AUDITING CHAPTER 4

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AUDITINGCHAPTER 4

• Professional Ethics
• By
• David N. Ricchiute

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TOPICS

• General, professional ethics collapse of Enron,
  Andersen
• AICPA Code of Professional Conduct
• AICPA Rules of Conduct SEC Independence Rules
• Ethics enforcement
• PCAOB rules AICPA practice monitoring system

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GENERAL, PROFESSIONAL ETHICS

• General ethics
• Study of ideal conduct, behavior
• Professional ethics
• Applies general ethics to choices, consequences
  of a profession
• Does not, cannot require ideal standards
• Enforces minimum standards

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ETHICAL REASONING

• Opinion
• Personal opinion absent self interest neither
  right nor wrong
• What do I think?
• Self-interest
• Whats in it for me?
• Consequence
• Whats in it for everyone
• Duty
• What is my duty?
• Character
• How will this reflect on me?

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ENRON, ANDERSEN FACTS

• Enron
• Once ranked 7th on Fortune 500
• Thousands of investors, retirees who invested
  heavily in Enron lost millions
• Andersen
• Big 5 auditor at the time

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ENRONQuestionable Accounting

• Deducting notes received for common stock from
  equity
• Reporting inflated values for broadband assets
  content-service businesses
• Special purpose entities (SPE)
• Enron off-loaded debt to SPEs
• Enron recorded gains on sales to SPEs because not
  consolidated
• Chewco, with lt3 at risk not consolidated when
  should have been

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ENRON QUOTE

• I am incredibly nervous that we will implode in a
  wave of accounting scandals. My 8 years of Enron
  work history will be worth nothing on my resume,
  the business world will consider the past
  successes as nothing but an elaborate accounting
  hoax.
• What form of ethical reasoning is this?
• New York Times, 1/16/02, p. A6.

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ANDERSENQuestionable Auditing

• Did not issue qualified opinion for
  unconsolidated Enron subsidiary, Chewco

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ANDERSEN QUOTE

• I have not spoken to the Practice Director. I do
  not know if he knows how much we cannot support
  this. Where do we go from here? This is a big
  item and the team apparently does not want to go
  back to the client on this.
• What form of ethical reasoning did the team use?
• http//energycommerce.house.gov/107/News/04022002_
  527.htm

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1980S CONSULTING, AUDITING

• Conflict
• Independence, objectivity
• Solutions
• Code Professional Conduct applies to all
  professional activities
• Mandatory quality assurance program

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21st CENTURY CONSULTING AUDITING

• SEC concerns
• Consulting . . . May shorten distance between
  auditor, management
• Big 5 clients paying more for consulting than
  auditing
• POB concerns
• Ratio accounting, auditing revenues to consulting
  revenues dropping to 1.51

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ETHICS VULNERABILITY RISK ASSESSMENT

• Assessment of risks bearing on corporate ethics
• Sexual harassment
• Environmental contamination
• Antitrust infractions
• Improper foreign payments
• Fraudulent financial reporting

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AICPA CODE OF PROFESSIONAL CONDUCT

• Principles
• Framework for Rules of Conduct
• Unenforceable
• Rules of Conduct
• Govern performance AICPA members

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PRINCIPLES OF PROFESSIONAL CONDUCT 1

• Responsibilities
• Use moral judgment
• Public interest
• Honor public trust
• Integrity

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PRINCIPLES OF PROFESSIONAL CONDUCT 2

• Objectivity, independence
• Free of conflicts of interest
• Independence in fact appearance when auditing
• Due care
• Observe technical, ethical standards improve
• Scope, nature of services
• Observe Code Professional Conduct

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INTERPRETATIONS ETHICS RULINGS

• Interpret scope, applicability of Rules of
  Conduct
• Summarize applicability of Rules of Conduct,
  Interpretations to detailed fact situations

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AICPA RULES OF CONDUCT Independence (101)

• Applies to all practicing CPAs in audit, attest
  services
• AICPA interpretations affecting independence
• Litigation or intent to litigate by management
  for deficiencies in work
• Litigation by auditor for fraud, deceit
• Other material litigation

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SECs AUDITOR INDEPENDENCE ISSUES

• Whether a relationship or service
• Is prohibited by Sarbanes-Oxley
• Involves client who has hired former auditor
  within 1 year
• Violates mandatory partner 5-year rotation rule
• Audit committee pre-approval of services rule
• Compensates audit partner for non-audit/attest
  services
• Fees not disclosed if for services

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SEC FINANCIAL INDEPENDENCE RULES

• No direct or material indirect financial
  relationship
• Joint, material closely held business investment
  with client
• Loan from client out of ordinary course of
  business
• Investment gt 5 clients equity securities
• No business relationship
• No bookkeeping
• No operating, supervising clients information
  system

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SEC OTHER INDEPENDENCE RULES

• Not supplying actuarial advisory services for
  policy reserves
• Not supplying more than 40 internal audit hours
• No management functions or decision making
• No human resources or broker-dealer functions
• No legal services

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AICPA RULES OF CONDUCT Integrity, Objectivity
(102)

• In any service, AICPA member shall
• Be free of conflicts of interest and
• Shall not knowingly
• Misrepresent facts
• Subordinate judgment

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AICPA RULES OF CONDUCT General Standards (201)

• AICPA member shall comply with standards for
• Professional competence
• Due professional care
• Planning supervision
• Obtaining sufficient relevant data

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AICPA RULES OF CONDUCT Compliance, Principles
(202, 203)

• AICPA member shall
• Comply with standards promulgated by designated
  bodies
• AICPA member shall not, if false
• Express opinion in conformity with GAAP
• State unaware of material modifications necessary
  to conform to GAAP
• If GAAP misleading, AICPA member can describe
  necessary departure

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GAAP HIERARCHY

• FASB Statements, APB opinions, ARBs
• FASB Technical Bulletins, AICPA accounting,
  auditing guides, AICPA Statements of Position
• AICPA accounting standards practice bulletins
• AICPA accounting interpretations, FASB
  implementation guides

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AICPA RULES OF CONDUCT Confidentiality (301)

• AICPA member shall not
• Disclose confidential client information without
  specific consent of client except under law or
  disciplinary body

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AICPA RULES OF CONDUCTContingent Fees (302)

• AICPA member shall not
• Perform any service for a contingent fee for any
  audit, review or compilation client
• Prepare tax return for contingent fee

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AICPA RULES OF CONDUCT Acts Discreditable (501)

• 3 Interpretations
• Working papers are accountants property
• No discrimination based on race, color, sex, age,
  national origin in hiring, promotion, salary,
  other employment practices
• Nondisclosure CPA exam questions, solutions after
  May 1996

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AICPA RULES OF CONDUCT Advertising, Soliciting
(502)

• AICPA member shall not
• Obtain clients by false, misleading, deceptive
  advertising
• Use coercion, overreaching, harassing conduct in
  solicitation

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AICPA RULES OF CONDUCT Commissions, Referral
Fees (503)

• Prohibited commissions
• Audit, review
• Compilation
• Examination prospective statements
• Must disclose permitted commissions referral
  fees

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AICPA RULES OF CONDUCT Form of Practice, Name
(505)

• Form of organization must be permitted by state
  law
• Name shall not be misleading
• May not designate itself as Members of AICPA
  unless all partners, shareholders are members of
  institute

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MOINTORING PUBLIC ACCOUNTING FIRMS

• For all firms
• Quality control
• Internal policies, procedures designed to assure
  consistent performance across engagements
• Firms that audit public companies
• PCAOB Rules for Inspection AICPA Center for
  Public Company Audit Firms
• Firms without public audit clients
• Peer review
• AICPA Peer Review Program

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ELEMENTS OF QUALITY CONTROL POLICIES

• Independence, integrity, objectivity
• Personnel management
• Acceptance, continuance of clients
• Engagement performance
• Monitoring

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PCAOB RULES

• Under authority of Sarbanes-Oxley
• Regular inspections
• Annually for firms auditing more than 100 public
  companies
• Special inspections
• Every 3 years for firms whose public audit
  clients number between 1 and 100

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JOINT ETHICS ENFORCEMENT

• 3 Organizations enforce ethical conduct
• AICPA
• State societies of CPAs
• State boards of accountancy
• Penalties include
• Suspension
• Expulsion
• License revocation