Entire Course (including glossary) (2024)

Chapter 2. Integrity and Objectivity

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The AICPA Code of Professional Conduct specifically addresses the principles of integrity, objectivity, and independence. Section 0.300.050 requires all members to maintain objectivity and be free of conflicts of interest in discharging professional responsibilities. Members in public practice are to be independent in fact and appearance when providing auditing and other attestation services. Section 0.300.040 contains a mandate to all members: “To maintain and broaden public confidence, members should perform all professional responsibilities with the highest sense of integrity.” What is integrity? Integrity is often referred to as a steadfast adherence to moral and ethical principles. When facing ethical dilemmas, integrity is the key principle guiding our behavior toward a positive outcome. According to the Code, “Integrity is an element of character fundamental to professional recognition. It is the quality from which the public trust derives and the benchmark against which a member must ultimately test all decisions.” Among other things, this means members must be honest and candid while respecting client confidentiality constraints. This also means integrity must be measured in terms of what is right and just in the absence of specific rules, standards, or guidance. As a practical matter, the Code associates integrity with the CPA's obligation to observe the principles of objectivity, independence, and due care.

TranscriptThe AICPA Code of Professional Conduct specifically addresses the principles of integrity, objectivity, and independence. Section 0.300.050 requires all members to maintain objectivity and be free of conflicts of interest in discharging professional responsibilities. Members in public practice are to be independent in fact and appearance when providing auditing and other attestation services. Section 0.300.040 contains a mandate to all members: “To maintain and broaden public confidence, members should perform all professional responsibilities with the highest sense of integrity.” What is integrity? Integrity is often referred to as a steadfast adherence to moral and ethical principles. When facing ethical dilemmas, integrity is the key principle guiding our behavior toward a positive outcome. According to the Code, “Integrity is an element of character fundamental to professional recognition. It is the quality from which the public trust derives and the benchmark against which a member must ultimately test all decisions.” Among other things, this means members must be honest and candid while respecting client confidentiality constraints. This also means integrity must be measured in terms of what is right and just in the absence of specific rules, standards, or guidance. As a practical matter, the Code associates integrity with the CPA's obligation to observe the principles of objectivity, independence, and due care.

For the CPA, finding the correct path of conduct may sometimes be difficult. Solving ethical dilemmas may not easily be reduced to a simple approach but using a standardized approach sometimes helps one to get a clearer picture of ethical issues in order to resolve them. In ET sections 1.000.010, 1.210.010, and elsewhere, the AICPA provides licensees a risk-based approach for ethical decision making.

The risk-based approach uses as a standard the likelihood that a reasonable informed third-party would conclude that the level of threat to compliance with the rules is acceptable after having weighed all the specific facts and circ*mstances. Both qualitative and quantitative factors are considered in evaluating the significance of a threat, and threats are considered both individually and in the aggregate.

The AICPA suggests a three-step approach to threat identification and resolution in ET section 1.000.010 Conceptual Framework for Members in Public Practice:

1. identify the threat;

2. evaluate its significance; and

3. identify and apply safeguards.

Seven (previously six) broad categories of threats are included and discussed in this guidance.

• Adverse interest threat– Member interests adverse to the client or employer can compromise objectivity.

• Advocacy threat– Excessive advocacy of a client or employer position can compromise objectivity.

• Familiarity threat– The threat that a long or close relationship with the client or employer could compromise objectivity and increase the risk of overreliance on the results of their work.

• Management participation threat– The threat that a member will take on the role of client management or otherwise assume management responsibilities, such as that which may occur during a nonattest services engagement.

• Self Interest threat– Here, the CPA (or an immediate or close family member) has financial ties in or other interests with, the client or employer. This situation can cause the CPA to act in a manner that is adverse to the legitimate interests of the firm, the client, the employer, or the public. Note the emphasis on the word “legitimate.” The CPA's actions may be in the interests of the firm, the client, or the employer and yet may be adverse to the legitimate interests of the public.

• Self-review threat– Overreliance on the results of services previously performed by the member or firm in the performance of current services.

• Undue influence threat– Undue influence can be intentional or unintentional, and can cause the member to subordinate his or her judgment to the client or employer.

The AICPA continues its discussion by providing three broad categories of safeguards.

• Professional, regulatory or legislative safeguards.

• Safeguards implemented by the client (these cannot be solely relied upon to reduce threats to an acceptable level).

• Safeguards implemented by the firm.

Threat safeguards must be effective to eliminate or control risk of noncompliance with the rules. Controlled risk must be maintained at or below a level deemed acceptable.

Finally, ET section 1.000.010.19 suggests that ethical conflicts be resolved by considering certain factors and their consequences in light of compliance with the rules. Phrased as questions, these factors are shown below.

• What are the relevant facts and circ*mstances concerning this situation?

• Have the threats been properly identified?

• Are safeguards suitably designed to meet their objectives?

• Which parties will be subject to the safeguards?

• How will the safeguards be applied?

• Will the safeguards be applied consistently?

• Who will apply the safeguards?

• How will safeguards between categories interact?

• Is the client a public interest entity?

Case Study

This case study explores ethical concepts on a situational level. Joan, a CPA, was recently hired as the company controller for Jefferson Cabinets, a local maker of custom kitchen cabinets. The company has historically maintained its books on the cash basis of accounting. Jefferson Cabinets has never employed a controller before, much less a CPA, but sales are beginning to grow and Mr. Jefferson believes they need help with the increasing workload. During her first weeks of employment, Joan has found a disturbing situation.

The company has a long-standing policy of offering installment credit to its customers. The installment payments are in the form of four checks, equal in amount and dated for the month of sale and three successive months. These checks are made payable to Jefferson Cabinets and are delivered by the customer to Mr. Jefferson's sister-in-law, Brenda.

As with many small companies, the family members perform many varied functions. Among her duties, Mrs. Jefferson handles payables, payroll, and cash management functions for the company. Her sister Brenda handles route sales and receivables. Because Brenda stays on the road, and because the checks are delivered at contract signing, she routinely carries the customer checks in the trunk of her car while awaiting deposit. Customer checks are not booked into the accounting system until they are deposited. Joan has discovered that customer checks are often not deposited for several months after their date. In some cases, these checks have required customer assistance for payments to clear the paying bank.

Joan tried to discuss this situation with Brenda, but Brenda tersely informed Joan that she was very busy and that she deposited the checks as time permitted. There was no rush, she had the checks and could deposit them as needed to ensure the company could pay its bills. Using “the royal we,” she emphasized, “We always make sure we have enough money in the checking account to pay our bills.”

It was obvious that the conversation was going nowhere. Brenda made that fact even clearer as she ended the conversation by proclaiming that she could talk no longer because “some of us have to go do our jobs.” Joan is still a probationary employee, and understands the office politics involved in pursuing the situation further. She is considering her next course of action.

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What are the threats to compliance Joan faces in this situation? Your answer options are:

• Familiarity threat

• Undue influence threat

• Self-interest threat

• Adverse interest threat

FEEDBACK: Undue influence threat is the correct answer. As a probationary employee, Joan is subject to termination without cause. Brenda's response could portend a difficult start, or a quick end, to Joan's new job. There is a risk that she will subordinate her judgment to Brenda and decide against pursuing the matter further.

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Consider the following: You're a CPA at a small firm, and you've discovered some irregularities in the financial records of one of your firm's clients. You approach your manager with your concerns.

She tells you that the calculations supporting the entries in question were devised by an ex-partner of the firm, who is now the client's CFO and the president of the local chapter of your state's society of CPAs. She tells you to ignore the problem because a mistake is highly unlikely.

Take a few minutes to consider your next steps. How would you address the situation and maintain your integrity? This is a difficult situation. Although you want to follow the instructions of your manager, you feel this problem deserves more investigation.

You should consider further discussion of the problem with your manager, highlighting the potential implications of the irregularities. You should provide supporting evidence. Express your concerns to the client service partner (your manager's superior), but be careful to avoid creating conflicts with your manager.

Keep in mind, as an accounting professional you should perform all professional responsibilities with the highest sense of integrity. You should not knowingly misrepresent facts or subordinate judgment to others.

Objectivity and Independence

Remember the requirements of Code Section 0.300.050? All members are to maintain objectivity and be free of conflicts of interest in discharging professional responsibilities. In public practice, members are to be independent in fact and appearance when providing auditing and other attestation services.

As the Code considers integrity an element of character, objectivity is considered a state of mind. Section 0.300.050.02 specifically states: “The principle of objectivity imposes the obligation to be impartial, intellectually honest, and free of conflicts of interest.” The Code recognizes that “members often serve multiple interests in many different capacities and must demonstrate their objectivity in varying circ*mstances.” However, the Code also indicates that “regardless of service or capacity, members should protect the integrity of their work, maintain objectivity, and avoid any subordination of their judgment.”

Although the focus of this discussion concerns integrity and objectivity, the concept of independence is intertwined, so we will consider it briefly.

Code Section 0.400.21 considers independence to have two elements:

1. independence of mind, and

2. independence in appearance.

This Section must be taken in concert with the mandate of Section 0.300.050 that members in public practice “should be independent in fact and appearance when providing auditing and other attestation services.”

Independence is the accountant's ability to act with integrity, objectivity, and professional skepticism without bias, or in a state of “neutrality.” A number of regulatory agencies and governing bodies have developed specific rules that define and interpret independence for the accounting professional. Independence rules generally focus on the relationship between the practitioner (CPA, firm, or network) and the responsible party (the client or, in some cases, a closely associated non-client entity). While Section 0.300.050 acknowledges members not in public practice can't maintain the appearance of independence, they are still charged with the responsibility to maintain objectivity in rendering professional services.

According to Section 0.300.050, “the maintenance of objectivity and independence requires a continuing assessment of client relationships and public responsibility.” One could argue that this requirement is applied specifically to members in public practice, and is therefore not relevant to other members. However, this argument would be incorrect.

Code Section 0.300.040 states: “Integrity requires a member to observe both the form and the spirit of technical and ethical standards; circumvention of those standards constitutes subordination of judgment.” For members not in public practice, the Code's admonishment to observe “the spirit of technical and ethical standards” means that integrity is more than just a legalistic exercise. For all members, integrity must be part of the fabric of their daily lives.

Accounting professionals in public practice continually monitor their investment activity to ensure they are not in violation of independence rules by holding a direct financial interest in their client. A direct financial interest or significant investment could make it very difficult to act with integrity, objectivity, and professional skepticism if your own financial investment, or that of an immediate family member, is at risk. Do you think you could issue an unfavorable opinion with the market value of your own investment portfolio at risk?

Maintaining a certain level of independence enables an accountant to act with integrity. Remember, independence is the accountant's ability to act with integrity, objectivity, and professional skepticism.

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Alvin Johnson was a senior accounting clerk at Golden Trust Bank. He joined the company just three months ago. One of his primary responsibilities was to prepare a daily reconciliation of branch activity to the corporate transaction ledger. When problems arose he would reach out to the branch managers to clarify any discrepancies and document teller shortages in accordance with bank policy. Alvin became very good friends with several of the branch managers. They would often hang out after work at one of the local bars.

This morning he received a call from his friend Patty. Patty managed a small branch with relatively inexperienced tellers. One day, one of her tellers was $300 short. Unfortunately this had become a recurring event at Patty's branch and Patty was under close scrutiny by the regional manager. Patty had spent several hours researching the out of balance the night before and charged the unresolved discrepancy to the branch suspense account. Patty did not want to write up her teller nor take the hit for another shortage so she decided to call Alvin to ask for his assistance.

Next you'll see a short video clip and then you'll be asked to analyze the potential solutions, risks and consequences of the dilemma.

Dealing with Dilemmas: Integrity Compromised

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Hey Alvin, I wanted to let you know that I posted an unresolved discrepancy to the branch suspense account. One of my tellers was $300 short, and I can't afford another error against my branch. I know if I had just a little more time, I could resolve this shortage. I am sure it is just a transposition error. Can I please leave the posting in the suspense account until I resolve the discrepancy?

TranscriptHey Alvin, I wanted to let you know that I posted an unresolved discrepancy to the branch suspense account. One of my tellers was $300 short, and I can't afford another error against my branch. I know if I had just a little more time, I could resolve this shortage. I am sure it is just a transposition error. Can I please leave the posting in the suspense account until I resolve the discrepancy?

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Remember, Alvin's dilemma is that he's concerned about violating bank policy by delaying the documentation of the discrepancy at Patty's branch. What are some of the potential solutions to this ethical dilemma? What are the risks and consequences associated with each solution? To continue, select each Tab to see how Alvin handles this situation.

Potential Solution #1 Alvin could tell Patty he will need to verify bank policy regarding the use of the suspense account. This will give her more time to research the shortage.

Risks The teller error may have impacted several customer accounts.

Consequence By delaying the documentation process, Alvin would delay other bank business processes designed to ensure customer accounts are accurate.

Potential Solution #2 Alvin could document the discrepancy despite Patty's request.

Risks The teller and Patty could lose their jobs or be placed on probation.

Consequence Alvin's rapport with the branch managers could be damaged. His reliance on their support in identifying discrepancies could be compromised.

Potential Solution #3 Alvin could speak with his supervisor regarding the situation without revealing the name of the branch manager.

Risk Alvin's supervisor reprimands him for not documenting the discrepancy immediately.

Consequence Alvin is a new employee and his supervisor could be concerned about his honesty and integrity.

Conclusion Oftentimes in ethical situations there is no clear cut right and wrong answer; rather, it is just a matter of evaluating the risks and mitigating damaging results. In Alvin's case, he must weigh personal integrity and trust issues against potential financial and business loss for customers and the bank. The solution you choose will depend on the area you value most.

Are you more concerned with how people perceive you or whether you are dealing fairly with customers?

Your decision could have a broader impact on the reputation of the bank. Violating bank policy could have legal implications for you, and you could lose your job.

The AICPA Code of Professional Conduct

The AICPA Code of Professional Conduct (cont'd)

In Sections 1.100.001 and 2.100.001, the Code specifically addresses the ethical issues of integrity and objectivity. The content of these Sections is known as the “Integrity and Objectivity Rule.” This rule provides that a member shall maintain objectivity and integrity, be free of conflicts of interest, and not knowingly misrepresent facts or subordinate his or her judgment to others.

Sec. 0.200.020, Application of the AICPA Code, addresses the conduct of members practicing outside the United States. In such cases, the member's conduct is acceptable if in accordance with the rules of the organized accounting profession in the country in which he or she is practicing. However, when the member is associated with financial statements in such a way that a reader would assume that practices of the United States were followed, the member must comply with the “Compliance With Standards Rule,” Secs. 1.310.001 and 2.310.001, and the “Accounting Principles Rule,” Secs. 1.320.001 and 2.320.001.

Interpretations under the “Integrity and Objectivity Rule”

Knowing misrepresentations in the preparation of financial statements or records

You shall be considered to have knowingly misrepresented facts in violation of the “Integrity and Objectivity Rule” when you knowingly—

1. Make, or permit or direct another to make, materially false and misleading entries in an entity's financial statements or records;

2. Fail to correct an entity's financial statements or records that are materially false and misleading when you have the authority to record an entry; or

3. Sign, or permit or direct another to sign, a document containing materially false and misleading information.

Section 2.170.010, “Pressure to Breach the Rules,” addresses situations creating “pressures that could result in a member taking actions that breach or cause others to breach the rules.” This section makes specific reference to the “Integrity and Objectivity Rule” [2.100.001].

Remember Alvin, the accounting clerk at Golden Trust Bank? When we left him, he was struggling with his decision to delay reporting the discrepancy at Patty's branch. Let's assume Patty was unable to find the discrepancy. Later that day she called Alvin in tears desperately looking for a way out. She explains to Alvin that the money can stay in the suspense account for up to 30 days without raising suspicions. Surely by that time the customer will have contacted her branch regarding the discrepancy, and she will move the funds from the suspense account to the customer's account. Everyone will be happy, and no one will ever know her branch was out of balance. Alvin agrees and records in his ledger that Patty's branch balanced that day. Unfortunately, Alvin just knowingly misrepresented the facts and violated the Integrity and Objectivity Rule.

Alvin signed the document containing false and misleading information. Sections 1.130.010/2.130.010 clearly state you shall be considered to have knowingly misrepresented facts in violation of the Integrity and Objectivity Rule when you knowingly sign or permit or direct another to sign a document containing materially false and misleading information. In this case, we do not know if the discrepancy is material to the overall balances at Patty's branch. The discrepancy may be the result of several errors, and more than one customer may be impacted. Clearly, Alvin's failure to follow bank policy could have a broader impact on the reputation of Golden Trust Bank and the financial health of the bank's customers.

Study Question 4

You recently joined GreenCo as the company controller. You are new to GreenCo's niche industry, and are excited for the challenges this move brings. GreenCo is a closely-held small business, with five full-time employees. Financials are published each calendar year end, which is rapidly approaching. Last week, you began reviewing year-to-date journal entries in preparation for this event. Almost immediately, you found several year-end entries to the accounting system made by your predecessor that appear questionable. You discussed the entries with owner of GreenCo and she told you they were fine; however, you still have questions. Which interpretation of the Integrity and Objectivity Rule provides guidance for this situation?

Conflicts of Interest

According to Sections 1.110/2.110, conflict of interest may occur if a member, or a member's firm, performs a professional service for a client or employer and the member or firm has a relationship with another person, entity, product, or service that could, in the member's professional judgment, be viewed by the client, employer—or other reasonable and informed, relevant parties—as impairing the member's objectivity. If you believe that the professional service can be performed with objectivity, and the relationship is disclosed to and consent is obtained from such client, employer, or other appropriate parties, the rule shall not operate to prohibit the performance of the professional service.

Basically this means that you must avoid conflicts of interest—whether in fact or in appearance—that would impede your ability to render professional services in an ethical manner. Certain professional engagements, such as audits, reviews, and other attest services, require independence. Impairments to independence under the “Independence Rule,” its interpretations, and rulings cannot be eliminated by a simple disclosure and consent. The appearance of impairments to objectivity, however, can sometimes be resolved by these means. The requirement that a member exercise professional judgment cannot be overemphasized.

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Practice Exercise

John Alba, CPA provides investment advice to his tax clients. He has an exclusive, quid pro quo agreement with the local franchisee of a personal financial planning (PFP) operation such that each refers clients to the other.

Should John consider the implications of the Integrity and Objective Rule concerning either conflicts of interest or subordination of judgment?

Answer Options: Yes or No

Feedback: Yes is the correct answer. Conflicts of interest occur if you perform a professional service for a client or employer and you or your firm has a relationship with another person or entity that could be viewed as impairing your objectivity. John's exclusive quid pro quo arrangement with the PFP franchisee gives, at least, the appearance of a conflict of interest and could cause others to view his objectivity as being impaired. If John believes his objectivity is not impaired, he should disclose the agreement and obtain consent from his tax clients before referring them under this arrangement.

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Practice Exercise

Helen Bates is the Chief Financial Officer at Lista Airlines. Her company has experienced tremendous growth and is considering the possible acquisition of Renaissance Air. She calls you to discuss a potential engagement with your firm's merger and acquisition practice. You are an audit partner with B.D. Taylor and Associates. You serve the Midwest travel and tourism industry. Lista Airlines is one of your more significant accounts. Over the past year, you have tried to expand the scope of your audit to include other attest services. You are thrilled when you get the call from Helen regarding M&A services, but you are concerned when you learn Renaissance Air is the other party involved. The firm's tax division just submitted a proposal to Renaissance Air to provide tax and advisory services.

Referring to the scenario on the previous page, can B. D. Taylor and Associates provide attest services to Lista Airlines and Renaissance Air?

Answer Options: Yes or No

Feedback: Yes is the correct answer. B.D. Taylor and Associates can provide attest services to Lista Airlines and Renaissance Air, provided that you disclose the relationship to both companies and that each of them agrees to let you represent the other company. Of course, you must also conclude that such a relationship will not impair your objectivity, after evaluating the significance of the threat created by the conflict of interest.

Obligations of a Member to his or her Employer's External Accountant

You are the controller for a small construction company which has a calendar year-end. The owner of the company personally handles sales and accounts receivable. The bank requires reviewed financial statements for certain receivables-based loans. Through trend analysis, you discover that the owner has entered invoices at year-end for work that will not be billable until January. These invoices will have a substantial impact on the balance sheet. When you question the owner, he tells you that the invoices will be reversed in January and replaced with invoices sent to the customer. He listens to your concerns (including the fact that the invoices are subject to challenge and negotiation by the customer, and that two of the largest invoices are subject to substantial write-down) but overrules you in favor of making a good impression on the bank.

When you argue that the external accountant will also find and question these invoices, he instructs you to tell the external accountant that these invoices are for completed work. In this case there is more than one issue, but your obligations to the external accountant under Sec. 2.130.030 are the focus. You are being instructed to be less than candid with the external accountant. If the external accountant requests clarification and you respond as required by the owner, you are guilty of knowingly misrepresenting facts. Even if the external accountant does not ask about the entries, your silence means that you have knowingly failed to disclose facts material to the financial statements.

Subordination of Judgment by a Member

Under Interpretation 1.130.020/2.130.020 of the Integrity and Objectivity Rule, if a member and his or her supervisor (or any other person within the member's organization) have a difference of opinion relating to the application of accounting principles, auditing standards, or other relevant professional standards, including standards applicable to tax and consulting services or applicable laws or regulations, the member should apply appropriate safeguards so that the member does not subordinate his or her judgment if the member concludes the difference of opinion creates significant threats to the member's integrity and objectivity.

In assessing the significance of any identified threats, the member should form a conclusion, after appropriate research or consultation, about whether the result of the position taken by the supervisor or other person:

• Fails to comply with professional standards, when applicable;

• Creates a material misrepresentation of fact; or

• May violate applicable laws or regulations.

If the member concludes that the position taken is not in compliance with professional standards but does not result in a material misrepresentation of fact or a violation of applicable laws or regulations, then threats would not be considered significant. However, the member should discuss his or her conclusions with the person taking the position.

If the member concludes that the position results in a material misrepresentation of fact or a violation of applicable laws or regulations, then threats would be considered significant. In such circ*mstances, the member should discuss his or her concerns with the supervisor. If the difference of opinion is still not resolved, then the member should discuss his or her concerns with the appropriate higher level(s) of management within the member's organization (for example, the supervisor's immediate superior, senior management, and those charged with governance).

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If after discussing such concerns with the supervisor and appropriate higher level(s) of management within the member's organization, the member concludes that appropriate action was not taken, then the member should consider, in no specific order, the following safeguards to ensure that threats to the member's compliance with the Integrity and Objectivity Rule are eliminated or reduced to an acceptable level. Select each layer to view the safeguards.

• Determining whether any additional requirements exist under his or her employer's internal policies and procedures for reporting differences of opinion.

• Determining whether any responsibilities exist to communicate to third parties, such as regulatory authorities or the employer's (former employer's) external accountant.

• Consulting with his or her legal counsel regarding his or her responsibilities.

• Documenting his or her understanding of the facts, the accounting principles, auditing standards, or other relevant professional standards involved or applicable laws or regulations and the conversations and parties with whom these matters were discussed.

If the member concludes that no safeguards can eliminate or reduce the threats to an acceptable level or if the member concludes that appropriate action was not taken, then he or she should consider his or her continuing relationship with the member's organization and take appropriate steps to eliminate his or her exposure to subordination of judgment.

Nothing in Interpretation 1.130.020/2.130.020 would preclude a member from resigning from the member's organization at any time. However, resignation may not relieve the member of his or her responsibilities in the situation, including any responsibility to disclose to third parties, such as regulatory authorities or the employer's (former employer's) external accountant.

A member should use professional judgment and apply similar safeguards, as appropriate, to other situations involving a difference of opinion so that the member does not subordinate his or her judgment.

In the previous exercise, the controller (a member) of a small construction company was directed by the owner of the construction company to accept invoices booked at year-end that the controller believes inappropriately accelerate revenue recognition to the current year. Under this rule, if the controller disagrees with the owner, the controller would first evaluate if the owner's approach was an acceptable alternative with authoritative support, and whether the approach materially misrepresents the facts. If the controller concludes that the financial statements or records could be materially misstated, then the controller should consider any responsibility that may exist to communicate to third parties, such as regulatory authorities or the external accountant. In this scenario, the controller would more than likely communicate with the external accountant. The controller may want to consult his legal counsel as well.

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Interpretations 2.160.010 and 1.140.010

Applicability of the Integrity and Objectivity Rule to members performing educational services

Educational services—for example, teaching full- or part-time at a university, teaching a continuing professional education course, or engaging in research and scholarship—are defined as professional services in Section 2.160.010 and are therefore subject to the Integrity and Objectivity Rule.

Professional services involving client advocacy

You or your firm may be requested by a client to:

1. perform tax or consulting services engagements that involve acting as an advocate for the client, or

2. act as an advocate in support of the client's position on accounting or financial reporting issues, either within the firm or outside the firm with standard setters, regulators, or others.

Services provided or actions taken pursuant to such types of client requests are considered professional services under Section 1.140 and therefore governed by the Code and subject to the Integrity and Objectivity Rule. When performing professional services requiring independence, you will also be subject to the Independence Rule.

There is a possibility that some professional services involving client advocacy may stretch the bounds of performance standards, may go beyond sound and reasonable professional practice, or may compromise credibility, and thereby pose an unacceptable risk of impairing the reputation of the individual and his or her firm with respect to independence, integrity, and objectivity. In such circ*mstances, you and your firm should consider whether it is appropriate to perform the service.

Study Question 5

Lisa Johnson, a tax accountant with J.B. & Associates, is finalizing the annual corporate tax returns for Flora Fashions. Flora Fashions is a small retail operation headquartered in Cincinnati, Ohio. Lisa was assigned to Flora fashions more than five years ago. Over the years, she has taken increased responsibility for the preparation and transmittal of their tax returns including the transmittal of any related payments to their taxing authority. Now she is being asked to appear as an expert witness for the client in a whistleblower action related to those tax return filings and payments. Is this level of client service permitted under the Integrity and Objectivity Rule?

Gifts and Entertainment

Sections 1.120.010/2.120.010 require you to consider whether your objectivity has been impaired when you offer to, or accept gifts or entertainment from, your firm's clients or your employer's customers or vendors (this includes customer or vendor representatives and listed client representatives).

Gifts and Entertainment (cont'd)

The basic rule, in 1.120.010.04/2.120.010.04, says that your objectivity would not be considered to be impaired if the gift or entertainment is reasonable in the circ*mstances. Among other factors, “reasonableness” may be based on:

• The nature of the gift or entertainment

• The occasion giving rise to the gift or entertainment

• The cost or value of the gift or entertainment

• The nature, frequency, and value of other gifts and entertainment offered or accepted

• Whether the entertainment was associated with the active conduct of business directly before, during, or after the entertainment

• Whether other clients, customers, or vendors also participated in the entertainment

• Who (from the member's firm or employer, and from the client, customer, or vendor) participated in the entertainment

Remember, you should also be aware of and abide by any applicable policies, laws, or regulations which would preclude the offer or acceptance of a gift or entertainment.

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You're a new Senior Manager with the accounting firm of Rozner and Rozner. Recently you completed an attest engagement for Kingsbury Tires. Kingsbury's controller just called and invited you to join him at a one-day transportation technology expo hosted by the major auto manufacturers and Silicon Valley companies.

The expo is free to the public, and is supposed to showcase technology still being tested. The two of you will travel to the expo by company vehicle and return the same day. You'll have to take personal time off, but you would really like to see the new technology.

You inform the controller you'll need to check with your managing partner and the firm's policy on gifts and entertainment before you can commit.

Study Question 6

Given the circ*mstances in the example on the previous page, are you prohibited from attending the expo by objectivity impairment concerns?

Chapter 3. General Standards, Compliance, and Accounting Principles

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This chapter covers General Standards, Compliance With Standards, and Accounting Principles of the AICPA Code of Professional Conduct. All CPAs, even those who are not members of the AICPA, are expected to comply with the rules set forth under the Code. Most state boards have established their own codes of professional conduct, often modeled after that of the AICPA and most with very little difference. Since the AICPA works with the state boards to govern the conduct and performance of CPAs, it is important that non-members also comply with the Code. Moreover, CPAs have a duty to comply with ethical standards set forth in the Code. This duty is born of the responsibility that CPAs have to the public, to their clients, to their employers and to any entity or individual expected to benefit from the services CPAs provide. Strict adherence to the rules set forth in the Code results in the profession maintaining its high ethical standards and in the public maintaining its confidence in the profession. After completing this chapter, you should be able to recognize the General standards of the AICPA Code of Professional Conduct.

TranscriptThis chapter covers General Standards, Compliance With Standards, and Accounting Principles of the AICPA Code of Professional Conduct. All CPAs, even those who are not members of the AICPA, are expected to comply with the rules set forth under the Code. Most state boards have established their own codes of professional conduct, often modeled after that of the AICPA and most with very little difference. Since the AICPA works with the state boards to govern the conduct and performance of CPAs, it is important that non-members also comply with the Code. Moreover, CPAs have a duty to comply with ethical standards set forth in the Code. This duty is born of the responsibility that CPAs have to the public, to their clients, to their employers and to any entity or individual expected to benefit from the services CPAs provide. Strict adherence to the rules set forth in the Code results in the profession maintaining its high ethical standards and in the public maintaining its confidence in the profession. After completing this chapter, you should be able to recognize the General standards of the AICPA Code of Professional Conduct.

General Standards

There is little doubt that the public has different expectations of professionals (i.e., doctors, accountants, or lawyers) than they do with nonprofessionals (i.e., salespeople). A profession is often granted rights that others do not enjoy. Unquestionably, these rights have been bestowed upon CPAs.

The accounting profession performs audit services and other attest services to give external parties some level of assurance. CPAs are asked to determine if management's representations are reliable and in accordance with established criteria, primarily GAAP. Unless CPAs are objective and unbiased, their opinions about management's representations would be worthless; therefore, independence is the foundation for the public's trust in the audit/attest function.

The accounting profession has traditionally governed itself and continues to do so with the requirements for peer reviews and investigations by appropriate bodies whenever it is discovered that possible ethics violations may have occurred. The advent of Sarbanes-Oxley has allowed the government to get involved in governing the accounting profession. All of these factors help CPAs to have credibility with the public. When a CPA loses this credibility with the public, the consequences can be quite severe, not only for the offending professional, but also for the profession.

Whether engaged in auditing or management—or as an employee or consultant—a professional accountant is expected to be both an accountant and a professional. That means professional accountants are expected to follow certain rules and a code of professional conduct, one being the AICPA Code of Professional Conduct (the Code).

The Code applies to all members in public practice and all members in business.

Throughout this chapter, we will be discussing the General Standards within the AICPA Code of Professional Conduct. The Code gives specific and separate guidance to members in public practice and members in industry. Members in public practice will find their General Standards within the Code, under Part 1—Members in Public Practice (Sections 1.300s); while members in business will find their guidance under Part 2—Members in Business (Sections 2.300s). Practitioners should read and follow the appropriate guidance for their circ*mstances and needs.

All of the topics covered in this chapter (the general standards, their definitions and their impact on professional engagements as well as adherence to GAAP and various other rulings and general technical standards) can be found in the AICPA Code of Professional Conduct.

General Standards Rule

The General Standards Rule addresses the general standards with which all CPAs are required to comply. There are four general standards. These standards are:

• Professional competence,

• Due professional care,

• Planning and supervision, and

• Sufficient relevant data.

To familiarize yourself with these four general standards, you may want to refer to the AICPA Code of Professional Conduct, sections 1.300 and 2.300. In the absence of an interpretation of the General Standards Rule section 1.300.001 that addresses a particular relationship or circ*mstance, a member should apply the Conceptual Framework for Members in Public Practice section 1.000.010. In the absence of an interpretation of the General Standards Rule section 2.300.001 that addresses a particular relationship or circ*mstance, a member should apply the Conceptual Framework for Members in Business section 2.000.010.

Many accountants, and many nonaccountants, hold the view that mastery of accounting, auditing, taxation, and computers are the most important aspect of the accounting profession. Interestingly, very few financial scandals have been caused by methodological errors in the application of a particular technique. Rather, these scandals have been caused by errors in judgment about the appropriate use of a technique or the disclosure related to it.

Some of these errors in judgment stem from misinterpretation of the problem due to its complexity, while others are caused by a lack of attention to the ethical values of honesty, integrity, objectivity, due care, confidentiality, and the commitment to the interests of others before oneself. One characteristic that seems common to many of these scandals is that the accountants involved start to rationalize their actions. These accountants engage in what is called moral disengagement. Moral disengagement occurs when we begin to rationalize behavior that we know to be unethical.

The public, and particularly the client, expects that a professional accountant will perform his/her work with competence, integrity, and objectivity. The public expects that the work done by the CPA is completed with professional proficiency. The CPA's integrity and objectivity are essential to the proper discharge of fiduciary duties. Along with competence, a CPA's integrity and objectivity add critical value to the services being performed and the outcome or result of those services.

Professional Competence

A CPA should not undertake any engagement for the performance of professional services which s/he cannot reasonably expect to complete with professional competence. The elements of professional competence include, but are not limited to, technical training, proficiency, adequate knowledge, requisite skills, sound judgment, reasonable care, and diligence. This includes compliance with applicable professional standards. If a CPA fails this critical step, his or her integrity, reputation, and credibility are damaged. In short, the CPA will lose the public's trust, and that of their clients.

This vital component, competence to perform professional services, involves both the technical qualifications of the CPA as well as his or her staff. In addition, it includes the ability to supervise and evaluate the quality of the work being performed.

The CPA must have knowledge of:

• the profession's standards,

• the techniques,

• technical subject matter involved, and

• the ability to exercise sound judgment in applying such knowledge in the performance of professional services.

When a CPA agrees to perform professional services, it is implied that he or she has the competence to complete those services according to professional standards as well as to apply his or her knowledge and skills with reasonable care and diligence. However, this belief does not assume a responsibility for infallibility of knowledge or judgment.

If a CPA does not have the professional competency required to complete the services in accordance with professional standards prior to the performance of the service, the CPA may perform additional research to address his or her deficiencies. The CPA may also consult with others to gain sufficient competence. If due professional competence cannot be reached by the member, he or she should suggest engaging a competent person to perform those services.

Due Professional Care

CPAs must always exercise due professional care in performing their professional services. This calls for the application of the care and skill expected of a reasonably prudent and competent professional in similar circ*mstances.

Additionally, due professional care requires the exercise of professional skepticism. Professional skepticism is an attitude that supports an inquisitive mind and a critical assessment of evidence obtained. One cannot presume that management is completely honest or dishonest. The CPA should not be satisfied with less than persuasive evidence. The member needs to use the knowledge, skills, and ability called for by the profession of public accounting to diligently perform, in good faith and with integrity, the gathering and objective evaluation of evidence.

An independent auditor needs to obtain sufficient appropriate audit evidence to provide him or her with a reasonable basis for forming an opinion. Because the auditor's opinion is based on the notion of obtaining reasonable assurance, the auditor is not an insurer, nor does the auditor's report constitute a guarantee.

Planning and Supervision

To exercise due professional care, CPAs must plan and supervise their professional engagements. They must be able to adequately plan their work as well as the work of their assistants, whether peers, staff, or contractors. CPAs are also required to provide adequate supervision of others who work on the professional service or engagement.

Employing another competent person (i.e., a specialist) to perform duties does not relinquish the CPA's responsibility. The CPA must be qualified to supervise and evaluate the work of the other competent person. Ultimately, the CPA must be able to define the tasks and evaluate the end product.

Planning and supervision activities should be viewed as ongoing and continuing throughout the engagement.

Adequate planning and supervision encompasses the following activities:

• preparing an engagement plan (e.g., an audit program);

• understanding the client's business;

• obtaining information about the client's business; and

• resolving differing opinions and attitudes among client personnel related to the engagement.

Sufficient Relevant Data

Obtaining the right data is key to coming up with the right conclusions or recommendations. CPAs must gather sufficient relevant data to support conclusions made (and recommendations given) in the course of providing professional services. Too little data could lead the CPA to the wrong conclusion or recommendation, while too much data will increase costs and waste valuable resources. The quantity and type of evidence required is ultimately a matter of the CPA's judgment.

Sufficient relevant data is obtained through:

• inspection,

• observation,

• inquiries, and

• confirmations.

Rather than a set of rules, the validity of evidence obtained is based on the CPA's judgment. The competence of evidence obtained is based on several factors including:

• pertinence of the evidence,

• objectivity,

• timeliness, and

• existence of corroborating evidence.

Independence and Financial Statements

One of the most important issues facing the accounting profession is the issue of independence. The requirement of independence is unique to the accounting profession. It is the cornerstone of the profession. In the performance of attest services—in which CPAs are asked to render some type of opinion about the financial statements or management performance—CPAs are expected to be independent. They cannot be advocates for their clients; otherwise, CPAs performing attest services lose creditability, and their opinions become meaningless and lose value. When the CPAs are independent—as they must be in the cases of audits and reviews—then their independence adds believability to the representations of management.

CPAs in public practice are allowed to prepare or submit financial statements as a stockholder, a partner, a director, an officer, or an employee of an entity using the firm's letterhead or similar identification. Of course, those who do so are not considered “independent” to the organization. In such cases, the CPA should comply with the Code's “Compliance With Standards” section 1.310.001 for members in public practice and 2.310.001 for members in business —including any requirements to disclose a lack of independence in his or her report.

For CPAs who are not in public practice and who prepare or submit an entity's financial statements to third parties, they must clearly communicate that they are not independent from the entity. This communication is best done in written form and should indicate the member's relationship to the entity. Of course, if the communication points out affirmatively that the financial statements are presented in conformity with the applicable financial reporting framework, the CPA should comply with the Code's “Accounting Principles Rules” section 1.320.001 for members in public practice and 2.320.001 for members in business.

For additional guidance, you may wish to refer to the “Use of a CPA Credential” interpretation (Section 2.400.100) and the “Submission of Financial Statements” interpretation (Section 2.300.030).

Use of a Third-Party Service Provider: Public Practice

CPAs in public practice can turn to third-party service providers for assistance. Third-party service providers could provide the following:

	bookkeeping,
	tax preparation,
	consulting services,
	attest services, and
	any related clerical or data entry functions.

As we discussed, employing another competent person—the third-party service provider—to perform duties does not relinquish the CPA's responsibility. The CPA must be qualified to supervise and evaluate the work of the third-party provider. The CPA must be able to define the tasks and evaluate the end product. Also, the CPA must evaluate and be assured that the third-party service provider has the required professional qualifications, technical skills, and other resources to accomplish the service.

While using a third-party provider, the CPA must still comply with the four vital components. The services must be performed with competence and due professional care, and sufficient relevant data must be gathered to support the work product and comply with all technical standards applicable to the professional services.

Although the CPA is responsible for planning and supervising the third-party service provider's work, this responsibility does not extend beyond the requirements of applicable professional standards—which may vary depending upon the nature of the CPA's engagement.

Note

For additional guidance, please refer to the “Use of a Third-Party Service Provider” interpretation (Section 1.150.040) of the “Integrity and Objectivity Rule” (Section 1.100.001) and the “Disclosing Information to a Third-Party Service Provider” (Section 1.700.040) of the “Confidential Client Information Rule” (Section 1.700.001).

Study Question 7

Which of the following professionals is expected to be independent of their clients?

Study Question 8

Which general standard calls for the application of the care and skill expected of a reasonably prudent and competent practitioner in similar circ*mstances?

Regulatory Bodies

Members who perform professional services—including attest services such as audits and reviews, compliance work, management, consulting, and taxation services—must follow established standards. These standards are established by a number of regulatory bodies, including the following.

• Federal Accounting Standards Advisory Board

• Financial Accounting Standards Board

• Governmental Accounting Standards Board

• Public Company Accounting Oversight Board

• International Accounting Standards Board

• AICPA Committees and Boards

• Accounting and Review Services Committee

• Auditing Standards Board

• Management Consulting Services Executive Committee

• Attestation Standards

• Tax Executive Committee

• Forensic and Valuation Services Executive Committee

• Personal Financial Planning Executive Committee

Note

Refer to Appendix A, “Council Resolution Designating Bodies to Promulgate Technical Standards,” of the Code for additional information about these regulatory bodies.

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TranscriptSeveral threats have been identified by AICPA ethics standards, including a self-review threat, advocacy threat, adverse interest threat, familiarity threat, undue influence threat, financial self-interest threat, and management participation threat. Self-review threats deal with situations when auditors or audit firms provide certain non-attest services to clients for which an audit is conducted. The problem is that the audit may entail examining the results of such services, and it may appear that the auditor may not point out deficiencies in the audit.

A reasonable observer may then conclude that independence is impaired because the auditor examines his or her own work performed for the audit client.

An advocacy threat to independence may occur when an auditor or audit firm finds itself in a position where its interests are opposed to the client's interests, making it difficult to act with objectivity. This can occur when the client asks the auditor to promote or represent their interests in some way. In this situation, the auditor would be biased in favor of the client and therefore could not be objective. An example is if the client asked the auditor to promote their shares for a stock exchange listing, or if the client asked the auditor to represent them in court.

An adverse interest threat to independence occurs when an auditor or audit firm finds itself in a position where its interests are opposed to the client's interests, making it difficult to act with objectivity. For example, an adverse interest threat might occur if the auditor or audit firm's interests are different than those of a client, such as in a litigation matter.

A familiarity threat occurs when an auditor or audit firm develops a close relationship with the client over a long period of time, which could lead the auditor or audit firm to become too sympathetic to the client's interests, or too accepting of the client's work product. An example is when a close relative of the auditor works in a key position or financial reporting oversight role for the client. The auditor may trust that person to not make mistakes, and therefore not review their work as thoroughly as they should. As a result, the auditor might allow material errors to go undetected in the financial statements. A familiarity threat can also arise after a long association with the client.

Based on the audit committee's evaluation, a client entity may threaten to replace the audit firm because of a disagreement over the application of an accounting principle. These situations create undue influence threats to independence. For example, the client may use the audit fee as leverage against the auditor on contentious matters. The auditor should not give into such pressure. Given the specific circ*mstances, the auditor may choose to resign from the engagement.

Threats to independence may exist if an auditor could benefit financially or otherwise from an interest in or relationship with a client or persons associated with the client. This could include becoming involved in a business relationship that creates a mutuality of interests. A financial self-interest threat also may occur when the auditor or member of their family, such as one's spouse, owns shares of stock in a client. The auditor would directly benefit from increases in client profits and may be reluctant to raise any concerns that could adversely affect the performance of the client. Another example is when a firm is dependent upon one client for a significant portion of their total fee income. The firm may not raise issues with the client under those circ*mstances for fear of losing the client.

A management participation threat occurs when an auditor takes on the role of client management or otherwise assumes management responsibilities. This may occur during an engagement to provide certain nonattest services. Examples include authorizing, executing, or consummating a transaction or otherwise exercising authority on behalf of the attest client or having the authority to do so. Management participation threats also exist when the auditor determines which recommendation of the firm should be implemented. Another such threat is when the auditor reports in a management role to those charged with governance.

Safeguards are controls that eliminate or reduce threats to independence to an acceptable level. These safeguards range from partial to complete prohibitions of the threatening circ*mstance to procedures that counteract the potential influence of a threat. Examples of safeguards are those created by the profession, legislation or regulation, those implemented by the attest client, and those implemented by the firm.

Safeguards created by the profession, legislation or regulation include the following:

• education

• training

• continuing education on ethics, independence, professional responsibilities, and professional standards

• the threat of discipline, and

• professional resources such as hotlines for consultation on ethics issues and regulations (i.e., the Securities Acts and Sarbanes-Oxley Act).

Safeguards implemented by the attest client include the following:

• personnel with suitable skill, knowledge, or experience who make managerial decisions and oversee the performance of professional services

• tone at the top that emphasizes the client's commitment to fair financial reporting and compliance with the applicable laws, rules, regulations and corporate governance policies, and

• a governance structure, such as an active audit committee, that oversees financial reporting and works with the external auditors when differences exist with management over the application of generally accepted accounting principles.

It is not possible to rely solely on safeguards that exist at the client entity because there are no assurances such safeguards will continue to exist throughout the engagement period. Safeguards implemented by the Audit firm itself include the following:

• documented policies to deal with independence issues, including threats and safeguards

• discussion of independence and ethics issues with the audit committee or others responsible for client governance

• the removal of an individual from the attest engagement team when that individual's financial interests or relationships pose a threat to independence or objectivity, and

• monitoring of the firm's partners' or partner equivalents' reliance on revenue from a single client that would necessitate addressing excessive reliance.

Practitioners must identify and evaluate threats to independence because these threats can have an effect on the members' independence and thus, their ability to fulfill their professional duty. There are a number of threats to an auditor's independence (i.e., self-review threat, advocacy threat, adverse interest threat, familiarity threat, undue influence threat, financial self-interest threat, and management participation threat).

Safeguards are controls that can eliminate or reduce the threats to independence. If no safeguards are available to eliminate an unacceptable threat—or reduce the threat to an acceptable level—then independence would be considered impaired.

There are a number of sections with the AICPA Code of Professional Guidance and Interpretation that can help a CPA navigate through these threats. Some sections include “Conceptual Framework for Members in Public Practice” [1.000.010] and “Conceptual Framework for Members in Business” [2.000.010], “Compliance With Standards Rule” (Sections 1.310.001 and 2.310.001), and “Ethical Conflicts” (Sections 1.000.020 and 2.000.020).

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Interactivity information:

Practice Exercise

Assume that you are a covered member with respect to an attest client. You also serve as a general partner in a separate partnership. The separate partnership owns shares in your attest client.

Would your independence be impaired?

ANSWER OPTIONS: Yes or No

FEEDBACK: Yes is the correct response. When a covered member acquires any direct financial interest in an attest client during the period of the professional engagement, the self-interest threat would impair the member's independence. Since you are a general partner in the separate partnership, you would be considered to have a direct financial interest and independence would be impaired.

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Practice Exercise

Assume that you own shares in a mutual fund. The fund has a net asset balance of $5,000,000. Your shares in the fund have a value of $25,000. Assume further that the fund has 5% of its assets invested in one of your audit clients. Your indirect financial interest would be as follows: $25,000 × .05 = $1,250.

Would your independence be impaired?

ANSWER OPTIONS:

1. Yes

2. No

3. It depends

FEEDBACK: C. It depends is the correct response. If the $1,250 is material to your overall net worth, then independence would be considered to be impaired. If the $1,250 is NOT material to your net worth, then independence would not be impaired.

If the covered member acquires any material indirect financial interest in an attest client during the period of the professional engagement, the self-interest threat would render the member's independence impaired. If a partner or professional employee of the firm, his or her immediate family, or any group of such persons acting together owned more than 5 percent of an attest client's outstanding equity securities or other ownership interests during the period of the professional engagement, the self-interest threat renders the member's independence impaired as well.

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Independence Scenario

Rose is a CPA with a dilemma. She has her practice in a small town where she performs audits, reviews, compilations, and tax services. Her largest client is the local bank, TrustUS Bank. Rose has been the auditor for the bank for a number of years. TrustUS Bank not only handles Rose's personal savings and checking accounts, but her business checking accounts as well. Rose has her home loan and other personal and business loans with another financial institution, Welcome Savings and Loan. The bank manager at TrustUS has approached Rose and suggested that they will take their audit business away from her if she does not move her loans to TrustUS.

What should Rose do?

Suggested Solution

There is nothing to prevent Rose from moving her loans to the TrustUS Bank. However, if she does this her independence would be impaired and she would no longer be able to perform any attest services for TrustUS. She could still perform nonattest services such as tax work, preparation of financial statements, compilations, and consulting. But she would no longer be able to do audits or reviews.

Rose should explain this to the bank manager. If the bank manager still insists that they handle all of her banking business, including loans, then Rose should consider moving her banking elsewhere. Of course, she will probably lose TrustUS as a client. But another aspect of this dilemma is that her client, TrustUS Bank, is creating an undue influence upon Rose by threatening to take their business away from her unless she does what they want.

Rose is likely to lose the attest business of TrustUS regardless of her decision. If she moves all of her banking activities her independence will be impaired and she will have to withdraw from such engagements. If she refuses to move all of her banking activities her client will probably discontinue using her services.

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Interactivity information:

In the performance of attest services, CPAs are asked to render some type of opinion about the financial statements or management performance. In these cases, the member is prohibited from expressing an opinion that is contrary to the evidence gathered. For example, a CPA cannot state that the financial statements are presented in conformity with GAAP, if they are not. A CPA cannot state that he or she is unaware of any material modifications, if such a statement is untrue. There are times where, upon occasion, there may be an unusual circ*mstance where the literal application of the accounting principles would render the financial statements misleading. If it can be shown that the departure from GAAP is due to an unusual circ*mstance—such that the financial statements or data would otherwise be misleading—then a CPA may still comply with the General Standards. This is a matter of professional judgment and the member must be able to support his or her position—i.e., that adherence to the promulgated principle would have produced a misleading result, if viewed by reasonable people. Examples of events which may justify departures from a principle include new legislation or the evolution of a new form of business transaction. On the other hand, an unusual degree of materiality or the existence of conflicting industry practices would not ordinarily be regarded as unusual; therefore, they would not be events that would justify departures from an appropriate accounting principle. In order to comply, the CPA is required to: describe the departure from GAAP; describe its approximate effects, and give the explanation as to why compliance with GAAP would result in misleading financial statements or data. Refer to “Accounting Principles Rules” of the Code for additional information.

TranscriptIn the performance of attest services, CPAs are asked to render some type of opinion about the financial statements or management performance. In these cases, the member is prohibited from expressing an opinion that is contrary to the evidence gathered. For example, a CPA cannot state that the financial statements are presented in conformity with GAAP, if they are not. A CPA cannot state that he or she is unaware of any material modifications, if such a statement is untrue. There are times where, upon occasion, there may be an unusual circ*mstance where the literal application of the accounting principles would render the financial statements misleading. If it can be shown that the departure from GAAP is due to an unusual circ*mstance—such that the financial statements or data would otherwise be misleading—then a CPA may still comply with the General Standards. This is a matter of professional judgment and the member must be able to support his or her position—i.e., that adherence to the promulgated principle would have produced a misleading result, if viewed by reasonable people. Examples of events which may justify departures from a principle include new legislation or the evolution of a new form of business transaction. On the other hand, an unusual degree of materiality or the existence of conflicting industry practices would not ordinarily be regarded as unusual; therefore, they would not be events that would justify departures from an appropriate accounting principle. In order to comply, the CPA is required to: describe the departure from GAAP; describe its approximate effects, and give the explanation as to why compliance with GAAP would result in misleading financial statements or data. Refer to “Accounting Principles Rules” of the Code for additional information.

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Interactivity information:

Departure from GAAP Scenario

HealthApp, Inc., is a publicly owned company that develops medical software for sale to various hospitals and healthcare organizations around the country. Eureka Medical Research Hospital is one of the largest hospitals that uses HealthApp products. HealthApp recently hired Casper & Casper, LLP, to conduct its December 31, 2015, audit. On February 15, 2016, Will Robinson, a CPA and the audit supervisor for Casper & Casper, received some disturbing news. It seems that the financial condition of the Eureka Medical Research Hospital has deteriorated to the point that it has filed for bankruptcy. Robinson contacts Dick Snider, the controller for HealthApp, who confirms that Eureka Medical has filed for bankruptcy.

Snider has spoken to the attorneys and he has determined that between 50 percent and 70 percent of the $3,000,000 accounts receivable balance may be recoverable, although anything over $1,500,000 is unlikely. Based on this information, Robinson proposes increasing the December 31, 2015, balance in the allowance for uncollectible accounts by $1,500,000. Snider points out that such a charge would significantly lower reported profits for the year as well as affect the bonuses that upper management was projected to receive. He asks Robinson to meet with him and Ed Black, HealthApp's CEO, to further discuss this matter.

A meeting is held between Ed Black, Dick Snider, Will Robinson, and Sam Lapine (who is the partner in charge of the audit). Black suggests that the pending loss should only be footnoted in the amount of $600,000 to $1,000,000. Black insists on this treatment for two reasons: (1) Eureka Medical Research Hospital has already confirmed in writing the $3,000,000 balance at December 31, 2015; and (2) a $1,500,000 charge-off will put HealthApp in violation of its debt covenant agreement because its working capital will be below the minimum required amount. Moreover, the lender may accelerate the due date of the debt because of the loan covenant violation, thereby requiring HealthApp to use $6 million that has been earmarked for expansion, to pay off the debt. At this point, Robinson and Lapine decide to postpone a final decision on the write-off so they can meet with the consulting partner on the engagement.

What are the accounting issues and ethical issues in this case? What would you do as a licensed CPA and auditor?

Facts to Consider

As you consider the two questions posed on the previous page, here are the important facts that you should consider.

1. HealthApp is an audit client.

2. Casper & Casper was hired by HealthApp to do the external audit.

3. Will Robinson is a licensed CPA employed by Casper & Casper as an audit supervisor.

4. A major HealthApp customer— Eureka Medical Research Hospital— has declared bankruptcy.

5. Although 50 percent to 70 percent of the $3,000,000 receivable from Eureka may be recoverable, anything over $1,500,000 is unlikely.

6. Robinson proposes increasing the allowance account by $1,500,000.

7. HealthApp's controller worries the $1,500,000 charge would significantly impact profits.

8. In discussing the problem, the HealthApp CEO, Black, wants only a disclosure in the footnotes of the pending loss since Eureka confirmed the receivable balance at year-end.

9. A $1,500,000 charge-off would put HealthApp in violation of its loan covenant.

10. HealthApp's management is afraid violating the loan covenant would cause the lender to demand immediate payment of the loan forcing HealthApp to use cash earmarked for expansion purposes.

To view this interactivity please view chapter 3, page 31

Interactivity information:

Here are the important ethical and accounting issues related to this matter. Select each Tab to view the issues.

GAAP

First of all, as CPAs, you are expected to follow GAAP. As a CPA and CPA firm, you are not supposed to issue a report that asserts the financial statements are presented in accordance with GAAP if such statements contain a departure from GAAP that has a material effect on the statements taken as a whole. If the client does not follow GAAP, and a justification for the departure from GAAP cannot be made, then the auditor is precluded from issuing an unqualified opinion.

In this situation, conservatism would require the write-down of the value of the accounts receivable. After all, a receivable only has value if it can be collected, and there is a high degree of uncertainty about the collectability of this receivable. In addition, failure to follow GAAP by consenting to the desires of the client would violate the integrity and objectivity rule because you would have subordinated your judgment to others.

Collectibility

When collectibility is substantially uncertain, the receivable in question loses its value and should be written down. In this case, the write-down would necessitate an estimated increase to the allowance account in order to represent that a portion of the receivable is uncollectible. By increasing the allowance account, bad debt expense is also increased, thereby reducing net income in addition to reducing working capital, the current ratio, and the acid-test ratio.

Auditing Standards

The AICPA Code of Professional Conduct would be at issue if the firm and the auditor are members of the AICPA, since the Code requires that the audit be conducted in accordance with GAAS. The audit report would have to be modified if GAAP is not followed.

Integrity and Objectivity

If the audit partners of Casper & Casper follow the CEO's advice and allow HealthApp to merely disclose the potential loss because the customer had already confirmed the December 31, 2015 balance, the auditors would be subjugating their professional judgment to others. In addition, the audit firm would have failed to follow appropriate audit standards.

Certainly, one reason that they might consider following the CEO's request would be fear of losing the client. In that situation, it could be argued that the auditors have compromised their integrity and the perception of independence as well.

It might also be argued that failure to record the adjustment could cause the financial statements to be materially misstated. Again, the firm and CPA would not only violate integrity and objectivity rules, but also acts discreditable which involves negligence in the practice of public accountancy. The CPA firm would not be following the professional standards or acting with due professional care.

TranscriptHere are the important ethical and accounting issues related to this matter. Select each Tab to view the issues.

Suggested Solution

Disclose Reason for Adjustment and Issue an Unqualified Opinion

The best course of action, from an accounting standpoint, is for the client to make the adjustment, disclose the reason for the adjustment in the notes to the financial statement, and allow the auditor to issue an unqualified opinion on the financial statements. This course of action would also allow the audit firm and the auditors to not be in violation of any professional rules of conduct. Following this decision would necessitate an additional disclosure regarding the contingent liability that would arise from the client's violation of the loan covenant.

It is this loan covenant violation that is of the most concern to HealthApp's management. They will not be happy with this alternative, since they are concerned about their bank forcing immediate payment of the loan which would have a negative impact on HealthApp's cash reserves. The auditor could be faced with the possibility of losing the client.

One thing that Robinson and Lapine could suggest to the management of HealthApp would be for the auditors and the client's management to go to the bank and attempt to explain the situation prior to the issuance of any report or financial statements. If the situation is explained, perhaps the bank's management could decide not to enforce the loan covenant. This could eliminate the fear of HealthApp having to repay the loan immediately. Certainly, such a gesture by the bank could be in the bank's best interests as they likely will not want to risk losing HealthApp as a customer.

Hopefully, the bank is willing to work with HealthApp. From an auditing standpoint, it would be a good idea to get the bank's decision in writing. This should be added to the audit workpapers, and the bank's decision should be included in any financial statement footnotes related to compliance.

Departure from GAAP Scenario – Part 2

Now let's change up the decision made by Casper & Casper LLP with regards to their audit client, HealthApp, Inc.

What if Robinson and Lapine had gone along with HealthApp's management? Remember, HealthApp's desire was to disclose the potential loss in the footnotes to the financial statements and NOT make an adjustment to the allowance account and bad debt expense. How would that decision affect things? Some important questions to consider include the following. How would you answer each of these questions?

	Is that decision profitable?
	Is the decision legal?
	Is the decision fair?
	Is the decision right?

Suggested Answers

Is that decision profitable? In this case, it would be profitable for the client (in the short-term) in that net income would remain at a profitable level and the company would not be in violation of their loan covenant. However, it could be unprofitable for the audit firm in that they might lose the client in addition to the potential legal liability and ethics violation costs with which they might have to contend.

Is the decision legal? This question is a bit harder to answer. On the surface, there would not appear to be any legal issues involved here; however, because this company is publicly traded, there could be potential violations of SEC and PCAOB regulations by presenting financial statements that are misstated to the SEC. In addition, the firm has to address the rules requirements regarding adherence to accounting and auditing standards. In addition, management would need to take into account the requirements of the Sarbanes-Oxley Act of 2002, in which management must attest to the fairness of the financial statements. If it were discovered that the financial statements are misstated, then management—and the audit firm—could be in danger of litigation.

Is the decision fair? Certainly, management would think that the decision is fair in that they would be able to maintain their current profitability level and not be in violation of their loan covenant. They would be able to use the $6 million of cash for their desired expansion —instead of using it to pay off the loan. However, the audit firm would need to consider if following management's wishes is fair to the creditors and stockholders of HealthApp.

Is the decision right? No, the decision is not right because GAAP and GAAS would not be followed and the company would be presenting financial statements that are misstated. As noted, failing to follow established standards puts the firm in violation of the accounting and professional general standards rules.

Study Question 9

Which of the following events may justify a departure from GAAP, allowing an auditor to still be in compliance, even when financial statements are not in conformity with GAAP?

Summary

There are many important concepts covered in this chapter. The most important things for you to remember are:

	All members must comply with the General Standards of the AICPA Code of Professional Conduct.
	CPAs should be familiar with the General Standards in order to understand how these standards apply to and impact professional engagements.
	Adherence to GAAP is the most appropriate method for reporting purposes under most circ*mstances. However, departures from GAAP are acceptable under certain unusual circ*mstances.

All of the topics covered in this chapter (the general standards, their definitions and their impact on professional engagements as well as adherence to GAAP and various other rulings and general technical standards) can be found in the AICPA Code of Professional Conduct.

Chapter 4. Hawaii Revised Statutes and Administrative Rules

The code of conduct for Hawaii CPAs is guided by two documents:

• Hawaii Public Accountancy Statutes

• Hawaii Administrative Rules

These documents represent the rules and laws that all CPAs in Hawaii must follow. Knowledge of the AICPA Code of Professional Conduct without comparable knowledge of the rules and laws that govern Hawaii CPAs is contrary to the spirit of the Code of Professional Conduct.

Additionally, you should familiarize yourself with some important definitions which are contained in Section 466-3 of the Revised Statutes.

The three supplements on this page are available under Course References in the Resources for the course.

Hawaii Revised Statutes

Chapter 466: Public Accountancy

Section 466-1 Purpose

It is the policy of this State, and the purpose of this chapter to promote the reliability of information that is used for guidance in financial transactions or for accounting for or assessing the financial status or performance of commercial and noncommercial enterprises, whether public or private. The public interest requires that persons professing special competence in accountancy or offering assurance as to the reliability or fairness of presentation of such information shall have demonstrated their qualifications to do so, and that persons who have demonstrated and maintained such qualifications be permitted to hold themselves out as having such special competence or to offer such assurance; that the professional conduct of persons licensed as having special competence in accountancy be regulated in a manner consistent with nationally recognized standards of professional conduct; that a public authority competent to prescribe and assess the qualifications and to regulate the professional conduct of practitioners of public accountancy be established; and that the use of titles relating to the practice of public accountancy that are likely to mislead the public as to the status or competence of the persons using such titles be prohibited.

Section 466–4 Board of Public Accountancy

Section 466–4 Board of Public Accountancy (cont'd)

Section 466–7 Permits to practice

Section 466–7 Permits to practice (cont'd)

Section 466–10 Prohibited Acts

Section 466–10 Prohibited Acts (cont'd)

Section 466–10 Prohibited Acts (cont'd)

Section 466–10 Prohibited Acts (cont'd)

Section 466–11 Injunctions Against Prohibited Acts

Section 466–12 Ownership of Accountant's Working Papers

All statements, records, schedules, working papers, and memoranda made by the licensee, partner, shareholder, officer, director, or employee incidental to, or in the course of rendering services to a client in the practice of public accountancy, except reports submitted by the licensee to the client and except for records that are part of the client's records, shall be and remain the property of the licensee in the absence of an express agreement between the licensee and the client to the contrary. No statement, record, schedule, working paper, or memorandum shall be sold, transferred, or bequeathed, without the consent of the client or the client's personal representative or assignee, to anyone other than one or more surviving partners or stockholders or new partners or stockholders of the licensee, or any combined or merged firm or successor in interest to the licensee or operation of law.

Peer Review

The Peer Review Process is covered in Part II of the Hawaii Revised Statutes, the entirety of which was provided as a PDF supplement earlier in this chapter.

Per the Hawaii Society of CPAs: As a condition of licensure and in order to practice public accountancy in Hawaii, every firm, including the Hawaii offices and Hawaii engagements of foreign or multistate firms, that is required to obtain a firm permit to practice pursuant to section 466-7 shall undergo a peer review every three years.

You can find additional useful information regarding peer preview on the HSCPA's website.

Study Question 10

What is the primary purpose of Chapter 466, Public Accountancy?

The Hawaii Administrative Rules are found in Title 16, Department of Commerce and Consumer Affairs (DCCA), Chapter 71

Here are a couple of items that every Hawaii CPA must know:

To view this interactivity please view chapter 4, page 17

Interactivity information:

Subchapter 1: General Provisions

§16–71–1

Objective: This chapter has been adopted by the board of public accountancy, hereafter referred to as “board,” and is intended to clarify chapter 466, Hawaii Revised Statutes, and to implement the administration thereof to the end that chapter 466, HRS, may be best effectuated and the public interest most effectively served.

§16-71-2

Biennial renewal: Continuing professional education in ethics or professional conduct.

§16–71–3

Notification and filing of names and addresses and changes: The current mailing address of each certified public accountant, registered public accountant, public accounting firm, and permit holder shall be registered with the board. The board shall be immediately notified in writing, of all changes.

§16–71–4

Evidence of authority to practice: Each permit holder and public accounting firm shall at all times display evidence of the authority to practice, together with the certificate or registration and other evidence of current validation, in the permit holder's and public accounting firm's place of business.

§16–71–4.5

Minimum insurance requirements for a professional corporation:

Subchapter 4: Permit to Practice

§16–71–24 Permit to practice

§16–71–24 Permit to practice (cont'd)

§16–71–26 Control and reporting

§16–71–27 Temporary permit to practice

An application for a temporary permit to practice, pursuant to section 466–7(c), HRS, shall be filed on a form prescribed by the board not later than sixty days prior to the commencement of the period covered by the application and shall be accompanied by a statement signed by an official of the jurisdiction which issued the certificate or registration, attesting that the same is currently valid, and unrevoked. The board may waive the filing deadline requirement for good cause.

Subchapter 5: Continuing Professional Education

§16–71–31 Basic concept

The overriding consideration in determining whether or not a specific program qualifies as acceptable continuing professional education is whether the program is a formal program of learning which will contribute directly to the professional competence of a licensee in public practice. Each licensee shall determine the course of study to be pursued by the licensee within the guidelines established by this chapter.

§16–71–32 Persons covered

Any person in public accounting practice, regardless of the extent or degree of the practice, shall be covered by this chapter. [Eff 1/1/74; am and ren §16–71–32, 6/25/81; am and comp 6/8/84; comp 10/23/87; comp 2/22/94; comp 6/3/95; comp 1/22/01; comp 1/30/10] (Auth: HRS §466–4) (Imp: HRS §466–7)

§16–71–33 Basic requirements of study hours

§16–71–34 Hours which qualify

A minimum of fifty minutes shall constitute one continuing professional education hour. No credit for continuing professional education hours shall be allowed for time expended for study outside of the classroom nor shall additional credits be allowed for programs or courses repeated in any single year. The hours spent in continuing professional education programs shall be measured, as follows:

§16–71–34 Hours which qualify (cont'd)

§16–71–35 Deficiency in hours and carryover hours

§16–71–36 Program classifications

CPE Program Subjects

§16–71–37 Requirements for group programs

Each group program shall:

§16–71–38 Requirements for individual self-study programs

Each individual self–study program shall:

Subject to compliance with the requirements of sections 16–71–37 and 16–71–38, the program sponsors who automatically qualify shall include:

§16–71–41 Requirements for approval by the board

Sponsors who do not automatically qualify shall be required to apply to the board on a form prescribed by the board prior to the program event. The sponsor shall comply with all requirements, policies, and standards set forth by the board. [Eff l/1/74; am 11/21/74; am and ren §16–71–41, 6/25/81; am and comp 6/8/84; comp 10/23/87; am and comp 2/22/94; comp 6/3/95; comp 1/22/01; comp 1/30/10] (Auth: HRS §466–4) (Imp: HRS §466–7)

§16–71–43 Duration of approval

The approval by the board of each group program sponsor and each individual self–study program sponsor shall expire on December 31 of every odd–numbered year.

§16–71–45 Information requirements

§16–71–46 Exceptions

The board may issue a permit to practice to any applicant who has not fully complied with the continuing professional education requirement in cases where failure by the applicant to fulfill the requirement has been caused by reason of:

§16–71–47 Certification to other jurisdiction

The board shall certify, upon request, to any state as to the compliance with continuing professional education requirements under the laws of the State by any of its licensees.

§16–71–48 Exception for temporary permits

This subchapter governing continuing professional education shall not apply to any applicant for a temporary permit to be issued under section 466–7(c), HRS.

Subchapter 7: Rules of Conduct

The Hawaii Administrative Rules, Subchapter 7: Rules of Conduct, correspond to the Rules promulgated in the AICPA Code of Professional Conduct. While abbreviated, the Rules of Conduct include essential elements of the Code. These elements are:

	§16–71–61 Independence, integrity and objectivity
	§16–71–62 Competence and technical standards
	§16–71–63 Responsibilities to clients and
	§16–71–64 Other responsibilities and practices

These elements capture the essence of the Code of Professional Conduct and guide CPAs by setting high standards of behavior and professionalism.

Section 16–71–61 Independence, integrity, and objectivity

(a) A licensee shall not express an opinion on financial statements of an enterprise in a manner as to imply that the licensee is acting as an independent public accountant with respect thereto unless the licensee is independent with respect to the enterprise.

Section 16–71–61 Independence, integrity, and objectivity (cont'd)

Independence shall be considered to be impaired if, for example:

Section 16–71–61 Independence, integrity, and objectivity (cont'd)

Paragraph (1) on the previous page and paragraph (2) immediately above are not intended to be all–inclusive examples.

(b) A licensee, in the performance of professional services shall not knowingly misrepresent facts, and shall not subordinate the licensee's judgment to others. In tax practice, however, a licensee may resolve doubt in favor of a client as long as there is reasonable support for the position.

(c) A licensee shall not pay a commission to obtain a client, nor accept a commission for a referral to a client of products or services of others. This subsection shall not prohibit payments for the purpose of all, or a material part, of an accounting practice or retirement payments to persons formerly engaged in the practice of public accountancy, or payments to the heirs or estates of those persons.

(d) A licensee shall not offer or perform professional services for a fee which is contingent upon the findings or results of those services; provided this subsection shall not apply to professional services involving federal, state, or other taxes in which the findings are those of the tax authorities and not those of the licensee, nor shall it apply to professional services for which the fees are to be fixed by courts or other public authorities, and which are, therefore, indeterminate in amount at the time the professional services are undertaken.

(e) A licensee shall not concurrently engage in the practice of public accountancy and in any other business or occupation which impairs the licensee's independence or objectivity in rendering professional services.

Section 16–71–62 Competence and technical standards

Study Question 11

Hawaii Administrative Rules:

Section 16–71–63 Responsibilities to clients

Section 16–71–63 Responsibilities to clients (cont'd)

Section 16–71–64 Other responsibilities and practices

Section 16–71–64 Other responsibilities and practices (cont'd)

Study Question 12

Hawaii competence and technical standards:

Contact information, websites, and other

Licensing Area: Accountancy

Central Phone Number: (808) 586–3000

Executive Officer

Laureen Kai

Telephone

(808) 586–2696

Address: Board of Public Accountancy, DCCA–PVL, Att: ACCT, P.O. Box 3469, Honolulu, HI 96801

Website: https://cca.hawaii.gov/pvl/boards/accountancy/

Email: accountancy@dcca.hawaii.gov

Renewal: Failure to timely renew by the renewal date will result in the forfeiture of the license. After the renewal date, the forfeited license may be restored subject to meeting restoration requirements.

Regulating Body: Board of Public Accountancy

In connection with independence, an acceptable level is a level at which a reasonable and informed third party who is aware of the relevant information would be expected to conclude that a member's independence is not impaired. When used in connection with any rule but the “Independence Rule” [1.200.001] an acceptable level is a level at which a reasonable and informed third party who is aware of the relevant information would be expected to conclude that a member's compliance with the rules is not compromised.

Source: AICPA Code of Professional Conduct, 0.400.01.

The AICPA membership adopted the Code of Professional Conduct (the code) to provide guidance and rules to all members in the performance of their professional responsibilities. The code consists of principles and rules as well as interpretations and other guidance. The principles provide the framework for the rules that govern the performance of members' professional responsibilities.

Founded in 1887, the American Institute of Certified Public Accountants (AICPA) represents the CPA profession nationally regarding rule-making and standard-setting, and serves as an advocate before legislative bodies, public interest groups and other professional organizations. The AICPA develops standards for audits of private companies and other services by CPAs; provides educational guidance materials to its members; develops and grades the Uniform CPA Examination; and monitors and enforces compliance with the profession's technical and ethical standards.

[“AICPA Mission and History” (AICPA website)]

A person or entity with respect to which an attest engagement is performed.

Source: AICPA Code of Professional Conduct, 0.400.03.

An engagement that requires independence, as set forth in the AICPA Statements on Auditing Standards (SASs), Statements on Standards for Accounting and Review Services (SSARSs), and Statements on Standards for Attestation Engagements (SSAEs).

Source: AICPA Code of Professional Conduct, 0.400.04.

Those individuals participating in the attest engagement, including those who perform concurring and engagement quality reviews. The attest engagement team includes all employees and contractors retained by the firm who participate in the attest engagement, regardless of their functional classification (for example, audit, tax, or management consulting services). The attest engagement team excludes specialists, as discussed in AU-C section 620, Using the Work of an Auditor's Specialist (AICPA, Professional Standards), and individuals who perform only routine clerical functions, such as word processing and photocopying.

Source: AICPA Code of Professional Conduct, 0.400.05.

Describes a financial interest providing an individual or entity the right to some or all of the underlying benefits of ownership. These benefits include the authority to direct the voting or disposition of the interest or to receive the economic benefits of the ownership of the interest.

Source: AICPA Code of Professional Conduct, 0.400.06.

Any person or entity, other than the member's employer that engages a member or member's firm to perform professional services (engaging entity) and also, a person or entity with respect to which a member or member's firm performs professional services (subject entity). When the engaging entity and the subject entity are different, while there is only one engagement, they are separate clients.

Source: AICPA Code of Professional Conduct, 0.400.07.

A parent, sibling, or nondependent child.

Source: AICPA Code of Professional Conduct, 0.400.08.

One of the four general standards addressed in the General Standards Rule of the AICPA's Code of Professional Conduct. A member shall comply with exercising due professional care in the performance of professional services.

Due care requires a member to discharge professional responsibilities with competence and diligence. It imposes the obligation to perform professional services to the best of a member's ability, with concern for the best interest of those for whom the services are performed, and consistent with the profession's responsibility to the public.

Ethics is a set of moral values and principles that you use to guide your behavior.

A system that aggregates source data underlying the financial statements or generates information that is significant to either the financial statements or financial processes as a whole. An FIS includes a tool that calculates results unless:

1. the tool performs only discrete calculations;

2. the attest client evaluates and accepts responsibility for the input and assumptions; and

3. the attest client has sufficient information to understand the calculation and the results.

Source: AICPA Code of Professional Conduct, Section 1.295.145.03 – effective January 1, 2021.

An ownership interest in an equity or a debt security issued by an entity, including rights and obligations to acquire such an interest and derivatives directly related to such interest.

Source: AICPA Code of Professional Conduct, 0.400.17.

A presentation of financial data, including accompanying disclosures, if any, intended to communicate an entity's economic resources or obligations, or both, at a point in time or the changes therein for a period of time, in accordance with the applicable financial reporting framework. Incidental financial data to support recommendations to a client or in (a) documents for which the reporting is governed by SSAEs and (b) tax returns and supporting schedules do not, for this purpose, constitute financial statements. The statement, affidavit, or signature of preparers required on tax returns neither constitutes an opinion on financial statements nor requires a disclaimer of such opinion.

Source: AICPA Code of Professional Conduct, 0.400.19.

A form of organization permitted by law or regulation whose characteristics conform to resolutions of the AICPA Council and that is engaged in public practice. A firm includes the individual partners thereof, except for purposes of applying the “Independence Rule” [1.200.001] and related interpretations. For purposes of applying the “Independence Rule,” a firm includes a network firm when the engagement is either a financial statement audit or review engagement and the audit or review report is not restricted, as set forth in the AICPA SASs and SSARSs (AICPA, Professional Standards).

Source: AICPA Code of Professional Conduct, 0.400.20.

A spouse, spousal equivalent, or dependent (regardless of whether the dependent is related).

Source: AICPA Code of Professional Conduct, 0.400.21.

According to ET section 0.300.040, “Integrity is an element of character fundamental to professional recognition. It is the quality from which the public trust derives and the benchmark against which a member must ultimately test all decisions.”

Integrity requires a member to be honest and candid within the constraints of client confidentiality, and cannot accommodate deceit or subordination of principle. It is measured in terms of what is right and just, and requires the member to observe both the form and the spirit of technical and ethical standards.

Pronouncements issued by the division of professional ethics to provide guidelines concerning the scope and application of the rules of conduct.

Source: AICPA Code of Professional Conduct, 0.400.27.

An investment in an entity or a property by the member and the attest client (or the attest client's officers or directors or any owner who has the ability to exercise significant influence over the attest client) that enables them to control the entity or property.

Source: AICPA Code of Professional Conduct, 0.400.28.

A contractual obligation to pay or right to receive money on demand or on a fixed or determinable date and includes a stated or implied rate of return to the lender. For purposes of this definition, loans include, among other things, a guarantee of a loan, a letter of credit, a line of credit, or a loan commitment. However, for purposes of this definition, a loan would not include debt securities (which are considered a financial interest) or lease arrangements.

Source: AICPA Code of Professional Conduct, 0.400.31.

A member, associate member, affiliate member, or international associate of the AICPA. When the term member is used in part 1 of the code, it means a member in public practice; when used in part 2 of the code, it means a member in business; and when used in part 3 of the code, it means all other members.

Source: AICPA Code of Professional Conduct, 0.400.33.

For purposes of the “Network and Network Firms” interpretation [1.220.010] of the “Independence Rule” [1.200.001], a network is an association of entities that includes one or more firms that (a) cooperate for the purpose of enhancing the firms' capabilities to provide professional services and (b) share one or more of the following characteristics:

1. The use of a common brand name, including common initials, as part of the firm name

2. Common control among the firms through ownership, management, or other means

3. Profits or costs, excluding costs of operating the association; costs of developing audit methodologies, manuals, and training courses; and other costs that are immaterial to the firm

4. A common business strategy that involves ongoing collaboration amongst the firms whereby the firms are responsible for implementing the association's strategy and are held accountable for performance pursuant to that strategy

5. A significant part of professional resources

6. Common quality control policies and procedures that firms are required to implement and that are monitored by the association

A network may comprise a subset of entities within an association only if that subset of entities cooperates and shares one or more of the characteristics set forth in the preceding list.

Source: AICPA Code of Professional Conduct, 0.400.33.

A professional employee who is not a partner of the firm but who either:

1. has the ultimate responsibility for the conduct of an attest engagement, including the authority to sign or affix the firm's name to an attest report or issue, or authorize others to issue, an attest report on behalf of the firm without partner approval; or

2. has the authority to bind the firm to conduct an attest engagement without partner approval. For example, the professional employee has the authority to sign or affix the firm's name to an attest engagement letter or contract to conduct an attest engagement without partner approval.

Firms may use different titles to refer to professional employees with this authority, although a title is not determinative of a partner equivalent. For purposes of this definition, partner approval does not include any partner approvals that are part of the firm's normal approval and quality control review procedures applicable to a partner.

This definition is solely for the purpose of applying the “Independence Rule” [1.200.001] and its interpretations and should not be used or relied upon in any other context, including the determination of whether the partner equivalent is an owner of the firm.

Source: AICPA Code of Professional Conduct, 0.400.40.

The period begins when a member either signs an initial engagement letter or other agreement to perform attest services or begins to perform an attest engagement, whichever is earlier. The period lasts for the entire duration of the professional relationship, which could cover many periods, and ends with the formal or informal notification, either by the member or client, of the termination of the professional relationship or by the issuance of a report, whichever is later. Accordingly, the period does not end with the issuance of a report and recommence with the beginning of the following year's attest engagement.

Source: AICPA Code of Professional Conduct, 0.400.41.

One of the four general standards addressed in the General Standards Rule of the AICPA's Code of Professional Conduct. A member shall comply with adequately planning and supervising the performance of professional services.

Professional competence is required to perform and complete services provided by CPAs.

Competence is derived from a synthesis of education and experience. It begins with a mastery of the common body of knowledge required for designation as a certified public accountant. The maintenance of competence requires a commitment to learning and professional improvement that must continue throughout a member's professional life. It is a member's individual responsibility. In all engagements and in all responsibilities, each member should undertake to achieve a level of competence that will assure that the quality of the member's services meets the high level of professionalism required by the Principles of Professional Conduct.

Include all services requiring accountancy or related skills that are performed by a member for a client, an employer, or on a volunteer basis. These services include, but are not limited to accounting, audit and other attest services, tax, bookkeeping, management consulting, financial management, corporate governance, personal financial planning, business valuation, litigation support, educational, and those services for which standards are promulgated by bodies designated by Council.

Source: AICPA Code of Professional Conduct, 0.400.42.

Actions or other measures that may eliminate a threat or reduce a threat to an acceptable level.

Source: AICPA Code of Professional Conduct, 0.400.46.

The documents upon which evidence of an accounting transaction are initially recorded. Source documents are often followed by the creation of many additional records and reports that do not, however, qualify as initial recordings. Examples of source documents are purchase orders, payroll time cards, and customer orders.

Source: AICPA Code of Professional Conduct, 0.400.49.

One of the four general standards addressed in the General Standards Rule of the AICPA's Code of Professional Conduct. A member shall comply with obtaining sufficient relevant data to afford a reasonable basis for conclusions or recommendations in relation to any professional services performed.

Sufficiency is the measure of the quantity of data. Relevance relates to the logical connection with, or bearing upon, the purpose of the professional service being performed.

In connection with independence, threats are relationships or circ*mstances that could impair independence. In connection with any rule but the “Independence Rule” [1.200.001], threats are relationships or circ*mstances that could compromise a member's compliance with the rules.

Source: AICPA Code of Professional Conduct, 0.400.52.

Welcome to Professional Ethics for Hawaii CPAs. Below is the full list of final exam questions associated with this course. When you launch the final exam for this course, it will contain a randomized subset of the questions below, totaling 20 questions. During the actual final exam, the questions will not appear in the same order as they do below. Note: Each attempt at the final exam will result in a new randomized subset of the questions below. You must earn a score of at least 70.00% in order to pass the exam and receive CPE credit for this course.After you have answered all the questions, select the "Submit Answers" button to receive your score.

Exam Question 1

Which of the following is an example of a management participation threat?

Exam Question 2

If a covered member performs bookkeeping services for an attest client, which type of threat to independence is most likely to exist?

Exam Question 3

In which one of the following situations would independence not be impaired?

Exam Question 4

Independence would be impaired in which one of the following situations?

Exam Question 5

Which of the following represents an immediate family member of a covered member?

Exam Question 6

Which of the following is not included in the three-step approach employed in the Conceptual Framework for Members in Public Practice?

Exam Question 7

In the performance of any professional service, a member shall do which of the following?

Exam Question 8

Which one of the following would be a violation of the Integrity and Objectivity Rule as it relates to knowing misrepresentations in the preparation of financial statements or records?

Exam Question 9

According to Code Section 1.110, which one of the following situations may cause a conflict of interest to arise?

Exam Question 10

You are working part time as a research fellow for a local university. Are you subject to the Integrity and Objectivity Rule?

Exam Question 11

The General Standards of the AICPA Code of Professional Conduct addresses the general standards with which all CPAs are required to comply. Which of the following is not one of the four general standards?

Exam Question 12

A CPA should not undertake any engagement for the performance of professional services which s/he cannot reasonably expect to complete with due professional competence. To be considered professionally competent, a CPA must have all except which of the following?

Exam Question 13

Professional skepticism is an attitude that supports an inquisitive mind and a critical assessment of evidence obtained. Which one of the following is not a characteristic of professional skepticism as it relates to the General Standards Rule?

Exam Question 14

According to the Accounting Principles Rule , which of the following is not a circ*mstance under which financial statements are permitted to be presented with a departure from GAAP?

Exam Question 15

Which of the following are controls that can eliminate or reduce the threats to independence?

Exam Question 16

A Hawaii CPA firm also has an office in California. One of the partners runs the California office, lives there permanently and does not have a Hawaii permit to practice. The other partners live in Hawaii. In securing a Hawaii permit to practice:

Exam Question 17

Hawaii recently enacted an ethics requirement for CPAs. Which of the following is true?

Exam Question 18

Public accountancy law in Hawaii established the mechanism to create the Board of Accountancy and otherwise regulate CPAs in Hawaii. Which of the following best describes the primary purpose of the law?

Exam Question 19

In accordance with the Hawaii Administrative Rules, a CPA or public accountant:

Exam Question 20

When is a licensee required to renew his or her permit to practice in Hawaii?

Exam Question 21

Which of the following is a prohibited act under §466–10?

Exam Question 22

How many CPE hours must an applicant complete and report to the Board during each renewal period?