Chapter 19

1. CHAPTER 19INDEPENDENCE, PROFESSIONAL CONTDUCT, AND QUALITY CONTROL Chapter 19

2. SEC RULES ON AUDITOR INDEPENDENCE • Rule 2-01 stipulates that auditors must be independent of their audit clients both in fact and appearance • Independence is impaired if the service: • Creates a mutual or conflicting interest between the accountant and the audit client • Places the accountant in the position of auditing his or her own work • Results in the accountant acting as management or an employee of the audit client • Places the accountant in a position of being an advocate for the audit client

3. SEC RULES ON AUDITOR INDEPENDENCE • Financial and employment relationships: • Revised rules focus on people who can influence the audit and not all partners in the CPA firm • Similar to the revised AIPCA rules

4. SEC RULES ON AUDITOR INDEPENDENCE • Nonaudit Services – Following are prohibited or limited: • Bookkeeping • Certain types of financial information systems design and implementation • Appraisal or valuation services and fairness opinions • Actuarial services to insurance companies • Management functions • Human resource services • Broker-dealer services • Legal services • Internal audit services

5. SEC RULES ON AUDITOR INDEPENDENCE • Disclosure of Nonaudit Services - Disclose in its proxy statement the following information: • Fees billed for services provided by the CPA • Audit fees • IT systems design and implementation fees • All other fees • Audit committee consideration of services

6. PARTS OF THE CODE OF PROFESSIONAL CONDUCT • AICPA Code of Professional Conduct consists of: • Principles of Professional Conduct • Rules of Conduct • Additional guidance for applying Rules of Conduct • Interpretations of Rules of Conduct • Ethics Rulings by the Professional Ethics Executive Committee

7. PRINCIPLES OF PROFESSIONAL CONDUCT • Responsibilities: • The public interest: • Integrity: • Objectivity and independence: • Due care: • Scope and nature of services:

8. Key Definitions • Close Relative: Parent, sibling or nondependent child • Covered Member: • Individual on the attest engagement team • Individual in a position to influence the engagement • Partner or Manager who provides > 10 hours of nonattest services to the attest client • Partner in the office where the lead engagement partner practices • The firm, including the firm’s employee benefit plan

9. Key Definitions • Holding Out: Action that informs others of CPA status • Immediate Family: Spouse (or equivalent) & dependent • Key Position: Individual who has primary responsibility for significant accounting functions; preparation of the financial statements; or exercise influence over the f/s • Practice of Public Accounting: Performance for a client of accounting, tax, financial planning, litigation support services, etc.

10. ORGANIZATION OF THE RULES OF CONDUCT • Independence, Integrity, and Objectivity • General Standards and Accounting Principles • Responsibilities to Clients • Responsibilities to Colleagues • Other Responsibilities and Practices

11. INDEPENDENCE RULE 101 A member in public practice shall be independent in the performance of professional services as required by standards promulgated by bodies designated by Council.

12. INDEPENDENCE • Revised rules are focused on a “covered member” and takes an engagement team approach • Independence is examined along two dimensions: • Financial interests: Prohibits members from any direct or material, indirect financial interest in the client. • Managerial interests: Generally prohibits a CPA from performing a managerial role within a client’s organization. (some exceptions: e.g. member who serves as honorary director)

13. INDEPENDENCE • Independence can be affected by: • Family relationships: Distinction between close relatives and immediate family. Immediate family is subject to Rule 101 but close relatives generally are not (with a few exceptions) • Effect of actual or threatened litigation: threatened or actual litigation (1) between the client and CPA; (2) by the shareholders; (3) other 3rd parties may affect candor • See Table 19-5

14. INTEGRITY AND OBJECTIVITY RULE 102 In the performance of any 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. Example: A member who knowingly makes false or misleading entries in f/s violates this Rule.

15. GENERAL STANDARDS AND ACCOUNTING PRINCIPLES • RULE 201 • A member shall comply with the following standards and with any interpretations thereof: • Professional Competence • Due Professional Care • Planning and Supervision • Sufficient Relevant Data

16. GENERAL STANDARDS AND ACCOUNTING PRINCIPLES RULE 202 A member who performs auditing, review, compilation, management consulting, tax, or other professional services shall comply with standards promulgated by bodies designated by Council.

17. ACCOUNTING PRINCIPLES RULE 203 A member shall not (1) express an opinion or state affirmatively that the financial statements or other financial data of any entity are presented in conformity with generally accepted accounting principles or (2) state that he or she is not aware of any material modifications that should be made to such statements or data in order for them to be in conformity with generally accepted accounting principles, if such statements or data contain any departure from an accounting principle promulgated by bodies designated by Council to establish such principles that has a material effect on the statements or data taken as a whole.

18. CONFIDENTIAL CLIENT INFORMATION RULE 301 A member in public practice shall not disclose any confidential client information without the specific consent of the client.

19. SITUATIONS WHERE A CPA CAN DISCLOSE CONFIDENTIAL CLIENT INFORMATION • Meet disclosure requirements for GAAP and GAAS • Comply with a valid and enforceable subpoena • Required by an authorized peer review • Part of an investigative or disciplinary proceeding

20. CONTINGENT FEES RULE 302 A member in public practice shall not: (1) Perform for a contingent fee any professional services for, or receive such a fee from a client for whom the member or the member's firm performs (a) an audit or review of financial statements; or (b) a compilation of a financial statement when the member expects, or reasonably might expect, that a third party will use the financial statement and the member's compilation report does not disclose a lack of independence; or (c) an examination of prospective financial information; or (2) Prepare an original or amended tax return or claim for a tax refund for a contingent fee for any client.

21. DISCREDITABLE ACTS RULE 501 A member shall not commit an act discreditable to the profession.

22. ACTS DISCREDITABLE UNDER RULE 501 • Retention of client records (e.g. journals or ledgers) • Discrimination and harassment in employment practices • Failure to follow standards and/or procedures or other requirements in governmental audits • Negligence in the preparation of financial statements or records

23. ACTS DISCREDITABLE UNDER RULE 501 (continued) • Failure to follow requirements of governmental bodies, commissions, or other regulatory agencies in performing attest or similar services • Solicitation or disclosure of CPA examination questions and answers • Failure to file tax return or pay tax liability

24. ADVERTISING AND OTHER FORMS OF SOLICITATION RULE 502 A member in public practice shall not seek to obtain clients by advertising or other forms of solicitation in a manner that is false, misleading, or deceptive.

25. EXAMPLES OF FALSE, MISLEADING OR DECEPTIVE ADVERTISING • Create false expectations of favorable results • Imply the ability to influence any court, tribunal, regulatory agency, or similar body or official • Representation that specific professional services in current or future periods will be performed for a stated fee, estimated fee, or fee range when it is likely that such fees would be substantially increased and the prospective client was not advised of that likelihood • Other representations that would be likely to cause a reasonable person to misunderstand or be deceived

26. COMMISSIONS AND REFERRAL FEES RULE 503 Prohibited commissions when a member or the member's firm also performs for that client • an audit or review of financial statements; or • a compilation of a financial statement when the member expects, or reasonably might expect, that a third party will use the financial statement and the member's compilation report does not disclose a lack of independence; or • an examination of prospective financial information

27. FORM OF ORGANIZATION AND NAME RULE 505 Requires that a member may practice public accounting only in the form of organization permitted by state law or regulation whose characteristics conform to resolutions of Council. A member shall not practice public accounting under a firm name that is misleading.

28. QUALITY CONTROL A system of quality control for a firm encompasses the firm's organizational structure and policies adopted and procedures established to provide the firm with reasonable assurance of conforming with professional standards