Lecture 7: Professional Conduct, Independence, and Quality Control

Question 1

What is the definition of Ethics?

Answer 1

It refers to a system or code of conduct based on moral duties and obligations that indicate how aan individual should interact w/ others in society.

Question 2

What is Professionalism?

Answer 2

It refers to the conduct, aims or qualities that characterize a profession or professional person. It recognizes the responsibility of its members to place the interests of public above their own when 2 are in conflict.

Question 3

What is the purpose of theories of ethical behavior?

Answer 3

It is used to guide the analysis of ethical issues in accounting.

Question 4

What are the 3 theories of Ethical Behavior?

Answer 4

1. Utilitarianism: recognizes that decision making involves trade-offs between the benefits and burdens of alternative actions & focuses on consequences and on individuals affected. The interest of all parties shall be considered, not just one’s self-interest. An action will produce more pleasure/ happiness for the greatest no. of people.
2. Rights-based approach: assumes that individuals have certain rights and other individuals have a duty to respect those rights when making decisions. Auditors must be willing to see issues through others eyes & put the interest of other stakeholders ahead of their own self-interest.
3. Justice-based approach: concerned w/ issues such as equity, fairness, and impartiality. Each person has a right to have the max. degree of personal freedom that is compatible w/ the liberty of others and social and economic actions should be to everyone’s advantage and benefits available to all.

Question 5

3 theories of Ethical Behavior

Answer 5

1. Utilitarianism: recognizes that deision making involves trade-offs between the benefits and burdens of alternative actions & focuses on consequences & on individuals affected. The interest of all parties should be considered, not just one’s self-interst. An action will produce more pleasure/ happiness for the greatest no. of people.
2. Rights-based approach: assumes that individuals have certain rights and other individuals have a duty to respect those rights when making decisions. Auditors must be willing to see through others eyes and put the interest of other stakeholders ahead of their own self-interest.
3. Justice-based approach: concerned w/ issues such as equity, fairness and impartiality. Each person has a right to have the max degree of personal freedom that is compatible w/ the liberty of others. Social and economic actions should be to everyone’s advantage and the benefits available to all.

Question 6

What are the elements of the American Institute of Certified Public Accountants (AICPA) Code of Professional Conducts?

Answer 6

1. Principles of Professional Conduct
2. Rules of Conduct
3. Interpretations of Rules of Conduct by the Professional Ethics Executive Committee (PEEC)

Question 7

What are the principles of Professional Conduct?

Answer 7

1. Responsibilities: members should exercise professional and moral judgements in all their activities.
2. The public interest: members should accept the obligation to act in a way that will serve the public interest, honor the public trust and demonstrate a commitment to professionalism.
3. Integrity: maintain & broaden public confidence, members should perform professional responsibilities w/ the highest sense of integrity
4. Objectivity and independence: maintain objectivity and be free of conflicts of interest in discharging professional responsibilities. Member should be independent in fact & appearance when providing auditing and other attestation services.
5. Due care: observe the profession’s technical & ethical standards, strive continually to improve competence & the quality of services, and discharge professional responsibility to the best of the member’s ability.
6. Scope and nature of services: observe the Principles of the Code of Professional Conduct in determining the scope & nature of services to be provided.

Question 8

Why public accounting, as a profession, promulgates ethical standards & establishes means for ensuring their observance?

Answer 8

Ethical standards are established so that users of accouting servies know what to expect and accounting professionals know what behaviors are acceptable, and so that discipline can be applied when necessary.

Question 9

What does the rule of “integrity and objectivity” state?

Answer 9

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 judgement to others.

Question 10

What does the rule of “independence” state?

Answer 10

A member in public practice shall be independent in the performance of professional services as required by standards promulgated by bodies designed by Council.

Question 11

How do we define Covered Members who are bound by the independence requirement?

Answer 11

• 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 nonattest services to the attest client within any fiscal year
• a partner or partner equivalent in the office in which the lead attest engagement partner or partner equivalent primarily practices in connection w/ the attest engagement
• the firm, including the firm’s employee benefits plan
• an entity whosse operating, financial, or accounting policies can be controlled by any of the individuals or entities described above or by 2 or more such individuals or entities if they act together

Question 12

What are the 2 types of prohibited financial relationships?

Answer 12

1. Direct: a financila interst that is owned directly by an individual or entity, or is under the control of an individual or entity
2. Indirect: may result when a covered member has a financial interest in an entity that is associated w/ an attest entity, for example an investment in a mutual fund that owns the entity’s stocks.

Question 13

What are prohibited business relationships?

Answer 13

Independence rule & relevant interpretations essentially indicate that the independence of a CPA is impaired if the CPA performs a managerial or other significant role for an entity’s org. during the time period covered by an attest engagement.
Firm’s independence is considered to be impaired w/ respect to an entity if a partner or professional employee leaves the firm & is subsequently employed by or associated w/ that entity in a key position unless a number of conditions are met.

Question 14

What are the effect of family relationships?

Answer 14

A covered member’s immediate family is subject to the Independence Rule and its interpretations.
Close relatives include nondependent children, siblings, parents, grandparents, parents in law, and their respective spouses.

Question 15

What are the 2 major situations w/ close relatives that can impair independence?

Answer 15

1. A close relative has a financial interst in the entity 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 entity.

Question 16

Who are considered to be close relatives?

Answer 16

Nondependent children, brothers, sisters, parents, grandparents, parents-in-law, and their respective spouses.

Question 17

What are the effects of actual or threatened litigation?

Answer 17

• commencement of litigation by management alleging deficiencies in audit work for the entity would be considered to impair independence
• expressed litigation by management to commence litigation against the CPA alleging deficiencies in audit work would also impair independence if auditor concluded that it’s probable that such a claim will be filed
• commencement of litigation by the CPA against management alleging management fraud or deceit would be considered to impair independence

Question 18

What are the provision of nonattest services?

Answer 18

AICPA Code of Professional Conduct restricts the types of nonaudit services that can be provided to attest entities.
SEC has more restrictive independence rules for audits of public co.

Question 19

What are the 4 principles of auditor objectivity and independence set out by SEC?

Answer 19

1. auditor shouldn’t audit his or her own work
2. auditor shouldn’t function in the role of management
3. auditor shouldn’t serve in an advocacy role for the entity
4. auditor shouldn’t have a mutual or conflicting interest w/ an audit client

Question 20

9 categories of prohibited nonaudit services are:

Answer 20

1. bookkeeping
2. actuarial services
3. broker or dealer
4. financial info system design & implementation
5. internal audit outsourcing services
6. legal services
7. appraisal/ valuation services
8. management functions or HR
9. expert services

Question 21

What are the independence req. for audits of public co.?

Answer 21

• lead and engagement review partners are limited to 5 consecutive years
• a one year “cooling off” period is req. for employees in a financial reporting oversight role who previously worked w/ the CPA firm performing the audit
• a firm isn’t independent if an audit partner’s compensation is based on selling engagements to that client for services other than audit, review and attest services

Question 22

SEC independence rule for audits of public co.

Answer 22

• an additional communication between auditors & their entities’ audit committees
• public co. entities to reveal info regarding the fees paid to auditors
• proxy statements & annual reports issued by public co. must contain the following disclosures:
  ~ audit fees
  ~ audit-related fees
  ~ tax fees
  ~ all other fees billed during the prior 2 fiscal years by the principal auditor of the co.’s F.S.

Question 23

What is the General Standards Rule?

Answer 23

It says that a member shall comply w/ the following standards & w/ any interpretations thereof by bodies designated by Council.

Question 24

The General Standards consist of:

Answer 24

1. Professional competence: only undertake professional services that members of the firm can reasonably expect expect to complete w/ professional competencies
2. Planning and supervision: adequately plan & supervise performance of professional services
3. Due professional care: exercise professional due care in the performance of professional services
4. Sufficient relevant data: obtain sufficient relevant data to afford a reasonable basis for conclusions/ recommendations related to any professional services provided

Question 25

What is the Compliance w/ Standard Rules?

Answer 25

It says a member who performs auditing, review, compilation, management consulting, tax, or other professional services shall comply w/ standards promulgated by bodies designated by Council.
It req. members of the AICPA to comply w/ professional standards when performing professional services, whether or not they are practicing in public accounting.

Question 26

What is the Accounting Principle Rule?

Answer 26

A member shall NOT:

• express an opinion or state affirmatively that the F.S. or other financial data of any entity are presented in conformity w/ GAAP or
• state that he/ she isn’t aware of any material modifications that should be made to such statements or data in order for them to be in conformity w/ GAAP if such statement 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.

Question 27

What is the Confidential Client Information Rule?

Answer 27

It says that a member in public practice shall NOT disclose any confidential info w/o specific consent of the client.

Question 28

What are the 5 situations where CPAs can disclose confidential info?

Answer 28

• as req. by an authorized peer review body
• to meet GAAP or GAAS disclosure req.
• as part of an investigative or disciplinary proceeding
• to comply w/ a valid subpoena
• to allow a review for the purchase, sale or merger of the practice

Question 29

What is the Contingent Fees Rule?

Answer 29

A member shall NOT:

• perform for a contingent fee any professional service for, or receive such a fee from, a client whom the member or member’s firm performs:
  a) an audit review of a F.S.
  b) a compilation of a F.S. expected to be used by a 3rd party if the compilation report does not disclose a lack of independence
  c) an examination of prospective financial info
• prepare an ori or amended tax return or claim for a tax refund for a contingent fee for any client

Question 30

What is the commission and referral fees rule?

Answer 30

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 F.S.
b) a compilation of F.S. expected to be used by a 3rd party & the compilation report does not disclose a lack of independence
c) an examination of prospective financial info

Disclosure of permitted commissions: a member in public practice who isn’t prohibited by this rule from performing services for or receiving a commission shall disclose the fact to any person or entity to whom the member recommends or refers a product or service to which the commission relates.

Referral fees: any member who accepts 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.

Question 31

What are some of the acts which are discreditable?

Answer 31

A member shall NOT commit an act discreditable to the profession.
Examples:
- discriminate & harass in employment practices
- solicitation or disclosure of CPA examination qs & ans
- failure to file a tax return or pay a tax liability
- negligence in the preparation of F.S. or records
- failure to follow req. of governmental bodies, commissions, or other regulatory agencies
- confidential info obtained from employment or volunteer activities
- false, misleading or deceptive acts in promoting or marketing professional services
- improper use of CPA credential
- failure to comply w/ records requests

Question 32

What does the rule of Advertising and other forms of solicitation states?

Answer 32

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.

Question 33

What are the examples of prohibited advertising?

Answer 33

• creating false / 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’s likely at the time of representation that such fees will be substantially increased & the prospective entity is not advised of that likelihood
• making any other representations that would be likely to cause a reasonable person to misunderstand or be deceived

Question 34

What is the form of organization and name rule?

Answer 34

A member may practice public accounting only in a form of org. 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 org.
A firm may not designate itself as “members of the AICPA” unless ALL of its CPA owners are members of the institute.

Question 35

What are the disciplinary actions?

Answer 35

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

1. termination of AICPA membership
2. suspend AICPA membership

Question 36

W/o the consent of the entity, a CPA should NOT disclose confidential entity info contained in working papers to:

Answer 36

The successor CPA firm that has been engageed to audit the former audit entity.

Question 37

What are the Quality Control Standards?

Answer 37

It says a CPA firm is req. to implement policies and procedures to monitor the firm’s practices & ensure that professional standards are being followed.
The AICPA continues to administer a quality review system in order to enable firms to meet their state licensing, federal regulatory, and AICPA membership req. & to serve firms that audit only privately held clients.

Question 38

What are the elements of Quality Control?

Answer 38

• leadership
• HR
• relevant ethical req.
• engagement performance
• acceptance & continuance of relationships
• monitoring

Question 39

How often do the PCAOB inspect registered public accounting firms?

Answer 39

The PCAOB conducts regular inspections of public accounting firms that are req. to register w/ the Board.