Chapter 19 – Professional Conduct, Independence, and Quality Control
19-1
CHAPTER 19
PROFESSIONAL CONDUCT, INDEPENDENCE,
AND QUALITY CONTROL
Answers to Review Questions
19-1 The three theories of ethical behavior are (1) utilitarianism, (2) rights-based approach,
and (3) justice-based approach. Utilitarian theory recognizes that decision making
involves trade-offs between the benefits and burdens of alternative actions, and it focuses
on the consequences of an action on the individuals affected. The theory proposes that the
interests of all parties affected, not just one’s self-interest, should be considered. The
rights-based theory assumes that individuals have certain rights and that other individuals
affected when a better distribution of benefits is provided to others.
19-2 Kmart has physical assets and trades in physical goods, but Arthur Andersen’s primary
asset was a reputation for competence, professionalism, and integrity. While Kmart could
file for bankruptcy and reorganize its business, Andersen’s loss of reputation, its most
important operating asset, could not be repaired, resulting in the loss of its clients.
in the U.S.
19-3 The AICPA establishes auditing standards for nonpublic-company audits (through the
ASB) and maintains a Code of Professional Conduct, mapping out the primary areas in
which ethical conduct is expected of public accountants.
The SEC has the legal authority to oversee the public accounting profession, but has
generally allowed private-sector entities such as the FASB and AICPA to set accounting
and auditing standards. However, in 2003 the PCAOB was established to set auditing
standards for the audits of public companies. The SEC and PCAOB have set rules
Chapter 19 – Professional Conduct, Independence, and Quality Control
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19-4 The AICPA Code of Professional Conduct consists of four major sections: a preface that
is applicable to all CPAs, and three “Parts”:
• Preface: applies to all CPAs; defines ideal Principles of Professional Conduct that are
expected of all CPAs.
• Part 1: applies to CPAs in public practice, including auditors practicing in public
accounting firms and government auditors who issue audit and other assurance reports
engage in any act that would be discreditable to the profession.
Guidance for applying the Rules of Conduct is provided by the Interpretations of Rules of
Conduct by the Professional Ethics Executive Committee (PEEC).
19-5 The six Principles of Professional Conduct are:
Responsibilities: In carrying out their responsibilities as professionals, members should
exercise sensitive professional and moral judgments in all their activities. This is the
responsibility of all CPAs.
The public interest: Members should accept the obligation to act in a way that will serve
the public interest, honor the public trust, and demonstrate commitment to
professional responsibility to the best of the member’s ability. This is the responsibility of
all CPAs.
Scope and nature of services: A member in public practice should observe the Principles
of the Code of Professional Conduct in determining the scope and nature of services to be
provided. This is the responsibility of all CPAs.
Chapter 19 – Professional Conduct, Independence, and Quality Control
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19-6 The eleven major sections of the Rules of Conduct in Part 1 of the Professional Code of
Conduct are:
• Integrity and Objectivity.
• Independence
• General Standards
• Form of organization and name
19-7 Interpretation 1.260 permits the following types of personal loans from a financial
institution:
• Automobile loans and leases collateralized by the automobile.
• Loans fully collateralized by the cash surrender value of an insurance policy.
Normal lending procedures, terms, and requirements are defined as lending procedures,
terms, and requirements that are reasonably comparable to those relating to loans of a
similar character given to other borrowers during the period in which the loan to the
member is given.
19-8 While most of the SEC’s independence rules are very similar to the AICPA’s, the SEC
has added some important restrictions in the following areas:
Provision of other professional services
• The SEC prohibits several types of professional services by accounting firms for
public company audit and review entities “unless it is reasonable to conclude that
the results of these services will not be subject to audit procedures during an audit
of the entity’s financial statements.” The rules do not limit the scope of nonaudit
services provided by accounting firms to nonpublic companies or to public
companies that are not audit entities. Additionally, accounting firms are allowed
to provide certain types of tax services to their audit entities. Specific categories
of nonaudit services that are considered to impair independence if provided to
a public company audit entity are:
Chapter 19 – Professional Conduct, Independence, and Quality Control
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o Actuarial services
Handling of human resource and compensation-related issues
• Lead and engagement quality review partners of public company audit firms
are required to “roll off” their clients every five years so that there is a fresh
• Audit partners must not receive compensation based on selling engagements
to the client for services other than audit, review, and attest services, if they
are to be considered independent.
Required communications
• The auditor of a public company must report to the company’s audit
committee all “critical accounting policies” used by the company, all
alternative treatments within GAAP related to material items discussed with
during the prior two fiscal years by the principal auditor.
Many of the independence restrictions for public company auditors were in response to
specific circumstances that came to light in the frauds of the early 2000s. The changes,
many of which were required by the Sarbanes-Oxley Act, are designed to correct these
circumstances.
19-9 Section 1.700 specifies five situations when a CPA can disclose confidential information
without the client’s consent: (1) to meet disclosure and performance requirements under
GAAP and GAAS, (2) to comply with a valid subpoena, (3) to allow a review of a
Chapter 19 – Professional Conduct, Independence, and Quality Control
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19-10 The following acts are considered discreditable under Section 1.400:
• Discrimination and harassment in employment practices (.010).
• Solicitation or disclosure of CPA examination questions and answers (.020)
• Failure to comply with records requests (.200)
19-11 The following are examples of advertising activities that are prohibited by the Rules of
Conduct, as outlined in Interpretation 1.600:
• Creating false or unjustifiable expectations of favorable results.
• Implying an ability to influence any court, tribunal, regulatory agency, or similar
body or official.
misunderstand or be deceived.
These acts are of concern to the profession because of the central role that reputation
plays to a CPAs service. Deceitful advertising will seriously damage the reputation of the
CPAs involved as well as negatively affect the reputation of the profession as a whole.
Just as with Arthur Andersen, if CPAs are not seen as credible, competent professionals,
the demand for a CPA’s services will disappear.
19-12
A firm’s system of quality control should be designed to provide the firm with reasonable
assurance that the firm and its personnel comply with professional, legal, and regulatory
requirements and that the partners issue appropriate reports (SQCS 8.12). The six
elements of quality control and examples of policies or procedures that can be used to
fulfill each element are:
Leadership responsibilities for quality within the firm (“tone at the top”):
• Assign management responsibilities so that commercial considerations do not over-
ride the quality of the work performed.
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Relevant ethical requirements:
• Communicate the firm’s independence requirements to its personnel and, when
applicable, others subject to them.
• Require personnel to promptly notify the firm of circumstances and relationships that
create a threat to independence so that appropriate action can be taken.
Acceptance and continuance of client relationships and specific engagements:
• Require the firm to obtain such information as it considers necessary in the
circumstances before accepting an engagement with a new client, when deciding
whether to continue an existing engagement, and when considering acceptance of a
within the engagement team; with those consulted; and, when applicable, between the
engagement partner and the engagement quality control reviewer.
Monitoring:
• Communicate to relevant engagement partners, and other appropriate personnel,
deficiencies noted as a result of the monitoring process and recommendations for
appropriate remedial action.
• Establish policies and procedures designed to provide reasonable assurance that
complaints and allegations that the work performed by the firm fails to comply with
19-13 AICPA and PCAOB quality control reviews are similar in that they both aim to ensure
that firms comply with relevant quality control standards. Both involve reviewing
selected audit and review engagements of the firm.
The AICPA’s Peer Review Program (PRP) is designed to review and evaluate those
portions of firms’ accounting and auditing practices that are not subject to inspection by
the PCAOB. Reviews are performed by firms and individuals approved by the Peer
Review Board. PCAOB inspections are conducted by the PCAOB’s own inspection
teams. The PCAOB is only required to inspect firms that audit public U.S. companies,
while any firm that is a member of the AICPA participates in the AICPA’s PRP.
Chapter 19 – Professional Conduct, Independence, and Quality Control
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Answers to Multiple-Choice Questions
19-14
c
19-21
a
19-15
d
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c
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c
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b
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b
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b
19-18
b
19-25
a
19-19
c
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a
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c
Solutions to Problems
19-27 1. The client clearly needs help with the following nonaudit services:
• Developing an automated accounting system.
for the company’s new products and other nonaudit work would be subject to
approval by the audit committee and would be strictly limited by the principles of not
performing a management function, not auditing one’s own work, and not performing
an advocacy role.
2. Most of the above non-audit services would not be prohibited if the client were not
publicly held, though there are restrictions to be observed. For example, see the
discussion relating to the AICPA’s restrictions regarding financial information
when deciding the nature of the services that they could provide.
19-28 a. A CPA may provide such advisory services to an audit client and not impair
independence because the member’s role is advisory in nature and because the client
is a privately held entity (see Section 1.200.001).
b. The CPA’s independence is not impaired under these circumstances provided the
client makes all significant management decisions related to the hiring of new
personnel and the implementation of the system. The auditor must also limit his or
Chapter 19 – Professional Conduct, Independence, and Quality Control
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© 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
c. The independence of the auditor, according to section 1.200.001 of the Code, would
be considered impaired whether or not the financial interest is placed in a blind trust.
d. Section 1.200.005 of the Code indicates that an auditor’s independence would be
considered impaired if a close relative (e.g., a parent) has a material financial interest
in an enterprise of which the auditor is participating in the engagement and has
knowledge of the financial interest.
e. Independence is impaired if a member has a direct financial interest in a client during
the period of the professional engagement or at the time of expressing an opinion.
The period of professional engagement starts when the member begins to perform
professional services requiring independence and ends with the client’s or member’s
notification of that relationship’s termination (see section 1.200.001).
f. Independence is impaired under section 1.200.001 of the Code because the note is a
prohibited loan from the member to the client.
19-29 a. Yes
19-30 a. Yes. Signing such a letter would be a known misrepresentation of fact in violation of
section 1.100.001 of the Code.
professional standards, the member should consider whether any responsibility exists
to communicate the problem to third parties, such as regulators. However, the CPA
should consult his attorney prior to any disclosure.
e. Yes. Under 1.400.040, a member who, through his or her negligence, makes or
permits another to make false and misleading entries in the financial statements has
committed an act discreditable to the profession.
Chapter 19 – Professional Conduct, Independence, and Quality Control
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19-31 a. Services that Perez may perform:
• Counsel on potential expansion plans.
• Search for and interview new personnel.
data without the concurrence of the client.
b. The significant matters related to an engagement generally include (a) the
engagement’s objectives, (b) the scope, (c) the approach, (d) the role of all personnel,
(e) the manner in which results are to be communicated, (f) the timetable, and (g) the
fee.
Solutions to Discussion Cases
19-32 a. If Pina, Johnson & Associates audited one of the entities that received one of the large
loans, it would not be appropriate for Johnson to seek financial information about that
information in determining the fair value of the loan to Sun City Savings & Loan. The
auditor has an obligation to use such information in assessing the entity’s ability to
repay the loan. The auditor should consider the rights of the parties involved and the
source of the information.
19-33 a. The Code of Professional Conduct applies to all parties who are members of the
AICPA or have CPA licenses, whether or not they are practicing public accounting.
There are, however, a number of interpretations of the Code of Professional Conduct
19–10
19-34 a. No, the independence rule is not violated because Adrian does not occupy a “financial
reporting oversight role” for Swiss Precision Tooling; therefore, the one-year
“cooling–off” period is not necessary.
b. No, the independence rule is not violated because although Susana does occupy a
SEC’s independence rules, were accepted by the client’s audit committee, and the
audit partner does not receive compensation based on selling engagements for
nonaudit services.
19-35 1. a. If the auditor records the “social” time, she may suffer some consequences from
her supervisor. She may also cause the team to go over budget. On the other
hand, the auditor may be helping the other auditors that work with this client in
the future. Further, healthy personal interaction is an important aspect of a
c. It is not fair for the supervisor to ask the auditor to give up her personal time to
do work that is not going to be recorded. On the other hand, it is not fair for one
auditor to affect the performance evaluation of the entire team by making it go
over budget.
2. Student answers will vary, depending on their individual viewpoint.
19-36 1. a. If the auditor signs off on the exception without examining the underlying
documents, he will save his and the client’s time. The downside is that if the
Chapter 19 – Professional Conduct, Independence, and Quality Control
19–11
© 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
c. It’s not fair for the auditor to deceive those who read the auditor’s report by failing
to properly investigate the exception. It’s also not fair for the in-charge senior to
ask the auditor to give up his integrity by not looking into the exception.
2. Student answers will vary, depending on their individual viewpoint.
Solution to Internet Assignment
19-37 a. If a covered member belongs to a trade association that is an attest client,
management participation or self review threats to the covered member’s compliance
with the Independence rule may exist. Such threats might be effectively mitigated,
however, as long as the member did not serve as an officer, director, or in any
management capacity See Interpretation 1.280.020 of the Code.
b. Independence would not be impaired if, as indicated in the problem, the member’s
role is strictly advisory in nature. If any of the activities listed were to cross the line to
1.245.010).
e. Independence would be considered to be impaired if any partner or professional
employee of the firm served as a director or officer of the organization and the
organization exercised managerial control over the local charities. If the member
believes that professional service can be performed objectively and the service is
disclosed to and consent is obtained from the involved parties, then the service would
be allowed. Otherwise independence is impaired (Interpretation section 1.275.010).
f. If fees pertaining to services provided more than one year prior to the date of the audit
report remain unpaid, the auditor’s independence is impaired with respect to that