MODERN AUDITING 7th Edition

1. MODERN AUDITING 7th Edition William C. Boynton California Polytechnic State University at San Luis Obispo Raymond N. Johnson Portland State University Walter G. Kell University of Michigan Developed by: Dr. Raymond N. Johnson, CPA John Wiley & Sons, Inc.

2. Ethics and Morality General Ethics attempts to deal with ethical questions by defining what is good for the individual and society, and by trying to establish the nature of obligations or duties that individuals owe themselves and each other. Professional Ethics must extend beyond moral principles. They include standards of behavior for a professional person that are designed for both practical and idealistic purposes.

3. Framework for Ethical Decision Making • Obtain the facts relevant to the decision. • Identify the ethical issues from the facts. • Determine who will be affected by the decision and how. • Identify the decision-maker’s alternatives • Identify the consequences of each alternative • Make the ethical choice

4. AICPA Code Sections and Related PronouncementsFigure 3-1

5. Focus on AICPA Rules • Universally understood by CPAs • HOWEVER, CPAs must be aware of rules that may be written into State Board of Accountancy law.

6. Principles In the Code, the 6 principles are identified as follows: 1. Responsibilities 2. The Public Interest 3. Integrity 4. Objectivity and Independence 5. Due Care 6. Scope and Nature of Services

7. Rules of Conduct Figure 3-2

8. Rules of Conduct Figure 3-2

9. Independence Rules • Sources of authoritative guidance on independence • AICPA Rule 101 • SEC Rules • Sarbanes-Oxley Rules • What is the logic behind an engagement based approach vs. a firm based approach?

10. Independence Rules – SEC/AICPA • All firm members are prohibited from having: • Financial interests of > 5% of audit clients • Business or employment relationship with the client • Covered Persons/Members are subject to additional independence rules

11. Independence Rules – SEC/AICPA Who are “Covered Persons/Members”? • Any member of the engagement team • Partners and managers with consultation, oversight or review responsibilities related to the engagement. • Direct supervisors of the engagement partner including all successive senior levels • Partners and managers who perform (or expect to perform) more than 10 hours of non-attest services for the client. • Partners who are in the same office as the lead partner on the engagement. • The firm, its benefit plans, and entities controlled by covered persons • Those who evaluate partners’ performance and compensations, including members of compensation committees • Individuals who consult with the audit team regarding technical or industry related issues that are specific to the engagement. • Individual who participate in quality control activities for the firm.

12. Independence Rules – SEC/AICPA • Prohibited Activities • Cannot have a direct, or material indirect, investment in the audit client. • Cannot be a trustee or a trust or executor of an estate who invests directly in an audit client. (The AICPA and SEC permits an exception for a trustee who lacks authority to make investment decisions) • Cannot have a joint, closely held investment that is material to the covered member. • Cannot have loans to or from the audit client (there are some very limited exceptions).

13. Independence Rules – SEC/AICPA Immediate family members of covered persons • Includes: spouse, spouse equivalent, dependent • Must follow same rules as covered person • Exception: can be employed by audit client unless “exercise influence” over client F/S (Key Person Test) Close relatives of covered persons • Includes: parents, non-dependent children, siblings of audit team members • May not hold a “key position” in an audit client and may not hold a material financial interest in an audit client

14. Independence • Independence in Fact • Appearance of Independence

15. Independence Rules – 101-2Employment or Association with an Audit Client If a partner or a professional employee leaves the CPA firm and is subsequently employed by the client in a key position, independence will be impaired unless ALL of the following conditions are met. • Retirement benefits • Not in a position to influence the accounting firm’s operations or policies • Not associated with the former firm • Consider the risk that, by virtue of the former partner or professional employees prior knowledge of the audit plan, that audit effectiveness will be reduced. • The attest engagement team has appropriate experience and stature to deal with the former partner or professional employee. • The subsequent attest engagement is reviewed to determine whether the engagement team members maintained the appropriate level of professional skepticism.

16. Independence Rules – Employment PCAOB & SEC • Positions: CEO, CFO, Controller, Chief Accounting Officer, or person in an equivalent position • Prohibited Activity: Cannot have been employed by the company’s audit firm during the 1 year period preceding the audit.

17. Independence Rules – Non-Attest Services PCAOB & SEC The following non-audit services are prohibited: • Bookkeeping and accounting services • IT Design & Implementation • Appraisal and Valuation services • Actuarial services • Internal audit services • Management & HR functions • Broker/Dealer and Investment Banking services • Legal or expert services unrelated to audit services • “Other services” the PCOAB determines to be unacceptable • So far tax services have not been prohibited.

18. Independence Rules – 101-3Performance of Other Services Rule 101-3 indicates that before performing non-attest services, the member should establish an understanding with the client regarding: • the objectives of the engagement, • the services to be performed, • management's responsibilities, • the CPA’s responsibilities, and • the limitations of the engagement.

19. Independence Rules – 101-3Performance of Other Services General activities that impair independence • Authorizing, executing or consummating a transaction, or otherwise exercising authority on behalf of a client or having the authority to do so • Preparing source documents or originating data, in electronic or other form, evidencing the occurrence of a transaction (for example, purchase orders, payroll time records, and customer orders) • Having custody of client assets • Supervising client employees in the performance of their normal recurring activities • Determining which recommendations of the member should be implemented • Reporting to the board of directors on behalf of management • Serving as a client's stock transfer or escrow agent, registrar, general counsel or its equivalent

20. Integrity and Objectivity (102) • In the performance of a professional service, a member shall maintain objectivity and integrity; shall be free of conflicts of interest, and shall not knowingly misrepresent facts or subordinate his or her judgment to others.

21. Confidential Client Information (301) • General rule: Must not disclose confidential client information without the consent of the client. • Exceptions • F/S not GAAP • Courts • Peer review or ethics board

22. Other Ethics Rules • Contingent Fees (302) • Discreditable acts (501) • Advertising and other forms of solicitation (502) • Commissions and referral fees (503) • Form of organization and name (505)

23. Board of Accountancy Enforcement of the Rules 1. Board of Accountancy Enforcement Procedures 2. Disciplinary Provisions a.Fines. b.Continuing professional education. c.Revoke license to practice.