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Lesson 4 professional ethics, Lecture notes of Accounting

London Business School (LBS)Accounting

Chapter 4

Typology: Lecture notes

2015/2016

Uploaded on 05/08/2016

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Lesson 4--Professional Ethics
4-1 What Are Ethics?
Ethics consist of moral principles or ways of behaving that benefit society. Some
ethical behaviors that you have been taught are summarized in Figure 1-1--such as
trustworthiness, respect, responsibility, fairness, etc.
Unfortunately, some individuals do unethical things. Your text suggests that there are
two basic reasons that people behave unethically--either their personal ethics differ
from those of society, or they are acting out of greed or selfishness.
4-2 Ethical Dilemmas
Ethical situations often present conflicting objectives, and it is sometimes tempting to
rationalize a particular course of action that is unethical. Typical rationalizations for
such behavior include: 1) everyone is doing it; 2) it it is legal it must also be ethical;
and 3) no one will know the difference. A process for managing one's personal ethical
dilemmas is as follows:
1. Obtain the facts;
2. Identify the ethical issues;
3. Examine the effects of various outcomes on each participant;
4. Identify alternatives;
5. Look at the consequences of each alternative;
6. Choose the appropriate action.
An illustration is provided in your text that illustrates this process.
4-3 Ethical Behavior in Accounting
CPAs are considered professionals, must like lawyers and doctors. Professionals are
typically required to hold a high standard of behavior, beyond the legal aspects of the
profession. Often, the CPA is acting on behalf of an unseen public--those individuals
and organizations who rely on the fairness of financial statements in making
investment and loan decisions.
Although professions are to some extent self-regulating, guidance in ethical behavior
is provided by the AICPA Code of Conduct, as well as PCAOB and the SEC.
4-4 The AICPA Code of Conduct
The AICPA Code of Conduct contains four parts--principles, rules of conduct,
interpretations of the rules, and ethical rulings.
There are six ethical principles of conduct:
1. Responsibilities--the CPA should exercise professional judgment;
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Lesson 4--Professional Ethics

4-1 What Are Ethics?

Ethics consist of moral principles or ways of behaving that benefit society. Some ethical behaviors that you have been taught are summarized in Figure 1-1--such as trustworthiness, respect, responsibility, fairness, etc. Unfortunately, some individuals do unethical things. Your text suggests that there are two basic reasons that people behave unethically--either their personal ethics differ from those of society, or they are acting out of greed or selfishness.

4-2 Ethical Dilemmas

Ethical situations often present conflicting objectives, and it is sometimes tempting to rationalize a particular course of action that is unethical. Typical rationalizations for such behavior include: 1) everyone is doing it; 2) it it is legal it must also be ethical; and 3) no one will know the difference. A process for managing one's personal ethical dilemmas is as follows:

  1. Obtain the facts;
  2. Identify the ethical issues;
  3. Examine the effects of various outcomes on each participant;
  4. Identify alternatives;
  5. Look at the consequences of each alternative;
  6. Choose the appropriate action.

An illustration is provided in your text that illustrates this process.

4-3 Ethical Behavior in Accounting

CPAs are considered professionals, must like lawyers and doctors. Professionals are typically required to hold a high standard of behavior, beyond the legal aspects of the profession. Often, the CPA is acting on behalf of an unseen public--those individuals and organizations who rely on the fairness of financial statements in making investment and loan decisions. Although professions are to some extent self-regulating, guidance in ethical behavior is provided by the AICPA Code of Conduct, as well as PCAOB and the SEC.

4-4 The AICPA Code of Conduct

The AICPA Code of Conduct contains four parts--principles, rules of conduct, interpretations of the rules, and ethical rulings. There are six ethical principles of conduct:

  1. Responsibilities--the CPA should exercise professional judgment;
  1. The Public Interest--CPAs must honor the public trust;
  2. Integrity--CPAs must operate with integrity;
  3. Objectivity and Independence--these are cornerstones of CPA behavior;
  4. Due Care--CPAs must exercise due care to improve competence and quality of service;
  5. Scope and Nature of Service--observe the principles of the Code of Conduct in determining the scope and nature of services to be provided. This sixth principle applies to CPAs in the attest function; the other five principles apply to all CPAs.

While the principles are broad guidelines, the rules of conduct are more specific, and are enforceable. This is implied by the word "rule", as opposed to "principle." Moreover, the rules imply specific factual circumstances and provide a definitive answer. A Summary Table of the Rules of Conduct is shown in Table 4-1 at the end of the chapter, and addresses issues such as independence, confidentiality, contingent fees, advertising, and forms of organization. Note also that each rule is numbered and that some rules apply to all AICPA members, while others are for members in public practice only.

4-5 Sarbanes-Oxley Act and SEC Independence

Requirements

The SEC and the Sarbanes-Oxley Act have created rules to strengthen auditor independence with respect to:

  1. Nonaudit services, including prohibition of nine services in those cases where the CPA firm also provides audit services. Those prohibited services are bookkeeping/accounting services, financial information systems design, appraisal/valuation services, actuarial services, internal audit outsourcing, management/human resource functions, investment banker services, legal and expert services unrelated to the audit, and any other service designated non- permissible by PCAOB.
  2. The Audit Committee, a selected group of the auditee's board of directors;
  3. Conflicts from employment relationships, such as the employment of former audit team members;
  4. Partner rotation after five years;
  5. Ownership interests
  6. Unpaid fees.

4-6 Rule 101--Independence

Rule 101, Independence, is the first rule of professional conduct. Independence must be maintained in fact--the auditor must maintain a balanced, unbiased attitude. But,

  1. Discrimination or harassment in employment practices;
  2. Failure to follow agency or governmental rules in an audit;
  3. Negligence in preparing financial statements or records;
  4. Failure to follow requirements of governments, commissions or other regulatory agencies;
  5. Solicitation or disclosure of CPA examination questions and answers;
  6. Failure to file a tax return or pay a tax liability.

Rule 502 covers Advertising. CPA firms are allowed to advertise, as long as the advertising or other solicitation of clients is free of deception or misleading statements. Caution is required in that individual states may have laws against advertising, however.

Rule 503 Commissions and Referral Fees states that CPA firms are allowed to engage in a variety of services as long as attestation services are not also being provided to those same clients.

Rule 505 Form of Organization and Name specifies the organization types that are permissible for CPA firms. The permissible types are:

  1. Proprietorship;
  2. General Partnership;
  3. General Corporation;
  4. Professional Corporation (PC);
  5. Limited Liability Company (LLC);
  6. Limited Liability Partnership (LLP).

4-8 The Enforcement Mechanisms

For violations of the Rules of Conduct, there are two levels of disciplinary action for CPAs. On the one hand, the offending member can complete a remedial program; the more serious level of discipline is appearance before the Joint Trial Board, which can result in suspension or expulsion from the AICPA. Additionally, a state may take away a practitioner's license to practice. As the chapter summary points out, the Code of Professional Conduct helps to maintain public confidence in the CPA profession.