Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
14. What is the danger from an ethical perspective of having a CPA firm that conducts the audit of
a public company also engaged in consulting with the company on the installation of a new
financial information system? What about giving tax advice to an audit client? What are the
possible ethical dangers of having the tax practitioners at a CPA firm that audits a client entity
prepare the tax return for members of management of the client who have a financial
reporting oversight role?
Objectivity is lost when you audit your own work. If you think it is a sound system, you will not see its
flaws. Even if the flaws are seen, can you criticize it when the firm received a significant payment for the
In giving tax advice to an audit client, the CPA becomes an advocate and may lose objectivity and
independence. However, with respect to objectivity, the CPA must remain unbiased and not compromise
objectivity. Serving in a tax advocacy position means you will represent the client’s tax interests if tax
15. In 2004, the Government Accountability Office (GAO) conducted an investigation of tax shelters of 61
Fortune 500 users of tax shelters provided by accounting firms that were their external auditors covering
more than one year between 1998-2003. In each case the company received benefits from the tax shelter:
61 companies had 82 transactions worth about $3.4 billion in estimated potential tax losses generally
reportable to the IRS.
What are the potential ethical dangers for an audit firm that provides tax shelters for an audit
client? Is it ethically appropriate to do so under the profession’s ethical standards?
A potential ethic danger for a firm that provides tax shelters for an audit client is the CPA becomes an
advocate for the audit client to save taxes. The advocate position can threaten the objectivity and
independence in appearance. Under PCAOB Rule 3522, a rule that was issued in the aftermath of the tax
shelter transactions, a registered public accounting firm is not independent of its audit client if the firm, or
any affiliate of the firm, during the audit and professional engagement period, provides any non-auditing
The SOX also requires that tax services provided for the audit client should be pre- approved by the
In the fall of 2003, the Senate Permanent Subcommittee on Investigations conducted hearings on the
extensive tax shelter activities of KPMG. As the hearings revealed, from the late 1990s into the next
decade,
KPMG devoted significant resources to developing and mass marketing hundreds of
of billions of dollars in lost tax revenue. KPMG,
which made hundreds of millions of dollars from its
tax shelter business, has by no means been the only y large accounting firm involved. During the last
few years, government investigations and lawsuits brought by the IRS and former clients have exposed
the tax
shelter activities of other firms including BDO. But KPMG had it s v ery exis t ence
16. The IRS contacted your client as part of an examination of its tax return and proposed that the
client owes an extra $100,000. As the client’s tax accountant and a CPA, can you agree to
handle the matter for 40 percent of what you save the client? Under what circumstances might
this be an acceptable form of payment for services rendered and when might it be
unacceptable and in violation of the AICPA rules and/or SSTS? Notwithstanding the AICPA
rules and SSTSs, is there anything ethically improper with agreeing to handle the matter for 40
percent of what you save the client?
Under Rule 302 of the AICPA Code, a CPA is prohibited from performing for a contingent fee any
professional services for, or to receive such a fee from, a client for whom the CPA or CPA firm performs
assurance or attest services. The reason for prohibiting contingent fee payments in these instances is the
requirement for independence when also performing attest services. This raises the bar with respect to not
becoming involved in any relationship with the client or a third party that may threaten independence, such
as when a financial self-interest exists as a result of the contingent fee arrangement. If an accounting firm
and audit client were to agree that the firm would receive 40 percent of any tax savings to the client
resulting from tax advice provided by the firm, the fee would be a contingent fee and impair the auditor’s
independence, notwithstanding an expectation that a government agency would consider issues related to
17. A large, national accounting firm decides it is time to outsource the preparation of income tax
returns to an organization in India that has performed outsource services for other U.S. CPA
firms. The firm will transmit income tax information necessary to prepare the returns
electronically and staff accountants in India will prepare the return. The return will then be
transmitted back to the United States for final review and approval, and then given to clients.
Assume the cost savings for the CPA firm are significant because of the lower salaries paid to
chartered accountants in India, and the quality of work in India is as good as or better than
that of U.S. tax accountants. Would you recommend that the firm outsource? Why or why not?
Be sure to address ethical considerations with respect to the AICPA Code.
If the firm is convinced the Indians are competent (i.e., meet the due care standard) and can be relied upon,
as long as proper supervision, oversight and control exists over the preparation of the returns, the
outsourcing can go forward. It certainly is possible to send data back and forth to India with sufficient
Many clients will consent to Indian sub-contracting if they are told the truth and share the fee savings. If
the clients are deceived that Americans are doing the work, the firm may pay a devastating price in lawsuits
The issues involved are truth, keeping promises made when rates were negotiated and
18. In August 2008, Ernst & Young LLP agreed to pay more than $2.9 million to the SEC to settle
charges that it violated ethics rules by coproducing a series of audio CDs with a man who was
also a director at three of EY’s audit clients. According to the SEC, EY collaborated with Mark
C. Thompson between 2002 and 2004 to produce a series of audio CDs called The Ernst &
Young Thought Leaders Series. Thompson served on the boards at several of EY’s clients
during the period when the CDs were produced. What threat to independence existed in the
relationship between EY and Thompson? What are the potential harms of EY or any other
accounting firm of engaging in this kind of relationship?
This situation is very similar to the PeopleSoft case in the chapter. Audit independence was violated by the
mutuality of interests created by the financial self-interest relationship between EY and Thompson. A threat
to independence existed that caused a violation of independence in fact and appearance when EY audited
19. On January 16, 2008, the SEC charged two former employees of PricewaterhouseCoopers LLP
with insider trading. According to the SEC’s complaint, Gregory B. Raben, a former PwC
auditor, and William Patrick Borchard, a former senior associate in PwC’s Transaction
Services Group, used their access to sensitive information about PwC’s clients to allow Raben
to buy stock ahead of a series of corporate takeovers. According to the complaint, Raben
netted trading profits of more than $20,000 by buying stock ahead of public announcements
disclosing the acquisitions and then selling his shares. Assume the actions of Raben and
Borchard had no effect on the client or its operations. What is wrong with allowing the actions
of Raben and Brochard from an ethical perspective? Would disclosure of the acquisition of
client stock (and then continue with) to the client solve the problem you identified? What about
disclosing it to the public?
Using insider information acquired by a CPA from an engagement violates confidentiality. It puts personal
gain ahead of the client’s interest. Although the question does not state that Borchard personally gained
from the situation, it is reasonable to question why Borchard would disclose the information unless he was
The disclosure of the acquisition of client stock does not compensate for the acquisition of client stock and
the lack of independence. Disclosure cannot cure all ills. While it may be valuable in informing the public
20. In the aftermath of the collapse of financial institutions like Lehman Brothers and audit
deficiencies of investment banking firms, a great deal of attention has been devoted to
requiring mandatory auditor rotation. Some critics of the audit profession are concerned about
a breakdown in external auditor independence, objectivity and professional skepticism. Others
point out the inherent conflict of interests in the “issuer pays” model for audit firms.
Kenneth Daly, president and CEO of the National Association of Corporate Directors, told the
PCAOB in its hearings on these matters that there should be a rigorous annual evaluation of
the external auditor led by the audit committee, endorsed by the board, and communicated to
shareholders.
Do you think such an annual process negates the need to consider mandatory auditor
rotation? What are some of the possible unintended consequences of instituting a mandatory
auditor rotation requirement? What are the costs and benefits of mandatory auditor
rotation from an ethical perspective? Do you believe auditors should be required to rotate
off a client’s audit engagement after a specific period of time? Why or why not?
Auditor rotation has been recommended by many years as a way to cut down on the cozy relationship that
develops between an auditor and the client. It has been suggested that a five year rotation is needed given
that independence, objectivity, and integrity are cornerstone ethical values in accounting. This may too
Let’s look at the recent financial crisis—Lehman Brothers, AIG and GM, for example—were with their
auditors for decades without obvious benefit to investors. Regulators are increasingly worried that being
According to Audit Analytics, a research firm in Sutton, Mass., 30% of the 1,000 leading U.S. companies
have used the same firm to audit their books for at least a quarter-century. Fully 11% have used the same
The PCAOB has asked whether long tenure might lead to complacency. In 2012, the board sought opinions
on whether it should require listed companies to rotate their accounting firms every few years. The PCAOB
has received 620 letters, about 20 times the normal amount, with most warning of unintended consequences
if rotation is passed. The last of those 611 public comments came in to the PCAOB in April 2013. An
Auditors say it helps to know their clients’ business intimately. The Big Four accounting firms—PwC,
Deloitte, Ernst & Young and KPMG— agree that forced rotation will impair audit quality.
PricewaterhouseCoopers and Deloitte pointed to studies casting doubt on whether changing auditors
The evidence suggests that mandatory auditor rotation might help to strengthen the auditor’s position
because the firm knows it will rotate off the audit after a period of time and does not want to compromise
independence so that another firm might have to deal with the issue in its audit. It is worth noting that
before Sarbanes-Oxley, not one of the accounting frauds in the late 1990s and early 2000s that led up to the
As for the large, international accounting firms, they have turned to lobbying efforts of the U.S. Congress
to prevent the mandatory rotation of audit firms. The lobbying effects and its underlying motivation for
those practices undermine the professionalism and integrity of the profession. The statements that auditor
rotation would be a step backwards and lead to auditors doing work on industries they know little about
The U.S. House of Representatives approved a bill in July2013 that prohibits the Public Company
The PCAOB issued a concept release in August 2011 proposing mandatory audit firm rotation as one way
to improve audit firm independence and held a series of roundtable meetings across the country in 2012 to
The congressional bill, H.R. 1564, the Audit Integrity and Job Protection Act, was introduced by Rep.
Robert Hurt, R-Va., and Rep. Gregory Meeks, D-N.Y., with the goal of short-circuiting the process, and it
passed the House Financial Services Committee. They argued that selecting a company’s external auditor
We believe PCAOB Chairman James Doty hit the nail on the head when he said some change was needed
If rotation is not found acceptable, regulators should at least require that companies disclose how long they
