Accounting Assignment

asalama

ACCT544-PowerPointChapter41.pptx

Home >Business & Finance homework help >Accounting homework help >Accounting Assignment

Chapter 4 Ethics and Professional Judgment in Accounting

Questions for Consideration

What are the underlying behavioral characteristics of good judgment?

What is the link between moral reasoning methods and making professional judgments?

How does cognitive dissonance influence professional judgment?

What is the role of professional judgment in making ethical decisions?

How does the AICPA Code address issues of professional judgment?

Public Watchdog Function (1 of 2)

Public responsibility transcending any employment responsibility with the client

Ultimate allegiance to the corporation’s creditors and stockholders, as well as to the investing public

Accountant must maintain total independence from the client at all times and requires complete fidelity to the public trust

Overriding duty to put the interests of investors first

Public Watchdog Function (2 of 2)

Need for professional skepticism in making professional judgments

Need for objectivity and due care in making judgments given the increasing complexity in financial reporting

Only profession where one’s public obligation supersedes that to a client

Professional Judgment in Accounting (1 of 2)

Professional judgment is influenced by personal behavioral traits

Attitudes

Ethical values

Personal values link to ethical sensitivity and judgment

Ethical awareness of an ethical dilemma is a mediator of the personal factors and ethical judgment relationship

Professional Judgment in Accounting (2 of 2)

Objectivity and due care are attitudes and behaviors that enable professional judgment

Professional skepticism is essential in making professional judgments; helps frame auditors’ mindset of independent thought

KPMG Professional Judgment Framework (1 of 2)

Judgment is the process of reaching a decision or drawing a conclusion where there are a number of possible alternative solutions

Judgment occurs in a setting of uncertainty, risk, and often conflicts of interest

Components revolve around ones’ mindset

Clarify issues and objectives

Consider alternatives

Gather and evaluate information

Reach conclusion

Articulate and document rationale

KPMG Professional Judgment Framework (2 of 2)

Prescriptive framework is used but pressures, time constraints, and limited capacity may cause deviations

Auditor should approach matters with objectivity and independence, with inquiring mind and critical assessment of audit evidence

Link between KPMG Framework and Cognitive Processes (1 of 2)

Auditors need to use System 2 thought process

Ethical awareness

Application of ethical reasoning, ethical analysis of harms and benefits and stakeholder rights; and professional obligations

Judgments can fall prey to cognitive traps and biases that negatively influence judgments

Group-think

Rush to solve problems

Judgment triggers

Link between KPMG Framework and Cognitive Processes (2 of 2)

Judgment triggers – can lead to accepting a solution before it is properly identified and evaluated

Availability tendency

Confirmation tendency

Overconfidence tendency

Anchoring tendency

Public Interest in Accounting (1 of 2)

When professional judgment is compromised by taking shortcuts or allowing pressures and biases imposed by others to taint decision making, the public looses trust in the accounting profession

The profession must rebuild its reputation on its historical foundation of ethics and integrity

IFAC’s Policy Position Paper #4, A Public Interest Framework for the Accounting Profession

A distinguishing mark of the accounting profession is the acceptance of its responsibility to act in the public interest.

Public Interest in Accounting (2 of 2)

International Ethics Standards Board for Accountants (IESBA) include integrity, objectivity, professional competence and due care, confidentiality, and compliance with laws and regulations

AICPA public interest includes clients, credit grantors, governments, employers, investors, the business and financial community, and others who rely on the objectivity and integrity of CPAs

Professionalism versus Commercialism (1 of 2)

In 2013 PwC acquired the consulting giant Booz & Company.

In 2014 KPMG brought Zanett Commercial Solutions and in 2015 acquired all the assets of Beacon Partners, Inc.

Unlike audits that are conducted primarily to satisfy the public interest, consulting services satisfy the client’s interest and does not require independence from the client.

Professionalism versus Commercialism (2 of 2)

Lynn Turner, former SEC chief accountant asked, “Are the auditors going to serve management, or are they going to serve the best interests of the investing public?”

As long as the appearance of independence has been tainted by the consulting relationship, the Independence standard would be compromised.

Investigations of the Profession

High profile frauds in the 1970s, 1980s, 2000s

Congressional concern of auditors’ ethical and professional responsibilities

Themes of investigations

Nonaudit services impairing auditor independence

Management to report on internal controls

Prevention and detection of fraud

Role of audit committee and communication between them and auditors

Peer reviews/inspections

Tread way Commission Report (2 of 2)

Established Committee of Sponsoring Organizations (COSO)

Need to change the corporate culture

Establish systems to prevent fraudulent reporting

Tone at the Top – sets ethical tone of organization

Importance of strong control environment

Internal auditors must have direct and unrestricted access to Audit Committee of BOD

COSO Enterprise Risk Management – Integrated Framework

2007–2008 Financial Crisis (1 of 2)

Excessive risk taking

Mortgage meltdown

Moral Hazard – Incentive for risk taking -- to put own interests first especially when perceived sanctions for inappropriate behavior not enforced

Concern over independence, objectivity, and audit quality

Growing personal and business relationships between auditing firms, the client, and client management

2007–2008 Financial Crisis (2 of 2)

Emphasis on marketing of professional services

Lehman Brothers

Failure of Lehman Brothers (1 of 2)

Insufficient liquidity to meet its current obligations and loss of confidence of its lenders

CEO, CFOs, and external auditors all failed to meet professional responsibilities

Lehman used “Repo 105”, did not disclose its use

Shares dropped 94% over 8 months; U.S. refused to fund a solution for Lehman

Failure of Lehman Brothers (2 of 2)

Auditors play a critical role in the proper functioning of public companies and financial markets

The public has every right to conclude that auditors who hold themselves out as independent will stand up to management and not succumb to pressure

External auditors need to recommit to their watchdog/gatekeeper function

AICPA Revised Code: Independence for Members in Public Practice

Conceptual framework incorporates a “threats and safeguards” approach

New section on “Ethical Conflicts”

Violation of the rules for a CPA to permit others acting on his behalf to engage in behavior that would have been a violation for the CPA

When differences exist between AICPA and those of the licensing state board of accountancy, the CPA should follow the state board’s rules

Conceptual Framework for Independence Standards

Independence required for audit and other attestation services; in fact and in appearance

AICPA uses risk based approach for analyzing threats using the following steps:

Identifying and evaluating threats to independence

Determining whether safeguards already eliminate or sufficiently mitigate identified threats and whether threats that have not yet been mitigated can be eliminated or sufficiently mitigated by safeguards

If no safeguards are available to eliminate an unacceptable threat or reduce it to an acceptable level, independence would be considered impaired

Threats to Independence (1 of 2)

Independence must be in fact and appearance

Threats include:

Self review threat

Advocacy threat

Adverse interest threat

Familiarity threat

Undue influence threat

Financial self-interest threat

Management participation threat

Threats to Independence (2 of 2)

Safeguards to counteract threats:

Safeguards created by the profession, legislation, or regulation

Safeguards implemented by the attest client

Safeguards implemented by the firm

Exhibit 4.2 Examples of Threats to Independence

Threat	Example
Self-Review Threat	Preparing source documents used to generate the client’s financial statements.
Advocacy Threat	Promoting the client’s securities as part of an initial public offering or representing a client in U.S. tax court.
Adverse Interest Threat	Commencing, or the expressed intention to commence, litigation by either the client or the CPA against the other.
Familiarity Threat	A CPA on the attest engagement team whose spouse is the client’s CEO.
Undue Influence Threat	A threat to replace the CPA or CPA firm because of a disagreement with the client over the application of an accounting principle.
Financial Self-Interest Threat	Having a loan from the client, from an officer or director of the client, or from an individual who owns 10 percent or more of the client’s outstanding equity securities.
Management Participation Threat	Establishing and maintaining internal controls for the client.

Safeguards

Source of the Safeguard	Examples of Safeguards
Created by the profession, legislation, or regulation	Professional resources, such as hotlines, for consultation on ethical issues.
Implemented by the client	The client has personnel with suitable skill, knowledge, or experience who make managerial decisions about the delivery of professional services and makes use of third-party resources for consultation as needed. The tone at the top emphasizes the client’s commitment to fair financial reporting and compliance with the applicable laws, rules, regulations, and corporate governance policies. Policies and procedures are in place to achieve fair financial reporting and compliance with the applicable laws, rules, regulations, and corporate governance policies. Policies and procedures are in place to address ethical conduct. Policies are in place that bar the entity from hiring a firm to provide services that do not serve the public interest or that would cause the firm’s independence or objectivity to be considered impaired.
Implemented by the firm	Policies and procedures addressing ethical conduct and compliance with laws and regulations.

Financial Relationships that impair Independence

Direct or material indirect financial interest in a client

Loans to or from a client

Example: Alexander Grant and ESM: CPA accepted loans from a financial institution client.

Led to changes in independence rules to prohibit such loans and Permitted Loans

Automobiles loans collateralized by the car

Loans fully collateralized by cash deposits at the same financial institution (passbook loans)

Credit cards and overdraft accounts of $10,000 or less

Other Relationships

Family Relationships

Immediate family members

Spouse or spouse equivalent, or dependents

Close relatives in financial sensitive position with the client or material financial interest

Parent, sibling, or nondependent child

Subject to independence rule if CPA knows member has material financial interest

Business Relationships

Partner or manager who provides more than 10 hours of non attest services to the attest client

Partnerships or joint ventures with attest client

Employment or Association with Attest Clients

Independence may be impaired when a partner or professional employee leaves the firm and is subsequently employed by the client in a key position unless following met:

Amounts due to the former professional are not material to the firm

The former professional is not in a position to influence the accounting firm’s operations or financial policies

The former professional employee does not participate in or appear to participate in or is not associated with the firm once the relationship with the client begins

Participating in the firm may be continuing to consult for it or have one’s name included in firm literature

Providing Non attest Services to an Attest Client

Certain lucrative non attest services create a conflict of interests

A CPA should not perform management functions or make management decisions for an attest client

Client must agree to perform the following functions:

Assume all management responsibilities

Designate competent overseer of these services

Evaluate adequacy and results of services performed

Accept responsibility for the results of the services

Nontraditional Forms of Ownership

A traditional CPA firm may be acquired by a public company that will provide nonattest services to clients while, at the same time, a spin-off of the original firm provides the attest services.

Only firms that are majority owned by CPAs can perform attest services.

Concerns whether managers of the public companies (or alternative practice structures) may attempt to exert pressure over those in the CPA firm and cause ethical problems.

The appearance may be that the audit work could be tainted by the relationship.

SEC Position on Independence

Emphasizes independence in fact and appearance in 3 ways:

Proscribing certain financial interests and business relationships with the audit client

Restricting certain nonauditing services to audit clients

Subjecting all auditor conduct to a general standard of independence

Three principles that underlie auditor independence:

An auditor cannot function in the role of management

An auditor cannot audit her own work

An auditor cannot serve in an advocacy role for her client

General Standard of Independence

Judged by a reasonable investor with knowledge of all relevant facts and circumstances

Auditor must be capable of exercising objective and impartial judgment on all issues within the engagement

Principles

Situations which impair independence

Creates a mutual or conflicting interest between an accountant and his audit client

Places an accountant in the position of auditing his own work

Results in an accountant acting as management or employee of the audit client

Places an accountant in position of being an advocate for the audit client

SEC Independence Actions Against Big 4 (1 of 2)

Deloitte

Violated independence rules when its consulting affiliate kept a business relationship with a trustee serving on boards/audit committees of three funds Deloitte audited

PeopleSoft – joint sales, marketing, license fees and royalty with client (mutuality of interests)

KPMG

Violated independence rules by providing certain nonaudit services to affiliates of companies whose books KPMG was auditing

SEC Independence Actions Against Big 4 (2 of 2)

PwC

Avon hired PwC for IT system; terminated project; did not write down full cost of project, approved by PwC

Pinnacle – PwC approved improper treatment of $8.5M as capital expenses and reserves

Cases raise red flags about consulting services and impairment of audit independence

Insider Trading Cases (1 of 2)

Deloitte

Thomas P. Flanagan, former management advisory partner and vice chair

Traded in the securities of multiple clients (including Best Buy, Motorola, Sears, and Option Care) from information learned in his partner duties

Tipped his son, Patrick so he could also trade on that information

Insider Trading Cases (2 of 2)

KPMG

Scott London, former partner of the KPMG’s Southern California’s regional audit practice

Leaked confidential information to Brian Shaw, about Skechers and Herbalife

Shaw repaid London with $50,000 in cash and a Rolex watch

Audit opinions signed by London on Skechers and Herbalife had to be withdrawn

Cases show the risk to audit independence when audit engagement team members trade on information that is not publicly available

AICPA Code: Ethical Conflicts

Assess whether an ethical conflict exists

Ethical conflicts create challenges to ethical decision making because they present barriers to meeting the requirements of the rules of conduct

Consider whether any departures exist to the rules, laws, or regulations and how they will be justified in order to ensure that conflicts are resolved in a way that permits compliance with these requirement

Any unresolved conflicts can lead to a violation of the rules of conduct which should focus the CPA’s attention on any continuing relationship with the engagement team, specific assignment, client, firm, or employer

Integrity and Objectivity (1 of 2)

Conflicts of interest for public practice occur when a professional service, relationship, or specific matter creates a situation that might impair objective judgment

A conflict of interest creates adverse and self-adverse threats to integrity and objectivity

Safeguards include

Implementing mechanisms to prevent disclosure or violation of confidentiality

Senior individual not involved in the engagement regularly reviewing safeguards

Integrity and Objectivity (2 of 2)

Member of the firm not involved in the conflict review the work performed to assess whether key judgments and conclusions are appropriate, and

Consulting with third parties, such as professional body, legal counsel, or another CPA

The CPA should disclose the nature of the conflict to clients and obtain their consent to perform professional services

If consent is not received, then the CPA should either cease performing the services or take action to eliminate or reduce the threat to an acceptable level

Subordination of Judgment (1 of 2)

Integrity rule prohibits a CPA from knowingly misrepresenting facts or subordinating one’s judgments when performing professional services for a client or employer

Addresses differences of opinion between a CPA accountant/auditor and that person’s supervisor or others in the organization including top management on material accounting issues

CPA should consider any threats to integrity and objectivity, and assess their significance whenever there is a material misrepresentation of fact

Subordination of Judgment (2 of 2)

CPA should assess if threats are at an acceptable level; if not, evaluate significance of safeguards to prevent impairment to independence/objectivity

Follow prescribed process to protect against subordination of judgment (see Exhibit 3.13)

AICPA Code: Conceptual Framework for Members in Business

The conceptual framework for members in business applies to integrity and objectivity, as well as other rules of conduct, but not independence

Threats

Adverse interest threat

Advocacy threat

Familiarity threat

Self-interest threat

Self-review threat

Undue influence threat

Safeguards to Mitigate Risk

Safeguards include

Tone at the top

Policies, procedures, implementation, and monitoring addressing ethical conduct and compliance with laws and regulations

Internal policies and procedures for disclosure of interests and relationships

Whistle-blower hotlines

Internal auditors not allowed to audit areas where they have operational responsibilities

Policies for promotion, rewards and enforcement of a culture of high ethics and integrity

Use of third-party resources for consultation as needed.

SOX: Nonaudit Services (1 of 2)

Financial information systems design and implementation

Appraisal or valuation services, fairness opinions, or contribution-in-kind reports

Actuarial services

Internal audit outsourcing services

Management functions or human resources

Broker or dealer services, investment adviser, or investment banking services

SOX: Nonaudit Services (2 of 2)

Legal services and expert services unrelated to the audit

Any other service prohibited by BOD

Tax services must be preapproved by the audit committee

Rules of Professional Practice (1 of 2)

The General Standards rule establishes requirements for competence, compliance with professional standards, and adherence to accounting principles

Acts Discreditable covers a broad number of actions that may bring discredit to the profession including

Discrimination and harassment

Solicitation or disclosure of CPA examination questions and answers

Failure of a CPA/CPA firm to file and pay taxes

Rules of Professional Practice (2 of 2)

Negligence in preparation of financial statements or records

Standards relating to governmental accounting and auditing

Confidentiality of information gained through employment, except in specified situations

Records Request governing what is client-provided records, member-prepared records, member’s work products, and member’s working papers

Contingent Fees, Commissions, and Referral Fees (1 of 2)

Contingent fees and commissions are permitted when performing advisory-type services for a nonattest client

Contingent fees are prohibited from an attest (audit) client

Prohibits acceptance of contingent fees if CPA or firm performs any of the following:

an audit or review of a financial statement

compilation of financial statement that third party may use

examination of prospective financial information

prepares original/amended tax return

Contingent Fees, Commissions, and Referral Fees (2 of 2)

Permits acceptance of contingent fee based upon initiation by and findings of governmental agencies (i.e., IRS-initiated investigation of income taxes paid)

Commissions and Referral Fees

Rule is similar to that for contingent fees; cannot accept commissions or referral fees from audit client

Commissions and referral fees require disclosures by CPAs when recommending or referring a service or product to which the commission relates

Advertising and Solicitation

Advertising and solicitation permitted

Requires that advertising not be false, deceptive or misleading

Imply ability to influence official bodies

Contain a representation that specific services will be performed for a stated fee, when such fees would be substantially increased

Prohibits solicitation by use of coercion, over-reaching, or harassing conduct

Contain any representation that would be likely to cause a reasonable person to misunderstand or be deceived

Confidentiality

Confidential information

CPA should not disclose confidential client information without specific consent of the client

Internal whistle blowing allowed; external may violate confidentiality; consult legal counsel

Permitted disclosure of confidential client information

Response to validly issued subpoena or summons

Adherence to applicable laws and regulations (i.e., Dodd-Frank whistle-blowing provisions)

Compliance with peer review of CPA practice under PCAOB, AICPA, state CPA society, or board of accountancy authorization

Defense in an investigation of the CPA

Concluding Thoughts (1 of 2)

Technical skills are important in accounting but so are ethical reasoning abilities

Virtue-based decision making is an important component because it depends on “practical wisdom,” or the ability to see the right thing to do in circumstances

The process in the Code is a conceptual framework to assess whether independence, integrity and objectivity may be compromised as a result of threats that exist

Safeguards can be put into place to reduce or eliminate such threats, although nothing can substitute for ethical intent and ethical action

Concluding Thoughts (2 of 2)

The accounting profession is in danger of losing sight of its mandate to protect the public interest because of increased commercial tendencies