Chapter 4 - Professional Ethics

Multiple Choice Questions From CPA Examinations

4-18

a.

(1)

b.

(3)

c.

(1)

4-19

a.

(1)

b.

(3)

c.

(3)

4-20
Service
Providing bookkeeping services to a public company. The
services were pre-approved by the audit committee of the
company.
Providing internal audit services to a public company that is
not an audit client.
Designing and implementing a financial information system
for a private company.
Recommending a tax shelter to a client that is publicly held.
The services were pre-approved by the audit committee.
Providing internal audit services to a public company client
with the pre-approval of the audit committee.
Providing bookkeeping services to an audit client that is a
private company.

a.
b.
c.
d.
e.
f.

Violation?
Yes
No
No
No *
Yes
No

* Recommending tax shelters is not prohibited, but has the potential to impair
independence.
4-22

a.
b.

c.

d.

e.
f.

No violation as long as Williams does not perform or give advice on management

functions of the organization. See Interpretation 101-4.
Violation. Rule 505 states that all owners of the firm shall be persons who actively
provide services to the firms clients. There is a violation of Rule 505 because
administrative personnel are responsible primarily for office administration, and
do not directly provide services to the firms clients. In addition, there may be a
violation if the state in which the firm operates does not allow incorporation of
CPA firms.
No violation. 101-3 permits the performance of other services for clients. Before a
member performs such services, he or she must carefully evaluate the potential
effect of such services on independence. The member should establish a clear
understanding with the client, and should not be responsible for preparing source
documents, originating data, or performing any management functions.
Violation if the services performed are attestation related, otherwise, no violation. A
CPA is not permitted to pay a commission to obtain a client for attestation related
services (Rule 503). This rule is intended to discourage obtaining clients on the
basis of a commission to a decision maker, rather than on the basis of the quality
of the attestation services or fee to the client.
No violation. Former Rule 401 and 502 would have prohibited this.
No Violation. This is normal practice and is done as a part of almost all audits.

4-22, continued
g. No violation. Rule 502 on advertising permits the use of promotional efforts
designating specialties or areas of practice as long as the advertising is not false,
misleading or deceptive.
h. No violation. The only questionable part of the information is the statement by the ecommerce article that Gutowski is an e-commerce expert. It may be difficult for
Gutowski to demonstrate that he is in fact an expert, but the interpretations of
Rule 502 no longer preclude him from making such a statement.
i. Violation. Rule 301 does not distinguish between audit, tax, and management
advisory services-related working papers. He has therefore violated the rules.
j. No violation. There are no longer rules restricting such practice.
4-24

a.

Independence is essential for an auditor because users of financial statements

expect an unbiased viewpoint in the CPA's attestation to the fairness of the
financial statements. If users believe that auditors are not independent, the value
of the audit function is eliminated.
b. Most other professions (attorneys, doctors, dentists, etc.) represent their clients and
perform services intended primarily to assist their clients. For this reason no
assumption of independence is required. The importance of independence for
CPAs is similar to that for judges. For both, a nonadvocacy position is essential.
c. Independence in appearance is how independent the auditor appears to outsiders
such as users of financial statements. Independence in fact refers to whether the
auditor has maintained an attitude of independence throughout the engagement.
For example, an auditor could possibly maintain an attitude of independence in
fact even though he or she held shares of stock in a company and performed the
audit (the auditor would have violated Rule 101). However, the auditor would not
likely be independent in appearance in such a situation. Both independence in
appearance and fact are essential and the Code of Professional Conduct
concerns both.
d.
1.
2.
3.

He has violated the Code of Professional Conduct. Rule 101 prohibits any
direct ownership by a partner or shareholder.
Such a small ownership is unlikely to have any impact on a partner's
objectivity in evaluating the financial statements. It is unlikely to affect the
partner's independence in fact.
Such ownership could affect the appearance of independence and
therefore impact the reputation and credibility of auditors. Additionally
these strict requirements eliminate any controversy as to the line between
a material and immaterial ownership. It also shows outsiders the
importance of independence to auditors and therefore hopefully improves
the reputation of the profession.

4-24

(continued)

INDEPENDENCE IN
FACT

INDEPENDENCE
IN APPEARANCE

1.

May cause the auditor

to permit
misstatements to
enhance personal
wealth.

Users may perceive that

auditors would permit
misstatements to enhance
personal wealth.

Minor, if any.

2.

Person doing this audit

may not do the audit
work carefully because
he or she did the
bookkeeping.

Users may perceive that

the auditor may not
independently audit his or
her own work.

Some clients find it less expensive

to have bookkeeping services
performed by an outside service. It
is often less expensive to have this
done by the auditor because the
auditor will already be
knowledgeable about the business.

3.

There may be an
absence of a careful
independent check of
the entries or preparation of the
statements because
they were originally
prepared by the
auditor.

Users may believe that the

auditor may not
independently audit his or
her own work or that of a
staff person from his or
her firm.

Many clients lack technical

expertise in accounting. Having
services performed by the auditor is
sometimes the least costly
alternative.

4.

The auditor may be

reluctant to criticize or
not rely on an
accounting system that
was originally
recommended by the
CPA firm. Additionally,
if the CPA firm obtains
considerable revenue
from management
advisory services, the
CPA firm may fear the
loss of the client and
therefore be controlled
by management.

Users may perceive either

of the two concerns
discussed under
independence in fact.

A CPA firm gains considerable

knowledge about a client and its
business during the audit. Due to
this knowledge, management
services can often be provided by
the same CPA firm at a lower cost
than alternative sources such as
other CPA firms or management
consultants.

5.

The audit team may

become complacent
due to familiarity and
not carefully evaluate
potential
misstatements.

Users may perceive the

possibility of complacency.

Knowledge gained by the audit

team about a client's business is
essential to evaluate when
misstatements in the financial
statements are likely and to plan
the audit. It is costly for a new audit
team to obtain that knowledge.

CONSEQUENCES

INDEPENDENCE IN
FACT

INDEPENDENCE
IN APPEARANCE

6.

The CPA firm may

become complacent
due to familiarity and
not carefully evaluate
potential
misstatements.

Users may perceive the

possibility of complacency.

The same conclusions reached in 5

about the audit team are applicable
to CPA firms. The cost of a new
CPA firm of obtaining the
knowledge is even greater because
of confidentiality requirements and
communication difficulties between
CPA firms.

7.

The auditor may be

unwilling to disagree
with management for
fear of being
terminated.

Users may perceive that

the auditor is un- willing to
disagree with
management.

Someone has to select the auditor.

Management is usually in the best
position to evaluate the
effectiveness and cost of
alternative auditors, especially for
private companies.

CONSEQUENCES

b. The AICPA Code of Professional Conduct prohibits only e(1). The SEC prohibits e(1)
if the person owning the stock is a member of the engagement team or is a
partner in the office of the partner primarily responsible for the audit engagement.
The SEC also prohibits e(2), and e(3) would also be considered a violation if the
adjusting entries were so extensive that they are, in essence, bookkeeping
services. The SEC also prohibits the management services in e(4) if they are one
of the nine nonaudit services prohibited by the SEC. Because the Sarbanes
Oxley Act requires that the audit committee select the auditor, e(7) is now also a
violation of SEC rules.,