Chapter 19
Professional
Conduct,
Independence,
and Quality
Control
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
LO# 1
Ethics and Professional Conduct
Ethics
Refers to a system or code of conduct
based on moral duties and obligations
that indicate how an individual should
interact with others in society
Professionalism
Refers to the conduct, aims, or
qualities that characterize or mark a
profession or professional person
19-2
LO# 2
Theories of Ethical Behavior
A subset of
Consequentialism
Recognizes that decision making involves
trade-offs between the benefits and burdens
of alternative actions and focuses on
consequences and on individuals affected
Rights-Based
Approach
Assumes that individuals have certain
rights and other individuals have a duty to
respect those rights when making decisions
Justice-Based
Approach
Is concerned with issues such as equity,
fairness, and impartiality
Utilitarianism
19-3
LO# 4
Standards for Auditor
Professionalism
19-4
Three Categories of Standards for
Ethics/Independence/Quality Control

Figure 19-1 in your text is not the way I organize
my thinking about these standards. I view them
as three categories:
– Work on US private companies

AICPA (Code of Professional Conduct; Statement on Quality
Control Standards No. 8)
– Work on US public companies

SEC Rule 2-01; PCAOB Rules 3520 thru 3524; AS 7
– Work on companies outside the US that do not register
with the US SEC

IFAC Handbook of the Code of Ethics for Professional Accountants
3 categories of standards (continued)

Here is how the text authors generally
present the information in Chapter 19, to
try to reduce unnecessary detail
– Independence rules at the individual person
level are discussed re the AICPA Code
– Independence rules at the CPA firm level are
discussed re the SEC rules
– Quality control is discussed re the PCAOB rules
– Discussion of peer review (AICPA)
– Discussion of inspections (PCAOB)
LO# 5
The AICPA Code
of Professional Conduct:
A Comprehensive Framework for Auditors
Principles of
Professional
Conduct
Rules of Conduct
Interpretations of
Rules of Conduct
Rulings by the
Professional Ethics
Executive
Committee (PEEC)
19-7
LO# 5
The AICPA Code of
Professional Conduct:
A Comprehensive Framework for Auditors
19-8
LO# 6
Principles of Professional Conduct
19-9
LO# 7
Rules of Conduct
19-10
LO# 8
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.
Financial
Statement
Audits
Financial
Statement
Reviews
Other Attest
Services as
defined by
SSAEs
Interpretation 101-1
“Covered members” must be independent.
19-11
LO# 8
Covered Members
1. An individual on the attest engagement team
2. An individual in a position to influence the attest
engagement
3. A partner or manager who provides nonattest
services to the attest client beginning once he or
she provides 10 hours of nonattest services
4. A partner in the office in which the lead attest
engagement partner primarily practices in
connection with the attest engagement
5. The firm, including the firm’s employee benefit plan
6. An entity whose operating, financial, or accounting
policies can be controlled by any of the individuals
or entities described above or by two or more such
individuals or entities if they act together
19-12
LO# 8
Prohibited Financial
Relationships
Direct
Material
Indirect
Results when a covered member has a
financial interest in an attest client, such as
ownership of stock or a loan to or from the
client
Results when a covered member has a
financial interest in an entity that is
associated with an attest client, for
example an investment in a mutual fund
that owns the client’s stock
Exception: Certain types of personal
loans from financial institutions who
are clients are permitted
19-13
Prohibited Business
Relationships
LO# 8
Rule 101 and relevant interpretations
essentially indicate that the independence of a
CPA is impaired if the CPA performs a
managerial or other significant role for a
client’s organization during the time period
covered by an attest engagement.
Interpretation 101-2 indicates that a firm’s
independence will be considered to be
impaired with respect to a client if a partner
or professional employee leaves the firm
and is subsequently employed by a client in
a key position unless a number of
conditions are met.
19-14
LO# 8
Effect of Family Relationships
A covered member’s immediate family (spouse,
spousal equivalent, or dependent) is subject to
Rule 101 and its interpretations and rulings.
19-15
LO# 8
Effect of Family Relationships
Two major situations with close relatives that can impair
independence:
1. A close relative has a financial interest in the client
that is material to the close relative, and the CPA
participating in the engagement is aware of the
interest.
2. An individual participating in the engagement has a
close relative who could exercise significant influence
over the financial or accounting policies of the client.
Close relatives include nondependent children, brothers, sisters,
parents, grandparents, parents-in-law, and their respective
spouses.
19-16
LO# 8
Effect of Actual or
Threatened Litigation
The commencement of litigation by management
alleging deficiencies in audit work for the client would
be considered to impair independence.
An expressed intention by management to commence
litigation against the CPA alleging deficiencies in audit
work would also impair independence if the auditor
concluded that it is probable that such a claim will be
filed.
The commencement of litigation by the CPA against
management alleging management fraud or deceit
would be considered to impair independence.
19-17
LO# 8
Provision of Nonaudit Services
AICPA Code of Professional Conduct restricts
somewhat the types of nonaudit services that
can be provided to attest clients.
SEC has more restrictive independence rules for
audits of public companies.
19-18
LO# 9
SEC Independence Requirements for
Audits of Public Companies
The SEC’s rules are predicated on three basic
principles of auditor objectivity and
independence:
1. An auditor should not audit his or her own work.
2. An auditor should not function in the role of
management.
3. An auditor should not serve in an advocacy role
for his or her client.
19-19
LO# 9
SEC Independence Requirements for Audits
of Public Companies
Categories of Generally Prohibited Nonaudit Services
Bookkeeping
Financial
Information
Systems Design
and
Implementation
Appraisal or
Valuation
Services
Actuarial
Services
Internal
Auditing
Outsourcing
Services
Management
Functions or
Human
Resources
Broker or
Dealer
Legal
Services
Expert
Services
19-20
LO# 9
SEC “revolving door” and “cross selling” rules
from SarBox (inspired by Enron/Andersen)
Partners are limited to
five consecutive years.
A one year “cooling off”
period is required if you
work on audit of a
company to leave CPA
firm and join company
in a “financial reporting
oversight role”.
A firm is not
independent if an audit
partner’s
compensation is based
on selling engagements
to that client for
services other than
audit, review, and attest
services.
19-21
LO# 9
SEC Required Communications for
Audits of Public Companies
SEC rules require additional communication
between auditors and their clients’ audit
committees and require public-company audit
clients to publicly reveal information regarding
the fees (audit and otherwise) paid to their
auditors.
19-22
LO# 9
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.
19-23
General Standards and
Compliance with Standards
LO# 10
Rule 201
A member shall comply with the following standards and
with any interpretations thereof by bodies designated by
Council.
Professional
Competence
Due
Professional
Care
Planning and
Supervision
Sufficient
Relevant
Data
19-24
General Standards and
Compliance with Standards
LO# 10
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.
This rule is important because it requires that members of the
AICPA comply with professional standards when performing
professional services, whether or not they are practicing in
public accounting.
19-25
LO# 10
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 GAAP 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 GAAP, 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.
19-26
Confidential Client Information
LO# 11
Rule 301
A member in public practice shall not disclose any
confidential client information without the specific
consent of the client.
Five Situations Where CPAs Can Disclose Confidential Information
To meet GAAP
or GAAS
disclosure
requirements
To comply with
a valid
subpoena
In connection with
a purchase, sale,
or merger of the
As required by
As part of an
practice
an authorized
investigative or
peer review
disciplinary
body
proceeding
19-27
LO# 11
Contingent Fees
Rule 302
A member shall not
(1)Perform for a contingent fee any professional service 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, (b) a compilation of financial
statements expected to be used by a third party if the
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
refund for a contingent fee for any client.
19-28
LO# 12
Acts Discreditable
Rule 501
A member shall not commit an act discreditable to the
profession.
19-29
LO# 12
Acts Discreditable











Inappropriate response to requests by clients and former clients for
certain records (501-1).
Discrimination and harassment in employment practices (501-2).
Failure to follow standards and/or procedures or other requirements in
government audits (501-3).
Negligence in the preparation of financial statements or records (501-4).
Failure to follow the requirements of government bodies, commissions, or
other regulatory agencies in performing attest or similar services (501-5).
Solicitation or disclosure of CPA examination questions and answers (5016).
Failure to file tax return or pay tax liability (501-7).
Including certain types of indemnification and limitation of liability
provisions in agreements for the performance of audit or other attest
services in jurisdictions where such provisions are prohibited (501-8).
Confidential information obtained from employment (501-9).
Financial interests (501-10).
False, misleading, or deceptive acts in promoting or marketing
professional services (501-11).
19-30
LO# 12
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.
Solicitation by the use of coercion, over-reaching, or
harassing conduct is prohibited.
Best CPA
in the
World!
19-31
LO# 12
Prohibited Advertising




Creating false or unjustifiable expectations of
favorable results.
Implying an ability to influence any court, tribunal,
regulatory agency, or similar body or official.
Claiming 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 at the
time of representation that such fees will be
substantially increased and the prospective client is
not advised of that likelihood.
Making any other representations that would be likely
to cause a reasonable person to misunderstand or be
deceived.
19-32
LO# 12
Commissions and Referral Fees
Rule 503
Prohibited Commissions: A member in public practice shall not for a
commission recommend or refer to a client any product or service
or receive a commission, when a member or the member’s firm
also performs for that client (a) an audit or review of financial
statements, (b) a compilation of financial statements expected to
be used by a third party and the compilation report does not
disclose a lack of independence, or (c) an examination of
prospective financial information.
Disclosure of Permitted Commissions: A member in public practice
who is not prohibited by this rule from performing services for or
receiving a commission and who is paid or expects to be paid a
commission shall disclose that fact to any person or entity to
whom the member recommends or refers a product or service to
which the commission relates.
19-33
LO# 12
Commissions and Referral Fees
Rule 503
Referral Fees: Any member who accepts a referral fee
for recommending or referring any service of a CPA to
any person or entity or who pays a referral fee to obtain
a client shall disclose such acceptance or payment to
the client.
19-34
LO# 12
Form of Organization and Name
Rule 505
A member may practice public accounting only in a form
of organization permitted by law or regulation whose
characteristics conform to resolutions of Council.
A member shall not practice public accounting under a
firm name that is misleading. Names of one or more
past partners may be included in the firm name of a
successor organization.
A firm may not designate itself as “Members of the
American Institute of Certified Public Accountants”
unless all of its CPA owners are members of the
Institute.
19-35
LO# 12
Disciplinary Actions
The Professional Ethics Executive Committee
(PEEC) can direct a member to take remedial or
corrective actions.
Termination of
AICPA
Membership
AICPA
Trial
Board
Actions
Suspend
AICPA
Membership
19-36
LO# 13
Quality Control Standards
CPA firms are required to implement policies and procedures
to monitor the firms’ practices and ensure that professional
standards are being followed.
In 2004, PCAOB assumed the AICPA’s responsibilities
relating to firms that audit public clients and instituted a
mandatory quality inspection program for those firms.
The AICPA continues to administer a quality review system in
order to enable firms to meet their state licensing, federal
regulatory, and AICPA membership requirements and to serve
firms that audit only privately held clients.
19-37
LO# 14
Elements of Quality Control
Leadership:
Tone at the Top
Relevant Ethical
Requirements
Client
Acceptance and
Continuance
Human
Resources
Engagement
Performance
Monitoring
19-38
LO# 15
PCAOB Inspections of Registered
Public Accounting Firms
The PCAOB conducts regular inspections
of public accounting firms that are
required to register with the Board.
19-39
End of Chapter 19
19-40