1. Professional Conduct, Independence, and Quality Control
Chapter 19
Professional Conduct, Independence, and Quality Control
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Ethics and Professional Conduct
LO# 1
Ethics and Professional Conduct
Refers to a system or code of conduct based on moral duties and obligations that indicate how an individual should interact with others in society
Ethics
Refers to the conduct, aims, or qualities that characterize or mark a profession or professional person
Professionalism
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3. Theories of Ethical Behavior
LO# 2
Theories of Ethical Behavior
Utilitarianism
A subset of Consequentialism
Recognizes that decision making involves trade-offs between the benefits and burdens of alternative actions and focuses on consequences and on individuals affected
Rights-Based Approach
Assumes that individuals have certain rights and other individuals have a duty to respect those rights when making decisions
Justice-Based Approach
Is concerned with issues such as equity, fairness, and impartiality
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4. Standards for Auditor Professionalism
LO# 4
Standards for Auditor Professionalism
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5. Three Categories of Standards for Ethics/Independence/Quality Control
Figure 19-1 in your text is not the way I organize my thinking about these standards. I view them as three categories:
Work on US private companies
AICPA (Code of Professional Conduct; Statement on Quality Control Standards No. 8)
Work on US public companies
SEC Rule 2-01; PCAOB Rules 3520 thru 3524; AS 7
Work on companies outside the US that do not register with the US SEC
IFAC Handbook of the Code of Ethics for Professional Accountants

6. 3 categories of standards (continued)
Here is how the text authors generally present the information in Chapter 19, to try to reduce unnecessary detail
Independence rules at the individual person level are discussed re the AICPA Code
Independence rules at the CPA firm level are discussed re the SEC rules
Quality control is discussed re the PCAOB rules
Discussion of peer review (AICPA)
Discussion of inspections (PCAOB)

7. LO# 5
The AICPA Code of Professional Conduct: A Comprehensive Framework for Auditors
Principles of Professional Conduct
Rules of Conduct
Interpretations of Rules of Conduct
Rulings by the Professional Ethics Executive Committee (PEEC)
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8. LO# 5
The AICPA Code of Professional Conduct: A Comprehensive Framework for Auditors
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9. Principles of Professional Conduct
LO# 6
Principles of Professional Conduct
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10. Rules of Conduct
LO# 7
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11. “Covered members” must be independent.
Independence
LO# 8
Rule 101
A member in public practice shall be independent in the performance of professional services as required by standards promulgated by bodies designated by Council.
Financial Statement Audits
Financial Statement Reviews
Other Attest Services as defined by SSAEs
Interpretation 101-1
“Covered members” must be independent.
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12. Covered Members An individual on the attest engagement team
An individual in a position to influence the attest engagement
A partner or manager who provides nonattest services to the attest client beginning once he or she provides 10 hours of nonattest services
A partner in the office in which the lead attest engagement partner primarily practices in connection with the attest engagement
The firm, including the firm’s employee benefit plan
An entity whose operating, financial, or accounting policies can be controlled by any of the individuals or entities described above or by two or more such individuals or entities if they act together
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13. Prohibited Financial Relationships
LO# 8
Prohibited Financial Relationships
Results when a covered member has a financial interest in an attest client, such as ownership of stock or a loan to or from the client
Direct
Results when a covered member has a financial interest in an entity that is associated with an attest client, for example an investment in a mutual fund that owns the client’s stock
Material Indirect
Exception: Certain types of personal loans from financial institutions who are clients are permitted
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14. Prohibited Business Relationships
LO# 8
Prohibited Business Relationships
Rule 101 and relevant interpretations essentially indicate that the independence of a CPA is impaired if the CPA performs a managerial or other significant role for a client’s organization during the time period covered by an attest engagement.
Interpretation indicates that a firm’s independence will be considered to be impaired with respect to a client if a partner or professional employee leaves the firm and is subsequently employed by a client in a key position unless a number of conditions are met.
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15. Effect of Family Relationships
LO# 8
Effect of Family Relationships
A covered member’s immediate family (spouse, spousal equivalent, or dependent) is subject to Rule 101 and its interpretations and rulings.
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16. Effect of Family Relationships
LO# 8
Two major situations with close relatives that can impair independence:
A close relative has a financial interest in the client that is material to the close relative, and the CPA participating in the engagement is aware of the interest.
An individual participating in the engagement has a close relative who could exercise significant influence over the financial or accounting policies of the client.
Close relatives include nondependent children, brothers, sisters, parents, grandparents, parents-in-law, and their respective spouses.
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17. Effect of Actual or Threatened Litigation
The commencement of litigation by management alleging deficiencies in audit work for the client would be considered to impair independence.
An expressed intention by management to commence litigation against the CPA alleging deficiencies in audit work would also impair independence if the auditor concluded that it is probable that such a claim will be filed.
The commencement of litigation by the CPA against management alleging management fraud or deceit would be considered to impair independence.
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18. Provision of Nonaudit Services
LO# 8
Provision of Nonaudit Services
AICPA Code of Professional Conduct restricts somewhat the types of nonaudit services that can be provided to attest clients.
SEC has more restrictive independence rules for audits of public companies.
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19. SEC Independence Requirements for Audits of Public Companies
LO# 9
SEC Independence Requirements for Audits of Public Companies
The SEC’s rules are predicated on three basic principles of auditor objectivity and independence:
An auditor should not audit his or her own work.
An auditor should not function in the role of management.
An auditor should not serve in an advocacy role for his or her client.
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20. SEC Independence Requirements for Audits of Public Companies
LO# 9
SEC Independence Requirements for Audits of Public Companies
Bookkeeping
Financial Information Systems Design and Implementation
Appraisal or Valuation Services
Actuarial Services
Internal Auditing Outsourcing Services
Management Functions or Human Resources
Broker or Dealer
Legal Services
Expert Services
Categories of Generally Prohibited Nonaudit Services
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21. Partners are limited to five consecutive years.
LO# 9
SEC “revolving door” and “cross selling” rules from SarBox (inspired by Enron/Andersen)
Partners are limited to five consecutive years.
A firm is not independent if an audit partner’s compensation is based on selling engagements to that client for services other than audit, review, and attest services.
A one year “cooling off” period is required if you work on audit of a company to leave CPA firm and join company in a “financial reporting oversight role”.
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22. SEC Required Communications for Audits of Public Companies
LO# 9
SEC Required Communications for Audits of Public Companies
SEC rules require additional communication between auditors and their clients’ audit committees and require public-company audit clients to publicly reveal information regarding the fees (audit and otherwise) paid to their auditors.
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23. Integrity and Objectivity
LO# 9
Integrity and Objectivity
Rule 102
In the performance of any professional service, a member shall maintain objectivity and integrity, shall be free of conflicts of interest, and shall not knowingly misrepresent facts or subordinate his or her judgment to others.
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24. General Standards and Compliance with Standards
LO# 10
General Standards and Compliance with Standards
Rule 201
A member shall comply with the following standards and with any interpretations thereof by bodies designated by Council.
Professional Competence
Due Professional Care
Planning and Supervision
Sufficient Relevant Data
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25. General Standards and Compliance with Standards
LO# 10
General Standards and Compliance with Standards
Rule 202
A member who performs auditing, review, compilation, management consulting, tax, or other professional services shall comply with standards promulgated by bodies designated by Council.
This rule is important because it requires that members of the AICPA comply with professional standards when performing professional services, whether or not they are practicing in public accounting.
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26. Accounting Principles
LO# 10
Accounting Principles
Rule 203
A member shall not (1) express an opinion or state affirmatively that the financial statements or other financial data of any entity are presented in conformity with GAAP or (2) state that he or she is not aware of any material modifications that should be made to such statements or data in order for them to be in conformity with GAAP, if such statements or data contain any departure from an accounting principle promulgated by bodies designated by Council to establish such principles that has a material effect on the statements or data taken as a whole.
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27. Confidential Client Information
LO# 11
Rule 301
A member in public practice shall not disclose any confidential client information without the specific consent of the client.
To comply with a valid subpoena
To meet GAAP or GAAS disclosure requirements
As required by an authorized peer review body
As part of an investigative or disciplinary proceeding
Five Situations Where CPAs Can Disclose Confidential Information
In connection with a purchase, sale, or merger of the practice
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28. Contingent Fees Rule 302 A member shall not
LO# 11
Rule 302
A member shall not
(1)Perform for a contingent fee any professional service for, or receive such a fee from, a client for whom the member or the member’s firm performs (a) an audit or review of financial statements, (b) a compilation of financial statements expected to be used by a third party if the compilation report does not disclose a lack of independence, or (c) an examination of prospective financial information, or
(2)Prepare an original or amended tax return or claim for
refund for a contingent fee for any client.
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29. A member shall not commit an act discreditable to the profession.
LO# 12
Acts Discreditable
Rule 501
A member shall not commit an act discreditable to the profession.
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30. LO# 12
Acts Discreditable
Inappropriate response to requests by clients and former clients for certain records (501-1).
Discrimination and harassment in employment practices (501-2).
Failure to follow standards and/or procedures or other requirements in government audits (501-3).
Negligence in the preparation of financial statements or records (501-4).
Failure to follow the requirements of government bodies, commissions, or other regulatory agencies in performing attest or similar services (501-5).
Solicitation or disclosure of CPA examination questions and answers (501-6).
Failure to file tax return or pay tax liability (501-7).
Including certain types of indemnification and limitation of liability provisions in agreements for the performance of audit or other attest services in jurisdictions where such provisions are prohibited (501-8).
Confidential information obtained from employment (501-9).
Financial interests (501-10).
False, misleading, or deceptive acts in promoting or marketing professional services (501-11).
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31. Advertising and Other Forms of Solicitation
LO# 12
Advertising and Other Forms of Solicitation
Rule 502
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. Solicitation by the use of coercion, over-reaching, or harassing conduct is prohibited.
Best CPA in the World!
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32. Prohibited Advertising
LO# 12
Prohibited Advertising
Creating false or unjustifiable expectations of favorable results.
Implying an ability to influence any court, tribunal, regulatory agency, or similar body or official.
Claiming that specific professional services in current or future periods will be performed for a stated fee, estimated fee, or fee range when it is likely at the time of representation that such fees will be substantially increased and the prospective client is not advised of that likelihood.
Making any other representations that would be likely to cause a reasonable person to misunderstand or be deceived.
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33. Commissions and Referral Fees
LO# 12
Rule 503
Prohibited Commissions: A member in public practice shall not for a commission recommend or refer to a client any product or service or receive a commission, when a member or the member’s firm also performs for that client (a) an audit or review of financial statements, (b) a compilation of financial statements expected to be used by a third party and the compilation report does not disclose a lack of independence, or (c) an examination of prospective financial information.
Disclosure of Permitted Commissions: A member in public practice who is not prohibited by this rule from performing services for or receiving a commission and who is paid or expects to be paid a commission shall disclose that fact to any person or entity to whom the member recommends or refers a product or service to which the commission relates.
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34. Commissions and Referral Fees
LO# 12
Commissions and Referral Fees
Rule 503
Referral Fees: Any member who accepts a referral fee for recommending or referring any service of a CPA to any person or entity or who pays a referral fee to obtain a client shall disclose such acceptance or payment to the client.
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35. Form of Organization and Name
LO# 12
Form of Organization and Name
Rule 505
A member may practice public accounting only in a form of organization permitted by law or regulation whose characteristics conform to resolutions of Council.
A member shall not practice public accounting under a firm name that is misleading. Names of one or more past partners may be included in the firm name of a successor organization.
A firm may not designate itself as “Members of the American Institute of Certified Public Accountants” unless all of its CPA owners are members of the Institute.
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36. LO# 12
Disciplinary Actions
The Professional Ethics Executive Committee (PEEC) can direct a member to take remedial or corrective actions.
Termination of AICPA Membership
AICPA Trial Board Actions
Suspend AICPA Membership
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37. Quality Control Standards
LO# 13
Quality Control Standards
CPA firms are required to implement policies and procedures to monitor the firms’ practices and ensure that professional standards are being followed.
In 2004, PCAOB assumed the AICPA’s responsibilities relating to firms that audit public clients and instituted a mandatory quality inspection program for those firms.
The AICPA continues to administer a quality review system in order to enable firms to meet their state licensing, federal regulatory, and AICPA membership requirements and to serve firms that audit only privately held clients.
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38. Elements of Quality Control
LO# 14
Elements of Quality Control
Leadership: Tone at the Top
Relevant Ethical Requirements
Client Acceptance and Continuance
Human Resources
Engagement Performance
Monitoring
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39. PCAOB Inspections of Registered Public Accounting Firms
LO# 15
PCAOB Inspections of Registered Public Accounting Firms
The PCAOB conducts regular inspections of public accounting firms that are required to register with the Board.
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40. End of Chapter 19
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