Ch 1 Ethics/Professional/Legal Responsibilities Flashcards
A CPA who fraudulently performs an audit of a corporation’s financial statements will:
A.
probably be liable to any person who suffered a loss as a result of the fraud.
B. be liable only to the corporation and to third parties who are members of a class of intended users of the financial statements.
C.
probably be liable to the corporation even though its management was aware of the fraud and did not rely on the financial statements.
D.
be liable only to third parties in privity of contract with the CPA.
A.
probably be liable to any person who suffered a loss as a result of the fraud.
A CPA who fraudulently performs an audit of a corporation’s financial statements will probably be liable to any person who suffered a loss as a result of the fraud.
The remaining answer choices are an attempt to confuse you with the issue of the Ultramares rule. Recall that the Ultramares decision dealt with a case of a CPA who was negligent as opposed to fraudulent in the conduct of the audit. The Ultramares court ruled that third parties who are not in privity of contract with the accountants cannot sue for negligence (though they can sue for gross negligence).
According to the standards of the profession, which of the following sources of information should a CPA consider before signing a client’s tax return?
I. Information actually known to the CPA from the tax return of another client
II. Information provided by the client that appears to be correct based on the client’s returns from prior years
A.
I only
B.
II only
C.
Both I and II
D.
Neither I nor II
C.
Both I and II
Before signing a client’s tax return, a CPA may rely in good faith without verification upon information provided by the client. However, the CPA should not ignore the implications of other information which has come to his or her attention. This would include information known to the CPA from the tax return of another client. The consideration of this information does not violate any rules regarding confidentiality.
When CPAs fail in their duty to carry out their contracts for services, liability to clients may be based on:
I. breach of contract.
II. strict liability.
A.
Both A and B
B.
Only A
C.
Neither A or B
D.
Only B
B.
Only A
A CPA may be held liable to clients for fraud, negligence, or breach of contract. Strict liability does not require a finding of fault. Common law has generally required some finding of fault in application to CPAs.
The IRS requested client records from a CPA who does not have possession or control of the records. According to Treasury Circular 230, the CPA must:
A.
notify the IRS of the identity of any person who, according to the CPA’s belief, could have the records.
B.
require the client to submit the records to the IRS or withdraw from the engagement.
C.
obtain the records from the client and submit them to the IRS.
D.
contact all third parties associated with the records, such as banks and employers, to obtain the requested records for submission to the IRS.
A.
notify the IRS of the identity of any person who, according to the CPA’s belief, could have the records.
Pursuant to Treasury Circular 230, Section 10.20(a), “A practitioner must, on a proper and lawful request by a duly authorized officer or employee of the Internal Revenue Service, promptly submit records or information in any matter before the Internal Revenue Service unless the practitioner believes in good faith and on reasonable grounds that the records or information are privileged.”
In addition, “Where the requested records or information are not in the possession of, or subject to the control of, the practitioner or the practitioner’s client, the practitioner must promptly notify the requesting Internal Revenue Service officer or employee and the practitioner must provide any information that the practitioner has regarding the identity of any person who the practitioner believes may have possession or control of the requested records or information.”
Hence, the CPA must notify the IRS of the identity of any person who, according to the CPA’s belief, could have the records.
The ability to transfer licensing credential from one state to another is controlled by state boards and reciprocity is not guaranteed. Individuals seeking a particular state’s licensing credential must present:
A.
a form attesting to the fact that the candidate is licensed elsewhere.
B.
authorization for release of score information.
C.
letters of recommendation from the prior jurisdiction.
D.
a letter of intent to transfer between states.
B.
authorization for release of score information.
The correct answer is to present an authorization for release of score information. This rule is not hard and fast, as it is essential to check each state’s rules and regulations. Since the CPA Examination is uniform in all jurisdictions, the scoring is uniform and will be accepted in all locations. The major differences are in experience required to receive a license. However, most states do provide a procedure for this process.
The mission of the Financial Accounting Standards Board (FASB) is to:
A.
establish local rules of accountancy.
B.
enforce IRS rules and regulations.
C.
govern accounting provided by governmental agencies.
D.
improve financial standards for nongovernmental entities.
D.
improve financial standards for nongovernmental entities.
The FASB’s Mission Statement recognizes that their mission is to improve the accounting standards that apply to nongovernmental entities. The FASB plays an integral role in the regulation of the accounting industry as it applies to CPAs and other financial professionals. The FASB’s major function is to establish accounting and reporting requirements for large, publicly held corporations.
The AICPA has made the FASAB the organization that will establish GAAP principles for:
A.
state and local CPAs.
B.
state agencies.
C.
international agencies.
D.
federal reporting entities.
D.
federal reporting entities.
Federal reporting entities will be required to follow the rules established by the Federal Accounting Standards Advisory Board (FASAB) when reporting to the public or other agencies.
Ivor and Associates, CPAs, audited the financial statements of Jaymo Corp. As a result of Ivor’s negligence in conducting the audit, the financial statements included material misstatements. Ivor was unaware of this fact. The financial statements and Ivor’s unmodified opinion were included in a registration statement and prospectus for an original public offering of stock by Jaymo. Thorp purchased shares in the offering. Thorp received a copy of the prospectus prior to the purchase but did not read it. The shares declined in value as a result of the misstatements in Jaymo’s financial statements becoming known. Under which of the following Acts is Thorp most likely to prevail in a lawsuit against Ivor?
A.
Securities Act of 1933 (Section 11)
B.
Securities Exchange Act of 1934 (Section 10(b), Rule 10b-5)
C.
Both the Securities Act of 1933 (Section 11) and the Securities Exchange Act of 1934 (Section 109(b), Rule 10b-5)
D.
Neither the Securities Act of 1933 nor the Securities Exchange Act of 1934
A.
Securities Act of 1933 (Section 11)
Under Section 11 of the Securities Act of 1933, the plaintiff need only show that misstated material information was contained in the prospectus prior to the public offering. Section 10(b)/Rule 10b-5 requires reliance by the purchaser and knowledge of the falsity (scienter) on the part of the CPA.
Professional rules and ethics for CPA tax practitioners that are merely advisory, rather than having formal administrative authority, include which of the following sources?
A.
AICPA Code of Professional Conduct
B.
AICPA Statements on Responsibilities in Tax Practice
C.
Internal Revenue Code
D.
Treasury Department Practice Rules (Circular 230)
B.
AICPA Statements on Responsibilities in Tax Practice
The AICPA Statements on Responsibilities in Tax Practice (SRTP) were issued from 1964 to 1977. On October 31, 2000, the AICPA replaced the SRTP with Statements on Standards for Tax Services (SSTS). Since the SSTS are now the enforceable tax practice standards, the SRTP are merely advisory.
Which of the following bodies promulgates standards for audits of federal financial assistance recipients?
A.
Governmental Accounting Standards Board
B.
Financial Accounting Standards Board
C.
Government Accountability Office
D.
Governmental Auditing Standards Board
C.
Government Accountability Office
The Government Accountability Office (GAO) is a federal agency and has power by law to promulgate standards for audits of federal financial assistance recipients. Because of its position, the GAO is also active in releasing reports concerning audits, Congressional testimony, and the like.
None of the other boards specified is a federal agency that has such power.
In a common law action against an accountant, lack of privity is a viable defense in most jurisdictions if the plaintiff:
A.
is the client’s creditor who sues the accountant for negligence.
B.
can prove the presence of gross negligence that amounts to a reckless disregard for the truth.
C.
is the accountant’s client.
D.
bases the action upon fraud.
A.
is the client’s creditor who sues the accountant for negligence.
Privity of contract is the existence of a contractual relationship between the accountant and the client. Therefore, there is no lack of privity defense in an action brought by the client. In most cases privity is a required element of any lawsuit by an aggrieved party against the accountant. However, privity is not required if the accountant has been guilty of fraud or gross negligence.
A client’s creditor (a third party) suing for mere negligence does not have privity with the accountant and does not fall within either of the mentioned exceptions, and therefore lack of privity of contract is a viable defense against such a lawsuit (under the Ultramares doctrine).
However, recently, many jurisdictions apply the Foreseeable Third-Party Beneficiary Rule, which holds the auditor liable for simple negligence to all third parties who can reasonably be foreseen to rely on the audited financial statements. In such circumstances, the client’s creditor could be a foreseeable third-party beneficiary and lack of privity would not be a valid defense against suit for negligence.
According to the profession’s ethical standards, a CPA would be considered independent in which of the following instances?
A.
A client leases part of an office building from the CPA, resulting in a material indirect financial interest to the CPA.
B.
The CPA has a material direct financial interest in a client, but transfers the interest into a blind trust.
C.
The CPA owns an office building and the mortgage on the building is guaranteed by a client.
D.
The CPA belongs to a client country club in which membership requires the acquisition of a pro rata share of equity.
D.
The CPA belongs to a client country club in which membership requires the acquisition of a pro rata share of equity.
ET Section 191.034 indicates that if membership in a client social club, such as a country club, is basically only for social purposes and the CPA does not serve on the board of directors, then independence would not be violated.
The other answer alternatives, according to ET Section 191, are impairments of independence:
A client leases part of an office building from the CPA, resulting in a material indirect financial interest to the CPA.
The CPA has a material direct financial interest in a client, but transfers the interest into a blind trust.
The CPA owns an office building and the mortgage on the building is guaranteed by a client.
Which of the following pairs of elements must a client prove to hold an accountant liable for common-law negligence?
A.
Freedom from contributory negligence and privity
B.
Breach of the accountant’s duty of care and loss
C.
Willful misrepresentation and breach of the accountant’s duty of care
D.
Scienter and a violation of GAAP
B.
Breach of the accountant’s duty of care and loss
An accountant has a liability due to client’s negligence when:
the accountant breached duty owed of an average, reasonable accountant; and
damages or losses resulted from the breach.
The quarterly data required by SEC Regulation S-K has been omitted. Which of the following statements must be included in the auditor’s report?
A.
The auditor was unable to review the data.
B.
The company’s internal control provides an adequate basis to complete the review.
C.
The company has not presented the selected quarterly financial data.
D.
The auditor will review the selected data during the review of the subsequent quarterly financial data.
C.
The company has not presented the selected quarterly financial data.
An independent auditor of registration filings under federal securities statutes is responsible to certify that he has reasonable grounds to believe that statements involved with the registration are true and that there was no omission to state a material fact required to be stated or necessary to make the statements not misleading.
Management has ultimate responsibility for the accuracy of the information filed with the SEC, but the Securities Act of 1933 extends the responsibility for any false or misleading statements to accountants.
This means that if management omits required quarterly data, the auditor is required to disclose the omission in the report.
Kar, CPA, is a staff auditor participating in the audit engagement of Fort, Inc. Which of the following circumstances impairs Kar’s independence?
A.
During the period of the professional engagement, Fort gives Kar tickets to a football game worth $75.
B.
Kar owns stock in a corporation that Fort’s 401(k) plan also invests in.
C.
Kar’s friend, an employee of another local accounting firm, prepares Fort’s tax returns.
D.
Kar’s sibling is an internal auditor employed part-time by Fort.
D.
Kar’s sibling is an internal auditor employed part-time by Fort.
Auditor independence is a crucial issue in the professional world today. According to the AICPA, Kar is a “covered member” since Kar is part of the engagement performing the audit. We must now dissect the question’s answers.
Kar’s sibling, who is an internal auditor employed “part time” by Fort, Inc., is a problem. It is probable that the sibling could have an “influence” over the firm’s operating or financial policies, or even over the financial statements or their contents. While it is true that the sibling is a part-time employee, the fact that such sibling is in such a position of possible “influence” is overriding. While an internal auditor does not make policy directly, an internal auditor may well influence such policy by recommendations and the like. As such, there is enough influence to consider the person to be in an “oversight role,” which could affect independence. This is the best answer choice.
A covered member may receive a “token gift” from a client. It is presumed that a $75, one-time football game ticket gift is a token gift, particularly if the client already had the tickets in their possession. Therefore, this answer is incorrect.
A quick reading of this scenario might give you the wrong impression—notice that Kar owns stock in a corporation that the Fort Corporation’s 401(k) plan also invests in. It is not Fort, Inc., stock. It is also not Kar’s 401(k) plan. If you did not read carefully, you might assume that this was Fort, Inc., stock owned by Kar’s 401(k), which would be prohibited. Accordingly, this answer is incorrect.
As to the friend that prepares the corporate tax return, there is no prohibition in being friends with people with whom you do not work. There is no sibling relationship. There should be no ability to influence the audit or the tax return. This is one area that might receive more review in the future, but for now it is not prohibited.
A CPA prepares income tax returns for a client. After the client signs and mails the returns, the CPA discovers an error. According to Treasury Circular 230, the CPA must:
A.
document the error in the workpapers.
B.
prepare an amended return within 30 days of the discovery of the error.
C.
promptly advise the client of the error.
D.
promptly resign from the engagement and cooperate with the successor accountant.
C.
promptly advise the client of the error.
When an error is found in a return that has previously been filed with the IRS, the CPA must promptly notify the client of the error. After notification, the CPA should be available to file an amended return to correct the error, if agreed to by the client.
A violation of the profession’s ethical standards least likely would have occurred when a CPA:
A.
purchased another CPA’s accounting practice and based the price on a percentage of the fees accruing from clients over a 3-year period.
B.
received a percentage of the amounts invested by the CPA’s audit clients in a tax shelter with the clients’ knowledge and approval.
C.
had a public accounting practice and also was president and sole stockholder of a corporation that engaged in data processing services for the public.
D.
formed an association—not a partnership—with two other sole practitioners and called the association “Adams, Betts, and Associates.”
A.
purchased another CPA’s accounting practice and based the price on a percentage of the fees accruing from clients over a 3-year period.
ET Section 101.01 notes that a CPA shall be independent in performing professional services. Furthermore, the Professional Ethics Executive Committee (PEEC) looks at the risk involved when establishing its evaluative process concerning independence, so this assessment will determine whether the risk is acceptable or not. Purchase of an accounting practice and the method of valuing the purchase do not violate independence or any other ethical rule. This is a common method of valuing a practice for sale.
The other answer choices involve situations that compromise the ethical position of the CPA, possibly resulting in a violation:
The CPA has a direct financial interest in the clients. (ET 101.02A1)
Whenever a CPA in public practice also has a direct interest in a corporation offering accounting services to the public, the possibility of lack of independence must be carefully monitored. Thus, while this option does not always result in a violation, the high possibility removes it from being considered the “least likely.” (ET 101.05 and 505.02)
Use of the name “Associates” is not permitted because it might mislead the public into thinking a true partnership exists (ET 591.269). Thus, a violation of ET Section 505, “Name of Practice,” would occur.
The AICPA Principles of Professional Conduct provide that those who set out to deliver accounting services as a CPA will hold themselves out as:
A.
public servants for the greater good.
B.
professionals.
C.
individuals that will honor the public trust.
D.
None of the answer choices are correct.
C.
individuals that will honor the public trust.
ET Section 0.300.030 (“The Public Interest”) provides that those who accept membership will do so only as long as they honor the public trust.
In which of the following types of action, brought against a CPA who issues an audit report containing an unmodified opinion on materially misstated financial statements, may a plaintiff prevail without proving reliance on the audit report?
A.
An action for common law fraud
B.
An action for common law breach of contract
C.
An action brought under Section 11 of the Securities Act of 1933
D.
An action brought under Rule 10b-5 of the Securities Exchange Act of 1934
C. An action brought under Section 11 of the Securities Act of 1933
A plaintiff does not have to prove reliance on materially misstated financial statements under Section 11 of the Securities Act of 1933.
Complaints can be filed against CPAs in most jurisdictions through online reporting sites or the state site itself. Reporting a violation requires that the person reporting:
A.
has an attorney file the complaint.
B.
lists his or her name for verification of the complaint.
C.
file the appropriate complaint form.
D.
None of the answer choices are correct.
D.
None of the answer choices are correct.
None of the answer choices are requirements for reporting a violation. Each jurisdiction sets its own standards for the filing of complaints, but generally, any method of filing with the state board of accountancy will suffice. In Texas, for example, a simple letter is appropriate and it is not necessary to include your name. (Texas Occupations Code, Chapter 901 (Public Accountancy Act))
Under the common law, which of the following defenses, if used by a CPA, would best avoid liability in an action for negligence brought by a client?
A.
The client was contributorily negligent.
B.
The client was comparatively negligent.
C.
The accuracy of the CPA’s report was not guaranteed.
D.
The CPA’s negligence was not the proximate cause of the client’s losses.
D.
The CPA’s negligence was not the proximate cause of the client’s losses.
Under common law, CPAs are liable to their clients for failure to exercise due professional care. Accordingly, ordinary negligence is a sufficient degree of misconduct to hold CPAs liable for damages caused to their clients. The CPA will not be held liable if losses are not the result of the CPA’s negligence. If the CPA’s negligence did not cause the losses, there would be no liability to the CPA.
Defenses available to the CPA include the following:
The CPA was not negligent or fraudulent.
Contributory negligence of the client caused the loss.
The CPA adhered to GAAS and planned audit examination to search for material fraud.
The error was immaterial.
The proximate cause of loss was not the erroneous financial statements.
To which of the following parties may a CPA partnership provide its working papers without either the client’s consent or a lawful subpoena?
A.
The IRS: Yes; The FASB: Yes
B.
The IRS: Yes; The FASB: No
C.
The IRS: No; The FASB: Yes
D.
The IRS: No; The FASB: No
D.
The IRS: No; The FASB: No
Generally, clients must be asked whether their materials can be released to other parties. Here, however, the question’s proper answer hinges on other matters.
Though the FASB is a governing board for accounting standards, it has neither the inherent ability nor the power to require CPAs to provide copies of working papers to the board. It is not a licensing (or regulatory) board, such as a state board of public accountancy.
The IRS has tremendous and broad administrative powers, particularly in criminal matters, yet it must still follow the law and follow due process procedures. The key to understanding this part of the question is the lack of a lawful subpoena being noted as having been issued. Once a subpoena has been issued, compliance will be necessary. Notice, however, that a third party, the judiciary, has independently reviewed the IRS’s materials and determined that probable cause or other appropriate justification is present to issue the subpoena. Unlike an attorney, a CPA does not have absolute privilege, although tax workpapers have some limited privilege. It is not clear here whether such requested records are tax or other working paper
The Financial Accounting Standards Board (FASB) structure is such that it is:
A.
tied directly to governmental agencies.
B.
independent of all other business and professional organizations.
C.
not able to reach all accountants equally.
D.
operated in a manner that is consistent with government policy.
B.
independent of all other business and professional organizations.
FASB is independent of all other business and professional organizations. It is part of a larger structure that helps to achieve consistent standards and improve financial accounting standards.
The National Association of State Boards of Accountancy (NASBA) is in place to establish standards for providers of continuing professional education (CPE) units throughout the country. The organization also works to:
A.
establish uniform rules of accountancy for all 54 U.S. Boards.
B.
require CPE program sponsors to provide program-level content.
C.
provide background checks on candidates.
D.
promulgate rules surrounding continuing education.
B.
require CPE program sponsors to provide program-level content.
State boards dictate the rules and expectations of licensure within their individual jurisdictions, so the NASBA is tasked with monitoring CPE programs for accuracy and content. Keep in mind that not every jurisdiction has the same education requirements, so it is essential to check with each locale in order to determine what is necessary and what is not.
