1. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 1 Professional Ethics Chapter 5

2. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 2 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.

3. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 3 Illustrative Prescribed Ethical Principles  Trustworthiness  Responsibility  Caring  Respect  Fairness  Citizenship

4. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 4 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.

5. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 5 Ethical Dilemmas An ethical dilemma is a situation a person faces in which a decision must be made about appropriate behavior.

6. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 6 Rationalizing Unethical Behavior  Everybody does it  Likelihood of discovery and consequences  If it’s legal, it’s ethical

7. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 7 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.

8. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 8 Special Need for Ethical Conduct in Professions Professional Ethics - Commitment by Profession - Ethical Principles and Rules of Conduct - extends beyond moral principles designed to encourage idealistic behavior, but must be realistic and enforceable - affects reputation of profession and confidence in it exclusive rights to practice; in return act in the public interest Members voluntarily accept standards of professional behavior that are more rigorous than those required by law.

9. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 9 Special Need for Ethical Conduct in Professions attempts to deal with ethical questions by defining what is good for the individual and society, and by trying to establish the nature of obligations or duties that individuals owe themselves and each other. General Ethics attempts to deal with ethical questions by defining what is good for the individual and society, and by trying to establish the nature of obligations or duties that individuals owe themselves and each other. must extend beyond moral principles. They include standards of behavior for a professional person that are designed for both practical and idealistic purposes. Professional Ethics must extend beyond moral principles. They include standards of behavior for a professional person that are designed for both practical and idealistic purposes.

10. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 10 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.

11. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 11 CPAs Encouraged to Conduct Themselves at a High Level Code of Professional Conduct PCAOB and SEC Conduct of CPA firm personnel Peer review Quality control CPA examination GAAS and interpretations Continuing education requirements Legal liability AICPA practice and quality centers

12. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 12 AICPA Code of Professional Conduct Principles Ideal standards of ethical conduct stated in philosophical terms. They are not enforceable. Rules of conduct Minimum standards of ethical conduct stated as specific rules. They are enforceable. Interpretations of the rules of conduct Interpretation of the rules of conduct by the AICPA Division of Professional Ethics. They are not enforceable, but a practitioner must justify departure.

13. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 13 Code of Professional Conduct Ethical rulings 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.

14. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 14 Journal of Accountancy quizzes (Q&A) &fact pattern & outcome Informal Rulings Status in an ethics investigation or disciplinary hearing: unclear

15. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 15 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.

16. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 16 Ethical Principles 3. Integrity: Members should perform all responsibilities with integrity to maintain public confidence. 4. Objectivity and independence: Members should be objective, independent, and free of conflicts of interest.

17. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 17 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.

18. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 18 Standards of Conduct Principles Rules of conduct Substandard conduct Ideal conduct by practitioners Minimum level of conduct by practitioners

19. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 19 Sarbanes-Oxley Act and SEC Provisions Addressing Auditor Independence 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 nonaudit services that can be provided to the public.

20. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 20 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.

21. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 21 Sarbanes-Oxley Act and SEC Provisions Addressing Auditor Independence 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 1. Prohibited Services

22. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 22 2. Audit Committees 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.

23. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 23 2. Audit Committees (cont’d) 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.

24. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 24 3. Conflicts Arising from Employment Relationships 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.

25. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 25 4.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.

26. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 26 5.Ownership Interests SEC rules prohibit ownership in audit clients by covered persons & their immediate family who can influence the audit. SEC rules on financial relationships take an engagement perspective.

27. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 27 Other Issues  Shopping for accounting principles  Engagement and payment of audit fees by management

28. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 28 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.

29. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 29 Financial Interests Interpretations of Rule 101 prohibit covered members from owning any direct investments in audit clients.  Covered members  Direct versus indirect financial interest  Material or immaterial

30. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 30 Related Financial Interests Issues  Former practitioners  Normal lending procedures  Financial interests and employment of immediate and close family members  Joint investor or investee relationship with client  Director, officer, management, or employee of a company

31. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 31 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.

32. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 32 Bookkeeping and Other Services The AICPA Code permits a CPA firm to do both bookkeeping and auditing for a nonpublic client.

33. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 33 Bookkeeping and Other Services 1.Client must accept full responsibility for the financial statements. 2.The CPA must not assume the role of employee or of management. 3.The audit must conform to use of auditing standards.

34. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 34 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  Unpaid fees

35. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 35 Other Rules of Conduct 102 – Integrity and objectivity 201 – General standards 202 – Compliance with standards 203 – Accounting principles 301 – Confidential client information

36. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 36 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

37. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 37 Enforcement  Action by AICPA Professional Ethics Division  Action by a state Board of Accountancy

38. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 4 - 38 End of Chapter 5