Essential CPA Ethics, Independence, and Professional Judgment Concepts

Posted on Nov 28, 2025 in Philosophy and ethics

Case 1-2: Giles & Regas Independence Conflict

A romantic relationship between a supervising partner and an audit team member on the same engagement jeopardizes the audit and creates a conflict of interest, risking independence in appearance.

Threats and Analysis

Threats: Familiarity (Primary), plus possible Undue Influence / Self-Interest.
Analysis Lenses: Virtue (favors avoiding risky relationships at the outset) and Responsibilities/Duties.

Risk-Based Approach Steps

Identify and evaluate threats.
Apply Safeguards: Disclose to leadership, remove one person or break the supervision/review link, consider independent review, and notify governance if appearance could be affected.
Document and monitor.

Principles Implicated: Integrity; Objectivity & Independence; Due Care; Responsibilities; and Scope & Nature of Services (when deciding to accept/continue).

Case 1-7: Time Reporting Integrity (Ghost-Ticking)

Pressure to underreport hours (“eating time”) or check off steps not performed (“ghost-ticking”) violates time-reporting integrity and constitutes fraudulent documentation.

AICPA Principles and Response

Principles Implicated: Integrity (most clearly violated when falsifying documentation), Due Care (do all required work competently and completely), and the Public Interest (do not mislead stakeholders). For attest work, this can also be an act discreditable.
Correct Response: Record actual time, never ghost-tick, state the principles, and escalate through firm channels if pressured.
Why It Matters: It erodes audit quality, misleads budgeting/oversight, and undercuts trust in the profession.

Scott London: Confidentiality Breach and Undue Influence

KPMG audit partner Scott London leaked client Material Nonpublic Information (MNPI) to a friend for cash/gifts, a classic breach of Confidentiality that also violates Integrity and Objectivity/Independence.

Threat Label: Undue Influence (pressure from a close relationship plus quid pro quo), not Self-Interest or Familiarity.
Independence: Independence in appearance is clearly impaired.
Principles Implicated: Integrity, Objectivity & Independence, Confidentiality. (This is acts discreditable territory.)
Risk-Based Approach: Identify the threat → evaluate significance → apply safeguards (e.g., resign/withdraw, governance notification, discipline) → document/monitor.

EY / Sealed Air: Independence Impairment and PCAOB Rule 3526

During Sealed Air’s 2014 auditor RFP, EY partners solicited and used nonpublic information from the company’s then-CAO to gain an inside track. EY failed to communicate required independence matters to the audit committee (PCAOB Rule 3526), won the job, and signed the 2015 audit while independence was impaired (appearance and fact). Sealed Air later dismissed EY (2019), and the SEC sanctioned EY in 2021 ($10M).

Key Takeaways for Exams

Threats Labeled: Advocacy, Undue Influence, Familiarity, and Self-Interest. Watch for employment negotiations risk.
Principles Hit: Objectivity & Independence, Integrity, Public Interest.
Independence Status: Impaired—appearance and fact.
Required Communication: PCAOB Rule 3526 written disclosures to the audit committee.
Right Response: Identify/evaluate threats → disclose in writing → decline or withdraw if threats can’t be reduced to an acceptable level → document/monitor.

Case 4-3: Undue Influence and GAAP Cutoff Violation

A year-end push to record December sales before shipment constitutes a GAAP cutoff violation (revenue should be recognized only when control passes).

Threat Label: Undue Influence (management pressure/coercion).
Principles Implicated: Integrity and Objectivity.
Required Response: Refuse the improper entry, explain cutoff, escalate (controller/CFO → audit committee/board if needed), and document.

Virtue Ethics and CPA Professional Standards

Virtue ethics focuses on your character, which leads to habits and consistent conduct. Aristotle’s virtues (honesty/integrity, open-mindedness, reliability, prudence) match CPA principles:

Integrity
Objectivity/Independence
Due Care (prudence/judgment)
Public Interest

In scenarios, pick the action that shows steady habits: pause and think (skepticism), consult, weigh stakeholders, and document your reasons—even when no rule spells it out.

Q: Which CPA principle best shows practical wisdom? Due Care (prudence, competence, consultation, documentation).
Q: Which behaviors show habituated virtue? Routinely telling the whole truth, escalating concerns that affect the public, seeking a second review, and writing a clear audit trail.

Six Pillars of Character: Trustworthiness Components

Trustworthiness has four essential parts:

Honesty: Tell the truth; no deception.
Integrity: Moral courage and consistency.
Reliability: Keep promises.
Loyalty: Protect confidences (but never above ethics or the public interest).

What is not Trustworthiness: Fairness (impartiality), Caring (empathy), Respect (civility), Responsibility (accountability), Citizenship (civic duty).

Sorting Examples

“Keeping promises” → Reliability (Trustworthiness)
“Telling the whole truth” → Honesty (Trustworthiness)
“Impartial decisions” → Fairness
“Empathy for users” → Caring
“Own mistakes/meet deadlines” → Responsibility
“Civility/listening” → Respect

AICPA Public Interest Principle and Auditor Duty

“The public” includes investors, creditors, clients’ employees, regulators/government, and the broader market/community who rely on truthful financial information. Your first duty is to public trust.

When there is a clash, choose Integrity and Objectivity/Independence: tell the whole truth, use evidence and skepticism, consult, disclose/escalate, and document (and withdraw if threats cannot be reduced).

Exam Q (Likely): Your client asks you to remove a required disclosure because “it makes us look bad.” Best answer: Keep the disclosure, explain the public-interest duty, elevate to governance if needed, and document—do not hide it to please the client.

IMA Credibility Standard: Communication and Disclosure

Credibility means you must:

Communicate information fairly and objectively.
Disclose all relevant information users need.
Report in a timely and accurate way.

Pick the option that shows unbiased reporting, full context (assumptions/limitations, risks), quick corrections, and on-time accuracy.

Distractors (Other IMA Standards)

“Maintain professional competence/follow laws” = Competence
“Keep information confidential/do not misuse it” = Confidentiality
“Mitigate conflicts/avoid acts discreditable” = Integrity

Integrity in Decision-Making: Avoiding Subordination

Integrity involves honesty without deception and the strength/courage of one’s convictions—act consistently with values, tell the whole truth, and do not let loyalty or pressure bend your judgment.

This requires complete & accurate communications, no misrepresentation, and no subordination of judgment when pushed by a boss or client. Integrity ties directly to serving the public interest with objectivity and due care.

What Integrity Is Not: “Results-only” thinking, expediency (cutting corners), or blind loyalty.

MCQ Flashes

Boss: “Sign off now; we’ll fix evidence later.” → Wrong (don’t misrepresent / don’t subordinate judgment).
Which best reflects integrity? “Provide complete, accurate disclosure even if unpopular.” (Correct)
Which is not integrity? “Do whatever works to meet targets.” (Not Integrity)

Independence: Spousal and Close Relative Relationships

If you are on (or can influence) an audit/attest job, you must be independent in fact and in appearance. A spouse is immediate family; if your spouse holds a key position at the client (e.g., CEO/CFO/financial reporting), independence is impaired—period.

Classic Example: CPA on the attest team whose spouse is the client’s CEO → Familiarity threat and fails the independence test.
Risk-Based Steps: Identify the threat → evaluate it → try safeguards (e.g., remove/reassign people, independent review) → if the threat cannot be reduced to an acceptable level, independence is impaired and you cannot continue the engagement.
Threat Labels: Familiarity (primary); possibly Self-Interest and Undue Influence.

Duty of Public Accounting: The Public Watchdog Role

Our first duty is to the public interest—investors, creditors, regulators, and the market—not just pleasing one client. Auditors serve a public-watchdog role: work with independence, objectivity/impartiality, integrity, and enough appropriate evidence to back opinions.

When client wishes clash with transparency, pick the action that protects the public trust: keep needed disclosures, get more evidence, escalate to governance, or modify/withdraw—not “keep it quiet to keep the client.”

Legal Compliance Versus Ethical Requirements

Law sets the minimum (the floor) of what is allowed; ethics asks what is right for stakeholders and often demands more. Avoid the rationalization: “If it’s not illegal, it can’t be wrong.” Legal compliance does not equal ethical conduct.

In gray areas, lean on integrity/objectivity and protect the public interest: tell the whole truth, disclose early, get enough evidence, consult, escalate, and document.

MCQ Likely: “A disclosure can legally be delayed until quarter-end. Which option is most ethical?” → Answer: “Disclose the risk now so users aren’t misled,” because ethics goes beyond mere legal compliance.

Situational Ethics and Common Rationalizations

Situational ethics recognizes context but easily slides into rationalizing bad choices. Know the classic lines:

“Everyone does it.”
“No one is hurt.”
“If it’s not illegal…”
“The other guy’s worse.”
“Just this once” (The slippery slope/incrementalism problem).

On exams, spot and reject these by choosing the response that keeps reporting truthful, complete, timely, and unbiased.

MCQ Likely: “Which statement is a rationalization?” → Answer: “It’s a tiny tweak and we’ll fix it next quarter” (Minimization + Slippery Slope).

Auditor’s Reports: Opinion Types and Pervasiveness

Audit opinions are sorted by two triggers: material vs. pervasive and GAAP departure vs. scope limitation.

Unmodified/Unqualified: Statements present fairly under GAAP.
Qualified: Problem is material but not pervasive (GAAP departure or scope limitation).
Adverse: GAAP problems are material and pervasive—statements do not present fairly.
Disclaimer: Cannot obtain sufficient appropriate evidence, and possible effects could be pervasive; no opinion expressed.

MCQ Likely: “Management blocks inventory observation; inventory is huge.” → Disclaimer (pervasive scope issue). If inventory were small, Qualified for scope.

Misappropriation of Assets (Defalcation) vs. Fraudulent Reporting

Misappropriation of assets (often called defalcation/embezzlement) is stealing or misusing the company’s assets (e.g., skimming cash, fake vendors).

This is one of the two fraud buckets. The other is fraudulent financial reporting, which manipulates the numbers to mislead users. Auditors provide reasonable assurance the financial statements are free of material misstatement.

MCQ Likely: “Cash receipts clerk diverts customer payments to a personal account and hides it with false entries. What is it?” → Misappropriation/Defalcation (asset theft).

Rest’s Four Components of Ethical Action

Your values shape what you notice, how you decide, and whether you follow through. Rest’s model states that ethical action requires all four components:

Moral Awareness: See the ethical issue.
Moral Judgment: Decide the right action.
Moral Motivation/Intent: Put ethical values ahead of nonethical ones (like bonuses).
Moral Character/Action: Have the courage and persistence to act.

A failure at any step breaks behavior. Your personal “lens” influences where you are strong or weak.

MCQ Likely: “Analyst spots a disclosure problem (awareness) and knows the right fix (judgment) but stays silent to protect a bonus. Which component failed?” → Motivation/Intent (and then Action).

Philosophical Reasoning: Matching Ethical Frameworks

Match the question to the method:

Consequences/Utilitarianism: “Which choice creates the greatest overall good for those affected?” (Maximizes total benefit.)
Rights/Duties (Deontology): “What duties/rights apply here, and are we respecting people as ends, not means?”
Justice/Fairness: “Are equals treated equally and outcomes fair behind a ‘veil of ignorance’?”
Virtue: “What would a person of good character (a virtuous CPA) do—what builds integrity and good habits?”

Kohlberg’s Stages of Moral Development

Level 1: Pre-conventional
- Stage 1: Obey rules to avoid punishment.
- Stage 2: Self-Interest (“what’s in it for me?”).
Level 2: Conventional
- Stage 3: Seek approval / “good team player.”
- Stage 4: Law-and-Order / duty to rules and authority.
Level 3: Post-conventional
- Stage 5: Social Contract (laws serve broader values; may question bad rules).
- Stage 6: Universal Ethical Principles (act from deep principles like justice/rights even against rules).

MCQ Likely: “Auditor follows a policy because ‘rules must be followed to keep order.’” → Stage 4. “Whistleblower acts because fairness and truth matter even if punished.” → Stage 6.

System 2 Thinking and Professional Skepticism

System 2 is the slow, careful, effortful way of thinking used when you pause, gather more evidence, consider alternatives, and document why. It helps fight quick, biased System 1 reactions like availability, confirmation, overconfidence, and anchoring, and it pairs with professional skepticism.

MCQ Likely: Last-day pressure to accept copies of key documents because “we’ve never had a problem”—what’s the System 2 move? Slow down, get original evidence, consult, and document (don’t shortcut).

Giving Voice to Values (GVV) Methodology

GVV is about how to act on your values at work. The process involves:

Rehearsing what you will say.
Mapping stakeholders (who is affected; who can help).
Preparing counter-arguments to common rationalizations.
Crafting a practical script.

MCQ Likely: Which prompt is NOT GVV? Answer: “Which choice maximizes total benefit?” (That is utilitarian analysis.)

WorldCom / Betty Vinson: Dissonance and Slippery Slope

The case shows the tension between beliefs and actions: Vinson knew the entries were wrong but gave in to pressure (“just this once”), then the slippery slope made it hard to stop. This is classic cognitive dissonance and rationalization under authority/loyalty pressure.

MCQ Likely: “Which theme does Vinson illustrate?” → Belief–action gap (dissonance) under pressure.

Ethical Dissonance Model: Person-Organization Fit

This model looks at the fit between a person’s ethics and the organization’s ethics across four patterns:

High-High: Good fit.
Low-High: Strong personal ethics / Weak organization ethics. (Pressure to “go along.”)

In the Low-High case, likely responses are to voice/raise concerns, seek safeguards/changes, and if nothing improves, exit.

MCQ Likely: “Staff with strong ethics in a low-ethics culture refuses to book a premature sale and escalates—identify the fit and expected response.” → Low-High fit; voice/escalate.

Independence Safeguards: Client, Profession, and Firm

Safeguards come from three sources:

Profession/Regulators: PCAOB inspections, state board discipline, required CPE.
Client: Ethical “tone at the top,” active, independent audit committee, qualified staff, hotlines, and policies to follow laws.
Firm: Strong quality-control system, annual independence representations, consultation with the audit committee, and enforcement of procedures.

Resolving Conflicts: Public Interest vs. Firm Expectations

Your primary duty is to the public (investors, creditors, the market), not to keeping a client happy. When revenue or retention pressure conflicts with objectivity, you choose public trust and independence, supported by the profession’s “public watchdog” role.

Professional Skepticism and Judgment Documentation

Skepticism is a questioning mind that looks for reliable evidence and challenges management when needed. The KPMG Professional Judgment Framework stresses mindset, consultation, considering alternatives, weighing evidence, and documenting your thinking. Good documentation includes alternatives considered, contrary evidence, and why the conclusion was reached.

Team Judgments: Mitigating Groupthink and Anchoring

Teams can slip into groupthink and conformity, or get stuck on first numbers (anchoring). To reduce this, emphasize structured consultation, inviting dissent, and planned brainstorming so alternatives and risks are discussed early and openly.

Whistleblowing: Independence Threats and Rationalizations

When speaking up about wrongdoing, independence can be threatened in three common ways:

Undue Influence: Pressure or retaliation threats to shut you up.
Advocacy: Acting as a promoter/advocate in a dispute or litigation.
Self-Interest: Personal gain or fear (e.g., bounty money or job security).

MCQ Likely: “Controller warns you you’ll be taken off the engagement if you escalate a suspected fraud.” → Undue Influence threat.

Consulting vs. Assurance: Independence Requirements

Audits and reviews serve the public interest and require independence; consulting serves the client’s interest and does not require independence. Use the Scope & Nature of Services idea to avoid management participation or self-review.

MCQ Likely: “Which situation most threatens independence?” → “The audit firm designs and implements the client’s financial system and then audits it” (Self-Review/Consulting–Assurance conflict).

AICPA Conceptual Framework for Independence

Follow the risk-based steps: identify threats → evaluate significance → apply safeguards → document/monitor. If threats cannot be reduced to an acceptable level, independence is impaired.

Seven Threat Names: Self-Interest, Self-Review, Advocacy, Familiarity, Undue Influence, Management Participation, and Structural/Adverse-Interest.

KPMG Professional Judgment Definition

Judgment is the process of reaching a decision in uncertainty by weighing evidence and choosing among reasonable alternatives. The framework reminds you to keep the right mindset, consider alternatives, consult, evaluate evidence, and document why you concluded what you did (skepticism throughout).

Client Safeguards: Limitations and Exceptions

What clients can do: Set an ethical tone at the top, run a hotline, staff qualified personnel, and have an active independent audit committee.

What clients cannot do: They cannot set or run your firm’s quality-control or independence policies—those are firm or profession/regulator safeguards.

Independence Risk-Based Steps Summary

Follow the framework:

Identify threats.
Evaluate their significance.
Apply safeguards.
Document and monitor.

If threats cannot be reduced to an acceptable level, independence is impaired and you must not proceed.

Confidentiality: Permitted Disclosures

Client information is confidential, but disclosure is permitted in specific situations:

To a successor auditor during a proper client-authorized communication.
In a peer review or inspection.
In response to a valid subpoena or law/regulation (e.g., Dodd-Frank whistleblowing).
To defend yourself in an investigation.

Outside of these, get client consent.

Contingent Fees and Commissions for Attest Clients

For attest clients, contingent fees and commissions are prohibited (audit/review, certain compilations, examinations of prospective info, and preparing original/amended tax returns). For non-attest work, some contingent fees/commissions are permitted with required disclosure.

MCQ Likely: “CPA earns a commission from an audit client for referring software—OK?” → No, prohibited.

Tax Standards (SSTS & Circular 230) Probability Thresholds

Memorize the four thresholds:

Reasonable Basis: ≈ 20%
Realistic Possibility: ≈ 1/3
Substantial Authority: ≈ 40%+
More-Likely-Than-Not (MLTN): > 50%

When advising a client (SSTS No. 1), aim for Realistic Possibility (~1/3). If below that but ≥ Reasonable Basis (~20%), advise only if you tell the client to disclose. When signing/preparing a return (SSTS No. 2), you may sign at Reasonable Basis if disclosed, and you must follow any stricter rule (e.g., Circular 230 requires MLTN for certain shelters).

Dual Representation Conflicts (Circular 230)

Circular 230 says do not represent clients if there is a conflict of interest (clients are directly adverse or your duties would materially limit you).

A conflict can be waived only if:

You reasonably believe you can still represent each client competently and diligently.
The representation is not illegal.
Each client gives informed consent in writing when the conflict is known (no later than 30 days).

Note: Conflicts cannot be waived when an engagement requires independence under AICPA rules.

Conformity and the Asch Experiment: Group Influence

The Asch studies show people often go along with the group even when they doubt it. Two forces drive this:

Normative Influence: Conform to fit in/avoid rejection.
Informational Influence: Conform because you think the group knows more.

MCQ Likely: “Staff stays quiet to avoid looking difficult even though she thinks revenue is misstated—what influence?” → Normative.

Ethical Blind Spots and Cognitive Biases

Motivated Blindness: Looking away from a problem because seeing it would cost you (e.g., protecting client fees).
Outcome Bias: Judging a decision by how it turned out instead of the quality of the process/evidence.
Bounded Ethicality: Good people act against their values without noticing due to time pressure or hierarchy.
System 1 Biases: Fast, automatic snap-judgments (e.g., anchoring/confirmation). Fight them with System 2.

Psychology Behind Good Judgment (Lauck)

Halo Effect: A big positive first impression spills into later judgments (e.g., rating risks lower after hearing management is “world-class”). Fix it by separating impressions from evidence.
Regression to the Mean: Extreme results usually move back toward average; do not overreact to one quarter.
Directional Goals: Being pulled toward the outcome we want; deliberately search for contrary evidence.
Randomness & Patterns: People see patterns in noise; use tools as red flags, not proof.

MCQ Likely: “You lowered control risk mainly because the partner called the client ‘world-class.’ What bias?” → Halo effect.

Management Representation Letters

Near the audit end, management (e.g., CEO/CFO) signs a representation letter stating they:

Prepared the statements.
Gave all relevant information.
Assessed ICFR.
Maintained effective controls.
Disclosed any deficiencies.

This letter supports integrity but does not replace audit evidence. If reps look untruthful, raise skepticism, inform the audit committee, and modify/withdraw.

MCQ Likely: “Which sentence belongs in the rep letter?” → ‘We provided all relevant financial records and related data.’