review, and

attest services.

A firm is not independent if an audit partner’s compensation

is based on selling engagements to that

client for services other than audit, review, and

attest services.

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SEC Required Communications for Audits of Public Companies

SEC rules require additional communication between auditors and their clients’ audit

committees and require public-company audit clients to publicly reveal information regarding

the fees (audit and otherwise) paid to their auditors.

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Integrity and ObjectivityRule 102

In the performance of any professional service, a member shall maintain objectivity and integrity, shall be

free of conflicts of interest, and shall not knowingly misrepresent facts or subordinate his or her judgment to

others.

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General Standards and Compliance with Standards

Rule 201 A member shall comply with the following standards and with any interpretations thereof by bodies designated by

Council.

Due Professional

Care

Professional Competence

Planning and Supervision

Sufficient Relevant

Data

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General Standards and Compliance with Standards

Rule 202 A member who performs auditing, review, compilation,

management consulting, tax, or other professional services shall comply with standards promulgated by bodies designated

by Council.

This rule is important because it requires that members of the AICPA comply with professional standards when performing professional services, whether or not they are practicing in

public accounting.

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Accounting Principles

Rule 203 A member shall not (1) express an opinion or state affirmatively that the financial statements or other

financial data of any entity are presented in conformity with GAAP or (2) state that he or she is not aware of any material modifications that should be made to such statements or data in order for them to be in conformity with GAAP, if such statements or data

contain any departure from an accounting principle promulgated by bodies designated by Council to

establish such principles that has a material effect on the statements or data taken as a whole.

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Confidential Client InformationRule 301

A member in public practice shall not disclose any confidential client information without the specific

consent of the client.

To comply with a valid

subpoena

To meet GAAP or GAAS

disclosure requirements

As required by an authorized peer review

body

As part of an investigative or

disciplinary proceeding

Five Situations Where CPAs Can Disclose Confidential Information

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In connection with a purchase, sale, or merger of the

practice

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Contingent Fees

Rule 302A member shall not

(1)Perform for a contingent fee any professional service for, or receive such a fee from, a client for whom the member or the member’s firm performs (a) an audit or review of financial statements, (b) a compilation of financial statements expected to be used by a third party if the compilation report does not disclose a lack of independence, or (c) an examination of prospective financial information, or

(2)Prepare an original or amended tax return or claim for

refund for a contingent fee for any client.

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Acts Discreditable

Rule 501 A member shall not commit an act discreditable to the

profession.

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Acts Discreditable Inappropriate response to requests by clients and former clients for certain

records (501-1). Discrimination and harassment in employment practices (501-2). Failure to follow standards and/or procedures or other requirements in

government audits (501-3). Negligence in the preparation of financial statements or records (501-4). Failure to follow the requirements of government bodies, commissions, or

other regulatory agencies in performing attest or similar services (501-5). Solicitation or disclosure of CPA examination questions and answers (501-

6). Failure to file tax return or pay tax liability (501-7). Including certain types of indemnification and limitation of liability

provisions in agreements for the performance of audit or other attest services in jurisdictions where such provisions are prohibited (501-8).

Confidential information obtained from employment (501-9). Financial interests (501-10). False, misleading, or deceptive acts in promoting or marketing professional

services (501-11).

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Advertising andOther Forms of Solicitation

Rule 502 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. Solicitation by the use of coercion, over-reaching, or

harassing conduct is prohibited.

Best CPA in the World!

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Prohibited Advertising Creating false or unjustifiable expectations of

favorable results. Implying an ability to influence any court, tribunal,

regulatory agency, or similar body or official. Claiming that specific professional services in current

or future periods will be performed for a stated fee, estimated fee, or fee range when it is likely at the time of representation that such fees will be substantially increased and the prospective client is not advised of that likelihood.

Making any other representations that would be likely to cause a reasonable person to misunderstand or be deceived.

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Commissions and Referral FeesRule 503

Prohibited Commissions: A member in public practice shall not for a commission recommend or refer to a client any product or service

or receive a commission, when a member or the member’s firm also performs for that client (a) an audit or review of financial

statements, (b) a compilation of financial statements expected to be used by a third party and the compilation report does not

disclose a lack of independence, or (c) an examination of prospective financial information.

Disclosure of Permitted Commissions: A member in public practice who is not prohibited by this rule from performing services for or receiving a commission and who is paid or expects to be paid a commission shall disclose that fact to any person or entity to

whom the member recommends or refers a product or service to which the commission relates.

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Commissions and Referral Fees

Rule 503 Referral Fees: Any member who accepts a referral fee

for recommending or referring any service of a CPA to any person or entity or who pays a referral fee to obtain a client shall disclose such acceptance or payment to

the client.

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Form of Organization and NameRule 505

A member may practice public accounting only in a form of organization permitted by law or regulation whose

characteristics conform to resolutions of Council.

A member shall not practice public accounting under a firm name that is misleading. Names of one or more past partners may be included in the firm name of a

successor organization.

A firm may not designate itself as “Members of the American Institute of Certified Public Accountants”

unless all of its CPA owners are members of the Institute.

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The Professional Ethics Executive Committee (PEEC) can direct a member to take remedial or

corrective actions.

The Professional Ethics Executive Committee (PEEC) can direct a member to take remedial or

corrective actions.

Disciplinary Actions

Termination of AICPA

Membership

Termination of AICPA

Membership

Suspend AICPA

Membership

Suspend AICPA

Membership

AICPA Trial

Board Actions

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Quality Control StandardsCPA firms are required to implement policies and procedures to monitor the firms’ practices and ensure that professional

standards are being followed.

In 2004, PCAOB assumed the AICPA’s responsibilities relating to firms that audit public clients and instituted a mandatory quality inspection program for those firms.

The AICPA continues to administer a quality review system in order to enable firms to meet their state licensing, federal

regulatory, and AICPA membership requirements and to serve firms that audit only privately held clients.

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Elements of Quality Control

Leadership: Tone at the Top

Relevant Ethical Requirements

Client Acceptance and

Continuance

Engagement Performance

Monitoring

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Human Resources

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PCAOB Inspections of Registered Public Accounting Firms

The PCAOB conducts regular inspections of public accounting firms that are

required to register with the Board.

The PCAOB conducts regular inspections of public accounting firms that are

required to register with the Board.

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End of Chapter 19

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