2Key Topics in Chapter 4 AICPA Code of Professional Conduct Rule 101, IndependenceRules 301, 302, 501, 503Sarbanes-Oxley Act and SEC Provisions Addressing Auditor Independence
3Special Need for Ethical Conduct in Professions Our society has attached a special meaningto the term professional.A professional is expected to conducthimself or herself at a higher levelthan most other members of society.Trustworthiness and a strong sense of ethicsare assets of the CPA.
4AICPA Code of Professional Conduct PrinciplesIdeal standards of ethical conductstated in philosophical terms.They are not enforceable.Rules ofconductMinimum standards of ethicalconduct stated as specific rules.They are enforceable.Interpretationsof the rulesof conductInterpretation of the rules of conduct bythe AICPA Division of Professional Ethics.They are not enforceable, but apractitioner must justify departure.
5AICPA Code of Professional Conduct EthicalrulingsPublished explanations and answersto questions about the rules ofconduct submitted to the AICPA bypractitioners and others interestedin ethical requirements.They are not enforceable, but apractitioner must justify departure.
6Who Falls Under the AICPA Rules of Conduct (Code)? Technically, members of the AICPA.However, state and federal courts have held that all practicing CPAs must follow ethical standards, as set forth in the Code of Professional Conduct.
7Standards of Conduct Substandard Ideal conduct by practitioners PrinciplesRules ofconductSubstandardIdeal conductby practitionersMinimum levelof conduct bypractitioners
8Independence The value of auditing depends heavily on the public’s perception of the independence of auditors.Independence in fact, means the member must be unbiased and objective mentally – it is a state of mind.Independence in in appearance means that knowledgeable users of financial statements must believe the auditor is independent – avoiding observable conflicts of interest
9AICPA Rules of Conduct Rule 101 – Independence A member in public practice shall beindependent in the performance ofprofessional services as required bystandards promulgated by bodiesdesignated by Council.
10Financial Interests Interpretations of Rule 101 prohibit covered members from owning anydirect investments in audit clients.Covered membersDirect versus indirect financial interestMaterial or immaterial
11Engagement Based Approach Covered members are persons in a position with the potential to influence audit decisions, including:Individuals on engagement team.Individuals who supervise or evaluate the engagement partner.Partners who provide non-attest services to the client.Refer to p. 86 of chapter for others.
12Prohibited Activities by Covered Members Members cannot:Have a direct or material indirect investment in the audit client.Be a director, officer, manager, or employee of the client.Participate in joint business ventures with the client.Have loans to or from the client.Automobile loans and leasesCollateralized loansCredit cards and cash advances#2 Trustee who lacks authority to make investment decisions is allowable.#4 Unpaid fees by the client assume the characteristics of a loan.Exceptions to the loan rule includeautomobile loans and leases (collateralized by the auto)loans fully collateralized by cash deposits of the cash surrender of life insurance policiesCredit cards and cash advances with the aggregate outstanding balance is $5,000 or less
13Related Financial Interests Issues Former practitionersNormal lending proceduresFinancial interests and employmentof immediate and close familyJoint investor or investeerelationship with clientDirector, officer, management,or employee of a company
14Litigation Between CPA Firm and Client A lawsuit or intent to start a lawsuitbetween a CPA firm and its client is aviolation of Rule 101 for the current audit.
15Bookkeeping The AICPA Code permits a CPA firm to do both bookkeeping and auditingfor the same client.See p. 89.Note that SOX takes a differentposition with publicly traded (SEC)clients, p. 83.
16Other Services and Unpaid Fees Consulting and other nonaudit servicesMust avoid performing management functionsNote that SOX takes a differentposition with publicly traded (SEC)clients, p. 83Unpaid feesCan cause a conflict of interest if theyrelate to professional services providedmore than one year prior to the date ofthe report
17Rule 301 – Confidential client information Generally, a member may not disclose any confidential client information without the specific consent of the client.Exceptions:Obligations related to technical standardsSubpoena or summonsPeer reviewResponse to ethics division
18Rule 302 – Contingent feesContingent fees for any professional services are generally prohibited when(1) a member (or firm) performs:(a) an audit or review of financial statements; or(b) a compilation of a financial statement (see text)(c) an examination of prospective financial information; or(2) Prepare an original or amended tax return or claim for a tax refund for a contingent fee for any client.
19Rule 501 – Acts discreditable A member shall not commit an act discreditable to the profession, including:Retention of client records.Discrimination and harassment in employment practices.Failure to follow standards and/or procedures or other requirements in governmental audits.Negligence in the preparation of financial statements or records.Failure to follow requirements of governmental bodies, commissions, or other regulatory agencies in performing attest or similar services.Solicitation or disclosure of CPA examination questions and answers.Failure to file tax return or pay tax liability.
20Rule 503 – Commissions and referral fees Commissions are not allowed when a member or the member's firm also performs for that client:An audit or review of financial statements; orA compilation of a financial statement (see text) ; orAn examination of prospective financial information.Disclosure of permitted commissions or referral fees.
21Other AICPA Rules of Conduct 102 – Integrity and objectivity201 – General standards202 – Compliance with standards203 – Accounting principles502 – Advertising and other formsof solicitation505 – Form of organization and name
22Enforcement mechanisms for the rules of conduct Action by AICPA:Remedial or corrective actionExpulsion and notification to that effect inthe CPA NewsletterAction by a state Board of Accountancy:Varies by state, but license may berevoked.
23Sarbanes-Oxley Act and SEC Provisions Addressing Auditor Independence The SEC adopted rules strengthening auditorindependence in January 2003 Consistent withthe requirements of the Sarbanes-Oxley Act.The Sarbanes-Oxley Act and the revised SECrules further restrict, but do not completelyeliminate the type of nonaudit servicesthat can be provided to the public.
24Who Falls Under the SEC Provisions for Auditor Independence? Auditors of publicly traded companies.
25Sarbanes-Oxley Act and SEC Provisions Addressing Auditor Independence Prohibited Services1. Bookkeeping and other accounting services2. Financial information systems design and implementation3. Appraisal or valuation services4. Actuarial services5. Internal audit outsourcing6. Management of human resource functions7. Broker or dealer or investment adviseror investment banker services8. Legal and expert services unrelated to the audit9. Any other service that the PCAOB determinesby regulation is impermissible
26Audit Committees An audit committee is a selected number of members of a company’s board of directorswhose responsibilities include helpingauditors remain independent of management.Duties include:Pre-approval of all audit and nonaudit servicesOversight of auditors workResolution of disagreements between managementand auditors
27Audit Committees The Sarbanes-Oxley Act requires that all members of the audit committeebe independent.Companies must disclose whether or notthe audit committee includes at leastone financial expert.
28Conflicts Arising from Employment Relationships The SEC has added a one year “cooling off ”period before a member of the auditengagement team can work for theclient in certain key management positions.Chief Executive OfficerChief Financial OfficerChief Accounting OfficerEquivalent positions to the above
29Partner Rotation The Sarbanes-Oxley Act requires that the lead and concurring audit partnerrotate off the audit engagementafter a period of five years.
30Ownership Interests SEC rules adopted in 2000 on financial relationships narrow the restrictions onownership in clients to those personswho can influence the audit.Members of the engagement teamThose in a position to influence auditengagementPartners and managers providing>10 hrs of non-audit svcs. to clientPartners in the office of the partnerprimarily responsible for engagement