Chapter 03

Professional
Ethics

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Steps in Resolving an Ethical Dilemma

• Identify the problem

• Identify possible courses of action
• Identify any constraints relating to the decision
• Analyze the likely effects of the possible courses of action
• Select the best course of action

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Ethical Dilemma

Gary Watson, a graduating business student at a small college, is

currently interviewing for a job. Gary was invited by both Tilly
Manufacturing Co. and Watson Supply Company to travel to a nearby
city for an interview. Both companies have offered to pay Gary’s
expenses. His total expenses for the trip were $96 for mileage on his
car and $45 for meals. As he prepares the letters requesting
reimbursement, he is considering asking for the total amount of the
expenses from both employers. His rationale is that if he had taken
separate trips, each employer would have had to pay that amount.

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Need for Professional Ethics

• Responsibility to serve the public

• CPA is representative of the public
• Complex body of knowledge
• Abundance of authoritative pronouncements
• Standards of Admission to the Profession
• Minimum standards for education and experience
• Need for public confidence
• CPA product is credibility

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 Code of Professional Conduct

• Designed to provide CPAs guidance and rules in the performance of

professional responsibilities
• Code consists of
• Principles
• Rules
• Interpretations
• Other guidance (definitions, pending revisions, etc.)

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AICPA Code of Professional Conduct
Figure 3.1

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AICPA Code of Professional Conduct
Figure 3.2

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 Conceptual Frameworks
• Purpose—Address situations not directly included in the Code of
Professional Conduct

• Overall approach—Consider the threats to compliance with requirements

and available safeguards

• Code includes 3 conceptual frameworks

• For CPAs in public practice
1. Threats to code compliance
2. Threats to independence
• CPAs in business
3. Threats to code compliance

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Conceptual Framework Threats

• Adverse Interest—client litigation against CPA

• Advocacy Threat—CPA endorses a client product
• Familiarity—CPA’s close friend employed by client
• Management Participation—CPA authorizes a client transaction
• Self-Interest—CPA has financial interest in client
• Self-Review—CPA makes accounting decisions for client
• Undue Influence—CPA and firm threatened with dismissal from an
engagement

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 Conceptual Framework Safeguards
• Created by profession, legislation, or regulation—continuing education
requirements for independence and ethics

• Implemented by the client—client tone at the top

• Implemented by the firm—policies and procedures designed to implement

and monitor engagement quality control

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Conceptual Framework
Figure 3.5

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 Principles of the Code

• Responsibilities
• The Public Interest
• Integrity
• Objectivity and Independence
• Due Care
• Scope and Nature of Services

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 The Rules of the AICPA Code of
Professional Conduct
RULES*
• Independence
• Integrity and Objectivity
• General Standards
• Compliance with Standards
• Accounting Principles
• Acts Discreditable
• Contingent Fees
• Commissions and Referral Fees
• Advertising and Other Forms of Solicitation
• Confidential Client Information
• Form of Organization and Name

* In order discussed in text (Integrity and Objectivity precedes independence in Code).

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 Independence

• Independence of mind (actual independence)

• Independence of appearance
• Both are required

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AICPA Conceptual Framework
for Independence
• The AICPA Conceptual Framework for Independence is
used to evaluate threats to independence. As with the
earlier presented framework for the code, the approach
considers:
• Whether the Code directly addresses the threat
• If the Code does not directly address the threat, the auditor
considers whether adequate safeguards exist to eliminate the
threat to independence
• The perspective used throughout is whether a
reasonable person, aware of all the relevant facts would
conclude that an unacceptable risk of lack of
independence exists

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 Threats to Independence

• Adverse Interest— Litigation between client and CPA firm

• Advocacy of client—CPA promotes client securities as part of an
initial public offering
• Familiarity—Spouse holds a key position with client
• Financial Self-Interest of CPA—CPA owns stock in the client
• Management Participation—CPA Serves as officer of client
• Self-Review—CPA firm has provided consulting services that relate to
financial statements
• Undue Influence--Pressure from client to reduce audit procedures

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Independence Safeguards
• Created by profession, legislation, or regulation—continuing education
requirements

• Implemented by attest client—effective board of director oversight

• Implemented by CPA firm—stressing importance of independence in training

programs

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Summary of Conceptual Framework Approach for
Evaluating Threats to Independence Figure 3.7

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 Individual vs. Firm Independence and
Covered Members
Individual vs. Firm Independence
Not all individuals must be independent
The firm must be independent to perform attest services

Covered Members include:

• Staff working on the attest engagement
• An individual who may influence the attest engagement
• A partner in the office in which the partner in charge of the attest
engagement primarily practices
• Partners or managers that provide a specified amount of nonattest services
to client
• The public accounting firm and its employee benefit plan
• Any entity controlled by one or more of the above

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 Independence Requirements for All
Partners and Staff
• No partner or professional employee may own more than 5% of attest
client’s outstanding equity securities
• Combination of all such persons may not own more than 5%
• No partner or professional employee may be a director, officer, employee,
promoter, trustee, etc. of a client

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Additional Independence
Requirements for Covered Members

• All direct financial interests are prohibited, regardless of amount

• Material indirect financial interests are prohibited
• Gifts from clients or management may impair independence

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 Additional Financial Interest Independence
Requirements for Covered Members
Direct Financial Indirect
Interest Financial
Interest
Example Investment in client, Investment in a
such as owning mutual fund, which
capital stock or in turns owns
providing a loan capital stock of a
client
Type allowed
for individual None Immaterial
CPA to retain
independence
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Effects of CPA Relationships on Firm
Independence Figure 3.9

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Effects of Interests of Family Members,
Relatives and Friends Figure* 3.10

*Summary omits consideration of certain detailed factors that may affect independence. Consult independence rule and its
interpretations for a detailed consideration of the effect on independence of family members and relatives.

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 Key Position
An individual that
• Has primary responsibility for significant accounting functions that support
material components of the financial statements;
• Has primary responsibility for the preparation of the financial statements;
or
• Has the ability to exercise influence over the contents of the financial
statements, including being a member of the board, chief executive officer,
president, chief financial officer, chief operating officer, general counsel,
chief accounting officer, controller, director of
internal audit, director of financial reporting, treasurer,

etc.

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 Consulting Services Prohibited by
the Sarbanes-Oxley Act
• Bookkeeping
• Financial systems design and Implementation
• Appraisal or valuation services
• Actuarial services
• Internal audit outsourcing
• Management functions or human resource services
• Investment services
• Legal services and expert services
• Certain tax services

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 AICPA Code of Professional Conduct on
Systems Design for Attest Clients

• Services that do not impair independence:

• Relate to a system other than the financial information system.
• Relate to implementation (using vendor available settings) of commercial off-the-shelf
financial information system software where the service does not include activities such
as those listed in the following bullet.

• Services that impair independence

• Relate to modification of commercial off-the-shelf financial information system software
(e.g., design, development, customizations, the building of interfaces, or the creation of
data translation programs).
• Relate to a financial information system the CPA designs or develops.

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 Approaches for Independence
Breaches
• AICPA
• Communicate breach to appropriate firm personnel.
• Determine breach situation no longer exists.
• Evaluate significance of breach.

• SEC
• Determine act was unintentional (covered person did not know of
circumstances causing breach).
• Correct breach situation as soon as possible.
• Determine firm has appropriate quality control system related to breaches.

• PCAOB
• Determine firm is capable of exercising objective and impartial judgment.
• Determine a reasonable investor would come to same conclusion.
• Communicate to audit committee which will make similar judgements.
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Integrity and Objectivity Rule

• Applies to all members of the AICPA and to all services provided by CPAs
• Violations
• Makes, or permits or directs another to make, materially incorrect
entries in a client’s financial statements or records
• Fails to correct financial statements that are materially false or
misleading when member has such authority
• Signs, or permits or directs another to sign, a document containing
materially false and misleading information

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 General Standards Rule

• General Standards
• Apply to all CPA services
• Member shall comply with following standards:
• Professional competence
• Due Professional Care
• Planning and Supervision
• Sufficient Relevant Data

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Compliance with Standards Rule

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Accounting Principles Rule

• Accounting Principles
• Designates GAAP
• The Statements and Interpretations of
• FASB
• GASB
• FASAB

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 Acts Discreditable Rule
Retaining client records may be considered an act
discreditable to the profession
Rules:
• Client prepared records—should always be returned to the client.
• Client records prepared by the CPA (e.g. payroll records)—should be
provided to client, except they may be withheld if they are incomplete or
fees are due for them.
• Supporting records (e.g., adjusting entries)—should be provided to
client, but may be withheld if fees are due for them.
• CPA working papers (e.g., audit programs)—CPA’s property and need
not be provided to client , unless required by law.

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Contingent Fees Rule

• Allowable for clients for which the CPA provides none of the
following services:
• An audit or review of financial statements
• A compilation of financial statements expected to be used by a third party
and does not disclose a lack of independence
• An examination of prospective financial information

• Contingent fees are not allowed to prepare an original or

amended tax return or claim for tax refund (Note: All tax
contingent fees are prohibited under PCAOB Standards)

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Commissions/Referral Fees and
Advertising Rules
 Commissions and Referral Fees Rule
 As is the situation with contingent fees, such fees are
only allowed for a nonattest client
 Allowable commissions received must be disclosed to
the client
 Advertising Rule
 May advertise as long as it is not false, misleading, or
deceptive

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Confidential Client Information Rule

• A member in public practice shall not disclose any

confidential client information without the specific
consent of the client.
• Auditors cannot directly disclose illegal acts by the
client unless they have a legal duty to do so
• Confidential but not privileged communications
with client

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 Form of Organization Rule

• Form of Organization and Name

• Can practice in any legal business form
• Allows fictitious names as long as not false,
misleading, or deceptive, e.g., a sole proprietor
practicing in a partnership name

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Alternative Practice Structures
Figure 3.13

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Code of Professional Conduct:
Applicability to Members in Business
and Others
• Members in business applicable rules
• Integrity and Objectivity
• General Standards
• Compliance with Standards
• Accounting Principles
• Acts Discreditable

• Others (primarily retired CPAs) applicable rule

• Acts Discreditable

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 IIA Ethics and Professionalism
Standards

The ethics section of the IIA standards, titled

Ethics and Professionalism, includes
requirements to
• Demonstrate Integrity
• Maintain Objectivity
• Demonstrate Competency
• Exercise Due Professional Care

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