1. Electronic Presentations in Microsoft ® PowerPoint ® Prepared by Brad MacDonald SIAST © 2003 McGraw-Hill Ryerson Limited

2. Copyright © 2003 McGraw-Hill Ryerson Limited Chapte r 1616 2 Professional Ethics and Auditor Responsibilities

3. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 3 General Ethics As part of a privileged profession, auditors have a set of moral, professional, and legal responsibilities to society. –Professional responsibilities (ethics) are the rules and principles for the proper conduct of an auditor in his/her professional work. Ethics are necessary for respect and confidence of the public. Rules of professional conduct attain order within the profession. Rules of conduct provide a means of self-policing the profession.

4. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 4 General Ethics Overview –Ethics: “that branch of philosophy which is the systematic study of reflective choice, of the standards of right and wrong…”. –Ethical problem: A situation when you must make a clear choice among alternative actions, and the right choice is not absolutely clear.

5. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 5 General Ethics –Ethical behavior: That which produces the greatest good, or that which conforms to rules and principles. Why do we need a code of ethical conduct? –A code serves as a reference and benchmark for individuals.

6. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 6 General Ethics Ethics refer to the role of the decision maker. In addition, the professional accountant serves other roles: –spectator - observing colleagues –advisor - counselling co-workers –instructor - teaching accounting students –judge - serving on disciplinary committees –critic – reviewing the ethical decisions of others

7. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 7 General Ethics An ethical decision process: 1.Recognize a decision problem. 2.Collect evidence. 3.Think about rules of behaviour. 4.Considering probable outcomes. 5.Analyze the situation. 6.Take action.

8. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 8 Learning Objective 1 Evaluate an ethical decision problem using principles of moral philosophy.

9. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 9 The Imperative Principle - Kant Universal principles must always be followed regardless of the consequences. –Rules must always be followed because they are rules. –General objection to this principle is that rules always have exceptions. –Second problem is determining which (conflicting) duty is important. –Rules of conduct have been greatly influenced by the imperative principle.

10. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 10 The Principle of Utilitarianism The ultimate criterion of an ethical decision is the balance of good over evil consequences produced by an action. –Greatest good for greatest number is all that matters. –Permits an action that causes a minority to suffer.

11. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 11 Other Ethical Models Character ethics: –Focuses on the virtues a person needs to take the most ethical action. Rights bases theories: –Rights are justified claims that individuals and groups can make on others. Ethics of care: –Emphasize emotional commitment to persons. Casuistry: –Moral judgements are based on intimate understanding of particular situations.

12. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 12 Learning Objective 2 Analyze fact situations and decide whether an accountant’s conduct conforms to a province’s Rules of Professional Conduct.

13. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 13 Rules of Professional Conduct and Code of Ethics Each of the PA bodies (CA, CGA, CMA) has its own rules of professional conduct. Typical framework follows: –Introduction and purpose –Fundamental principles and standards –General Rules –Specific rules –Discipline –Interpretations of the rules

14. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 14 Fundamental Principles –The member should act to maintain the profession’s reputation. –The member should use due care and maintain his/her professional competence. –The member should maintain independence in the appearance, as well as the fact of independence of his/her professional judgement. –The member should preserve client confidentiality. –The member should base his/her reputation on professional excellence. –The member should show professional courtesy to other members at all times.

15. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 15 Rules of Professional Conduct The Rules of Professional Conduct derive their authority from the bylaws of the profession. –Rules apply to members and all persons associated in public practice including employees and partners. –Certain principles apply to all professional accountants.

16. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 16 Fundamental Principles in Codes of Conduct Members should –at all times maintain the good reputation of the profession and its ability to serve the public interest –perform with: integrity objectivity independence due care confidentiality –not be associated with any misleading information or misrepresentation

17. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 17 Serving the Public Interest The single most important principle is that accountants must serve the public interest. The profession must maintain a good reputation at all time. –If a professional accountant is convicted of a relatively minimal offence or fraud, his/her certification is usually revoked.

18. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 18Integrity Integrity is the duty to be honest and conscientious in performing professional services. –A PA must “be upright” not be “kept upright.”

19. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 19 Learning Objective 3 Explain the increasing importance of an independence framework for auditors.

20. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 20 Independence and Objectivity Independence and objectivity are closely related terms. –Objectivity: Member in public practice shall hold himself/herself free of any influence, interest, or relationship that impairs the member’s professional judgment. –Independence: The objectivity in the case of an assurance engagement.

21. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 21Independence The concept of independence is critical to the public accounting profession. –Not only must an accountant be independent in fact, he/she must also appear independent to others. Independence in fact is a mental state, and is difficult to prove. Independence in appearance is governed by legislation and rules of professional conduct.

22. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 22 Canadian Business Corporations Act, Section 161 The term “independence” is used in the Canadian Business Corporations Act as a key qualification of an auditor. 161. (1) Qualification of auditor. – Subject to subsection (5), a person is disqualified from being an auditor of a corporation if he is not independent of the corporation…”

23. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 23 Canadian Business Corporations Act, Section 161 161 (2) Independence – For the purpose of this section, a)independence is a question of fact; and b)a person is deemed not to be independent if he or his business partner I.is a business partner, a director, an officer or an employee of the corporation or any of its affiliates, or a business partner of any director, officer or employee of any such corporation or any of its affiliates;

24. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 24 Canadian Business Corporations Act, Section 161 161 (2) Independence – For the purpose of this section, a)independence is a question of fact; and b)a person is deemed not to be independent if he or his business partner II.beneficially owns or controls, directly or indirectly, a material interest in the securities of the corporation or any of its affiliates, or

25. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 25 Canadian Business Corporations Act, Section 161 161 (2) Independence – For the purpose of this section, a)independence is a question of fact; and b)a person is deemed not to be independent if he or his business partner III.has been a receiver-manager, liquidator or trustee in bankruptcy of the corporation or any of its affiliates within two years of his proposed appointment as auditor of the corporation. (3) Duty to resign. – An auditor who becomes disqualified under this section shall, subject to subsection (5) resign forthwith…

26. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 26Independence The Canadian Business Corporations Act requires independence for audits. –Many other services offered by public accountants also require independence. A public accountant “holds out to be a PA” or “offers to perform services that PAs perform.” –The accounting associations include deemed conflict of interest rules similar to the provisions of the act.

27. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 27 Deemed Conflict of Interest Deemed conflict of interest where: Who:Relationship (a)Member, partner, or employee  Director, officer, or employee of the client Immediate family of member or partner  Director or officer of the client (b)Member, partner, employee or immediate families  Indebted to the client  Own debt instruments of the client  Trustee in bankruptcy, liquidator, receiver or receiver-manager of the client  Executor, administrator, or trustee of the client

28. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 28 Deemed Conflict of Interest Who:Relationship (c)Member’s close relatives  Hold a material interest in the client  Director, officer, or significant employee of the client  Executor, administrator, or trustee of the client  Executor, administrator, or trustee of an estate or trust that holds a material interest in the client

29. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 29 Permitted Loans The accountant will not be deemed to be in conflict of interest for: home mortgages, immaterial loans and secured loans –made by financial institutions under normal lending procedures, terms and requirements.

30. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 30 Permitted Loans Independence also is not impaired by a member obtaining: auto loans or leases collateralized by the automobile, insurance policy loans based on surrender values, loans collateralized by cash deposits, or credit card balances if the loans are made in the normal course of business for the issuer.

31. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 31 Other Issues Related to the Independence Principle Honorary Positions in Non-Profit Organizations: –PAs’ independence is not impaired if the member is an honorary director where criteria are met. Retired Partners: –Retired partners may impair independence after they have left the firm, except where conditions relating to their retirement are satisfied. Accounting Services: –Where PA has appearance of having prepared the statements, independence may be impaired.

32. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 32 Other Issues Related to the Independence Principle Rotation of Partners: –Rotation of the lead audit partner and/or the concurring partner is required every five years. Actual or Threatened Litigation: –PAs are considered not independent when company management threatens or starts a suit against the PA, or when the PA threatens or starts a suit against the company.

33. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 33 Other Issues Related to the Independence Principle Investor or Investee Relationships: –Material investments by the PA and by the client need to be considered. Effect of Family Relationships: –Financial interests of spouses and dependent persons, and some interests of close relatives are attributed to the member. Analysis: –Objectivity, integrity are always required, but the rules concentrate on “conflicts of interest” based on financial measures.

34. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 34 Professional Competence and Due Care Professional competence and due care principles are incorporated into the rules of conduct, as well as in the general audit standards. –The professional competence and due care principles are a comprehensive statement of general standards that accountants are expected to observe in all areas of practice. These are principles that enforce the various series of professional standards.

35. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 35 Compliance with Professional Standards PAs shall perform professional services in accordance with generally accepted standards of practice for the profession –extension and refinement of the due care principle –practical effect of the rule is to make noncompliance with all technical standards subject to disciplinary proceedings –the failure to follow auditing standards, accounting and review standards, and assurance, compilation and professional conduct standards is a violation of this rule

36. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 36Confidentiality A member in public practice shall not disclose any confidential information without the specific consent of the client. This rule does not –relieve the PA from complying with a valid summons –or prohibit a member from complying with applicable laws a review of his/her professional practice participating in disciplinary hearings

37. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 37Confidentiality Confidentiality is intended to facilitate a free flow of information. –PA will require access to sensitive information to discharge responsibilities. –Creates difficulties over auditors’ obligations to blow the whistle on illegal practices. In general, PAs are not obligated to do so. May be required if the client has intentionally associated PA with misleading statements, conduct, or reports. Seek legal counsel.

38. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 38Fees Contingency Fees: –PAs shall not offer professional service for a fee contingent on the results of such service. –PAs should not represent that no fee will be charged except in the case of services of a charitable nature. Fee Quotation: –Fees are quoted only when requested by a client or prospective client, and then only when adequate information is obtained.

39. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 39 Discreditable Acts Public accountants will not bring discredit to the profession. –Discreditable acts might include the following: fraud, false tax returns conviction on a criminal offence withholding client’s books and records employment discrimination failure to follow government guidelines in government audits false entries in clients records –Rules include expulsion of members.

40. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 40 Advertising and Other Forms of Solicitation A PA shall not seek clients by advertising in a manner that is false, misleading, or deceptive. –Advertising must not include: unjustified expectations of favourable results implied ability to influence officials or agencies or courts incorrect fee estimates misleading representations –Some liberalization of rules has taken place because of the Canadian Charter of Rights and Freedoms.

41. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 41 Commissions and Referral Fees Prohibited Commissions: –PAs may not receive any referral commissions where the engagement involves assurance services. –PAs may receive commissions on the sale or purchase of an accounting practice.

42. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 42 Form of Organization and Name Form of Organization –The practice shall be under the personal charge of a member who is a public accountant. Name of Organization –Firm names may not be misleading. The name of the firm usually consists of the names of the partners. Names of past owners may be included in successor firms.

43. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 43 Learning Objective 4 Identify and explain the various professional associations and government agencies that enforce rules of conduct and explain the types of penalties they can impose on accountants.

44. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 44 Regulation and Quality Controls A public accountant will be expected to observe rules of conduct published in several codes of ethics. –Determined by the nature of the services provided, by membership in accounting associations, and by the nature of the client.

45. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 45 Self-Regulatory Discipline Accounting firms and individuals are subject to the rules of an association by choice. –Only by choosing to belong do they become subject to the rules. –The institutes have a responsibility to investigate all complaints. Three conclusions are possible: The member did not breach the rules. The member did breach the rules, but the infraction is not serious. Issue a written admonishment. The breach is serious, charges are laid, and the matter is brought before the disciplinary committee.

46. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 46 Self-Regulatory Discipline The disciplinary committee can reach a decision of guilty or not guilty. –If guilty, penalties may include one or more actions. The member could be: reprimanded or suspended, struck off student registry or expelled assigned professional development course required to complete a period of supervised practice reinvestigated charged costs or fines the decision and member’s name may be publicized –The institutes provide for an appeal process.

47. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 47 Consequences of Unethical / Illegal Acts Conforming to the rules is not always easy due to conflicts between the various rules. –Deficiencies in the codes of conduct: No or insufficient prioritization is put forward. Consultation on ethical matters is inhibited for some members. Fair hearing process is not indicated, members are uncertain whether to come forward. There is no protection for “whistle blowers.” Sanctions are unclear; applicability is not defined. Conflict resolution mechanisms are deficient.

48. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 48 Appendix 16A: The SEC on Independence Bookkeeping Family Relations Financial Interests Former Partners SEC Views

49. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 16 49 Appendix 16B: Additional Background in Logic in the Context of Auditing Role of Logic in Auditing: –Logic is the study of reasoning. –Central problem in auditing is the strength of the auditor’s conclusion as reflected by his/her opinion. –Opinion needs to be warranted. –Data (evidence from audit procedures) –Qualifiers