Announcing PCAOB’s new auditor’s reporting model

In June 2017,  the United States Public Company Accounting Oversight Board (PCAOB ) issued a new standard and related amendments called “The Auditor's Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion and Related Amendments to PCAOB Standards”. The new standard creates the first significant change to the standard form auditor’s report in 70 years. Reports prepared by public company auditors will contain more information for investors and other financial statement users as a result of new rules.

Under the new standard, the auditor's report will retain the pass/fail opinion of the existing auditor’s report but will also include a new description of “critical audit matters,” providing financial statement users with information about complex aspects of the audit. Critical audit matters are any matters arising from the current period's audit of the financial statements that were communicated or required to be communicated to the audit committee, and that (1) Relate to accounts or disclosures that are material to the financial statements, and (2) Involved especially challenging, subjective or complex auditor judgment.

The US Center for Audit Quality (CAQ), affiliated with the AICPA, views the new standard as a positive step toward continuous improvement of the audit to better serve investors and capital markets. The CAQ welcomes the enhanced auditor’s reporting model to provide additional information to investors and other stakeholders in an increasingly complex and global business environment. It noted the PCAOB’s responsiveness to the auditing profession’s concerns and recommendations throughout the proposal process, including observations from the CAQ’s field-testing.

In October 2017, the US Securities and Exchange Commission (SEC) unanimously approved the PCAOB’s new auditor’s reporting standard, supporting the communication of “critical audit matters” as a way for auditors to provide more information to investors and the public.

For more information on the work of the PCAOB with regards to professional judgment and the auditor, review previous blog postings.

Ethical Lapses Force More CEOs Out of Office

The share of CEOs forced out of office for ethical lapses has been on the rise, according to the 2016 CEO Success study by Strategy&, PwC’s strategy consulting business. The study, which analysed CEO successions at the world’s largest 2,500 public companies over the past 10 years, reports that forced turnovers due to ethical lapses rose from 3.9% of all successions in 2007–2011, to 5.3% in 2012–2016. The 36% increase was due in large part to increased public scrutiny and accountability of executives.

The increase was more dramatic at companies in the US and Canada, where forced turnovers for ethical lapses increased from 1.6% of all successions in 2007–2011 to 3.3% in 2012–2016, or a 102% jump. In Western Europe, the share of CEOs forced out for ethical lapses increased to 5.9% from 4.2%, and in the BRIC countries, to 8.8% from 3.6%.

It is noteworthy that there were 12 women globally appointed to the role of CEO in 2016 – 3.6% of the incoming class. This marks a return of the slow trend toward greater diversity that had been in place over the last several years, and a recovery from the previous year’s low point of 2.8%. The share of incoming female CEOs was highest in the US and Canada, rebounding to 5.7% after falling for the previous three years. Five industries – healthcare, industrials, information technology, consumer staples, and telecom services – did not have a single incoming female CEO in 2016.

Read the full story “More CEOs forced out of office for ethical lapses” at Chartered Accountants Worldwide online. This article was originally published by the Institute of Singapore Chartered Accountants (ISCA) in the June 2017 edition of ISCA Journal. 

Defining the “Public Interest” - Financial Reporting and Assurance Standards Canada

The accounting profession serves the “public interest” but what exactly does the term mean? Canada’s Auditing and Assurance Standards Oversight Council (AASOC) has clarified how it defines the “public interest” in a newly-released paper. The paper, “AASOC’s Consideration of the Public Interest,” outlines who is the public, what are the interests of the public and how the AASOC evaluates whether an action, decision or policy is in the public interest.

To provide a structure for the consideration of the “public,” a stakeholder approach was adopted.  Fostering trust, economic growth and long-term financial stability are of immense importance to the public at large. This makes the public at large, even those who do not invest in capital markets, a stakeholder in our work. The broader public, including those who do not invest in stocks and bonds of individual companies, are also often stakeholders through investment funds, pension plans and as taxpayers.

Present and potential investors, financial institutions and other creditors of private entities and public institutions, including government related bodies and not-for-profit organizations, have a prominence as stakeholders in our considerations. In short, those economic participants who entrust or consider entrusting their money to an entity.

Additional stakeholder groups that are integral to the functioning of audit and assurance services in Canada, each with roles in serving and protecting the public interest, include:

•    audit committees and similar bodies or persons charged with governance, including parliamentary committees;

•    management and financial information preparers;

•    providers of audit and assurance services; and

•    various financial regulators and inspectors.

The paper notes that, "Ultimately, the consideration of whether a particular activity is in the public interest requires the exercise of professional judgment." The exercise of professional judgment includes that we stand back from the full suite of criteria (for example, transparency, public accountability, competence, independence, due process and balancing of potential outcomes) to consider whether the final result is in the public interest." Read the AASOC paper to learn more about the interests of the public and how the AASOC evaluates whether an action, decision or policy is in the public interest.

ICAS – Ethical Decision-Making Framework

According to the Institute of Chartered Accountants of Scotland (ICAS), “There has been a lot in the media recently about Artificial Intelligence (AI). One of the most difficult tasks for any AI designer will be to replicate the ability to place ethical considerations into the decision-making process. Whilst this might be easier for certain aspects, such as determining compliance with a set of rules on auditor independence, it will be much trickier in other areas where a real understanding of the circumstances, and possible available courses of action, is required.”

The ICAS has prepared guidance for those faced with such dilemmas by publishing a Discussion Paper on Ethics Principles and an Ethical Decision-Making Framework. To learn more, read the ICAS discussion paper, The Five Fundamental Ethics Principles: Time for Evaluation? and the ICAS guidance on an Ethical Decision-Making Framework. In addition, review the guidance entitled, What Do You Do Now? Ethical Issues Encountered by Chartered Accountants, and the ICAS ethical dilemmas series called Shades of Grey.

Enhancing Public Trust in the Accounting Profession Using Professional Judgment

A 2004 dissertation empirically examined the impact of ethics instruction and ability on student propensity to use professional judgment in resolving accounting ethics dilemmas. The literature has supported the need for increased ethics instruction in accounting programs as a vehicle to improve ethical decision making in the accounting profession. The significance of the American Institute of Certified Public Accountants (AICPA; 2004) Code of Professional Conduct as the profession’s source of authority relative to ethical decision making was documented.

The Code emphasizes three trust characteristics (ability, benevolence, and integrity) identified in the literature that are important relative to enhancing public trust in the accounting profession. Ability is important to ethics instruction as it determines the extent to which students acquire a working knowledge of the provisions of the AICPA Code of Professional Conduct. The ethical norms contained in the Code’s provisions are derived from the underlying ethical decision-making characteristics inherent in the accounting profession’s organizational culture. These characteristics relate to an individual’s ethics system, ethics application perspective, moral reasoning perspective and level of moral reasoning.

The literature has supported a deontological ethics system, holistic ethics application perspective, orthodox moral reasoning perspective, and conventional level of moral reasoning as appropriate for ethical decision making in the accounting profession. All of these characteristics point to the use of professional judgment rather than personal judgment in the resolution of accounting ethics dilemmas.

According to the author, there are several avenues for future research efforts relative to increasing the use of professional judgment in present and future accounting leaders and ultimately enhancing public trust in the accounting profession. They are (a) replicating the study’s repeated measures experiment to other sample frames within the sample population, (b) extending the repeated measures experiment to other sample populations, (c) conducting a longitudinal study involving student use of professional judgment, (d) preparing and conducting repeated measures experiments that evaluate the impact of the other important trust characteristics of benevolence and integrity on student use of professional judgment, and (e) developing and testing a comprehensive model of professional judgment that incorporates all three of the important characteristics that enhance public trust.

This 100-page dissertation is available online. For more information, read, Enhancing Public Trust in the Accounting Profession Using Professional Judgment Rather Than Personal Judgment in Resolving Accounting Ethics Dilemmas, by Gene R. Sullivan submitted in April 2004 to Regent University School of Leadership Studies in partial fulfillment of the requirements for the degree of Doctor of Philosophy in Organizational Leadership.

New Code of Professional Conduct for Ontario CPAs

In a June 2016 communication, the executive of the Chartered Professional Accountants of Ontario (CPAs) stated that: “As CPAs, we hold ourselves to a high standard in everything we do. We conduct ourselves at all times according to the shared values and ideals of our profession, regardless of position, sector or tenure, and we commit to our profession 24 hours a day, seven days a week. That’s why I am pleased to inform you of a new CPA Code of Professional Conduct  that was recently approved by CPA Ontario’s Council and is now in effect. It will be presented to members for ratification at the next Annual General Meeting in September 2016."

"While most members will not be impacted, the new CPA Code recognizes that our membership provides professional services beyond public accounting. Members providing these services may note a number of changes, such as in the Rules that govern relationships amongst professional colleagues and in Rule 210 Conflicts of Interest, as well as greater guidance provided to clarify common areas of confusion."

"As CPAs, we share common interests, ethics and concerns; now, we share a common philosophy, principles and, indeed, rules of the profession. The inclusion of all professional accountants under a common code — one that reflects the most stringent requirements of the legacy bodies — is one of the benefits of unification."

"Though the CPA Code is built upon foundational pillars — the fundamental principles of professional behaviour, integrity and due care, objectivity, professional competence and confidentiality — the whole is greater than the sum of its parts. Our commitment to its principles is not situational; it does not stop at the end of the working day. In short, as CPAs, we live our lives according to our personal values and professional code — the CPA Code of Professional Conduct. Its purpose is clear, its principles timeless, and its vision defines us not only as a profession but as a community."

For an overview of the new CPA Code, refer to the article, A New Code of Professional Conduct, on page 8 of the Spring 2016 issue of the publication Discussion and Analysis, available online.

Guidance on Professional Judgment for CPAs in China

At a China Press Conference in Beijing on February 15, 2006, Graham Ward, President, International Federation of Accountants remarked that: “The decision by China to converge towards international auditing standards sends a clear message to the world that both the Chinese people and the Chinese accountancy profession are committed to transparency, quality and high professional standards. Support of these standards will benefit not only the accountancy profession, but also, and even more importantly, all Chinese citizens and the Chinese economy as a whole. Why? Because following high, internationally accepted standards builds trust in the audit process; it builds credibility in the information provided by auditors; it builds investor confidence – all of which are vital to the development of your capital markets. As your economy continues to expand, you are far better positioned to improve the quality of life of your citizens.”

He concluded that: “I am proud that IFAC and the CICPA are working together. Through adherence to high professional standards we can, together, bring about social stability and good governance in business. Through convergence to international standards we can, together, deliver our promise of quality. And through acting in the public interest, we can, together, build public trust and sound economies that support a better quality of life for all. I firmly believe that China’s move toward convergence will go a long way towards improving the life and livelihoods of the people of the People’s Republic of China.”

In line with the convergence towards international auditing standards,  Guidance on Professional Judgment for CPAs (released by the Chinese Institute of Certified Public Accountants on March 26, 2015) states that: “the term professional judgment refers to the application of relevant training, knowledge and experience, within the context provided by auditing, accounting and ethical standards, in making informed decisions about the courses of action that are appropriate in the circumstances of the audit engagement.” Accordingly, the guidance makes recommendations related to improvement of the quality of CPA’s professional judgment, recommendations for accounting firms, recommendations for CPAs, recommendations for regulators and recommendations for standard setters.

Learn more about the Chinese Institute of Certified Public Accountants – CICPA and the current situation in China by reading the Overview of the Accountancy Profession in China (released by the CICPA on January 21, 2016). The Overview explains that: “The accountancy profession was introduced to China in the early 20th century, mainly serving the booming national industry and commerce. After the founding of the PRC, the profession had played a vital role in the national economic recovery. It was suspended in the Mid-20th century when China adopted a planned economic system; along with China’s historical economic reform and opening up policies, the accountancy profession was revitalized and reconstructed and grew steadily. With over 30 years of development and growth, the accountancy profession in China is now a widely recognized and respectable profession. Accountants are an important link of integrity chain of the market economy and they are entrusted to safeguard the public interest.”

Teaching Ethics and Professional Judgment

According to an article published in the CPA Magazine, the big themes of morality, the public good and what it means to act with integrity are hot topics for business schools charged with teaching ethics and professional judgment to the next generation of accountants. So, what is the next generation of business leaders being taught about ethics and professional judgment? 

Traditionally, at the undergraduate level, they were taught only what is required by the profession’s code of conduct. Newer courses at some schools involve critical/ethical decision-making frameworks. Students learn what not to do using case studies of old and new ethical breaches that highlight what can happen when judgment/ethics is lacking. They learn about the pressures they’ll face to stay quiet and do nothing if they want to keep a job, protect a gold-standard brand or maintain a steady revenue flow for the company.

Is this enough when, in many cases, professional judgment and ethics don’t become a key focus until students have entered a master’s degree or a CPA professional education program? The article suggests that  “The objective is to make professional accounting students aware of ethical issues and failures so they can advise colleagues and executives on these matters and how to use ethical decision-making in other areas of the organization. They don’t teach business ethics in law school and they don’t stress it in marketing or anywhere else. Because the profession is based on ethics and because CPAs are preparing financial statements and auditing them, they have a lot at stake or should. If you want a culture of integrity, the profession has a big role to play.”

To learn more, read the article Teaching Ethics by Mary Teresa Bitti in the CPA Magazine, January/February 2016 edition. Also, look at other views on the topic of ethics.