Module 4

Question 1

Concerns of CPAs

Recurring Concerns for CPAs

Answer 1

At Enron, there were allegations that the audit firm was not objective in its auditing because of links between the CPA firm and Enron’s accounting department and the extent of profitable non-audit services provided by the CPA firm.

Focus of investigations & reviews:

1. Non-audit services impairing auditor independence
2. Management needs to report on internal controls
3. Prevention & detection of fraud

Until 2002, professional organizations, such as the AICPA, (rather than Congress) enhanced minimum expectations through changes to code of conduct and auditing standards.

Question 2

Concerns of CPAs

Why Ethics

Answer 2

• 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.

Question 3

Concerns of CPAs

AICPA Code of Professional Conduct

Four Sections

Answer 3

• The code is composed of these 4 sections.
• Most interpretations and ethical rulings deal with the first Rule on independence, which primarily applies to CPAs in public practice

Now, let’s look at the guiding principles.

Question 4

AICPA Code of Professional Conduct

The Principles

Answer 4

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 Engagement
• Audits of F.S.

Question 5

AICPA Code of Professional Conduct

The Principles

Responsibilities

Answer 5

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.

Question 6

AICPA Code of Professional Conduct

The Principles

The Public Trust

Answer 6

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.

Question 7

AICPA Code of Professional Conduct

The Principles

Integrity

Answer 7

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.

Question 8

AICPA Code of Professional Conduct

The Principles

Objectivity and Independence

Answer 8

Objectivity and 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.

Question 9

AICPA Code of Professional Conduct

The Principles

Due Care

Answer 9

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.

Question 10

AICPA Code of Professional Conduct

The Principles

Answer 10

Scope and 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.

Question 11

Rule 101: Independence

Answer 11

Independence

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.

Question 12

Independence.

Fact and Appearance

Answer 12

Means independence in fact and appearance - so, rules may appear too restrictive.

• Applies to all attest (not just audit) engagements.
• Why is independence important?

Question 13

Independence

Assurance

Answer 13

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.

Question 14

Independence

AICPA Conceptual Framework for Independence

Answer 14

The perspective used throughout is whether a reasonable person, aware of all the relevant facts, would conclude that an unacceptable risk to independence exists.

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.

Question 15

Independence

AICPA Conceptual Framework for Evaluating Threats to Independence

Answer 15

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 “totally disassociated” from an attest engagement that covers part of the prior employment period.

Question 16

Independence Impairment

3 Stage Process

Answer 16

3 Stage Process

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.

Note: Interpretation 101-17 defined “Firm” to include network or associated organizations which may be separate legal entities and provided criteria for determining this.

Question 17

Independence Impairment

When: Period of Professional Engagment

Answer 17

While you are engaged

1. Conducting planning and field work
2. Rendering opinion/drafting report
3. Begins when engagement letter signed or agreement reached, or CPA starts work.

Period engaged continues until attest relationship ends by formal or informal notice from either CPA or client.

Question 18

Independence Impairment

SEC and PCAOB Independence Rules

Answer 18

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).

Question 19

AICPA Rule Responsibilities

Rule 102: Integrity and Objectivity

Answer 19

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 engagements, including tax work.
• This rule even applies to employees who are AICPA members esp. as it relates to integrity and knowingly doing some which is known to be wrong, including an accountant role in:
  
  • Recording transactions and preparing F.S., including taking instructions from his superiors
  • Being candid and without misrepresentations or incomplete responses with his employer’s external CPA
• AICPA Ethical Ruling #113: Gifts or Entertainment can impair objectivity if not reasonable in the circumstances. They can impair integrity if CPA knew they violated client or CPA firm vendor policy.
• See supplemental handout for a summary of the applicability of each of the Rules of the Code.

Question 20

AICPA Rule Responsibilities

ET Section 55, Article IV - Objectivity and Independence

Answer 20

A member should maintain objectivity and be free of conflicts of interest in discharging (all) professional responsibilities. A member in public practice should be independent in fact and appearance when providing auditing and other attestation services.

Objectivity is something that the CPA must use in drawing his conclusions and opinions, while independence is only required when a CPA is providing conclusions or opinions which are likely to be provided to 3rd parties.

Question 21

AICPA Rule Responsibilities

ET Section 55, Article IV - Objectivity and Independence

.01

Answer 21

Objectivity is a state of mind, a quality that lends value to a member’s services. It is a distinguishing feature of the profession. 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.

Many students are confused as to the difference between objectivity and independence, and the difference is subtle in that independence represents relationships that might impair one’s objectivity.

Question 22

AICPA Rule Responsibilities.

Rule 201: General Standards

Answer 22

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

This rule applies to all services. Basically says that a CPA must comply with the auditing standards in the General & Field Work categories, except: Independence (already a separate Rule) Understanding internal controls and the client and its environment as such is not applicable to all engagements. Later we will identify the “bodies designated by the AICPA.

Question 23

AICPA Rule Responsibilities

Rule 202: Compliance with Standards

Answer 23

A member who performs auditing, review, compilation, management consulting, tax, or other professional services shall comply with standards promulgated by bodies designated by Council.

This rule basically says that the CPA must comply with whatever standards cover a particular engagement type.

Question 24

AICPA Rule Responsibilities

Rule 203: Accounting Principles

A member shall not:

Answer 24

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 . . .

This rule basically requires a CPA to measure what a client has reported when generally accepted accounting principles are the appropriate criteria.

Question 25

AICPA Rule Responsibilities Rule 301: Confidential Client Information

Answer 25

A member in public practice shall not disclose any confidential client information without the specific consent of the client. * 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. When a CPA uses 3rd party service providers, except clearly administrative services, the CPA should obtain client consent (integrity Interpretation 191.225) and possibly get a written confidentiality agreement from the 3rd party provider (Interpretation 391.002).

Question 26

AICPA Rule Responsibilities Rule 302: Contingent Fees

Answer 26

* Cannot accept if related to a client for which CPA also performs any of the following engagements: 1. Audit or review of historical F.S. 2. Compilation of F.S. and a 3rd party might use the CPA's report and the report does not disclose this lack of independence 3. 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

Question 27

AICPA Rule Responsibilities Rule 501: Acts Discreditable

Answer 27

A member shall not commit an act discreditable to the profession. According to the Code, the following are considered acts that discredit the CPA profession: * Violation of Law * Gross Negligence * Discrimination * 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). Member can charge a fee to copy or retrieve records, but possibly not for client provided records (e.g., ledgers maintained by the client). Interpretation #501-1 (Feb 2006).

Question 28

AICPA Rule Responsibilities Rule 502: Advertising and Other Forms of Solicitation

Answer 28

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

Question 29

AICPA Rule Responsibilities Rule 503: Commissions and Referral Fees

Answer 29

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. Rule 503 prohibits 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.

Question 30

AICPA Rule Responsibilities Rule 503: Commissions and Referral Fees

Answer 30

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. 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.

Question 31

AICPA Rule Responsibilities Rule 505: Advertising and Other Forms of Solicitation

Answer 31

* 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 are 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.

Question 32

Additional Ethics for Tax Services Tax Advocacy

Answer 32

CPA must still be objective (Rule 102) – 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.

Question 33

Additional Ethics for Tax Services Tax Shelters (Investments)

Answer 33

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 1996 & 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.

Question 34

Additional Ethics for Tax Services Prior Year Tax Return Errors

Answer 34

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. 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.

Question 35

Additional Ethics for Tax Services AICPA Quality Control Standards on Ethics

Answer 35

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.

Question 36

Ethics for California Licensed CPAs

Answer 36

* Part of the California Business & Professional Code. * Entitled: California Standards of Professional Conduct * Based on AICPA’s code. * Violation could result in suspension or revocation of a CPA or CPA firm’s CPA license to practice. California also requires passing an ethics exam after passing the CPA exam in order to obtain a CPA license and the required passing grade is 90 percent. California also requires periodic recurring ethics training throughout a CPA’s career and starting in 2014 will also require 10 college semester units of ethics study before a CPA license can be issued.

Question 37

Ethics for California Licensed CPAs Employment After Audit Engagement

Answer 37

California prohibits employment for 12 months after an audit report is issued on a public company, for any engagement team member who: * Exercised significant judgment on the audit (in-charge through partner) AND * Accepted a position that has significant authority over accounting or financial reporting.

Question 38

Ethics for California Licensed CPAs Commisions and Referal Fees

Answer 38

California prohibits accepting any commission or referral fee for referring a client to a 3rd party if the 3rd party services or products are not provided in conjunction with a CPA client service.

Question 39

Ethics for California Licensed CPAs Commisions and Referal Fee Disclosure Process

Answer 39

* California has more specifics on commission/referral fee disclosure process: * In writing and clear and conspicuous. * Signed by the recipient of the product or service. * States amount of the commission or basis on it will be computed. * Identifies the source of the payment & relationship between the payment source and the CPA. * Presented to the client at or prior to the time the recommendation of the product or service is made. * Fees include a commission, rebate, preference, discount, or other consideration, whether in the form of money or otherwise.

Question 40

Ethics for California Licensed CPAs Services Requiring Independence

Answer 40

California prohibits acceptance of contingent fees from a client if CPA also performs any service requiring independence (so all attestation services).

Question 41

Ethics for California Licensed CPAs Confidentiality

Answer 41

California may prohibit disclosure of client names in certain cases where such disclosure may inadvertently disclose confidential information.

Question 42

Ethics for California Licensed CPAs CPA Reporting to CBA within 30 Days

Answer 42

1. Many specific acts discreditable to the profession, including convictions and suspensions or revocations. 2. Any restatement of a financial statement and related disclosures by a client audited by the licensee. 3. Any civil action settlement or arbitration award against the licensee relating to the practice of public accountancy where the amount or value of the settlement or arbitration award is \>$30,000 where the licensee is not insured for the full amount. 4. Any notice of the start of a formal investigation of the licensee by the SEC or its designee. 5. Any SEC notice from the Securities and Exchange Commission to a licensee requesting a Wells Submission. 6. Any notice of the start of an investigation by the PCAOB or its designee CBA means the California Board of Accountancy. A Wells notice is a letter that the U.S. Securities and Exchange Commission (SEC) sends to people or firms when it is planning to bring an enforcement action against them. The notice indicates that the SEC staff has determined it may bring a civil action against a person or firm, and provides the person or firm with the opportunity to provide information as to why the enforcement action should not be brought. Regulators are not legally required to provide a notice; however, it is the practice of the SEC and the Financial Industry Regulatory Authority (FINRA) to provide such notice.