1. Ethics and the Audit Profession
Chapter 5
Ethics and the Audit Profession 1

2. Learning Objectives
Distinguish ethical from unethical behavior in personal and professional contexts.
Resolve ethical dilemmas using an ethical framework.
Explain the importance of ethical conduct for the accounting profession.
Describe the purpose and content of the AICPA Code of Professional Conduct.

3. Learning Objectives
Understand Sarbanes-Oxley Act and other SEC and PCAOB independence requirements and additional factors that influence auditor independence.
Apply the AICPA Code rules and interpretations on independence and explain their importance.
Understand the requirements of other rules under the AICPA Code.
Describe the enforcement mechanisms for CPA conduct.

4. 1
Distinguish ethical from unethical behavior in personal and professional contexts.

5. What Are Ethics? Ethics can be defined broadly as
a set of moral principles or values.
Each of us has such a set of values.
We may or may not have considered
them explicitly.

6. Illustrative Prescribed Ethical Principles
Responsibility
Trustworthiness
Caring
Core Ethical
Values
Trustworthiness includes honesty and integrity
Respect includes civility, courtesy and decency
Responsibility means being accountable for ones actions and exercising restraint.
Fairness and justice include issues of equality and impartiality
Caring means being genuinely concerned for the welfare of others and includes showing benevolence.
Citizenship includes obeying laws and performing one’s fair share to make society work.
Respect
Citizenship
Fairness

7. Need for Ethics Ethical behavior is necessary for a society
to function in an orderly manner.
The need for ethics in society is sufficiently
important that many commonly held
ethical values are incorporated into laws.

8. Why People Act Unethically
The person’s ethical standards are different
from those of society as a whole.
The person chooses to act selfishly.
Selfish actions are often for personal gain.
Instructor may want to refer to the three elements of the fraud triangle to understand the rationale for unethical acts.

9. A Person Chooses to Act Selfishly – Example
Person A finds a briefcase containing
important papers and $1,000.
He tosses the briefcase and keeps the money.
He brags to his friends about his good fortune.
This action probably differs from most of society.

10. A Person Chooses to Act Selfishly – Example
Person B faces the same situation but
responds differently.
He keeps the money but leaves the briefcase.
He tells nobody and spends the money.
He has violated his own ethical standards
and chose to act selfishly.

11. Resolve ethical dilemmas using an ethical framework.2
Resolve ethical dilemmas using an ethical framework.

12. Ethical Dilemmas An ethical dilemma is a situation a person
faces in which a decision must be made
about appropriate behavior.
Auditors face many ethical dilemmas in
their business careers.

13. Rationalizing Unethical Behavior
Everybody does it
If it’s legal, it’s ethical
Likelihood of discovery and consequences

14. Resolving Ethical Dilemmas
Obtain the relevant facts
Identify the ethical issues from the facts
Determine who is affected

15. Resolving Ethical Dilemmas
4. Identify the alternatives available to the
person who must resolve the dilemma
5. Identify the likely consequence of each
alternative
6. Decide the appropriate action

16. Relevant Facts A staff person has been informed that
he will work hours without recording
them as hours worked.
Firm policy prohibits this practice.
Another staff person has stated that
this is common practice in the firm.

17. Ethical Issue Is it ethical for the staff person to work hours and
not record them as hours worked in this situation?
Who is
affected?
How are
they affected?
What alternatives does the staff person have?

18. 3
Explain the importance of ethical conduct for the accounting profession.

19. Special Need for Ethical Conduct in Professions
Our society has attached a special
meaning to the term “professional”.
Professionals are expected to conduct
themselves at a higher level
than most other members of society.
The reason for an expectation of a high level of professional conduct by any profession is the need for public confidence in the quality of service by the profession, regardless of the individual providing it.

20. Difference Between CPA Firms and Other Professionals
CPA firms are engaged and paid by the
company issuing the financial statements.
Primary beneficiaries of the audit are
statement users.
It is essential that users regard CPA firms as competent and unbiased. If users believe that CPA firms do not perform a valuable service, the value of the audit and other attestation reports is reduced and the demand for these services is reduced.

21. CPAs Encouraged to Conduct Themselves at a High Level
GAAS and
interpretations
CPA
examination
Continuing
education
requirements
Quality
control
Conduct of
CPA firm
personnel
Legal
liability
Peer
review
AICPA practice
sections
PCAOB
and SEC
Code of
Professional
Conduct

22. 4
Describe the purpose and content of the AICPA Code of Professional Conduct.

23. Code of Professional Conduct
Published explanations and answers to questions about the rules of
conduct submitted to the AICPA by practitioners and others interested
in ethical requirements. They are not enforceable, but a
practitioner must justify departure.

24. Ethical Principles 1. Responsibilities:
Professionals should exercise sensitive and
moral judgments in all their activities.
2. The public interest:
Members should accept the obligation to act
in a way that will serve and honor the public.

25. Ethical Principles 3. Integrity:
Members should perform all responsibilities
with the highest sense of integrity.
4. Objectivity and independence:
Members should be objective, independent,
and free of conflicts of interest.

26. Ethical Principles 5. Due care:
Members should observe the profession’s
standards and strive to improve competence.
6. Scope and nature of services:
A member in public practice should observe
the Code of Professional Conduct.

27. Standards of Conduct

28. IESBA Code of Ethics for Professional Conduct
Part A
Part B
Part C
Establishes five
fundamental
principles
Describes how framework applies
in certain situations
Five fundamental principles are integrity, objectivity, professional competence and due care, confidentiality, and professional behavior.
Evaluate and
eliminate threats
Accountants in
public practice
Accountants
in business

29. 5
Understand Sarbanes-Oxley Act and other SEC and PCAOB independence requirements and additional factors that influence auditor independence.

30. Independence The AICPA and IESBA codes of ethics
both define independence as
consisting of two components
Independence of mind
The AICPA code of professional conduct and the IESBA code of ethics
For professional conduct both define independence as consisting of two
components: independence of mind and independence in appearance.
Independence in appearance

31. Sarbanes-Oxley Act and SEC Provisions Addressing Auditor Independence
SEC auditor independence rules strengthened
in 2003 consistent with the Sarbanes-Oxley Act.
The Sarbanes-Oxley Act and revised SEC
rules further restrict the type of nonaudit
services that can be provided by auditors.
The SEC adopted rules strengthening auditor independence in January 2003 consistent with
the requirements of the Sarbanes-Oxley Act.
The Sarbanes-Oxley Act and the revised SEC rules further restrict, but do not completely
eliminate the type of non-audit services that can be provided to the public.

32. Sarbanes-Oxley Act and SEC Provisions Addressing Auditor Independence
The PCAOB has also issued additional
independence rules related to the
provision of certain tax services.

33. Sarbanes-Oxley Act and SEC Provisions Addressing Auditor Independence
Prohibited Services
1. Bookkeeping and other accounting services
2. Financial information systems design and
implementation
3. Appraisal or valuation services
4. Actuarial services
5. Internal audit outsourcing
6. Management of human resource functions
7. Broker, dealer, or investment adviser
or investment banker services
8. Legal and expert services unrelated to the audit
9. Any other service that the PCAOB determines
by regulation is impermissible

34. Audit Committees A selected number of members of a
company’s board who help auditors remain
independent.
An audit committee is a selected number of members of a company’s board of directors
whose responsibilities include helping auditors remain independent of management.
Most audit committees are made up of three to five or sometimes as many as seven
directors who are not a part of company management.
Comprised of three to five independent
directors.

35. Audit Committees All members must be independent.
At least one audit committee member must be
a financial expert.
The Sarbanes-Oxley Act requires that all members of the audit committee
be independent
Companies must disclose whether or not the audit committee includes at least
one financial expert.

36. Conflicts Arising from Employment Relationships
A one year “cooling off” period must occur
before a member of the audit engagement
team can accept a key management
position at a client.
The SEC has added a one year “cooling off ” period before a member of the audit
engagement team can work for the client in certain key management positions.
Oftentimes, companies may offer employment to a member of the audit team. Should the offer occur during the audit, the independence and objectivity of the auditor may be compromised. Such situations involve a decision by the partner and manager about whether the individual should be removed from the engagement.

37. Partner Rotation The Sarbanes-Oxley Act requires that
the lead and concurring audit partner
rotate off the audit engagement
after a period of five years.
The purpose of this rule is for the audit firm to maintain its overall independence and objectivity with respect to the client.

38. Ownership Interests SEC rules on financial relationships
take an engagement perspective.
SEC rules prohibit ownership in
audit clients by those persons
who can influence the audit.
The rules prohibit any ownership by covered persons and their immediate family, including (a) members of the audit engagement team, (b) those in position to influence the audit engagement in the firm chain of command, (c ) partners and managers who provide more than 10 hours of nonaudit services to the client, and (d) partners in the office of the partner primarily responsible for the engagement.

39. Other Issues Shopping for accounting principles
Engagement and payment of
audit fees by management
Can the auditor be truly
independent if payment depends
on company management?

40. 6 Apply the AICPA Code rules and interpretations on independence
and explain their importance.

41. Rules of Conduct Rule 101 – Independence
A member in public practice shall be
independent in the performance of
professional services as required by
standards promulgated by bodies
designated by Council.

42. Financial Interests Interpretations of Rule 101 prohibit
covered members from owning any
direct investments in audit clients.
Covered members
Covered members include:
individuals on the attest engagement team
an individual in a position to influence the attest engagement, such as individuals who supervise the engagement partner
a partner or manager who provides non-attest services to the client
a partner in the office of the partner responsible for the attest engagement
the firm and its employee benefit plans
an entity that can be controlled by any of the covered members listed above
Ownership of stock or other equity shares and debt securities by members of their immediate family is called a direct financial interest.
An indirect financial interest exists when there is a close but not a direct ownership relationship between the auditor and the client.
Materiality affects whether ownership is a violation of Rule 101 only for indirect ownership.
Direct versus indirect financial interest
Material or immaterial

43. Related Financial Interests Issues
Former practitioners
Normal lending procedures
Financial interests and employment
of immediate and close family members
Joint closely held investments with a
client
Director, officer, management,
or employee of a company
Former partners who left the firm or have sold their ownership interest are permitted to have relationships with clients of the firm.
Generally loans between a CPA firm or covered members and an audit client are prohibited because it is a financial relationship.
Immediate family members, defined as a spouse, spousal equivalent or dependent are ordinarily treated as if they were the financial interest of the covered member.
If a CPA is a member of the board of directors or an officer of a client company, his or her ability to make independent evaluations of the fair presentation of financial statements is affected.

44. Litigation Between CPA Firm and Client
A lawsuit or intent to start a lawsuit between
a CPA firm and its client, the ability of the
CPA firm and client to remain objective
is questionable.
The interpretations regard such litigation as
a violation of Rule 101.

45. Bookkeeping and Other Services
The AICPA Code permits a CPA firm
to do both bookkeeping and auditing
for a private company audit client.

46. Bookkeeping and Other Services
1. Client must accept full responsibility
for the financial statements.
The CPA must not assume the role
of employee or of management.
The CPA must conform to auditing
standards.

47. Bookkeeping and Other Services
The SEC and AICPA rules do not allow
audit firms to provide bookkeeping
services to public company audit clients.
Consulting and other nonaudit services
Under Rule 101, independence is considered impaired if billed or unbilled fees remain unpaid for professional services provided more than 1 year before the date of the report. Such unpaid fees are considered a loan from the auditor to the client and are therefore a violation of Rule 101.
Unpaid fees

48. Understand the requirements of other rules under the AICPA Code.7
Understand the requirements of other rules under the AICPA Code.

49. Other Rules of Conduct 102 – Integrity and objectivity
201 – General standards
202 – Compliance with standards
203 – Accounting principles
301 – Confidential client information
A member shall be free from conflicts of interest and shall not knowingly misrepresent facts or subordinate his or her judgment to others.
A member shall comply with the following standards and with any interpretations designated by council:
professional competence
due professional care
planning and supervision
sufficient and relevant data
A member shall comply with standards promulgated by bodies designated by council.
See previous discussion regarding rule 203 in chapter 3.
It is essential that practitioners not disclose confidential information obtained in any type of engagement without the consent of the client.

50. Other Rules of Conduct 302 – Contingent fees 501 – Acts discreditable
502 – Advertising and other forms
of solicitation
503 – Commissions and referral fees
505 – Form of organization and name
CPA firms are permitted to charge contingent fees for nonattestation services unless the CPA firm is also performing attestation services for the same client.
A member shall not commit an act discreditable to the profession.
A member in public practice shall not seek to obtain clients by advertising or other forms of solicitation in a manner that is false, misleading, or deceptive.
A member in public practice shall not for a commission recommend or refer any product or service to be supplied by a client or receive a commission when the member’s firm performs an audit, compilation, or examination of financial information for that client.
A member shall not practice public accounting under a firm name that is misleading.

51. Describe the enforcement mechanisms for CPA conduct.8
Describe the enforcement mechanisms for CPA conduct.

52. Enforcement AICPA Professional Ethics Division State Board of
Accountancy
PCAOB
Enforcement Division

53. Are there any questions?

54. Copyright
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