Professional Ethics
Chapter 4
4-1
Key Topics in Chapter 4
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AICPA Code of Professional Conduct
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Rule 101, Independence
Rules 301, 302, 501, 503
Sarbanes-Oxley Act and SEC Provisions Addressing
Auditor Independence
Special Need for Ethical Conduct
in Professions
Our society has attached a special meaning
to the term professional.
A professional is expected to conduct
himself or herself at a higher level
than most other members of society.
Trustworthiness and a strong sense of ethics
are assets of the CPA.
AICPA Code of Professional Conduct
Principles
Ideal standards of ethical conduct
stated in philosophical terms.
They are not enforceable.
Rules of
conduct
Minimum standards of ethical
conduct stated as specific rules.
They are enforceable.
Interpretations
of the rules
of conduct
Interpretation of the rules of conduct by
the AICPA Division of Professional Ethics.
They are not enforceable, but a
practitioner must justify departure.
AICPA Code of Professional Conduct
Ethical
rulings
Published explanations and answers
to questions about the rules of
conduct submitted to the AICPA by
practitioners and others interested
in ethical requirements.
They are not enforceable, but a
practitioner must justify departure.
Who Falls Under the AICPA Rules
of Conduct (Code)?

Technically, members of the AICPA.
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However, state and federal courts have
held that all practicing CPAs must follow
ethical standards, as set forth in the
Code of Professional Conduct.
Standards of Conduct
Ideal conduct
by practitioners
Principles
Minimum level
of conduct by
practitioners
Rules of
conduct
Substandard
conduct
Independence
The value of auditing depends heavily on the
public’s perception of the independence of auditors.
• Independence in fact, means the member
must be unbiased and objective mentally – it is
a state of mind.
•Independence in in appearance means that
knowledgeable users of financial statements
must believe the auditor is independent –
avoiding observable conflicts of interest
AICPA Rules of Conduct
Rule 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.
Financial Interests
Interpretations of Rule 101 prohibit
covered members from owning any
direct investments in audit clients.
Covered members
Direct versus indirect financial interest
Material or immaterial
Engagement Based Approach
Covered members are persons in a position with the
potential to influence audit decisions, including:
1. Individuals on engagement team.
2. Individuals who supervise or evaluate the
engagement partner.
3. Partners who provide non-attest services to the
client.
4. Refer to p. 86 of chapter for others.
Prohibited Activities by Covered
Members
Members cannot:
 Have a direct or material indirect investment in the
audit client.
 Be a director, officer, manager, or employee of the
client.
 Participate in joint business ventures with the
client.
Have loans to or from the client.
Automobile loans and leases
Collateralized loans
Credit cards and cash advances
Related Financial
Interests Issues
 Former practitioners
 Normal lending procedures
 Financial interests and employment
of immediate and close family
 Joint investor or investee
relationship with client
 Director, officer, management,
or employee of a company
Litigation Between CPA Firm
and Client
A lawsuit or intent to start a lawsuit
between a CPA firm and its client is a
violation of Rule 101 for the current audit.
Bookkeeping
The AICPA Code permits a CPA firm
to do both bookkeeping and auditing
for the same client.
• See p. 89.
• Note that SOX takes a different
position with publicly traded (SEC)
clients, p. 83.
Other Services and Unpaid Fees
Consulting and other nonaudit services
• Must avoid performing management functions
Note that SOX takes a different
position with publicly traded (SEC)
clients, p. 83
Unpaid fees
• Can cause a conflict of interest if they
relate to professional services provided
more than one year prior to the date of
the report
Rule 301 – Confidential client information
Generally, a member may not disclose any
confidential client information without the
specific consent of the client.
Exceptions:
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Obligations related to technical standards
Subpoena or summons
Peer review
Response to ethics division
Rule 302 – Contingent fees
Contingent fees for any professional services are
generally prohibited when
(1) a member (or firm) performs:
(a) an audit or review of financial statements; or
(b) a compilation of a financial statement (see text)
(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.
Rule 501 – Acts discreditable
A member shall not commit an act discreditable to the
profession, including:
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Retention of client records.
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.
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.
Rule 503 – Commissions and referral fees
Commissions are not allowed when a member or the
member's firm also performs for that client:
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An audit or review of financial statements; or
A compilation of a financial statement (see text) ; or
An examination of prospective financial information.
Disclosure of permitted commissions or referral fees.
Other AICPA Rules of Conduct
102 – Integrity and objectivity
201 – General standards
202 – Compliance with standards
203 – Accounting principles
502 – Advertising and other forms
of solicitation
505 – Form of organization and name
Enforcement mechanisms for the
rules of conduct
Action by AICPA:
• Remedial or corrective action
• Expulsion and notification to that effect in
the CPA Newsletter
Action by a state Board of Accountancy:
• Varies by state, but license may be
revoked.
Sarbanes-Oxley Act and SEC
Provisions Addressing Auditor
Independence
The SEC adopted rules strengthening auditor
independence in January 2003 Consistent with
the requirements of the Sarbanes-Oxley Act.
The Sarbanes-Oxley Act and the revised SEC
rules further restrict, but do not completely
eliminate the type of nonaudit services
that can be provided to the public.
Who Falls Under the SEC Provisions
for Auditor Independence?
Auditors of publicly traded
companies.
Sarbanes-Oxley Act and SEC
Provisions Addressing Auditor
Independence
Prohibited Services
1. Bookkeeping and other accounting services
2. Financial information systems design and implementation
3. Appraisal or valuation services
4. Actuarial services
5. Internal audit outsourcing
6. Management of human resource functions
7. Broker or dealer or investment adviser
or investment banker services
8. Legal and expert services unrelated to the audit
9. Any other service that the PCAOB determines
by regulation is impermissible
Audit Committees
An audit committee is a selected number
of members of a company’s board of directors
whose responsibilities include helping
auditors remain independent of management.
Duties include:
• Pre-approval of all audit and nonaudit services
• Oversight of auditors work
• Resolution of disagreements between management
and auditors
Audit Committees
The Sarbanes-Oxley Act requires that all
members of the audit committee
be independent.
Companies must disclose whether or not
the audit committee includes at least
one financial expert.
Conflicts Arising from
Employment Relationships
The SEC has added a one year “cooling off ”
period before a member of the audit
engagement team can work for the
client in certain key management positions.
• Chief Executive Officer
• Chief Financial Officer
• Chief Accounting Officer
• Equivalent positions to the above
Partner Rotation
The Sarbanes-Oxley Act requires that
the lead and concurring audit partner
rotate off the audit engagement
after a period of five years.
Ownership Interests
SEC rules adopted in 2000 on financial
relationships narrow the restrictions on
ownership in clients to those persons
who can influence the audit.
• Members of the engagement team
• Those in a position to influence audit
engagement
• Partners and managers providing
>10 hrs of non-audit svcs. to client
• Partners in the office of the partner
primarily responsible for engagement