Accountancy Ethics

Question 1

What is the IRC?

Answer 1

Internal Revenue Code – set of tax laws created by the IRS

Question 2

When may a tax preparer disclose a client’s confidential information?

Answer 2

(1) in a quality review
(2) for processing
(3) to comply with a gov’t agency’s orders

Any other disclosure can receive penalties from the IRS

Question 3

When might a tax preparer be held liable for a return with an understated tax liability?

Answer 3

If the understatement is unrealistic

For 2013, the penalty can be $1,000 or half the income the preparer received from his client

Question 4

What are three different kinds of unrealistic positions for a tax preparer to take?

Answer 4

(1) general/undisclosed positions
(2) disclosed positions – i.e. the preparer marks them out as unsure
(3) tax shelters & reportable transactions

Question 5

What are the standards by which preparers are judged for unrealistic positions?

Answer 5

(1) undisclosed = must have substantial authority to be justified (~40%)
(2) disclosed = must have reasonable basis (~20%) or realistic possibility (~33%)
(3) tax shelters/reportable transactions = must be more likely than not (>50%)

Question 6

What is the penalty for a preparer who fails the due diligence requirements for earned income credits?

Answer 6

As of 2013, $100

Question 7

When would a preparer receive a harsher penalty than usual for a liability understatement?

Answer 7

If it is intentional, the 2013 penalty for which is $5,000

Question 8

Are preparers required to file their clients’ returns electronically?

Answer 8

Yes, unless they file (or expect to file) fewer than ten total returns

Question 9

What is Treasury Department Circular 230?

Answer 9

A number of U.S. Treasury regulations governing the representation of taxpayers before the IRS (e.g. by CPAs, attorneys, or others)

Question 10

What does Circular 230 require preparers to have due diligence for?

Answer 10

Not only (a) the actual preparation of tax returns, but also (b) whatever the preparer communicates to a client about the IRS and (c) any other person’s work upon which he relies

Question 11

What kind of fee can a preparer not charge his client?

Answer 11

A contingent fee – i.e. a fee dependent upon the success or failure of the return with the IRS

There are some exceptions to this, however

Question 12

What contingent fees is a preparer allowed to charge?

Answer 12

(1) returns or refund claims that are challenged by the IRS

(2) judicial proceedings

Question 13

Can a tax preparer retain his client’s records?

Answer 13

No, he should promptly return the records the client needs for his tax duties

The preparer can keep copies, though

Question 14

What is the more-likely-than-not (MLTN) standard?

Answer 14

Teaches that a preparer cannot sign a return without reasonably believing that it is more likely than not correct

Question 15

When may a preparer advise a client to take a position which doesn’t satisfy the MLTN standard?

Answer 15

If it is non-frivolous (i.e. not obviously wrong) and the client is advised to disclose the position to the IRS

Question 16

What are different levels of reporting standards?

Answer 16

(1) more likely than not (>50%)
(2) substantial authority (~40%)
(3) realistic possibility of success (~33%)
(4) reasonable basis (~20%)

E.g., if a certain position must have “substantial authority” backing it, then the preparer should be at least 40% confident his position is right

Question 17

If a tax preparer is aware of potential tax penalties a client might receive, what he should do?

Answer 17

Advise the client of the possible penalties and mention any opportunity he has to avoid penalty through disclosure

Question 18

What is an exploitative position?

Answer 18

A tax position that exploits the audit selection process of the IRS

Tax preparers are forbidden to take these

Question 19

Are preparers allowed to rely on the taxpayer’s say-so?

Answer 19

Yes, a preparer does not ordinarily need to obtain corroboration for a taxpayer’s claims (or for a third party’s)

This obviously has plenty of qualifications; e.g. if info sounds suspicious or incorrect, it deserves further inquiry

Question 20

Can a preparer rely on estimates from the client in lieu of exact data?

Answer 20

Yes, if exact numbers cannot be practicably provided and if the estimates seem reasonable

Question 21

If a preparer comes across an error in an older return of the client’s, whom is he obligated to tell?

Answer 21

He is bound to tell the client, but not the taxing authority – in fact, he is forbidden from telling the authority without the client’s permission (unless required by law)

Question 22

What should a preparer consider if the taxpayer knows of an error but doesn’t want the tax authority to know of it?

Answer 22

He should consider withdrawing from the current-year tax return, and also any future relationship

Question 23

What do state boards of accountancy have authority over?

Answer 23

Establishing requirements for licensing and continuing professional education, and punishing CPAs who violate standards

Question 24

What does Rule 102(e) authorize the SEC to do?

Answer 24

Punish any professional who…

(a) is unqualified to represent others
(b) has engaged in unethical or improper professional conduct
(c) has willfully violated federal securities laws

Question 25

How does the SEC situate “improper professional conduct”?

Answer 25

Worse than simple negligence, but not as bad as recklessness

Question 26

What kind of duties does an accountant ordinarily have towards his client?

Answer 26

Not fiduciary, but contractual – grounded in express and implied duties

Question 27

Can an accountant delegate his contractual duties he has towards a client?

Answer 27

Not ordinarily, since they require personal services

Question 28

Is an accountant liable to discover fraud in a client?

Answer 28

Not ordinarily, though he can be held liable if fraud was not discovered due to negligence

Question 29

What is the standard by which an accountant’s possible negligence is assessed?

Answer 29

A standard of reasonable care – how a reasonable person would behave in the circumstances

Question 30

What is the difference between actual fraud and constructive fraud?

Answer 30

Actual = intentional, i.e. due to scienter (an intent to deceive)

Constructive = unintentional, i.e. due to “reckless disregard for truth”

Question 31

What kinds of accountant wrongdoings can lead to punitive damages from a client?

Answer 31

A civil suit based on negligence or on fraud could involve punitive damages

A contractual breach or a simple negligence case typically wouldn’t

Question 32

To which third parties is an accountant liable for ordinary negligence?

Answer 32

The accountant has tort liability to third parties whom he knew (or ought to have to known) would rely on his work

Question 33

What is the Ultramares doctrine?

Answer 33

(1) the accountant has a duty of care only to parties for whom the accountant’s work was intended
(2) only parties in a contractual relationship (i.e. privity) could hold an accountant as liable for negligence

Name arises from court case Ultramares Corporation v. Touche

Question 34

To which third parties is an accountant liable for fraud?

Answer 34

All third parties that rely on his work, not just intended ones

Question 35

What is a third-party beneficiary?

Answer 35

Someone who may enforce contractual rights despite not being a party to the contract – he gets these rights if the actual contracted parties intend him to receive the benefits of the contracted performance

E.g. if an accountant prepares financial statements for a client to get a bank loan, the bank is a third-party beneficiary

Question 36

How does the Securities Act of 1933 affect an accountant’s liability to third parties?

Answer 36

Section 11 holds an accountant liable for any materially false or misleading statements in a prospectus or registration statement

Any investor who purchased securities covered by it can then sue the accountant

Question 37

To successfully sue an accountant per the 1933 Act, what does an investor need to prove?

Answer 37

Only that a material misstatement was made in the statement by which he bought the securities – not that it was caused by fraud or negligence, nor even that the investor relied upon the misstatement

Question 38

To defend himself from a lawsuit under the 1933 Act, what does an accountant need to prove?

Answer 38

That he exercised due diligence in preparing the prospectus or registration statement

Question 39

How does the time gap between when an accountant reviews a registration statement and the statement’s effective date affect his liability under the 1933 Act?

Answer 39

He is liable for any errors as of the effective date, not the date when he reviewed it – thus he is responsible for any changes to be made between his initial review and the effective date

Question 40

What is the statute of limitations for an accountant’s liability under the 1933 Act?

Answer 40

Action must be taken within one year of the time the error was discovered (or ought to have been discovered) – but the absolute latest is three years from when the securities were issued

Question 41

What are the damages an accountant must pay under the 1933 Act?

Answer 41

The difference in stock price between the amount paid by the investor and the value at the beginning of the lawsuit

If the investor sold the stock, then the damages are the difference between what he bought it for and what he sold it for

Question 42

What is an accountant’s main source of liability under the Securities Exchange Act of 1934?

Answer 42

The financial statements in the Form 10-K

Question 43

Per the 1934 Act, what must an investor prove to successfully sue an accountant who made a material misstatement?

Answer 43

(1) reliance on the misstatement
(2) unawareness of the statement’s falsity
(3) that the price of the stock transacted was affected by the falsity
(4) scienter in the accountant

Question 44

What is the statute of limitations for the 1934 Act?

Answer 44

The same as for the 1933 Act – one year from the discovery of the misstatement, but an absolute max of three years from the securities’ issuance

Question 45

What is the Private Securities Litigation Reform Act of 1995 (PSLRA)?

Answer 45

Amends the Acts of 1933 and 1934, giving guidelines for accountants to disclose corporate fraud

Question 46

What does Title III of PSLRA require?

Answer 46

External auditors to include auditing procedures that analyze:

(1) potential illegal acts
(2) related party transactions
(3) the firm’s ability to be a going concern

Question 47

Under PSLRA, what is the firm’s duty and the accountant’s duty upon discovering an illegal act?

Answer 47

After the accountant reports it to the firm, it is obligated to report it to the SEC within one business day

If it does not do so, the accountant must report it to the SEC himself and/or withdraw from the engagement

Question 48

What is the PCAOB?

Answer 48

Public Company Accounting Oversight Board – established by SOX to oversee audits for companies that issue publicly traded securities

The PCAOB is overseen by SEC

Question 49

Who composes the PCAOB?

Answer 49

Five full-time members, and two maximum can be CPAs

Question 50

What activities does the SEC prohibit an auditor of a public company from engaging in for his client?

Answer 50

Various nonaudit services that could compromise his independence: bookkeeping, actuarial services, valuation, internal auditing, management, etc.

Question 51

Does the SEC require audit partners to rotate off an audit?

Answer 51

Yes, a lead audit partner (or the partner who reviews the audit) must change every five years

Question 52

What rule does the SEC have to prevent conflicts of interest in external audits of public companies?

Answer 52

The company’s officers and controllers cannot have been employed by the audit firm within the past year

Question 53

What duties does the SEC impose upon executives of public companies?

Answer 53

(1) They must be responsible for the reports given to the SEC (e.g. Form 10-K)
(2) They must forgo any profits or incentives from the sale of stock if received twelve months before a restatement of company earnings

Question 54

What sort of ownership does an auditor have over his workpapers?

Answer 54

He truly owns them, so he does not need to give them to the client – yet he has a custodial interest in them, meaning that he cannot disclose their contents to others without the client’s consent

Question 55

What is a benefit of the accountant’s keeping his own workpapers?

Answer 55

He can show the nature and extent of his auditing services if another person needs to see it (e.g. in a lawsuit, or to a successor auditor)

Question 56

What duty does the Federal Trade Commission (FTC) impose on accountants?

Answer 56

Duties concerning privacy practices for any services an accountant provides for a client (though it doesn’t apply if the client is a bank, investment adviser, etc.)

Question 57

What does the FTC require accountants to do?

Answer 57

They must include various disclosures regarding their privacy policy to clients, both for new clients and annually for old clients

Question 58

What kind of privacy information does the FTC require accountants to disclose?

Answer 58

What type of personal info he collects or discloses, to whom he discloses any info, his policy on sharing the info of former clients, how he protects client confidentiality, and so on

Question 59

What does it mean to say that an accountant has “privileged communications” with his client?

Answer 59

He does not have to testify in court about matters discussed with his client (unless the client so desires)

Applies to some state courts, as well as to most noncriminal tax matters before the IRS and federal courts

Question 60

Under what circumstances can an accountant disclose confidential info about a client?

Answer 60

(1) with the client’s consent
(2) under a voluntary, AICPA-authorized quality review
(3) if a court demands it
(4) if required by GAAP or GAAS

Question 61

Under what circumstances can an auditor be held liable for another auditor’s work?

Answer 61

If he relies on the other’s work without mentioning such in the audit report (e.g. by clearly dividing responsibilities)

Question 62

Under what circumstances can an auditor rely on unaudited info?

Answer 62

Ordinarily he is forbidden from doing so

Question 63

How can an auditor avoid liability for misstatements arising from conditions after the auditor completes his fieldwork?

Answer 63

If the audit report is dated on the last day of fieldwork (i.e. as it ought to be dated)

Question 64

What is the auditor’s duty if subsequent events reveal that the audited statements have a material misstatement?

Answer 64

To investigate the situation immediately, to revise the statements (if practicable), and/or to notify anyone relying on the statements

Question 65

Under what circumstances can an accountant be held liable for unaudited statements?

Answer 65

(1) if the pages do not all say “unaudited”
(2) if there is not a disclaimed opinion
(3) if he does not inform the client of any misstatements

Question 66

What kind of violations can give an accountant criminal penalties?

Answer 66

(1) willful violations of the Securities Acts of 1933 and 1934
(2) certain violations of the Internal Revenue Code
(3) certain violations of state laws (usually fraud)

Question 67

What kind of IRC violations can subject an accountant to criminal penalties?

Answer 67

(1) perjury
(2) tax evasion
(3) fraud (including inventory fraud – hiding inventory to evade taxes)