Ethics (2014)

EthicsEthics
presented by
Heidi Tribunella, MS, CPA, Clinical Associate Professor of
Accounting, Simon Graduate School of Business, University
of Rochester
Thomas Tribunella, MBA, PhD, CPA, Professor of
Accounting, School of Business, SUNY Oswego
August 12, 2014
Insero & Company’s 2014 Accounting & Finance Education Series

Objectives Covered
1. Introduction to ethical thought: Distinguishing between
ethical and unethical behavior in personal and
professional contexts.
2. Review some of western history’s greatest
philosophers.
3. Discuss various ethical theories.
4. Review information ethics and explain the necessity of
ethical conduct for the accounting profession.
5. Resolve ethical dilemmas using the Frame, Analyze
and Communicate (FACt) approach and consider
decision making steps for ethical choices.
6. Examine the nature of fraud and white collar crime.
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Objectives Covered
7. Discuss who commits fraud and the reasons why.
8. Review computer fraud and abuse techniques.
9. Provide an overview of the AICPA Ethics
Codification Project.
10. Show the organization of topics in the Code of
Professional Conduct.
11. Review the conceptual framework for members in
public practice.
12. Review the conceptual framework for
independence.

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Objectives Covered (Cont.)
13. Review the conceptual framework for
members in business.
14. Review rules and interpretations applicable to
15. Apply the AICPA code to different fraud cases.
16. Detail how the AICPA rules of conduct are
enforced.
17. Review the NYSSCPA Code of Conduct.

Objective 1
Introduction to ethical thought: Distinguishing
between ethical and unethical behavior in
personal and professional contexts.
5

Ethics
 Ethics are the principles and standards that
guide our behavior toward other people.
 Ethics are rooted in history, culture, and
religion.
 May differ from person to person, country to
country, or culture to culture.
 The study of ethics is the story of personal
ethical choices (descriptive).
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Ethics
 It is also the study of how professionals should act
(normative and prescriptive) according to social and
professional responsibility.
 But there is a big difference between how professionals
should act and how they do act.
 Many individuals seek to maximize their personal utility
by making choices that benefit themselves.
 These personal choices may be different than choices
based on virtue and ethics.
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Need for Ethics
 In order for a society to operate in a rational
manner, ethical behavior needs to be
practiced by its members.
 Individuals cannot interact with each other if
they cannot trust each other.
 Certain ethical behaviors are written into the
laws of the society.
 In American we are “a nation of laws, not of
men,” according to John Adams.

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Examples of Ethical Principles
 Honesty
 Respect for others
 Fairness
 Trustworthiness
 Responsibility
 Caring for others
 Giving of one’s talents

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Why People Act Unethically
 The person’s ethical standards differ from the
normal average person within the society.
 The person chooses to act in an unethical
manner.
 Both a and b.

Ethics
 The conflict between ethics and personal gain has motivated the
writings of many of history’s greatest thinkers.
 Ethics has been addressed by some of history’s most well known
philosophers.
 Socrates, Plato, Aristotle as well as the founding fathers of the
US all discussed ethics.
 Every major religion and culture has established ethical beliefs.
 We cannot review all ethics philosophy in this short presentation.
 But we can cover some western thought and the ethical theories
that lead to current day professional ethics.
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Objective 2
Review some of western history’s greatest
philosophers.
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Socrates 469 BC – 399 BC
 This classical Greek philosopher is credited as a founder of
Western philosophy.
 Through his portrayal in Plato's dialogues, Socrates has
become renowned for his contribution to the field of ethics
and the Socratic method.
 The method remains a commonly used tool in which a
series of questions are asked not only to draw individual
answers, but also to encourage fundamental insight into
the issue at hand.
 The influence of his ideas and the Socratic approach
remains strong in providing a foundation for much of the
western philosophy.
13

Socrates
 Socrates believed the best way for people to
live was to focus on self-development rather
than the pursuit of material wealth.
 He encouraged others to concentrate on
friendships and a sense of community, he
believed this was the best way for people to
grow together as a civil society.
 His actions lived up to his words: for
example, Socrates’ service to Athens and his
reputation for valor on the battlefield was well
known.
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Socrates
 The idea that humans possessed certain virtues formed a
theme in Socrates' teachings.
 Philosophical and intellectual virtues represented the most
important qualities for a person to have.
 Socrates stressed that virtue was the most valuable of all
possessions; the ideal life was spent in search of the Good.
 He believed that truth and virtue exists and humans are
capable of knowing it through questioning their beliefs and
observing the world.
 However, it is one of the jobs of the philosopher to show
his students how little they really know by questioning their
positions.
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Socratic Method Applied to Professional
Ethics
Socrates once said, “I know you won't believe me, but the
highest form of Human Excellence is to question oneself and
others.”
Beliefs: Am I acting consistently with my beliefs? If not, why
is this situation an exception to my beliefs? Have I
contradicted myself?
Laws: Am I in compliance with professional and legal
standards? Have I reviewed my decision with a well-
informed and unbiased third party?
Fairness: Would I want to be treated the same way as I
treat others? Am I being fair, just, unprejudiced and even-
handed?
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Socratic Method Applied to Professional
Ethics
 Logic: Did I make the decision while I was feeling
emotional? Is my decision logical? Can the decision be
explained to others and understood by others?
 Honesty: Am I being open, honest and truthful? Have I
explicitly stated all relevant facts? Will the decision stand
up to daylight and public scrutiny?
 Community: Will I be proud of this decision in the future?
Would my family, friends and peers respect my decision?
Does this decision serve the best long-run interests of my
customers, investors and professional community?
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Auditing and the Socratic Method
 Auditing is the act of questioning the fairness
of financial statements.
 Internal and external auditors examine and
question account balances (substantive
testing of variables).
 They also question compliance with internal
controls to judge their impartiality (attributes
testing).
 This method helps to protect the property
rights of investors and creditors.
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Hippocrates: 460 BC – 370 BC
 He was an ancient Greek physician of Classical Athens
and is considered one of the most prominent figures in the
history of medicine.
 He was the founder of the Hippocratic School of Medicine.
 The school revolutionized medicine in ancient Greece by
establishing it as a discipline distinct from other fields such
as theology, thus instituting medicine as a separate
profession.
 He also greatly advanced the systematic study of clinical
medicine, summarized the medical knowledge of previous
generations, and prescribed practices for physicians
through the Hippocratic Corpus and other works.
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Hippocratic Theory
 Hippocrates is credited with being the first person to believe that
diseases were caused naturally, not because of superstition
and gods.
 He argued that disease was not a punishment inflicted by the
gods but rather the product of environmental factors, diet, and
living habits.
 Accordingly, there is not a single mention of a mystical illness in
the Hippocratic Corpus.
 The Hippocratic school achieved great success by applying
general diagnoses and passive treatments.
 With a focus on patient care, it advanced the treatment of
diseases and allowed for significant developments in clinical
practice.
20

Professionalism and the Hippocratic Oath
 The Oath required a new physician to swear
that he will uphold a number of professional
ethical standards.
 It is believed to have been written by
Hippocrates who is regarded as the father of
western medicine.
 Still today 2,400 years later, the oath is
considered a rite of passage for practitioners
of medicine in many countries.
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 Hippocrates combined the philosophy of science
with medicine.
 The medical profession and its philosophy of
science, logic and rational thought lead the way
for the professionalization of many other fields.
 Today the vast majority of professions not only
require training but the practitioners must adhere
to a code of professional ethics.
 This tradition has its roots in ancient Greek
philosophy.
The Start of Professions
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Hippocrates and the 4 Es
 Education
 Experience
 Examination
 Ethics
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Plato: 423 BC – 348 BC
 He was a classical Greek philosopher, a student
of Socrates, and founder of the Academy in
Athens, the first institution of higher learning in
the Western world.
 Along with his mentor, Socrates, and his
student, Aristotle, Plato helped to lay the
foundations of Western philosophy and science.
 Plato's Socratic dialogues have been used to
teach a range of subjects, including philosophy,
logic, ethics, rhetoric, and mathematics.
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Aristotle: 384 BC – 322 BC
 The student of Plato and tutor to Alexander the
Great.
 Authored many scrolls on virtue and the soul as
well as helped to develop the concept of ethics.
 Aristotle argued that the correct approach to
studying ethics is to start with what people of
good up-bringing and experience would agree to
be true about ethics.
 To start with worldly observations and work up to
a higher theoretical understanding.
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Aristotelian Ethics
 Ethics and virtue can be known through
observation and rational thought (natural
laws).
 Individuals should be free to choose to do the
right thing on a regular basis as they live life
(natural rights).
 Righteous actions can be taught by leaders,
philosophers and teachers (training).
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Aristotelian Virtues
 A person of "great soul" is someone who
would be truly generous and altruistic and
therefore deserving of high praise.
 A virtuous person is a just and fair leader in a
good community (a republic).
 A virtuous person exercises good practical
judgment and is a good representative (or
manager).
 A virtuous person is a trustable, reliable and
a truly good friend.
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Marcus Cicero: 106 BC – 43 BC
 Cicero was a Roman philosopher, lawyer,
and constitutionalist.
 He is widely considered one of Rome's
greatest orators.
 He introduced the Romans to Greek
philosophy and distinguished himself as a
linguist and philosopher.
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Cicero
 Medieval philosophers were influenced by
Cicero's writings on natural laws and rights.
 The rediscovery of Cicero's writings created
interest in ancient Greek writings and
motivated the search for Classical Antiquity
that led the west out of the dark ages to the
Renaissance in the 14th
century.
 Following the invention of the printing press,
Cicero's letters was the second book to be
printed after the Gutenberg Bible.
29

Cicero
 Cicero’s republican philosophy inspired the
Founding Fathers of the United States.
 John Adams said of him "As all the ages of the
world have not produced a greater statesman
and philosopher united than Cicero, his authority
should have great weight."
 Thomas Jefferson named Cicero as one of a
handful of major figures who contributed to a
tradition “of public rights” that guided his draft of
the Declaration of Independence and shaped
the American understanding of “the common
sense” basis for natural rights.
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Thomas Aquinas: 1225 – 1274
 He was an Italian Dominican priest of the
Roman Catholic Church, and an immensely
influential philosopher and theologian.
 He was the foremost classical proponent of
natural theology.
 His influence on Western thought is
considerable, particularly in the areas of ethics,
natural law, metaphysics, and political theory.
 Much of modern philosophy was conceived as a
reaction against or as an agreement with, his
ideas.
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Luca Pacioli: 1445 – 1517
 Was an Italian mathematician, Franciscan friar,
and collaborator with Leonardo da Vinci.
 A seminal and significant contributor to the fields
of accounting and math.
 His writings including the first published
description of bookkeeping that Venetian
merchants used during the Italian Renaissance
known as the double-entry accounting system.
 The system he published included most of the
accounting cycle as we still practice it today, 500
years later.
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Luca Pacioli
 Also, his treatise touches on a wide range of
related topics from accounting ethics to cost
accounting.
 His ethics were very applied:
 stay organized,
 keep your books in balance,
 work hard,
 develop good math skills,
 get up early,
 do not be wasteful,
 and keep track of costs.
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Luca Pacioli
 He described the use of journals and ledgers
as well as the rules that state debits equaled
credits and that assets equal liabilities plus
equity.
 The balance sheet was developed as a
mathematical expression of property rights (a
natural right).
 Asset (business property) = Liabilities
(creditor property) + Equity (owner property)
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John Locke: 1632 - 1704
 His contributions to classical republicanism and liberal theory are
reflected in the United States Declaration of Independence.
 Locke's theory of mind is often cited in the work of later
philosophers such as Hume and Kant.
 He believed the mind was a blank slate and posited we are born
without innate ideas and knowledge is determined only by
experience derived from sense and perception.
 Locke uses the term property in both broad and narrow senses.
 In a broad sense, it covers a wide range of human interests and
aspirations.
 More narrowly property refers to material goods.
 He argues that property is a natural right and it is derived from
labor.
35

Locke
 Locke argues that the individual ownership of goods and property
is justified by the labor exerted to produce that property.
 He also believed that the production of goods is beneficial to
human society.
 Locke stated his belief that nature on its own provides little of
value to society; he postulated that labor expended in the
creation of goods gives them their value.
 Accordingly, Locke believed that ownership of property is created
by the application of labor.
 In addition, he believed property precedes government and
government cannot "dispose of the estates of the subjects
arbitrarily."
 Karl Marx later critiqued Locke's theory of property in his own
social theory.
36

Immanuel Kant: 1724 – 1804
 Kant's method involves trying to convert our
everyday, obvious, rational knowledge of
morality into philosophical knowledge.
 Using practical (deductive) reasoning to reach
conclusions which are able to be applied to the
real world of experience and choice.
 Deductive reasoning involves using given true
premises to reach a conclusion that is also true.
 But not deriving any principles from personal
experience.
37

Kant
 He thought that action should have pure intentions
behind it.
 Kant believed that an action should be done with the
motive of duty and have moral value.
 He did not necessarily believe that the final result
was the most important aspect of an action.
 How the person felt while carrying out the action
was the value that applied to the result.
 Kant also posited the counter-utilitarian idea that
considerations of individual rights temper
calculations of aggregate utility (a concept that is a
principle in economics).
38

Adam Smith: 1723 to 1790
 Smith was a Professor of Moral Philosophy at
the University of Glasgow in Scotland author
of “The Theory of Moral Sediments”.
 A significant figure in the Scottish
Enlightenment he worked with David Hume.
 Known as the father of economics and
capitalism since “An Inquiry into the Nature
and Causes of the Wealth of the Nations”
established the field of modern economics.
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Smith
 The “Theory of Moral Sentiments” culminated in
man as self-interested and self-commanded
individual.
 In “Moral Sentiments” Smith first referred to the
"invisible hand" to describe the benefits to
society of people pursuing their own interests.
 Individual freedom, according to Smith, was
rooted in self-reliance, the ability of an individual
to pursue his self-interest while commanding
himself based on the principles of natural laws
and rights.
40

Smith
 Smith writes: “... In spite of their natural
selfishness and rapacity, though they mean only
their own conveniency, though the sole end
which they propose ... be the gratification of their
own vain and insatiable desires, they divide with
the poor the produce of all their improvements.
They are led by an invisible hand to make nearly
the same distribution of the necessaries of life,
which would have been made, had the earth
been divided into equal portions among all its
inhabitants, and thus without intending it, without
knowing it, advance the interest of the society.”
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Smith
 In other words, when the business owner
pursues wealth they create jobs, serve
customers and enrich investors as an untended
consequence of their self enlightened actions.
 By serving themselves, they serve the greater
good of society.
 Their intentions are irrelevant (the opposite of
Immanuel Kant).
 The interests of the rich are aligned with the
needs of the poor.
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David Hume: 1711 - 1776
 Hume strove to create a total naturalistic
"science of man" that examined the
psychological basis of human nature.
 In stark opposition to the rationalists who
preceded him (such as Immanuel Kant), he
concluded that desire rather than reason
governed human behavior.
 A prominent figure in the skeptical philosophical
tradition and a strong empiricist, he argued
against the existence of innate ideas, concluding
instead that humans have knowledge only of
things they directly experience.
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Hume
 He developed the position that mental behavior is
governed by customs and our use of induction (inferring
general principles or rules from specific observable facts).
 For example, our actions are justified only by our idea of
observable causes and effects.
 He concluded that humans have no actual conception of
the self, only of a bundle of experiences associated with
the self.
 He was also held that ethics are based on feelings rather
than abstract moral principles.
 In other words, you are a product of your experiences and
environment.
44

John Stuart Mill: 1806 – 1873
 Utilitarianism was described by John Stuart Mill as the
“greatest happiness principle".
 Is an ethical theory holding that the proper course of action
is the one that maximizes the overall "happiness".
 His “harm principle” holds that each individual has the right
to act as he wants, so long as these actions do not harm
others.
 It is a form of consequentialism, meaning that the moral
worth of an action is determined only by its resulting
outcome, and that one can only weigh the morality of an
action after knowing all its consequences.
45

Karl Marx: 1818 – 1883
 Marx's theories hold that all societies progress
through class struggle.
 This is a conflict between an ownership class
which controls production and a lower class
which produces the labor for goods.
 Heavily critical of capitalism, he believed
capitalism to be run by the wealthy classes
purely for their own benefit.
 He predicted that capitalism would inevitably
produce internal tensions which would lead to its
self-destruction and replacement by a new
system of socialism.
46

Marx He argued that under socialism, society would be governed
by the working class in what he called the workers'
democracy.
 He believed that socialism would eventually be replaced by
a stateless, classless society called communism.
 Marx arguing that both social theorists and underprivileged
people should carry out organized revolutionary action to
topple capitalism and bring about socio-economic change.
 He believed that it is ethical to confiscate private property
from capitalists and redistribute it to workers.
 He believed in physical rights such as a right to food and
education (positive rights and entitlements).
 Marx failed to adequately address the behavioral effect of
incentives on individual behavior.
47

Joseph Schumpeter: 1883 – 1950
 Supported the idea of Creative Destruction which is the
process of transformation that accompanies innovation.
 Entry by entrepreneurs creates new products and
business models which sustains long-term economic
growth, even though it may destroy the value of
established companies.
 Disruptive technologies do not collapse the system but
allow for human progress.
 Creative destruction is also known as social Darwinism
or economic Darwinism.
48

Schumpeter: Examples of Creative
Destruction
 Cassette tape replaced the 8-track.
 Compact disc replaced records, cassette and video
tapes.
 Compact disc is now being undercut by MP3 players and
downloadable media.
 Wal-Mart has achieved a strong market position, through
its use of supply chain efficiency, marketing, and
personnel-management techniques, to lower prices and
gain market share over older or smaller companies such
as Kmart and Sears.
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Objective 3
Discuss various ethical theories.
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Various approaches to Ethics
 Utilitarian Approach: produces the greatest good over
harm, a moral theory that says that what is morally right is
whatever produces the greatest overall good for the greatest
number. Utilitarianism is attributed to the work of J.S. Mill. It
is an approach that emphasizes the result or the outcome.
 Fairness or Justice Approach: all equals should be treated
equally.
 Common Good Approach: life in a community is a good
that should be supported by the actions of individuals.
 Legal Approach: the letter of the law must be obeyed.
 Natural Law: believers in natural law hold that there is a
natural order to the human world, that this natural order is
good, and that people should not violate that order.
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Ethics
 Natural Rights: are human rights that are universal and
inalienable. They do not come from governments but
from our creator and are rational, logical and self evident.
They cannot be taken away by law, democracy, or a king.
They are the basis for the Magna Carta, Declaration of
Independence, and the US Constitution.
 Libertarianism: refers to a political philosophy
maintaining that all persons are the absolute owners of
their own lives. Individuals should be free to do whatever
they wish with their persons or property as long as they
allow others the same liberty. Libertarians favor an ethic
of self-responsibility and strongly oppose the welfare
state. They believe forcing someone to provide aid to
others is ethically wrong and ultimately counter-
productive.
52

Ethics
 Pluralism: The belief that there are multiple perspectives
on an issue, each of which contains part of the truth but
none of which contain the whole truth. In ethics, moral
pluralism is the belief that different moral theories each
capture part of truth of the moral life, but none of those
theories has the entire answer.
 Relativism: In ethics, there are two main types of
relativism. Descriptive ethical relativism simply claims that
different people have different moral beliefs, but it takes no
stand on whether those beliefs are valid or not. Normative
ethical relativism claims that each culture’s (or group’s)
beliefs are right within that culture and that it is impossible
to validly judge another culture’s values from the outside.
53

Ethics
 Rights Approach: best protects the rights of those affected.
Rights are entitlements to do something without interference
from other people (negative rights) or entitlements that obligate
others to do something positive to assist you (positive rights).
Some rights (natural rights, human rights) belong to everyone
by nature or simply by virtue of being human. Legal rights
belong to people by virtue of their membership in a particular
political state. Moral rights are based in acceptance of a
particular moral theory.
 Personal Virtue: is based on the work of Aristotle, Plato, and
Socrates. It reinforces that we should act in ways that convey a
sense of honor and self-worth. Ethical actions should be
consistent with virtues such as honesty, courage, compassion,
generosity, tolerance, love, fidelity, integrity, fairness, self-
control, prudence, etc…
54

Ethics
 Economic Darwinism: in a competitive world, if
surviving organizations use a particular operating
procedure or technology over the long run, then these
procedures likely yield benefits in excess of costs.
Surviving firms continue to live by selling goods and
services at lower cost and/or higher quality. A firm
cannot survive by making more mistakes then it’s
competition. Firms must add value to their customers’
lives by selling them competitive products.
 Socialism: Economic Darwinism will collapse the
system. Therefore, resources should be distributed to
prevent the uprising of the workers and the collapse of
civil society. “From each according to his ability to
each according to his needs. (Marx)”
55

What Ethics Is Not in the US
 Feelings: Ethics should not be the same as feelings. An
individual’s feelings about what is right or wrong do not ensure
an ethical decision. While some individuals will feel bad when
they have done something wrong, others may not. Ethical
decisions are often difficult precisely because the “wrong”
decision feels more desirable (i.e. is easier).
 Religion: Ethics is not merely religion. Although most if not all
religions present a set of ethical standards. Many people are
not religious, but ethics applies to everyone. Most religions do
advocate high ethical standards but sometimes do not address
all the types of problems we face.
 Law: Ethics is not merely following the law, a good system of
law does incorporate many ethical standards, but law can
deviate from what is ethical.
56

What Ethics Is Not in the US
 Government: Governments can become ethically
corrupt such as totalitarian regimes. The government
can be a function of power and designed to serve the
interests of narrow special interest groups.
 Culture: Ethics is not merely following culturally
accepted norms. Some cultures are quite ethical, but
others become corrupt—or blind—to certain ethical
concerns (such as Nazi Germany). “When in Rome, do
as the Romans do” is not a satisfactory ethical standard.
On the other hand, it is advisable to be aware of and
sensitive to cultural norms when entering other
environments.
57

Objective 4
Review information ethics and explain the
necessity of ethical conduct for the accounting
profession.
58

Introduction
 Handling information responsibly means
understanding the following issues:
 Ethics
 Personal privacy
 Threats against information
 Protection of information
59

60
Special Need for Ethical Conduct in
Professions
 Professionals are held to a higher standard
that most others in a society.
 Professionals are expected to maintain the
public trust.
 Therefore, professionals need to conduct
themselves in a highly ethical manner to
maintain the trust of the public.

Accounting Ethics
 Accounting ethics is primarily a field of applied ethics, the
study of moral values and judgments as they apply to the
profession of accountancy.
 Accounting ethics were first introduced by Luca Pacioli,
and later expanded by governmental groups and
professional organizations.
 Due to the diverse range of accounting services and recent
corporate collapses, attention has been drawn to ethical
standards accepted within the accounting profession.
 To combat the criticism and prevent fraudulent accounting,
various accounting organizations and governments have
developed regulations and remedies for improved ethical
behavior among the accounting profession.
61

Accounting Ethics Protect Investors
 The nature of the work carried out by accountants
and auditors requires a high level of ethics.
 Shareholders, potential shareholders, and other
users of the financial statements rely heavily on the
yearly financial statements of a company as they
can use this information to make an informed
decision about investments.
 Knowledge of ethics can help accountants and
auditors to overcome ethical dilemmas, allowing for
the right choice that, although it may not benefit the
company, will benefit the public who relies on the
accountant/auditor's reports.
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63
Policies and Systems that Encourage
Accountants to Remain Professional
 CPA Examination
 GAAS and Interpretations
 Continuing Education Requirements
 Quality Control
 Peer Review
 Legal Liability
 PCAOB and SEC
 AICPA Practice and Quality Centers
 Code of Professional Conduct

Objective 5
Resolve ethical dilemmas using the Frame,
Analyze and Communicate (FACt) approach
and consider decision making steps for ethical
choices.
64

Factors that Determine How You Decide
Ethical Issues
 Actions in ethical dilemmas are determined
by:
 Your basic ethical structure
 The circumstances of the situation
 Your basic ethical structure determines what
you consider to be:
 Minor ethical violations
 Serious ethical violations
 Very serious ethical violations
65

Help for Ethical Dilemmas
 Talk to someone whose judgment you trust.
 Visit company’s ethical ombudsman.
 Ask many questions about what you are
being asked to do (frame the questions in
terms of company’s, employees, customers,
investors and society’s best interest).
 You may have to refuse to do something you
consider unethical.
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67
Step by Step Approach to Resolving Ethical
Dilemmas applied within the FACt Approach.
A. Frame
1. Identify the ethical issue.
2. Gather the relevant facts surrounding the issue.
3. Determine which parties are affected.
B. Analyze
4. Identify the solutions to the issue.
5. Identify the likely consequence of each potential solution.
6. Analyze and question the various solutions and consequences,
seek advice (Socratic Method).
A. Communicate
7. Decide and take the appropriate action on the solutions selected.
8. Reflect on the results to improve future ethical decision making.
Source: Brickley and Posavac, 2005.

Objective 6
Examine the nature of fraud and white collar
crime.
68

Introduction
 Information systems are becoming
increasingly more complex and society is
becoming increasingly more dependent on
these systems.
 Companies also face a growing risk of these
systems being compromised.
 Recent surveys indicate 67% of companies
suffered a security breach in the last year with
almost 60% reporting financial losses.
69

Fraud Definition
 Fraud is any and all means a person uses to
gain an unfair advantage over another person.
 In most cases, to be considered fraudulent, an
act must involve:
 A false statement (oral or in writing)
 About a material fact
 Knowledge that the statement was false when it was
uttered (which implies an intent to deceive)
 A victim relies on the statement
 And suffers injury or loss as a result
70

Fraud: Civil vs. Criminal
 The definition is the same whether it is a
criminal or civil fraud case.
 The only difference is the burden of proof
required.
 Criminal case: Beyond a reasonable doubt.
 Civil case: Preponderance of the evidence or
clear and convincing evidence.
71

The Fraud Process
 Since fraudsters don’t record their frauds, we
can only estimate the amount of losses:
 The Association of Certified Fraud Examiners (ACFE)
estimates that total fraud losses in the U.S. run around
5% of annual GDP or almost $1 trillion in 2014.
 More than we spend on education and roads in a year.
 6 times what we pay for the criminal justice system.
 Income tax fraud is estimated to be over $400 billion
per year.
 Fraud in the healthcare industry is estimated to
exceed $100 billion a year.
 Identity fraud cost the US economy over $25 billion a
year.
72

The Fraud Process
 Fraud against companies may be committed by
an employee or an external party.
 Former and current employees (called knowledgeable
insiders) are much more likely than non-employees to
perpetrate frauds against companies.
 Wells (2001) surveyed 12,000 employees, and 33%
reported that they stole company money or property.
 The majority of fraud is detected by way of tips
(43.3%) as opposed to management reviews (14.6%)
or audits (14.4%).
 Also fraud occurs a median of 18 months before
detection (ACFE, 2012).
73

The Fraud Process
 Fraud perpetrators are often referred to as
white-collar criminals.
 Distinguishes them from violent criminals,
although some white-collar crime can ultimately
have violent outcomes, such as:
 Perpetrators or their victims committing suicide.
 Healthcare patients killed because of alteration of
information, etc., that can result in their deaths.
74

Types of Frauds
OCCUPATIONAL
 Fraudulent Statements
 Financial
 Non-financial
 Asset Misappropriation
 Theft of Cash
 Fraudulent disbursements
 Inventory and other assets
 Bribery and Corruption
 Bribery
 Illegal gratuities
 Economic extortion
 Conflict of interest
OTHER
 Intellectual property theft
 Financial institution fraud
 Check and credit card fraud
 Insurance fraud
 Healthcare fraud
 Bankruptcy fraud
 Tax fraud
 Securities fraud
 Money laundering
 Consumer fraud
 Computer and Internet fraud
75

Misappropriation of Assets
 Three types of occupational fraud:
 Misappropriation of assets
• Involves theft, embezzlement, or misuse of company assets
for personal gain.
• Examples include billing schemes, check tampering,
skimming, and theft of inventory.
• In a recent Report to the Nation on Occupational Fraud and
Abuse, 92.7% of occupational frauds involved asset
misappropriation at a median cost of $93,000.
76

Corruption
 Corruption
• Corruption involves the wrongful use of a position to
procure a benefit that is contrary to the responsibilities of
that position.
• Examples include kickback schemes and conflict of
interest schemes.
• About 30.1% of occupational frauds include corruption
schemes at a median cost of $250,000.
77

Fraudulent Statements
 Corruption
 Fraudulent statements
• Financial statement fraud involves misstating the financial
condition of an entity by intentionally misstating amounts or
disclosures in order to deceive users.
• About 7.9% of occupational frauds involve fraudulent
statements at a median cost of $1 million. The median pales
in comparison to the maximum cost which can be billions.
78

 The National Commission on Fraudulent
Financial Reporting (the Treadway Commission)
defined fraudulent financial reporting as
intentional or reckless conduct, whether by act
or omission, that results in materially misleading
financial statements.
 Financial statements can be falsified to:
 Deceive investors and creditors
 Cause a company’s stock price to rise
 Meet cash flow needs
 Hide company losses and problems
79

 Fraudulent financial reporting is of great
concern to independent auditors, because
undetected frauds lead to half of the lawsuits
against auditors.
 In the case of Enron, a financial statement
fraud led to the total elimination of Arthur
Andersen, a top international public
accounting firm.
80

The Fraud Process
 Common approaches to “cooking the books”
include:
 Recording fictitious revenues
 Recording revenues prematurely
 Recording expenses in later periods
 Overstating inventories or fixed assets
(WorldCom)
 Concealing losses and liabilities
81

Agency Theory
 An agent (employee) is hired to act on behalf of the principal
(owner, stockholder, voter, etc…).
 The principal-agent problem arises when a principal compensates
an agent for working on behalf of the principal and the elements of
performance are costly to measure.
 Ensuring appropriate incentives involves changing the rules of the
game so that the self-interested rational choices of the agent
coincide with what the principal desires.
 Doing this in practice results in a multitude of compensation
mechanisms (‘the carrot’, bonuses, stock options, profit sharing,
salary raises, promotions, etc...) and supervisory schemes (‘the
stick’, demotion, employment termination, negative review, pay
cuts, etc…).
 Increase incentives to perform and decrease incentives to steal.
82

Organizations as a Nexus of Contracts
 If organizations are viewed as a nexus of contracts
between agents and principals then management
systems must supply information to principals that
monitor and enforce their contractual relationships with
agents.
 The contracts could be with external or internal
organizations and individuals.
 Organizations must have clear hierarchies of reporting
and responsibility.
 Internal controls are systems that hope to enforce these
contractual obligations.
83

Objective 7
Discuss who commits fraud and the reasons
why.
84

Who Commits Fraud and Why
 Researchers have compared the psychological and
demographic characteristics of three groups of people:
 White-collar criminals
 Violent criminals
 The general public
 They found:
 Significant differences between violent and white-collar criminals.
 Few differences between white-collar criminals and the general
public.
85

 White-collar criminals tend to mirror the general
public in:
 Education
 Age
 Religion
 Marriage
 Length of employment
 Psychological makeup
86

 Perpetrators (perps.) of computer fraud tend to
be younger and possess more computer
knowledge, experience, and skills.
 Hackers and computer fraud perps. tend to be
more motivated by:
 Curiosity
 A quest for knowledge
 The desire to learn how things work
 The challenge of beating the system
 Gain stature in the hacking community
87

 Criminologist Donald Cressey, interviewed 200+
convicted white-collar criminals in an attempt to
determine the common threads in their crimes.
As a result of his research, he determined that
three factors were present in the commission of
each crime. These three factors have come to
be known as the fraud triangle.
 Pressure
 Opportunity
 Rationalization
88

The “Fraud Triangle”
Donald Cressey
Pressure
Opportunity
Rationalization
89

Extended Fraud Triangle (Romney and
Steinbart)
90

Fraud Rationalizations
 Rationalizations of fraud take many forms,
including:
 I was just borrowing the money.
 It wasn’t really hurting anyone. (Corporations are
often seen as non-persons, therefore crimes against
them are not hurting “anyone.”)
 Everybody does it.
 I’ve worked for them for 35 years and been underpaid
all that time. I wasn’t stealing; I was only taking what
was owed to me.
 I didn’t take it for myself. I needed it to pay my child’s
medical bills.
91

 Pressure
 Cressey referred to this pressure as a
“perceived non-shareable need.”
 The pressure could be related to
finances, emotions, lifestyle, or some
combination.
92

 The most common pressures were:
 Not being able to pay one’s debts, nor admit it to one’s
employer, family, or friends (which makes it non-
shareable)
 May be associated with vices, such as drugs,
gambling, mistresses, etc.
93

 Fear of loss of status because of a personal failure
 Business reversals
 Example would be mismanagement of a personal
investment or retirement fund.
 Not many people can walk away from a failing
business.
94

 Physical isolation
 When an individual is isolated, physically or
psychologically, almost any pressure becomes non-
shareable.
95

 Status gaining
 Many frauds are motivated by nothing more than a
perceived need to keep up with the Joneses.
 The problem is that there is always a richer “Jones”
down the street and the pressure continues to mount,
as do the resulting thefts.
96

 Difficulties in employer-employee relations
 May create pressure to get revenge, take the money
you feel is rightfully owed to you, etc.
97

 In the case of financial statement frauds, common
pressures include:
 To prop up earnings or stock price so that management can:
 Receive performance-related compensation.
 Preserve or improve personal wealth held in company stock
or stock options.
 Keep their jobs.
 To cover the inability to generate cash flow.
 To obtain financing.
 To appear to comply with bond covenants or other agreements.
 May be opposite of propping up earnings in cases involving
income-tax motivations, government contracts, or regulation.
98

 Opportunity is the opening or gateway that
allows an individual to:
 Commit the fraud
 Conceal the fraud
 Convert the proceeds
99

 Concealing the fraud often takes more time
and effort and leaves more evidence than the
actual theft or misrepresentation.
 Examples of concealment efforts:
 Charge a stolen asset to an expense account or to
an account receivable that is about to be written
off.
 Create a ghost employee who receives an extra
paycheck.
100

Lapping
 Examples of concealment efforts:
 Lapping
• Steal a payment from Customer A.
• Apply Customer B’s payment to Customer A’s account so
Customer A won’t get a late notice.
• Apply Customer C’s payment to Customer B’s account, so
Customer B won’t get a late notice, etc.
101

Kitting
 Kiting (playing the float, paper hanging):
 Creates “cash” by transferring money between banks.
 Requires multiple bank accounts.
 Basic scheme:
• Write a check on the account of Bank A.
• Bank A doesn’t have sufficient funds to cover the check, so write
a check from an account in Bank B to be deposited in Bank A.
• Bank B doesn’t have sufficient funds to cover the check, so write
a check from an account in Bank C to be deposited in Bank B,
etc…
102

Ponzi Scheme
 A fraudulent investment operation that pays returns to investors from
their own money or money paid by subsequent investors, rather than
from any actual profit earned.
 The Ponzi scheme usually entices new investors by offering returns
other investments cannot guarantee, either abnormally high or
unusually consistent.
 The perpetuation of the returns requires an ever-increasing flow of
money from investors to keep the scheme going.
 The system is destined to collapse because the earnings, if any, are
less than the payments to investors.
 The scheme is named after Charles Ponzi, who became notorious for
using the technique in early 1920.
 Ponzi did not invent the scheme, Charles Dicken’s 1857 novel Little
Dorrit described such a scheme decades before Ponzi was born.
103

Money Laundering
 Money laundering is the process of changing
large amounts of money obtained from
crimes, such as drug trafficking, into funds
that appears to have originated from a
legitimate source such as a business.
 This method allows the criminals involved to
claim the money is legitimate, pay taxes on it,
and spend it.
104

Converting Proceeds
 Unless the target of the theft is cash, then the
stolen goods must be converted to cash or
some form that is beneficial to the
perpetrator.
 Checks can be converted through alterations,
forged endorsements, etc…
 Non-cash assets can be sold (online auctions are
a favorite forum) or returned to the company for
cash.
105

Opportunities that Permit Fraud
 Internal Control Factors
 Failure to enforce/monitor internal controls
 Management not involved in control system
 Management override of controls and guidelines
 Ineffective oversight by board of directors
 No effective internal auditing staff
 Infrequent third-party reviews
 Insufficient separation of authorization, custody,
and record-keeping duties
 Unclear lines of authority
106

Opportunities that Permit Fraud
 Other Factors
 Large, unusual, or complex transactions
 Numerous adjusting entries at year end
 Related-party transactions
 Accounting department understaffed and
overworked
 Incompetent personnel
 Rapid turnover of key employees
 Frequently changing auditors, legal counsel
107

The Fraud Management Wheel
 Like the Fraud Triangle, the purpose of the Fraud
Management Wheel (the Wheel) is to organize psychological
models as they relate to fraud in a logical and visual
representation.
 We (Tribunella, Friedman, Cizmeli, Tribunella, 2014) hope
that the Wheel will depict a richer prospective on fraud,
display concepts that are conceptually absent from models
such the Fraud Triangle, provide a framework for
understanding fraud, and suggest future research that links
psychological theory with fraud.
 Fraud does not occur in a vacuum, it manifests itself in a
specific macro-level context. Accordingly, the outer most
circle of the Wheel suggests that fraud occurs within
economic, social and technological contexts.
108

109
Risky
Shift,
Group
Think,
ResponsibilityDiffusion
Justice, Rewards, Leadership,
Controls,
HR Management
Individual
Group
Organization
Fraud
Management
M
oralDevelopm
ent,
Cognitive
Dissonance,Expectancy,
Equity,Risk
Propensity,Prospect

The Wheel: Macro-Level Context
 Economic: During favorable economic conditions characterized
by growth and solid economic returns, there may be less
perceived motivation to commit fraud as individuals receive
generous rewards (given a pay for performance reward
program).
 Social: Refers to societal norms, politics, and cultures, both
national and organizational. For example, bribes are considered
unlawful with heavy sanctions in some areas of the world yet
considered a relatively acceptable normal way of doing business
in other areas (World Bank, 2013).
 Technological: Refers to the role of technology in fraud.
Technology is a double-edge sword. Technology can be used to
prevent and detect fraud with various techniques, but technology
can also be used to commit fraud, such as phishing and hacking.
110

Psychological Theories: Individual Level
 Cognitive Dissonance: A theory developed by Festinger
(1957) that individuals experience a feeling of discomfort after
they perform an action that is deviant behavior from their self-
concept. They try to reduce the feeling of discomfort by (1)
changing their deviant behavior, and/or (2) attempting to
justify their deviant behavior.
 Moral Development: The decision-maker's moral
development level may be a moderating variable. Individuals’
moral reasoning, the basis for acting ethically, develops in a
predictable sequence of six stages: (1) obedience and
punishment, (2) self-interest, (3) conformity, (4) social order,
law and authority, (5) social contract orientation, and (6)
universal ethical principles (Kohlberg, 1973, 2008).
111

 Expectancy Theory: States that motivation is a function
of the perceived probability that effort will result in
performance (effort to performance expectancy, or E-P),
that performance will result in certain outcomes
(performance to outcome expectancy, or P-O), and that
these outcomes are valued, (Issac, Wilfred, & Douglas,
2001; Porter & Lawler, 1968; Vroom, 1964).
 Equity Theory: Addresses how individuals process
information and determine the extent to which they are
treated fairly at work (Adams, 1963). The vast majority of
research on Equity theory deals with perceptions of pay
fairness.
112

 Risky Decision-Making: Under what circumstances are individuals
more likely to make risky decisions? Two relevant theories follow:
 Risk Propensity: Individuals' propensity for risk vary. A decision
maker that is willing to take more risk establishes objectives,
evaluates alternatives, and selects alternatives differently than
individuals who are more risk averse (Ivanevich et al, 2013).
 Prospect Theory: When individuals are faced with making a risky
decision, they do not process their alternatives in the same way.
Kahneman and Tversky (1979) introduced Prospect Theory to
address this issue. Accordingly, people value gains and losses
differently. If people are given two equal choices, one
communicated in terms of possible gains and the other in possible
losses, even though the two choices are equal, people will be more
likely to choose the gains. Therefore, most people are risk adverse.
113

Psychological Theories: Group Level
 Groups: Decision-making literature suggests that in
general groups make better decisions if they rely on the
person with the most expertise and if group members
are motivated by group interests rather than their self-
interests (De Dreu, Nijstad, & van Knippenberg, 2008).
When these conditions are not met, groups can make
worse decisions.
 Risky Shift: Occurs when a group collectively agrees on
a course of action that is more extreme than they would
have made if asked individually. Empirical evidence also
suggests that groups tend to make riskier decisions than
individuals (Janis, 1982).
114

Psychological Theories: Group Level
 Groupthink: Janis (1982) defines groupthink as a kind
of thinking in which group members are mainly motivated
to maintain group cohesiveness rather than making
better or more realist decisions.
 Responsibility Diffusion: Group members may
experience de-individuation and a diffusion of
responsibility for their deviant behaviors. This may result
in an illusory perception of being not personally
accountable for fraudulent behavior based on the
assumption that it will be the group’s fault if the
fraudulent behavior is discovered.
115

Psychological Theories: Organizational Level
 Organizational Justice and Rewards: Are “concerned with the
ways in which employees determine if they have been treated fairly
in their jobs and the ways in which those determinations influence
other work-related variables” (Moorman, 1991, p. 845).
 Leadership: Research with respect to corporate governance, Man
& Wong (2013) found that board independence can increase
external monitoring of managerial fraudulent activities such as
misappropriation of funds, and that female directors can better
develop trust leadership, open communications, and transparency.
 Bhal and Dadhich (2011) found that ethical leadership can
encourage whistle blowing.
 Huberts, Kaptein, and Lasthuizen (2007, p. 587) found that
“employees appear to copy the leader’s integrity standards in their
daily interaction with one another.”
116

Objective 8
Review computer fraud and abuse techniques.
117

Computer Fraud
 The U.S. Department of Justice defines
computer fraud as any illegal act for which
knowledge of computer technology is
essential for its:
 Perpetration;
 Investigation; or
 Prosecution.
118

Computer Fraud
 Many computer frauds go undetected.
 An estimated 80-90% of frauds that are
uncovered are not reported because of fear of:
 Adverse publicity
 Copycats
 Loss of customer confidence.
 There are a growing number of competent
computer users, and they are aided by easier
access to remote computers through the Internet
and other data networks.
119

Hacker Rationalizations
 Creators of worms and viruses often use
rationalizations like:
 The malicious code helped expose security flaws, so I
did a good service.
 It was an accident.
 It was not my fault—just an experiment that went bad.
 It was the user’s fault because they didn’t keep their
security up to date.
 If the code didn’t alter or delete any of their files, then
what’s the problem?
120

Computer Fraud Economic Espionage
 Economic espionage, the theft of
information and intellectual property, is
growing especially fast.
 Government as well as organizations are the
target.
 This growth has led to the need for
investigative specialists or cyber-sleuths.
 In some case cyber-war is conducted.
121

Computer Viruses
 Perpetrators have devised many methods to commit
computer fraud and abuse. These include computer
viruses.
 Many viruses have two phases:
 First, when some predefined event occurs, the virus replicates
itself and spreads to other systems or files.
 Another event triggers the attack phase in which the virus
carries out its mission.
 A virus may lay dormant or propagate itself without causing
damage for an extended period.
122

Computer Worms
 A worm is similar to a virus except for:
 A worm is a stand-alone program, while a virus is only a
segment of code hidden in a host program or executable file.
 A worm will replicate itself automatically, while a virus requires a
human to do something like open a file.
 Worms often reproduce by mailing themselves to the recipient’s
mailing list.
 They are not confined to PCs and have infected cell phones in
Japan.
 A worm typically has a short but very destructive life.
 It takes little technical knowledge to create worms or viruses;
several websites provide instructions.
 Most exploit known software vulnerabilities that can be corrected
with a software patch, making it important to install all patches as
soon as they are available.
123

Denial of Service Attack
 Denial of service attacks
 Experts estimate there as many as 5,000 denial-of-
service attacks weekly in the U.S.
 A denial-of-service can cause severe economic damage
to its victim or even drive them out of business.
 An attacker overloads and shuts down an Internet
Service Provider’s email system by sending email bombs
at a rate of thousands per second—often from randomly
generated email addresses.
 May also involve shutting down a web server by sending
a load of requests for the web pages.
124

Phishing
 Phishing is a form of social engineering with
three stages: bait, hook and boat.
 Perpetrator sends out many email, instant, or
text messages.
 The message asks the victim to send financial
information, passwords, or click-through to a site
that collects the information.
 The perp. tries to deceive the victim into thinking
they are a legitimate source.
125

Phishing
 For example, phishers have impersonated
the IRS.
 The phisher told victims they had a refund
(bait).
 Victims were told to go to a Web site to make
a claim (hook).
 Once there, the site asked for financial
information such as passwords and bank
account numbers (boat).
126

Objective 9
Provide an overview of the AICPA Ethics
Codification Project
127

AICPA Ethics Codification Project
 Project was undertaken to make using the code
more intuitive and easy for members.
 The code has been restructured by topic and
placed online with a platform that allows for
searches, email links, bookmarks and notes.
 Also included in the code are pop-ups for
defined terms and hyperlinks that connect
relevant portions of the code together.
 Nonauthoritative Guidance is included at the end
of the applicable topic or section of the code.
128

Changes to the code
 Most of the code remains the same.
 Certain language was changed for
consistency.
 Certain provisions were updated to reflect the
conceptual frameworks.
 Certain nonauthoritative guidance was
included.
129

Old Code vs. New Code
 To easily find guidance from the previous
code in the new updated code you can use
the AICPA’s mapping document which can
be downloaded at:
http://www.aicpa.org/InterestAreas/ProfessionalEthi
130

AICPA’s Mapping Document
131

Frameworks
 The Project also added two frameworks to
the code: Conceptual Framework for
Members in Public Practice and Conceptual
Framework for Members in Business.
 The frameworks can be used where there is
a lack of guidance on a particular relationship
or circumstance.
 The previous Conceptual Framework for
independence has been retained in the new
code.
132

Effective Dates
 The new AICPA Code of Professional
Conduct is effective December 15, 2014.
 Early implementation is permitted.
 The Conceptual Frameworks and related
interpretations will be effective December 15,
2015.
133

Information on the Project
http://www.aicpa.org/InterestAreas/Professional
Ethics/Community/Pages/aicpa-ethics-
codification-project.aspx
134

Location of Current Code
135
http://www.aicpa.org/Research/Standards/CodeofConduct/Pages/default.as
px

Location of Online Code
136
http://pub.aicpa.org/codeofconduct/Ethics.aspx

Objective 10
Show the organization of topics in the code of
Professional Conduct.
137

Parts of the code
 Preface: Applicable to All Members
 Part 1: Members in Public Practice
 Part 2: Members in Business
 Part 3: Other Members
138

Preface: Applicable to All Members
 0.100 Overview of the Code of Professional
Conduct
 0.200 Structure and Application of the AICPA
Code
 0.300 Principles of Professional Conduct
 0.400 Definition
 0.500 Nonauthoritative Guidance
 0.600 New, Revised, and Pending
Interpretations and Other Guidance.
139

Part 1: Members in Public Practice
 1.000 Introduction
 1.100 Integrity and Objectivity
 1.200 Independence
 1.300 General Standards
 1.400 Acts Discreditable
 1.500 Fees and Other Types of Renumeration
 1.600 Advertising and Other Forms of Solicitation
 1.700 Confidential Information
 1.800 Form of Organization and Name
140

Part 2: Members in Business
 2.100 Integrity and Objectivity
 2.300 General Standards
141

Part 3: Other Members
142

Objective 11
Review the conceptual framework for members
in public practice
143

Conceptual Framework for Members
in Public Practice
 Located at 1.000.010 in the code.
 Utilizes a threats and safeguard approach.
 Applies when there is no guidance in the
code.
 Cannot be used to override existing rules and
interpretations of the code.
 Effective December 15, 2015, early
implementation is allowed provided the
member has implemented the revised code.
144

Definitions
 “Acceptable level – A level at which a
reasonable and informed third party who is
aware of the relevant information would be
expected to conclude that a member’s
compliance with the rules is not compromised.
 Safeguards – Actions or other measures that
may eliminate a threat or reduce a threat to an
acceptable level.
 Threats – Relationships or circumstances that
could compromise a member’s compliance with
the rules.”
145
AICPA Code of Professional conduct 1.000.010.04-.06

Conceptual Framework Approach
1. “Identify threats
2. Evaluate the significance of a threat.
3. Identify and apply safeguards”
146AICPA Code of Professional Conduct 1.000.010.07

Types of Threats
 “Adverse interest threat – the threat that a
member will not act with objectivity because the
member’s interests are opposed to the client’s
interests.
 Advocacy threat – the threat that a member will
promote a client’s interest or position to the point
that his or her objectivity or independence is
compromised.
 Familiarity threat – The threat that, due to a long or
close relationship with a client, a member will
become too sympathetic to the client’s interests or
too accepting of the client’s work or product.”
147
AICPA Code of Professional Conduct 1.000.010.10-.12

Types of Threats
 “Management participation threat – the
threat that a member will take on the role of
client management or otherwise assume
management responsibilities, such may
occur during an engagement to provide
nonattest services.
 Self-interest threat – 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.”
148AICPA Code of Professional Conduct 1.000.010.13-.14

Types of Threats
 “Self-review threat – the threat that a member will
not appropriately evaluate the results of a previous
judgment made 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 threat – the threat that a member
will subordinate his or her judgment to an individual
associated with a client or any relevant third party
due to that individual’s reputation or expertise,
aggressive or dominate personality, or attempts to
coerce or exercise excessive influence over the
member.”
149

Categories of Safeguards
1. “Safeguards created by the profession
legislation or regulation.”
2. “Safeguards implemented by the client”
(cannot not rely solely on)
3. “Safeguards implemented by the firm,
including policies and procedures to
implement professional and regulatory
requirements.”

Examples of profession, legislation or
regulation safeguards
1. “Education and training requirements on independence and
ethics rules.
2. Continuing education requirements on independence and
ethics.
3. Professional standards and threat of discipline.
4. External review of a firm’s quality control system.
5. Legislation establishing prohibitions and requirements for a
firm or a firm’s professional employees.
6. Competency and experience requirements for professional
licensure.
7. Professional resources, such as hotlines, for consultation on
ethical issues.”
151
AICPA Code of Professional Conduct 1.000.010.21

Examples of client safeguards
1. “Client has personnel with suitable skill, knowledge, or
experience who make managerial decisions about the
delivery of professional services and makes use of third-
party resources for consultation as needed.
2. The tone at the top emphasizes the client’s commitment to
fair financial reporting and compliance with the applicable
laws, rules, regulations, and corporate governance policies.
3. Policies and procedures are in place to achieve fair financial
reporting and compliance with applicable laws, rules,
regulations, and corporate governance policies.
4. Policies and procedures are in place to address ethical
conduct.”
152

Examples of client safeguards
5. “A governance structure, such as an active audit
committee, is in place to ensure appropriate decision
making, oversight, and communications regarding a
firm’s services.
6. Policies are in place that bar the entity from hiring a firm
to provide services that do not serve the public interest
or that would cause the firm’s independence or
objectivity to be considered impaired.”

Examples of firm safeguards
 “Firm leadership that stresses the importance of
complying with the rules
 Policies and procedures related to engagement quality
control
 Policies and procedures that identify
interests/relationships between the firm, partners,
professional staff and clients
 Training on firm’s policies and procedures
 Disciplinary mechanism that is designed to promote
compliance with policies and procedures.”
154

Examples of firm safeguards
 “Policies and procedures designed to empower staff to
communication to senior members of the firm.
 Rotation of senior personnel who are part of the
engagement team.
 Having another firm to reperform a nonattest service to
the extent necessary for it to take responsibility for that
service.
 Removal of a individual from an attest engagement team
when that individual's financial interests or relationships
pose a threat to independence.”
 For more examples see AICPA Code of Professional
Conduct 1.000.010.23
155

Factors that influence the
effectiveness of safeguards
 “The facts and circumstances specific to a particular situation.
 The proper identification of threats.
 Whether the safeguard is suitably designed to meet its
objectives.
 The party(ies) who will be subject to the safeguard.
 How the safeguard is applied.
 The consistency with which the safeguard is applied.
 Who applies the safeguard.
 How the safeguard interacts with a safeguard from another
category.
 Whether the client is a public interest entity.”
156

Objective 12
Review the conceptual framework for
independence.
157

Conceptual Framework for
Independence
code.
158

Definitions
 “Acceptable level – A level at which a reasonable and
informed third party who is aware of the relevant
information would be expected to conclude that a
member’s independence is not impaired.
 Impair(ed) – in connection with independence, to
effectively extinguish independence. When a member’s
independence is impaired, the member is not
independent.
 Safeguards – Actions or other measures that may
eliminate a threat or reduce a threat to an acceptable
level.
 Threats – Relationships or circumstances that could
impair independence”
159

 “Identify threats
 Evaluate the threat that the member would not be
independent or would be perceived as not being
independent.
 Reduce or eliminate the threat to an acceptable level to
conclude the member is independent.
 Threats are at an acceptable level either because:
1. The types of threats and their potential effect
2. Safeguards have eliminated or reduced the threat.”

Types of Threats
 “Adverse interest threat – the threat that a
member will not act with objectivity because the
member’s interests are opposed to the interest of an
attest client.
promote an attest client’s interest or position to the
point that his or her independence is compromised.
 Familiarity threat – The threat that, because of a
long or close relationship with an attest client, a
member will become too sympathetic to the attest
client’s interests or too accepting of the attest
client’s work or product.”
161

Types of Threats
 “Management participation threat – the
threat that a member will take on the role of
attest client management or otherwise
assume management responsibilities for an
attest client.
 Self-interest threat – the threat that a
member could benefit, financially or
otherwise, from an interest in, or relationship
with, an attest client or persons associated
with the attest client.”

Types of Threats
 “Self-review threat – the threat that a member will
not appropriately evaluate the results of a previous
judgment made 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 an attest engagement.
 Undue influence threat – the threat that a member
will subordinate his or her judgment to that of an
individual associated with an attest client or any
relevant third party due to that individual’s reputation
or expertise, aggressive or dominate personality, or
attempts to coerce or exercise excessive influence
over the member.”
163

legislation or regulation.”
2. “Safeguards implemented by the attest
client” (cannot not rely solely on)
3. “Safeguards implemented by the firm,
including policies and procedures to
implement professional and regulatory
requirements.”

Objective 13
Review the conceptual framework for members
in business
165

Conceptual Framework for Members
in Business
code.
 Effective December 15, 2015, early
implementation is allowed provided the
member has implemented the revised code.
166

Definitions
 “Acceptable level – A level at which a
reasonable and informed third party who is
aware of the relevant information would be
expected to conclude that a member’s
compliance with the rules is not compromised.
 Safeguards – Actions or other measures that
may eliminate a threat or reduce a threat to an
acceptable level.
 Threats – Relationships or circumstances that
could compromise a member’s compliance with
the rules.”
167

1. “Identify threats
2. Evaluate the significance of a threat.
3. Identify and apply safeguards”

Types of Threats
 “Adverse interest threat – the threat that a member will
not act with objectivity because the member’s interests
are opposed to the interests of the employing
organization.
promote an employing organization’s interest or position
to the point that his or her objectivity is compromised.
 Familiarity threat – The threat that, due to a long or
close relationship with a person or an employing
organization, a member will become too sympathetic to
their interests or too accepting of the person’s work or
employing organization’s product or service.”
169

Types of Threats
 “Self-interest threat – the threat that a member could
benefit, financially or otherwise, from an interest in, or
relationship with, the employing organization or persons
associated with the employing organization.
 Self-review threat – the threat that a member will not
appropriately evaluate the results of a previous judgment
made or service performed or supervised by the member
or an individual in the employing organization and that
the member will rely on that service in forming a
judgment as part of another service.”

Types of Threats
 “Undue influence threat – the threat that a
member will subordinate his or her judgment to an
individual associated with the employing
organization or any relevant third party due to that
individual’s position, reputation or expertise,
aggressive or dominate personality, or attempts to
coerce or exercise excessive influence over the
member.”
171

legislation or regulation.
2. Safeguards implemented by the employing
organization.”

Examples of profession, legislation or
regulation safeguards
1. “Education and training requirements on ethics and
professional responsibilities.
2. Continuing education requirements on ethics.
3. Professional standards and threat of discipline.
4. Legislation establishing prohibitions and requirements for
entities and employees.
5. Competency and experience requirements for professional
licensure.
6. Professional resources, such as hotlines, for consultation on
ethical issues.”
173

Examples of employing organization
safeguards
 “Tone at the top emphasizing a commitment to fair
financial reporting.
 Tone at the top emphasizing compliance with applicable
laws, rules, regulations, and corporate governance
policies.
 Audit committee charter, including independent audit
committee members.
 Internal policies and procedures related to purchasing
controls.
 Internal policies and procedures related to customer
acceptance or credit limits.”
174

Examples of employing organization
safeguards “Human resource policies and procedures stressing the
hiring and retention of technically competent employees
 Policies and procedures for implementing and monitoring
ethical policies.
 Policies segregating personal assets from company
assets.
 Staff training on applicable laws, rules, and regulations.”
 For more examples see AICPA Code of Professional
Conduct 2.000.010.20
175

Factors that influence the
effectiveness of safeguards
 “The facts and circumstances specific to a particular situation.
 The proper identification of threats.
 Whether the safeguard is suitably designed to meet its
objectives.
 The party(ies) who will be subject to the safeguard.
 How the safeguard is applied.
 The consistency with which the safeguard is applied.
 Who applies the safeguard.
 How the safeguard interacts with a safeguard from another
category.
 Whether the employing organization is a public interest
entity.”
176

Objective 14
Review the rules and interpretations applicable
to members in business
177

2.100.001
Integrity and Objectivity Rule
“In the performance of any professional service,
a member shall maintain objectivity and
integrity, shall be free of conflicts of interest and
shall not knowingly misrepresent facts or
subordinate his or her judgment to others.”
178
AICPA Code of Professional Conduct 2.100.001

Interpretations of Integrity and Objectivity Rule:
Application of Conceptual Framework
 A member is considered in violation of the rule if
the member cannot demonstrate that
safeguards were applied that eliminated or
reduced significant threats to an acceptable
level.
 A member should consider the guidance in
Ethical Conflicts (see next slide)
 In absences of an interpretation, the member
should refer to the conceptual framework for
179

Interpretations of Integrity and
Objectivity Rule: Ethical Conflicts
 “A member may be required to take steps to
best achieve compliance with the rules and
law. “…Members should consider the
following factors:
 Relevant facts and circumstances, including
applicable rules, laws, or regulations
 Ethical issues involved
 Established internal procedures.”

Interpretations of Integrity and Objectivity Rule: Ethical Conflicts
 Member should be prepared to justify departures from rules and
laws.
 May have to address consequences for violating such rules and
laws.
 Should consider consulting with appropriate persons within the
employing organization before taking action.
 If deciding not to consult with someone in the organization, should
consider consulting with other individuals, professional bodies or
legal counsel.
 Should consider documenting the substance of the issues, the
parties discussed with, details of the discussions and decisions
made.
 If the issues is still unresolved, the member will most likely be in
violation of one or more rules and should consider his or her
continuing relationship with the specific assignment or employer.
181

Interpretations of Integrity and Objectivity Rule:
Offering or Accepting Gifts or Entertainment
 When accepting gifts or entertainment from a
vendor or customer of the member’s
employer the following threats may exist:
 Self-interest
 Familiarity
 Undue influence
182

Cases When Threats could not be
reduced to an acceptable level
 The acceptance of gifts or entertainment
violate applicable laws, rules, or regulations
or policies of the employer, vendor or
customer.
 “The member knows of the violations or
demonstrates recklessness in not knowing.”
 The gifts/entertainment is not reasonable.
183
AICPA Code of Professional Conduct 2.120.010.03 & .05

Reasonableness of gifts/entertainment
 Threats are considered at an acceptable level when the
gifts/entertainment is reasonable.
 Member should consider the following facts and circumstances:
 “The nature of the gift or entertainment
 The occasion giving rise to the gift or entertainment
 The cost or value of the gift or entertainment
 The nature, frequency, and value of other gifts or entertainment
offered or accepted.
 Whether the entertainment was associated with the active
conduct of business directly before, during or after the
entertainment
 Whether other customers or vendors participated in the
entertainment.
 The individuals from the customer or vendor and a member’s
employer who participated in the entertainment.”
184

Interpretations of Integrity and Objectivity Rule: Knowing
Misrepresentations in the Preparation of Financial
Statements or Records
 Threats could not be reduced to an acceptable level
through the use of safeguards if the member:
 “Makes, or permits or directs another to make,
materially false and misleading entries in an entity’s
financial statements or records.
 Fails to correct an entity’s financial statements or
records that are materially false and misleading when
the member has the authority to record the entries; or
 Signs, or permits or directs another to sign, a
document containing materially false and misleading
information.”

Interpretations of Integrity and Objectivity
Rule: Subordination of Judgment
 Self-interest, familiarity and undue influence threats may
exist when there is a difference of opinion on
professional standards between the member and
another person within the organization.
 Member needs to evaluate if the threats are at an
acceptable level, if not, safeguards need to be applied.
 Threats are considered at an acceptable level if the
position taken does not result in a failure to comply with
professional standards, a material misrepresentation of a
fact or a violation of laws and regulations.
186

Threats at acceptable level
 Discuss conclusions with the person taking
position.
 No further action required
187

Threats not an acceptable level
 Member should discuss concerns with supervisor
 If not resolved with supervisor, should discuss concerns with
the appropriate higher level of management within the
organization.
 If appropriate action was not taken the following safeguards
should be applied:
 Determine if the organizations internal policies and procedures
have additional reporting requirements for differences of opinion.
 Determine requirements for reporting to third parties.
 Consult with legal counsel
 Document his or her understanding of the facts, professional
standards/laws/regulations and conversations and parties
included in the discussions.
188

Threats not an acceptable level
 If no safeguards can eliminate or reduce
threats to an acceptable level or if
appropriate action is not taken, then the
member should consider the continuing
relationship with the member’s organization
and takes steps to eliminate subordination of
judgment.
 Nothing precludes a member from resigning,
but resignation does not relieve the member
of responsibilities, such as disclosure to third
parties.
189

2.130.030 Obligation of a Member to His or
Her Employer’s External Accountant
“When dealing with an employer’s external
accountant, a member must be candid and not
knowingly misrepresent facts or knowingly fail
to disclose material facts.”
190

2.160.010 Educational Services
“Members who perform educational services,
such as teaching full or part-time at a
university, teaching a continuing professional
education course, or engage in research and
scholarship are performing professional
services and, therefore, are subject to the
Integrity and Objectivity Rule.”
191

2.300.001 General Standards Rule
“A member shall comply wit the following standards and with any
interpretations thereof by bodies designated by Council.
a. Professional Competence. Under take only those
professional services that the member or the member’s
firm can reasonably expect to be completed with
professional competence.
b. Due Professional Care. Exercise due professional care
in the performance of professional services.
c. Planning and Supervision. Adequately plan and
supervise the performance of professional services.
d. Sufficient Relevant Data. Obtain sufficient relevant data
to afford a reasonable basis for conclusions or
recommendations in relation to any professional services
performed.”
192

Interpretations of the General Standards Rule:
Application of the Conceptual Framework
 In the absence of interpretations the
conceptual framework should be used.
 The member is in violation if you cannot
demonstrate that safeguards reduced threats
to an acceptable level.
 Should consider the guidance in Ethical
Conflicts.
193

Interpretations of General Standards
Rule: Competence
 Competence means that the member or member’s staff
has the technical qualification to provide the service.
 Agreement to provide the service implies that the
member is competent in that area.
 A member may have the knowledge, or may need to
conduct additional research or consult with others to gain
competence.
 If a member is unable to obtain sufficient competence,
then the member should suggest a competent person to
perform the service.
194

Interpretations of General Standards Rule:
Submission of Financial Statements
“When a member is a stockholder, a partner, a
director, an office, or an employee of an entity
and, in this capacity, prepares or submits the
entity’s financial statements to third parties, the
member should clearly communicate,
preferably in writing, the member’s relationship
to the entity and should not imply that the
member is independent of the entity.”

2.310.001 Compliance with Standards
Rule
“A member who performs auditing, review,
compilation, management consulting, tax or
other professional services shall comply with
standards promulgated by bodies designated
by Council.”
196

Designated Bodies of Council
 Financial Accounting Standards Advisory Board
 FASB
 GASB
 PCAOB
 IASB
 AICPA Committees and Boards.
 Auditing Standards Board
 Management Consulting Services Executive Committee
 Attestation Standards
 Tax Executive Committee
 Forensic and Valuation Services Committee
 Personal Financial Planning Executive Committee
197
AICPA Code of Professional Conduct Appendix A

Interpretations Under the Compliance with Standards
Rule: Application of Conceptual Framework
 In the absence of an interpretation the
Conflicts.

2.320.001 Accounting Principles Rule
“A member shall not (1) express an opinion or state affirmatively that
the financial statements or other financial data of any entity are
presented in conformity with generally accepted accounting principles
or (2) state that he or she is not aware of any material modifications
that should be made to such statements or data in order for them to be
in conformity with generally accepted accounting principles, if such
statements or data contain any departure from an accounting principle
promulgated by bodies designated by Council to establish such
principles that has a material effect on the statements or data taken as
a whole. If, however, the statements or data contain such a departure
and the member can demonstrate that due to unusual circumstances
the financial statements or data would otherwise have been misleading,
the member can comply with the rule by describing the departure, its
approximate effects, if practicable, and the reasons why compliance
with the principle would result in a misleading statement.”

Interpretations Under the Accounting Principles
Rule: Application of Conceptual Framework
Conflicts.
200

Interpretations Under the Accounting Principles Rule:
Responsibility for Affirming That Financial Statements Are in
Conformity With the Applicable Financial Reporting Framework
 May not state affirmatively that an entity’s
financial statements or other financial data are
presented in conformity with GAAP if there is a
departure from an accounting principle.
 Representation in a letter or other
communication that the entity’s financial
statements are in conformity with GAAP would
be considered an affirmative statement with
respect to a signature

Interpretations Under the Accounting Principles
Rule: Status of FASB, GASB, FASAB and IASB
Interpretations
Bodies Designated by Council:
Financial Accounting Standards Advisory Board
FASB
GASB
PCAOB
IASB
AICPA Committees and Boards.
202AICPA Code of Professional Conduct 2.320.020.01-03 and Appendix A

Departures from Generally Accepted Accounting
Principles
 Strong presumption that adherence to GAAP
would result in financial statements that are not
misleading.
 However, there may be unusual circumstances
when GAAP might be misleading. In such
cases, the proper accounting treatment is to
apply that which will not make the financial
statements misleading.
 Unusual circumstances is a matter of
professional judgment
203
AICPA Code of Professional Conduct 2.320.030.01-02

Financial Statements Prepared Pursuant to Financial
Reporting Frameworks Other Than GAAP
 Financial Statements prepared based on
accounting principles not designated by
council is a reporting framework other than
GAAP.
 Member’s reports cannot lead the users to
believe that the financial statements are in
accordance with GAP and must clarify the
financial reporting framework used.
204
AICPA Code of Professional Conduct 2.320.040.01-.02 and .04

Examples of Other Financial
Reporting Frameworks
 “Financial reporting frameworks generally accepted in
another country, including jurisdictional variations of
IFRS such that the entity’s financial statements do not
meet the requirements for full compliance with IFRS, as
promulgated by the IASB;
 Financial reporting frameworks prescribed by an
agreement or contract; or
 Other special purpose frameworks, including statutory
financial reporting provisions required by law or a U.S. or
foreign governmental regulatory body to whose
jurisdiction the entity is subject.”

Multiple Choice #1
206
a. b. c. d.
0% 0%0%0%
According to the profession’s ethical
standards, which of the following
events may justify a departure from a
Statement of Financial Accounting
Standard?
Evolution
of a new form
of business
New Legislation transaction
a. No Yes
b. Yes No
c. Yes Yes
d. No No
Source: Adopted from the AICPA CPA exam

Acts Discreditable Rule
“A member shall not commit an act
discreditable to the profession.”
207

Interpretations Under the Acts Discreditable Rule:
Application of Conceptual Framework
Conflicts.
208

Interpretations Under the Acts
Discreditable Rule:
 2.400.010 Discrimination and Harassment in
Employment Practices
 2.400.020 Solicitation or Disclosure of CPA
Examination Questions and Answers
 2.400.030 Failure to File a Tax Return or Pay
a Tax Liability
 2.400.090 False, Misleading, or Deceptive
Acts in Promoting or Marketing Professional
Services
209

Negligence in the Preparation of Financial Statements or
Records
“A member shall be considered in violation of the Acts
Discreditable Rule if the member, by virtue of his or her
negligence, does any of the following:
a.Makes or permits or directs another to make, materially
false and misleading entries in the financial statements or
records of an entity.
b.Fails to correct an entity’s financial statements that are
materially false and misleading when the member has the
authority to record an entry.
c.Signs, or permits or directs another to sign, a document
containing materially false and misleading information.”
210

Governmental Bodies, Commissions or Other Regulatory
Agencies
 Governmental bodies, commissions and other
regulatory agencies establish requirements that
members are required to follow in preparation of
financial statements or related information.
 Members should follow such requirements in
addition to the applicable financial reporting
framework.
 A material departure would be an act
discreditable, unless the departure and the
reasons for the departure are disclosed.
211

Indemnification and Limitation of Liability
Provisions
 Certain governmental bodies, commissions and other
regulatory agencies have established requirements that
prohibit entities subject to their regulation from including
certain types of indemnification and limitation of liability
provisions in agreements for the performance of audit
and attestation services and the existence of such
provisions disqualifies a member from rendering services
to such entities.
 Entering into such contracts with indemnification and
limitation of liability provisions with these entities under
their jurisdiction is an act discreditable.

Confidential Information Obtained From Employment or
Volunteer Activities
 Must maintain confidentiality of employer’s confidential
information in dealings with vendors, customers or
lenders of the employer.
 Confidential employer information is any proprietary
information pertaining to the organization that is not
know to be available to the public
 Should avoid inadvertent disclosure to a close business
associate, close relative or immediate family member.
 Take reasonable steps to ensure that staff under
supervision and persons from whom advice or
assistance are obtained are aware of the confidential
nature of the information.

Confidential Information Obtained From Employment or
Volunteer Activities
 When changing employment a member cannot use
confidential employee information to his/her own
personal advantage or to the advantage of a third party.
 Confidentiality does not end with termination of
employment.
 Member can use experience and expertise.
 If disclosing confidential information, but gain proper
authority or specific consent of the employer, unless
there is a legal or professional responsibility to disclose
the information.
214

Ethics (2014)

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