C HAPTER 3

P ROFESSIONAL E THICS
Learning Check
3.1.

General ethics attempts to deal with two questions that can serve as guides
to behavior: (1) "What good do I seek?" and (2) "What is my obligation in
this circumstance?" General ethics attempts to deal with these questions by
defining what is good for the individual and society, and by trying to
establish the nature of obligations or duties that individuals owe themselves
and each other.

3-2. The ethical absolutist school of thought says there are universal standards
that do not change over time that apply to everyone. The ethical relativist
school of thought says that people's ethical judgments are determined by the
changing customs and traditions of society in which they live.
3-3. The six steps in one general framework for ethical decision making are:
Obtain the facts relevant to the decision.
Identify the ethical issues from the facts.
Determine who will be affected by the decision and how.
Identify the decision maker's alternatives.
Identify the consequences of each alternative.
Make the ethical choice
3-4.

a. Professional ethics include standards of behavior for a professional

person that are designed for both practical and idealistic purposes. They
must be both realistic and enforceable; they should be above the law but
below the ideal.
.b Professional ethics are imposed by a profession on its members who
voluntarily accept standards of professional behavior more rigorous than

those required by law. They are generally promulgated through a code of

ethics.
3-5.

a. The core values identified in the CPA Vision Project are (1) continuing
education and lifelong learning, (2) competence, (3) integrity, (4)
attunement to business issues, and (5) objectivity.
b. Continuing education and lifelong learning is important to ensuring the
public confidence in a CPAs ability to maintain cutting edge skills in a
rapidly changing environment. CPAs must demonstrate competence in
GAAP, GAAS, and in their ability to understand the connection between
business performance and reported financial performance in order to
earn the publics trust. Integrity, which means practicing with honesty
and acting with professional ethics, is critical earning the public trust. A
CPAs opinion on the financial statements would be worthless without
confidence that CPAs are honest and act with integrity. Attunement to
broad business issues is what separates CPAs from other professionals
and allows CPAs to exercise the professional judgment that is so
important in accounting and auditing. Finally, objectivity and the
freedom of bias or conflicts of interest allows CPAs to earn both a
clients and the publics trust. In combination, these core values have
helps CPAs earn a reputation for being a trusted in their role as
independent auditors.

3-6. The Professional Ethics Team of the AICPA functions through an executive
committee that is responsible for:
Planning the programs of the division's subcommittees and supervising
their implementation.

3-7.

Issuing formal policy statements and pronouncements

Establishing prima facie violations of the Code or bylaws for possible

disciplinary action.

Proposing changes in the Code.

a. The two sections of the AICPA's Code of Professional Conduct are (a) the
Principles and (b) the Rules of Conduct. The two types of
pronouncements related to them are Interpretations of the Rules of
Conduct and Ethics Rulings.

b. Only the Rules of Conduct are meant to be enforceable. However, the

CPA must justify any departures from the Interpretations and Ethics
Rulings.
3-8.

a. The term practice of public accounting means performance for a client,

by a member or a member's firm, while holding out as CPA(s), of the
professional services of accounting, tax, personal financial planning,
litigation support services, and those professional services for which
standards are promulgated by bodies designated by Council.
b. The term holding out refers to any action initiated by a member that
informs others of his or her status as a CPA or AICPA accredited
specialist.

3-9.

a. The principles express the basic tenets of ethical conduct and provide
the framework for the rules.
b. The principles and their essence are:
Responsibilities - members should exercise sensitive professional
and moral judgments in all their activities.

Public interest - members should serve the public interest, honor the
public trust, and demonstrate commitment to professionalism.
Integrity - members should have the highest sense of integrity.

Objectivity and independence - a member should maintain

objectivity and be free of conflicts in all engagements and be
independent in fact and in appearance in rendering auditing and
attest services.

Due care - a member should observe the professions standards,

strive continually to improve competence and the quality of service,
and discharge responsibilities to the best of the member's ability.

Scope and nature of services - the Principles of the Code should be

observed in determining the scope and nature of services to be
provided.

3.10. a. The authority of the rules is provided in the bylaws of the AICPA.
b. The rules differ in their applicability. Six rules apply only to members in
public practice whereas the remainder apply to all members.

3-11. a. Rule 101 states: A member in public practice shall be independent in the
performance of professional services as required by standards
promulgated by bodies designated by Council.
b. The bodies that have issued technical standards that require a member to
be independent are the Auditing Standards Board and the Accounting
and Review Services Committee.
3-12. a. The expression "a member or a member's firm" includes:

All individuals (of any rank) participating in the engagement, except

those who perform only routine clerical functions, such as typing
and photocopying.

All individuals with a managerial position located in an office

participating in a significant portion of the engagement (e.g., the
director of human resources).

All proprietors, partners, or shareholders of the member's firm,

whether or not participating in the engagement.

Any entity (for example, a partnership, corporation, trust, joint

venture, or pool) whose operating, financial, or accounting policies
can be controlled by one or more of the persons described above or
by two or more such persons if they choose to act together.

b. There are three time periods:

The period of the auditor's professional engagement, which includes
audit planning and both interim and year-end field work.

The period covered by the financial statements, which is the client's

fiscal year.

The time of expressing the auditor's opinion, which is the date of the
auditor's report.

3-13. a. First, a member of his firm cannot have (or be committed to have) any
direct financial interest in a client such as owning stock. An indirect
financial interest exists when a member or his firm owns stock in a
mutual fund that, in turn, owns stock in the client or when a member's
nondependent close relative has a financial interest in the client. An

indirect financial interest cannot be material. Second, a member is not

allowed to have a joint closely held business investment with a client or
officers, directors, or principal stockholders that is material. Third, a
member is not permitted to have any loan to or from a client or the
individuals mentioned above which is not made under normal lending
terms.
b. The types of business relationships that are prohibited are those in
which the member or member's firm (1) has significant influence over
the operating, financial, or accounting policies of the client or (2) is
involved in "audit-sensitive" activities within the client's organization.
3-14.

a. Alternative practice structures are arrangements are what appears to be

a single accounting firm may in fact be several separate legal entities.
b. Following are several examples of alternative practice structures. The
consulting practice of an accounting firm may be part of an alternative
practice structure, with many of the same shareholders as the accounting
and auditing practice, but different profit sharing arrangements.
Organizations like American Express have also purchased various
accounting firms, employ the CPAs directly, and lease employees back
to the CPA firm which keeps its own identity to perform attest work.
c. A Common reason for developing alternative practice structures is to
better manage the multi-disciplinary environment that many accounting
firms compete in. Alternative practice structures allow firms to
establish different profit sharing arrangements in each practice structure
and to shield one part of the practice from the liability exposure of
another part of the practice.

3-15.

a. Rule 201 states: A member shall comply with the following standards
and with any interpretations thereof by bodies designated by Council.
b. The four subcategorizes are (1) professional competence, (2) due
professional care, (3) planning and supervision, and (4) sufficient
relevant data.

3-16.

a. The essence of Rule 301 is that a member in public practice shall not
disclose any confidential client information without the consent of the
client.
b. Rule 302 prohibits contingent fees for any professional service
whenever a member in public practice also performs (1) an audit or
review of a financial statement; or (2) a compilation of a financial
statement when the member expects, or reasonably might expect, that
a third party will use the financial statement and the member's
compilation report does not disclose a lack of independence; or (3) an
examination of prospective financial information. The rule also
prohibits preparing an original or amended tax return or claim for a tax
refund for a contingent fee for any client.

3.17.

a. Under Rule 501, a member is prohibited from (1) retaining client

records, (2) discrimination in employment, (3) failure to follow
standards in government audits, and (4) negligence in the preparation of
financial statements.
b. Under Rule 502, a member cannot engage in advertising or other
forms of solicitation in a manner that is false, misleading, or deceptive.
Solicitation by the use of coercion, overreaching, or harassing conduct
is also prohibited.
c. Rule 503 states that a member in public practice shall not for a
commission recommend or refer to a client any product or service or
any product or service to be supplied by a client, or receive a
commission when the member or the member's firm also performs for
that client (1) an audit or review of a financial statement; (2) a
compilation of a financial statement and the member's compilation
report does not disclose a lack of independence; or (3) an examination
of prospective financial information.

3-18.

a. Rule 505 permits a CPA to practice public accounting only in a form of

organization permitted by state law or regulation whose characteristics
conform to resolutions of Council. Depending on the state, this may
include a sole proprietorship, a partnership, a professional corporation,
and a limited liability partnership or corporation (LLP or LLC).

b. Under Rule 505, characteristics conforming to resolutions of Council

include:
A super majority (66 2/3%) of the ownership of a firm must belong
to CPAs. Non-CPA owners must be actively engaged in providing
services to the firm's clients as their principal occupation.
Ownership by others is considered against the public interest and
continues to be prohibited
A CPA must have ultimate responsibility for all services provided
by the firm that are governed by Statements on Auditing Standards
or Statements on Standards for Accounting and Review Services.
Non-CPA owners must abide by the AICPA Code of Professional
Conduct, must meet certain education requirements, and complete
the same work-related continuing professional education
requirements as CPAs.
3-19. The two groups that are responsible for enforcing the rules are the AICPA
and state societies of CPAS. The maximum penalty by either group is
expulsion from membership.
3-20. The purpose of JEEP is to make enforcement of the Rules of Conduct more
effective and disciplinary action more uniform. Under JEEP, complaints
against a member may be filed with either the AICPA or the state society.
Each group may act independently or jointly.
3-21. The Joint Trial Board consists of at least 36 AICPA members. The trial board
becomes involved only when earlier enforcement procedures have found the
complaint to be serious or the member involved has refused to cooperate.
The trial board may (1) admonish the member, (2) suspend the member for a
period of no more than two years, or (3) expel the member.
3-22. Under the automatic disciplinary provisions of the AICPA, suspension or
termination of membership can result without a hearing for certain acts. The
actions that may invoke automatic disciplinary provisions are:

A crime punishable by imprisonment for more than one year.

Willful failure to file any income tax return that the member, as an
individual taxpayer, is required by law to file.

The filing of a false or fraudulent income tax return on the member's or

a client's behalf.

Willful aiding in the preparation and presentation of a false and

fraudulent income tax return of a client.

Objective Questions

3-23.

1. d

2. b

3. a

3-24.

1. a

2. a

3. c

3-25.

1. b

2. c

3. b

Comprehensive Questions

3-26.

(Estimated time - 20 minutes)

a. Professional ethics evolve over time and continue to be in the process
of change as the practice of public accounting changes. A code of
ethics provides standards of behavior for a professional person that are
designed for both practical and idealistic purposes. A code of ethics
significantly affects the reputation of a profession and the confidence
in which it is held.
b. In some respects, the Principles section of the Code that expresses the
basic tenets of ethical conduct, and that is more enduring, draws from
the ethical absolutists school of thought. In contrast, the Rules of
Conduct section, which is revised more frequently to reflect changing
customs and traditions of society, draws from the ethical relativists
school of thought.
c. Example 1: In auditing Client A, the auditor discovers that Client A has
been underbilled by another client, Client B. Should the auditor inform
Client B when doing the audit of B?

Example 2: While performing a management consulting engagement,

the engagement team discovers an irregularity that was missed by the
separate audit engagement team that performed the last annual audit.
Does the CPA firm have a responsibility to bring the matter discovered
by the management consulting team to anyone's attention?
d. According to the Preamble to the AICPA's Code, the CPA has
responsibilities to the following three groups: (1) the public, (2)
clients, and (3) colleagues.
3-27.

(Estimated time - 25 minutes)

Obtain the facts relative to the decision: This would include determining
the specifics of the string of operating losses and the client's current
financial position, data on the probability and effects of additional
operating losses, including an assessment of materiality from the
perspective of potential users of the financial statements, and the specifics
of the financial statement and footnote disclosures management proposes
to make.
Identify ethical issues from the facts: The ethical issue relates to the need
to make a decision on whether to require the client to make the disclosure
based on a judgment call when there may be evidence that different
auditors might reach different judgments based on the same facts. The
auditor may have difficulty reaching a judgment, but the auditor must not
subordinate his or her judgment to others.
Determine who will be affected by the decision and how: Among the
stakeholders are management, employees, customers, creditors, and
stockholders whose welfare could be adversely affected by the disputed
disclosure if it were to become a self-fulfilling prophecy as feared by
management. On the other hand, some of these stakeholders might benefit
from the disclosure now if in fact the entity ultimately has to close down.
The auditor is also a stakeholder. Compelling the client to make the
disclosure might result in loss of the client. But failure to require the
disclosure followed by the entity's having to discontinue operations could
leave the auditor vulnerable to charges of failing to comply with
professional standards, possibly resulting in monetary losses and damage
to the auditor's reputation as well as the reputation of the profession.

Identify the decision maker's alternatives: Two alternatives are: (1) defer
to the client's reasoning and judgment and do not require the disclosure,
and (2) insist on the disclosure. In case of the latter, if the client refuses to
go along, the auditor may have to issue a qualified or adverse opinion,
rather than an unqualified opinion with explanatory language, or withdraw
from the engagement.
Identify the consequences of each alternative: The consequences are
dynamic and will likely depend on whether the entity does in fact have to
close down. If the auditor does not require the disclosure and the entity
does have to close down due to continued losses, many parties, including
the auditor, may suffer adverse consequences. But mandating the
disclosure might induce negative consequences that could otherwise have
been avoided, or it might reduce the negative consequences that might
ensue from not making the disclosure. Regardless of whether the entity
eventually has to shut down, the auditor's giving in to the client's position
could establish a precedent that would be difficult to overcome in future
dealings with the client, and if it were to become known, in dealings with
other clients. Further, if the auditor subordinates his or her judgment to
the client, he or she has violated the AICPA's Code (Rule 102) and is
subject to sanctions.
Make the ethical choice: This is each individual's call.
3-28.

(Estimated time - 25 minutes)

a.a There are two integral sections of the Code:
Principles that express the basic tenets of ethical conduct and
provide the framework of the Rules.
Rules which govern the performance of professional services by
members.
b. The principles are not enforceable in their own right. All of the rules
are enforceable in their own terms.
c.a The six principles (articles) are

Responsibilities. In carrying out their responsibilities as

professionals, members should exercise sensitive professional and
moral judgments in all their activities.

The public interest. Members should accept the obligation to act

in a way that will serve the public interest, honor the public trust,
and demonstrate commitment to professionalism.

Integrity. To maintain and broaden public confidence, members

should perform all professional responsibilities with the highest
sense of integrity.

Objectivity and independence. A member should maintain

objectivity and be free of conflicts of interest in discharging
professional responsibilities. A member in public practice should
be independent in fact and appearance when providing auditing
and other attestation services.

Due care. A member should observe the profession's technical and

ethical standards, strive continually to improve competence and
the quality of services, and discharge professional responsibility to
the best of the member's ability.

Scope and nature of services. A member in public practice should

observe the Principles of the Code of Professional Conduct in
determining the scope and nature of services to be provided.

d. Possible courses of action are:

Responsibilities - a member should cooperate with other members
to (1) improve the art of accounting, (2) maintain the public's
confidence in the profession, and (3) carry out the profession's
self-governance responsibilities.

The public interest - members should act with integrity and strive
earnestly to continually demonstrate their dedication to
professional excellence. A CPA is expected to meet both quality
and professional standards in all engagements.

Integrity - members must be honest and candid; members act with

integrity when they observe both the form and the spirit of
technical and ethical standards.

Objectivity and independence - members should avoid

circumstances that involve conflicts of interest; a CPA should not
have a financial interest or a key business relationship with the
client.

Due care - a member should discharge his or her professional

responsibilities with competence and diligence and engagements
should be planned and supervised.

Scope and nature of services - a member should decline any

engagement if any principle cannot be met and should assess
whether the requested service is consistent with his or her role as a
professional.

e. The rules are applicable to all members of the AICPA whenever they
perform professional services except that Rules 101, 301, 302, 502,
503, and 505, pertain only to members in public practice.
3-29.

(Estimated time - 30 minutes)

3-30.

(Estimated time - 30 minutes)

a.

In auditing and expressing opinions on financial statements, the CPA

is required at all times to maintain independence of thought and
action. Independence is a major part of the CPA's professional
integrity-the quality that makes his or her opinion valuable to third
parties who will be relying on the financial statements on which he or
she gives an opinion.
Independence is an attitude of mind that goes much deeper than
surface compliance with visible standards. It results in unbiased
judgment and objective consideration of all the factors involved in
planning and conducting an audit and in arriving at and expressing an
opinion. It results in the CFA's rising above the interests of the client
in deference to the interests of readers and users of the statements.
The requirement for independence of action places upon the
CPA the responsibility for assessing his or her relationships with the
enterprise. These relationships must be evaluated by the same criteria
that a third party in possession of all the facts would apply, that is,
whether the CPA is in a position where there would be pressures to

subordinate decisions or judgments to personal financial interests or

the reasons of others.
b

Six of the Rules of Conduct relate either directly or indirectly to

independence. The rules are:
Rule 101 - Independence, which states that a member in public
practice shall be independent in the performance of professional
services. Interpretation 101-1 precludes any direct or material indirect
financial interest and certain business relationships with the client
enterprise.
Rule 102 - Integrity and Objectivity, which states that the member
shall not knowingly misrepresent facts nor subordinate his or her
judgment to others in the practice of public accounting.
Rule 202 - Compliance with Standards, which includes the GAAS
that requires the auditor to maintain an independent mental attitude in
all matters relating to the assignment.
Rule 302 - Contingent Fees, which requires the CPA to avoid certain
situations where he or she might receive an exceptional financial
return that is conditioned by the outcome of his or her findings.
Rule 502 - Advertising and Other Forms of Solicitation, which
prohibits a CPA from soliciting business in a manner that may lessen
his or her independence.
Rule 503 - Commissions and Referral Fees, which prevents the
member from paying or receiving commissions in certain situations
because such dealings may impair his or her independence.

c.

The acceptance by the CPA of the unsecured interest bearing notes in

payment of unpaid fees would not be construed as discrediting the
CPA's independence in relations with the client because the notes are
merely a substitution for an open account payable. The rule of
professional conduct that prohibits a CPA from having any financial
interest in a client does not extend to the liability for the CPA's
unpaid fee as long as any prior year's fees are paid prior to issuing a

report on the current year's statements. If liability for the CPA's

current fee was considered to be financial interest in a client, the
present form of the CPA client relationship would not be permitted to
continue because often (frequently in engagements for continuing
audits) the client statements being audited include a liability for the
CPA's services.
d.a

1. Under the conditions cited, the CPA cannot render an independent

opinion on the financial statements of the Rocky Hill
Corporation. The basic premise underlying the rules of
professional conduct pertaining to independence is that the CPA
should make a conscious effort to refrain from any relationships
with a client that might leave professional independence open to
question where he or she intends to express an opinion on the
financial statements.
In this case the CPA has twice violated the profession's Rules
of Professional Conduct. By being the client's secretary, the CPA
has been an officer in the company during the period of the
professional engagement. Secondly, by temporarily resigning and
then resuming the position upon expressing an opinion (which
does not cure the first violation), the CPA has violated the spirit
of the Rules of Professional Conduct pertaining to independence
because he or she is not in fact independent with respect to the
client.
2. Though the CPA merely assumed an officership with a client as a
temporary measure, the Rules of Professional Conduct pertaining
to independence provide for no exceptions. The CPA is not in a
position to render an opinion on the financial statements of the
Rocky Hill Corporation covering the period during which he or
she was an officer. After the CPA has resigned and has become in
fact independent, he or she may express an opinion on statements
covering subsequent periods.

3-31. (Estimated time - 30 minutes)

1.

a. Rule of Conduct

b. Additional Circumstance

Rule 203 - Accounting

A member shall not express an

opinion......unless the

a. Rule of Conduct

b. Additional Circumstance

Principles

pronouncements of the
Governmental Accounting
Standards Board (GASB) have
been followed.

2.

Rule 501 - Acts Discreditable

A member fails to comply with

continuing professional education
requirements.

3.

Rule 502 - Advertising and

Other Forms of Solicitation

Solicitation of clients by the use of

coercion, overreaching, or
harassing conduct is prohibited.

4.

Rule 503 - Commissions and

Referral Fees

A member shall not pay a

commission to obtain a client
when the member also performs
an examination of prospective
financial statements.

5.

Rule 302 - Contingent Fees

A member's fees may not be

contingent on the results of the
service.

6.

Rule 301 - Confidential Client

Information

A member is permitted to disclose

information in an AICPA quality
control review.

7.

Rule 101 - Independence

A member shall not be connected

with the enterprise as a promoter,
director, or officer.

8.

Rule 201 - General Standards

A member shall exercise due

professional care in the
performance of an engagement.

9.

Rule 101 - Independence

A member shall not have any

joint, closely held business
investment with the enterprise.

10.

Rule 505 - Form of Practice

and Name

The firm cannot designate itself as

"Members of the AICPA" unless

a. Rule of Conduct

b. Additional Circumstance
all its owners are members of the
Institute.

11.

Rule 102 - Integrity and

Objectivity

A member shall not knowingly

misrepresent facts.

12.

Rule 202 - Compliance with

Standards

A member shall comply with the

standards of the Accounting and
Review Services Committee in a
review engagement.

13.

Rule 302 - Contingent Fees

Fees are not regarded as

contingent if fixed by courts.

14.

Rule 301 - Confidential Client

Information

Information may be disclosed to

comply with a validly issued and
enforceable subpoena.

15.

Rule 203 - Accounting

Principles

A member issues an unqualified

opinion when the statements
depart from principles
promulgated by the GASB.

3-32. (Estimated time - 35 minutes)

a. Rule of Conduct

b. Effect on Rule

1. Rule 101 Independence

Indeterminate. The information needed to

assess the applicability of Interpretations 1011(A)(4) and 101-5 is not stated.
No violation. GASB principles are recognized
as authoritative pronouncements for
governmental entities.
Violation. This is considered to be an act
discreditable creditable to the profession.

2. Rule 203 - Accounting

Principles
3. Rule 501 - Acts

a. Rule of Conduct

b. Effect on Rule

4. Rule 101 Independence

No violation. Retirement payments to

individuals formerly engaged in the practice of
public accounting are specifically permitted
absent certain conditions.
No violation. The prohibition against direct
financial interest in interpretation 101-1 applies
only to the period of the professional
engagement or at the time of expressing an
opinion.

5. Rule 101 Independence

6. Rule 201 - General

Standards
7. Rule 302 - Contingent
Fees
8. Rule 502 - Advertising
and Other Forms of
Solicitation
9. Rule 101 Independence
10. Rule 301 - Confidential
Client Information
11. Rule 102 - Integrity and
Objectivity

Violation. A member shall undertake only

engagements that member or member's firm
can reasonably expect to complete with
professional competence.
No violation. A member's fee may vary
depending on the complexity of the
engagement.
No violation. The rule can no longer be used to
prevent members from using advertising that
includes self-laudatory claims.
Violation. Interpretation 101-1 states that a
member cannot be an officer of the client
during the time period covered by the financial
statements.
Indeterminate. No information is given as to
whether the client approved disclosure of the
information.
Violation. A member should not perform a
professional service when he or she has a
conflict of interest.

12. Rule 502 - Advertising

and Other Forms of
Solicitation

No violation. The rule can no longer be used to

prevent members from using advertising that
includes testimonials.

13. Rule 202 - Compliance

No violation. The Accounting and Review

a. Rule of Conduct

b. Effect on Rule

with Standards

Services Committee is the body designated to

promulgate standards for review services for
nonpublic entities.
14. Rule 101 Violation. Interpretation 101-1 states that a
member's independence is impaired by serving
Independence
in this capacity (business relationship) for a
bank client.
15. Rule 503 - Commissions Indeterminate. A member is allowed to pay a
and Referral Fees
commission to obtain a client provided
disclosure is made to the client.

Cases
3.33.

(Estimated time - 30 minutes)

a.

Under AICPA rules (Interpretation 101-3) CPAs may perform

bookkeeping and accounting services and remain independent if the
following four conditions are met.
The CPA must not have any other relationships, such as a financial
interest, that would impair his or her independence.
The client must accept full responsibility for the financial statements.
The CPA must not assume the role either of an employee or
management in the clients operations (e.g., the CPA should not
initiate transactions or sign check).
The CPA must conform to professional standards in performing the
attest engagement.
Even thought Jones and Jones drafts the financial statements, they can
remain independent as long as the above conditions are met.

b.

If WTI is a public company SEC rules have long prohibited CPAs from
performing bookkeeping and accounting services for SEC registrants.

c.

Under AICPA rules Jones and Jones can perform business valuation
services and consulting services for non-public companies. If Jones and
Jones is to remain independent, however, they must not assume

management responsibility in the process and the client must take full
responsibility for key assumptions and any final decisions based on a
consulting engagement. Jones and Jones must act strictly in an advisory
capacity.
d. Under the SEC rules CPAs can perform a variety of consulting services and
business valuation services for a client. (Authors Note: Under SEC Rules
adopted on November 15, 2000 there are significant restrictions on the
nature of non-audit services, including business valuation and consulting
services that can be performed for an audit client. For example, an
accounting firm cannot provide appraisal or valuation services, or fairness
opinions, where it is reasonably likely that the results of any valuation or
appraisal would be material to the financial statements. There are also
significant restrictions on the role that an accounting firm can play when
assisting the client with IT consulting services. Students and faculty should
consult the supplemental material provided on the new SEC Independence
Rules).
3-34.

(Estimated time - 30 minutes)

1. A member of the AICPA may practice public accounting in any form of
organization permitted by state law or regulation as long as the
characteristics of the organization conform to a resolution adopted by
Council of the AICPA. However, a super majority (66 2/3%) of the
ownership of a firm must belong to CPAs. Non-CPA owners must be
actively engaged in providing services to the firm's clients as their
principal occupation. Ownership by others is considered against the
public interest and continues to be prohibited. Bradley's 50%
ownership, and provision of insurance services rather than professional
accounting services, violates this characteristic.
2. A member in the practice of public accounting may have a financial
interest in a commercial corporation which performs, for the public,
services of a type performed by public accountants and whose
characteristics do not conform to resolutions of Council, provided such
interest is not material to the corporation's net worth, and the member's
interest in and relation to the corporation is solely that of an investor.
Certainly Gilbert's 50 percent interest is material to Financial Services,

Inc., and Gilbert's status is not that of an investor. In this respect,

Gilbert is in violation of Interpretation 505-1.
3. Expressing an unqualified opinion on Grandtime's financial statements,
which did not disclose a material lien on the building asset, is a
violation of both Rule 202 (Compliance with Standards), and Rule 203
(Accounting Principles). Rule 202 includes auditing standards
promulgated by the Auditing Standards Board. These standards include
the requirement that a member shall not permit his or her name to be
associated with financial statements unless the member has complied
with generally accepted auditing standards. The third standard of
reporting says that informative disclosures are to be regarded as
reasonably adequate unless otherwise stated in the report. Since there
was no disclosure of the building lien in the financial statements,
Gilbert should have qualified his opinion.
Rule 203 requires that a member shall not express an opinion that
financial statements are presented in conformity with generally
accepted accounting principles if such statements contain any
departure from an accounting principle promulgated by the body
designated by Council to establish such principles. Accounting
Research Bulletin No. 50, which was published by a body designated
by Council, requires disclosure of assets pledged as security for loans.
4. Having Bradley inform the insurance company of the prior lien on
Grandtime's building is a violation of Rule 301 of the Code, which
enjoins a member from violating the confidential relationship between
himself and his client without consent of the client. The lien should
have been disclosed in Gilbert's report on Grandtime's statements, but
it may not be disclosed by him independently to a third party unless the
client agrees to such disclosure. However, Rule 301 should not be
interpreted to preclude a CPA from correcting a previous error - in this
case expressing an opinion that the financial statements were prepared
in accordance with generally accepted accounting principles when, in
fact, they were not. Gilbert should have first, exhausted all means to
persuade Grandtime to correct the error by recalling the original
financial statements and reissuing them in corrected form with a new
auditor's report.

3-35.

(Estimated time - 35 minutes)

Research Questions
For the reasons stated in the introduction to this manual, solutions are not provided
for this category of questions.