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ETHICS: UNDERSTANDING AND MEETING ETHICAL EXPECTATIONS

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Title: 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
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