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Situations that may violate the Code of Professional Conduct.
Question 1 The following are situations that may violate the Code of Professional Conduct. Assume, in each case, that the CPA is a partner. Discuss whether the facts in any of the situations indicate violations of the Code of Professional Conduct. If so, identify the nature of the violation(s).
A. Contel, CPA, advertises in the local paper that his firm does the audit of 14 of the 36 largest community banks in the state. The advertisement also states that the average audit fee, as a percentage of total assets for the banks he audits, is lower than any other CPA firms in the state.
B. Davis, CPA, sets up a small loan company specializing in loans to business executives and small companies. Davis does not spend much time in the business because he spends full time with his CPA practice. No employees of Davis’s CPA firm are involved in the small loan company.
C. Elbert, CPA, owns a material amount of stock in a mutual fund investment company, which in turn owns stock in Elbert’s largest audit client. Reading the investment company’s most recent financial report, Elbert is surprised to learn that the company’s ownership in his client has increased dramatically.
D. Able, CPA, owns a substantial limited partnership interest in an apartment building. Frederick Marshall is a 100% owner in Marshall Marine Co. Marshall also owns a substantial interest in the same limited partnership as Able. Able does the audit of Marshall Marine Co.
E. Baker, CPA, approaches a new audit client and tells the president that he has an idea that could result in a substantial tax refund in the prior year’s tax return by application of a technical provision in the tax law that the client had overlooked. Baker adds that the fee will be 50% of the tax refund after it has been resolved by the Internal Revenue Service. The client agrees to the proposal. (15 marks)
Sample Answer
The following analysis discusses whether the provided situations violate the AICPA Code of Professional Conduct, identifying the nature of any violation(s).
A. Advertising Claims
Violation?
Nature of Violation
Yes
Acts Discreditable Rule and Advertising and Other Forms of Solicitation Rule
Discussion:
While the Code allows CPA firms to advertise, the advertisement must not be false, misleading, or deceptive.
Claim of Auditing 14 of 36 Largest Banks: This is a verifiable factual claim and is likely permissible, provided the data is accurate.
Claim of Lower Average Audit Fee: Stating that the firm's average audit fee, as a percentage of total assets, is "lower than any other CPA firms in the state" is an unsupported and potentially misleading claim. It is nearly impossible to verify this against all other firms in the state, and the statement is too absolute. Such a claim, which lacks substantiation and is likely unverifiable, can violate the Advertising and Other Forms of Solicitation Rule (which prohibits false, misleading, or deceptive advertising) and the Acts Discreditable Rule.
A CPA is generally permitted to engage in other business or occupations, provided they do not violate any rules of conduct.
The fact that Davis has a separate small loan company is permissible as it is an entity separate from the CPA firm, and the CPA is not spending time on it to the detriment of his practice.
The primary concern would be a Conflict of Interest or Independence threat. If the small loan company were to extend loans to any of Davis's audit clients, a direct financial relationship would be created, which would impair independence.
However, based only on the facts provided (that it specializes in loans to business executives and small companies, and no employees of the CPA firm are involved), there is no clear violation.
C. Owning Stock in a Mutual Fund
Violation?
Nature of Violation
No
No violation (Indirect financial interest is generally acceptable)
Discussion:
This situation involves an indirect financial interest in an audit client. Elbert owns a material amount of stock in a mutual fund, which in turn owns stock in the audit client.
According to the Code, an auditor's independence is impaired by a direct financial interest or a material indirect financial interest in an audit client.
A financial interest in a mutual fund that owns a client's stock is considered an indirect financial interest.