ETHICS: UNDERSTANDING AND MEETING ETHICAL EXPECTATIONS

1
Chapter 3

• ETHICS UNDERSTANDING AND MEETING ETHICAL
  EXPECTATIONS

2
Discuss Strong Governance and High Ethical
Standards

• History shows companies with strong corporate
  governance and high ethical standards generally
  perform better then those with weak governance
  and low ethical expectations
• The key is the tone set by top management. A
  well-managed organization will have and enforce a
  code of ethics and/or a conflict of interest
  policy to guide its members.

3
Comment on Accepting a Public Trust

• To maintain the public's trust, public
  accountants must act with professional integrity
• To help accountants with ethical dilemmas,
  professional associations including the AICPA,
  Institute of Management Accountants, and
  Information Systems Audit and Control
  Association, have codes of professional conduct
• The individual state boards of accountancy and
  state societies of CPAs have generally adopted
  the AICPA's Rules of Conduct

4
Reflect Upon the Unique Licensure for CPAs

• Audits and other attestation reports on financial
  statements can only be signed by those licensed
  to practice as CPAs by their state board of
  accountancy
• Each state board of accountancy sets its own
  requirements to become a licensed CPA
• To become a licensed CPA, a person must pass the
  CPA exam, meet specific education and experience
  requirements, and agree to uphold the profession
  and its code of professional conduct

5
Independence A Foundation Requirement

• Auditors express an opinion about whether
  financial statements are fairly presented
• To be perceived as creditable, auditors must be
  independent in fact and appearance
• In fact, means the member must be unbiased and
  objective
• In appearance means that knowledgeable users of
  financial statements must believe the auditor is
  independent

6
What are major threats to independence?

• Independence is a state of mind that can be
  impaired by a number of potential threats
• Compensation Schemes
• Partners' compensation in many CPA firms is based
  in large part on attracting and keeping clients.
  Partners may feel pressure to accede to client
  wishes in order to keep them happy
• Who is the Client?
• Although the client has the authority to hire and
  the auditor, CPA firms must reinforce to its
  auditors that maintaining the public trust is
  more important than retaining a client where it
  might appear that its objectivity could be
  compromised
• Familiarity with the Client
• Auditors serving a client for several years may
  develop relationships that cause the auditor to
  be less skeptical than necessary

7
What are major threats to independence?

• Time Pressure
• Those in charge of audits are evaluated not only
  on the quality of their work, but also on their
  ability to complete audits within time budgets.
  This may create situations where auditors do not
  investigate potential problems thoroughly in
  order to save time
• Ability to Rationalize
• It takes time to investigate potential
  misstatements. To save time, an auditor may
  rationalize that the misstatement is not likely
  to be material
• Auditing Your Own Work
• CPAs may provide certain services to non-public
  companies that put auditors in the position of
  auditing their own work
• Other threats
• Actual/threatened litigation, beneficial interest
  in shares etc, overdue fees, acceptance of goods
  and services on favourable terms

8
Discuss Ways of Managing Threats to Independence

• Establishing and Monitoring Codes of Conduct
• Balanced Compensation Schemes
• Independent Reviews of Client Acceptance/Retention
  Decisions
• Separation of Consulting Activities from Audit
  Activities
• Independent Reviews of Audit Work and Audit
  Documentation
• Peer Reviews within the Profession
• Improved Hiring Practices

9
SEC's Principles for Judging Independence
Prohibited Service

• In rules on auditor independence issued in 2001,
  the SEC summed up its objectives
• The independence requirement serves two public
  policy goals
• Foster high quality audits by minimizing the
  possibility that any
• external factors will influence an auditor's
  judgment
• Promote investor confidence in the financial
  statements of public companies
• In judging independence, the SEC determines
  whether a relationship or the provision of
  service
• Creates a mutual or conflicting interest between
  accountant and client
• Places the accountant in the position of auditing
  his/her own work
• Results in the accountant acting as management or
  an employee of an audit client
• Places the accountant in the position of being an
  advocate for the client
• The SEC requires the audit committees to assess
  auditor independence and make a written statement
  on that assessment to the stockholders

10
Prohibited Services, Sarbanes-Oxley Act of 2002

• Prohibits a public accounting firm that audits a
  public company from providing the following
  non-audit services to the company
• Bookkeeping or other services related to the
  accounting records or financial statements of the
  audit client
• Financial information systems design and
  implementation
• Appraisal or valuation services, fairness
  opinions, or contribution-in-kind reports
• Actuarial services

11
Prohibited Services, Sarbanes-Oxley Act of 2002
(continued)

• Internal audit outsourcing services
• Management functions or human resources
• - Broker or dealer, investment advisor, or
  investment banking services
• Legal services and expert services unrelated to
  the audit
• Any other service that the Board determines, by
  regulation, is impermissible
• The Act requires that the client's audit
  committee pre-approve any non-audit services,
  including tax services, not specifically
  prohibited

12
Review the AICPA Code of Professional Conduct

• The AICPA Code of Professional Conduct consists
  of principles and rules the Division of
  Professional Ethics issues interpretations and
  rulings to the rules.
• PRINCIPLES are ideals of ethical conduct and
  provide a broad conceptual framework for
  professional conduct
• RULES provide more detailed guidance on the
  principles to help CPAs in carrying out their
  public responsibilities, and are enforceable
  under AICPA bylaws
• INTERPRETATIONS provide specific guidance to help
  CPAs interpret the rules
• RULINGS are issued in response to member
  questions about specific situations

13
Review the AICPA Principles of Professional
Conduct

• Responsibilities - members should exercise
  sensitive professional and moral judgment in all
  their activities
• Public interest - members should act in a way
  that serves the public interest, maintains public
  trust, and shows commitment to professionalism
• Integrity - members should perform all
  professional responsibilities with the highest
  sense of integrity
• Objectivity and independence - members should be
  objective and free of conflicts when performing
  professional responsibilities. Members in public
  practice must be independent in fact and
  appearance when providing attestation services.
• Due care - members shall observe the profession's
  ethical and technical standards, strive to
  improve competence and quality of services
  provided, and discharge professional
  responsibilities to the best of their ability.
• Scope and nature of services - members in public
  practice shall observe the principles of the Code
  of Professional Conduct in determining the scope
  and nature of services to be provided.

14
List the AICPA Rules of Conduct

• Rule 101 Independence
• Rule 102 Integrity and Objectivity
• Rule 201 General Standards
• Rule 202 Compliance with Standards
• Rule 203 Accounting Principles
• Rule 301 Confidential Client Information
• Rule 302 Contingent Fees
• Rule 501 Acts Discreditable
• Rule 502 Advertising and Other Forms of
  Solicitation
• Rule 503 Commissions and Referral Fees
• Rule 505 Form of Organization and Name

15
AICPA's Approach to Independence

• 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 the Council."
• The auditor is required to be independent when
  providing attestation services. The standards for
  providing consulting, tax, or bookkeeping
  services do not require independence.
• There are several interpretations and over 100
  rulings that provide more detailed guidance on
  the application of Rule 101.

16
Interpretations of Rule 101 - Financial Interest

• Independence would be considered impaired if
  during the period of engagement, a covered member
  had, or was committed to acquire, a direct or
  material indirect financial interest (5 -10) in
  an attestation client.
• Covered member is defined as
• 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
• A covered member's immediate family is also
  subject to Rule 101 with some exceptions

17
Interpretations of Rule 101 - Employment

• Independence would be considered impaired if a
  member holds management, employee, or director
  positions with attest clients during the period
  covered by the financial statements or the period
  of engagement.
• A covered member's independence would be
  considered impaired if a close relative is
  employed by an audit client where the relative is
  allowed to exercise significant control over
  operating, financial, or accounting policies, or
  significant internal accounting controls

18
Independence Safeguard A Proactive Approach

• Actions that firms can take to safeguard
  independence
• The firm's leadership sets the proper "tone at
  the top"
• Communications with client's audit committee on
  matters that may affect the firm's independence
• Participating in peer review programs
• Implement quality control standards
• Set up internal monitoring and compliance
  procedures
• Require professional staff to communicate to firm
  management any independence or objectivity issues
  of concern
• Encourage partner peer review by someone outside
  of the audit engagement
• Periodically rotate partner in charge of the
  audit engagement
• Monitor threats to independence

19
Rule 102 - Integrity and Objectivity

• Requires members to act with integrity and
  objectivity, be free of conflicts of interest,
  and not knowingly misrepresent facts or
  subordinate their judgment to others.
• Rule applies to performance of all professional
  services by all members

20
Rule 201 - General Standards

• Members shall provide only those services that
  they are able to perform with professional
  competence
• Members shall exercise due professional care in
  performance of services
• Professional services shall be adequately planned
  and supervised
• Members must gather sufficient relevant data to
  provide a reasonable basis for any conclusions or
  recommendations rendered in connection with
  professional services
• The above applies to all services provided by all
  members

21
Rule 301 - Confidential Client Information

• In order for an auditor to develop a complete
  understanding of the client, there must be a free
  flow and sharing of information between client
  and auditor. To ensure this happens, the client
  must be assured that the auditor will not
  communicate confidential information to outside
  parties.
• Rule 301 prohibits members from disclosing
  confidential client information obtained during
  an engagement except with client consent.

22
Rule 301 - Confidential Client Information -
Exceptions

• Disclosures required by GAAP or GAAS
• Comply with subpoenas or summons or to comply
  with applicable laws and government regulations
• Provide information for outside review of firm's
  practice under PCAOB, AICPA, or State Board of
  Accountancy authorization
• Initiate a compliant with, or respond to
  inquiries made by, recognized investigative and
  disciplinary agencies (including the AICPA, state
  CPA societies, State Board of Accountancy)

23
Rule 302 - Contingent Fees

• Contingent fee - fee for the performance of a
  service where the collection or amount depends on
  whether a specified finding or result is attained
• Contingent fees are prohibited for any service
  provided to an attestation client. Why? Such
  contingent fees would give the auditor a
  financial interest in client results

24
Rule 502 - Advertising and Other Forms of
Solicitation

• Members in public practice shall not advertise or
  solicit in any way that is false, misleading,
  deceptive, harassing, or coercive. This would
  include advertising that
• Creates a false or unjustified expectation of
  favorable results
• Implies ability to influence any court,
  regulatory agency, or similar body
• Understates fees for current or future fees
• Contains any other representations that would
  likely cause a reasonable person to understand or
  be deceived

25
Rule 503 - Commissions and Referral Fees

• Members in public practice are prohibited from
  receiving commissions for recommending products
  and services to attest clients. Why? The
  commission gives the auditor a financial interest
  in his/her client's decisions.
• Commissions are allowed for recommending products
  or services to non-attest clients, but must be
  disclosed to the client
• Members may pay or receive fees for referral of
  any professional services (including attest
  services) as long as the client is notified of
  the fee

26
Enforcement of the Code

• Members who violate the AICPA code may have their
  membership terminated
• Members who violate a State Board of
  Accountancy's code are subject to disciplinary
  action including suspension or revocation of the
  member's certificate and license to practice.
• If the State Board suspends the member's
  certificate, it can mandate conditions, such as
  additional continuing education, that must be
  satisfied before the member's certificate is
  reinstated.

27
Discuss Ethical Theories Resolving Issues

• Ethical problem occurs when an individual is
  morally or ethically required to take an action
  that conflicts with his or her immediate
  self-interest
• Ethical dilemma occurs when there are conflicting
  moral duties or obligations
• Ethical theories present frameworks to assist
  individuals in dealing with both ethical problems
  and dilemmas. Two such frameworks - utilitarian
  theory and rights theory - have influenced the
  development of codes of conduct and can be used
  by professionals dealing with ethical issues

28
Discuss Utilitarian Theory

• Utilitarian theory - an action is ethical if it
  achieves the greatest good for the greatest
  number of people. Utilitarianism requires
• Identify potential problem and courses of action
• Identify potential impact of actions on each
  affected party
• Assess the desirability of each action
• Perform overall assessment of the greatest good
  for the greatest number
• Problems with utilitarianism include
• Disagreement about the likely impact of actions
• Problems measuring the "greatest good"
• Assumption that the ends achieved justify the
  means

29
Discuss Rights Theory

• Rights theory - evaluates actions based on the
  fundamental rights of the parties involved. Uses
  a hierarchy of rights where higher-order rights
  take precedence over lower-order rights.
• Rights theory requires the rights of affected
  parties be examined as a constraint on ethical
  decision making.
• It is most effective in identifying outcomes that
  should be eliminated or identifying situations in
  which the utilitarian answer would be at odds
  with most societal values.

30
Comment on An Ethical Framework (utilizing
Utilitarian Rights Theories)

• Identify the ethical issue(s)
• Determine the affected parties and identify their
  rights
• Determine the most important rights
• Develop alternative courses of action
• Determine the likely consequences of each
  proposed course of action
• Assess possible consequences including estimation
  of the greatest good for the greatest number
• Determine whether rights framework would cause
  any action to be eliminated
• Decide on appropriate course of action