AICPA Code of Professional Conduct

AICPA Code of Professional Conduct

Learning Objectives

  • Learning Objective 4-1: Explain professional judgment and the CPA’s obligations under the AICPA Code of Conduct.

  • Learning Objective 4-2: Explain how to apply the threats and safeguards approach to independence.

  • Learning Objective 4-3: Discuss SEC actions taken against auditors because of a lack of independence.

  • Learning Objective 4-4: Describe the process to resolve ethical conflicts that may cause violations of the rules.

  • Learning Objective 4-5: Explain how the conceptual framework works to keep in check possible violations of integrity and objectivity for CPAs in business.

  • Learning Objective 4-6: Explain how to apply the rules of conduct in the AICPA Code to the performance of professional services.

  • Learning Objective 4-8: Describe the PCAOB independence and ethics rules.

Professional Judgment in Accounting

  • Definition of Professional Judgment: The process of reaching a decision or drawing a conclusion with various possible alternative solutions. It is influenced by personal behavioral traits such as:

    • Attitudes: Influence professional judgment through ethical values.

    • Ethical Values: Personal values linked to ethical sensitivity and judgment. Both factors lead to ethical awareness which is a mediator in ethical judgment situations.

  • Key Components of Professional Judgment:

    • Objectivity and Due Care: Essential attitudes/beliefs that promote sound professional judgment.

    • Professional Skepticism: An essential mindset that fosters independent thought among auditors.

KPMG Professional Judgment Framework

  • Framework Components:

    • Clarify Issues and Objectives: Determine what needs to be addressed.

    • Consider Alternatives: Explore different paths or solutions.

    • Gather and Evaluate Information: Collect necessary data and assess its relevance.

    • Reach Conclusion: Formulate a decision based on the information processed.

    • Articulate and Document Rationale: Clearly document the reasoning behind the conclusion reached.

  • Prescriptive Framework: While a structured way of professional judgment exists, auditors often face pressures like time constraints that may deviate their practices.

Cognitive Processes and the KPMG Framework

  • Importance of System 2 Thought Process:

    • Involves ethical awareness and application of ethical reasoning.

    • Navigating ethical analysis of harms, benefits, and stakeholder rights.

  • Cognitive Traps and Biases:

    • Groupthink: Tendency to conform to group consensus without critical evaluation.

    • Rush to Solve Problems: Prompting premature conclusions.

    • Judgment Triggers and Tendencies:

    • Availability Tendency: Relying on immediate examples or information that comes to mind.

    • Confirmation Tendency: Favoring information that supports existing beliefs.

    • Overconfidence Tendency: Excessive confidence in one's knowledge or decisions.

    • Anchoring Tendency: Fixation on initial information leading to biased decisions.

Role of Professional Skepticism

  • Definition: Professional skepticism is essential in developing professional judgment and involves maintaining independent thought, objectivity, and due care.

  • CPA Firm Management: Must establish a culture that encourages questioning minds during audits and enhances the exercise of professional skepticism during evidence evaluation.

AICPA Revised Code: Independence for Members in Public Practice

  • Violation of Rules: A CPA must not allow others acting on their behalf to engage in behaviors that they themselves are prohibited from.

  • State Board Regulations: In cases where AICPA rules conflict with regulations of the state board, CPAs are required to comply with the state board's rules.

General Responsibilities of the Independent Auditor

  • Quality of Professionals: Ensuring that audit work is performed by highly qualified professionals.

  • Quality Control Procedures: Maintaining high standards in both performance and compliance.

  • Independence, Objectivity, and Impartiality: Key traits necessary for auditors to perform their roles without biases.

  • Avoiding Conflicts of Interest and Maintaining Integrity: Essential principles governing auditor conduct.

Conceptual Framework for AICPA Independence Standards

  • Independence Requirement: Mandates both in fact and in appearance for audits and other attestation services.

  • Risk-Based Approach: The AICPA uses a structured method to identify and evaluate threats to independence:

    • Step 1: Identify and evaluate threats.

    • Step 2: Assess whether existing safeguards are sufficient to mitigate identified threats.

    • Step 3: If threats cannot be sufficiently mitigated, independence is considered impaired.

Threats to Independence

  • Self-Review Threat: Preparing documents used for the financial statements leads to self-review.

  • Advocacy Threat: Involvement in advocating for client interests such as in an IPO.

  • Adverse Interest Threat: Initiating legal action by either the client or the CPA implies conflict.

  • Familiarity Threat: CPA's close relationship with a client’s executive, like a spouse being the CEO.

  • Undue Influence Threat: Client threatens to change CPA firms due to disagreements, creating an undue influence.

  • Financial Self-Interest Threat: Financial ties, like loans to CPAs from clients, present self-interest issues.

  • Management Participation Threat: CPAs actively involved in establishing client's internal control systems.

Safeguards Against Independence Threats

  • Safeguards Established by Profession, Legislation, or Regulation: Resources such as ethical hotlines.

  • Client Implemented Safeguards: Ensuring suitable personnel with competency oversee service delivery and compliance.

  • Firm Implemented Safeguards: Policies and procedures that address ethical conduct and compliance.

SOX and Nonaudit Services

  • Prohibited Nonaudit Services Under SOX: Includes financial system design, valuation services, internal audit outsourcing, and more. Tax services must be pre-approved by the audit committee.

Relationships that May Impair Independence

  • Relationships Considered: Financial, business, employment, and associative relationships that may impair independence.

Providing Nonattest Services to an Attest Client

  • Management Responsibilities: Clients must take full control over management functions, ensuring no conflict arises from the services provided.

SEC Position on Auditor Independence

  • Core Principles:

    • Independence must be maintained in both fact and appearance.

    • Certain financial interests and relationships with audit clients must be prohibited.

    • Auditor roles should not overlap management functions.

General Standard of Independence

  • Assessment: Independence is judged from the perspective of a reasonably informed investor considering all relevant circumstances.

  • Situations Impairing Independence: Includes conflicting interest, auditing one's own work, acting in a managerial capacity, or advocating for the client.

Discreditable Acts

  • Examples of Discreditable Acts: Cheating on internal exams, discriminatory practices, and failure to adhere to professional conduct standards.

SEC Actions Against Big Four Audit Firms

  • Specific Incidents:

    • PwC engaged in prohibited nonaudit services.

    • EY partners involved in inappropriate relationships.

    • KPMG cases of insider trading.

    • Deloitte maintained unduly close ties with audit clients.

Loosening the Independence Rules

  • Current Focus: Emphasis shifted towards auditor objectivity and impartiality rather than mere adherence to fixed independence rules as of October 2020.

Materiality Issues

  • Criteria Usage: Firms using materiality standards to gauge whether nonaudit services diverge from independence requirements create challenges in ethical assessments.

Ethical Conflicts in the AICPA Code

  • Conflict Situations: Highlighted ethical conflicts exist when professional relationships or services potentially impair objective judgment.

  • Resolving Ethical Conflicts: CPAs must assess conflicts, justify any departures from rules/laws, and ensure transparency with clients regarding conflicts and possible resolutions.

Subordination of Judgment

  • Integrity Rule: Prohibits willful misrepresentation or suppression of factual interpretations; CPAs must confront differing opinions on material matters rigorously without compromising integrity.

Conceptual Framework for Members in Business

  • Threats to Integrity: Similar threats as mentioned above apply although independence is not governed in this section.

Rules for the Performance of Professional Services

  • General Standards: Require competence, adherence to accounting principles, and the avoidance of acts that could discredit the profession.

  • Acts Discreditable Range: Includes a variety of violations that may discredit an accounting firm/individual.

Confidentiality of Information

  • Protection of Client Information: CPAs must refrain from disclosing confidential information unless under specified conditions.

Ethics and Tax Services

  • Tax Services Definition: Encompasses tax compliance, consulting, and planning focusing on ethical advisement over tax positions.

  • Legal Definitions: Clarification that tax avoidance is legal while tax evasion is criminal.

Tax Shelters

  • Misconduct in Tax Shelters: Notable cases such as KPMG’s fraudulent documentation to evade tax and Caterpillar’s profit shifting exemplify severe ethical breaches in tax practices.

PCAOB Rules

  • Standards Overview: Various PCAOB rules governing ethics and independence, including guidelines for auditor independence and transparency requirements related to internal controls.

PCAOB Inspections and Quality Control

  • Inspection Findings: Recent inspections reveal concerning deficiencies in quality control among auditing firms, with significant quality control criticisms reported in audits conducted.