Chapter 4 Flashcards
What is professional judgement influenced by?
Personal behavioral traits as well as ones knowledge of accounting and auditing issues in question
Personal values link to ethical and sensitivity judgement
T OR F
T
For an auditor, what is essential in making professional judgements?
Professional skepticism
What is judgement?
Process of reaching a decision or drawing a conclusion where there are a number of possible alternative solutions
Where does judgement occur?
In a setting of uncertainty, risk, and conflicts of interest
Intuitive judgements fall prey to cognitive traps and biases that negatively influence judgement
T
Judgement triggers can lead to
Accepting a solution to the problem before it is properly identified and evaluated
What is professional skepticism?
To inquire or reflect
Inquire is to seek for information by asking questions
What is linked to professional judgement through ethical standards of independent thought, objectivity, and due care which are incorporated in AICPA code of professional conduct?
Professional skepticism
How to promote professional skepticism?
Set a tone that emphasizes a questioning mind throughout the audit and exercise of professional skepticism
When professional judgement is compromised by taking shortcuts or allowing biases and pressures to be imposed by others to taint decision making, how does the public feel about this?
The public loses trust in the accounting profession
Public interest for accountancy profession, policy position paper #4, addresses what?
Public interest, it is designed to enable IFAC and others to evaluate if public interest is being served
The international ethics standards board for accountants (IESBA), includes fundamental principles of professional ethics. What are the fundamental principles?
- Integrity
- Objectivity
- Professional competence & due care
- confidentiality
- Professional behavior
In AICPA, the public interest includes who?
- Clients
- Creditors
- Governments
- Employers
- Investors
- Business and financial community
- Others that rely on objectivity and integrity of CPA
What were the major themes in the investigation of profession?
- Whether nonauditing services impair auditor independence
- Need for mgmt to report on IC
- Importance of developing techniques to prevent and detect fraud
- Need to strengthen role of audit committee and communications between auditor and audit committee
What was the first real investigation of accounting profession since 1930s?
Metcalf (Moss) committee
What were the recommendations made for moss committee?
- Establish self regulatory organization of firms that audit publicly owned companies
- Limit management services to those relating directly to accounting
Cohen commission examines a variety of issues, what’s one of the main ones?
Auditors responsibility to detect fraud and expectation gap between public and audit services
What were some recommendations that the Cohen commission made and was enacted in legislation as part of SOX?
- mgmt should report its IC to users of FS
- auditor should evaluate mgmt report
Representative RON WYDEN introduces a bill. What was this bill?
This bill holds accounting profession responsible for the detection of fraud in light of the failure of ESM government securities failures
What was the greatest collapse of US financial institutions since the Great Depression?
Saving and loan failures
The accounting issues in failed S&Ls centered on what three issues?
- Failure to provide adequate allowances for loan losses
- Failure to disclose dubious deals between S &Ls
- Existence of inadequate IC
Treadway committee was formed in 1985 to study and report what?
The factors that can lead to fraudulent financial reporting
National commission on fraudulent financial reporting is known as
Treadway commission report
What creates the public company accounting oversight board (PCAOB)? And for what purpose??
SOX 2002
Oversee auditing profession
What does SOX 2002 indicate?
Mgmt is responsible for establishing and maintaining IC.
CEO AND CFO must confirm the IC over financial reporting
Auditors need to attest the effectiveness of IC
What is corporate management responsible for?
To review and ensure a firms FS presentations and disclosures are fair
Should inform external auditors about material IC weaknesses and potential frauds
Audit committee must consist of?
- independence
- one must be financial expert
- responsible to oversee internal auditors and work with external auditors
The financial crisis of 2007-2008 was brought on by what?
Excessive risk taking and mortgage meltdown
What is moral hazard?
One party is responsible for interests of another, but has incentive to put its own interests first
Who leads the financial crisis?
Lehman brothers
Why did the Lehman brothers fail?
Unable to retain confidence of lenders
Did not have sufficient liquidity to meet current obligations
What is repo 105?
Accounting loophole to repurchase (repo) transactions
Attempt to hide true amounts of leverage
What happens in the repo market?
Firm can gain access to fiends for short periods in exchange for collateral
Firm that borrows funds promises to pay back ST loan never changes hands
This is what allows firms to record incoming cash as a sale — collateral is assumed to have been sold off and bought later
AICIPA Issued what?
Codification of the principles, rules and interpretations and rulings in AICPA professional code of conduct that’s simplified the identification of topics
What is the most significant change in revised code ?
There are two broad conceptual frameworks,
- one for members in public practice
- one for CPAS in business
The two new conceptual frameworks provide a what kind of approach?
Threats and safeguards
Designed to assist users in analyzing relationships and circumstances that code does not specifically address
What was the most significant improvement in the AICPA revised code?
Ethical conflicts section
The conceptual framework for independence standards is used to evaluate what?
Independence matters
AICPA uses what to assess whether CPAs relationship with client would pose unacceptable risk?
Risk based approach
Under the risk based approach, steps are taken to do what?
Prevent circumstances that threaten independence from compromising the professional judgements required in the performance of an attest engagement
The risk based approach, involves what steps?
- Identify and evaluate threats to independence
- Determine if safeguards already eliminate identified threats and if threats have not been mitigated and can be elimated by safe guards
- If no safeguard available to eliminate threat or reduce it to a acceptable level, independence will be considered impaired
Independence is defined as?
State of mind that permits the performance of an attest service without being affected by influences that compromise professional judgment thereby allowing individual to act with integrity and professional skepticism
What are some threats to independence?
- Self review
- occurs when a CPA reviews evidence during attest engagement that is based on her own or her firms nonattest work - Advocacy threat
- promotes clients interest in a way that objectivity may be perceived as compromised - Adverse interest threat
- takes action opposite to an attest clients interest or position - Familiarity threat
- close relationship between COA and attest client or employees, top management etc - Undue influence threat
- attempt made by mgmt of an attest client or other parties to coerce COA or exercise excessive influence over CPA - Financial self interest threat
- potential benefit to CPA from financial interest with attest client - Management participation threat
- CPA takes on role of client mgmt or other performs mgmt functions on behalf of attest client
What are safeguards?
Controls that eliminate or reduce threats to independence
There are three broad categories of safeguards, what are the three?
- Safeguards created by profession, legislation or regulation
- Safeguards implemented by client
- Safeguards implemented by firm
IFAC establishes international ethics standards board for accountants (IESBA) to develop?
To develop and issue high quality ethical standards and other pronouncements for professional accountants for use around the world
What are the IFAC fundamental principles?
- Integrity
- Objectivity
- Professional competence and due care
- Confidentiality
- Professional behavior
Financial relationships problems
The problem with owning direct and material indirect financial interests in a client is that it might create the impression that CPA cannot make decisions without being influence by stock ownership
An example of financial self interest threat is
When a CPA becomes involved ins loan transaction to or from a client including home mortgage loans
What are some permitted loans?
Automobile loans collateralized by car
Loans fully collateralized by cash deposits
Aggregate credit card balances from credit cards and overdraft account reduced to $10000 or less
Threats to independence also include
- family relationships
- spouse, spouse equivalent, dependents,
- close relatives such as parent, sibling non dependent children
-other relationships
• partner or manager who provides more than 10 hours of non attestation services to attested clients
•
Independence may be impaired if a partner or professional employee leaves the firm and is subsequently employed by client in a key position unless:
- Amounts due to former professional are not material to firm
- Former professional employee is not in position to influence the accounting firms operations or financial policies
- Former professional employee does not participate in, appear to participate in or is not associated with the firm when relationship with client begins
Congress and SEC are concerned about a possible impairment of audit independence when the firm provides what type of services to client?
Non audit services
What are the requirements for the client when a cpa performs nonattest services?
- Assume all mgmt responsibilities
- Oversee service by a individual in particular senior mgmt
- Evaluate the adequacy and results of services performed
- Accept responsibility for the result of services
What are some non traditional forms of ownership?
- CPA firm is acquired by public company that provides non attestation services and also provides a spin off of the original firm that provides attest services
SEC emphasizes independence in what three ways?
- Proscribing certain financial interests and business relationships with audit client
- Restricting provision of certain nonauditing services to clients
- Subjecting all auditor conduct to general standard of independence
SEC came up with three basic principles that underlie auditor independence, what are they?
- An auditor cannot function in the role of government
- And auditor cannot audit her own work
- An auditor cannot serve in an advocacy role for his client
How is general standard of independence evaluated?
By applying four principles that are similar to AICPA conceptual framework and indicate if auditor independence may be impaired by relationship with audit client
An auditors independence may be impaired due to the following situations, what are the situations?
- Create a mural or conflicting interest between accountant and audit client
- Place accountant in position of auditing own work
- Results accountant acting as mgmt
- Places an accountant in a position of being an advocate for the audit client
Under the revised code ( AICPA CODE), what should CPAs do ?
They should assess to see if an ethical conflicts exist
How do ethical conflicts create challenges?
It creates challenges to decision making because they present barriers to meeting the requirements of the rules of conduct
If the conflicts are left unresolved, what will happen?
It will lead to a violation of the rules of conduct
Conflicts of interest for members in Public practice occur when?
A professional service, relationship or specific matter creates a situation that might impair objective judgement
Conflicts creates what type of threats to integrity and objectivity?
Adverse threats
Self interest threats
If a conflict of interest exists, what should the CPA do?
Disclosure nature of conflict to clients and obtain their consent to perform professional services even if threats are at an acceptable level.
If CPAs do not receive consent from client to perform professional services, what should The CPA do?
- should cease performing services
- take action to eliminate or reduce threat to an acceptable level
What does the subordination of judgement interpret?
Addresses differences of opinion between a CPA and that person’s supervisor or others within the organization
Steps that should be taken when faced with situations where difference of opinions exist
- Consider any threats to integrity and objectivity
- Evaluate significance of threats to determine if at acceptable level
- If at acceptable level, discuss conclusion with person taking position, if not at acceptable level discuss concerns to supervisor
- If not resolved discuss with higher management
Some safeguards include:
- Tone at top
- Policies and procedures that address ethical conduct and compliance with laws rules regulations
- Internal policies and procedures for disclosure of interests and relationships
- Whistleblower hotlines
- Internal auditors not allowed to audit areas where they have operational responsibilities
- Policies for promotion, rewards and enforcement of a culture of high ethics and integrity
- Use of third party resources for consultation as needed
Section 201 of SOX provides that the following non attest services may not be performed for attest clients in addition to book keeping or towhee services related to accounting records or financial statements of the audit client:
( SOX NON AUDIT SERVICES)
- Financial information system design and implementation
- Appraisal or valuation services
- Actuarial services
e4. Internal audit outsourcing services - Mgmt functions or Human Resources
- Broker or dealer, investment adviser or investment banking services
- Legal services and expert services unrelated to audit
- Any other service that the BOD by regulation is impermissible
What are the rules of professional practice?
- General standards
- Acts discreditable
- Fees and other types of remuneration
- Advertising and other forms of solicitation
- Confidential information
- Form of organization and name
What is the general standards rule?
Establishes requirements for competence, compliance with professional standards and adherence to accounting principles
Acts discreditable covers what?
A broad number of actions that may bring discredit to the profession including discrimination and harassment in employment practices, solicitation or disclosure of CPA examination questions and answers, failure of CPA firm to file and pay income taxes, negligence in preparation of financial statements and standards relating to governmental accounting and auditing.
Under the rule, CPA is prohibited to accept contingent fees if CPA performs the following:
- Audit or review of F/S
- Compilation of F/S when CPA expects or might reasonably expect that a third party will use the financial statement and compilation report does not disclose lack of independence
- Examination of prospective financial information
- Preparation of an original or amended tax return or claim for tax refund for a contingent fee for any client
What is the danger of accepting contingent fee?
It creates financial self interest threat to independence that may be not be reduced or eliminated by safeguards
Exceptions do exists in tax practice where a contingent fee can be accepted including
- If fee is fixed by court or Public authority
- Of fee is determined based on results of judicial proceedings or the findings of governmental agencies
- When filing amended state fed tax return claiming tax refund based on tax issue that is subject of a tax case incolving different tax payer
- When filing amended federal or state income tax return claiming a tax refund that is greater than the threshold for review by joint committee
Contingent fees and commissions are permitted when?
Performing advisory type services for a non attestation client
Is the commission and referral fee similar to contingent fees?
Yes
When advertising and solicitating, the forms of communication cannot be
False, misleading or deceptive
What is the general requirement to maintain client confidentiality ?
The CPA should not disclose confidential client information without the specific consent of the client
Rule permits CPA to discuss confidential client information without violating the rule in the following situations:
- In response to a validly issued subpoena or summons
- Provide information necessary for review of CPA professional practice
- Provide information necessary for ones defense in an investigation of the COA in a disciplinary matter
What do tax services include?
Tax compliance, much of service is served from audited financial records, tax consulting, tax planning and tax shelters
Tax professional dual obligations to the client include ?
To act as an advocate and to foster integrity in the tax system by honestly and fairly administering tax laws
When performing tax services, a CPA is expect to consider what?
If there Any threats to independence that cannot be reduced or elimated by safeguards and how such matters will be handled to avoid a violation of audit independence
How many statements on standard for tax services (SSTS) exist? And what do they explain?
There are 7
They explain CPAs responsibilities to their clients and tax systems in which they practice
SSTS No. 1 tax return position sets forth what?
Applicable standards for CPAs when recommending tax return positions or preparing or signing tax returns filed with any taxing authority
What is a tax return position?
aPosition is reflected on a tax return on which a CPA has specifically advised a taxpayer, or position about which a CPA has knowledge of all material facts and in the basis of those facts has concluded Whether the position is appropriate
Tax payer is who?
The client
CPAs employer or
Any third party
The statement addresses CPAs obligation, what is their obligation?
Their obligation is to advise a taxpayer of a relevant tax return disclosure responsibilities and potential penalties
A cpa should not recommend a tax return position or prepare or sign a tax return taking a position UNLESS
He has good faith that the position has at least a realistic possibility of being sustained administratively or judicially on its merits of challenged
SSTS NO. 1-1 realistic possibility standard applies to whom?
CPAs when providing tax services that involve tax planning
What are the basic standards of SST 1-1?
- Establish the relevant background facts
- Consider the reasonableness of assumptions and representations
- Apply the pertinent authorities to relevant facts
- Consider the business purpose and economic substance of the transaction, if relevant to the tax consequences of transaction
- Arrive at conclusion supported by authorities
Tax shelters are sometimes labeled as?
Tax avoidance transactions
What does a prohibited tax shelter transaction mean?
Listed transactions,
Transactions with contractual protection iOR
Condfidential transactions
The creation of tax shelter investments help who?
Wealthy clients avoid paying taxes
Rule 3520
Auditor independence
-establishes requirement for accounting firm to be independent of its audit client throughout the audit and professional engagement period
Rule 3521
Contingent fees
-this rule MIRRORS RULEs in AICPA code where it prohibit contingent fees, commissions and referral fees
Rule 3522
Tax transactions
Rule 3523
Tax services for persons in financial reporting
Rule 3524
Audit committee preapproval of certain tax services
Rule 3525
Audit committee preapproval of non auditing services related to IC over financial reporting
Rule 3526
Communication with audit committees concerning independence
Solicitation is prohibited when the following occurs
- coercion
- overreaching
- harassing conduct
