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AUDITING CHAPTER 4

AUDITING CHAPTER 4. Professional Ethics By David N. Ricchiute. 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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AUDITING CHAPTER 4

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  1. AUDITINGCHAPTER 4 Professional Ethics By David N. Ricchiute

  2. 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 GBW 8th ed., Ch. 4

  3. 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 GBW 8th ed., Ch. 4

  4. ETHICAL REASONING • Opinion • Personal opinion absent self interest; neither right nor wrong • “What do I think?” • Self-interest • “What’s in it for me?” • Consequence • “What’s in it for everyone • Duty • “What is my duty?” • Character • “How will this reflect on me?” GBW 8th ed., Ch. 4

  5. 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 GBW 8th ed., Ch. 4

  6. 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 <3% at risk not consolidated when should have been GBW 8th ed., Ch. 4

  7. 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. GBW 8th ed., Ch. 4

  8. ANDERSENQuestionable Auditing • Did not issue qualified opinion for unconsolidated Enron subsidiary, Chewco GBW 8th ed., Ch. 4

  9. 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 GBW 8th ed., Ch. 4

  10. 1980’S CONSULTING, AUDITING • Conflict • Independence, objectivity • Solutions • Code Professional Conduct applies to all professional activities • Mandatory quality assurance program GBW 8th ed., Ch. 4

  11. 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 1.5:1 GBW 8th ed., Ch. 4

  12. ETHICS VULNERABILITY RISK ASSESSMENT Assessment of risks bearing on corporate ethics • Sexual harassment • Environmental contamination • Antitrust infractions • Improper foreign payments • Fraudulent financial reporting GBW 8th ed., Ch. 4

  13. AICPA CODE OF PROFESSIONAL CONDUCT • Principles • Framework for Rules of Conduct • Unenforceable • Rules of Conduct • Govern performance AICPA members GBW 8th ed., Ch. 4

  14. PRINCIPLES OF PROFESSIONAL CONDUCT 1 • Responsibilities • Use moral judgment • Public interest • Honor public trust • Integrity GBW 8th ed., Ch. 4

  15. 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 GBW 8th ed., Ch. 4

  16. INTERPRETATIONS & ETHICS RULINGS • Interpret scope, applicability of Rules of Conduct • Summarize applicability of Rules of Conduct, Interpretations to detailed fact situations GBW 8th ed., Ch. 4

  17. 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 GBW 8th ed., Ch. 4

  18. SEC’s 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 GBW 8th ed., Ch. 4

  19. 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 > 5% client’s equity securities • No business relationship • No bookkeeping • No operating, supervising client’s information system GBW 8th ed., Ch. 4

  20. 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 GBW 8th ed., Ch. 4

  21. 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 GBW 8th ed., Ch. 4

  22. 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 GBW 8th ed., Ch. 4

  23. 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 GBW 8th ed., Ch. 4

  24. GAAP HIERARCHY • FASB Statements, APB opinions, ARB’s • FASB Technical Bulletins, AICPA accounting, auditing guides, AICPA Statements of Position • AICPA accounting standards & practice bulletins • AICPA accounting interpretations, FASB implementation guides GBW 8th ed., Ch. 4

  25. 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 GBW 8th ed., Ch. 4

  26. AICPA RULES OF CONDUCT:Contingent 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 GBW 8th ed., Ch. 4

  27. AICPA RULES OF CONDUCT: Acts Discreditable (501) • 3 Interpretations • Working papers are accountant’s 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 GBW 8th ed., Ch. 4

  28. 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 GBW 8th ed., Ch. 4

  29. AICPA RULES OF CONDUCT: Commissions, Referral Fees (503) • Prohibited commissions • Audit, review • Compilation • Examination prospective statements • Must disclose permitted commissions & referral fees GBW 8th ed., Ch. 4

  30. 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 GBW 8th ed., Ch. 4

  31. 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 GBW 8th ed., Ch. 4

  32. ELEMENTS OF QUALITY CONTROL POLICIES • Independence, integrity, objectivity • Personnel management • Acceptance, continuance of clients • Engagement performance • Monitoring GBW 8th ed., Ch. 4

  33. 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 GBW 8th ed., Ch. 4

  34. JOINT ETHICS ENFORCEMENT • 3 Organizations enforce ethical conduct • AICPA • State societies of CPAs • State boards of accountancy • Penalties include • Suspension • Expulsion • License revocation GBW 8th ed., Ch. 4

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