Professional Ethics What are we not to do?

Professional Ethics What are we not to do?
In chapter 2 we saw what we are to do, now we’ll see what we are not to do. In chapter 4, we’ll see what happens if we fail in either of these areas. Why have ethics? Instill public confidence which is what CPAs really sell. Part of what’s expected of any Profession: Serve the public Possess complex body of knowledge (CPA Exam) Standards for admission & retention (licensing, CPE, Monitoring by State Board) Need for public confidence (capital markets) 1

AICPA Code of Professional Conduct
Compliance required of all AICPA members, even CPAs working as accountants. Basis for CPA ethics rules in each state. (So noncompliance can affect CPA License, even if working as an Accountant.) PCAOB partially adopted as their interim standards. Some rules only apply to members in public practice. Some Rules only apply to certain types of engagements or to certain class of clients.

PRINCIPLES (Overall Framework) RULES (The “Don’t Do” Specifics) INTERPRETATIONS (Clarifies Scope & Application of Rules) ETHICS RULINGS/GUIDANCE (Answers to Particular Circumstances) On June 1, 2014, the AICPA issued a codification of the Code’s existing principles, rules, interpretations and rulings (revised code), which are generally effective 12/15/2014. Many ethical rulings have been deleted over the years as their content are superseded by interpretations. 2 2

Revised and codified in June 2014 Only minor changes to the content of the Code Effective Dec 15, 2014, except for: Conceptual Framework for Members in Public Practice Conceptual Framework for Members in Business Effective Dec 15, 2015, unless adopted earlier. 2 2

Application Terminology “Should consider”: used in connection with a specified procedure or action, consideration of the procedure or action by the member is presumptively required. “Consider”: used when the member is required to think about several matters. “Evaluate”: used when the member has to assess and weigh the significance of a matter. “Determine”: used when the member has to come to a conclusion and make a decision on a matter. These words are periodically used in the revised Code to provide guidance to CPAs in carrying-out their responsibilities for complying with the Code. 2 2

The Principles Responsibilities The Public Trust Integrity
Objectivity & Independence Due Care Scope & Nature of Services As you can see, the Principles are broad and much like Motherhood and Apple Pie. These principles generally apply to all CPAs, like Objectivity, whereas Independence is required only for Attest-type engagements: All Attest Engagements Audits of F.S.

The Principles Responsibilities In carrying out their responsibilities as professionals, members should exercise sensitive professional and moral judgments in all their activities. According to the AICPA code: CPAs have responsibilities to all those who use their professional services. Members also have a continuing responsibility to cooperate with each other to improve the art of accounting, maintain the public's confidence, and carry out the profession's special responsibilities for self-governance. The collective efforts of all members are required to maintain and enhance the traditions of the profession.

The Principles The Public Trust Members should accept the obligation to act in a way that will: serve the public interest honor the public trust demonstrate commitment to professionalism According to the AICPA code: “A distinguishing mark of a profession is acceptance of its responsibility to the public. The accounting profession's public consists of clients, credit grantors, governments, employers, investors, the business and financial community, and others who rely on the objectivity and integrity of certified public accountants to maintain the orderly functioning of commerce. This reliance imposes a public interest responsibility on certified public accountants. The public interest is defined as the collective well-being of the community of people and institutions the profession serves.”

The Principles Integrity To maintain and broaden public confidence, members should perform all professional responsibilities with the highest sense of integrity. According to the AICPA code, “Integrity requires a member to be, among other things, honest and candid within the constraints of client confidentiality. Service and the public trust should not be subordinated to personal gain and advantage. Integrity can accommodate the inadvertent error and the honest difference of opinion; it cannot accommodate deceit or subordination of principle..” Integrity is something that is expected of all professionals, like doctors, architects and your home remodeling contractor.

Objectivity & Independence
The Principles Objectivity & Independence A member should maintain objectivity and be free of conflicts of interest in discharging professional responsibilities. A member in public practice should be independent in fact and appearance when providing auditing and other attestation services. This is the principle that is frequently mentioned as possibly being violated when the reliability of an auditor’s results are questioned.

Objectivity & Independence (con’t)
The Principles Objectivity & Independence (con’t) The principle of objectivity imposes the obligation to be impartial, intellectually honest, and free of conflicts of interest. Independence precludes relationships that may appear to impair a member’s objectivity in rendering attestation services. So, Objectivity is more of a frame of mind that might result in unreliable results in performance of professional services. Independence generally relates to relationships that might cause a CPA’s objectivity to be impacted or be perceived by others as likely to have been impaired.

The Principles Due Care A member should observe the profession's technical and ethical standards, strive continually to improve competence and the quality of services, and discharge professional responsibility to the best of the member's ability. This is the principle that is frequently cited as being violated when an auditor sued for negligence.

Scope & Nature of Services
The Principles Scope & Nature of Services A member in public practice should observe the principles of the Code of Professional Conduct in determining the scope and nature of services to be provided. The concept behind this principle is that accountants and auditors should not be providing services for which they are not competent or have a current knowledge of standards they are to follow, such as GAAP or other engagement performance standards.

Code Structure for Rules, Interpretations and Other Guidance
Preface: Applicable to All Members Part 1: Members in Public Practice Part 2: Members in Business Part 3: Other Members (e.g., retired or unemployed) The revised code breaks out requirements by the CPA’s job position to make reviewing the code easier.

Part 1 for Members in Public Practice
Public practice consists of the performance of professional services for a client by a member or member’s firm. Client is any person or entity, other than the member’s employer, that engages a member or member’s firm to perform professional services. Basically when services are be sold to another party.

Conceptual Framework for Members in Public Practice
Absence a Rule interpretation that addresses a particular relationship or circumstance, a member should evaluate whether that relationship or circumstance would lead a reasonable and informed third party who is aware of the relevant information to conclude that there is a threat to the member’s compliance with the Rules that is not at an acceptable level.

Acceptable Level. A level at which a reasonable and informed 3rd party, who is aware of the relevant information, would be expected to conclude that a member’s compliance with the rules is not compromised.

Evaluation Steps: Identify threats (Relationships or circumstances that could compromise a member’s compliance with the rules). Evaluate the significance of a threat. Identify and apply safeguards (Actions or other measures that may eliminate or reduce a threat to an acceptable level). Remember that we only use the conceptual framework when a Rule interpretation does NOT address the relationship or circumstance.

Common Threats: Adverse Interest (member’s interests are opposed to the client’s interests such as with legal proceedings) Advocacy (member promotes a client’s interest/position to the point that his/her objectivity or independence is compromised) Familiarity (member or his/her relative or friend has long or close relationship with a client (e.g., employment) where a member becomes too sympathetic to the client’s interests or too accepting of the client’s work or product) The Code has a number of examples of threats and possible safeguards.

Common Threats: (con’t) Management Participation (member takes on the role of client management or assume client management responsibilities) Self-Interest (member could benefit financially or otherwise from client interest or relationship) Self-Review (member previous judgment or service performed) Undue Influence (subordinate to client) The Code has a number of examples of threats and possible safeguards.

Ethical Conflicts Arises when a member encounters one or both of the following: Obstacles to following an appropriate course of action due to internal or external pressures Conflicts in applying relevant professional standards or legal standards For example, a member suspects a fraud may have occurred, but reporting the suspected fraud would violate the member’s responsibility to maintain client confidentiality. Inability to resolve could involve elevating the issue or asking to be removed from the situation or resignation from employment.

Integrity and Objectivity Rule
Rules of the AICPA Code of Professional Conduct Integrity and Objectivity Rule 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. This rule applies to all professional services.

Rules of the AICPA Code of Professional Conduct Integrity and Objectivity Rule Interpretation Topics Conflicts of Interest Gifts & Entertainment (member must not offer or accept to/from client that violates member firm or client policy or are unreasonable in the circumstances) Preparing & Reporting Info (knowingly misrepresents info or subordinates one’s judgment) For gifts & entertainment, evaluation of reasonableness should consider: a. The nature of the gift or entertainment b. The occasion giving rise to the gift or entertainment c. The cost or value of the gift or entertainment d. The nature, frequency, and value of other gifts and entertainment offered or accepted e. Whether the entertainment was associated with the active conduct of business directly before, during, or after the entertainment f. Whether other clients also participated in the entertainment g. The individuals from the client and member’s firm who participated in the entertainment

Rules of the AICPA Code of Professional Conduct Integrity and Objectivity Rule Interpretation Topics (con’t) Client Advocacy (generally related to non-attest services, such as tax and consulting services, that involve acting as an advocate for the client or supporter of a client’s position on accounting or financial reporting issues within the firm or outside the firm with standard setters, regulators, or others) Use of 3rd party Service Providers (for “professional” services, disclosure to client required) For client advocacy concerns, member should consider if performed or to be performed non-attest services will inappropriately threaten the member’s integrity or objectivity on other engagements. Clients might not have an expectation that a member would use a third-party service provider to assist the member in providing the professional services. Therefore, before disclosing confidential client information to a third-party service provider, the member should inform the client, preferably in writing, that the member may use a third-party service provider. If the client objects to the member’s use of a third party service provider, the member either should not use the third-party service provider to perform the professional services or should decline to perform the engagement.

Rules of the AICPA Code of Professional Conduct
Independence Rule Member in public practice shall be independent in the performance of professional services as required by standards promulgated by bodies designated by Council. (For AICPA & PCAOB governed engagements, applies to all attestation engagements, including F.S. audits.) This is by far, the most complex and restrictive of the Rules. Also, this is where the overall guiding “practical” rule applies: “Do what’s right, even to the CPA’s personal disadvantage.” Good intentions are not enough since Independence must be in fact and appearance to instill public trust and confidence. In the work and work products of CPAs. Bodies designated by the Council (AICPA) are the AICPA, PCAOB, SEC and other federal and state governmental agencies, discussed later. For engagements governed by AICPA standards, the Objectivity & Independence principle of the AICPA code specifies: A member in public practice should be independent in fact and appearance when providing auditing and other attestation services. So, all attestation services. An attest engagement is one that requires independence, which technically includes F.S. compilation engagements if a lack of independence is not mentioned in the CPA’s report. For some attest engagements, CPA/members must be independent of the “requesting” or “responsible” party. 3 3

Independence Why is independence important?
Rules of the AICPA Code of Professional Conduct Independence Means independence in fact and appearance - so, rules may appear too restrictive. Applies to all attest (not just audit) engagements. Why is independence important?

CPAs are providing assurance on data reliability to 3rd party users.
Rules of the AICPA Code of Professional Conduct Independence CPAs are providing assurance on data reliability to 3rd party users. On attest engagements, CPAs are generally hired to perform tests of assertions or statements made by client management and issue an opinion as to whether the assertion or statement is fairly stated or reliable. The report is desired generally because the client is providing it to a 3rd party who wants to rely on the assertion to make a decision.

AICPA Conceptual Framework for Independence
Rules of the AICPA Code of Professional Conduct AICPA Conceptual Framework for Independence The framework is a decision flowchart used to evaluate threats to a CPA’s independence. When a threat arises, the approach considers: Whether the Code directly addresses the threat and If the Code does not directly address the threat, the auditor considers whether adequate safeguards exist to eliminate or mitigate the threat to independence to an acceptably low level. This framework is used when the answer to an ethical dilemma is not found in the Code. There are a number of specific relationships and circumstances that interpretations to the Independence Rule state will impair, or be perceived as impairing, independence, for which the conceptual framework approach is not appropriate. This framework has been effective for a number of years and must be followed before the other Conceptual Frameworks added to the code and must be complied with no later than Dec 15, 2015.

AICPA Conceptual Framework for Independence
Rules of the AICPA Code of Professional Conduct AICPA Conceptual Framework for Independence The perspective used throughout is whether a reasonable person, aware of all the relevant facts, would conclude that an unacceptable risk to independence exists.

AICPA Conceptual Framework for Evaluating Threats to Independence
Rules of the AICPA Code of Professional Conduct AICPA Conceptual Framework for Evaluating Threats to Independence In determining whether safeguards “sufficiently mitigate” a risk to independence, the CPA is to assess how a relationship with a client would be perceived by that reasonable person. In the Code, there is at least one example whether the Code provides for such a mitigation: former employment of a CPA by an attest client where the CPA firm’s independence is not impaired if the CPA who used to work for the client is “disassociated” from the attest client and the attest engagement that covers any portion of the prior employment period.

Independence Impairment
Determining if independence is impaired for a CPA firm is a 3-Stage Process: Is independence of individual auditor impaired? 1. When did it occur? 2. What was the relationship? If individual auditor independence is impaired, is the CPA firm impaired? 3. Who in the firm is involved? Taking an independence problem step-by-step makes it easier to solve.

When Period of the Professional Engagement:
Independence When Period of the Professional Engagement: Conducting planning and field work Rendering opinion/drafting report Begins when engagement letter signed or agreement reached, or CPA starts work. Ends when professional relationship ends. Period engaged begins at the earliest of these 3 actions. Period engaged continues until attest relationship ends by formal or informal notice from either CPA or client. While you are engaged.

When Period(s) Covered by the Attestation Engagement
Independence When Period(s) Covered by the Attestation Engagement (e.g., the client’s fiscal year for a financial statement audit) The primary concept behind including this period is that a CPA or auditor should not be put in a position to possibly audit their own work when they were previously employed by the client.

Independence What - Category A Had/committed to acquire any direct or material indirect financial interest in the client. Direct = Stock, bonds or loans to client (even 1 share of stock) Indirect = Investment in a company or mutual fund which holds financial interests in client. Material = Significance of amount to CPA or if ANY partner or professional employee of CPA firm has significant influence over fund. Financial Interests generally includes equity or debt securities. Indirect financial interest is an interest in another entity which has a direct financial interest in the client (for example a Mutual Fund). Immaterial indirect interest would be one in a highly diversified fund and member has interest in Mutual Fund < 5%. Otherwise must evaluate effective interest in client against member’s net worth. The relationships in category A apply to the period of the professional engagement only. For unsolicited (e.g., gift or inheritance) acquisitions, member generally has 30 days to dispose of the financial relationship after gaining knowledge and can dispose of the investment, but covered member cannot participate on the attest engagement team and the direct financial interest or indirect financial interest is not material to the covered member.

Independence What - Category A Was trustee of any trust or executor or administrator of any estate which had or was committed to acquire any direct or material indirect financial interest in the client AND Covered member had authority to make investment decisions or Trust/estate owned or was committed to acquire more than 10 percent of the client's outstanding equity securities or other ownership interests or Value of the trust/estate's holdings in the client exceeded 10 percent of the total assets of the trust/estate. Only impairs independence if any one of the following applies: the covered member (individually or with others) has the authority to make investment decisions for the trust or estate, b. the trust or estate owned or was committed to acquire more than 10 percent of the attest client’s outstanding equity securities or other ownership interests, or c. the value of the trust’s or estate’s holdings in the attest client exceeds 10 percent of the total assets of the trust or estate. The relationships in category A apply to the period of the professional engagement only.

Independence What - Category A Had a joint closely held investment (with client, client officer/director or owner who has ability to exercise significant influence over the client) that was material to the covered member (auditor or CPA firm). The relationships in category A apply to the period of the professional engagement only.

Independence What - Category A Cooperative Arrangements With Attest Clients, unless: The participation of the firm and attest client are governed by separate agreements, arrangements, or understandings that do not create rights or obligations between the firm and attest client and Neither the firm nor the attest client assumes responsibility for the other’s activities or results and Neither party has the authority to act as the other’s representative or agent. The relationships in category A apply to the period of the professional engagement only. Examples of cooperative arrangements include the following: Prime and subcontractor arrangements to provide services or products to a third party Joint ventures to develop or market products or services Arrangements to combine one or more of the firm’s services or products with one or more of the attest client’s services or products and market the package with references to both parties Arrangements under which the firm acts as a distributor or marketer of the attest client’s products or services or the attest client acts as the distributor or marketer of the firm’s products or services

Independence What - Category A Had any loan to/from (1) the client, (2) any officer or director of the client, or (3) any individual owning 10 percent or more of the client's outstanding equity securities or other ownership interests. Except . . . The relationships in category A apply to the period of the professional engagement only.

Independence Loan Exceptions Home mortgages, secured loans, and immaterial unsecured loans (generally OK if not obtained from an existing attest client by a covered member and collateral fair value equals or exceeds loan balance.) Automobile loans and leases collateralized by the automobile Loans fully collateralized by the cash surrender value of an insurance policy Loans fully collateralized by cash deposits at same lending institution Aggregate outstanding balances from credit cards and overdraft reserve accounts with a balance of $10,000 or less after payment of the most recent monthly statement made by the due date or within any available grace period For all loans, loan is made under normal lending terms & kept current. Applies to the engagement period.

Independence What - Category B During the period of the professional engagement, a partner or professional employee of the CPA firm, his or her immediate family, or any group of such persons acting together owned more than 5 percent of an attest client's outstanding equity securities or other ownership interests. The relationship in category B applies to the period of the professional engagement only. This type of relationship is measured by knowing what a CPA firm audit professionals own through disclosure requirements. This 5% relationship causes CPA firm to lack independence from the client and cannot issue an attestation report.

Independence What - Category C A partner or professional employee of the member’s firm is simultaneously employed or associated with an attest client, except for adjunct (part-time) faculty member of an educational institution with certain restrictions and safeguards The relationship in category C applies to the BOTH periods: Financial statement or attestation period Performance of the professional engagement This is rare because the member or CPA must be working for, or associated with, the client at the same time. Most common when a CPA volunteers to be on the board of a nonprofit organization which is an attestation client of the CPA firm. Violation of the relationship always causes CPA firm to lack independence of the client. Restrictions and Safeguards for Adjunct Faculty: Does not hold a key position at the educational institution Does not participate on the attest engagement team Is not an individual in a position to influence the attest engagement Is employed by the educational institution on a part-time and non-tenure basis Does not participate in any employee benefit plans sponsored by the educational institution, unless participation is required Does not assume any management responsibilities or set policies for the educational institution

Independence Who - Category A Covered Member - (Whose Impairment of Independence Passes to the CPA Firm): a. Individual on the attest engagement team This group consists of individuals participating in the attest engagement, including those who perform concurring and second partner reviews, plus all employees and contractors retained by the firm who participate in the attest engagement, irrespective of their functional classification (for example, audit, tax, or management consulting services). Excludes specialists and individuals who perform only routine clerical functions.

Independence Who - Category A Covered Member - (Whose Impairment of Independence Passes to the CPA Firm): a. Individual on the attest engagement team b. Individual in a position to influence the attest engagement This group consists of individuals who do any one of the following: Evaluate performance or recommends compensation of the attest engagement partner. Directly supervise or manages the attest engagement partner, including all successively senior levels above that individual through the firm's chief executive (chain of command). Consult with the attest engagement team regarding technical or industry-related issues specific to the attest engagement. Participate in, or oversees, at all successively senior levels, quality control activities, including internal monitoring, with respect to the specific attest engagement

Independence Who - Category A Covered Member - (Whose Impairment of Independence Passes to the CPA Firm): Individual on the attest engagement team Individual in a position to influence the attest engagement A partner, partner equivalent or manager who provides more than 10 hours of nonattest services to the attest client within any fiscal year. This means that even CPA firm partners and managers performing even minor non-attest services for an attest client, must be independent of that client. Coverage ends on the later of date (i) the firm signs the report on the financial statements for the fiscal year during which those services were provided or (ii) he/she no longer expects to provide 10 or more hours of non-attest services to the attest client on a recurring basis. Partner Equivalent: A professional employee who is not a partner of the firm but who either has the ultimate responsibility for the conduct of an attest engagement, including the authority to sign or affix the firm’s name to an attest report or issue, or authorize others to issue, an attest report on behalf of the firm without partner approval; or has the authority to bind the firm to conduct an attest engagement without partner approval. For example, the professional employee has the authority to sign or affix the firm’s name to an attest engagement letter or contract to conduct an attest engagement without partner approval.

Independence Who - Category A Covered Member - (Whose Impairment of Independence Passes to the CPA Firm): Individual on the attest engagement team Individual in a position to influence the attest engagement A partner, partner equivalent or manager who provides more than 10 hours of non-attest services to the attest client within any fiscal year. A partner or partner equivalent in the office in which the lead attest engagement partner or partner equivalent primarily practices in connection with the attest engagement. This covered member group is only independence for appearance as just being in the same office would not necessary have any influence on the engagement.

Independence Who - Category A Covered Member - (Whose Impairment of Independence Passes to the CPA Firm): Individual on the attest engagement team Individual in a position to influence the attest engagement A partner, partner equivalent or manager who provides more than 10 hours of non-attest services to the attest client within any fiscal year. A partner or partner equivalent in the office in which the lead attest engagement partner pr partner equivalent primarily practices in connection with the attest engagement. The firm, including the firm's employee benefit plans. It makes sense that the CPA firm itself should be independent of attest clients as the report is issued as a firm report.

Independence Who - Category A Covered Member - (Whose Impairment of Independence Passes to the CPA Firm): Individual on the attest engagement team Individual in a position to influence the attest engagement A partner, partner equivalent or manager who provides 10 or more non-attest services to the attest client within any fiscal year. A partner or partner equivalent in the office in which the lead attest engagement partner or partner equivalent primarily practices in connection with the attest engagement. The firm, including the firm's employee benefit plans. An entity whose operating, financial, or accounting policies can be controlled by any of the individuals or entities described in a through e above or by two or more such individuals or entities if they act together. This covered member group is designed to address where covered members from a thru e might use a separate entity that they control to hide a relationship with an attest client.

Who - Category B All Partners
Independence Who - Category B All Partners All Professional Employees of the CPA firm His or her Immediate Family Any group of such persons acting together owned more than 5 percent of an attest client's outstanding equity securities or other ownership interests. It doesn’t matter if they have nothing to do with the attest engagement. Immediate Family = Spouse (or Equivalent) + Dependents This category applies only to the engagement performance period.

Who - Category C Any CPA Partner Any CPA Firm Professional Employee
Independence Who - Category C Any CPA Partner Any CPA Firm Professional Employee For category C, the employment or association applies to the period covered by the F.S. and the period of the professional engagement, if a partner or professional employee of the firm was simultaneously associated with the client as a: 1. Director, officer, or employee, or in any capacity equivalent to that of a member of management; 2. Promoter, underwriter, or voting trustee; or 3. Trustee for pension or profit-sharing trust of the client.

Conveying Relationships for Relatives to the Auditor
Independence Conveying Relationships for Relatives to the Auditor In some cases, relationships between an auditor’s relatives and an attest client convey to the auditor as if the auditor was in the relationship. FAIR? This is another example where the possible perception of a reasonable person drives the contents of the Code.

Immediate Family (spouse, spousal equivalent or dependent)
Independence Effects of Relative Business and Financial Interests on Auditor Independence Immediate Family (spouse, spousal equivalent or dependent) Any of the forbidden relationships flows to the CPA, Except: Can be a client employee if NOT in a Key Position, as long as participation in the client’s employee benefit plans (including share-based compensation and nonqualified deferred compensation plans) does not violate a number of specific restrictions. For employment exception, includes period covered by the financial statements and during the period of the professional engagement. For dependents, the same rules as the IRS uses applies. Just like the CPA, even one share of stock in the client is an impairment. Key position is a position in which an individual has primary responsibility for significant accounting functions that support material components of the financial statements; primary responsibility for the preparation of the financial statements; or the ability to exercise influence over the contents of the financial statements, including when the individual is a member of the board of directors or similar governing body, chief executive officer, president, chief financial officer, chief operating officer, general counsel, chief accounting officer, controller, director of internal audit, director of financial reporting, treasurer, or any equivalent position. For purposes of attest engagements not involving a client’s financial statements, a key position is one in which an individual is primarily responsible for, or able to influence, the subject matter of the attest engagement. 4 4

(Parents, Siblings, Nondependent Children)
Independence Effects of Relative Business and Financial Interests on Auditor Independence Close Relatives (Parents, Siblings, Nondependent Children) Relationship or impairment only flows to the CPA when: 1. On attest engagement team and a close relative has either: A key position with the attest client during the period covered by the financial statements or during the period of the professional engagement. A financial interest in the attest client during the professional engagement period that: the individual knows or has reason to believe was material to the close relative or enabled the close relative to exercise significant influence over the attest client. Close relatives only pose a problem for certain groups of covered members – generally the ones who have a direct impact of the attestation work and conclusions. 4 4

(Parents, Siblings, Nondependent Children)
Independence Effects of Relative Business and Financial Interests on Auditor Independence Close Relatives (Parents, Siblings, Nondependent Children) 2. Position to influence the attest engagement or any partner or partner equivalent in the office in which the lead attest engagement partner or partner equivalent primarily practices for the attest engagement & a close relative has either: A key position with the attest client during the period covered by the F.S. or during the engagement period. A financial interest in the attest client during the engagement period that: the individual, partner, or partner equivalent knows or has reason to believe was material to the close relative and enabled the close relative to exercise significant influence over the attest client. 4 4

Independence Effects of Relative Business & Financial Interests on Auditor Independence Non-Close Relatives Normally the relationships of non-close relatives do NOT impair a CPA’s independence. Unless a reasonable and knowledgeable person would conclude otherwise. So, the CPA would probably have to have a very close relationship with such a relative to effectively move their status to close relative or immediate family. For example, a reasonable person would likely conclude that a non-close relative, such as your aunt and uncle or grandparents, are more like close relatives if they raised you. 4 4

Other Independence Problems
As you can see, there are a number of other circumstances that can impair the independence of an individual auditor and possibly the CPA firm itself. Past employment with attest client Future employment with attest client Pending/actual litigation with client Rendering certain non-attest services Non-independence of network firm Past due fees from client - over 1 year Significant gifts or entertainment

Non-independence of Network Firm
Other Independence Problems Non-independence of Network Firm On financial statement audits of international companies, the large CPA firms frequently use related CPA firms in other countries to perform part of the audit. Therefore, these firms, which are generally separate legal entities in the foreign country, become covered members and could impair the independence of the group auditor issuing the audit report on the consolidated financial statements. For purposes of the “Network and Network Firms” interpretation [ ] of the “Independence Rule” [ ], a network is an association of entities that includes one or more firms that: cooperate for the purpose of enhancing the firms’ capabilities to provide professional services and share one or more of the following characteristics: The use of a common brand name, including common initials, as part of the firm name Common control among the firms through ownership, management, or other means Profits or costs, excluding costs of operating the association; costs of developing audit methodologies, manuals, and training courses; and other costs that are immaterial to the firm A common business strategy that involves ongoing collaboration amongst the firms whereby the firms are responsible for implementing the association’s strategy and are held accountable for performance pursuant to that strategy A significant part of professional resources Common quality control policies and procedures that firms are required to implement and that are monitored by the association

Past Due Fees from Client
Other Independence Problems Past Due Fees from Client If an attest client has not paid any professional service fees and more than 1 Year has passed, the CPA firm is not independent of that client until the fees have actually been paid. A promissory note does not constitute payment according to ethical rulings in the Code. The reason for this is that the CPA may become bias in drawing their conclusions and no longer be objective. (Exception: client in bankruptcy.) One year is based on the current attest report date.

Significant Gifts or Entertainment
Other Independence Problems Significant Gifts or Entertainment Impairment occurs during engagement period when: A member’s firm, a member of the attest engagement team or an individual in a position to influence the attest engagement accepts a gift from an attest client and the value is not clearly insignificant to the recipient. A covered member accepts entertainment from an attest client that is not reasonable in the circumstances. A covered member offers a gift or entertainment to an attest client that is not reasonable in the circumstances. Attest client includes individuals in key positions with attest client and individuals owning 10% or more of the attest client’s outstanding equity securities or other ownership interests. Restrictions on gifts or provided entertainment is another example of an independence impairment because of the appearance it gives to a reasonable person. An example might be tickets to a 49ers game versus season tickets for you and your family; the latter probably causing an impairment. These guidelines are similar to ones under the Objectivity & Independence Rule of the Code discussed earlier.

Past Employment with Attest Client
Other Independence Problems Past Employment with Attest Client Impairment occurs when a covered member, who participates on the client’s attest engagement or is in a position to influence the attest engagement covering any period that includes the covered member’s former employment or association with the attest client s, and: Was formerly employed by an attest client or an associated entity as an officer, a director, a promoter, an underwriter, a voting trustee, or a trustee for the entity’s pension or profit sharing trust. Failed to disassociate (financial interest, benefit plans) from the attest client before becoming a covered member There could also be self-review risks if the member was in a key position for which safeguards must be used. The key concern is that one should not audit what one may have done or approved in the past as it might impact one’s ability to be objective. There are some legal (e.g., COBRA) exceptions for disassociation with former employer.

Considering Future Employment with Attest Client
Other Independence Problems Considering Future Employment with Attest Client Seeking or discussing potential employment or association with an attest client or receipt of a specific offer: Only an impairment if it involves a covered member on an attest engagement team or in a position to influence the attest engagement at the specific attest client. The individual or another covered member must report such consideration or offer to appropriate person in the CPA firm. The individual immediately ceases participation in the attest engagement and does not provide any services to the attest client until the employment offer is rejected or employment is no longer sought. (safeguard) The firm considers altering attest procedures. (safeguard) The key is to ensure that the effectiveness of the attest engagement is not negatively impacted.

Future Employment with Attest Client
Other Independence Problems Future Employment with Attest Client Safeguards required if a partner or professional employee is hired into a Key Position at an attest client. Safeguards: Amounts due to the former employee for previous interest in the firm and unfunded vested retirement benefits cannot be material to the CPA firm. Former employee is not in a position to influence the CPA firm’s operations or financial policies. The former employee does not participate or appear to participate in the firm’s business and is not otherwise associated with the firm. Consider changing attest team composition and or attest procedures. The key is to ensure that the effectiveness of the attest engagement is not negatively impacted in reality or in appearance. The last bullet is to counter risks posed when a significant attest engagement team leaves.

Litigation with Attest Client
Independence impaired when: Litigation starts and client is alleging deficiencies in audit work. Litigation starts and CPA is alleging fraud/deceit by client mgmt. Client expressed intention to start litigation alleging deficiencies in audit work and CPA concludes it’s probable suit will be filed. Independence NOT impaired when: Litigation is unrelated an attest engagement and is for an amount not material to the CPA firm or attest client. Probable generally means > 50% probability. For independence not impaired, examples include: immaterial disputes regarding billings for services, results of tax or management services advice, or similar matters. Certain cross-claims occur in litigation by security holders. Conceptual framework may be needed for other litigation.

Rendering Certain Non-Attest Services
Other Independence Problems Rendering Certain Non-Attest Services Rendering Certain Non-Attest Services – Overall Criteria: Cannot be management responsibility/decision- making Responsibilities spelled-out in engagement letter Specific activities impair independence General advisory services OK The restrictions on providing non-attest services to an attest client has overall criteria and includes a list of services that, according to the Code, would impair the CPA firm’s independence. If the non-attest services do not relate to the specific subject matter of the attestation/non-audit engagement (under SSAEs), then the non-attest services do NOT impair independence. (Code ref: )

Specific Non-Attest Services/Activities That Impair Independence
Other Independence Problems Specific Non-Attest Services/Activities That Impair Independence setting policy or strategic direction for the attest client. directing or accepting responsibility for actions of the attest client’s employees except to the extent permitted when using internal auditors to provide assistance for services performed under auditing or attestation standards. authorizing, executing, or consummating transactions or otherwise exercising authority on behalf of an attest client or having the authority to do so. preparing source documents that evidence the occurrence of a transaction. having custody of an attest client’s assets. deciding which recommendations of the member or 3rd parties to implement or prioritize. reporting to those charged with governance on behalf of management. serving as attest client’s stock transfer, escrow agent, registrar, general counsel or equiv. accepting responsibility for the management of an attest client’s project. accepting responsibility for the preparation and fair presentation of the attest client’s financial statements in accordance with the applicable financial reporting framework. accepting responsibility for designing, implementing, or maintaining internal control. performing ongoing evaluations of attest client’s internal control as part of its monitoring activities. These are considered to be exercising responsibilities of client management.

Non-Attest Services/Activities Which Impair Independence
Other Independence Problems Non-Attest Services/Activities Which Impair Independence determines or changes journal entries, any account coding or classification of transactions, or any other accounting records without first obtaining the attest client’s approval. authorizes or approves transactions. prepares source documents. makes changes to source documents without the attest client’s approval. accepts responsibility to authorize payment of attest client funds, electronically or otherwise, except for most electronic payroll tax payments accepts responsibility to sign or cosign an attest client’s checks, even if only in emergency situations. maintains an attest client’s bank account or otherwise has custody of an attest client’s funds or makes credit or banking decisions for the attest client. approves vendor invoices for payment. These are categorized as Bookkeeping, Payroll and Other Disbursements

Non-Attest Services/Activities Which Impair Independence
Other Independence Problems Non-Attest Services/Activities Which Impair Independence Certain Information Systems Design, Implementation, or Integration: designs or develops an attest client’s financial information system. makes other than insignificant modifications to source code underlying an attest client’s existing financial information system. supervises attest client personnel in the daily operation of an attest client’s information system. operates an attest client’s network. Outsourcing of an Internal Audit function and performing certain internal control monitoring & evaluations. Certain Business Risk and Corporate Finance Consulting Certain litigation services The Key is that the auditors should not perform management functions or perform tasks for the client which they might be something they would need to evaluate on an attestation engagement, which might cause significant self-review risks.

Other Independence Rules
Securities and Exchange Commission (SEC) Public Company Accounting Oversight Board (PCAOB) Government Accountability Office (GAO) U.S. Department of Labor (DOL) Internal Revenue Service U.S. Department of the Treasury Banking and Insurance Regulatory Agencies State Boards of Accountancy State CPA Societies

SEC Independence Rules
Specific Rules: Prohibits Certain Non-Audit Services Requires Prior Approval of Non-Audit Services by Client’s Audit Committee Requires Lead & Concurring Partner Rotation Prohibits Any Partner Compensation Based on Obtaining Non-Audit or Non-Attest Work Requires 1-Year Gap Before Someone Who Worked on the Audit Can Accept Job With Client for Certain Positions (Cooling Off Period). Rules apply to SEC-regulated F.S. audit clients. Final rules, esp. exceptions, being finalized. PCAOB is also formulating its rules for “registered” CPA firms.

SEC Independence Rules Prohibited Non-Audit Services
1. Bookkeeping & Services Related to Acctg Records 2. Financial Info System Design/Implementation (IT) 3. Appraisal/Valuation Services 4. Actuarial Services 5. Internal Audit Outsourcing 6. Management Functions (Even Temporary), HR 7. Broker-Dealer, Investment Adviser or Banking 8. Legal Services & Certain Tax Services 9. Expert Services Unrelated to Audit

PCAOB Independence Rules
Rule 3600: AICPA Rule 101 as of interpretations. Rule 3502: Person associated with an audit firm not to knowingly or recklessly contribute to rule or law violations. Rule 3520: Firm must be independent for F.S. period and engagement period. Rule 3521: No contingent fees for audit client. Rule 3522: No marketing, planning or opining on confidential or aggressive tax position transactions.

PCAOB Independence Rules (con’t)
Rule 3523: No personal tax services for those in financial reporting oversight role or immediate family. Rule 3525: Audit Comm. pre-approval for non-prohibited non-audit services on internal control over financial reporting. Rule 3526: Initially and annually confirm independence in writing and describe any relationships that might bear on independence.

General Standards Rule
“A member shall comply with the following standards and with any interpretations thereof by bodies designated by Council. A. Professional Competence . . . B. Due Professional Care . . . C. Planning and Supervision . . . D. Sufficient Relevant Data “ Applies to all services. Basically says CPA must comply with the GAAS standards in the General & Field Work categories, except: Independence (already a separate Rule) Understand Internal Controls (why? Not applicable to all engagements) 3 3

Compliance with Standards Rule
“A member who performs auditing, review, compilation, management consulting, tax, or other professional services shall comply with standards promulgated by bodies designated by Council.” Comply with whatever standards cover the particular engagement type. So, duplicates Rule 201 entirely???? 3 3

Accounting Principles Rule
“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 generally accepted accounting principles 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 generally accepted accounting principles, if such statements or data contain any departure from an accounting principle . . .” Must measure against GAAP when called for. “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 generally accepted accounting principles 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 generally accepted accounting principles, 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. If, however, the statements or data contain such a departure and the member can demonstrate that due to unusual circumstances the financial statements or data would otherwise have been misleading, the member can comply with the rule by describing the departure, its approximate effects, if practicable, and the reasons why compliance with the principle would result in a misleading statement.” 3 3

Promulgating Bodies for Code Rules
Body Standards/Principles Rules FASAB Federal Financial Accounting Stds. Accounting Principles FASB St. of Financial Accounting Stds. Compliance w/ Standards GASB St. of Governmental Accounting Stds. PCAOB Audit & Attestation Standards General Standards AICPA Various Engagement Performance Standards IASB International Financial Accounting & Reporting Principles The above list comes from Appendix A to the Code of Conduct. Basically, the accounting standard promulgating bodies establishes the accounting principles required to be followed by Rule “Accounting Principles”, but the AICPA also recognizes that these bodies also present F.S. “disclosure” requirements, so the Code of Conduct references these bodies for Rule on “Engagement Standards” as well – probably marginal. Various AICPA Committees establish minimum performance standards for certain types of engagement which are addressed in both the General Standards and the Compliance with Standards Rules.

Confidential Client Information Rule
Rules of the AICPA Code of Professional Conduct Confidential Client Information Rule A member in public practice shall not disclose any confidential client information without the specific consent of the client. See next slide 3 3

Confidential Client Information Rule
Rules of the AICPA Code of Professional Conduct Confidential Client Information Rule Need client consent to disclose in most cases. Permitted disclosure of confidential client information without consent: Response to validly issued subpoena or summons Adherence to applicable laws & regulations (e.g., SAA, PCAOB) Compliance with peer review/investigation of CPA practice Defense in an investigation of the CPA Reviews conducted in connections with CPA firm sale or merger . Confidentiality agreement required. (Interpretation 301-3). Internal whistle blowing permitted. External whistle blowing may violate rule. Safeguard to prevent release to anyone, except when specifically identified in the Code. Peer and other reviewers (are allowed access, but they cannot disclose under the Code either. There is also an exception for audits of federal expenditures under the Single Audit Acts when disclosure is to federal officials, and is necessary. Note: When a CPA uses 3rd party service providers, except clearly administrative services, the CPA should obtain client consent and possibly get a written confidentiality agreement from the 3rd party provider.

Contingent Fees Rule Cannot accept if related to a client for which CPA also performs any of the following engagements: Audit or review of historical F.S. Compilation of F.S. and a 3rd party might use the CPA’s report and the report does not disclose this lack of independence An examination (attest) of prospective F.S. Cannot accept for tax preparation. “A member in public practice shall not (1) Perform for a contingent fee any professional services 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 a financial statement; or (b) a compilation of a financial statement when the member expects, or reasonably might expect, that a third party will use the financial statement and the member's 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 a tax refund for a contingent fee for any client.” For the 1st rule, period includes both the period of the F.S. and period of the engagement. PCAOB also prohibits ALL contingent fees related to taxes for public company audit clients. Does NOT apply to investment advisory services provided to client owners, officers, or employees.

Acts Discreditable Rule
Rules of the AICPA Code of Professional Conduct Acts Discreditable Rule A member shall not commit an act discreditable to the profession. Examples: Not Returning Client records, even for failure to pay CPA fees due, except where member was engaged to prepare records (e.g., adjusting journal entries, closing entries), which member can withhold until fee is paid. Member can charge a fee to copy or retrieve records, but possibly not for client provided records (e.g., ledgers maintained by the client). Discrimination and Harassment in Employment Practices Solicitation or Disclosure of CPA Examination Questions and Answers Failure to File a Tax Return or Pay a Tax Liability Negligence in the Preparation of Financial Statements or Records Material departure from regulatory agency reporting requirements or services related thereto Departing from requirements on Government audits False, Misleading, or Deceptive Acts in Promoting or Marketing Professional Services Misuse of CPA Credential 3 3

Advertising and Other Forms of Solicitation Rule
Rules of the AICPA Code of Professional Conduct Advertising and Other Forms of Solicitation Rule 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. Since Federal Trade Commission lawsuits against AICPA a number of years ago, there are only really two advertising restrictions: Cannot be false, deceptive or misleading, such as promises as to results. Cannot be harassment 3 3

Commissions and Referral Fees Rule
Rules of the AICPA Code of Professional Conduct Commissions and Referral Fees Rule Prohibited commissions A member in public practice shall not for a commission recommend or refer to a client any product or service, or for a commission recommend or refer any product or service to be supplied by a client, or receive a commission, when the member or the member's firm also performs for that client: (a) an audit or review of a financial statement; or (b) a compilation of a financial statement when the member expects, or reasonably might expect, that a third party will use the financial statement and the member's compilation report does not disclose a lack of independence; or (c) an examination of prospective financial information. Prohibits acceptance of commissions related to any client for which the CPA firm also performs financial statement engagements for which 3rd party reliance is likely so as to avoid an appearance of an impairment to independence. This prohibition applies during the period in which the member is engaged to perform any of the services listed above and the period covered by any historical financial statements involved in such listed services. Unacceptable commissions must be returned. 3 3

Rules of the AICPA Code of Professional Conduct Commissions and Referral Fees Rule 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. 3 3

Rules of the AICPA Code of Professional Conduct Commissions and Referral Fees Rule 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. 3 3

Form of Organization and Name Rule
Rules of the AICPA Code of Professional Conduct Form of Organization and Name Rule 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 owners 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. The form of organization permitted is generally determined by the state that licenses the CPA firm and most large CPA firms ore Limited Liability Partnerships (LLP) where the personal assets of a partner is only at risk for engagements that they were involved in. The CPA firm name also cannot be misleading, such as indicated there are multiple CPAs when the firm is a sole proprietorship. However, the firm name can be fictitious. 3 3

Part 2 for Members in Business
Rules of the AICPA Code of Professional Conduct Part 2 for Members in Business Similar Rules, Conceptual Framework and Ethical Conflicts exist that we covered for members in public practice, so we will focus on the differences.

Rules of the AICPA Code of Professional Conduct Part 2 for Members in Business Common Threats to Compliance: Adverse Interest (member’s interests are opposed to the interests of the employing organization such as legal proceedings or relative interest with a competitor) Advocacy (member will promote an employing organization’s interests or position to the point that his or her objectivity is compromised) Familiarity (long or close relationship with a person or an employing organization, a member will become too sympathetic to their interests or too accepting of the person’s work or employing organization’s product or service)

Rules of the AICPA Code of Professional Conduct Part 2 for Members in Business Common Threats to Compliance: Self-Interest (member could benefit, financially or otherwise, from an interest in, or relationship with, the employing organization or associated persons) Self-Review (member will not appropriately evaluate the results of a previous judgment made or service performed or supervised by the member) Undue Influence (a member will subordinate his or her judgment to that of an individual associated with the employing organization or a 3rd party)

Rules of the AICPA Code of Professional Conduct Part 2 for Members in Business Integrity and Objectivity Rule: Rule identical to Part 1. Fewer Interpretations: Offering or Accepting Gifts or Entertainment: Virtually identical to Part 1, but substitutes customer & vendor for client. Knowing Misrepresentations in the Preparation of Financial Statements or Records and Subordination of Judgment: Virtually identical to Part 1 External Auditors: must be candid and not knowingly misrepresent facts or knowingly fail to disclose material facts.

Rules of the AICPA Code of Professional Conduct Part 2 for Members in Business Rules & Interpretations virtually identical to Part 1: General Standards Rule Compliance with Standards Rule Accounting Principles Rule Acts Discreditable Rule No other Rules.

Part 3 for Other Members Primarily for members who are retired, unemployed and not in public practice. Only has one Rule: Acts Discreditable, which is virtually identical to that in Parts 1 & 2.

Additional Ethics for Tax Services
Rules of the AICPA Code of Professional Conduct Additional Ethics for Tax Services Tax Advocacy: CPA must still be objective – Must have a reasonable basis (tax code/court decisions) for a tax position. Position should have a realistic possibility of being upheld by the taxing authority or a tax court. Source: AICPA’s Statements on Standards for Tax Services (SSTS) This topic is discussed in the textbook on pages 215.

Additional Ethics for Tax Services
Rules of the AICPA Code of Professional Conduct Additional Ethics for Tax Services Tax Shelters (Investments): Marketing of tax shelters must have a valid purpose, such as helping clients legally pay minimum taxes. Court Case: Tax shelter business was very profitable for KPMG between & 2002. KPMG held criminally liable for attempting to deceive IRS with false docs. KPMG paid $456 mil; Tax Partner & Manager to jail. This topic is discussed in the textbook on pages 218. PCAOB rule 3523 prohibiting personal tax services for those in financial reporting oversight role or immediate family came shortly after the KPMG case.

Prior Year Tax Return Errors
Rules of the AICPA Code of Professional Conduct Prior Year Tax Return Errors CPAs Must: Advise taxpayer of potential consequences of errors or omissions. Recommend to client measures to correct the error or omission. Not inform taxing authority without the taxpayer’s permission, unless required by law. Consider withdrawing from engagement if: Client has not taken appropriate action to correct an error or omission. Current & subsequent years’ tax returns cannot be prepared without perpetuating the error. Source: Statements on Standards for Tax Services (SSTS) No. 6 SSTS #6 recommends reviewing prior tax returns in preparing current year return. U.S. Treasury Circular requires CPA to advise taxpayer of the potential consequences of the error or omission if on federal return.

AICPA Quality Control Standards on Ethics
Rules of the AICPA Code of Professional Conduct AICPA Quality Control Standards on Ethics A CPA firm should establish policies & procedures to provide reasonable assurance that the firm and its personnel comply with relevant ethical requirements with special emphasis on independence, including requiring: Annual written confirmation of compliance with its policies and procedures on independence from all firm personnel required to be independent. Maintenance & updating info relating to independence. Rotation of staff after a specified period, when required. The AICPA not only has standards for audits and many other types of engagement, but they also require firms to have a system of quality controls to ensure quality services are provided to clients and all standards, including the Code of Professional Conduct is followed.

Professional Ethics What are we not to do?

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