Ch 3 - Ethics and Auditing

Question 1

Is auditing a credence good?

Answer 1

Yes, it is

Question 2

A type of good with qualities that cannot be observed by the consumer after purchase, making it difficult to assess its utility

Answer 2

Credence Good

Question 3

What’s a (non acc) example of a credence good?

Answer 3

Expert services such as medical procedures, automobile repairs, and dietary supplements

Question 4

T/F: Feedback loops / Extrinsic motivations to do what’s right are delayed and weak in Auditing.

Answer 4

True

Question 5

Factors external to the actor that influence their behavior

Answer 5

Extrinsic motivations

Question 6

What are 3 (non acc) examples of Extrinsic motivations?

Answer 6

1) Monetary rewards

2) Punishments

3) Criminal/legal consequences

Question 7

The 3 primary Extrinsic Motivations in auditing are:

Answer 7

1) Client losses (acting unethically to keep a client)

2) Litigation (take 5-10+ years, not super concerning)

3) Regulatory fines/punishment (take 5+ years)

Question 8

Factors internal to the actor that influence their behavior.

Answer 8

Intrinsic Motivations (i.e. sense of duty / responsibility, religion, moral codes)

Question 9

T/F: We need auditors who are extrinsically motivated

Answer 9

False; need intrinsically motivated auditors

Question 10

The ____ & _____ delegate the writing of auditing Ethics standards to the _____.

Answer 10

PCAOB & SEC

–> AICPA

Question 11

AICPA Ethics Hierarchy:

Answer 11

• Generic Principles (professional conduct)
• specific rules that you have to follow (code of conduct)
• interpretative guidance for weird/difficult situations

Question 12

AICPA Ethics Principles (6):

Answer 12

1. Responsibilities
2. Public Interest (ultimate allegiance)
3. Integrity
4. Objectivity & Independence
5. Due Care
6. Scope & Nature of Service

Question 13

Accountants working at a Public Accounting/CPA firm

Answer 13

Members in Public Practice

(auditors, tax preparers, consultants)

Question 14

Accountants working as a CPA in other roles. We often call this “Industry”

Answer 14

Members in Business

(CFOs, controllers, CPA lawyers, corporate accountants)

Question 15

Everyone else with a CPA (i.e. retired ppl, professors)

Answer 15

Other Members

Question 16

Which member group has the most rules they have to follow?

Answer 16

Members in Public Practice

Question 17

What is the one rule that Members in Public Practice, Members in Business, and Other Members must follow?

Answer 17

Acts discreditable

Question 18

The ____________ are the body that issues/tracks CPA licenses & are responsible for CPA license suspensions and removals.

Answer 18

State Boards of Accountancy

Question 19

T/F: all the Government Authorities with real power to take your license, fine or imprison you have said that you must follow the AICPA ethical rules.

Answer 19

True

Question 20

The auditor must be intellectually honest & must be free from any obligation to or interest in the client, its management, or its owners

Answer 20

Independence

Question 21

Whether or not the auditor is actually independent in their mind/heart.

Answer 21

Independence in Fact

Question 22

Whether or not the auditor looks independent to an outside observer.

Answer 22

Independence in Appearance

Question 23

T/F: Only Independence in Fact is critical to the functioning of the industry.

Answer 23

False; BOTH independence in fact and appearance are critical & auditors must maintain both

Question 24

The specific CPA has an independence conflict and is prohibited from participating in the audit of that client.

Answer 24

Impaired Independence – Individual Level

Question 25

The entire CPA firm is treated as if it had independence conflict and is prohibited from participating in the audit of that client.

Answer 25

Impaired Independence – Firm Level

Question 26

Which level of impaired independence is more common?

Answer 26

Firm level

Question 27

An individual from the audit team/firm who can influence the audit; they have stricter rules

Answer 27

Covered Member/Person

Question 28

Individual with primary responsibility for accounting functions, preparing financial statements, ability to influence contents of financial statements; some stricter rules

Answer 28

Key Position

Question 29

No partner or professional employee, or his/her immediate family member, or any group of such persons acting together may own more than ___% of the client’s outstanding equity securities during the period of the professional engagement; This applies to ________ in the CPA firm; results in a _____ (individual/firm) level impairment.

Answer 29

5% ; Everyone ; firm

Question 30

No partner or professional employee may simultaneously be working for the CPA firm and the client firm; This applies to ________ in the CPA firm; results in a _____ (individual/firm) level impairment.

Answer 30

Everyone ; firm

Question 31

Employees must fill out detailed ___________ statements to ensure no rules are violated.

Answer 31

Financial disclosure

Question 32

2 Additional rules that only apply to covered members:

Answer 32

1. can’t directly purchase ANY stock or directly loan ANY $ to the client. 2. Indirect investments (things not directly controlled by you, like a mutual fund or retirement fund) are only allowed if they are immaterial to you.

Question 33

If a covered member violates their additional/stricter rules, it results in a _______ (individual/firm) level impairment.

Answer 33

Firm

Question 34

If a person is rotated out of the Covered Member definition, then it's a _____ (individual/firm) level impairment.

Answer 34

Individual

Question 35

T/F: The higher up you are in the firm (i.e. Partner), the easier it is to rotate out of the Covered Member definition.

Answer 35

False; it's harder (easier for lower-level employees to rotate out)

Question 36

A non-covered member CPA has a material joint closely held investment with the client. Is firm independence impaired?

Answer 36

No

Question 37

A non-covered member CPA has any direct or a material indirect financial interest in the attest client. Is firm independence impaired?

Answer 37

No (unless direct interest is 5% or greater --> yes)

Question 38

Spouse, spousal equivalent, or dependent child are all considered... & have to follow same rules as if they were you; can result in _____ (indiv/firm) level impairments.

Answer 38

Immediate family firm

Question 39

Parent, sibling, or nondependent child are all considered...

Answer 39

Close Relatives

Question 40

What are the 2 exceptions for immediate family?

Answer 40

1. When a family member is employed by a client in something other than a key position (not acc job). 2. In certain circumstances in which the immediate family member participates in a benefit plan related to a client.

Question 41

Firm level impairment if a close relative has... (2 things)

Answer 41

1. A key position with the client, or 2. A material financial interest of which the accountant has knowledge.

Question 42

According to SOX, there must be a _____ “Cool off” period before a Partner can take employment in a Key Position with client firm

Answer 42

1 year

Question 43

T/F: A firm can still conduct the CY audit even if prior year fees are owed.

Answer 43

False; Can't conduct CY audit

Question 44

A member shall comply with the following standards (regarding professional competence, due care, planning and data gathering)

Answer 44

General Standards Rule

Question 45

A member shall not (1) express an opinion … or (2) state that he or she is not aware of any material modifications that should be made … if such statements or data contain any departure from an accounting principle … that has a material effect on the statements (i.e. only give clean opinions if you TRULY BELIEVE there are no material misstatements)

Answer 45

Accounting Principles Rule

Question 46

T/F: Audit information is Confidential and Privileged!

Answer 46

False; Confidential, but NOT privileged (only lawyers are)

Question 47

T/F: If the fraud/act does NOT have a direct material affect on the financials, issue a clean/unqualified audit opinion.

Answer 47

True (only care about material fraud)

Question 48

A fee based on the type of opinion given (i.e. paying extra for an unqualified opinion); explicitly banned

Answer 48

Contingent fee

Question 49

The idea is you can lose your CPA license for ethical violations that don’t directly relate to auditing/accounting, but that make the industry look bad

Answer 49

Acts Discreditable

Question 50

T/F: CPAs can advertise, so long as it’s “not false or deceptive”.

Answer 50

True

Question 51

Auditors ___ (can/can't) accept commissions/referrals.

Answer 51

Can't

Question 52

Virtually every CPA firm is set up as a ___________.

Answer 52

Limited Liability Partnership (think: LLC but P)

Question 53

Have both Limited Liability and One Layer of Taxation

Answer 53

LLP's

Question 54

T/F: LLPs are good because partners (owners) cannot be held responsible for paying out of their personal assets for engagements they did not work on.

Answer 54

True

Question 55

Who is considered a covered member in the context of auditor independence?

Answer 55

- an engagement team member - the audit firm's CEO - an engagement office partner - a non-attest service provider to the audit client

Question 56

5 audit firm employees each own 1% of a client's equity. What kind of (if any) independence impairment does this create?

Answer 56

Firm level impairment