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Module B

Professional Ethics

“I have gained this by philosophy: That I do without being commanded what others do only from fear of the Law.”

- Aristotle

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B-2

Module Topics

• General Ethics

• Philosophical Principles in Ethics

• Independence and Integrity Rules and Issues

• Rules of Conduct

• Regulation and Quality Control

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B-3

General Ethics

• Ethics that branch of philosophy which is the systematic study

of reflective choice, of the standards of right and wrong by which it is to be guided, and of the goods toward which it may ultimately be directed.

- Wheelwright, 1959

• Key elements– Decision problems– Moral principles– Consequences

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B-4

Philosophical Principles in Ethics

• The Imperative Principle (Kant)

• The Principle of Utilitarianism– Rule Utilitarianism

• The Generalization Argument

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B-5

An Ethical Decision Process

• Define all facts and circumstances

• Identify stakeholders.

• Identify stakeholders’ rights and obligations in general and to each other.

• Identify alternatives and consequences

• Choose superior alternative with respect to consequences and/or rules.

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B-6

PrinciplesBasic tenets of ethical conduct• Responsibilities - exercise sensitive professional and moral

judgment• Public Interest - honor the public trust• Integrity - perform responsibilities with the highest sense of

integrity• Objectivity - impartial, unbiased, and independence. Free

of conflicts of interest and independent in fact and appearance”

• Due care - diligence, competence, thorough, prompt• Scope and nature of services - observe the principles when

considering the scope and nature of services provided.

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B-7

Code of Professional Conduct • Ideal standards of ethical conduct

• Minimum standards of ethical conduct stated as specific rules

• Interpretations of the rules by the AICPA division of professional ethics

• Published explanations and answers to questions about rules of Conduct

Principles

Rules of Conduct

Interpretations

Ethical Rulings

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B-8

RULES and INTERPRETATIONS

– Rules of Conduct (ENFORCEABLE)

– Interpretations (ENFORCEABLE) and Ethics Rulings

– Authority is derived from the BY-LAWS of the AICPA

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RULES OF CONDUCTRule 101 - 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

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B-10

Independence• SEC

– Financial employment relationships– Nonaudit services– Disclosures about fees– Independence Standards Board (ISB)

• ISB 1: Independence discussions with Audit Committees• ISB 2: Certain Independence Implications of Audits of Mutual Funds

and Related Entities• ISB 3: Employment with Audit Clients

• PCAOB• AICPA

– AICPA Code of Professional Conduct Rule 101

• Government Independence Standards

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B-11

Non Audit Services Prohibited by SEC

• Bookkeeping or accounting records.

• Appraisal or valuation

• Internal audit

• Human resources

• Legal services

• Financial information systems

• Actuarial services• Management

functions• Broker-dealer• Expert services

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B-12

RULES OF CONDUCTRule 101 - Independence

• Applies to attestation engagements (audits and reviews). • Financial Relationships

– No DIRECT financial interest– No MATERIAL INDIRECT financial interests– No MATERIAL JOINT VENTURES with client, officers, directors, or

shareholders– No LOANS – (except normal lending practices, collateral required)

• Managerial Relationships– Cannot act as a PROMOTER, UNDERWRITER, or equivalent to an

employee (DECISION-MAKING)

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B-13

Who is a Member?

A member is (AICPA)• All individuals participating in an engagement• An individual in a position to influence the engagement• A partner or manager who provides nonattest services to an

attest client.• A partner in the office where engagement partner practices• The firm’s benefit plan• An entity that can be controlled by any person considered a

member

Note: SEC calls them “covered members”

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B-14

RULES OF CONDUCTRule 101 - Independence

A member cannot • Have a direct financial interest in a client• Have a materially indirect financial interest in a client• Be a trustee or executor if the trust or estate had a direct or

material indirect interest in a client• Have a joint investment with a client, officer, or stockholder

that was material• Be a promoter, underwriter, voting trustee, director, officer or

employee • Be a trustee of any pension or profit sharing trust of the client

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B-15

RULES OF CONDUCTRule 101 - Independence

For the purpose of independence • Immediate family members have the same restrictions as

the member– Spouse, spousal equivalent, or dependent cannot have

• A direct financial interest• A material indirect financial interest• Hold a position of influence with an audit client

• Close relative– All immediate family members and parents, siblings, or

nondependent child cannot• Ownership or control of an audit client• Employment with a client in an audit sensitive position

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B-16RULES OF CONDUCTRule 101 - Independence

Write-up services are allowed if• Client understands and accepts the statements as their own

• Auditor does not assume a role of employee or management

• No other relationship that impairs integrity and objectivity

Exception: Cannot do write-up services for SEC clients

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B-17

RULES OF CONDUCTRule 101 - Independence

Loans from financial institutions are permitted

1) Obtained prior to 2/5/01 under old rules

2) Obtained prior to the lender becoming a client

3) Loan was sold to an attest client

4) Loan was obtained before the CPA became a member

5) Loans on life insurance

6) Fully collateralized by cash deposits, loans, leases, etc.

7) Credit cards and cash advances less then $5000

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B-18

RULES OF CONDUCTRule 101 - Independence

Threatened litigation impairs independence if

management and the auditors are suing each other

Lawsuits from third-parties do not effect independence

Management Auditor

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B-19RULES OF CONDUCTRule 101 - Independence

Financial interest in a nonclient may impair

independence when the nonclient has a financial

interest in the client

Auditor Nonclient ClientOwns Owns

Audit

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B-20

Employment with a client

• SEC—One year “cooling off” period

• AICPA—report conversations– Remove from engagement– Review work– If employee accepts position

• Additional review of next engagement

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B-21

RULES OF CONDUCTRule 102 – Integrity and Objectivity

• Free of conflicts of interest– A conflict of interest may exist when there is a significant

relationship with a person, entity, product, or service that could be viewed as impairing the members objectivity

• Not knowingly misrepresent facts • Do not subordinate judgments to others. • Cannot knowingly make false or misleading entries in

an entities financial records.

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B-22RULES OF CONDUCT

Rule 102 – Integrity and Objectivity

If disagreements concerning the preparation of financial statements or the recording of transactions exist

• Take the supervisor’s position if acceptable

• Report to higher level if supervisors position is not acceptable

• Consider resigning if upper management will not take appropriate action.

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B-23

RULES OF CONDUCTRule 201 – General Standards

• Following professional standards and interpretations • Perform only those services that can be completed

with professional competence• Exercise due professional care• Adequately plan and supervise all engagements• Obtain sufficient relevant data to afford a reasonable

basis for all conclusions and recommendations

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B-24

RULES OF CONDUCTRule 201 – General Standards

Professional competence

1) Technical qualifications of a professional

2) Ability to supervise and evaluate work

3) Knowledge of all technical subject matter

4) Ability to exercise judgment

5) Ability to research and consult

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B-25

RULES OF CONDUCTRule 301 - Confidentiality of Client Information

• A CPA cannot disclose confidential information without client's consent

• Exceptions:– To remain in compliance with standards– If workpapers are subpoenaed by court– As part of a peer or quality review of practice– As part of an ethics violation for state board of

accountancy investigation.

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B-26

RULES OF CONDUCTRule 302 - Contingent Fees

Fees based on a particular FINDING or OUTCOME• Not permitted for ATTEST ENGAGEMENTS• Not contingent if:

– Fixed by courts– Based on HOURS WORKED or SERVICES

PROVIDED

• Allowed for NON-ATTEST (Tax, Consulting, Expert Witness) engagements

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B-27RULES OF CONDUCT

Rule 501 - ACTS DISCREDITABLE

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

• Discrimination

• Failure to follow Gov. Standards on a Gov. audit

• Making false or misleading journal entries

• Failure to met requirements of a Gov. body, commission, or regulatory body

• Disclosure of CPA examination questions or answer

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B-28

RULES OF CONDUCTRule 502 -Advertising

• Advertising and solicitation of new clients is permitted

• Advertising: Cannot be “False, Misleading, or Deceptive” – Cannot create False or Unjustified Expectations

of Favorable Results– Cannot State Ability to Influence Third Parties– Cannot Underestimate Fees

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B-29

RULES OF CONDUCTRule 503 - COMMISSIONS AND REFERRALS

• COMMISSIONS: recommending the products or services of clients or third parties (non-CPA)– permitted for non-attest, if disclosed– prohibited for attest engagements

• REFERRALS: recommending the services of

CPAs– permitted for any engagement, if disclosed

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B-30

RULES OF CONDUCTRule 505 - Form of Organization and Name

• A firm can practice in any form permitted by state including:– Limited Liability Partnership (LLP)– Limited Liability Corporation (LLC)

• Name should not be misleading

• All partners must be CPAs or members

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B-31

Regulation and Quality Control

• Self-Regulatory Discipline– AICPA– State Societies of CPAs

• Public Regulation Discipline– State Board of Accountancy– SEC– IRS

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B-32

ENFORCEMENT OF THE CODE OF CONDUCT

Settlement OfferAcquittal

Complaint Preliminary Ethics Letter of Admonishment

Received Investigation Committee Corrective Continuing Action Education

Trial Disposition Board

(acquit, admonish, suspend, expulsion)