Chapter 4

Professional Ethics

Key objectives:

3. Explain why ethics is so important to the accounting profession.

4. Describe the purpose and content of the AICPA Code of Professional
Conduct.
5. Understand Sarbanes–Oxley and other SEC independence requirements
and other factors that influence auditor independence.
6. Apply the AICPA Code rules and interpretations on independence.
7. Know the code rules on confidentiality and contingent fees. Understand
the rules on advertising and solicitation, and how changes in these rules
have affected competition in the profession.

1. Importance of ethics to CPA Profession

Why is ethics so important for CPAs?

(Discussion)

The need for public confidence in auditors is

especially great because even though auditors
are hired by the client, users are the primary
beneficiaries. This "two masters" nature of
accounting is much different than other
professions. We sell integrity.

What are the alternatives? (Discussion)

We historically have been a highly regarded

profession in terms of ethics, although recent
events have at least temporarily hurt the
reputation of the profession.

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2. Individual Ethical Issues

• Discussion of case on p. 80-82 of text

relating to auditor responses to time pressure.
(Discussion)

• Discussion of Leigh Ann Walker Case

(Discussion)

3. AICPA Code of Professional Conduct - The

AICPA code consists of four elements:

Principles ⋅ Ideal standards

⋅ Not enforceable
Rules of ⋅ Specific rules of
Conduct minimum conduct
⋅ Enforceable
Interpretati ⋅ Interpret rules
ons ⋅ Not enforceable, but
must
justify departure
Ethical ⋅ Published
Rulings explanations
⋅ Not enforceable, but
must
justify departure

4. Independence - Independence is regarded as

the cornerstone of the profession. Auditors should
be independent in fact and appearance.

As a result of the increase in stock ownership in

the United States and the growth of consulting
services, the SEC significantly revised it rules on
independence in 2000. As a result of the SEC's

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 actions, the AICPA adopted similar revisions to its
interpretations of the rules on independence. The
SEC added some additional restrictions as a
result of the Sarbanes-Oxley Act.

AICPA Rule 101 on independence - Member in

public practice shall be independent in
providing professional services.

• Applies only to attestation engagements

when the AICPA has established
independence requirements through rule-
setting bodies, such as the Auditing Standards
Board.

A. Covered Members – Rules apply to individuals

on the attest engagement team and others in a
position to influence the engagement.

1. Individuals on engagement
2. Individuals in a position to influence the
engagement, such as people who
supervise the engagement partner
3. Partners or managers who provide
nonattest services to the client
4. Partners in the office of the partner
responsible for the engagement

B. Financial interests

1. Direct interests - not allowed by the

covered memmber or immediate family
members.

2. No material indirect interests.

Materiality is based on individual's wealth
and income. Indirect interests include
mutual funds, non-immediate family
members, etc.

3. Partners versus staff - Rules always

apply to partners and shareholders in CPA
firm. Rules only apply to staff if on the
engagement or in the office that performs
the engagement.

Rules for Financial Interests

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 Covered Members Others
Direct Not allowed Allowed
Interest
Indirect Allowed if immaterial Allowed
Interest

Note: Rules apply to member and immediate family

(spouse, children, and relatives living with or
supported by the CPA)

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 C. Bookkeeping - Allowed by AICPA for private
companies. (SEC does not allow for public
companies.) The critical distinction is that the
CPA merely function in a clerical/advisory
capacity, not as management.

D. Miscellaneous
1. Non-payment of fees. CPA is not
independent if material portion of prior year
audit fee is unpaid.
2. Borrowing between client and auditor is
prohibited, except for immaterial amounts
in the normal course of business.
3. Directorships - not allowed to serve as a director
of a client, except in an honorary role for a non-profit
organization.

5. Sarbanes-Oxley Provisions

A. SEC Principles
1. An auditor cannot function as management
2. An auditor cannot audit his or her own work
3. An auditor cannot serve as an advocate for the
client

B. Consulting – Sarbanes-Oxley expands existing

SEC prohibitions. Auditors of public companies are
prohibited from IT consulting, internal audit
outsourcing, and several other services.
• Allowable services must be pre-approved by the
audit committee
• Fees for audit and non-audit services must be
disclosed.

Note that auditors are not restricted from

providing non-audit services to private
companies, and public companies that are not
audit clients.

C. Employment – There is a one year “cooling-off”

period before an audit team member can accept
employment in a key management position.

D. Partner Rotation – Lead and concurring partner

must rotate off the audit of a public company after 5
years.

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7. Other Rules of Conduct

A. Integrity and Objectivity (Rule 102) - Auditor

must not subordinate his/her judgment to others,
even supervisors such as managers and partners.

B. Confidential information (Rule 301) - Client

information is confidential.

Audit files are confidential. Need client

permission (including required communication
between successor and predecessor auditor),
except for:
1. Subpoena or summons. Client - CPA relation is
not privileged.
2. Peer review
3. Response to ethics division.

C. Contingent fees (Rule 302) and Commissions

(Rule 503)

In general, it is sufficient to know that these

activities are allowed, except for most audit
and attest clients.

Both contingent fees and commissions were

previously prohibited. These are now allowed as
the result of a consent agreement between the
AICPA and the FTC (Federal Trade Commission).
The existence of the commission must be
disclosed to the client.

D. Advertising (Rule 502) - Advertising is allowed,

as long as it is not false or deceptive. Many of
the Big 4 advertise on national TV - primarily for
consulting services.

E. Form of Organization - Prior to 1994, all owners

had to be CPAs. Now up to 50 percent of the
owners can be non-CPAs.
A recent development has been the acquisition of
CPA firms by corporate entities, such as H&R
Block and American Express. These alternative

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 practice structures are permissible, as long as
CPAs remain responsible for any attest work
performed.

Chapter 4

Discussion Case – Leigh Ann Walker

Homework Problems
4-20
4-21

Problem 4-20 Violation?

a. Bookkeeping for public company Yes
b. Internal audit for non-audit client No
c. IT consulting for a private company No
d. Recommend tax shelter No *
e. Provide internal audit to public audit client Yes
f. Bookkeeping for a private company No

* Potential for violation.

Problem 4-21
Rule Violation Explanation
s ?
a. 101 No Martinez is not a covered member.
violation
b. 201 Violation Engagement acceptance implies having the necessary
competence to complete the engagement.
c. 102 Violation You can resolve doubt in favor of the client with
reasonable support. The client did not provide any
support for the tax deductions.
d. 203 Violation Statements claimed to follow international standards but
these were not used in preparing the financial reports.
e. 101 Violation The recommendation of his insurance agency may impair
102 independence. Also a conflict of interest to recommend
own firm to perform the insurance review.
f. 301 Violation Firm needs client permission for the audit file review,
because it is not part of an AICPA peer review.
g. 501 No The arrest likely involves a civil, not a criminal action.
violation
h. 101 No These services are allowed for non-SEC clients, as long

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violation as the CPA does not make management decisions.

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