Question

In what circumstances are the various conceptual frameworks within the Code of Professional Conduct considered by accountants?

How do the rules for the audit of public versus nonpublic companies differ with respect to the independence of a CPA who performs routine accounting services for a client?

Answer 1

Conceptual frame Work for Within The Code of Professional Conduct Considered by Accountants

In early April 2018, the IESBA released a completely rewritten and revamped Code of Ethics for professional accountants (PAs). Renamed “International Code of Ethics for Professional Accountants (including International Independence Standards) (“the Code” or “the revised and restructured Code”), the Code will become effective in June 2019. It packages all substantive advancements in ethics and independence over the last four years into a single document and includes the new provisions relating to non-compliance with law and regulations (“NOCLAR"), which are already effective since July 2017, and the revised independence provisions relating to long association which comes into effect in December 2018.

Key Areas of Focus

The fundamental principles within the Code – integrity, objectivity, professional competence and due care, confidentiality and professional behavior – establish the standard of behavior expected of a professional accountant (PA) and it reflects the profession’s recognition of its public interest responsibility. Those fundamental principles as well as the categories of threats to them – self-review, self-interest, advocacy, familiarity and intimidation threats are unchanged. Also unchanged, are the overarching requirements to apply the conceptual framework to comply with the fundamental principles and where applicable, be independent. In addition to the structural revisions made to the entire Code, the substantive revisions include:

• An enhanced conceptual framework, which includes extensive revisions to “safeguards” throughout the Code that are better aligned to threats;
• Strengthened independence provisions regarding long association of personnel with audit clients;
• Strengthened provisions relating to offering and accepting of inducements, including gifts and hospitality that apply to both PAs in business (“PAIBs”) and PAs in public practice (“PAPPs”);
• Strengthened provisions dedicated to PAIBs, including:
  • A new section relating to pressure to breach the fundamental principles; and
  • Revised provisions relating to the preparation and presentation of information.
• Clarifications about the applicability of PAIB provisions to PAPPs;
• New material to emphasize the importance of understanding facts and circumstances when exercising professional judgment; and
• New material to explain how compliance with the fundamental principles supports the exercise of professional skepticism in an audit or other assurance engagements.

Comparison of Public vs. Private Company Audit Standards

Public companies have their shares traded on a stock exchange, and private companies do not. That's the big difference between them, but from that difference, other differences spring. Private company audit requirements are different from public companies, but over time, they've moved closer together.

Public Company Audit Requirements

Audits are an internal or external review of a company’s financial operations. Companies use audits to ensure they are in compliance with national accounting standards and internal accounting policies. Publicly held companies typically face more audits based on requirements from government regulatory agencies and stock exchanges. These companies require more audits because investment firms and individual investors have a financial stake in the company’s financial returns. Audits typically involve a few universal principles for public companies.

Financial Statements

Financial statements are usually the final output of a company’s accounting process and provide investors with key information on the company’s financial health. Auditors will review the statements to ensure they include accurate and valid financial information. The most common statements include the balance sheet, income and cash flow statement. Auditors will start with the financial statements and trace information back to the individual accounts and transaction that make up the information on the financial statement.

Comparison

Auditors can also compare a company’s financial information and trend analysis to other companies in the business environment. This comparison process is possible because publicly held companies are required to file reports with the Securities and Exchange Commission (SEC) and they often have financial information reported on financial websites. Auditors who find questionable information in a company’s ledger or other accounting reports may focus on specific areas to review. While companies do not often mirror an industry’s or competitor’s information, a significant variance from the average can provide auditors with red flags relating to inappropriate accounting processes.

Internal Controls

Publicly held company must implement internal controls to safeguard their financial processes and information. Internal control requirements became widespread from the Sarbanes-Oxley Act of 2002, which attempts to limit the fraud or abuse of a company’s financial information. Auditors will review internal controls to determine if they truly safeguard information as intended. Ineffective internal controls are worthless in the company’s accounting process and create more work for employees and provide little or no benefit to shareholders.

Independence and Nonpublic Companies

Auditor independence protects the interests of capital providers in public capital markets. Investor losses, in part attributable to recent audit failures such as Enron and WorldCom, have subjected the accounting profession to increased regulatory scrutiny. The Sarbanes-Oxley Act of 2002 has created stricter independence requirements for the auditors of publicly traded companies. Although the act applies primarily to public companies, section 209 of the act delegates to state regulatory agencies the applicability of the standards to small and mid-sized accounting firms that provide services to nonpublic companies.

The audit process has long served the financial markets by ensuring reliable financial reporting to an organization’s stakeholders. An audit client can obtain short-term benefits when its auditor acquiesces to questionable reporting practices. As questionable reporting practices are revealed, however, stock prices can drop dramatically because stakeholders cannot depend on the information in financial reports and on the audit process that approves them.

An auditor must objectively judge whether management has met appropriate financial statement assertions as required by GAAP. The auditor cannot permit a personal relationship with the client to interfere with objectivity. The audit process provides the highest level of assurance; other common types of nonpublic financial statement engagements include reviews and compilations. A review provides only limited assurance as to whether the financial statements comply with GAAP, while compilations provide no such assurance. Whether the new independence rules for public companies should apply to audits, reviews, and compilations of nonpublic companies remains an open question.