Professional Documents
Culture Documents
Professional Ethics
Review Questions
4-1 The six core ethical values described by the Josephson Institute are:
1. Trustworthiness 4. Fairness
2. Respect 5. Caring
3. Responsibility 6. Citizenship
There are many other potential sources of ethical values, including laws
and regulations, church doctrines, codes of professional ethics, and individual
organizations’ codes of conduct.
4-1
4-4
PART PURPOSE
1. Principles of 1. Provide ideal standards of ethical conduct
Professional Conduct and help practitioners understand the
ideal conduct of a CPA.
2. Rules of conduct 2. Provide minimum standards of ethical
conduct stated as specific rules.
3. Interpretation of the 3. Provide formal interpretations of the rules
rules of conduct of conduct to answer questions that
frequently arise about the rules of
conduct.
4. Ethical rulings 4. Provide more detailed guidance to
practitioners about interpretation of the
rules of conduct for less commonly
raised questions.
4-5 Independence in fact exists when the auditor is actually able to maintain
an unbiased attitude throughout the audit, whereas independence in appearance
is dependent on others' interpretation of this independence and hence their faith
in the auditor.
Activities which may not affect independence in fact, but which are likely to
affect independence in appearance are: (Notice that the first two are violations of
the Code of Professional Conduct.)
4-7 Auditors of public companies are prohibited from performing the following
nonaudit services:
4-2
4-7 (continued)
Nonaudit services that are not prohibited by the Sarbanes–Oxley Act and
the SEC rules must be pre-approved by the company’s audit committee. In
addition, an accountant is not independent of an audit client if an audit partner
received compensation based on selling engagements to that client for services
other than audit, review and attest services.
Companies are required to disclose in their proxy statement or annual
filings with the SEC the total amount of audit and nonaudit fees paid to the audit
firm for the two most recent years. Four categories of fees are to be reported: (1)
audit fees; (2) audit-related fees; (3) tax fees; and (4) all other fees. Companies
are also required to provide further breakdown of the “other fees” category, and
provide qualitative information on the nature of the services provided.
4-8 The rules concerning stock ownership by partners and professional staff:
Partner violation: A partner in the San Francisco office owns one share of stock
of a client whose audit is conducted by a different partner in the San Francisco
office.
Professional staff violation: An audit manager owns stock in a client whose audit
is performed by the office where the audit manager works. The manager is
promoted to partner mid-year. As soon as the manager becomes a partner, there
is a violation of Rule 101.
4-9 Ways to reduce the appearance of the lack of independence are: the use
of an audit committee to select auditors made up of directors who are not a part
of management; a requirement that all changes of auditors and reasons therefore
be reported to the SEC or other regulatory agency; and approval of the CPA firm
by stockholders at the annual meeting. The Sarbanes–Oxley act requires that the
audit committee of a public company consist only of independent members and
be responsible for the appointment, termination, and compensation of the audit
firm.
4-3
4-10 A CPA firm has several options when it decides it is not competent to
perform an audit:
4-11 A fee based upon the amount of time it takes to complete is not a violation
of Rule 302. Rule 302 on contingent fees states that professional services for
clients receiving assertion opinions shall not be offered or rendered under an
agreement whereby no fee will be charged unless a specific finding or result is
attained, or where the fee is otherwise contingent upon the findings or results of
such services. The purpose of the rule is to prevent sacrificing the quality of
audits because of the pressure felt by the auditor in producing the required audit
outcome. An example would be the fee being dependent upon the issuance of an
unqualified opinion or the obtaining of a loan by a client.
4-12 The following are exceptions to the confidentiality requirement for the
CPA's audit files:
4-4
4-14 (continued)
1. A proprietorship
2. A general partnership
3. A general corporation (if permitted by state law)
4. A professional corporation
5. Limited liability company (if permitted by state law)
6. Limited liability partnership (if permitted by state law)
4-17 There are major differences between the nature of the enforcement by the
AICPA and a state Board of Accountancy.
4-20
Service Violation?
a. Providing bookkeeping services to a public company.
The services were pre-approved by the audit Yes
committee of the company.
b. Providing internal audit services to a public company No
that is not an audit client.
c. Designing and implementing a financial information No
system for a private company.
d. Recommending a tax shelter to a client that is publicly No *
held. The services were pre-approved by the audit
committee.
e. Providing internal audit services to a public company Yes
client with the pre-approval of the audit committee.
f. Providing bookkeeping services to an audit client that is No
a private company.
* Recommending tax shelters is not prohibited, but has the potential to impair
independence.
4-6
4-21 (continued)
4-8
4-23 (continued)
4-9
4-24 (continued)
d.
1. He has violated the Code of Professional Conduct. Rule 101
prohibits any direct ownership by a partner or shareholder.
2. Such a small ownership is unlikely to have any impact on a
partner's objectivity in evaluating the financial statements. It
is unlikely to affect the partner's independence in fact.
3. Such ownership could affect the appearance of
independence and therefore impact the reputation and
credibility of auditors. Additionally these strict requirements
eliminate any controversy as to the line between a material
and immaterial ownership. It also shows outsiders the
importance of independence to auditors and therefore
hopefully improves the reputation of the profession.
e.
INDEPENDENCE IN INDEPENDENCE
FACT IN APPEARANCE CONSEQUENCES
1. May cause the auditor Users may perceive Minor, if any.
to permit that auditors would
misstatements to permit misstatements to
enhance personal enhance personal
wealth. wealth.
2. Person doing this audit Users may perceive Some clients find it less
may not do the audit that the auditor may not expensive to have
work carefully because independently audit his bookkeeping services
he or she did the or her own work. performed by an outside
bookkeeping. service. It is often less
expensive to have this done
by the auditor because the
auditor will already be
knowledgeable about the
business.
3. There may be an Users may believe that Many clients lack technical
absence of a careful the auditor may not expertise in accounting.
independent check of independently audit his Having services performed
the entries or pre- or her own work or that by the auditor is sometimes
paration of the of a staff person from the least costly alternative.
statements because his or her firm.
they were originally
prepared by the
auditor.
4-10
4-24 (continued)
INDEPENDENCE IN INDEPENDENCE
FACT IN APPEARANCE CONSEQUENCES
4. The auditor may be Users may perceive A CPA firm gains
reluctant to criticize or either of the two considerable knowledge
not rely on an concerns discussed about a client and its
accounting system that under independence in business during the audit.
was originally fact. Due to this knowledge,
recommended by the management services can
CPA firm. Additionally, often be provided by the
if the CPA firm obtains same CPA firm at a lower
considerable revenue cost than alternative
from management sources such as other CPA
advisory services, the firms or management
CPA firm may fear the consultants.
loss of the client and
therefore be controlled
by management.
5. The audit team may Users may perceive the Knowledge gained by the
become complacent possibility of audit team about a client's
due to familiarity and complacency. business is essential to
not carefully evaluate evaluate when
potential misstatements in the
misstatements. financial statements are
likely and to plan the audit.
It is costly for a new audit
team to obtain that
knowledge.
6. The CPA firm may Users may perceive the The same conclusions
become complacent possibility of reached in 5 about the audit
due to familiarity and complacency. team are applicable to CPA
not carefully evaluate firms. The cost of a new
potential CPA firm of obtaining the
misstatements. knowledge is even greater
because of confidentiality
requirements and
communication difficulties
between CPA firms.
7. The auditor may be Users may perceive Someone has to select the
unwilling to disagree that the auditor is un- auditor. Management is
with management for willing to disagree with usually in the best position
fear of being management. to evaluate the
terminated. effectiveness and cost of
alternative auditors,
especially for private
companies.
4-24 (continued)
4-11
f. The AICPA Code of Professional Conduct prohibits only e(1). The SEC
prohibits e(1) if the person owning the stock is a member of the
engagement team or is a partner in the office of the partner
primarily responsible for the audit engagement. The SEC also
prohibits e(2), and e(3) would also be considered a violation if the
adjusting entries were so extensive that they are, in essence,
bookkeeping services. The SEC also prohibits the management
services in e(4) if they are one of the nine nonaudit services
prohibited by the SEC. Because the Sarbanes–Oxley Act requires
that the audit committee select the auditor, e(7) is now also a
violation of SEC rules.,
4-25 The Code of Professional Conduct and interpretations are not clear as to
what constitutes a violation in these three situations. A central point is that
Marie Janes must maintain independence in fact and appearance because
she is not an employee of the company and must not give the impression
that she is one.
(a) (b)
RULES OF CONDUCT VIOLATED? APPROPRIATE ACTION?
1. Marie Janes has likely not violated the 1. Marie Janes should discuss the
rules; the discount is available to discount with the firm's managing
customers on a widespread basis. partner if she intends or wants to
Presumably many of the employees of buy the automobile. She should
the CPA firm buy automobiles from the certainly not feel compelled to buy
agency. the automobile but she should
also not automatically turn it
down. The situation would be
entirely different if the sale were
limited to employees. In such a
case it would likely be a violation.
2. If Marie Janes were to eat there on an 2. Marie Janes should eat elsewhere
ongoing basis that would likely be a if it is practical to do so but if the
violation of the rules of conduct. It only practical place for her to eat
would not likely be a violation if she is the lunchroom, she should
occasionally eats with employees she make arrangements with her firm
is dealing with at the audit. to make certain that the company
is reimbursed for the expenses.
3. Accepting such a gift is likely to be a 3. Ideally Janes should not accept
violation of the rules of conduct. That the gift and state that since she is
gift is reasonably large and would be not an employee, she would
considered by many employees as prefer not to take it. If she
equivalent to a bonus. believes that it would be
embarrassing to the company,
she should graciously accept it
and return it with an explanation
of her reasons as soon as
practical.
4-12
4-26
1. No violation. Because JKB management selected the IT hardware and
software and the external auditors merely installed it, the firm is not
acting as a member of management and has no independence
problem.
2. Violation. The Rules of Conduct state that a CPA cannot supervise
client employees. The external auditors supervised employees in
the daily operation of the IT system, which is a violation of Rule
101.
3. No violation. Because JKB management selected the specifications
and options of the payroll software application, the CPA firm did not
act as a member of management by customizing the package for
the client’s use.
4. No violation. The Rules of Conduct permit the external auditor to train
client employees on the use of a newly installed information
system.
5. Violation. By determining which of JKB’s products would be offered on
the company’s Web site, the external auditors acted as part of
JKB’s management. Independence has presumably been impaired
in this case.
6. Violation. Again, the external auditors are acting as members of
management by operating the client’s local area network. If JKB is
an SEC client, this would also be a violation of SEC independence
rules.
Cases
4-27 The answers to these questions are more judgmental than most others in
the chapter. They may, in some cases, be a violation of the spirit of the Code if
the CPA is acting in a certain manner, and they may not be a violation if the CPA
is acting in a different manner. For example, in 4, if Davis is sending business
executives in small companies to his small loan company, there's likely to be a
violation of the rule of conduct. On the other hand if he recommends the small
loan company along with several others, only for those clients who truly need the
services of a small loan company, he is not likely to be in violation. (Changing the
facts throughout the discussion may increase the value of the case.)
4-13
4-27 (continued)
2. Contingent fee arrangements between the CPA and the client are a
violation of the rules for clients receiving attestation services.
However, Rule 302 specifically states that fees are not regarded as
being contingent if fixed by courts or other public authorities or, in
tax matters, if determined based on the results of judicial
proceedings and the findings of government agencies. This
situation involves tax matters the results of which are determined
by judicial proceedings, therefore there is no violation.
3. Rule 502 permits advertising as long as it is not false, misleading,
or deceptive. The advertising expressly states two facts: 14 of 36 of
the largest savings and loans companies are audited by their firm
and second, the average audit fee, as a percentage of total assets,
is lower than any of the other CPA firms in the city. Contel must be
able to support those factual statements. Assuming he can, there is
no violation. However, it may be difficult to support the comparison
to the fees of other firms.
4. There is no violation because Rule 504--Incompatible Occupations
no longer exists. There may have been a violation under old Rule
504 if Davis or his employees consistently sent clients of Davis to
the small loan company and/or encouraged them to make loans
from such company.
5. There may be a material indirect interest in the audit client. Elbert
owns a material amount of stock and if the mutual fund in turn
invests a large portion of its money in an audit client of Elbert,
Elbert in essence has a material investment in an audit client.
Simply because the mutual fund's investment has increased
dramatically in the audit client does not mean there is a material
investment, however. For example, it may have increased from one
percent to three percent of the total holdings of the mutual
company. Nevertheless Elbert must evaluate whether the holding
could be a material indirect investment under Rule 101.
6. It is essential that Finigan retain both an attitude of independence in
fact and in appearance. It is not possible to determine if Finigan is
maintaining an attitude of independence in fact, given her
involvement in the company, but it is certainly possible that she is.
Finigan is not necessarily violating the Code of Professional
Conduct. She does the audit, tax return, bookkeeping and
management services work for the client, but that is not a violation
if Gilligan is a private company.
It is questionable whether Finigan is maintaining an attitude
of independence in appearance, especially given the comments by
Gilligan. It is essential that she maintain an attitude of
independence throughout all her work. So she must be careful that
she is not on the side of Gilligan without consideration of her
professional responsibilities in conducting the audits and in all other
aspects of her professional responsibilities.
(4) Alternatives
(a) Throw away schedules.
(b) Inform Jack that she will not throw schedules away.
(c) Talk to manager or partner about Jack's request.
(d) Refuse to work on the engagement.
(e) Quit the firm.
(5) Consequences
(a) The misstatements may be discovered subsequently
and the firm may lose the client, or be sued. Even if
the misstatements are not material, the client may be
justifiably upset because the problems giving rise to
the misstatements may have been solved sooner.
(b) Barbara informs Jack that she won't throw away
schedules. This may result in a confrontation. She
may get an unfavorable review.
4-28 (continued)
4-15
(c) If she talks to the manager or partner, they may
admire Barbara's attempt to be ethical, or they may
think she is out of line for bypassing Jack's authority
without discussing the matter with him in detail.
(d) If she refuses to continue on the engagement, it will
not look good on Barbara's record. She may be
labeled as "hard to get along with."
(e) If she quits, she will likely miss out on some
potentially valuable experiences in public accounting.
(6) Appropriate Action
Only Barbara can decide. One reasonable approach is
for Barbara to start by discussing the matter further with
Jack. She should listen carefully to his reasoning and
express her reservations about throwing the schedules away.
She should not subordinate her judgment to Jack, as this
would be a violation of Rule of Conduct 102. If Jack satisfies
her that it is acceptable to throw the schedules away (this
seems unlikely in the circumstances), then she may be
justified in doing so. However, if she still has reservations,
she should inform Jack that she intends to contact a
manager or partner.
4-16
4-30 (continued)
4. Alternatives
a. Write a statement and inform other partners if engagement
partner refuses to include the statement in the audit files.
b. Agree with the partner.
5. Consequences
a. If Frank agrees with the partner, a potentially inappropriate
accounting method may lead to an unqualified opinion on
materially misstated financial statements.
b. Other partners may be upset with Frank for failing to disclose
his feelings on the matter.
c. The firm could be sued and suffer losses.
d. On the other hand, perhaps the partner is right and the
revenue recognition method is appropriate.
e. If Frank writes the statement and expresses his
disagreement, he may be labeled as "hard to get along with."
However, most firms which do high-quality audit work
encourage practitioners at all levels to express their views on
matters which require professional judgment such as the
appropriateness of a given accounting principle.
6. Appropriate action:
Frank should express his opinion, leaving room for the
possibility that he may be wrong. He should be respectful of the
position of all other partners in the firm. Most, if not all, of the other
partners in the firm would probably appreciate Frank's willingness
to express his opinion regarding the inappropriateness of the
revenue recognition method used by the client.
4-17
Internet Problem Solution: Public Company Disclosure of Audit and
Nonaudit Fees
1. What fees were paid to Ford’s and GM’s audit firms for the year ended
December 31, 2002?
Answer:
Ford Motor Company paid PricewaterhouseCoopers the following (in
millions):
2002 2001
Audit $ 21.0 $ 17.6
Audit-related 4.8 4.6
Tax 19.7 20.7
All other 4.4 13.0
Total $ 49.9 $ 55.9
General Motors Corporation paid Deloitte & Touche (and Deloitte Consulting)
the following (in millions):
2002 2001
Audit $ 25.0 $ 24.0
Audit-related 22.0 18.0
Tax 9.0 9.0
All other 100.0 51.0
Total $ 156.0 $ 102.0
2. Given your findings, do you believe that Ford’s and GM’s auditors are
independent? Do you believe that the provision of non-audit services hinders,
strengthens, or has no effect on an auditor’s independence? Why?
Answer:
Student responses will most likely vary. This question can be used as a
starting off point in a discussion of independence. You may wish to ask the
students if they perceive a difference in the independence of Ford’s and GM’s
auditors given the vast different amount of fees paid to the two firms. Are their
perceptions affected by the size of these companies? Also, you may want to
ask students if their opinions have been influenced by recent press accounts
involving corporate malfeasance at Enron, WorldCom and other corporations.
(Note: Internet problems address current issues using Internet sources. Because Internet
sites are subject to change, Internet problems and solutions are subject to change. Current
information on Internet problems is available at www.prenhall.com/arens).
4-18