Code of Professional Conduct
The AICPA Code of Professional Conduct is the ethical foundation for all CPAs in the United States. It establishes the standards of behavior and professional responsibility that members of the AICPA must follow. For the AUD exam, you must understand the Code's structure, its six governing principles, the independence rules, and how threats and safeguards interact within the conceptual framework approach.
This section covers the full architecture of the Code, the ethical principles that guide professional conduct, and the detailed independence requirements that apply to attest engagements.
Structure of the AICPA Code of Professional Conduct
The Code of Professional Conduct is organized in a hierarchical structure. Each level provides progressively more specific guidance:
| Level | Description |
|---|---|
| Principles | Broad, aspirational statements that express the profession's ideals and provide the framework for the rules. Not enforceable on their own. |
| Rules | Specific, enforceable requirements that CPAs must follow. Violations can lead to disciplinary action. |
| Interpretations | Published guidance from the AICPA Professional Ethics Executive Committee that explains how rules apply to specific circumstances. Presumptively mandatory — a CPA must follow them or demonstrate that alternative actions achieve the rule's objective. |
| Other Guidance | Ethics rulings, practice aids, and other nonauthoritative resources that provide additional context for applying the rules. |
The Code is divided into three parts based on the CPA's role: (1) Members in Public Practice, (2) Members in Business, and (3) Other Members. Independence requirements apply primarily to members in public practice performing attest engagements.
The Six Principles of Professional Conduct
The six principles represent the profession's core values. Although they are aspirational and not directly enforceable, they provide the ethical foundation for all of the specific rules.
1. Responsibilities
Members should exercise sensitive professional and moral judgments in all their activities. As professionals, CPAs have a responsibility to cooperate with each other to improve the art of accounting, maintain the public's confidence, and carry out the profession's special responsibilities for self-governance.
2. 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 a commitment to professionalism. The profession's public consists of clients, credit grantors, governments, employers, investors, the business and financial community, and others who rely on the objectivity and integrity of CPAs.
3. Integrity
Members should perform all professional responsibilities with the highest sense of integrity. Integrity requires a CPA to be honest and candid within the constraints of client confidentiality. Service and the public trust should not be subordinated to personal gain.
4. Objectivity and Independence
Members should maintain objectivity and be free of conflicts of interest in discharging professional responsibilities. Members in public practice should be independent in fact and appearance when providing attest and other assurance services.
Independence in fact means the auditor actually maintains an unbiased mental attitude. Independence in appearance means a reasonable, informed third party would conclude the auditor is unbiased. Both are required. The CPA exam frequently tests the distinction between these two concepts.
5. Due Care
Members 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. Due care requires a CPA to act diligently and in accordance with applicable standards.
6. Scope and Nature of Services
Members in public practice should observe the Code's principles in determining the scope and nature of services to be provided. CPAs must consider whether providing a particular service could create a conflict of interest or impair independence.
Independence: The Conceptual Framework Approach
The AICPA uses a conceptual framework approach to evaluate independence. Rather than relying solely on a checklist of prohibited activities, this framework requires the CPA to:
- Identify threats to independence
- Evaluate the significance of those threats
- Apply safeguards to eliminate or reduce threats to an acceptable level
- If safeguards cannot reduce the threat to an acceptable level, the CPA must decline or discontinue the engagement
This framework applies when the CPA encounters a relationship or circumstance that is not explicitly addressed by the specific independence rules.
Example: Gies Co. asks its audit firm to also provide employee training on how to use a new accounting software system. The specific rules do not directly address this situation. The auditor uses the conceptual framework to identify any threats (such as management participation), evaluates whether those threats are significant, and determines whether safeguards — such as ensuring Gies Co. management makes all decisions about the system — can reduce the threat to an acceptable level.
Seven Threats to Independence
The Code identifies seven categories of threats that can impair a CPA's independence:
| Threat | Description | Example |
|---|---|---|
| Self-Review | The threat that a CPA will not appropriately evaluate the results of a previous judgment or service performed by the CPA's firm | The audit firm prepared MAS Inc.'s tax return and now must audit the tax provision on MAS Inc.'s financial statements |
| Advocacy | The threat that a CPA will promote a client's position to the point that objectivity is compromised | The auditor represents Kingfisher Industries in a tax dispute before the IRS |
| Adverse Interest | The threat that a CPA will not act with objectivity because the CPA's interests are opposed to the client's interests | The audit firm is involved in litigation against BIF Partners, an audit client |
| Familiarity | The threat that, due to a long or close relationship with a client, a CPA will become too sympathetic to the client's interests | An auditor has audited Illini Entertainment for 15 years and has developed a close personal friendship with the CFO |
| Undue Influence | The threat that a CPA will subordinate professional judgment because of pressure from a client, employer, or other party | Illini Security's CEO threatens to replace the audit firm unless the auditor agrees with management's aggressive accounting position |
| Management Participation | The threat that a CPA will take on the role of management or otherwise assume management responsibilities for an attest client | The auditor makes hiring decisions or approves vendor payments on behalf of MSA Records |
| Financial Self-Interest | The threat that a CPA could benefit, financially or otherwise, from an interest in or relationship with an attest client | The engagement partner owns shares of stock in Gies Co., the audit client |
The CPA exam frequently presents scenarios and asks candidates to identify the type of threat. Practice recognizing each threat category by focusing on the key characteristic: self-review involves reviewing your own work, advocacy involves promoting the client's position, familiarity involves closeness, and so on.
Independence Rules for Attest Engagements
Financial Interests
The independence rules strictly regulate a CPA's financial interests in attest clients:
- Direct financial interest: Any ownership interest (stock, bonds, notes, etc.) held directly by the covered member. Always prohibited, regardless of materiality.
- Indirect financial interest: A financial interest held through an intermediary, such as a mutual fund or retirement plan. Prohibited only if material to the covered member.
Example: An audit partner at the firm that audits Kingfisher Industries inherits 10 shares of Kingfisher Industries stock from a relative. Even though the value is small, this is a direct financial interest and independence is impaired. The partner must dispose of the shares promptly to restore independence. However, if the partner owns a diversified mutual fund that happens to hold Kingfisher Industries stock, this is an indirect financial interest and would impair independence only if the amount is material to the partner.
"Covered members" include the engagement partner, the engagement team, anyone in a position to influence the engagement, and the firm itself. Prohibited financial interests apply to covered members and their immediate family members.
Employment and Business Relationships
Independence is impaired when a covered member's immediate family holds a key position at an attest client. Key positions include CEO, CFO, controller, chief accounting officer, or any role equivalent to a member of senior management.
If a partner or professional on the engagement team has a close relative (parent, sibling, or nondependent child) employed by the client in a key position, the member should evaluate the threat using the conceptual framework.
A former practitioner of the firm who joins an attest client in a key position can impair the firm's independence if the former practitioner continues to participate in the firm's business or professional activities, or if amounts owed to the former practitioner (such as retirement benefits) are other than fixed and determinable.
Nonattest Services and Independence
A CPA firm can provide nonattest services (such as tax, consulting, or bookkeeping) to an attest client without impairing independence, provided three overarching requirements are met:
- The attest client's management agrees to assume all management responsibilities for the nonattest service
- The client oversees the service by designating an individual (preferably in senior management) who possesses suitable skill, knowledge, or experience
- The CPA does not assume management responsibilities — meaning the CPA does not make decisions, act in a management capacity, or perform ongoing management functions
Example: BIF Partners engages its audit firm to assist with bookkeeping services during the year. Independence is maintained as long as BIF Partners' management reviews and approves all journal entries, takes responsibility for the financial records, and has an individual with the competence to oversee the bookkeeping work. If the audit firm were to approve transactions or make accounting decisions without client oversight, independence would be impaired.
The three requirements for nonattest services — management responsibility, client oversight, and no management role for the CPA — appear frequently on the exam. Remember that the client must always be "in the driver's seat."
Unpaid Fees
Independence is considered impaired if fees for services provided more than one year before the current-period report date remain unpaid when the current-period report is issued. The reasoning is that the unpaid fees begin to resemble a loan to the client, creating a financial self-interest threat.
Example: MSA Records owes its audit firm $85,000 for last year's audit. If those fees remain unpaid when the firm issues the current-year audit report, independence is impaired. The firm should collect the outstanding fees before issuing the report or consider whether continuing the engagement is appropriate.
Gifts and Entertainment
A covered member's independence is impaired if the member accepts a gift from an attest client, unless the gift is clearly insignificant to both parties. Modest gifts — such as a promotional item, a holiday basket, or a meal of nominal value — generally do not impair independence.
Entertainment (meals, sporting events, etc.) is evaluated based on whether it is reasonable in the circumstances. The CPA should consider:
- The nature and value of the entertainment
- The frequency of such activities
- Whether the entertainment could create an expectation of favorable treatment
Close Relatives and Former Practitioners
Close Relatives
A close relative is defined as a parent, sibling, or nondependent child. If a close relative of a covered member:
- Has a key position at an attest client, or
- Has a financial interest in an attest client that is material to the close relative and the covered member knows or has reason to know about it
...then the covered member should apply the conceptual framework to determine if threats to independence can be reduced to an acceptable level.
Former Practitioners
When a former partner or professional employee of the firm joins an attest client, the firm's independence can be impaired if:
- The individual is in a position to influence the attest engagement
- Capital balances or retirement payments owed to the individual are not fixed and determinable
- The individual continues to participate in or appear to participate in the firm's activities
Example: A former senior manager at the firm that audits Illini Entertainment joins Illini Entertainment as Controller. The firm must ensure that the former employee no longer has any involvement with the firm and that all retirement payments owed are fixed. If the former manager's retirement balance depends on the firm's future profits, independence is impaired.
Summary: Key Independence Rules at a Glance
| Area | Rule |
|---|---|
| Direct financial interest in attest client | Always prohibited |
| Indirect financial interest in attest client | Prohibited if material to covered member |
| Immediate family in key position at client | Independence impaired |
| Nonattest services for attest client | Permitted if client assumes management responsibility and oversees the work |
| Unpaid fees (> 1 year old) | Independence impaired when current report is issued |
| Gifts from attest client | Permitted only if clearly insignificant |
| Loans to/from attest client | Generally prohibited (except certain grandfathered or permitted loans) |
| Former practitioner joins client | Must sever all ties with the firm; retirement payments must be fixed and determinable |
When facing an independence question on the CPA exam, follow this process: (1) Identify the relationship or circumstance. (2) Determine if it involves a covered member. (3) Check the specific rules first. (4) If no specific rule applies, use the conceptual framework — identify the threat, evaluate its significance, and determine if safeguards can reduce it to an acceptable level.