June 2011

Revised structure, wording will make ethics standards more consistent.

The AICPA’s Professional Ethics Executive Committee (PEEC) is undertaking a project to recodify the Institute’s ethics standards. The Ethics Codification Project’s primary focus is to improve the AICPA Code of Professional Conduct so that members and others can apply the rules and reach correct conclusions more easily. To achieve this, PEEC will restructure the Code into topical areas, edit the Code using consistent drafting and style conventions, and revise certain Code provisions (primarily independence) to reflect the “conceptual framework” approach. PEEC will expose the restructured and redrafted Code for public comment before considering it for final adoption.

 

TIME TO REORGANIZE

The AICPA Code is being rewritten and restructured for the same reasons that FASB created its Accounting Standards Codification (ASC). The AICPA’s project, though, is on a much smaller scale than the FASB ASC, which simplified user access by reorganizing authoritative U.S. GAAP into a single, searchable code.

 

While the AICPA Code is technically “codified” today, some subjects are scattered about the Code, making it more difficult for members and other users to know whether they have considered all relevant standards. In addition, a substantial amount of nonauthoritative ethics guidance is found outside the Code. These materials include informal AICPA staff positions; frequently asked questions on nonattest services; and basis-for-conclusions documents that can help members better understand and apply certain ethics rules. The Codification Project gives PEEC an opportunity to re-evaluate that guidance, where it resides, and its connection to the Code. Some of that material may become authoritative through this process.

 

INTERNATIONAL CONNECTION

As a member body of the International Federation of Accountants (IFAC), the AICPA agrees to have ethics standards that at a minimum meet the ethics standards issued by the International Ethics Standards Board for Accountants (IESBA). Since 2001, the AICPA Code has been converging with the IESBA Code of Ethics for Professional Accountants. For example, in 2006, PEEC adopted as an authoritative standard the Conceptual Framework for AICPA Independence Standards (AICPA Framework [ET § 101-1]), and, in 2010, PEEC adopted an independence standard on network firms (ET § 101.19). The conceptual framework and the network firm standard are integral parts of the IESBA Code; the former lays the foundation for the entire code. PEEC’s Codification Project will continue to consider convergence issues.

 

WHAT IS A CONCEPTUAL FRAMEWORK?

A conceptual framework helps members comply with ethics requirements (see “Comparing the Ethics Codes: AICPA and IFAC,” Oct. 2010, page 24). For example, the AICPA framework defines several concepts and terms (such as independence, threat, safeguard and acceptable level), and provides examples of different types of threats and safeguards. A member who identifies a threat to his or her compliance with independence standards would use the framework, evaluate the significance of the threat, and, if necessary, determine whether safeguards could be applied to eliminate or reduce the threat to an acceptable level. Some have questioned the effectiveness of a system that relies so heavily on a member’s judgment, but others believe the conceptual framework approach helps achieve a stronger Code, overall. That is because ethics codes, by their very nature, cannot possibly address all—or even most—of the issues practitioners will encounter. A framework provides a foundation for the rules and adds consistency and discipline to a member’s analysis when no rules address a situation. The IESBA Code fully embraces the conceptual framework approach, and the Codification Project provides an opportunity to further integrate the framework into the AICPA Code. This is consistent with PEEC’s convergence objectives.

 

It is important to note that the framework cannot be used to overcome existing prohibitions or requirements contained in the AICPA Code. PEEC intends to maintain a robust set of independence rules as part of the codification, and any revisions proposed as part of re-evaluating those rules will undergo full due process, including exposure and comment by the public and members.

 

The following illustration demonstrates how the conceptual framework approach would be applied to address a hypothetical independence matter:

An audit partner’s nondependent daughter is a human resources manager with the client. His daughter informs him that she has received an unexpected and very expensive gift from the company’s controller. This occurred during the audit when the partner and the controller were having tense disagreements over the controller’s accounting for certain material assets. The concerned partner consults the Code and concludes that his independence would be impaired if he received an expensive gift from the client, however, the Code is silent in terms of gifts given to his close relatives. In this case, the AICPA Code (ET § 101.02, Other Considerations) requires that he apply the framework.

Turning to the AICPA framework, the partner identifies the situation as an “undue influence” threat to his independence (ET § 100.01.17(c)), including the appearance of his independence. Next, he considers whether or not the threat is significant. If he concludes the threat is not significant because it is at an “acceptable level” (that is, would not taint or appear to taint his objectivity in performing the audit), he would not need to evaluate the matter any further. However, he believes the threat is significant, so he must also consider whether safeguards—actions or other measures that counter threats—could eliminate or reduce the threat to an acceptable level.

 

He considers the sample safeguards in the framework, including their effectiveness and availability, and concludes that the only safeguards that would eliminate the threat to his independence would be to have his daughter return the gift to the controller or for him to withdraw from the engagement and have another partner in the firm complete the audit. He discusses these facts with other appropriate persons in his firm and agrees to bring the matter to the attention of the client’s audit committee. He also documents his analysis and actions.

 

EMBEDDING THE CONCEPTUAL FRAMEWORK

As the codification is developed, PEEC will also propose certain textual changes. First, PEEC will apply drafting and style conventions to the entire Code to improve consistency and make it clearer. PEEC also will recast several provisions (primarily under the topic “Independence,” but also other topics such as “Integrity and Objectivity”) to reflect the application of the conceptual framework approach, a significant change as very few rules today mention these concepts.

 

PEEC believes recasting will enhance understanding of the Code by providing additional context for the rules of conduct and guidance on the application of the framework. However, recasting will not change the substance of existing rules or allow members to apply judgment where none is permitted today. For example, under the AICPA framework, if a covered member holds stock in an audit client, the only safeguard that would eliminate or sufficiently mitigate the “financial self-interest” threat to independence would be to dispose of that interest or cease being a “covered member”—the same outcome as under the current rule.

 

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