Review Question CH4.doc

Chapter 4Professional Ethics4-1 (Objective 4-1) What are the six core ethical values described by the Josephson Institute? What are some other sources of ethical values?The six core ethical values described by the Josephson Institute are:1. Trustworthiness4. Fairness2. Respect5. Caring3. Responsibility6. CitizenshipThere are many other potential sources of ethical values, including laws and regulations, church doctrines, codes of professional ethics, and individual organizations codes of conduct.4-2 (Objective 4-2) Describe an ethical dilemma. How does a person resolve an ethical dilemma?An ethical dilemma is a situation that a person faces in which a decision must be made about the appropriate behavior. There are many possible ethical dilemmas that one can face, such as finding a wallet containing money, or dealing with a supervisor who asks you to work hours without recording them.An ethical dilemma can be resolved using the six-step approach outlined on p. 76 of the text. The six steps are:1. Obtain the relevant facts.2. Identify the ethical issues from the facts.3. Determine who is affected by the outcome of the dilemma and how each person or group is affected.4. Identify the alternatives available to the person who must resolve the dilemma.5. Identify the likely consequence of each alternative.6. Decide the appropriate action.4-3 (Objective 4-3) Why is there a special need for ethical behavior by professionals? Why do the ethical requirements of the CPA profession differ from those of other professions?There is a special need for ethical behavior by professionals to maintain public confidence in the profession, and in the services provided by members of that profession. The ethical requirements for CPAs are similar to the ethical requirements of other professions. All professionals are expected to be competent, perform services with due professional care, and recognize their responsibility to clients. The major difference between other professional groups and CPAs is independence. Because CPAs have a responsibility to financial statement users, it is essential that auditors be independent in fact and appearance. Most other professionals, such as attorneys, are expected to be an advocate for their clients.4-4 (Objective 4-4) List the four parts of the Code of Professional Conduct, and state the purpose of each.PARTPURPOSE1.Principles of Professional Conduct1.Provide ideal standards of ethical conduct and help practitioners understand the ideal conduct of a CPA.2.Rules of conduct2.Provide minimum standards of ethical conduct stated as specific rules.3.Interpretation of the rules of conduct3.Provide formal interpretations of the rules of conduct to answer questions that frequently arise about the rules of conduct.4.Ethical rulings4.Provide more detailed guidance to practitioners about interpretation of the rules of conduct for less commonly raised questions.4-5 (Objective4-5) Distinguish between independence of mind and independence in appearance. State three activities that may not affect independence of mind but are likely to affect independence in appearance.Independence in fact exists when the auditor is actually able to maintain an unbiased attitude throughout the audit, whereas independence in appearance is dependent on others interpretation of this independence and hence their faith in the auditor.Activities which may not affect independence in fact, but which are likely to affect independence in appearance are: (Notice that the first two are violations of the Code of Professional Conduct.)1. Ownership of a financial interest in the audited client.2. Directorship or officer of an audit client.3. Performance of management advisory or bookkeeping or accounting services and audits for the same company.4. Dependence upon a client for a large percentage of audit fees.5. Engagement of the CPA and payment of audit fees by management.4-6 (Objective 4-5) Why is an auditors independence so essential?Independence in auditing means taking an unbiased viewpoint. Users of financial statements would be unlikely to rely on the statements if they believed auditors were biased in issuing audit opinions.4-7 (Objective 4-5) What consulting or nonaudit services are prohibited for auditors of public companies? What other restrictions and requirements apply to auditors when providing non audit services to public companies?Auditors of public companies are prohibited from performing the following nonaudit services:1. Bookkeeping and other accounting services2. Financial information systems design and implementation3. Appraisal or valuation services4. Actuarial services5. Internal audit outsourcing6. Management or human resource functions7. Broker or dealer or investment adviser, or investment banker services8. Legal and expert services unrelated to the audit9. Any other service that the PCAOB determines by regulation is impermissibleNonaudit services that are not prohibited by the SarbanesOxley Act and the SEC rules must be pre-approved by the companys audit committee. In addition, an accountant is not independent of an audit client if an audit partner received compensation based on selling engagements to that client for services other than audit, review and attest services.Companies are required to disclose in their proxy statement or annual filings with the SEC the total amount of audit and nonaudit fees paid to the audit firm for the two most recent years. Four categories of fees are to be reported: (1) audit fees; (2) audit-related fees; (3) tax fees; and (4) all other fees. Companies are also required to provide further breakdown of the “other fees” category, and provide qualitative information on the nature of the services provided.4-8 (Objective 4-6) Explain how the rules concerning stock ownership apply to partners and professional staff. Give an example of when stock ownership would be prohibited for each.The rules concerning stock ownership by partners and professional staff:A partner in the office of the partner responsible for an audit engagement cannot own stock in that audit client. A partner can own stock in an audit client, as long as (1) he or she cannot influence the audit engagement and (2) he or she is not in the same office as the partner responsible for the audit engagement. A professional staff member cannot own stock in an audit client if he or she is assigned to the engagement or if he or she becomes a partner in the office of the partner responsible for the audit engagement. A professional staff member can own stock in a firms audit client as long as he or she does not participate in the audit engagement.Partner violation: A partner in the San Francisco office owns one share of stock of a client whose audit is conducted by a different partner in the San Francisco office.Professional staff violation: An audit manager owns stock in a client whose audit is performed by the office where the audit manager works. The manager is promoted to partner mid-year. As soon as the manager becomes a partner, there is a violation of Rule 101.4-9 (Objective 4-5) Many people believe that a CPA cannot be truly independent when payment of fees is dependent on the management of the client. Explain two approaches that could reduce this appearance of lack of independence.Ways to reduce the appearance of the lack of independence are: the use of an audit committee to select auditors made up of directors who are not a part of management; a requirement that all changes of auditors and reasons therefore be reported to the SEC or other regulatory agency; and approval of the CPA firm by stockholders at the annual meeting. The SarbanesOxley act requires that the audit committee of a public company consist only of independent members and be responsible for the appointment, termination, and compensation of the audit firm.4-10 (Objective 4-7) After accepting an engagement, a CPA discovers that the clients industry is more technical than he realized and that he is not competent in certain areas of the operation. What are the CPAs options?A CPA firm has several options when it decides it is not competent to perform an audit:1. Withdraw from the engagement.2. Obtain the expertise through continuing education and self-studies.3. Hire someone who has the expertise.4. Work on a consulting basis with another CPA firm.4-11 (Objective 4-7) Assume that an auditor makes an agreement with a client that the audit fee will be contingent upon the number of days required to complete the engagement. Is this a violation of the Code of Professional Conduct? What is the essence of the rule of professional ethics dealing with contingent fees, and what are the reasons for the rule?A fee based upon the amount of time it takes to complete is not a violation of Rule 302. Rule 302 on contingent fees states that professional services for clients receiving assertion opinions shall not be offered or rendered under an agreement whereby no fee will be charged unless a specific finding or result is attained, or where the fee is otherwise contingent upon the findings or results of such services. The purpose of the rule is to prevent sacrificing the quality of audits because of the pressure felt by the auditor in producing the required audit outcome. An example would be the fee being dependent upon the issuance of an unqualified opinion or the obtaining of a loan by a client.4-12 (Objective 4-7) The auditors audit files usually can be provided to someone else only with the permission of the client. Give three exceptions to this general rule.The following are exceptions to the confidentiality requirement for the CPAs audit files:1. The confidentiality requirement cannot interfere with the members obligation to follow auditing standards or generally accepted accounting principles. 2. A member must comply with a validly issued subpoena or summons enforceable by order of a court.3. A review of a members professional practice under AICPA or state CPA society or state Board of Accountancy authorization is permitted.4. A member must respond to any inquiry made by the 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.4-13 (Objective 4-7) Identify and explain factors that should keep the quality of audits high even though advertising and competitive bidding are allowed.Audits should be maintained at a high level of quality even if solicitation, advertising, and competitive bidding are allowed for several reasons:1. Professionals do high quality work because it is a characteristic of being a professional.2. A reputation of doing high quality work usually pays off in more clients and a more profitable practice.3. Potential legal liability is also a deterrent to substandard work.4. The Code of Professional Conduct requires a high quality of performance.4-14 (Objective 4-7) Summarize the restrictions on advertising by CPA firms in the rules of conduct and interpretations.A member is permitted to advertise by Rule 502 except in a false, misleading, or deceptive manner. Interpretation 502-2 clarifies the meaning of false, misleading or deceptive acts, including activities that:1. Create false or unjustified expectations of favorable results.2. Imply the ability to influence any court, tribunal, regulatory agency or similar body or official.3. Contain a representation that specific professional services will be performed for a stated fee, when it was likely at the time of the representation that such fees would be substantially increased and the prospective client was not informed of that likelihood.4. Contain any other representations that would be likely to cause a reasonable person to misunderstand or be deceived. When engagements are obtained through the efforts of third parties, Interpretation 502-5 indicates that the member has the responsibility to ascertain that all promotional efforts are within the bounds of the Rules of Conduct.4-15 (Objective 4-7) What is the purpose of the AICPAs Code of Professional Conduct restriction on commissions as stated in Rule 503?Prohibiting paying commissions to obtain clients who receive attestation services in Rule 503 is intended to discourage overly aggressive obtaining of clients by