19-1
McGraw-Hill/Irwin
Chapter 19
CHAPTER 19
INDEPENDENCE,
PROFESSIONAL CONTDUCT,
AND QUALITY CONTROL
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
19-2
SEC RULES ON AUDITOR
INDEPENDENCE

Rule 2-01 stipulates that auditors must be independent
of their audit clients both in fact and appearance

Independence is impaired if the service:
 Creates a mutual or conflicting interest between the
accountant and the audit client
 Places the accountant in the position of auditing his
or her own work
 Results in the accountant acting as management or
an employee of the audit client
 Places the accountant in a position of being an
advocate for the audit client
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
19-3
SEC RULES ON AUDITOR
INDEPENDENCE

Financial and employment relationships:

Revised rules focus on people who can influence the
audit and not all partners in the CPA firm

Similar to the revised AIPCA rules
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
19-4
SEC RULES ON AUDITOR
INDEPENDENCE

Nonaudit Services – Following are prohibited or limited:
 Bookkeeping
 Certain types of financial information systems design
and implementation
 Appraisal or valuation services and fairness opinions
 Actuarial services to insurance companies
 Management functions
 Human resource services
 Broker-dealer services
 Legal services
 Internal audit services
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
19-5
SEC RULES ON AUDITOR
INDEPENDENCE

Disclosure of Nonaudit Services - Disclose in its proxy
statement the following information:

Fees billed for services provided by the CPA
Audit
fees
IT systems design and implementation fees
All other fees

McGraw-Hill/Irwin
Audit committee consideration of services
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
19-6
PARTS OF THE CODE OF
PROFESSIONAL CONDUCT


McGraw-Hill/Irwin
AICPA Code of Professional Conduct consists of:

Principles of Professional Conduct

Rules of Conduct
Additional guidance for applying Rules of Conduct

Interpretations of Rules of Conduct

Ethics Rulings by the Professional Ethics
Executive Committee
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
19-7
PRINCIPLES OF
PROFESSIONAL CONDUCT

Responsibilities:

The public interest:

Integrity:

Objectivity and independence:

Due care:

Scope and nature of services:
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
19-8
Key Definitions

Close Relative: Parent, sibling or nondependent child

Covered Member:
 Individual on the attest engagement team
 Individual in a position to influence the engagement
 Partner or Manager who provides > 10 hours of
nonattest services to the attest client
 Partner in the office where the lead engagement
partner practices
 The firm, including the firm’s employee benefit plan
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
19-9
Key Definitions

Holding Out: Action that informs others of CPA status

Immediate Family: Spouse (or equivalent) & dependent

Key Position: Individual who has primary responsibility
for significant accounting functions; preparation of the
financial statements; or exercise influence over the f/s

Practice of Public Accounting: Performance for a client
of accounting, tax, financial planning, litigation support
services, etc.
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
19-10
ORGANIZATION OF THE
RULES OF CONDUCT





McGraw-Hill/Irwin
Independence, Integrity, and Objectivity
General Standards and Accounting Principles
Responsibilities to Clients
Responsibilities to Colleagues
Other Responsibilities and Practices
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
19-11
INDEPENDENCE
RULE 101
A member in public practice shall be independent in
the performance of professional services as required
by standards promulgated by bodies designated by
Council.
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
19-12
INDEPENDENCE

Revised rules are focused on a “covered member”
and takes an engagement team approach

Independence is examined along two dimensions:
 Financial interests: Prohibits members from any
direct or material, indirect financial interest in the
client.

McGraw-Hill/Irwin
Managerial interests: Generally prohibits a CPA
from performing a managerial role within a
client’s organization. (some exceptions: e.g.
member who serves as honorary director)
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
19-13
INDEPENDENCE


McGraw-Hill/Irwin
Independence can be affected by:

Family relationships: Distinction between
close relatives and immediate family.
Immediate family is subject to Rule 101 but
close relatives generally are not (with a few
exceptions)

Effect of actual or threatened litigation:
threatened or actual litigation (1) between the
client and CPA; (2) by the shareholders; (3)
other 3rd parties may affect candor
See Table 19-5
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
19-14
INTEGRITY AND OBJECTIVITY
RULE 102
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.
Example: A member who knowingly makes false or
misleading entries in f/s violates this Rule.
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
19-15
GENERAL STANDARDS AND
ACCOUNTING PRINCIPLES
RULE 201
A member shall comply with the following standards
and with any interpretations thereof:
Professional
Due
Professional Care
Planning
and Supervision
Sufficient
McGraw-Hill/Irwin
Competence
Relevant Data
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
19-16
GENERAL STANDARDS AND
ACCOUNTING PRINCIPLES
RULE 202
A member who performs auditing, review, compilation,
management consulting, tax, or other professional
services shall comply with standards promulgated by
bodies designated by Council.
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
19-17
ACCOUNTING PRINCIPLES
RULE 203
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 generally accepted accounting principles 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 generally accepted
accounting principles, 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.
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
19-18
CONFIDENTIAL CLIENT
INFORMATION
RULE 301
A member in public practice shall not disclose any
confidential client information without the specific
consent of the client.
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
19-19
SITUATIONS WHERE A CPA CAN
DISCLOSE CONFIDENTIAL CLIENT
INFORMATION

Meet disclosure requirements for GAAP and GAAS

Comply with a valid and enforceable subpoena

Required by an authorized peer review

Part of an investigative or disciplinary proceeding
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
19-20
CONTINGENT FEES
RULE 302
A member in public practice shall not:
(1) Perform for a contingent fee any professional
services for, or receive such a fee from a client for whom
the member or the member's firm performs
(a) an audit or review of financial statements; or
(b) a compilation of a financial statement when the
member expects, or reasonably might expect, that a
third party will use the financial statement and the
member's compilation report does not disclose a lack of
independence; or
(c) an examination of prospective financial
information; or
(2) Prepare an original or amended tax return or claim
for a tax refund for a contingent fee for any client.
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
19-21
DISCREDITABLE ACTS
RULE 501
A member shall not commit an act discreditable to
the profession.
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
19-22
ACTS DISCREDITABLE
UNDER RULE 501

Retention of client records (e.g. journals or ledgers)

Discrimination and harassment in employment
practices

Failure to follow standards and/or procedures or
other requirements in governmental audits

Negligence in the preparation of financial statements
or records
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
19-23
ACTS DISCREDITABLE
UNDER RULE 501 (continued)

Failure to follow requirements of governmental
bodies, commissions, or other regulatory agencies in
performing attest or similar services

Solicitation or disclosure of CPA examination
questions and answers

Failure to file tax return or pay tax liability
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
19-24
ADVERTISING AND OTHER FORMS
OF SOLICITATION
RULE 502
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.
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
19-25
EXAMPLES OF FALSE, MISLEADING
OR DECEPTIVE ADVERTISING

Create false expectations of favorable results

Imply the ability to influence any court, tribunal,
regulatory agency, or similar body or official

Representation 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 that such
fees would be substantially increased and the prospective
client was not advised of that likelihood

Other representations that would be likely to cause a
reasonable person to misunderstand or be deceived
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
19-26
COMMISSIONS AND REFERRAL FEES
RULE 503
Prohibited commissions when a member or the
member's firm also performs for that client
 an audit or review of financial statements; or
 a compilation of a financial statement when the
member expects, or reasonably might expect,
that a third party will use the financial
statement and the member's compilation report
does not disclose a lack of independence; or
 an examination of prospective financial
information
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
19-27
FORM OF ORGANIZATION AND
NAME
RULE 505
Requires that a member may practice public
accounting only in the form of organization
permitted by state law or regulation whose
characteristics conform to resolutions of Council.
A member shall not practice public accounting under
a firm name that is misleading.
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
19-28
QUALITY CONTROL
A system of quality control for a firm encompasses
the firm's organizational structure and policies
adopted and procedures established to provide the
firm with reasonable assurance of conforming with
professional standards
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.