1. ETHICS: UNDERSTANDING AND MEETING ETHICAL EXPECTATIONS
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

7. What are major threats to independence?
Familiarity with the Client
Auditors serving a client for several years may develop relationships that cause the auditor to be less skeptical than necessary
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

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 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 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
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 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