Review Questions Solutions
Chapter 3, The Auditor’s Role in Society
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A1 How is a doctor’s professional relationship with a client different from an
auditor’s?
The patient “hires” the doctor. A doctor acts as an advocate of his or her patient
client, trying to achieve the best health result for the patient. The patient (or the patient’s
insurance company on behalf of the client) pays the doctor.
An auditor is hired by the client company and the client company pays the
auditor. But, the auditor does not act as an advocate for the client. In fact, the auditor is
specifically prohibited from being positively biased towards the client. The auditor must
provide an objectively obtained opinion, whether it is good or bad for the client company.
A2 Who elects the Board of Directors?
The shareholders.
A3 Who hires management?
The Board of Directors.
A4 Under SOX, who selects and hires the auditor?
The audit committee of the Board of Directors.
A5 With whom does the auditor interact most – shareholders, the Board of
Directors, or management?
Management
A6 In performing its work, to whom does the audit firm owe “ultimate
responsibility”?
The public; protecting the public interest
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B1 What are some of the influences on individual judgment regarding what is
“good” or “bad”?
Family
Community, country, culture
Faith, religious beliefs
Legal and political systems
Extent and speed of information dissemination
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Global economy
B2 What are the three levels of moral development?
Pre-conventional: The individual decides what is right or wrong based upon self
interest and personal consequences.
Conventional: The individual is concerned about expectations of significant
others and relies upon rules and laws to determine what is right or wrong.
Post conventional: The individual decides what is right or wrong using ethical
principles of right and wrong, such as the common good and justice.
B3 Compare and contrast an ethic of rights and an ethic of care.
The “ethic of rights” concept focuses on individual rights. This is the basis for the
legal system in the United States and has historically been the view adopted by
businesses in this country.
An “ethic of care” concept focuses on connecting with others and puts the best
interests of the collective unit ahead of individual rights. This ethics standard is
predominant in other countries around the world. In the United States an “ethic of care”
mentality is seen in the military, athletic teams, teams within the business environment,
and families.
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C1 What are the characteristics of a profession?
An occupational group with a collective identity.
Specific body of knowledge for which the group has expertise.
Controls standards for entry and continued membership.
Self discipline and (at least some) self regulation.
Recognizable individual characteristics or traits.
Social contract.
C2 What personal characteristics are usually associated with a person who is called
a professional?
They are expected to possess technical expertise and behave with integrity.
Professionals are expected to be objective and do their best work regardless of self
interest. Professionals tend to believe their work is valuable and important, and that it
makes a contribution.
C3 Describe the view of auditors as professionals who have a contract with society.
Having a contract with society means that the professional group, as well as the
individuals within it, commit to certain behaviors and receive rewards in return. Auditors
commit to protecting the public interest, maintaining standards of excellence, and
governing and discipline the members of the professional group. In return, they receive
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prestige, economic rewards, the right to at least some self governance, and the monopoly
right to perform audits.
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D1 What are the steps in a decision model that is to be used for making decisions
that have ethical components and outcomes?
Determine the facts of the situation.
Identify the ethical issues and people involved, including all stakeholders.
Identify the values related to the situation.
Identify the alternative courses of action that are available.
Evaluate the various courses of action that have been identified, and match each
with the relevant values.
Consider the consequences of the possible viable courses of action.
Make the decision; take indicated action
D2 What is moral intensity?
Moral intensity describes the characteristics of a situation or its potential
outcomes that may cause a decision maker to recognize that a decision has ethical
components. When moral intensity rises to a high enough level the decision maker uses
an ethical decision model rather than another decision model, such as a purely financial
or economic model.
Moral intensity criteria include: consequences that are large or significant; social
agreement (or disagreement) about an issue; consequences that are very likely to happen,
to happen soon, and that may affect people or environments close to the decision maker;
consequences that will have a broad or widespread impact rather than affecting a
concentrated location or group of people.
D3 Does using an ethical decision framework guarantee a moral decision outcome?
Would the moral decision outcome be the same for everyone?
Use of an ethical decision framework only means that the decision maker
considers ethical issues and outcomes as at least a part of the decision making process. It
does not guarantee that the decision maker will make the “right” decision. Further, since
there are so many influences on what causes people to decide what is right or wrong,
different people using the same information and ethical decision making model will often
come to different decision results.
D4 What is a moral dilemma?
Situations for which, even for a single individual using their own personal beliefs,
there is no clear cut right or wrong ethical answer.
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E1 List organizations and entities that exercise authority over auditors.
AICPA
PCAOB
States, through laws, legislation and regulation
SEC
Other federal regulatory agencies
Courts
E2 What is the relationship between the AICPA Code of Conduct and the codes of
the various states?
All states have their own ethics or conduct standards, but most are very similar to
the AICPA Code of Conduct.
E3 What are the four levels in the structure of the AICPA Code of Conduct?
Principles of Professional Conduct
Rules of Conduct
Interpretations of the Rules of Conduct
Rulings by the Professional Ethics Executive Committee
E4 Which level of the AICPA Code is intended to be the ideal standard of conduct?
The enforceable guide of conduct?
Principles of Professional Conduct
Rules of Conduct
E5 Do all rules of the Code of Conduct apply to all members of the AICPA?
No, some are dependent on whether the member is working for a public
accounting firm in “public practice.”
E6 Why are Interpretations of the AICPA Code written?
To address instances when a particular issue about the understanding or
application of a Rule is frequently questioned by members.
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F1 What is the difference between immediate family and close relative?
For purposes of applying the AICPA Code of Conduct, an “immediate family”
member (spouse, spousal equivalent, or dependent) “steps into the shoes” of the auditor.
The status “close relative” (parent, sibling, or nondependent child) has different impacts.
The most obvious difference is that a CPA (who is a covered member as defined in the
Code) is expected to know and be able to influence/control the ownership holdings of a
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spouse, “spousal equivalent,” or anyone dependent on him or her for support. For
individuals who are not dependent on the CPA, the circumstances that impair
independence are those that would generally be observable to any outsider – such as
being a CFO or other important member of the management team for an audit client. The
covered member is not expected to know about, or be able to influence, the financial
holdings of relatives who are beyond spouse/spouse equivalents and dependents. It is
important to know that an individual does not actually have to be a relative of the CPA to
fall under the rules of “immediate family.” The requirement is that the individual is
financially dependent on the CPA, whether or not related.
F2 What is the difference between being in a key position and being in a position to
influence an engagement?
The important difference is that the term “key position” refers to someone who is
employed by the audit client, and the term “being in a position to influence an
engagement” refers to someone within the audit firm.
A key position is one at or associated with the client; it is a position in which an
individual:
a. Has a primary responsibility for significant accounting functions that support
material components of the financial statements
b. Has primary responsibility for the preparation of the financial statements
c. Has the ability to exercise influence over the contents of the financial statements,
including when the individual is a member of the board of directors or similar
governing body, 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, or any equivalent position.
Being in a position to influence an engagement refers to a position associated
with the audit firm, and related to an attest engagement is someone who:
a. Evaluates the performance or recommends the compensation of the attest
engagement partner;
b. Directly supervises or manages the attest engagement partner, including all
successively senior levels above that individual through the firm’s chief
executive;
c. Consults with the attest engagement team regarding technical or industry-related
issues specific to the attest engagement; or
d. Participates in or oversees, at all successively senior levels, quality control
activities including internal monitoring, with respect to the specific attest
engagement.
F3 How can the definition of covered member apply to both an individual and a
firm?
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The firm providing the services is always a covered member. Certain individuals
of the firm are covered members as a result of their proximity to the particular
engagement:
An individual on the attest engagement team;
An individual in a position to influence the audit engagement;
A partner or manager who provides 10 or more hours of nonattest services to the
client within a certain time frame;
A partner in the office in which the lead attest engagement partner primarily
practices in connection with the attest engagement;
Certain related entities
F4 Why is the phrase “holding out” important?
Holding out has a specific definition and means that the CPA is informing others
of his or her professional status.
(This is not discussed in detail in the chapter because of its legal complexity. It is
an important term with practical implications because individuals who identify
themselves as a CPA may also identify themselves as an employee. In this situation, for
application of the Code, they are viewed as being in the practice of public accounting.
This is complicated and has been the object of several lawsuits.)
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G1 What does Rule 102 mean in stating that a CPA should not subordinate
judgment?
The CPA should not let others make decisions that are his or her responsibility.
G2 What does Rule 201 mean when it calls for “due professional care”?
The CPA should perform work diligently and abide by professional standards.
G3 Under Rule 203, is it ever acceptable for financial statements to NOT conform to
GAAP?
Yes, if due to unusual circumstances, complying with GAAP would make the
financial statements or data misleading. Specific disclosures are required.
(As you will learn in the chapter that discusses audit reports, the PCAOB does not
allow this exception to following GAAP and issuing and unqualified opinion.)
G4 What are the exceptions to Rule 301 that permit a CPA to disclose confidential
client information without the client’s permission?
The following exceptions are allowed for disclosing confidential client
information under Rule 301. Note that all these circumstances involve disclosing the
information under legal or government requirements, or to other CPAs performing
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professional duties – who would therefore be required to maintain any required client
confidentiality. Exceptions exist to:
(1) comply with a validly issued and enforceable subpoena or summons, or to comply
with applicable laws and government regulations,
(2) facilitate review of a member’s professional practice under AICPA or state CPA
society or Board of Accountancy authorization, or
(3) facilitate a member initiating a complaint with, or responding to any inquiry made by,
the professional ethics division or trial board of the Institute or a duly constituted
investigative or disciplinary body of a state CPA society or Board of Accountancy.
G5 What is a contingent fee? How do fees fixed by courts or other public authorities
fit into Rule 302?
A contingent fee is when the amount of the fee for professional services depends
upon the outcome of the work, such as one fee for an unqualified audit opinion and a
different fee when a different type of opinion is issued. Tax fees that differ based on the
amount of the tax liability would also be contingent fees. Fees that are based on the
nature of the service, complexity of the work, or time spent are not contingent fees.
Fees set by the court or other public authorities are not considered contingent fees
because the CPA cannot influence the decision, and therefore the CPA would not have
any motivation to alter the outcome of the work to achieve a certain fee.
G6 Can a CPA ever receive a commission or referral fee?
Yes, if the CPA is not providing
(a) an audit or review of a financial statement; 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.
The CPA must disclose the potential receipt to the client.
G7 Summarize Rule 505 regarding the form of organization under which a CPA can
practice, and the limitations on names for such an organization.
CPAs can practice public accounting in organizations structured as sole
proprietorships, various forms of partnerships, or similar structures that are consistent
with the AICPA’s rules. The organization name may not be misleading, such as
indicating that the entity is a partnership when it has only one owner.
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H1 What is the difference between independence in fact and independence in
appearance?
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Independence in fact is a state of mind, while independence in appearance is
avoiding situations and relationships that may cause observers to question an auditor’s
independence. Since independence in fact can not be monitored, we rely on independence
in appearance. Further, if auditors avoid situations that do not appear independent, it is
expected they will be better able to maintain true, mental independence.
H2 Why do auditors need to be independent?
Auditors need to be independent so they will not be biased in performing their
work and issuing audit opinions, and so that users of audit reports will have confidence in
the reports.
H3 In what situations of financial interest is materiality important?
If an auditor has a direct financial interest, this causes the auditor to lack independence,
whether or not the financial interest is material. If the auditor has an indirect financial
interest, the auditor is not independent if the interest is material to the auditor. (Recall
that a financial interest held by the immediate family of an auditor is evaluated as though
it is the auditor’s financial interest. This concept still applies when considering direct,
indirect, material and immaterial.)
H4 Do most of the independence rules address independence in fact or in
appearance?
In appearance. There is no way to objectively evaluate independence in fact.
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I1 What does Section 206 of SOX say about the independence of an audit firm when
a member of the audit team goes to work for a client?
If the audit team member leaving the audit firm goes to work for the client as
CEO, CFO, Chief Accounting Officer (CAO), controller, or any equivalent position, the
audit firm will not be independent with respect to the client for one year.
I2 What is the emphasis of the most recent revision of the SEC rules regarding
independence?
The recent revision reduces the number of individuals who are included in the
pool of individuals who must be independent of an audit client; this change makes the
rules fit better with the current technology of the business environment and the high
number of dual career families.
I3 What services does the SEC prohibit for a CPA that also performs a company’s
audit? How can these services be grouped consistently with the SEC’s personal
independence rules?
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The following services when provided to an audit client, will impair
independence:
-Bookkeeping or other services related to the accounting records or financial
statements of the audit client.
-Financial information systems design and implementation.
-Appraisal or valuation services, fairness opinions, or contribution-in-kind reports
-Actuarial services.
-Internal audit outsourcing services
-Management functions
-Human resources
-Broker-dealer, investment adviser, or investment banking services
-Legal services
-Expert services unrelated to the audit
Grouping these services according to the SEC’s personal independence rules
produces the following way of viewing independence impairment:
Auditing the Firm’s Own Work: bookkeeping, actuarial services, internal audit
outsourcing, systems design and implementation, appraisal and valuation (etc.) services
Making Management Decisions: management functions, broker services, human
resources
Being an Advocate: broker-dealer services, expert services, legal services
I4 What services that are provided by a company’s must be approved by the audit
committee of a public company?
All services provided by the firm that performs the audit must be approved by the
audit committee, specifically:
The audit
Other non-audit work
I5 What information related to CPA firm fees appears on a public company’s proxy
statement?
Fees for audit services
Fees for non audit services
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J1 What are Quality Control Standards? What authoritative sources require quality
control standards?
Quality Control (QC) Standards provide guidance for public accounting firms
regarding policies needed for well-functioning, well-monitored practices. The QC
Standards provide standards against which firms can be compared in monitoring and
inspection processes.
SOX, the PCAOB and the AICPA are all involved with quality control standards.
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J2 Identify the elements of quality control.
The AICPA QC Standards promulgate the following Elements of Quality Control:
Leadership responsibilities for quality within the firm (the “tone at the top”)
Relevant ethical requirements
Acceptance and continuance of client relationships and specific engagements
Human resources
Engagement performance
Monitoring
The SOX requirement for Quality Control Standards to be adopted by the PCAOB
is:
The [PCAOB] shall include in the quality control standards that it adopts with respect to
the issuance of audit reports, requirements for every registered public accounting firm
relating to -1. monitoring of professional ethics and independence from issuers on behalf of which
the firm issues audit reports
2. consultation with such firm on accounting and auditing questions
3. supervision of audit work
4. hiring, professional development, and advancement of personnel
5. the acceptance and continuation of engagements
6. internal inspection
7. such other requirements as the PCAOB may prescribe
J3 What are practice monitoring programs?
The term practice monitoring, often also called peer review, is used to refer to the
quality control review programs sponsored, required and administered by the AICPA.
(States may also have similar programs available and required if a CPA firm is not
associated with the AICPA.) Any firm that provides audit, attest, review, or compilation
services is required to undergo a practice monitoring review.
J4 Explain the PCAOB registration and practice inspection requirements.
All firms who want to audit the reports of companies that file with the SEC must
register with the PCAOB; if the firm is not registered the SEC will not accept the audit of
the company. A part of registration is to consent to inspections and to cooperate with the
PCAOB. Firms provide large amounts of information to complete the registration
process. They also must file various ongoing reports with the PCAOB.
Inspections are required in SOX; the frequency of inspections depends on the
number of audits of public companies performed by a CPA firm; inspections are
conducted by employees of the PCAOB and address both quality control of the firm and
audits, including audit processes, documentation, conclusions and opinions.
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