Module B + C Flashcards
Categorical imperative
Kant’s specification of an unconditional obligation to act as
One thinks others should act regardless of circumstances
Act-utilitariansm
Emphasis on an individual act as it is affected by specific
Circumstances of a situation
By focusing on individual acts, the long run effect of setting
Examples for other people appears to be ignored
Commission
Percentage fee charged for professional services
in connection With executing a transaction Or performing some
other business activity
Contingent fee 3
Type of compensation established for performance of any service
In an arrangement where no amount will be charged
Unless specific finding or result is attained/or fee depends on
The result
Ex. CPA’s can charge contingent fees for representing client in IRS
tax audit, or consulting service engagement
Fees are not contingent if they are…
Fixed by a court or public authority, in tax matters
Covered member (broad definition)
Individual who might be in position to compromise integrity of audit
Covered member (4 part definition AICPA Code of Professional Conduct), individual among others who is…
1 on audit engagement team
2 in position to influence audit engagement
3 partner or manager of nonaudit client service team
4 partner from local office
Generalization argument 3
Judicious combination of imperative and utilitarian principles
To act as one thinks others should act in similar circumstances
Ex. “What would happen if everyone acted in a certain way?” If the
Answer to the question is the consequences would be undesirable,
The conclusion is that way of acting is unethical and shouldn’t be
done
Independence
Mental attitude and appearance that auditor is not influenced
By others in judgements and decisions
Referral fee 3
1) Compensation CPA receives for recommending another CPA’s
Services and 2) that a CPA pays to obtain a client
May not be based on percentage of amount of any transaction
Rule-utilitarianism
Emphasis on centrality rules for ethical behavior while still
maintaining the criterion for greatest universal good
Decision makers must first determine the rules that will promote
The greatest general good for the largest number of people
Self-regulation
Quality control reviews and disciplinary actions conducted by fellow CPAs-professional peers
Virtue ethics, define, examples
Focus on the role of one’s character in decision making process
Ex. “What action will help me become my ideal self?”, “what action would I be proudest of?”
Ethics 3 elements
1 decision problems
2 moral principles
3 good or bad
Decision problems
Questions requiring reflective choice
Moral principles
Guides of right and wrong
Good or bad
Concerned with consequences
Ethical situation
Individual must make a choice, and right choice isn’t absolutely
Clear
Ethical problem situation
Choice of alternative actions affects well being of others
Ethical behavior 3 elements
That which…
1 produces the greatest good
2 conforms to moral rules and principles
3 demonstrates virtues you value most
Codes of professional ethics
Provide guidance in addressing situations that may not be
Specifically available in general ethics theories
Problem with using conscience as a guide?
It tells you about the wrong decision after you act
Imperative principle
Directs decision maker to act according to requirements of
Ethical rule
Does not involve considering consequence
Principle of utilitarianism
Emphasizes examining consequences of action rather than
following some rules
The criterion of producing greater good is made an explicit part
Of the decision process
The initial question in rule utilitarianism is not which action has the greatest utility but…
Which rule
Generalization argument may be considered a judicious combination of…
Imperative and utilitarian principles
Cargo rival imperative focuses on…
Rules
Consequentialism focuses on…
Outcomes
Virtue ethics focuses on…
Character
Source of Rules of Conduct: SEC
Who are they applicable to? 2
1 Persons who practice before the SEC as accountants
2 Auditors for SEC registered companies
Source of Rules of Conduct: PCAOB
Who are they applicable to?
Registered firms and individuals who perform audits of companies
Under the jurisdiction of the PCAOB
Source of Rules of Conduct: International Federation of Accountants (IFAC)
Who are they applicable to?
Public accounting firms and CPAs performing audits of multinational
Companies
Source of Rules of Conduct: American Institute of CPAs
Who are they applicable to?
AICPA members
Source of Rules of Conduct: Applicable state board of accountancy
Who are they applicable to?
Persons licensed by the state to practice accounting
The SEC has federal statutory authority to regulate the public accounting professions for what 2 purposes?
1 protecting reliability and integrity of financial statements of public
Companies
2 promoting investor confidence in financial statements and
Securities markets
Who what group does the SEC oversee?
PCAOB
what does the PCAOB set standards for and oversee for public accounting firms? 3
1 quality control
2 ethics
3 independence issues for accounting professionals who audit
Financial statements of public companies
For audits of multinational companies, auditors must follow guidelines of the…
International Federation of Accountants (IFAC)
Function of the Professional Ethics Executive Committee (PEEC) of the AICPA
Makes and enforces all rules of conduct for CPAs who are AICPA
members
2 sections of the AICPA Professional Code of Conduct
1 Principles of Professional Conduct
2 rules an applicability of principles
6 AICPA Principles of Professional Conduct
1 responsibilities 2 the public interest 3 integrity 4 objectivity and independence 5 due care 6 scope and nature of services
Principles
Aspirational goals of behavior
Rules
Enforceable ethical regulations that CPAs must follow
Interpretations
Applications of rules to specific business situations
Independence in fact
Independence in state of mind of auditor
Independence in appearance
Financial statement users’ perceptions of auditors’ independence
2 major ways auditors preserve independence
1 avoid financial connections that makes their wealth depend on
The audit
2 avoid managerial connections were auditors make decisions
For management
Familiarity threat
CPAs have close/longstanding with client
Ex. Spouse is in a key client position or partner served prolonged
Tenure with client
Adverse interest threat
CPAs acting in opposition to clients
Ex. Litigation
Undue influence threat
Attempts to coerce and otherwise influence CPA member
Ex. Significant gifts, or threats to replace auditor over accounting principles disagreement
Self-review threat
CPAs reviewing their own work
Financial self-interest threat
CPAs having financial relationship with client
Management Participation threat
CPAs taking on role of client management/performing management
Functions
Advocacy threat
CPAs promoting client’s interests or position
If a CPA firm is in litigation with a client, what are they required to do?
Declare nonindependence and provide a disclaimer of opinion
Grandfathered loans (not subject to impairment of independence)
Loans obtained either…3
1 before independence rules changed
2 from financial institution before it became client for services
Requiring independence
Ex. Home mortgages, loans not material to CPA’s net worth
When can CPA’s serve on board of directors without impairing independence?
When they serve as honorary directors for nonprofits
The CPA can’t vote with the board on management functions
What 4 items must be disclosed in proxy statements that are deemed important to investors?
1 total audit fees
2 total fees for tax and advisory work
3 whether audit committee/board considered advisory work
Compatible with maintaining auditor’s independence
4 % of audit hours (if over 50% total) performed by temps rather
Than full time audit staff
SOX limitation on engagement partners on client?
Other partners associated with engagement?
5 years limit for engagement partners
7 year limit for other partners associated with the engagement
Client advocacy in support or advancement of client positions
Is acceptable only as long as…3
1 The member acts with integrity
2 maintains objectivity
3 does not subordinate judgement to others
What 3 rule making bodies has the AICPA Council designated to pronounce accounting principles under Rule 203?
1 FASB
2 GASB
3 Federal Accounting Standards Advisory Board (FASAB)
Confidential Client Information
A member in public practice shall not disclose confidential
Information without specific consent of the client
Privileged information
Information that can’t even be demanded by the court
State created accounting client privilege has…
Never been recognized in federal court
Holders of privilege
Can be waived only by client, patient or penitent
For all practical purposes, when is info not considered confidential?
If it’s disclosure is necessary to prevent financial statements
From being misleading
5 situations where contingent fees aren’t allowed
1 audit of financial statements 2 review of financial statements 3 compilation of financial statements 4 examine prospective financial info 5 everyday tax preparation
Where does most commission activity for CPAs occur?
2) where is it prohibited?
occurs for personal financial planning services
2 prohibited for Attestation services
The expulsion penalty, while servere, does not prevent…
A CPA from continuing to practice public accounting
Which bodies conduct public disciplinary actions? 3
1 trial board of AICPA
2 SEC
3 PCAOB
Penalties 5
Last Question for Module B
1 monetary 2 litigation 3 expulsion 4 penalize CPA's company 5 require additional education hours
Breach of contract
Claim that accounting or auditing services weren’t performed in
The manner described in the contract
Causation of defense
Argument available to auditors who can show that plaintiff’s
Economic loss
was caused by a factor other than the auditor’s failure to exercise
To exercise appropriate level of professional care/breach of contract
Class action
Situation where group of plaintiffs comes together in legal action
Against another party
Comfort letter
Letter issued by auditors to underwriters of securities that
Provides an opinion on fairness of issuers’ financial statements
Provides assurance to underwriters
Common law 3
1 Liability for injuries that is based on reasons other than violation
Of a written law or statute
2 legal precedent used in assessing degree of responsibility or
Fault of parties
3 auditors have common law liability to clients and nonshareholder
Third parties
Jurisdiction of common law actions
Typically a court in the state the alleged action occurred
In Common law, when no legal precedent can be found the judge follows a sense of…
justice or morality, considering the prevailing customs
And moral standards
Constructive fraud
Failure to provide any care in fulfilling a duty owed to another
Including a reckless disregard for truth
Similar to gross negligence
Contributory negligence, is a Legal defense theory where…
plaintiff’s own failure to perform With appropriate level of
professional care bars recovery from Auditors
“Deep pockets” theory
Concept that lawsuits may be brought against auditors not
Because they are necessarily at fault
But because they are the only party with resources against
Which recovery can be made
Expectation gap
Difference between the actual work and assurance required by
GAAS and expectation of that work by the General public
Financial Reporting Releases (FRRs)
Reports prepared by SEC staff that express new rules and
Policies about disclosure
Foreseeable party
Individuals or organizations whose decisions normally rely on
Audited financial statements
and opinions on those financial statements
Foreseen party
Limited class of individuals or organizations that could be reasonably expected to rely on auditors' work
Form 8-K
“Current events” report filed periodically at the occurrence of
Major events
4 common major events that require an 8-K filing
1 earnings releases
2 major asset sales
3 acquisitions
4 auditor changes
Form 10-K
Form to use for annual filing of financial statements
And related disclosures by public companies with the SEC
Form 10-Q
Form to use for quarterly filing of financial statements
And related disclosures by public companies with the SEC
Fraud
Misrepresentation of facts that the individual knows to be false
With the intention to deceive
Gross negligence
Breach of duty owed to another party because of lack of
Minimal care
Similar to constructive fraud
Initial public offering (IPO)
Initial issuance of securities by a registrant entity to the investing
Public
through a market that is subject to the provisions of the Securities
Act of 1933
Joint and several liability, which is of deep concern to auditors, is a legal doctrine that…
When multiple defendants are named
The full amount of damage award may be collected from any of
The defendants named in lawsuit even though they may be
Partially at fault
Limited liability partnership
Form of organization adopted by most large accounting firms
combines the advantages of traditional partnership with liability
Protection afforded to corporations
Ordinary negligence
Unintentional breach of duty owed to another as a result of
Lack of reasonable care
Plaintiff
Person or organization that initiates a lawsuit
Ex. Client or third party user of financial statements
Primary beneficiary
Person known by name to auditor
For whose primary benefit the audit or accounting service is
Performed
Privity of contract
Situation in which parties have contractual relationship
Proportionate liability
Legal doctrine that payment of share of court’s damage award
Be based on extent
or proportion of fault exhibited by convicted Defendant
Prospectus
Legal document offering securities for sale
Includes significant info about issuing entity, including historical
Financial statements and other necessary disclosures
Registration statement
Set of documents, including prospectus
Company files with SEC prior to IPO
Regulation S-K
SEC requirements relating to all business, analytical and
supplementary financial disclosures
Other than financial statements themselves
Regulation S-X
SEC accounting requirements for annual and interim financial
Statements
filed under both the Securities Act and the Securities Exchange
Act
Scienter
Mental state embracing intent to deceive, manipulate or defraud
Prior to committing those actions
Ex. Auditors’ knowledge of misstatement in financial statements
And the intentional failure to disclose this misstatement in their
Report
Staff Accounting Bulletins (SABs)
The unofficial but important interpretations of Regulation S-X
And Regulation S-K by SEC staff
Statutory law
Legal rules affecting liability based on violations of written laws
Or statutes
Auditors have statutory liability to third party investors under the
Securities acts
Tort
Civil complaint charging that the action of one person caused injury
(Personal or financial) to another
Action against auditors usually initiated by users of financial
statements
SEC’s issuance of a Wells notice
Formal signal that civil charges may be forthcoming
Auditors owe client’s a responsibility to conduct an audit in accordance with…
GAAS, consistent with the terms of the engagement letter
Engagement letter
Serves as contract between client and auditor
Loss suffered by client: breach of contract example
Losses from Delays in financing because auditors couldn’t meet
The engagement timeline
2 reasons client’s may suffer loss because of auditors
1 breach of contract
2 lack of due professional care (ex. detecting employee fraud)
Main defense for auditors
They followed GAAS to perform their audits
The primary statutory laws relevant to the audit of financial statements are the laws governing…
The purchase and sale of securities
Tort actions cover other…
Civil complaints
Civil complaints
Fraud, deceit, injury arising from auditors failure to exercised
Due professional care
When privity of contract exists what 4 things must plaintiff demonstrate?
1 suffered economic loss
2 breach of contract by auditors
3 auditors failed to exercise appropriate due care
4 breach of contract and lack of due care caused loss
3 levels of substandard performance that may lead to tort liability
1 ordinary negligence
2 gross negligence
3 fraud
If auditors exhibit ordinary negligence, clients will typically…
Prevail in their legal actions against auditors
3 defenses by auditors to mitigate clients’ claims
1 auditors did exercise due care under contract
2 causation defense (economic loss caused by reason other than
Auditors)
3 contributory negligence
It is well established that auditors are liable to all third parties for levels of performance representing…
Gross negligence and fraud
Auditors extent of liability for ordinary negligence varies by…
Jurisdiction
To bring a suit against auditors under common law, third parties must demonstrate all of these 4 things
1 suffered economic loss
2 auditors failed to exercise due care
3 financial statements contained material misstatement
4 loss was caused by reliance on materially misstated financials
Ultramares precedent, expressed the view that if auditors’ failures to exercise the appropriate level of professional care were so great as to constitute gross negligence, grounds might exist that auditors engaged in…
Constructive fraud (reckless disregard for truth)
2 possibilities for recognizing primary beneficiaries, that varies by jurisdiction
1 in some jurisdictions beneficiary must be named in contract
2 in others beneficiary need only be identified to auditors before
Engagement
An accounting firm may be informed that the report is needed for a bank loan application with First National Bank. What is this an example of?
First National Bank is a primary beneficiary because it is known
By name to auditors
Foreseen parties: if client informs auditors that it will be using audited financial statements to obtain financing and doesn’t identify any banks, under the doctrine of restatement of torts…
Any bank that uses audited financial statements in making Lending decisions may have legal standing to sue auditors for negligence
When are auditors liable for ordinary negligence to foreseen parties in many jurisdictions?
In jurisdictions where restatement of torts doctrine specifies that
Auditors are liable if they are aware that auditors opinion
And financial statements are used by some third party
Foreseeable parties, which 3 groups do they include?
Investors, creditors, potential investors
If Grand Bank is relying on audited financial statements to decide whether to provide a loan to Prize Company, when would Gand bank be classified as a foreseen party
If Prize Company informed auditors that the audited financial
Statements would be used to obtain s loan
But not specify the name of a third party
If Grand Bank is relying on audited financial statements to decide whether to provide a loan to Prize Company, when would Gand bank be classified as a foreseen party?
In almost any situation because audited financial statements
Are commonly used to obtain financing
3 defenses available to auditors against 3rd party plaintiffs
1 3rd party doesn’t have appropriate standing to sue
2 3rd party’s loss was caused by events other than financial
Statements and auditors exam
3 auditors performed in accordance with GAAS
Causation defense, define and example
3rd party’s loss was caused by events other than financial
Statements and auditors exam
Ex. Failure of entity may result from poor business practices and
Decisions
Liability under statutory law
Auditors can be liable to individuals when they violate a specific
Law or statute when performing professional services
6 federal statutes that pose potential liability to auditors
1 Federal False Statements Statute 2 Federal Mail Fraud Statute 3 Federal Conspiracy Statute 4 Securities Act of 1933 5 Securities Act of 1934 6 SOX
What does the Securities Act of 1933 regulate
The initial issuance of securities by registrants to public
Requires company register with the SEC and provide prospectus
Burden of proof for plaintiff investors against auditors according to section 11 of the Securities Act of 1933. 2
1 they suffered economic loss
2 financial statements contained material misstatement
According to section 11, auditors have the…
Burden of proof (assumes auditors are guilty until proven innocent)
2 defenses auditors have under section 11
1 due diligence defense
2 causation defense
Criminal liability
Monetary fines and prison terms
Results from willfully causing materially misstated statements
The Securities Exchange Act of 1934
Regulates daily trading of securities
requires most entities whose securities are traded in interstate
Commerce to register and file pertinent info with the SEC
Under the securities exchange act of 1934, entities having total
assets of over $10 million and over 500 shareholders…
Are required to register under the Securities Exchange Act
What 3 forms that are significant for auditors are required for filing under the Securities Exchange Act of 1934?
1 Form 10-K
2 Form 10-Q
3 Form 8-K
The form and content of 10-K and 10-Q filings are governed by
The SEC through…
Regulation S-X (annual and quarterly financial st.)
and Regulation S-K (supplementary disclosure)
What reports express new rules and policies about disclosure for public ally traded companies?
Financial Reporting Releases (FRRs)
What provides unofficial but important interpretations of Regulations S-X and S-K?
Staff Accounting Bulletins (SABs)
4 documents that provide authoritative literature on financial reporting of public ally traded companies that must be filed with the SEC?
1 Regulation S-X
2 Regulation S-K
3 Financial Reporting Releases (FRRs)
4 Staff Accounting Bulletins (SABs)
Section 10 of Securities and Exchange Act: antifraud
Makes it unlawful for persons to use manipulative or deceptive
Devices in connection with sale or purchase of securities
Section 17 antifraud (of securities act 1933)
Makes it unlawful to use mail or instruments of transportation
In interstate commerce to defraud others
Statute of limitations
Gives time frame that auditors can be held liable for violating
A statute
Auditors defenses for Securities Exchange Act
Auditors acted in good faith and had no knowledge of material
Misstatements
Criminal liability depends on the auditors…
Willfully and knowingly committing the act
Foreign Corrupt Practices Act (1977) (FCPA) 2 things
1 bribery with foreign officials illegal
2 required entities to develop effective internal controls
The doctrine of joint and several liability, may expose auditors to…
Extensive/unreasonable losses when they are only partially at
Fault
SOX has extended what against auditors?
Time frame for filing a lawsuit from 2 years (before SOX) to
5 years after incident occurred
Auditors are not subject to RICO complaints, unless they…
Actively participate in management or operation of corrupt
business
Proportionate liability (from the Private Securities Litigation Reform Act of 1995) 3 terms
1 total responsibility for loss is divided between all parties
Responsible for loss
2 if other defendants are insolvent, solvent defendant’s liability
Is extended to 50% more than proportion found at trial
3 only defendants who knowingly committed violation of securities
Law are held jointly and severally liable
If plaintiffs have a net worth of less than $200,000 and lost
10% or more of their net worth, auditors remain…
Jointly and severally liable
Federal courts are preferable venues for defendants in…
Class action lawsuits
