A Global Standard for Professional Ethics
Cross-border business concerns
Catherine Allen, CPA and Robert Bunting, CPA | May 2008
- Standard setting organizations in more than 100 countries have adopted the International Federation of Accountants' (IFAC) Code of Ethics for Professional Accountants, while others are in the process of converging with the code. The code applies to professionals in public practice, business, academia and government.
- The IFAC code's relevance for U.S. practitioners has grown as business has become increasingly global and as the AICPA has begun the process of converging its Code of Professional Conduct with the IFAC guidance.
- Under IFAC's Statements of Membership Obligations (SMOs), member bodies agree to use their best efforts to meet these obligations, among them to have standards of conduct that are not less stringent than those of IFAC.
- The IFAC code uses a conceptual framework approach to evaluate relationships or circumstances that raise ethical issues. It requires in many situations that professionals identify and analyze threats to their independence and apply appropriate "safeguards " that eliminate those threats or reduce threats to an acceptable level. The IFAC code addresses most of the same areas as the AICPA code, such as objectivity, independence, due care and confidentiality. IFAC's conceptual framework approach suggests safeguards that may reduce threats in particular circumstances.
If you were traveling on business to Mexico City for the first time, you'd be wise to research the local currency, laws and business etiquette. Similarly, if your audit client operates a major subsidiary in Mexico and your audit report will be relied upon by users of the client's financial statements in Mexico, you need a working knowledge of international professional standards. You should know about the accounting, auditing, ethics and quality control standards that affect the engagement and your accounting practice.
While all of these professional standards are critically important, this article focuses on the international ethics standards—including auditor independence—promulgated by the International Federation of Accountants (IFAC) and how U.S. practitioners may be affected by them. (Co-author Robert Bunting is deputy president of IFAC.) The visibility of the IFAC Code of Ethics for Professional Accountants in the U.S. has grown in recent years as business has become increasingly global and as the AICPA has begun the process of converging its Code of Professional Conduct with the IFAC guidance. If you think global ethics rules are irrelevant for your practice, you may be surprised to learn that CPA firms of all sizes are being asked to confirm their compliance with global standards.
Here are a few scenarios:
- A three-partner firm in Albany, N.Y., is the auditor for a beverage manufacturer. In a major acquisition, a Canadian company purchases the manufacturer. The new parent's auditor asks the U.S. firm to confirm that it is independent of the new owner under international standards.
- A local firm is part of a global accounting association that is deemed, under international standards, to be a network. All firms in the network must be independent of the other firms' audit and review clients in accordance with those standards. In fact, the network requires its members to meet global ethics standards for all multinational assurance engagements.
- A regional firm in southern California serves as auditor of a small Los Angeles-based software developer that acquires a company in Bangalore, India. The Indian company's significant vendors and its lenders expect to rely on the California firm's audit report and, thus, expect the firm to meet global standards.
- A small firm's client expands its business by opening a branch office in China. Lessors, vendors and lenders in China ask the firm to audit the client's financial information in accordance with international auditing standards, which will call for the firm to comply with international ethics standards.
If your client has operations outside the U.S., you should know the professional standards that apply to audits performed in those countries. To do otherwise places your client and your firm at risk. Even if these standards do not affect you today, the constant expansion of global business opportunities and the AICPA's convergence efforts involving auditing and ethics standards will likely impact your practice sooner than you think.
A Common Language for Professional Standards
Many in the profession agree on the value of unified accounting and auditing standards. A similar case may be made for a global ethics standard. Consider this scenario: A Malaysian firm that audits a Malaysian company issues its audit report in accordance with the International Standards on Auditing (ISA), which require the firm to state that it complies with ethical requirements, namely, the requirements set out in the IFAC code. The company acquires your U. S. audit client. The Malaysian auditor would like to rely on your firm's work but, to do so, needs assurance that your firm is independent under IFAC ethics standards. Your firm typically complies with the AICPA independence rules. To the extent those rules have converged with IFAC's rules, you can quickly provide assurances that you are independent under IFAC standards.
For areas in which the codes have not converged, valuable time could be lost in researching IFAC standards and bringing your firm into compliance. If the company is under a time constraint to meet its financial statement deadlines, it may decide to fill its audit needs for the U. S. company by having its Malaysian auditors conduct the audit of the U.S. company from Malaysia, a potentially costly endeavor for the client. Or it may choose to hire another U.S. firm that is IFAC compliant. Either way, your inability to confirm your independence under IFAC standards can lead to you being unable to provide your clients the service they expect. Thus, speaking a common ethics language—the IFAC code—can translate to convenience and lower costs for clients.
Cross-border work, particularly in the audit and tax areas, has grown rapidly in recent years among accounting firms of all sizes. To keep pace with their clients, accounting firms have expanded their scope of practice and expertise through mergers, experienced hires, networking with lawyers and other international experts, and participating in associations of accounting and other professional firms.
Gradually, it has become clear that a single set of professional standards is critical to promoting the efficiency of global capital markets and spurred many to act. Examples of the progress made to date include:
- More than 100 countries require or permit the use of International Financial Reporting Standards (IFRS). Similarly, more than 100 countries use or rely on ISA.
- Beginning in 2005, listed companies in a regulated market in the European Union (EU) were required to apply IFRS in preparing their consolidated financial statements.
- The SEC may decide to permit U.S. companies to file their financial statements using IFRS as soon as 2010.
- U.S. standard setters are working toward converging their standards with accounting and auditing standards of the International Accounting Standards Board (IASB) and International Auditing and Assurance Standards Board (IAASB). While the PCAOB has not announced a convergence project, PCAOB Chairman Mark Olson has stated that convergence of international auditing standards is a goal.
- The World Bank uses the IAASB's ISA as the basis for its Reports on the Observance of Standards and Codes for assessing the quality of national auditing standards.
Consistent with this global momentum, more than 100 standard setting organizations have adopted the IFAC code, while others are in the process of converging with the code. IFAC, an organization whose member bodies include the AICPA, the Canadian Institute of Chartered Accountants, the Japanese Institute of Certified Public Accountants, and professional accountancy bodies in a number of developing and other nations, first issued a code of ethics in 1980. The code applies to professionals in public practice, business, academia and government.
Generally, when your attest work will be relied upon in another country, compliance with that country's code of ethics for accountants becomes essential. Because of the pace of international convergence with the IFAC code, chances are high that non-U.S. users of the audited financial statements will expect you to meet their nationally adopted version of IFAC standards.
U.S. practitioners who operate solely within the U.S. are increasingly likely to be expected to meet requirements on par with those of the IFAC code because, under IFAC's Statements of Membership Obligations (SMOs), member bodies (such as the AICPA) agree to use their best efforts to meet these obligations, among them to have standards of conduct that are not less stringent than those of IFAC.
For the AICPA, this is another reason, in addition to the practical examples illustrated earlier in this article, that its Auditing Standards Board and Professional Ethics Executive Committee (PEEC) closely follow the activities of IFAC standard setters to achieve, to the extent possible, a convergence between U.S. and international rules.
Comparing the Codes
The International Ethics Standards Board for Accountants (IESBA), a standard-setting body of IFAC, establishes and maintains the requirements in the IFAC code. That code uses a conceptual framework approach to evaluate ethical conduct. The code requires in many situations that professionals exercise judgment to identify and analyze threats to their independence and apply appropriate "safeguards " that eliminate those threats or reduce threats to an acceptable level.
The code is comprehensive, addressing most of the same areas as the AICPA Code of Professional Conduct, such as objectivity, independence, due care and confidentiality. IFAC's conceptual framework approach suggests safeguards that may reduce threats in particular circumstances. Nevertheless, the IFAC code is not devoid of rules. In certain instances, the code states that no safeguards may be applied to reduce or eliminate a specific threat, thus prohibitions (that is, rules) are imposed. For example, an audit team member would not be able to apply safeguards to mitigate the self-interest threat created by accepting an expensive gift from a client. Thus, the IFAC code explicitly prohibits the auditor from accepting such a gift.
Generally, the AICPA code is more restrictive than the IFAC code because it is more rules-based and because independence rules often convey what an accountant should not do. Despite the IFAC code's conceptual framework approach, both codes contain prohibitions that are intended to guard against the loss of independence. The AICPA code, for example, prohibits a member of the audit team from having a direct financial interest in the client. The IFAC code contains the same prohibition, which applies even if the auditor claims that safeguards, such as having another accountant check his or her work, would eliminate the threat to independence.
The codes use similar approaches to evaluate independence. Under both, the evaluation begins by determining if a provision in the code directly addresses the situation with a specific requirement. If it does not, the next step is to analyze the threats to independence and the extent to which safeguards are available to eliminate those threats or reduce them to an acceptable level. For example:
Sam Benkert, a CPA and audit partner in a global accounting firm, has been friends with Kevin Smith since college. Sam's largest client is PriceDashers Inc., a regional supermarket chain. He learns from another audit team member that Kevin has just become the vice president of sales at PriceDashers, a highly visible position in the company. Though extremely close friends throughout college and shortly thereafter, in recent years Sam and Kevin generally only see each other once or twice a year.
Is Sam independent? Sam would not find a rule in either code that specifically addresses his situation. The rules in the AICPA code would direct him to the Conceptual Framework for AICPA Independence Standards, a conceptual framework that is quite similar to the IFAC framework. Sam would likely seek consultation in his firm to assess the threats to his independence and that of his firm and determine whether safeguards to protect independence should be applied. The IFAC code provides general guidance for this situation. If he took the same facts and applied the IFAC code, Sam would probably reach a similar conclusion.
In a different example, say, borrowing money from a bank audit client, Sam might reach a different conclusion under the AICPA code because of the more prohibitive rules on this subject in the AICPA code.
How Does The AICPA Converge Its Code With The IFAC Code?
As the body within the AICPA that interprets and amends the AICPA code, PEEC follows a rigorous due process and seeks public feedback on its proposals. PEEC participates in all aspects of the IESBA's standard-setting activities and ensures that the U.S. perspective is adequately considered in the IESBA's deliberations before the standards are exposed for comment.
PEEC also monitors the AICPA code and works to modify it where necessary to bring it in line with the IFAC code. This would typically happen in areas where the AICPA code is deemed to be less stringent than the IFAC code, but in theory could occur when the opposite is true.
Typically, a PEEC-appointed task force would study the relevant issues, perform research and, in a public meeting, lead a discussion of the issues before recommending to PEEC a particular course of action. Any proposed guidance is exposed to membership and other interested parties so that PEEC can better understand the impact the proposed rule may have on AICPA members and the public.
Thus, convergence is a process through which PEEC explores the merits of a new or revised ethics rule in the AICPA code and determines whether the rule makes sense in the U.S. practice environment and provides benefits that surpass the expected costs of compliance.
One illustration of the convergence effort is the August 2007 PEEC proposal of definitions of "network " and "network firm" and a related independence interpretation to provide guidance on when an association of CPA firms would be deemed to be a network. Under the PEEC proposal, which in most respects is consistent with the IFAC rule on network firms, a network would be deemed to exist if firms participating in the association share certain characteristics, such as the use of a common brand name in the firm name or common quality controls or business strategy. A key factor in the proposal is that, where a network exists, all of the firms in the network must be independent of each other's audit and review clients.
Mindful of the significant impact the new rules could have on professionals practicing in CPA firm associations, PEEC solicited comments before and after issuing its proposal. At its January 2008 meeting, PEEC members discussed at length the comments received on this proposal. No decision on a final pronouncement had been made pending consideration by the task force of feedback received through comment letters and during the January meeting.
On The Horizon?
Over the past year, the IESBA has considered several revisions to the code's independence requirements. The AICPA has not determined whether a convergence path is necessary in these areas. One key IESBA debate centered around public interest entities (PIEs) and related audit partner rotation requirements. In evaluating a threat to independence and determining whether safeguards may effectively counteract the threat, the IFAC code requires practitioners to consider the extent of public interest in the entity. In January 2008, the IESBA agreed on new guidance for determining PIEs—considered by IESBA to include listed companies and certain other entities in which there is significant public interest, such as pension plans and financial institutions.
The IESBA agreed to require all key audit partners on the audit engagement team for a PIE to rotate off the engagement team after seven years of service as a key audit partner and refrain from providing services related to the audit of that client for two years. A key audit partner is an engagement partner, concurring reviewer (whether a partner or not) or other partner on the team who makes key judgments on significant audit-related matters regarding the consolidated financial statements. Partners of firms that are unable to implement the rule because they have only a few people with the necessary knowledge and experience to serve as a key audit partner are exempt from the rotation requirement if an independent regulator provides for this type of an exemption and imposes specific alternative safeguards to mitigate the independence threat.
Also in January 2008, the IESBA agreed on a more comprehensive set of independence rules for performing tax services for audit clients. Those rules describe several safeguards and some prohibitions that are largely consistent with the AICPA code, which in some cases exceeds the IFAC requirements.
In July 2007, the IESBA proposed additional revisions to the independence rules addressing internal audit services, economic dependence (relative size of fees) and contingent fees. Final rules are expected in mid-2008. The IESBA has indicated that it will take a hiatus from additional rulemaking for at least two years to give member bodies and firms time to digest the recent changes and conform their codes and practices as needed.
Ben Franklin advised, "Drive thy business or it will drive thee." As CPAs serving a global marketplace and a public interest that spans national borders, we should be engaged in the global process that drives the professional standards by which our conduct and that of our colleagues will be judged. There are many ways to do this, such as staying aware of standard-setting developments and attending public meetings, volunteering to serve on a committee or task force, and, finally, by providing thoughtful commentary on rule proposals.
The U.S. profession must continue its recent efforts to be involved in the global standard-setting process from beginning to end. The real opportunity for shaping future standards is during the research, eliberation and drafting phases, not after standards have been exposed for comment.
Professional accounting organizations, and particularly CPA associations and networks, need to employ their resources wisely to become part of a process that has significant ramifications for their practices and the practices of their constituents.
The International Ethics Standards Board for Accountants establishes and maintains the requirements in the IFAC code. Members of the 2007–2008 Board:
- Five members nominated by IFAC's Transnational Auditors Committee (TAC), which plays a major role in encouraging member firms to meet high standards in the international practice of auditing (currently one from each of the Big Four accounting firms and RSM McGladrey)
- Three public members (from Germany, South Africa and the U.K.)
- 10 members nominated by IFAC member bodies. These board members represent Ireland, the United States, Germany, Canada, Japan, France, Australia, the Netherlands and Spain
IESBA activities are overseen by the Public Interest Oversight Board (PIOB). The PIOB, whose chairman is professor Stavros Thomadakis, comprises individuals from a number of professions and all branches of regulation. Its eight members were nominated by the International Organization of Securities Commissions, the Basel Committee on Banking Supervision, the International Association of Insurance Supervisors and The World Bank.
About the Authors
Catherine Allen, CPA, is the founder of the consulting firm Audit Conduct. Robert Bunting, CPA, is a partner at Moss Adams LLP and is deputy president of IFAC. Their e-mail addresses, respectively, are firstname.lastname@example.org and robert.bunting@mossadams. com.