Integrity, Objectivity and Independence: Core Elements of the AICPA Code of Professional Ethics Jane Zhang, Assistant Professor and Debra M. Grace, Professor Dept. of Accountancy California State University at Long Beach

Structure of the AICPA Code of Professional Conduct Principles Rules Interpretations & Ethics Rulings

To maintain and broaden public confidence, members should perform all professional responsibilities with the highest sense of integrity. in·teg·ri·ty ( ĭ n-t ĕ g′r ĭ -t ē ) Article III—AICPA Code of Professional Ethics

Integrity relates to a person’s inner character. Individuals with integrity: Follow strict moral or ethical codes Are honest, good and honorable Accept responsibility for their actions Do the right thing at all times Tell the truth What is integrity?

Individuals without integrity: Are dishonest Act in questionable manners Are corruptible Tell lies Blame others Avoid taking responsibility for their actions Only do the right thing if they are watched What is NOT integrity?

Why is integrity necessary? To maintain the public’s trust (Article III.01) The Code of Professional Conduct and Integrity

What does integrity require? Honesty (Article III.02) Candidness (respecting client confidentiality (Article III.02) Lack of deceit (Article III.02) Not subordinating your principles to others (Article III.02) Not acting for personal gain (Article VI.01) Observing objectivity, independence and due care (Article III.04) The Code of Professional Conduct and Integrity

What does integrity mean? What is right (Article III.03) What is just (Article III.03) Asking yourself: Am I doing what a person of integrity would do? (Article III.03) The Code of Professional Conduct and Integrity

A member shall not knowingly misrepresent facts The Code of Professional Conduct and Integrity Rule 102—AICPA Code of Professional Ethics

When does misrepresentation of facts mean? You, or someone under your control, has: Made materially false and misleading entries in financial statements or records Not corrected false and misleading financial statements or records Signed documents containing materially false and misleading information Interpretation of Rule 102 The Code of Professional Conduct and Integrity

Situation: Janet knows her company’s financial statements are materially misstated, yet she signs a representation letter to her company’s external auditors saying that the statements are true and correct. Has Janet violated the Code of Professional Conduct? Example of Integrity Answer: Yes, Janet has violated the Integrity principle. Under Rule 102, a member must not sign a document with materially false and misleading information. Interpretation of Rule 102-1(c)

Situation: John, a new accountant, realizes that an entry on his company’s books is false and will materially affect the financial statements. He did not change the entry. Has John violated the Code of Professional Conduct? Example of Integrity Answer: Yes, John has violated the Integrity principle. Under Rule 102, a member must correct materially false and misleading financial statements or records.. Interpretation of Rule 102-1(b)

Situation: Shana, the company’s CEO, directs the accounting department head to record an entry that she knows to be fictitious and materially false. Has Shana violated the Code of Professional Conduct? Example of Integrity Answer: Yes, Shana has violated the Integrity principle. Under Rule 102, a member cannot make, or direct others to make, materially false and misleading entries to financial statements or records Interpretation of Rule 102-1(a)

A member should maintain objectivity and be free of conflicts of interest in discharging professional responsibilities ob·jec·tiv·i·ty ( ŏ b ′ j ĕ k-t ĭ v′ ĭ -t ē ) Article IV—AICPA Code of Professional Ethics

Being able to make impartial judgments, without being influenced by emotions or personal prejudices Individuals with objectivity are: Neutral and even-handed Impartial and free from bias Fair and just Truthful Open-minded Nonpartisan What is objectivity?

Individuals without objectivity are: Subjective Influenced by emotions or personal prejudices Biased Opinionated Not free from conflicts of interest Subordinating their judgments to others What is NOT objectivity?

Why is objectivity necessary? To perform professional services free from conflicts of interest (Article IV.01) The Code of Professional Conduct and Objectivity

What does objectivity require? Impartiality (Article IV.01) Candidness (but not violating client confidentiality) (Article IV.01) Not subordinating your judgment to others (Article IV.02) Acting scrupulously in applying GAAP (Article IV.04) Being candid in all dealings (Article IV.04) The Code of Professional Conduct and Objectivity

A member shall be free of conflicts of interest and shall not subordinate judgment to others The Code of Professional Conduct and Objectivity Rule 102—AICPA Code of Professional Ethics

When do conflicts of interest occur? A member’s relationship with another impairs the member’s objectivity. Interpretation of Rule 102 The Code of Professional Conduct and Objectivity

When is objectivity impaired from conflicts of interest? A member is: Providing litigation services to someone suing a client of the member’s firm Asked to continue providing tax services to a divorcing couple Asking a client to invest in a business in which the member has an interest Serving on a city board of tax appeals on matters affecting his firm’s clients Recommending a service firm to a client in which the member holds a material interest Interpretation of Rule 102 The Code of Professional Conduct and Objectivity

What can be done if there is a conflict of interest? The service can be performed if the member: Believes she/he can be objective and The relationship is disclosed to the appropriate parties and Consent is obtained from the appropriate parties Interpretation of Rule 102 The Code of Professional Conduct and Objectivity

Situation: A local bank has asked Anthony to serve on its board of directors. Many of the clients of Anthony’s CPA firm engage in significant transactions using this bank. Has Anthony violated the Code of Professional Conduct? Example of Objectivity Answer: Yes, Anthony has violated the Objectivity principle. Under Rule 102, it is generally not desirable for a member in public practice to serve as a bank director where his firm’s clients engage in significant transactions with the bank. ET Sec 191(85) – Ethics Rulings

Situation: Susan and Matt, longtime clients of Rebecca, are getting a divorce. Matt and Susan each ask Rebecca to provide tax services during and after the divorce process. Rebecca agrees. Has Rebecca violated the Code of Professional Conduct? Example of Objectivity Answer: Yes, Rebecca has violated the Objectivity principle. Under Rule 102, she faces conflict of interest charges in trying to represent two clients who are in dispute with each other. Interpretation of Rule 102-2

Situation: Adam is asked to serve as an expert witness for one of his firm’s clients in a legal trial. Has Adam violated the Code of Professional Conduct? Example of Objectivity Answer: No, a member serving as an expert witness does not serve as an advocate for a client, but as someone with specialized knowledge who would be able to arrive at positions objectively. ET Sec 191(101) – Ethics Rulings

What does subordination of judgment mean? You are directed by another to make false or misleading judgments Interpretation of Rule 102 The Code of Professional Conduct and Objectivity

How do you avoid subordination of judgment? Step One: If you disagree with your supervisor on preparing financial statement or recording transactions, ask yourself: Does my supervisor’s approach fairly represent the facts? If yes, do nothing Interpretation of Rule 102 The Code of Professional Conduct and Objectivity

How do you avoid subordination of judgment? Step Two: If you determine financial statements or records could be materially misstated: Make your concerns known to higher management Document your understanding of facts and GAAP involved Document names of persons with whom you talked Interpretation of Rule 102 The Code of Professional Conduct and Objectivity

How do you avoid subordination of judgment? Step Three: If you conclude appropriate action was not taken: Consider whether to continue with your employer Consider consulting a lawyer Interpretation of Rule 102 The Code of Professional Conduct and Objectivity

Situation: Carmen, a senior accountant, was directed by her supervisor to enter a journal entry different from the original one. What should Carmen do to avoid subordinating her judgment? Example of Objectivity Answer: Carmen must determine whether her supervisor’s entry represents a correct alternative. If it does, she need not do anything further. Interpretation of Rule 102-4(1)

Situation: Rosalie is directed by her supervisor to enter a journal entry different from the original one. Rosalie’s research indicates the new entry would result in a material misrepresentation in the financial statements and records. What should Rosalie do to avoid subordinating her judgment? Example of Objectivity Answer: Rosalie must make her concerns known to higher management. She should document her understanding of the facts, the accounting principles involved and the parties with whom she discussed the matters. Interpretation of Rule 102-4(2)

Situation: Aaron is directed by his supervisor to enter a journal entry different from the original one, which would result in a material misrepresentation in the financial statements and records. Aaron has brought this to the attention of higher management but no action was taken. What should Aaron do to avoid subordinating her judgment? Example of Objectivity Answer: Aaron should consider whether to continue with his employer. He may wish to consult with legal counsel. Interpretation of Rule 102-4(3)

in·de·pen·dence ( ĭ n ′ d ĭ -p ĕ n′d ə ns) A member in public practice should be independent in fact and appearance when providing auditing and other attestation services. Article IV—AICPA Code of Professional Ethics

Freedom from control or influence of other persons Individuals with independence: Are self-controlled Make their own opinions Set their own course of conduct Are not ruled by others What is independence?

Individuals without independence are: Subjective Influenced by emotions or personal prejudices Biased Opinionated Not free from conflicts of interest Subordinating their judgments to others What is NOT independence?

Why is independence necessary? To avoid impairing one’s objectivity in performing attestation services (Article IV.01) The Code of Professional Conduct and Independence

What does independence require for members in public service? Continuing assessment of client relationships and public responsibility (Article IV.03) Being independent in fact and appearance (Article IV.03) Being free from conflicts of interest (Article VI.01) The Code of Professional Conduct and Independence

A member in public practice shall be independent in the performance of professional services The Code of Professional Conduct and Independence Rule 101—AICPA Code of Professional Ethics

When is independence impaired? A member has: A direct or material indirect financial interest in a client A joint closely held investment with a client A loan to or from a client More than 5% of a client’s stock An association with the client as: Director, officer or employer Promoter, underwriter or voting trustee Trustee for the client’s pension or profit-sharing trust Interpretation of Rule 101 The Code of Professional Conduct and Independence

Situation: Vincent owns an immaterial amount of a client’s outstanding bonds. Is Vincent’s independence impaired? Example of Independence Answer: Yes. Ownership of a client’s bonds is considered a loan to the client. ET Sec 191(29) – Ethics Rulings

Situation: Gigi serves is a member of a client’s board of directors in addition to being the auditor of the client’s profit sharing and retirement trust. Is Gigi’s independence impaired? Example of Independence Answer: Yes. Service as a director constitutes participation in management functions that affect the client's trust. ET Sec 191(21) – Ethics Rulings

Situation: A client of Ben’s firm has not paid fees for services performed last year. Is Ben’s independence impaired for the current year? Example of Independence Answer: Yes. Ben’s independence is impaired if client fees remain unpaid for more than one year prior to the date of the report. ET Sec 191(52) – Ethics Rulings

The End