Messier 11e Chap19

Auditing and Assurance Services
A Systematic Approach
Eleventh Edition
Chapter 19
Professional Conduct,
Independence, and
Quality Control
Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution

without the prior written consent of McGraw-Hill Education.
Learning Objective 19-1
Ethics and Professional Conduct
Refers to a system or code of

conduct based on moral duties and
Ethics obligations that indicate how an
individual should interact with others
in society
Refers to the conduct, aims, or

Professionalism qualities that characterize a
profession or professional person

without the prior written consent of McGraw-Hill Education. 19-2
Theories of Ethical Behavior
Recognizes that decision making involves

trade-offs between the benefits and burdens
Utilitarianism of alternative actions and focuses on
consequences and on individuals affected
Rights-Based Assumes that individuals have certain rights

and other individuals have a duty to respect
Approach those rights when making decisions
Justice-Based Is concerned with issues such as equity,

Approach fairness, and impartiality

FIGURE 19-1 Relevant Professional Standards for

Audits of Private versus Public Companies

The AICPA Code of Professional Conduct:

A Comprehensive Framework for Auditors
Principles of Professional Conduct
Rules of Conduct
Interpretations of Rules of
Conduct by the Professional
Ethics Executive Committee
(PEEC)

FIGURE 19-2 Code of Professional Conduct

TABLE 19-1 Principles of Professional Conduct

Overview of Part 1 AICPA Rules of Conduct (Table 19-2) (1 of 4)
Code
Rule Title Text of the Rule*
Section
1.100.001 Integrity and In the performance of any professional service, a member shall
objectivity 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.
1.200.001 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.
1.300.001 General A member shall comply with the following standouts and with any
standards interpretations thereof by bodies designated by Council:
A. Professional competence.
B. Due professional care.
C. Planning and supervision.
D. Sufficient relevant data.
1.310.001 Compliance A member who performs auditing, review, compilation, management

with consulting, tax, or other professional services shall comply with
standards standards promulgated by bodies designated by Council.

Code
Section
1.320.001 Accounting A member shall not (1) express an opinion...that the financial
principles 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...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...that has a material effect...
1.400.001 Acts A member shall not commit an act discreditable to the profession.
discreditable
1.510.001 Contingent fees A member in public practice shall not (1) perform for a contingent
fee any professional services for... a client for whom the member
or the members film performs, an audit or review of a financial
statement... or (2) prepare an or amended tax return or claim
for a tax refund for a contingent fee for any client

Code
Section
1.520.001 Commission A member in public practice shall not for a commission recommend or
s and refer to a client any product or service, or for a commission
referral lees 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 an audit or review of a financial
statement....
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.
1.600.001 Advertising A member in public practice shall not seek to obtain clients by
and other advertising or other forms of solicitation in a manner that is false,
forms of misleading, or deceptive. Solicitation by the use of coercion,
solicitation overreaching, or harassing conduct is prohibited.
1.700.001 Confidential A member in public practice shall not disclose any confidential client
client information without the specific consent of the client...
information Members... shall not use to their own advantage or disclose any
members confidential client information that comes to their
attention...

Code
Section
1.800.001 Form of A member may practice public accounting only in a form of

organization organization permitted by law or regulation whose characteristics
and name 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.
*
Some of the longer rules have been excerpted abridged. Refer to
the full set rules and interpretations at www.aicpa.org.

Knowledge Assessment
Which of the following statements best explains why public

accounting, as a profession, promulgates ethical standards
and establishes means for ensuring their observance?
A. Vigorous enforcement of an established code of ethics is the bes way to

prevent unscrupulous acts.
B. Ethical standards that emphasize excellence in performance over material
rewards establish individual reputations for competence and character.
C. Ethical standards are established so that users of accounting services
know what to expect and accounting professionals know what behaviors
are acceptable, and so that discipline can be applied when necessary.
D. A requirement for a pression is to establish ethical standards that
primarily stress responsibility to entities and colleagues.
(MC Question 19-14)

Which of the following statements best explains why public

accounting, as a profession, promulgates ethical standards and
establishes means for ensuring their observance?
A. Vigorous enforcement of an established code of ethics is the bes way to

prevent unscrupulous acts.
B. Ethical standards that emphasize excellence in performance over material
rewards establish individual reputations for competence and character.
C. Ethical standards are established so that users of accounting
services know what to expect and accounting professionals know
what behaviors are acceptable, and so that discipline can be applied
when necessary.
D. A requirement for a pression is to establish ethical standards that primarily
stress responsibility to entities and colleagues.
(MC Question 19-14)

Integrity and Objectivity
Integrity and Objectivity Rule

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.

Independence
Independence Rule
A member in public practice shall be independent in the
performance of professional services as required by
standards promulgated by bodies designated by Council.
Other Attest
Financial Financial
Services as
Statement Statement
defined by
Audits Reviews
SSAEs
Interpretation of the Independence Rule

“Covered members” must be independent.

Covered Members
1. An individual on the attest engagement team
2. An individual in a position to influence the attest engagement
3. A partner, partner equivalent, or manager who provides more
than 10 hours of nonattest services to the attest client within
any fiscal year.
4. 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
5. The firm, including the firm’s employee benefits plan
6. An entity whose operating, financial, or accounting policies can
be controlled by any of the individuals or entities described
above or by two or more such individuals or entities if they act
together

Prohibited Financial Relationships
A financial interest that is owned

directly by an individual or entity, or
Direct is under the control of an individual
or entity
May result when a covered member

has a financial interest in an entity
Material that is associated with an attest
Indirect entity, for example an investment in a
mutual fund that owns the entity’s
stock
Exception: Certain types of personal loans

from financial institutions who are audited
by a covered member

Could unpaid fees be considered an outstanding debt by

the entity to the auditor – a direct financial interest on
the part of the auditor?
(Stop and Think p. 646)

Could unpaid fees be considered an outstanding debt by

the entity to the auditor – a direct financial interest on
the part of the auditor?
The interpretations in Code Section 1.230 specify that if

fees pertaining to services provided more than one year
prior to the date of the audit report remain unpaid, the
auditor’s independence is impaired with respect to that
entity. However, unpaid fees from an audited entity
that is in bankruptcy do not impair the auditor’s
independence.
(Stop and Think p. 646)

Prohibited Business Relationships

Independence Rule and relevant interpretations
essentially indicate that the independence of a
CPA is impaired if the CPA performs a managerial
or other significant role for an entity’s
organization during the time period covered by an
attest engagement.
Interpretations indicate that a firm’s
independence will be considered to be
impaired with respect to an entity if a
partner or professional employee leaves the
firm and is subsequently employed by or
associated with that entity in a key position
unless a number of conditions are met.
Effect of Family Relationships

(1 of 2)
A covered member’s immediate family

(spouse, spousal equivalent, or
dependent, regardless of whether the
dependent is related) is subject to the
Independence Rule and its interpretations.

Effect of Family Relationships

(2 of 2)
Close relatives include nondependent children, brothers,
sisters, parents, grandparents, parents-in-law, and their
respective spouses.
Two major situations with close relatives that can

impair independence:
1. A close relative has a financial interest in the entity
that is material to the close relative, and the CPA
participating in the engagement is aware of the interest.
2. An individual participating in the engagement has a
close relative who could exercise significant influence
over the financial or accounting policies of the entity.

Effect of Actual or Threatened

Litigation
The commencement of litigation by management
alleging deficiencies in audit work for the entity would
be considered to impair independence.
An expressed intention by management to commence

litigation against the CPA alleging deficiencies in audit
work would also impair independence if the auditor
concluded that it is probable that such a claim will be
filed.
The commencement of litigation by the CPA against

management alleging management fraud or deceit
would be considered to impair independence.

Provision of Nonattest Services
The AICPA Code of Professional Conduct

restricts the types of nonaudit services
that can be provided to attest entities.
The SEC has even more restrictive

independence rules for audits of public
companies.

SEC and PCAOB Independence Requirements

for Audits of Public Companies (1 of 3)
The SEC’s rules are predicated on four basic principles

of auditor objectivity and independence:
1. An auditor should not audit his or her own work.
2. An auditor should not function in the role of
management.
3. An auditor should not serve in an advocacy role
for the entity.
4. An auditor should not have a mutual or
conflicting interest with an audit client.


Nine Categories of Prohibited Nonaudit Services
Financial
Information Appraisal or
Bookkeeping Systems Design Valuation
and Services
Implementation
Management
Internal Audit
Actuarial Functions or
Outsourcing
Services Human
Services
Resources
Broker or Expert
Legal Services
Dealer Services


Lead and engagement review partners are limited to
five consecutive years.
A one year “cooling off” period is required for

employees in a “financial reporting oversight role” who
previously worked with the CPA firm performing the
audit.
A firm is not independent if an audit partner’s

compensation is based on selling engagements to that
client for services other than audit, review, and attest
services.

SEC Required Communications for

Audits of Public Companies
SEC rules require additional communication

between auditors and their entities’ audit
committees and require public-company audit
entities to reveal information regarding the fees
(audit and otherwise) paid to their auditors.

General Standards and Compliance

with Standards (1 of 2)
General Standards Rule
A member shall comply with the following standards and
with any interpretations thereof by bodies designated by
Council.
Due
Professional
Professional
Competence
Care
Sufficient
Planning and
Relevant
Supervision
Data

General Standards and Compliance

with Standards (2 of 2)
Compliance with Standards Rules
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 is important because it requires that

members of the AICPA comply with professional
standards when performing professional
services, whether or not they are practicing in
public accounting.

Accounting Principles
Accounting Principles Rule
A member shall not:
1. Express an opinion or state affirmatively that the
financial statements or other financial data of any entity
are presented in conformity with GAAP 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 GAAP
if such statements or data contain any departure from an
accounting principle promulgated by bodies designated by
Council to establish such principles that has a material
effect on the statements or data taken as a whole.

Confidential Client Information

Confidential Client Information Rule
A member in public practice shall not disclose any confidential
information without the specific consent of the client.
Five Situations Where CPAs Can Disclose Confidential Information
To meet GAAP
To comply with
or GAAS
a valid
disclosure
subpoena
requirements
To allow a
As required by As part of an
review for the
an authorized investigative
purchase, sale,
peer review or disciplinary
or merger of
body proceeding
the practice*
*In the last case, the CPA should take precautions that the prospective buyer does not disclose
any confidential entity information to outside parties.

Contingent Fees
Contingent Fees Rule
A member shall not:
1. Perform for a contingent fee any professional service
for, or receive such a fee from, a client whom the
member or the member’s firm performs:
a. An audit or review of a financial statement
b. A compilation of a financial statement expected to be used
by a third party if the compilation report does not disclose
a lack of independence
c. An examination of prospective financial information
2. Prepare an original or amended tax return or claim for a
tax refund for a contingent fee for any client

Commissions and Referral Fees (1 of 2)
Commission and Referral Fees Rule

Prohibited Commissions: A member in public practice shall not for a
commission recommend or refer to a client any product or service or
receive a commission, when a member or the member’s firm also
performs for that client:
a. an audit or review of financial statements,
b. a compilation of financial statements expected to be used by a
third party and the compilation report does not disclose a lack of
independence
c. an examination of prospective financial information
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.

Commissions and Referral Fees (2 of 2)
Commission and Referral Fees Rule

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.

Acts Discreditable (1 of 2)
Acts Discreditable Rule

A member shall not commit an act discreditable
to the profession.

Acts Discreditable (2 of 2)
• Discrimination and harassment in employment practices
• Solicitation or disclosure of CPA Examination questions and
answers
• Failure to file a tax return or pay a tax liability
• Negligence in the preparation of financial statements or records
• Failure to follow requirements of governmental bodies,
commissions, or other regulatory agencies
• Confidential information obtained from employment or volunteer
activities
• False, misleading, or deceptive acts in promoting or marketing
professional services
• Improper use of the CPA credential
• Failure to comply with records requests

Advertising and Other Forms of

Solicitation
Advertising and Other Forms of Solicitation
Rule
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.

Prohibited Advertising
• Creating false or unjustifiable expectations of favorable
results.
• Implying an ability to influence any court, tribunal,

regulatory agency, or similar body or official.
• Claiming that specific professional services in current or

future periods will be performed for a stated fee, estimated
fee, or fee range when it is likely at the time of
representation that such fees will be substantially increased
and the prospective entity is not advised of that likelihood.
• Making any other representations that would be likely to

cause a reasonable person to misunderstand or be
deceived.

Form of Organization and Name

Form of Organization and Name Rule
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
partners 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.

Disciplinary Actions
The Professional Ethics Executive Committee (PEEC)

can direct a member to take remedial or corrective
actions.
AICPA
Termination of Trial Suspend AICPA
AICPA Board Membership
Membership Actions

Without the consent of the entity, a CPA should not disclose

confidential entity information contained in working papers to
a(n):
A. Authorized quality control review board

B. Successor CPA firm that has been engaged to audit the
former audit entity
C. Federal court that has issued a valid subpoena
D. Disciplinary body created under state statute
(MC Question 19-24)

Without the consent of the entity, a CPA should not disclose

confidential entity information contained in working papers to
a(n):
A. Authorized quality control review board

B. Successor CPA firm that has been engaged to audit
the former audit entity
C. Federal court that has issued a valid subpoena
D. Disciplinary body created under state statute
(MC Question 19-24)

Quality Control Standards
CPA firms are required to implement policies and

procedures to monitor the firms’ practices and ensure that
professional standards are being followed.
In 2004, PCAOB assumed the AICPA’s responsibilities

relating to firms that audit public companies and instituted
a mandatory quality inspection program for those firms.
The AICPA continues to administer a quality review system

in order to enable firms to meet their state licensing,
federal regulatory, and AICPA membership requirements
and to serve firms that audit only privately held clients.

Elements of Quality Control
Acceptance
Relevant
Leadership: and
Ethical
Tone at the Top Continuance of
Requirements
Relationships
Human Engagement
Monitoring
Resources Performance

PCAOB Inspections of Registered

Public Accounting Firms
The PCAOB conducts regular inspections of

public accounting firms that are required
to register with the Board.


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Auditing and Assurance Services

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution

Ethics and Professional Conduct

Refers to a system or code of

Refers to the conduct, aims, or

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution

Theories of Ethical Behavior

Recognizes that decision making involves

Rights-Based Assumes that individuals have certain rights

Justice-Based Is concerned with issues such as equity,

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution

FIGURE 19-1 Relevant Professional Standards for

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution

The AICPA Code of Professional Conduct:

Principles of Professional Conduct

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution

FIGURE 19-2 Code of Professional Conduct

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution

TABLE 19-1 Principles of Professional Conduct

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution

Overview of Part 1 AICPA Rules of Conduct (Table 19-2) (1 of 4)

1.200.001 Independence A member in public practice shall be independent in the performance

1.310.001 Compliance A member who performs auditing, review, compilation, management

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution

Overview of Part 1 AICPA Rules of Conduct (Table 19-2) (2 of 4)

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution

Overview of Part 1 AICPA Rules of Conduct (Table 19-2) (3 of 4)

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution

Overview of Part 1 AICPA Rules of Conduct (Table 19-2) (4 of 4)

1.800.001 Form of A member may practice public accounting only in a form of

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution

Which of the following statements best explains why public

A. Vigorous enforcement of an established code of ethics is the bes way to

(MC Question 19-14)

Which of the following statements best explains why public

A. Vigorous enforcement of an established code of ethics is the bes way to

(MC Question 19-14)

Integrity and Objectivity

Integrity and Objectivity Rule

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution

Interpretation of the Independence Rule

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution

Prohibited Financial Relationships

A financial interest that is owned

May result when a covered member

Exception: Certain types of personal loans

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution

Could unpaid fees be considered an outstanding debt by

(Stop and Think p. 646)

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution

Could unpaid fees be considered an outstanding debt by

The interpretations in Code Section 1.230 specify that if

(Stop and Think p. 646)

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution

Prohibited Business Relationships

Effect of Family Relationships

A covered member’s immediate family

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution

Effect of Family Relationships

Two major situations with close relatives that can

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution