Chapter 3
The Auditor’s Role in Society
Learning Objectives
1. Describe the contributions audit services make to society and
relationships among auditors, audit clients and the public.
2. Describe the different inputs to and influences on personal
ethics and morals.
3. Understand the role and contributions of professionals in
society.
4. Recognize the potential for ethical considerations and outcomes
in decisions and the decision-making models applicable to
ethical decisions.
5. Become familiar with external regulation and professional
standards governing the accounting profession’s conduct and
quality control.
Auditors as Professionals
 Professionals
 Make a living by providing services to others
 Recipients of professional services have to trust the
professional because they do not have the knowledge
that would be needed to monitor the quality of work
 Auditors
 Are different from most professionals because their
services benefit the public but their compensation for
the services does not come from the public
Constituents of Auditors’ Services
 The public and capital markets are the ultimate
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beneficiaries
As owners of the company being audited, the
shareholder group is actually the client
The shareholders elect the Board of Directors to
oversee the company for them
As a committee of the Board of Directors, the Audit
Committee is a subset of the board of directors
The Audit Committee selects and hires the auditors,
oversees the auditor’s compensation, and interacts with
the auditors
Examples of Different Philosophies
What is right? It depends on the philosophical
underpinning…
 Whatever creates the greatest good
 Whatever is fundamentally “right,” regardless of
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consequences
Whatever preserves the life of even one person
The decision made by a single ruler with ultimate
authority
The decision made by the group of people affected
Whatever the law requires
Theory of Moral Development
 Pre-conventional level: completely self-
centered decisions
 Conventional level: considers impacts
beyond personal consequences;
considers others
 Post-conventional level: abstract
analysis of right and wrong
Food for thought
Accountants and auditors must behave at a
conventional level when performing their work. If
they were to behave in a post-conventional manner
they would apply abstract analysis and decide that
their preferences were “right.” If accountants and
auditors used personal preferences instead of
following the standards set according to due
process, financial statements would lose
comparability.
Ethical Orientation
 Ethic of Rights
 Business
 Laws
 Courts
 United States culture
 Ethic of Care
 Family
 Sports teams
 Military
 Pacific Rim and other cultures
Sociology of Professions
 Entry and membership in the group
 Regulation
 Self regulation
 Coordination with authorities
 Individual characteristics
 Taxonomic description
Technical expertise
Integrity
Believe their work is of value, important
Believe they make a contribution through their work
 Social contract
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Auditing is a Profession
 A profession is an occupational group of individuals with a
collective identity
 Body of knowledge: accounting and auditing
 Community of peers: AICPA and other groups
 Entry and Membership: CPA exam, continuing education
 Regulation of the group: AICPA is internal; SEC, PCAOB, states
and courts are external
 Individual Characteristics: competence, integrity
 Social Contract: oversight of the quality of financial reporting
provided to the public in exchange for professional status
Decision Process for Moral Issues
 Environment produces issues with moral components
 Decision maker recognizes the moral issue or moral components. Moral
intensity affects whether the decision maker recognizes the moral
components.
 Magnitude of the consequences
 Social consensus
 Probability of effect
 Temporal immediacy
 Proximity
 Concentration of effect
 Decision maker goes through a decision process to make a judgment
regarding the issue, and selects and carries out a behavior. This is done
using a decision model that considers ethical consequences.
Model for Making Ethics-Related Decisions
 Determine the facts of the situation.
 Identify the ethical issues and people involved. Who are the
stakeholders?
 Identify the values related to the situation: honesty, loyalty,
compassion, integrity, etc. Identify any that conflict.
 Identify alternative courses of action that are available.
 Evaluate courses of action and match each with relevant
values.
 Consider the consequences of viable courses of action
remaining.
 Make the decision; take indicated action.
Value of Using an Ethics Decision Model
 Supports considering ethics during the decision
making process
 Does not guarantee a particular decision result
 Moral dilemmas will still exist; this type of
decision model just helps provide a process for
addressing them
 A moral dilemma is an ethics-related
situation for which there is no clear right or
wrong answer
AICPA Code of Conduct
 Principles of Professional Conduct
 Conceptual, ideal standards; not enforceable
 Rules of Conduct
 Threshold for minimum acceptable behavior
 Stated in behavior-related language
 Enforceable
 Interpretations of the Rules of Conduct
 Response when there are frequent questions about a rule
 Departures must be justified in any disciplinary hearing
 Rulings by the Professional Ethics Executive Committee
 Rulings on individual cases; responses to specific factual circumstances
 Justification for departures may be requested in any disciplinary
hearing
Principles
 Responsibilities
 Professional and moral judgment
 Public interest
 Integrity
 Objectivity and Independence
 Conflict of interest
 Public practice; attest functions, independent in fact and
appearance
 Due Care
 Scope and Nature of Services
 Observe the other principles in making these decisions
How AICPA Rules Use the Term “Public Practice”
 What does it mean to be in public practice?
 …covered in the definitions
 Performance for a client by a member or a member’s firm,
while holding out as a CPA, of the professional services of
accounting, tax, personal financial planning, litigation support
and professional services for which standards are promulgated
by bodies designated by Council.
 Council is the AICPA’s Council
 For example, standards referred to are: SFAS, SAS, SSARS,
SSCS, SSAE – and now also IFRS and ISA
AICPA Code, Rules
 Rule 101 - Independence
 Rule 102 – Integrity and Objectivity
 Be objective
 Behave with integrity
 Don’t misrepresent facts
 Don’t subordinate judgment
 Rule 201 – General Standards
 Professional competence
 Due professional care
 Planning and supervision
 Sufficient relevant data
 Rule 202 – Follow the rules
 Rule 203 - Financial statements have to be GAAP to issue a clean opinion
unless the exception applies
AICAP Code, Rules continued
 Rule 301 - Confidential client information
 Exceptions: subpoenas, practice monitoring, complaints regarding professional
performance
 Rule 302 - Contingent Fees
 Rule 501 – Acts Discreditable
 Rule 502 – Advertising & Other Forms of Solicitation
 False, misleading, deceptive, coercion, overreaching, harassing
 Rule 503 –
 Can’t recommend anything to (attest) client if you get a fee for it
 Can’t recommend anything an attest client does or sells to anyone if you get a
fee from the attest client
 If you are allowed to, and receive a commission, have to disclose it to the person
to whom you make the recommendation
 Referral fees; if you pay or receive a referral fee have to disclose it to the client
 Rule 505 – Form of Practice and Name
 Only an allowed organizational form
 Name that is not misleading
 All owners have to be AICPA members to say the firm is: “Member of AICPA”.
Definitions
The following terms have specific definitions for the
AICPA Code of Professional Conduct:
Attest engagement
Interpretation
Professional services
Attest engagement team
Key position
Significant influence
Client
Loan
Close relative
Key position
Council
Loan
Covered member
Manager
Financial institution
Member
Firm
Normal lending procedures
Holding out
Office
Immediate family
Partner
Individual…position to influence Period of the…engagement
Institute
Practice of public accounting
Conceptual Framework, AICPA Independence
ET 100.01…a member’s relationship with a client is
evaluated to determine whether it poses an
unacceptable risk to the member’s independence. Risk
is unacceptable if the relationship would compromise
(or would be perceived as compromising by an
informed third party having knowledge of all
relevant information) the member’s professional
judgment when rendering an attest service to the
client.
Independence
 In fact and in appearance
 General SEC guidelines communicate the essence of
independence
 SEC General Standard of Auditor Independence
 No mutual or conflicting interest with the audit client
 Audit firm cannot audit its own work
 Audit firm cannot act as management
 Audit firm cannot be an advocate for the client
 In 2001 SEC relaxed the group of people to whom
independence rules apply
AICPA Interpretation 101 of Rule 101
 Independence shall be considered to be impaired
if:
 A. During the period of the professional engagement a
covered member…
Definitions, Important for Covered Member
 Individual: the person or the person’s immediate
family
 Immediate family: spouse, spousal equivalent,
dependent (whether or not related)
 Attest engagement team: Individuals participating in
the attest engagement, including those who perform
concurring and second partner reviews, regardless of
functional classification (audit, tax, consulting).
Excludes specialists and those performing clerical
tasks.
Definitions, Important for Covered Member
 An individual in a position to influence the audit engagement;
Someone who
 Evaluates the performance or recommends the compensation
of the attest engagement partner
 Directly supervises or manages the attest engagement
partner (all the way up to firm’s chief executive)
 Consults with the attest engagement team on technical or
industry-related issues specific to the attest engagement
 Participates in or oversees quality control activities with
respect to this attest engagement (all the way up to the top
of the firm)
A Covered Member Is….
 An individual on the engagement team
 An individual in a position to influence the
engagement
 A partner or manager who provides 10 or more
hours of nonattest services to the client
 Another partner in the office of the lead attest
engagement partner
 The firm, including the firm’s employee benefit plans
 Any entities whose policies are controlled by any of
the people described above
AICPA Interpretation 101
 Important terms:
 Financial interest: direct financial interest, material indirect financial interest
 Management role
 Family: immediate, close
 Period covered by the audit, period of the professional engagement
 Financial interests that are problems:
 Have direct or material indirect interest
 Be a trustee or executor of an entity with a direct or material indirect interest
 Have joint investment
 Have a loan through other than normal lending procedures
 Cannot own more than 5% of the client either together or in a group (even if it is
not material and indirect)
 Applies to CPAs doing the audit and people who previously worked for the client;
Someone who worked for client and moves to audit firm can sever financial ties
AICPA Interpretation 101 continued
 Control positions/functions that are problems
 Director
 Officer
 Management or equivalent
 Promoter
 Underwriter
 Voting trustee
 Pension or profit sharing trustee
 Works in both directions
 CPA performing those services for the client
 Person in a client control position coming to work for the CPA firm and
auditing the period they perform the control function.
Close Relatives
 Close relative – only independence problems
 When close relative is in a key position, or
 Has a financial interest that is material to the close relative
that the auditor knows about that can result in significant
influence over the client
 in a key position means…
 Significant accounting function
 Preparation of financial statements
 Ability to exercise influence over the contents of the financial
statements
 Can influence an attest engagement that is not about the
financial statements
Immediate Family, Close Relatives
 Differences exist for independence issues when
immediate family and close relatives are involved
 Covered member is expected to know everything about
immediate family
 Financial interests and employment of immediate family
can cause independence problems
 Employment of close relative in key position is visible, so
covered member knows about it
 Finances of close relative can only be a problem if the
covered member has knowledge
Public Company Issues
 Sarbanes Oxley 1 year cooling off period (Section 206, Conflicts of Interest)
 Services that impair independence: SEC, SOX
 Bookkeeping
 Systems design and implementation
 Appraisal or valuation services
 Actuarial services
 Internal audit outsourcing services
 Management functions
 Human resources
 Broker-dealer, investment adviser, investment banking services
 Legal services
 Expert services unrelated to the audit
Note: Not all of these would be prohibited by AICPA rules
 Fees paid to the audit firm for non-audit services must be disclosed in the proxy
statement
Audit Committee Approvals
 Under SOX
 Audit committee hires the auditor, and as a
result, approves the audit service
 Audit committee approves any other services
 If a non-audit service is not prohibited it
must be approved in advance by the
client’s audit committee
Peer Review
 AICPA
 Peer Review Program (AICPA PRP)
 National Peer Review Committee
Reviews the portion of a firm’s practice not inspected by
the PCAOB
 PCAOB
 Firm Registration
 Inspections
International Code of Ethics
 International Federation of Accountants
International Ethics Standards Board for Accountants
(IESBA)
Code of Ethics for Professional Accountants
Applicability of IESBA Code
 CPAs must comply with the standards of
the applicable jurisdiction, or most
restrictive code
 IESBA Code revised in July 2009,
effective January 1, 2011
 CPA Exam coverage of IESBA Code could
begin effect January 2011
Structure of IESBA Code
 Set up in 3 sections
 Part A, General Application of the
IESBA Code
 Part B, Professional Accountants in Public
Practice
 Part C, Professional Accountants in
Business
Conceptual Framework, IESBA
 Uses a Conceptual Framework approach
 Identify threats to compliance with the
fundamental principles
 Evaluate the significance of the threats
identified
 Apply safeguards, when necessary to
eliminate threats or reduce them to an
acceptable level
Fundamental Principles, IESBA
 Integrity
 Objectivity
 Professional Competence and Due
Care
 Confidentiality
 Professional Behavior
Threat Categories, IESBA
 Self-interest threat
 Self-review threat
 Advocacy threat
 Familiarity threat
 Intimidation threat
Some of these look familiar – AICPA, SEC
Safeguards, IESBA
 Safeguards created by the
profession, legislation or regulation
 Safeguards in the work environment
Safeguards: Professional, Legislation, Regulation
 Educational, training and experience requirements
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for entry into the profession
Continuing professional development requirements
Corporate governance regulations
Professional standards
Professional or regulatory monitoring and
disciplinary procedures
External review by a legally empowered third
party
Other Safeguards
 Safeguards to identify or deter
 Effective, well-publicized compaint systems
 Explicitly stated duty to report breaches of ethical
requirements
 From the work environment
 Presented in Parts B and C
 These are the details of Parts B and C – what CPAs
should and shouldn’t do
AICPA, IESBA
 An example of differences between the Codes:
 Addressing familiarity threats, these examples are
not addressed directly in AICPA Code:
 Long Association of Senior Personnel (Including Partner
Rotation) with a Client
 Fees-Relative Size
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