From
MODULE B
Professional Ethics
LEARNING OBJECTIVES
Review Checkpoints / MultipleChoice / Exercises, Problems, and Simulations
- Understand general ethics and a series of steps for making ethical decisions.
- Reason through an ethical decision problem using the imperative, utilitarian and generalization principles of moral philosophy.
3, 4
/ 20 /55, 56, 57
- Identify the different entities that make ethics rules for CPAs and public accounting firms.
- With reference to American Institute of Certified Public Accounting (AICPA), Government Accountability Office (GAO), Public Company Accounting Oversight Board (PCAOB), and Securities and Exchange Commission (SEC) rules, analyze factual situations and decide whether an accountant’s conduct does or does not impair independence.
- With reference to AICPA rules on topics other than independence, analyze factual situations and decide whether an accountant's conduct does or does not conform to the AICPA Rules of Conduct.
49, 50, 51, 52, 58, 63
- Explain the types of penalties that can be imposed on accountants.
(*) Item relates to multiple learning objectives
A note to instructors about Module B, relating to the "Generalization Argument":
In the interest of fairness, it should be noted that the generalization argument does not work in all cases, particularly in two circumstances: (1) When the argument is invertible, that is (a) when both doing something and not doing something would be undesirable and (b) when both everyone and not everyone doing something would be undesirable. For example: "What if everyone was a fulltime farmer?" The results would be undesirable in our society because all other social functions would disappear, but this cannot mean that no one should be a farmer because then we would all starve. (2) When the argument is reiterable, that is, when arbitrary times, places, or measures can be inserted in such a way as to make a decision appear to be nonsense. For example, "What if every auditor were permitted to own 1/10 of a share of each client's common stock? Presumably, the consequences of such minor holdings would not be generally undesirable, and so ownership of 1/10 of a share could be permitted. Now change the amount to 1 share, 5 shares or 100 shares. How about 1,000 shares? One can see that ultimately the problem becomes one of "where to draw the line."
SOLUTIONS FOR REVIEW CHECKPOINTS
B.1A professional accountant must be prepared to be an agent, a spectator, an advisor, an instructor, a monitor, a judge, and a critic. Overall, the primary goal as a professional is to employ a consistent process for making ethical decisions. Consequently, an understanding of some of the general principles of ethics can provide background for a detailed consideration of standards for professional conduct.
As a professional, you will face choices that necessitate reflective thinking.This involves engaging in an important sequence of events beginning with the recognition of a decision problem. In the ethics context, collection of evidence refers to thinking about rules of behavior and outcomes of alternative actions. The process ends with analyzing the situation and taking an action. Ethical decision problems almost always involve projecting yourself into the future to live with your decisions. Professional ethics decisions usually turn on these questions: “What written and unwritten rules govern my behavior?” and “What are the possible consequences of my choices—whom will my decision affect?”
B.2Conscience might not be a sufficient guide for
a.Personal ethics decisions because the individual's indefinable mental processes may be based on caprice, immaturity, ignorance, stubbornness, or misunderstanding. Conscience may fail to show the consistency, clarity, practicability, impartiality, and adequacy preferred in ethical standards and behavior.
b.Exactly the same can be said about professional ethics decisions because a non-hypocritical individual can no more split her or his behavior between personal life and professional life than she or he can voluntarily split her or his own personality.
B.3
a. The rule "failure to tell the truth is wrong" would require that the staff accountant (1) refuse to "enhance" the financial statements and (2) not to worry about the consequences that seem to be predicted. (They might not turn out bad anyway if the company can get the loan honestly or can find another lender or can develop other means of survival.)
b.This rule may be called imperative because it requires the truth regardless of what you might personally feel about the consequences. Strict imperative theory (e.g., Kant) excuses the individual from responsibility for undesirable consequences as long as the decisions do not cause other people to be used as the means.
B.4Utilitarian ethics theory requires a decision maker to recognize the value attributes of the consequences of ethical choice alternatives (good v. evil), somehow measure or weigh these, and then decide on the basis of the greater good (or the lesser evil). Imperative ethics does not require that consequences be considered.
B.5a.The AICPA PEEC makes independence rules applicable to CPAs who (1) are members of AICPA (not all CPAs are members) and (2) perform audits of financial statements (of both public companies and private entities).
b., c.The SEC and PCAOB make independence rules applicable to (1) all accountants (most are CPAs, but the law doesn’t specify CPAs) who (2) perform audits of public companies (only of public companies that file financial statements with SEC, not all other audits).
d.The IFAC makes independence rules applicable to CPAs who perform audits of multinational companies. When faced with a choice between the AICPA code and the IFAC code, the CPA should always comply with the more restrictive of the standards that is applicable given the facts and circumstances.
B.6Rules of conduct for
a.Practicing public accounting come from:
- State boards of accountancy.
- American Institute of CPAs.
- International Federation of Accountants.
- State societies of CPAs.
- Public Company Accounting Oversight Board.
- General Accounting Office.
b.Practicing internal auditing:
- The Institute of Internal Auditors (IIA)
(1). Standards for the Professional Practice of Internal Auditing.
(2) The Institute of Internal Auditors Code of Ethics.
c.Practicing management accounting:
- Institute of Management Accountants (IMA).
- Standards of Ethical Conduct for Management Accountants.
d.Practicing fraud examiners:
- The National Association of Certified Fraud Examiners.
B.7The intent of this question is to require students to study the SEC definitions. Yolanda is in the chain of command (item 3–person who evaluates performance or recommends compensation of Javier, the audit engagement partner of Besame)
a. Because Yolanda is a covered person in the firm, independence is impaired when she owns Besame stock.
b. Independence is not impaired when her close relative (brother) owns a small number of shares.
B.8No, audit independence is impaired when the audit firm’s employees render legal services of this type.
B.9The SEC believes that people who use financial statements and auditors’ reports can be enlightened with information about auditors’ fee arrangements with clients. (The “enlightenment” involves users’ perceptions of auditor independence regarding the relation of nonaudit and audit revenues from an audit client.)
What must be disclosed are (1) total audit fees, (2) total fees to the audit firm for consulting services on the design and implementation of financial information systems, and (3) total fees to the audit firm for all other consulting and advisory work (over and above the audit fees and the information systems fees above). In addition, the disclosure rules also require revealing (1) whether the those charged with governance (including the audit committee or the board of directors) considered the audit firm’s information systems work and other consulting work to be compatible with maintaining auditors’ independence and (2) whethermore than 50 percent of the audit hours were performed by persons other than the principal accountant's full-time, permanent employees (“leased employees” in an “alternative practice structure” arrangement).
B.10Both want to ensure that those charged with governance (including the public company audit clients’ audit committees and boards of directors) consider their auditors’ independence in general and in connection with any nonaudit services provided concurrently by the audit firm.
B.11The threat to independence is that while a member of the audit team, an auditor who considers a job offer from a client might not perform audit work properly. That is, the auditor may have some newfound loyalty to the client and interest in its success. This may impact decision made on the audit.
B.12Members of the AICPA have ethical responsibilities for acts of nonmembers under their supervision. That is, a member shall not permit others to carry out, on his or her behalf, either with or without compensation, acts that, if carried out by the member, would place him or her in violation of the Rules of Conduct.
B.13Rules of conduct that apply specifically to AICPA members in government and industry include:
Rule 102 (integrity and objectivity): Members in government and industry cannot subordinate their judgment to superiors and produce misleading financial statements. Members in government and industry must be candid and not omit information when dealing with external auditors, and not have undisclosed conflicts of interest in their jobs.
Rule 203 (accounting principles): When members in government and industry represent their companies' financial statements as being "in conformity with GAAP," they are expressing an "opinion" that is subject to Rule 203, which requires disclosure of any material departure from accounting principles promulgated by a body designated by Council (FASB and GASB).
Rule 501 (acts discreditable): Participation in the production of false and misleading financial statements is a discreditable act.
B.14According to the AICPA, there are rules of conduct related to the form of organizational control:
a.CPAs shall have majority (50 percent or more) ownership and voting rights of a firm.
b.CPAs must have ultimate responsibility for attest services at the firm.
c.Non-CPAs cannot be passive investors but must be active in the practice of the firm.
Non-CPAs cannot hold themselves out as CPAs.
Non-CPAs must abide by the AICPA Code of Professional Conduct.
Non-CPAs must have the same educational levels and meet the same continuing education requirements as CPAs.
B.15The primary difference between commissions and referrals is that commissions relate to the sale of products while referrals relate to a fee received by the CPA for services performed by another CPA or that the CPA pays to another CPA firm to obtain a client. Rule 503 of the AICPA Code of Conduct outlines the rules related to commissions and referral fees.
B.16AICPA and the state societies can impose a number of penalties, including the following:
- Admonish a violator (which amounts to a slap on the wrist).
- Suspend the violator's membership.
- Expel the violator from membership.
- Require CPE hours to be undertaken by the violator.
- Publish the violator's name in a report of proceedings (e.g., in CPA Letter and a state society newsletter or magazine
B.17The SEC and the PCAOB can impose penalties, including the following:
1.Admonish a license holder (which amounts to a slap on the wrist).
2.Suspend the violator's license to practice.
3.Revoke the violator's license to practice.
4.Impose a fine on the violator.
In addition, the SEC can deny (temporarily or permanently) the privilege of practice before the SEC with a "Rule 102(e)" proceeding. (The SEC can also "censure" a CPA, which amounts to a slap on the wrist and settle for an injunction in which the CPA promises not to violate the rules of conduct in the future.) In addition, when laws are broken (e.g. rule 501), the SEC can initiate legal proceedings resulting in fines and/or imprisonment.
SOLUTIONS FOR MULTIPLECHOICE QUESTIONS
B.18a.IncorrectIndependence in fact refers to the facts, not appearances.
b.CorrectSince appearances influence the public, this is important.
c.IncorrectFundamental principles do not mention independence in appearance.
d.IncorrectThis has nothing to do with independence in appearance.
B.19a.IncorrectAn external auditor is not able to “assure” that they are independent.
b.IncorrectSarbanes-Oxley and PCAOB have placed the responsibility for ensuring that the external auditors are independent on those charged with governance (including the audit committee). Management is not responsible for the auditor’s independence.
c.CorrectSarbanes-Oxley and PCAOB have placed the responsibility for ensuring that the external auditors are independent on those charged with governance (including the audit committee).
d.IncorrectThe PCAOB sets standards for the auditing profession and serves at the regulator for audit firms. The PCAOB is not responsible for the auditor’s independence.
B.20a.CorrectImperative means that a rule is always followed.
b.IncorrectUtilitarian means that some exceptions based on a calculation of good and bad outcomes is sometimes used.
c.IncorrectThis is the second best answer because generalization can resemble imperative thought.
d.IncorrectThe firm is following a rule, not listening to members’ collective conscience.
B.21a.Incorrect FASB makes accounting principles (not independence rules).
b.Incorrect GAO makes auditing standards for government audits.
c.Correct The PCAOB (in cooperation with SEC) makes independence rules for auditors of public companies.
d.Incorrect ARSC makes practice standards for accountants’ work on unaudited financial statements.
B.22a.Incorrect Merely auditing competitors does not impair independence.
b.Correct This implies that the auditor subordinated judgment to the client’s officer.
c.Incorrect Lack of competence itself is not an impairment of independence. The facts may have been misrepresented, but the auditors didn’t know it.
d.Incorrect Another example of lack of competence. In this case, the auditors misrepresented facts (giving the unqualified report when the audit was not entirely in conformity with GAAS), but they did not knowingly do so.
B.23b.CorrectSarbanes-Oxley and the PCAOB have placed the responsibility for auditors’ independence on the audit committee. Primary in this responsibility is the monitoring of all engagements contracted with the external auditors to ensure that the auditors are not performing any assignments that are prohibited by PCAOB standards or otherwise impair the auditors’ independence.
B.24a.Incorrect Rule 101 is focused on members in public practice, not members serving in industry or government.
b.Correct Integrity and objectivity are required of all members.
c.Incorrect Rule 301 is focused on members in public practice, not members serving in industry or government.
d.Correct Prohibition of discreditable acts applies to all members.
B.25a.Incorrect This type of bookkeeping service impairs independence.
b.Correct Independence is notimpaired for nonfinancial statement–related internal audit services when the client has its own director of internal auditing in charge.
c.Incorrect Independence is impaired when the audit firm performs more than 40 percent of financial-related internal audit work (i.e., outsourced internal audit work) for all clients with more than $200 million assets. So, this is an incorrect response.
d.Incorrect Independence is impaired when auditors perform important actuarial work and then audit their own work product (the client’s actuarial calculations based on the audit team-prepared assumptions).
B.26a.Incorrect The answer is both (a) and (b). Independence is not impaired in (a). Managers not on the engagement can own shares in nonclient sister funds.
b.Incorrect The answer is both (a) and (b). Independence is not impaired in (b). Close family members of audit partners can own shares in audit client sister funds not audited by the close family member’s relatives, so long as the shares are held through the family member’s employee benefit plan.
c.Correct: Independence is not impaired in (a) and is not impaired in (b). So, (c) is the correct answer.
d.Incorrect Independence is not impairedin (a) and is not impaired in (b). So, (c) is the correct answer.
B.27a.IncorrectA spouse is defined as an immediate family member.
b.IncorrectA spousal equivalent is defined as an immediate family member.
c.CorrectA parent is defined as a close relative but not an immediate family member.
d.IncorrectAn uncle is neither an immediate family member nor a close relative.
B.28a.IncorrectThe audit organization may not reduce the scope of its audit.
b.IncorrectThere are restrictions concerning where in the organization the nonaudit work can be performed.
c.IncorrectThe audit organization, not the government organization, must document why the nonaudit service does not affect independence.
d.CorrectThe scope of the audit work cannot be reduced because a public accounting firm performed it.
B.29a.Incorrect This is not true. For example, an auditor’s freedom to talk with clients about employment is not denied. The audit firm simply must take actions to mitigate any possible threat to the quality audit work.
b.Incorrect Maybe a second-best answer, but the “efficiencies” are offset by the extra review the audit firm is obligated to perform.
c.Incorrect Former audit partners can retain material retirement accounts only if they are fixed as to amount and timing. (The “variable” word in the question negates the “fixed” requirement.)
d.Correct The public accounting firm must discuss with the audit client’s board or its audit committee the independence implications of the client’s hiring the audit engagement team manager as its financial vice president.
B.30d.Correct The Accounting and Review Services Committee has been so authorized.
B.31b.CorrectThe Federal Accounting Standards Advisory Board has been so authorized.
B.32a.CorrectHe is "holding out" as a CPA and does work that other CPAs perform.
b.IncorrectMere partnership with another CPA is not enough if the other CPA does not "hold out."
c.IncorrectWorking in a corporation with another CPA is not enough if the other CPA does not "hold out."
d.IncorrectIf he does not "hold out" as a CPA, he is not in public accounting, according to the AICPA.
B.33a.IncorrectCPAs generally prefer to compete on the basis of quality of service rather than price.
b.IncorrectThe conventional wisdom is the opposite of this statement.
c.CorrectThe FTC dragged the AICPA kicking and screaming into the agreement.
d.IncorrectThe AICPA "principles" statements assert that objectivity is always necessary.
B.34a.IncorrectIndependence is impaired by a direct financial interest in the client.