1. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 4 - 1 Professional Ethics Chapter 4

2. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/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. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 4 - 3 Why People Act Unethically The person’s ethical standards are different from those of society as a whole. The person chooses to act selfishly. In many instances, both reasons exist.

4. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 4 - 4 A Person’s Ethical Standards Differ from General Society EmbezzlersCon artistsShoplifters Most people who commit such acts feel no remorse when they are apprehended because their ethical standards differ from those of society as a whole.

5. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 4 - 5 A Person Chooses to Act Selfishly – Example Person A finds a briefcase containing important papers and $1,000. He tosses the briefcase and keeps the money. He brags to his friends about his good fortune. This action probably differs from most of society.

6. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 4 - 6 Rationalizing Unethical Behavior Everybody does it. If it’s legal, it’s ethical. Likelihood of discovery and consequences

7. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 4 - 7 Ethical Dilemmas An ethical dilemma is a situation a person faces in which a decision must be made about appropriate behavior.

8. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 4 - 8 Resolving Ethical Dilemmas 1. Obtain the relevant facts. 2. Identify the ethical issues from the facts. 3. Determine who is affected.

9. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 4 - 9 Resolving Ethical Dilemmas 4. Identify the alternatives available to the person who must resolve the dilemma. 5. Identify the likely consequence of each alternative. 6. Decide the appropriate action.

10. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 4 - 10 Ethical Dilemma A staff person has been informed that he will work hours without recording them as hours worked. Firm policy prohibits this practice. Another staff person has stated that this is common practice in the firm.

11. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 4 - 11 Resolving the Ethical Dilemma Is it ethical for the staff person to work hours and not record them as hours worked in this situation? Who is affected? How are they affected? What alternatives does the staff person have?

12. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 4 - 12 Other Ethical Dilemmas A supervisor asks you to initial certain audit procedures as performed when they were not. You conclude that you cannot be promoted to manager unless you persuade assistants to work hours that they do not record. Management informs you, now a partner, that either the company gets an unqualified opinion for a $40,000 audit fee or the company will change auditors. Management informs you that the audit fee will be increased $25,000 if you can find a plausible way to increase earnings by $1 million.

13. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 4 - 13 Special Need for Ethical Conduct in Professions Our society has attached a special. meaning to the term professional. A professional is expected to conduct himself or herself at a higher level than most other members of society.

14. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 4 - 14 CPAs Encouraged to Conduct Themselves at a High Level Conduct of CPA firm personnel CPA examination GAAS and interpretations Continuing education requirements

15. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 4 - 15 CPAs Encouraged to Conduct Themselves at a High Level Conduct of CPA firm personnel SEC Peer review Quality control

16. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 4 - 16 CPAs Encouraged to Conduct Themselves at a High Level Conduct of CPA firm personnel Legal liability Division of CPA firms Code of Professional Conduct

17. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 4 - 17 AICPA Code of Professional Conduct Principles Rules of conduct Interpretation of the rules of conduct Ethical rulings Four parts to the Code:

18. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 4 - 18 Code of Professional Conduct Principles Ideal standards of ethical conduct in philosophical terms They are not enforceable. Rules of conduct Minimum standards of ethical conduct stated as specific rules They are enforceable.

19. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 4 - 19 Code of Professional Conduct Interpretation 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. They are not enforceable, but a practitioner must justify departure.

20. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 4 - 20 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. They are not enforceable, but a practitioner must justify departure.

21. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 4 - 21 Ethical Principles 1. Responsibilities Professionals should exercise sensitive and moral judgments in all their activities. Members should accept the obligation to act in a way that will serve and honor the public. 2. Public Interest

22. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 4 - 22 Ethical Principles 3. Integrity Members should perform all responsibilities with integrity to maintain public confidence. Members should be objective, independent, and free of conflicts of interest. 4. Objectivity and Independence

23. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 4 - 23 Ethical Principles 5. Due Care Members should observe the profession’s standards and strive to improve competence. A member in public practice should observe the Code of Professional Conduct. 6. Scope and Nature of Services

24. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 4 - 24 Independence Independence means taking an unbiased viewpoint in performing audit tests. Independence in fact Independence in appearance Other sources of independence include: SEC (revised in 2000), Sarbanes-Oxley Act 2002, Independence Standards Board (1997-2001), State Boards of Accountancy (rules of conduct)

25. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 4 - 25 Rules of Conduct: Independence 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.

26. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 4 - 26 Interpretations: Financial Interests Interpretations of Rule 101 prohibit covered members from owning any direct investments in audit clients. Direct financial interest Indirect financial interest Material or immaterial

27. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 4 - 27 Related Financial Interests Issues Former practitioners (permit) Normal lending procedures (some permitted) Financial interest and employment of immediate (prohibited) and close family (permit) Joint investor or investee relationship with client (prohibited) Director, officer, management, or employee of a company (prohibited)

28. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 4 - 28 Related Financial Interests Issues A lawsuit or intent to start a lawsuit between a CPA firm and its client is a violation of Rule 101 for the current audit. The interpretations permit a CPA firm to do both bookkeeping and auditing for the same client. The SEC prohibits performing bookkeeping and auditing services by the same CPA firm.

29. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 4 - 29 Related Financial Interests Issues Internal auditing and extended audit services (ok if not appear or act as management Or employee) Unpaid fees (prohibit)

30. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 4 - 30 Rules of Conduct 101 Independence 102 Integrity and objectivity 201 General standards 202 Compliance with standards 203 Accounting principles 301 Confidential client information

31. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 4 - 31 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 See Table 4-1 for complete definitions

32. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 4 - 32 Enforcement Action by AICPA Professional Ethics Division Action by a State Board of Accountancy It’s all a matter of trust.

33. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 4 - 33 End of Chapter 4