Chapter 3

Question 1

Acceptable level of risk of noncompliance

Answer 1

A situation in which a reasonable and informed third party who is aware of the relevant information would be expected to conclude that a member’s ability to comply with the rules is not compromised. For independence, this is referred to as the acceptable level of risk to independence.

Question 2

Attest engagement team

Answer 2

Consists of individuals participating in the attest engagement, including those who perform concurring and second partner reviews. The attest engagement team includes 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), except specialists as discussed in the professional standards and individuals who perform only routine clerical functions, such as word processing and photocopying.

Question 3

Audit committee

Answer 3

A committee of a corporation’s board of directors that engages, compensates, and oversees the work of the independent auditors, monitors activities of the internal auditing staff, and intervenes in any disputes between management and the independent auditors. Members of the audit committee must be independent directors, that is, members of the board of directors who do not also serve as corporate officers or have other relationships that might impair independence.

Question 4

Close relative

Answer 4

A parent, sibling, or nondependent child.

Question 5

Covered member

Answer 5

A covered member may be (a) an individual on the attest engagement team; (b) an individual in a position to influence the attest engagement; (c) a partner, partner equivalent, or manager who provides nonattest services to the attest client beginning once he or she provides 10 hours of nonattest services to the client within any fiscal year and ending on the latter of the date (1) the firm signs the report on the financial statements for the fiscal year during which those services were provided, or (2) he or she no longer expects to provide 10 or more hours of nonattest services to the attest client on a recurring basis; (d) 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; (e) the firm, including the firm’s employee benefit plans; or (f) an entity whose operating, financial, or accounting policies can be controlled by any of the individuals or entities described in (a) through (e) or by two or more such individuals or entities if they act together.

Question 6

Direct financial interest

Answer 6

A personal investment under the direct control of the investor. The Code of Professional Conduct prohibits CPAs from having any direct financial interests in their attest clients. Investments made by a CPA’s spouse or dependents also are regarded as direct financial interests of the CPA.

Question 7

Ethical conflict

Answer 7

An ethical dilemma. As defined in the AICPA Code of Professional Conduct, a situation in which an individual encounters obstacles in deciding an appropriate course of action due to internal or ethical pressures or when conflicts exist in applying relevant professional standards, to legal standards, or both.

Question 8

Ethical dilemma

Answer 8

Also referred to as a moral dilemma or ethical conflict, is a situation in which there is a choice to be made between two options, neither of which resolves the situation in an ethically acceptable fashion. To follow one option makes it impossible to follow the other option.

Question 9

Financial Interest

Answer 9

An ownership interest in an equity or a debt security issued by an entity, including the rights and obligations to acquire such an interest and derivatives directly related to such interest. See also direct financial interest and indirect financial interest.

Question 10

Immediate family member

Answer 10

A spouse, spousal equivalent, or dependent (whether or not related).

Question 11

Impaired independence

Answer 11

When independence is effectively extinguished. That, is when an auditor’s independence is impaired, that auditor is not independent.

Question 12

Independence

Answer 12

Independence includes two concepts—independence of mind and independence in appearance.

Question 13

Independence in appearance

Answer 13

The avoidance of circumstances that would cause a reasonable and informed third party, having knowledge of all relevant information, including safeguards applied, to reasonably conclude that the integrity, objectivity, or professional skepticism of a firm or a member of the attest engagement team has been compromised.

Question 14

Independence of mind

Answer 14

The state of mind that permits the performance of an attest service without being affected by influences that compromise professional judgment, thereby allowing an individual to act with integrity and exercise objectivity and professional skepticism.

Question 15

Indirect financial interest

Answer 15

A financial interest owned through an intermediary (e.g., a mutual fund) when the CPA neither controls the intermediary nor has the authority to supervise or participate in the intermediary’s investment decisions. An example is an investment in a professionally managed mutual fund. The Code of Professional Conduct allows CPAs to have indirect financial interests in attest clients, as long as the investment is not material in relation to the CPA’s net worth.

Question 16

Individual in a position to influence the attest engagement

Answer 16

An individual who (a) evaluates the performance or recommends the compensation of the attest engagement partner; (b) directly supervises or manages the attest engagement partner, including all successively senior levels above that individual through the firm’s chief executive; (c) consults with the attest engagement team regarding technical or industry-specific issues related to the attest engagement; or (d) participates in or oversees at all successively senior levels quality control activities, including internal monitoring, with respect to the specific attest engagement.

Question 17

Interpretations

Answer 17

Guidelines issued by the AICPA for the scope and application of the Rules of Conduct.

Question 18

Joint closely held investment

Answer 18

An investment in an entity or property by the member and the client (or the client’s officers or directors, or any owner who has the ability to exercise significant influence over the client) that enables them to control (as defined by GAAP for consolidation purposes) the entity or property.

Question 19

Key position

Answer 19

A position in which an individual has (a) primary responsibility for significant accounting functions that support material components of the financial statements; (b) primary responsibility for the preparation of the financial statements; or (c) 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.

Question 20

Manager

Answer 20

A professional employee of the public accounting firm who has continuing responsibility for the planning and supervision of engagements for specified clients.

Question 21

Partner equivalent

Answer 21

A professional employee who is not a partner of the firm, but who has the ultimate responsibility for an attest engagement or has the authority to bind the CPA firm to conduct an attest engagement without partner approval. For example, assume a CPA firm employee is a manager who functions as a partner in that she has ultimate responsibility for several engagements—this employee is a partner equivalent.

Question 22

Period of the professional engagement

Answer 22

A period that begins when a member either signs an initial engagement letter or other agreement to perform attest services or begins to perform an attest engagement for a client, whichever is earlier. The period lasts for the entire duration of the professional relationship (which could cover many periods) and ends with the formal or informal notification, by either the member or the client, of the termination of the professional relationship or by the issuance of a report, whichever is later. Accordingly, the period does not end with the issuance of a report and recommence with the beginning of the following year’s attest engagement.

Question 23

Principles

Answer 23

The part of the AICPA Code of Professional Conduct that expresses the profession’s responsibilities to the public, clients, and colleagues and provides a framework for the Rules.

Question 24

Privileged communication

Answer 24

A confidential legally protected communication between a person making the communication and the person receiving it. For example, communications between clients and their lawyers. The rationale here is that clients should be able to communicate freely with their lawyers. Privileged communications are controversial because they exclude relevant facts from the truth-seeking process. While the AICPA Code of Professional Conduct creates a confidential relationship between CPAs and their clients, CPAs do not in general have privileged communication, a legal concept, with their clients other than in in particular state court systems. CPAs do not have privileged communication in federal courts.

Question 25

Profession

Answer 25

An activity that involves a responsibility to serve the public, has a complex body of knowledge, has standards for admission, and has a need for public confidence.

Question 26

Prospective financial information

Answer 26

Presentations of future financial position, results of operations, or cash flows. Such presentations are often referred to as financial forecasts or projections.

Question 27

Rules

Answer 27

A group of enforceable ethical standards included in the AICPA Code of Professional Conduct.

Question 28

Safeguards (to independence)

Answer 28

Controls that mitigate or eliminate threats to independence. Safeguards range from partial to complete prohibitions of the threatening circumstance to procedures that counteract the potential influence of a threat.

Question 29

Significant influence

Answer 29

The criteria established in accounting standards to determine the ability of an investor to exercise significant influence over another entity. In general, these criteria include an ownership interest of 20 percent or more of the entity.

Question 30

Threats (to overall code compliance or independence)

Answer 30

Circumstances not directly addressed by the Code of Professional Conduct that could result in member non-compliance with the Code. The AICPA’s list of broad categories of threats include (1) adverse interest, (2) advocacy, (3) familiarity, (4) self-interest, (5) self-review, (6) undue influence, and, for those in public practice, (7) management participation.