Auditing and Assurance Services, 16e (Arens/Elder/Beasley)

Chapter 4 Professional Ethics

True or False:

1) One of the main reasons people act unethically is that they choose to act selfishly.
Answer: TRUE

2) Most people define unethical behavior as conduct that differs from what they believe is
appropriate given the circumstances.
Answer: TRUE

3) Ethical frameworks help identify the ethical issues and will always lead to the appropriate
course of action.
Answer: FALSE

4) A rationalization method that can easily result in unethical behavior is the argument that
"everybody does it."
Answer: TRUE

5) If an action is considered legal, it must also be considered ethical.

Answer: FALSE

6) Professionals are expected to conduct themselves at a higher level than most other members of
society.
Answer: TRUE

7) An advantage of specific rules in the Code of Professional Conduct is the enforceability of

minimum behavior and performance standards.
Answer: TRUE

8) It is a violation of the rules of conduct if someone does something on behalf of a member that
is a violation if the member does it.
Answer: TRUE

9) An advantage of the principles of professional conduct in the Code of Professional Conduct is

that they are more easily enforced than are the specific rules of conduct.
Answer: FALSE

10) Safeguards can always reduce the threat to an acceptable level.

Answer: FALSE

11) Interpretations of rules of conduct in the Code of Professional Conduct are not officially
enforceable and practitioners need not justify departure from them.
Answer: FALSE

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12) Adverse interest is the threat that a member will not act with objectivity because their
interests are opposed to the client's interests.
Answer: TRUE

13) In the AICPA Code of Professional Conduct, the second principle of professional conduct,
entitled "The Public Interest," applies only to members of the AICPA in public practice and not
to members who work as accountants in business, government, or education.
Answer: FALSE

14) In the AICPA Code of Professional Conduct, the sixth principle of professional conduct,
entitled "Scope and Nature of Services," applies to members of the AICPA who work in public
practice, business, government, or education.
Answer: FALSE

15) The Conceptual Framework for AICPA Independence Standards can be used when making
decisions on ethical matters not explicitly addressed in the Code.
Answer: TRUE

16) Each state also has rules of conduct that are required for licensing by the state.
Answer: TRUE

17) Both SEC rules and the Sarbanes-Oxley Act prohibit auditors from providing bookkeeping
services to their public company audit clients.
Answer: TRUE

18) Under the interpretations to the AICPA Code, independence is considered to be impaired if
fees remain unpaid for professional services provided more than six months before the date of
the current year's report.
Answer: FALSE

19) Auditors are allowed to have an indirect financial interest in an audit client, such as
ownership of stock in a client's company by the auditor's brother, as long as the amount of the
financial interest is immaterial to the brother.
Answer: TRUE

20) CPA firms are required to be independent when performing any professional service.
Answer: FALSE

21) The prohibition on direct financial interests applies to covered members in a position to
influence an engagement.
Answer: TRUE

22) All litigation by a client related to tax or other nonaudit services will impair independence.
Answer: FALSE

23) A CPA firm may use any name as long as it is not misleading.
Answer: TRUE
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24) Under the Form of Organization and Name rule, a CPA firm is prohibited from practicing as
a limited liability partnership.
Answer: FALSE

25) Imprisonment for a period of six months or longer will result in automatic expulsion from the
AICPA.
Answer: FALSE

26) A CPA firm may practice public accounting only in a form of organization permitted by
federal law or regulation.
Answer: FALSE

27) Under the Confidential Client Information rule, permission is not required from the client to
use the audit documentation relating to that client during an AICPA authorized peer review
program with another CPA firm.
Answer: TRUE

28) Information obtained by a CPA from a client is legally privileged in federal court.
Answer: FALSE

29) Members of the AICPA in public practice are prohibited from performing comparative
advertising.
Answer: FALSE

30) Under the Form of Organization and Name rule, a CPA firm may not designate itself as
"Members of the American Institute of Certified Public Accountants" unless a majority of its
owners are members of the Institute.
Answer: FALSE

31) Under the AICPA's Code of Professional Conduct, CPAs are prohibited from offering audit
clients a discount for referring a prospective client even if they are disclosed.
Answer: FALSE

32) All owners of a CPA firm must be CPAs who are qualified to practice.
Answer: FALSE

33) Expulsion from the AICPA for failing to follow the rules of conduct is, by itself, sufficient to
prevent a CPA from practicing public accounting.
Answer: FALSE

34) A public company may obtain internal audit services from their financial statement auditor if
it is approved by the company's audit committee.
Answer: FALSE

35) For a public company, the Sarbanes-Oxley Act requires audit committee approval of all
nonaudit services prior to their performance by the company's external auditor.
Answer: TRUE
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Multiple choice:

1) Ethics are
A) needed in the professions, but is not needed for society in general.
B) a set of moral principles or values.
C) not formed by life experiences.
D) always incorporated in laws.

2) ________ means that a person acts according to conscience, regardless of the situation.
A) Caring
B) Fairness
C) Integrity
D) Respect

3) Which of the following is a prescribed set of moral principles or values?

A) codes of business ethics for professional groups
B) laws and regulations
C) codes of conduct within an organization
D) all of the above

4) A six-step approach is often used to resolve an ethical dilemma. The first step in this process
is to
A) identify the alternative actions available.
B) identify the ethical issues from the facts.
C) determine who will be affected by the outcome of the dilemma.
D) obtain the relevant facts.

5) The underlying reason for a code of professional conduct for any profession is
A) the need for public confidence in the quality of service of the profession.
B) it provides a safeguard to keep unscrupulous people out.
C) it is required by federal legislation.
D) it allows licensing agencies to have a yardstick to measure deficient behavior.

6) Which of the following statements is true when the CPA has been engaged to perform an audit
of financial statements?
A) The CPA firm is engaged and paid by the client; therefore, the firm has primary responsibility
to be an advocate for the client.
B) The CPA firm is engaged and paid by the client, but the primary beneficiaries of the audit are
those who rely on the financial statements.
C) Should a situation arise where there is no convincing authoritative standard available, and
there is a choice of actions which could impact a client's financial statements, the CPA is free to
endorse the choice which is in the investors' interests.
D) The CPA firm has primary responsibility to the FASB.

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7) The ________ is a standard of conduct for all members of the AICPA.
A) IESBA Code of Conduct
B) SEC Code of Conduct
C) PCAOB Code of Professional Conduct
D) AICPA Code of Professional Conduct

8) Which of the following is(are) true concerning the Ethical Principles of the Code of
Professional Conduct?
I. They identify ideal conduct.
II. They are general ideals and are not enforceable.
A) I only
B) II only
C) I and II
D) Neither I nor II

9) Which of the following is not one of the major parts of the AICPA's Code of Professional
Conduct?
A) principles
B) rules
C) interpretations
D) definitions

10) One of the AICPA's Ethical Principles deals with the public interest. It states that members
should accept the obligation to act in a way that will
A)
Honor the public trust Serve the client's interest
Yes Yes

B)
Honor the public trust Serve the client's interest
No No

C)
Honor the public trust Serve the client's interest
Yes No

D)
Honor the public trust Serve the client's interest
No Yes

11) A CPA performs bookkeeping services for a client and then performs an audit of those
financial statements. This is an example of a ________ threat.
A) familiarity
B) self-interest
C) self-review
D) management participation
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12) Since the rules cannot address all circumstances, the Code includes a conceptual framework
approach for members to use to evaluate threats to compliance. Using this framework,
A) the first step is to discuss the threat with the client's management team.
B) all threats must be completely eliminated.
C) safeguards can be used to eliminate any threat.
D) more than one safeguard may be necessary.

13) Which part of the AICPA's Code of Professional Conduct is enforceable?

A) ethical rulings
B) rules of conduct
C) principles
D) interpretations

14) Interpretations of the rules of conduct

A) are enforceable.
B) are finalized after being approved by the FASB.
C) are issued as exposure drafts to the profession and others for comments.
D) do not apply to members in business.

15) The AICPA's Code of Professional Conduct requires independence for all
A) attestation engagements.
B) services performed by accountants in public practice.
C) accounting and auditing services performed.
D) professional work performed by CPAs.

16) When a member observes the profession's technical and ethical standards and strives to
continually improve her competence and quality of services, she is exercising
A) due care.
B) integrity.
C) independence.
D) objectivity.

17) Four of the six Ethical Principles in the AICPA's Code of Professional Conduct are equally
applicable to all members of the AICPA. Which of the following principles applies only to
members in public practice?
A) Scope and Nature of Services
B) Integrity
C) Due Care
D) The Public Interest

18) The Code of Professional Conduct is established by the membership of the AICPA, and the
Interpretations of the Rules of Conduct are prepared by the
A) Financial Accounting Standards Board.
B) Securities and Exchange Commission.
C) CPA licensing agencies within each state.
D) Professional Ethics Executive Committee of the AICPA.

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19) Due to a shortage of personnel, the client asks a member firm to assist with the authorization
of accounting transactions. This is an example of which type of threat to compliance with the
rules under the AICPA Code of Professional Conduct?
A) management participation
B) self-interest
C) self-review
D) undue influence

20) For which of the following professional services must CPAs be independent?
A) management advisory services
B) audits of financial statements
C) preparation of tax returns
D) all of the above

21) "Independence" in auditing means

A) maintaining an indirect financial interest.
B) not being financially dependent on a client.
C) taking an unbiased viewpoint.
D) being an advocate for a client.

22) When CPAs are able to maintain their actual independence, it is referred to as independence
in
A) conduct.
B) appearance.
C) fact.
D) total.

23) The Sarbanes-Oxley Act ________ a CPA firm from doing both bookkeeping and auditing
services for the same public company client.
A) encourages
B) prohibits
C) allows
D) allows on a case-by-case basis

24) The financial interests of a CPA's family members can affect the CPA's independence.
Which of the following parties would not be included as a "direct financial interest" of the CPA?
A) spouse
B) dependent child
C) relative supported by the CPA
D) sibling living in the same city as the CPA

25) Interpretations of the rules regarding independence allow an auditor to serve as

A) a director or officer of an audit client.
B) an underwriter for the sale of a client's securities.
C) a trustee of a client's pension fund.
D) an honorary director for a not-for-profit charitable or religious organization.

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26) Interpretations of the independence rule of the AICPA Code prohibit covered members from
owning any stock or other direct investment in audit clients. Covered members would include
which of the following?
A)
All partners in the
engagement office even if
they have no engagement Individuals on the attest The firm and its employee
responsibility engagement benefit plans
Yes Yes Yes

B)
All partners in the
engagement office even if
they have no engagement Individuals on the attest The firm and its employee
responsibility engagement benefit plans
Yes No No

C)
All partners in the
engagement office even if
they have no engagement Individuals on the attest The firm and its employee
responsibility engagement benefit plans
No Yes Yes

D)
All partners in the
engagement office even if
they have no engagement Individuals on the attest The firm and its employee
responsibility engagement benefit plans
No No No

27) Independence is required of a CPA when performing

A) management advisory services.
B) all attestation services.
C) all attestation and tax services.
D) all professional services.

28) CPAs may provide bookkeeping services to their private company audit clients, but there are
a number of conditions that must be met if the auditor is to maintain independence. Which of the
following conditions is not necessary?
A) The CPA must not assume a management role or function.
B) The client must hire an external CPA to approve all of the journal entries prepared by the
auditor.
C) The auditor must comply with GAAS when auditing work prepared by his/her firm.
D) The client must accept responsibility for the financial statements.

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29) An example of an "indirect financial interest in a client" would be
A) ownership of less than 10% of the client's stock by the covered members spouse.
B) an ownership of less than 10% of the client's stock by a staff member who is not involved in
the audit.
C) the covered member's ownership of a mutual fund that has an investment in the client.
D) All of the above are examples of an indirect financial interest in a client.

30) When determining whether independence is impaired because of an ownership interest in a

client company, materiality will affect ownership
A) in all circumstances.
B) only for direct ownership.
C) only for indirect ownership.
D) under no circumstances.

31) A direct financial interest violates independence in which of the following circumstances?
A) when close relatives such as nondependent children, brothers, and sisters have a significant
financial interest in the client
B) when close relatives such as nondependent children, brothers, and sisters have any financial
interest in the client
C) when the CPA owns shares in a mutual fund that has an ownership interest in the client
D) when close relatives such as a brother, sister, or in-laws are employed by the client in their
engineering department

32) A CPA sole practitioner purchased stock in a client corporation and placed it in a trust as an
educational fund for the CPA's minor child. The trust securities were not material to the CPA but
were material to the child's personal net worth. Would the independence of the CPA be
considered to be impaired with respect to the client?
A) Yes, because the stock is a direct financial interest.
B) Yes, because the stock is an indirect financial interest that is material to the CPA's child.
C) No, because the CPA does not have a direct financial interest in the client.
D) No, because the CPA does not have a material indirect financial interest in the client.

33) Julie and Lisa are sisters. Julie is a CPA auditing the company where Lisa works. Julie's
independence is impaired if
A) Lisa is the controller.
B) Lisa owns 2% of the company.
C) Lisa is the marketing manager.
D) all of the above.

34) Oehlers, CPA, is a staff auditor participating in the engagement of Capital Trust, Inc. Which
of the following circumstances impairs Oehlers' independence?
A) Oehlers' sister is an internal auditor employed by Capital Trust.
B) Oehlers' friend, an employee of another local accounting firm, prepares the tax return of
Capital Trust's CEO.
C) Oehlers' and Capital Trust's 401K plans own stock with the same corporation.
D) During the period of professional engagement, Capital Trust and Oehlers discussed business
over lunch at a first-class restaurant.
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35) An auditor's independence is considered impaired if the auditor has
A) an immaterial, indirect financial interest in a client.
B) an outstanding $8,000 balance on a credit card issued by a client.
C) an automobile loan from a client bank, collateralized by the automobile.
D) a joint, closely held business investment with the client that is material to the auditor's net
worth.

36) According to the profession's ethical standards, an auditor would be considered independent
in which of the following instances?
A) The auditor's checking account, which is fully insured by a federal agency, is held at a client
financial institution.
B) The auditor is also an attorney who advises the client as its general counsel.
C) An employee of the auditor serves as treasurer of a charitable organization that is a client.
D) The client owes the auditor fees for two consecutive annual audits.

37) Whichof the following loans would be prohibited between a CPA firm or its members and an
audit client?
A) automobile loans
B) loans fully collateralized by cash deposits at the same financial institution
C) new home mortgage loans
D) unpaid credit card balances not exceeding $10,000 in total

38) Under the AICPA independence rules, the auditor

A) is prohibited from performing a company's audit and installing and designing the client's new
information system.
B) does not need to document the understanding and willingness of the client to perform all
management functions associated with the nonaudit service.
C) is prohibited from doing any bookkeeping services for the client if performing the audit.
D) must follow the more restrictive SEC independence rules when dealing with a public
company.

39) Which of the following instances would impair a CPA's independence when they have been
retained as the auditor?
I. A charitable organization where the CPA serves as treasurer
II. A municipality where the CPA owns $250,000 of the $25 million outstanding bonds of the
municipality
III. A company that the CPA's investment club owns a 10% investment interest
A) I and II
B) I and III
C) II and III
D) I, II, and III

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40) The Code of Conduct rule on independence indicates that materiality must be considered
when
A)
Evaluating direct investments Evaluating indirect
made by the CPA ownership investments
Yes Yes

B)
Evaluating direct investments Evaluating indirect
made by the CPA ownership investments
No No

C)
Evaluating direct investments Evaluating indirect
made by the CPA ownership investments
Yes No

D)
Evaluating direct investments Evaluating indirect
made by the CPA ownership investments
No Yes

41) Under the AICPA independence rules, independence can be considered impaired when
A) billed fees remain unpaid for professional services for more than ninety days.
B) a client in bankruptcy has unpaid fees for more than one year.
C) there is litigation by the client related to the auditor's tax or other nonaudit services for an
immaterial amount.
D) there is a lawsuit by the client claiming deficiencies in the previous year's audit.

42) Which of the following is least likely to impair a CPA firm's independence with respect to an
audit client in the Oklahoma City office of a national CPA firm?
A) A partner in the Oklahoma City office owns an immaterial amount of stock in the client.
B) A partner in the Jersey City office owns 25% of the client's stock.
C) A partner in the Oklahoma City office, who does not work on the audit engagement,
previously served as controller for the audit client.
D) A partner in the Chicago office previously served as vice president of finance for the audit
client.

43) The CPA firm will lose its independence if

A) a staff auditor providing audit services to the client acquires stock in that client.
B) a staff tax preparer who provides 15 hours of non-audit services to the client acquires stock in
that client.
C) an audit manager in an office different than the office providing audit services has a direct,
immaterial financial interest in the audit client.
D) a covered member has an indirect, immaterial financial interest in an audit client.

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44) A CPA's financial interests in nonclients may have an effect on independence if the
nonclients are investors in or investees of the client. Which situation would not impair a CPA's
independence?
A) The client has an immaterial investment in a nonclient investee in which the CPA has an
immaterial investment.
B) The CPA has a material indirect financial interest in a nonclient in which the client has a
material investment.
C) The client investor has a nonmaterial investment in the nonclient investee in which the CPA
has a material investment.
D) The CPA has a joint closely held investment with the client in a nonclient that is material to
the client as well as the CPA.

45) Interpretations to the Rules of Conduct permit a CPA firm to do both bookkeeping and
auditing for the same private company client if three criteria are met. Which of the following is
not one of those criteria?
A) The client must accept full responsibility for the financial statements.
B) The client is required to file an annual report, including audited financial statements, with the
Securities and Exchange Commission.
C) The CPA must not assume the role of employee or of manager.
D) The CPA must follow applicable auditing standards.

46) Which of the following circumstances impairs an auditor's independence?

I. Litigation by a client against an audit firm claiming a deficiency in the previous audit
II. Litigation by a client against an audit firm related to tax services
III. Litigation by an audit firm against a client claiming management fraud or deceit
A) I and II
B) I and III
C) II and III
D) I, II, and III

47) A CPA firm should decline an offer to perform consulting services engagement if
A) the proposed engagement is not accounting related.
B) recommendations made by the CPA firm are to be subject to review by the client.
C) acceptance would require the CPA firm to make management decisions for an audit client.
D) any of the above is true.

48) Interpretations of the AICPA Code of Professional Conduct are dominated by the concept of
A) independence.
B) compliance with standards.
C) accounting.
D) acts discreditable to the profession.

49) Under Sarbanes-Oxley, the audit committee of a public company

A) must meet on a monthly basis.
B) must be comprised entirely of financial experts.
C) is responsible for the oversight of the work of the independent auditor.
D) should have at least one independent member.
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50) If the board of accountancy in the state in which a CPA firm is licensed has rules that are
different than the AICPA's rules, the CPA firm must follow
A) whichever rules are less restrictive.
B) whichever rules are more restrictive.
C) the rules of the AICPA.
D) the rules of the state's board of accountancy.

51) Which of the following is a true statement regarding the enforcement mechanism for CPA
conduct?
A) The PCAOB has the authority to investigate and discipline registered public accounting firms.
B) All disciplinary action by the AICPA must go through the Joint Trial Board.
C) Disciplinary actions taken by the AICPA are not disclosed to the public.
D) Only a few states have adopted the AICPA rules of conduct.

52) The Sarbanes-Oxley Act requires which employees of an accounting firm to rotate off the
engagement every five years?
A)
In-Charge Auditor Lead audit partner
Yes Yes

B)
In-Charge Auditor Lead audit partner
No No

C)
In-Charge Auditor Lead audit partner
Yes No

D)
In-Charge Auditor Lead audit partner
No Yes

53) Which of the following statements is true with respect to audit committees?
A) Audit committee members should consist of members of the company's management.
B) All members of the audit committee must be financial experts.
C) The audit committee of a public company is responsible for hiring the auditor.
D) Audit committees must have a minimum of ten members.

54) The provisions of the Sarbanes-Oxley Act are most likely to allow which of the following
non-audit services for audit clients?
A) appraisal or valuation services (e.g., pension, post-employment benefit liabilities)
B) financial information systems design and implementation
C) internal audit outsourcing
D) tax consulting

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55) Which of the following services are allowed by the SEC whenever a CPA also audits the
company?
A) internal audit outsourcing
B) legal services unrelated to the audit
C) appraisal or valuation services
D) services related to assessing the effectiveness of internal control over financial reporting

56) Which of the following services is not prohibited by the SEC whenever a CPA also audits
the company?
A) actuarial services
B) assisting the company in preparing certain SEC registration statements (e.g., 10-Q, 10-K)
C) investment banker services
D) bookkeeping services

57) The members of a client's "audit committee" should be

A) members of management.
B) directors who are not a part of company management.
C) non-directors and non-managers.
D) directors and managers.

58) The Sarbanes-Oxley Act requires a cooling off period of ________ before a member of an
audit team can work for a client in a key management position?
A) one year
B) eighteen months
C) three years
D) five years

59) Which of the following is an accurate statement?

A) Auditing standards detail the requirements that a CPA firm must follow when it is requested
to provide an opinion on the application of accounting principles for a client of another CPA
firm.
B) SEC rules prohibit ownership in audit clients by those persons who can influence the audit.
C) PCAOB rules require a CPA firm, before its selection as the company's auditor to document
all relationships between the firm and the company.
D) All of the above are accurate statements.

60) Companies are required to disclose in their proxy statement or annual filings with the SEC
the total amount of audit and non-audit fees paid to the audit firm for the two most recent years.
Which of the following is not one of the categories of fees that must be disclosed?
A) tax fees
B) consulting fees
C) audit-related fees
D) all other fees

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61) The CPA must not subordinate his or her professional judgment to that of others in any
A) engagement.
B) audit engagement.
C) engagement excluding tax services.
D) engagement where the opinion of a specialist is used.

62) Under the rules and interpretations of the AICPA Code,

A) a CPA can be a client advocate during an audit, but not while performing tax or management
services.
B) staff auditors should always defer to the judgment of their immediate supervisor.
C) a conflict of interest is a relationship that might interfere with objectivity or integrity.
D) even if a conflict of interest is disclosed to the member's client or employer, it is still
considered a violation of the rules of conduct.

63) Several months after an unqualified audit report was issued, the auditor discovers the
financial statements were materially misstated. The client's CEO agrees that there are
misstatements, but refuses to correct them. She claims that "confidentiality" prevents the CPA
from informing anyone. Which of the following statements is correct?
A) The CEO is correct and the auditor must maintain confidentiality.
B) The CEO is incorrect, but since the audit report has been issued, it is too late to correct the
report.
C) The CEO is correct, but to be ethically correct, the auditor should violate the confidentiality
rule and disclose the error.
D) The CEO is incorrect, and the auditor has an obligation to issue a revised audit report, even if
the CEO will not correct the financial statements.

64) A CPA firm may charge a contingent fee for

A) an audit.
B) consulting services for a client for which they do not perform any attestation services.
C) the preparation of an original tax return for a client for which they do not perform any
attestation services.
D) the preparation of an amended tax return.

65) The AICPA's Code of Professional Conduct states that a CPA should maintain integrity and
objectivity. The term "objectivity" in the Code refers to a CPA's ability to
A) choose independently between alternate accounting principles and auditing standards.
B) distinguish between accounting practices that are acceptable and those that are not.
C) be unyielding in all matters dealing with auditing procedures.
D) maintain an impartial attitude on matters that come under the CPA's review.

66) CPAs are prohibited from which of the following forms of advertising?
A) self-laudatory advertising
B) celebrity endorsement advertising
C) use of trade names, such as "Awesome Auditors"
D) use of phrases, such as "Guaranteed largest tax refunds in town!"

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67) A member in public practice shall neither receive from, nor pay to, a client a commission
when the member or member's firm also performs certain services for that client. Are
commissions allowed if the CPA performs
A)
A compilation that will be An audit of prospective
used by a third party financial information
Yes Yes

B)
A compilation that will be An audit of prospective
used by a third party financial information
No No

C)
A compilation that will be An audit of prospective
used by a third party financial information
Yes No

D)
A compilation that will be An audit of prospective
used by a third party financial information
No Yes

68) Which of the following is required for a firm to designate itself "Member of the American
Institute of Certified Public Accountants" on its letterhead?
A) At least one of the owners must be a member of the AICPA.
B) All CPA owners must be members of the AICPA.
C) The CPA owners whose names appear in the firm name must be members of the AICPA.
D) A majority of the owners must be members of the AICPA.

69) Which of the following would be considered a violation of the AICPA Code of Conduct?
A) The CPA makes the audit files available to the client's bank without the permission of the
client.
B) The CPA firm charges a contingent fee for nonattestation services to a client for whom he
does not perform any attestation services.
C) The CPA firm takes a prospective client to lunch to discuss auditing services.
D) A CPA firm uses the name San Diego Tax Specialists.

70) The AICPA's Code of Professional Conduct requires CPAs to maintain the confidentiality of
client information. This rule would be violated if a CPA disclosed information without a client's
consent as a result of a
A) subpoena or summons.
B) peer review.
C) complaint filed with the trial board of the Institute.
D) request by a client's largest stockholder.

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71) Which one of the following statements is false?
A) Confidentiality is broken when an auditor is presented with a subpoena concerning an audit
client.
B) Information that a CPA obtains from a client is generally not privileged.
C) When a CPA firm conducts an AICPA-authorized peer review of the quality controls of
another CPA firm, permission of the client is not needed to examine audit documentation.
D) A CPA firm which observes substandard audit documentation of another firm during a peer
review can initiate a complaint to the AICPA.

72) A CPA firm

A) can sell securities to a client for whom they perform an attestation service.
B) can receive a commission for a client that they are engaged to perform an attestation service
for.
C) cannot receive a referral fee for recommending the services of another CPA.
D) can receive a commission from a nonattestation client as long as the situation is disclosed.

73) Which of the following represents all of the ways a CPA firm can be organized?
A) proprietorships and partnerships
B) proprietorships, partnerships, and professional corporations
C) proprietorships, general partnerships, general corporations, professional corporations, limited
liability companies, and limited liability partnerships if permitted by state law
D) single proprietorships, partnerships, professional corporations if permitted by state law, or
regular corporations

74) In which of the following circumstances would a CPA be ethically bound to refrain from
disclosing any confidential client information?
A) The CPA is issued a summons enforceable by a court order which orders the CPA to present
confidential information.
B) A major stockholder of a client company seeks accounting information from the CPA after
management declined to disclose the requested information.
C) The confidential client information is made available as part of a quality review of the CPA's
practice by a peer review team authorized by the AICPA.
D) An inquiry by a disciplinary body of a state CPA society requests confidential client
information.

75) Which of the following fee arrangements is not a violation of the AICPA's Code of
Professional Conduct?
A) basing fees as an expert witness on the amount awarded to the plaintiff, even though the CPA
performs a compilation for client use
B) basing consulting fees on a percentage of a bond issue, even though the CPA performs a
review of the client's financial statements
C) basing fees for a tax service on the amount of the refund that the client will receive
D) basing consulting fees on a percentage of a bond issue, even though the CPA performs an
audit of the client's financial statements

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76) Which of the following is not defined as an act discreditable in either the Rules or the
Interpretations of the AICPA's Code of Professional Conduct?
A) The CPA firm's partner in charge failed to file his tax return for the past year.
B) The CPA firm discriminates in its hiring practices based on the age of the applicant.
C) The CPA retains the client's books and records to enforce past-due payment of the CPA's bill,
even after the client has demanded they be returned.
D) The CPA firm's partner-in-charge was a passenger in a car driven by his wife. On the way
home from the firm's Christmas party, she was charged with "driving while intoxicated."

77) Freedom from ________ means the absence of relationships that might interfere with
objectivity or integrity.
A) independence
B) acts discreditable
C) impartiality
D) conflicts of interest

78) Membership in the AICPA can be terminated without a hearing for

A) a crime punishable by imprisonment for more than one year.
B) the filing of a fraudulent income tax return on a client's behalf.
C) the willful failure of a CPA to file their own personal tax return.
D) all of the above.

79) Which of the following activities is allowed for a CPA firm's attestation clients?
A) contingent fees fixed by a court
B) commissions for referring a review client to an insurance agency for insurance coverage
C) preparation of tax returns for which fees are based upon client refunds
D) each of the above is allowed

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Essay Questions

1) Describe an ethical dilemma that an auditor or an accountant might face in his or her business
career, then illustrate how the auditor or accountant might use the six-step approach presented in
the text to resolve that dilemma. Be specific.
Answer: An ethical dilemma is a situation a person faces in which a decision must be made
about an appropriate behavior. Although students' answers will vary depending on the dilemma,
their answer should list the following six steps, along with a discussion of how each step relates
to their particular dilemma:
1. Obtain the relevant facts. Students should list the key facts from their dilemma.
2. Identify the ethical issues from the facts. Students should identify the key ethical issue(s) in
their dilemma.
3. Determine who is affected by the outcome of the dilemma and how each person or group is
affected. Students should identify who is involved and how each person is affected by the
dilemma.
4. Identify the alternatives available to the person who must resolve the dilemma. Students
should list the alternatives available to the auditor or accountant.
5. Identify the likely consequence of each alternative. Students should identify both the short-
term and long-term effects of each alternative.
6. Decide the appropriate action.

2) Explain why there is a special need for ethical conduct in the auditing profession.
Answer: The reason for an expectation of a high level of professional conduct by any profession
is the need for public confidence in the quality of service by the profession, regardless of the
individual providing it. It is not practical for most customers to evaluate the quality of the
performance of professional services because of their complexity. Therefore, since the users
(e.g., the general public) of services provided by an auditor generally cannot evaluate the quality
of the auditor's performance, it is critical to the auditing profession that the public have a high
degree of confidence in the quality of the services provided by the auditor. Public confidence in
the quality of professional services is enhanced when the profession encourages high standards
of performance and ethical conduct by all its members. If users of auditing services were to lack
confidence in the quality of those services, then the value of CPA firms' audits would be
diminished, as would the demand for audits. It is essential that the users regard CPA firms as
competent and unbiased.

3) Threats to compliance with the AICPA's Code of Professional Conduct fall into seven broad
categories. List and explain three of these categories.
Answer: Threats to compliance include:
• Adverse interest. The threat that a member will not act with objectivity because the member's
interests are opposed to the client's interests.
• Advocacy. The threat that a member will promote a client's interest or position to the point
that their objectivity or independence is compromised.
• Familiarity. The threat that, due to a long or close relationship with a client, a member will
become too sympathetic to the client's interest or too accepting of the client's work or product.
• Management participation. The threat that a member will take on the role of client
management or otherwise assume management responsibilities.
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• Self-interest. The threat that a member could benefit, financially or otherwise, from an
interest in, or relationship with, a client or persons associated with the client.
• Self-review. The threat that a member will not appropriately evaluate the results of a previous
judgment or service performed or supervised by the member or an individual in the member's
firm and that the member will rely on that service in forming a judgment as part of another
service.
• Undue influence. The threat that a member will subordinate their judgment to an individual
associated with a client or any relevant third party due to that individual's reputation or expertise,
aggressive or dominant personality, or attempts to coerce or exercise excessive influence over
the member.

NOTE: The student only had to list and explain three of the above threats.

4) The AICPA Code of Conduct includes a conceptual framework approach for the member to
evaluate threats to compliance with the Code. List the three steps necessary to evaluate the
threats.
Answer: The three steps to evaluate the threats to compliance with the Code are:
1. Identify the threats.
2. Evaluate the significance of the threat.
3. Identify and apply safeguards.

5) What are the six Ethical Principles stated in the Code of Professional Conduct? Briefly
discuss each principle. Are these principles enforceable?
Answer: The six Ethical Principles of the Code of Professional Conduct are:
1. Responsibilities. Members should exercise sensitive professional and moral judgments.
2. The Public Interest. Members should demonstrate commitment to professionalism by serving
the public interest and honoring the public trust.
3. Integrity. Members should perform all professional responsibilities with the highest sense of
integrity.
4. Objectivity and Independence. Members should maintain objectivity and remain free of
conflicts of interest. A member in public practice should be independent in both fact and
appearance when providing auditing and other attestation services.
5. Due Care. Members should observe the profession's technical and ethical standards, strive
continually to improve competence and quality of services, and discharge professional
responsibilities to the best of their ability.
6. 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.

The Ethical Principles are not enforceable.

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6) Each of the following situations involves a possible violation of the rule on independence. For
each situation, (1) decide whether the Code of Professional Conduct has been violated, and (2)
briefly explain how the situation violates (or does not violate) the Code of Professional Conduct.

a. Harry Brown is a partner in the Topeka office of Hedley & Co., CPAs. Harry's brother is
employed in an audit-sensitive position by Jensen Appliances, a publicly held company in
Kansas. Jensen Appliances is one of Hedley & Co.'s audit clients. Neither Harry nor personnel
from the Topeka office is involved in the audit of Jensen.

Violation? Yes No
Explanation:

b. John Woods is an audit manager with Calden & Co., CPAs, a one-office CPA firm. John owns
100 shares of common stock in one of the firm's audit clients, but he does not provide any audit
or non-audit services to the company.

Violation? Yes No
Explanation:

c. The accounting firm of Fine & Herman, CPAs, provides bookkeeping and tax services for
Henderson Corporation, a privately held company. Fine & Herman also performs the annual
audit of Henderson Corporation.

Violation? Yes No
Explanation:

d. Bob Shelton, CPA, is the auditor of Cafe Ecko. A couple of weeks ago, Cafe Ecko's
management commenced litigation against Bob, alleging he was negligent in last year's audit.

Violation? Yes No
Explanation:

e. Hamilton Appliance has not paid Karen Linwood, CPA, her audit fee for the past two years.
Karen is starting work on the current year's audit of Hamilton.

Violation? Yes No
Explanation:
Answer:
a. No violation. Although partners in a CPA firm are not allowed to have close relatives
employed in a position of significant influence by a client, it is acceptable to have a close relative
employed in an audit sensitive position (with no significant influence), as long as the partner
does not participate in the engagement and is not in an office that participates on the
engagement.

b. No violation. John is not a covered member with respect to the audit client as he has no
responsibility for the engagement and is not in a position to influence the engagement.

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c. No violation. The AICPA does not prohibit CPA firms from providing bookkeeping, tax, and
audit services to the same nonpublic client.

d. Violation. When there is a lawsuit or intent to start a lawsuit between a CPA and an audit
client's management related to audit services, independence is impaired.

e. Violation. Independence is impaired if fees remain unpaid for services provided more than one
year prior to the date of the report.

7) Don Crosby, a partner in a national CPA firm, has just learned that his self-sufficient daughter
has accepted a position as the CFO of Sunglasses, Inc., a current client within the office with
which he is employed. Explain the independence ramifications on 1) Don's independence, 2) his
office, and 3) the firm's independence.
Answer:
1. Don's non-dependent daughter is considered a close relative. Because she has a key position
for the client, Don's independence is impaired.
2. Because Don is considered a covered member any office in which he is employed cannot be
independent.
3. The firm will not be considered independent. However, the firm can maintain its independence
if they either move:
a. Don to an office that does not participate on the engagement or
b. the audit engagement to an office in which Don is not employed.

8) Discuss the Confidential Client Information Rule, including the four exceptions to the rule.
Answer: The Confidential Client Information Rule prohibits a member from disclosing any
confidential client information without the specific consent from the client. However, there are
four conditions when client permission is not required:
• Obligations related to technical standards; the rule makes it clear that the auditor's
responsibility to discharge professional standards is greater than that for confidentiality.
• In response to a valid subpoena or summons and compliance with laws and regulations.
• A peer review authorized by the AICPA, state CPA Society, or State Board of Accountancy.
• The CPA is initiating or responding to an inquiry from a recognized investigative body or the
professional ethics division.

9) The following situations involve a possible violation of the AICPA's Code of Professional
Conduct. For each situation, (1) determine the applicable rule from the Code, (2) decide whether
or not the Code has been violated, and (3) briefly explain how the situation violates (or does not
violate) the Code.

a. In 2014, Freeman and Johnson, both CPAs, decided to form a CPA practice. In 2016, Freeman
and Johnson approached Bill Delaney, a physician and medical expert, and asked him to assist
them with their growing medical consulting practice. Delaney agreed, but only after he was
given an ownership interest in the firm. Delaney does not intend to quit his private medical
practice.

Rule: ________ Violation? Yes No

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Explanation:

b. Brian DePalie has a successful dentistry practice in Charleston. Brian has recommended one
of his patients to Katie Walton, CPA. To show gratitude for the referral, Katie has agreed to pay
Brian a token gift of $50. Katie discloses the payment arrangement to her new clients.

Rule: ________ Violation? Yes No

Explanation:

c. The accounting firm of Bayer & Peng, CPAs, is negotiating a fee with a new audit client. They
agree the client will pay $50,000 if Bayer & Peng issues a clean, unmodified opinion, $40,000 if
a qualified opinion is issued, and only $20,000 if an adverse opinion is issued.

Rule: ________ Violation? Yes No

Explanation:

d. Don Smith, CPA, is a member of the engagement team that performs the audit of Shaw
Corporation. Don's five-year-old daughter, Precious, received ten shares of Shaw Corporation's
common stock for her fifth birthday. The stock was a gift from Precious's grandmother.

Rule: ________ Violation? Yes No

Explanation:

e. Jennifer Harris, CPA, is a partner in the CPA firm that audits Alltech, Inc., a closely held
corporation. Jennifer's sister-in-law is the chief financial officer at Alltech, Inc.

Rule: ________ Violation? Yes No

Explanation:
Answer:
a. Violation of the rule on Form of Organization and Name. Non-CPA ownership of firms is
allowable; however, non-CPA owners must actively provide services to the firm's clients as their
principal occupation.

b. No violation of the Commissions and Referral Fees rule. A CPA may pay a referral fee to a
non CPA as long as the payment is disclosed to the client.

c. Violation of the Contingent Fees rule. Charging a contingent fee for attestation services is
prohibited.

d. Violation of the Independence rule. Don is a covered member for purposes of the
independence rule. Because his daughter is a dependent, her ownership interest in Shaw is
treated as a direct financial interest of her father.

e. No violation of the Independence rule. According to the Code a close relative is defined as a
parent, sibling, or nondependent child. Thus, a sister-in-law is not considered to be a close
relative.

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10) The following situations involve a possible violation of the AICPA's Code of Professional
Conduct. For each situation, (1) determine the applicable rule from the Code, (2) decide whether
or not the Code has been violated, and (3) briefly explain how the situation violates (or does not
violate) the Code.

a. Howard Cunningham & Co., CPAs, designates its firm as "Members of the American Institute
of Certified Public Accountants." All of the partners of the firm are CPAs. However, one of the
partners has recently chosen to allow her membership to lapse because of personal reasons.

Rule: ________ Violation? Yes No

Explanation:

b. Brad Long, CPA, was traveling from Orlando to Miami, Florida when he was pulled over by a
police officer on suspicion of driving under the influence. He was convicted in court of driving
while under the influence of alcohol. Because of past convictions, Brad was sentenced to 5 years
in prison.

Rule: ________ Violation? Yes No

Explanation:

c. Kelley Brent, CPA, is a partner in a one-office CPA firm that audits Dane, Inc., a closely held
corporation. Kelley's sister was recently appointed as the chief financial officer for Dane, Inc.

Rule: ________ Violation? Yes No

Explanation:

d. Sarah Martin, CPA, is a senior auditor in the San Francisco office of Cooper & Howell, CPAs.
Sarah's father is employed as the controller of Line Electronics, a public company in Detroit,
Michigan. Line Electronics is one of the firm's audit clients. Neither Sarah nor the San Francisco
office is involved in the audit of Line Electronics.

Rule: ________ Violation? Yes No

Explanation:

e. On August 20, 20x7, Min Lee, CPA and partner, was offered and accepted the engagement to
audit the annual financial statements of Jernigan Corporation for the year ended December 31,
20x7. Preliminary work began on the audit on September 15, 20x7 and the engagement ended on
March 7, 20x8. Jernigan is regulated by the SEC. Min served as controller of Jernigan
Corporation from December 1, 20x2, until April 10, 20x7, at which time she terminated her
employment with Jernigan.

Rule: ________ Violation? Yes No

Explanation:
Answer:
a. Violation of the Form of Organization and Name rule (Rule 505). A firm may not designate
itself as "Members of the American Institute of Certified Public Accountants" unless all of its
owners are members of the Institute.
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b. Violation of the Acts Discreditable rule (Rule 501). Felonies are considered acts discreditable.

c. Violation of the Independence rule (Rule 101). According to the Code, Kelly's sister is a "close
relative" and she occupies a key position at an audit client. Because Kelly is a partner in the
office that provides the audit services to Dane, the firm is not independent.

d. No violation of the Independence rule (Rule 101). While Sarah's father occupies a key position
with an audit client of the firm, there is no independence violation as long as Sarah is not a
member of the engagement team. The firm may provide the audit services.

e. Violation of the Independence rule (Rule 101). Since Min had an employment relationship
with the client during part of the period covered by the financial statements, her independence is
impaired.

11) The scenarios below all involve a possible violation of the AICPA's Code of Professional
Conduct.
1. Using the list below, indicate which of the Code of Conduct Rules applies to the scenario.
a. Independence
b. Integrity and Objectivity
c. Contingent Fees
d. Acts Discreditable
e. Commissions and Referral Fees
f. Form of Organization and Name
2. State if the scenario is a violation of the Code.

Scenario:
1. Margaret Henry is a partner in the Tupelo office of Jenkins & Thorn, CPAs. Margaret's
father is the controller at Markrich Sporting Supplies, Inc., a publicly held company in Tupelo.
Markrich is one of Jenkins & Thorn's audit clients. Margaret is not involved in the audit of
Markrich.

2. Jason Alexander is an audit manager with Reese & Co., CPAs. Jason owns 100 share of
common stock in one of the firm's audit clients, but he does not provide any audit or non-audit
services to the company.

3. The accounting firm of Fine & Herman, CPAs, provides bookkeeping and tax services for
Henderson Corporation, a privately held company. Mr. Herman also performs the annual audit of
Henderson Corporation.

4. Elaine Cooper, CPA, is the auditor of Paula's Pizza. Toward the end of the audit, Paula gave
Elaine her estimate of receivable collectability and Elaine accepted it without any testing.

5. Charley Ray, CPA, is a member of the engagement team that performs the audit of Desiree
Corporation. Charley's five-year-old daughter, Becky, received ten shares of Desiree common
stock for her fifth birthday in a trust fund established by Becky's grandmother.

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6. Freeman and Johnson formed a successful CPA practice ten years ago. In the current year,
they approached Adam Sawtooth, a surgeon and medical expert, and asked him to assist them
with their growing medical consulting practice. Sawtooth agreed, but only after he was given an
ownership interest in the firm. Sawtooth does intend to reduce his private practice hours and
spend 40% of his working hours devoted to the Freeman & Johnson practice.

7. Sally Preen has a successful computer network consulting business. Sally has recommended
one of her clients to Sam Walton, CPA. To show gratitude for the referral, Sam has agreed to pay
Sally a token gift of $50. Sam has not disclosed the payment arrangement to his ne clients.

8. The accounting firm of Smith & Black, CPAs, is negotiating a fee with a new audit client
where the client will pay $50,000 if the client obtains the line of credit needed for working
capital purposes. Otherwise, the fee will be $40,000.

9. Brad Barns, CPA, was traveling from Las Vegas to the Grand Canyon when he was pulled
over by a police officer for suspicion of driving under the influence. He was convicted in court of
driving under the influence of alcohol and received six months' probation.

10. Manuel Lopez, CPA, is a senior in a small, local, CPA firm that audits Childress, Inc., a
closely held corporation. Manuel's sister was recently appointed as the controller for Childress,
Inc.
Answer:
Part 1: 1. a 6. f
2. a 7. e
3. a 8. c
4. b 9. d
5. a 10. a

Part 2: 1. Yes 6. Yes

2. No 7. Yes
3. No 8. Yes
4. Yes 9. No
5. Yes 10. Yes

12) Describe the methods used by the AICPA and State Boards of Accountancy to enforce the
rules of conduct.
Answer: The AICPA uses two levels of disciplinary action. For less serious, and probably
unintentional, violations of Rules of Conduct, the division limits the discipline to a requirement
of remedial or corrective action. For more serious violations, the level of disciplinary action goes
before the Joint Trial Board. The violator may be suspended or expelled from membership in the
AICPA.
Violation of a State Boards' rules of conduct is punishable by loss of the violator's CPA
certificate and license to practice.

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