Missed MCQ's Unit 2 11.16.23 Flashcards
Which of the following facts must be proven for a lender to prevail in a state-law negligent misrepresentation action against a CPA who prepared a borrower’s tax return that was disclosed to the lender?
A. The misrepresentations concerned opinions.
B. The misrepresentations were in writing.
C. The plaintiff justifiably relied on the misrepresentations.
D. The defendant made the misrepresentations with a reckless disregard for the truth.
C. The plaintiff justifiably relied on the misrepresentations.
Negligent misrepresentation occurs when the accountant makes a false representation of a material fact not known to be false but intended to induce reliance. The plaintiff must reasonably have relied on the accountant’s misrepresentation and incurred damages.
Under the traditional doctrine rule, to which of the following parties will a CPA be liable for common law negligence?
D. Parties in Privity = Yes
Foreseen Parties = No
The traditional rule was that a CPA was liable for negligence only to a plaintiff that was in privity of contract with the CPA or a primary beneficiary of the engagement. This was the holding of a case decided in 1931. Typically, a third party is considered to be a primary beneficiary if (1) the CPA is retained principally to benefit the third party, (2) the third party is identified, and (3) the benefit pertains to a specific transaction.
In a nonstatutory action against a CPA, lack of privity is a viable defense if the plaintiff
A. Is the client’s creditor who sues the CPA for negligence.
B. Is the CPA’s client.
C. Bases the action upon fraud.
D. Can prove the presence of gross negligence that amounts to a reckless disregard for the truth.
A. Is the client’s creditor who sues the CPA for negligence.
A CPA’s liability for negligence may be restricted to those parties in privity of contract or who are primary beneficiaries of the engagement. The liability of the CPA also may extend to foreseen third parties. Some courts hold that reasonably foreseeable third parties have standing to sue. Thus, (1) the nature of the action, (2) the nature of the plaintiff, and (3) the jurisdiction whose law is to be applied determine whether lack of privity is a possible defense. A creditor of the client who sues for negligence is more likely to be subject to the defense than a party whose suit is based on gross negligence or fraud.
One traditional test of whether a third party can recover from an accountant for negligence is the primary benefit test. Which of the following has standing under the primary benefit test?
A. A shareholder of the client.
B. A bank that is considering a loan to the accountant’s client and is waiting for the tax returns on which to base its decision.
C. A bank when the accountant was aware tax returns would be sent to many banks as part of loan applications by the client.
D. A general trade creditor of the client.
B. A bank that is considering a loan to the accountant’s client and is waiting for the tax returns on which to base its decision.
Under the primary benefit test, the accountant must have been aware that (s)he was hired to produce a work product to be used and relied upon by a particular third party. This is the narrowest test, and most courts allow such a third party to sue the accountant for ordinary negligence.
If a CPA recklessly departs from the standards of due care when conducting an audit, the CPA will be liable to third parties who are unknown to the CPA under the law of
A. Negligence.
B. Strict liability.
C. Breach of contract.
D. Gross negligence.
D. Gross negligence.
In some states, if the CPA has not contracted to perform for the third party, (s)he is not liable to that third party for negligence. Lack of privity is a defense. However, reckless departure from the standards of due care is treated as a form of constructive fraud and results in liability to foreseeable third parties for gross negligence that may be unknown to the CPA.
Ritz Corp. wished to acquire the stock of Stale, Inc. In conjunction with its plan of acquisition, Ritz hired Fein, CPA, to audit the financial statements of Stale and to prepare its state and federal income tax returns. Based on these documents, Ritz acquired Stale. Within 6 months, it was discovered that Stale’s revenues and taxable income had been grossly overstated. Ritz commenced an action against Fein. Ritz believes that Fein failed to exercise the knowledge, skill, and judgment commonly possessed by CPAs in the locality but is not able to prove that Fein either intentionally deceived it or showed a reckless disregard for the truth. Ritz also is unable to prove that Fein had any knowledge that revenues and taxable income were overstated. Which of the following two common law causes of action provide Ritz with proper bases upon which Ritz will most likely prevail?
A. Gross negligence and breach of contract.
B. Negligence and gross negligence.
C. Negligence and breach of contract.
D. Negligence and fraud.
C. Negligence and breach of contract.
A CPA’s nonstatutory liability to a client can be based upon breach of contract, negligence, or fraud. A breach of contract occurs when an accountant fails to perform duties required under a contract. These duties can either be express or implied. All contracts carry the implied duty to perform in a nonnegligent manner. To prevail in an action for negligence, the client must prove that the CPA did not act with the same degree of skill and judgment possessed by accountants in the locality. In an action for fraud, the client must prove scienter (intent to deceive or a reckless disregard for the truth). Ritz most likely prevails in an action brought for negligence or breach of contract if Fein failed to perform with the knowledge, skill, and judgment commonly possessed by CPAs in the area.
Under the position taken by a majority of state courts, to which third parties will a CPA who negligently prepares a client’s tax return be liable?
A. Any third party whose reliance on the tax return was reasonably foreseeable.
B. All third parties who relied on the tax return and sustained injury.
C. Only those third parties in privity of contract with the CPA.
D. Any foreseen or known third party who relied on the tax return.
D. Any foreseen or known third party who relied on the tax return.
The majority rule is that the CPA is liable to foreseen (but not necessarily individually identified) third parties (foreseen users and users within a foreseen class of users).
If a CPA is engaged by an attorney to assist in the defense of a criminal tax fraud case involving the attorney’s client, information obtained by the CPA from the client after being engaged
A. Is not privileged in jurisdictions that do not recognize an accountant-client privilege.
B. Will be deemed privileged communications under certain circumstances.
C. Is not privileged because the matter involves a federal issue.
D. Will be deemed privileged communications provided that the CPA prepared the client’s tax return.
B. Will be deemed privileged communications under certain circumstances.
The attorney-client privilege protects the information. The defendant is the client of the attorney, and the CPA is the agent of the attorney. Thus, communications between the CPA and the defendant are, in effect, between the attorney and the defendant. However, if the defendant is the CPA’s client, their communications will not be privileged unless the case involves a state tax matter in a jurisdiction that has enacted a statute protecting accountant-client communications. The limited federal accountant-client privilege does not apply in criminal tax matters.
Which of the following statements, if any, are true regarding the state law elements that must be proven to support a finding of constructive fraud against a CPA in the preparation of a tax return?
I. The plaintiff has justifiably relied on the CPA’s misrepresentation.
II. The CPA has acted in a grossly negligent manner.
A. Neither I nor II.
B. Both I and II.
C. I only.
D. II only.
B. Both I and II.
The tort of intentional misrepresentation (fraud, deceit) consists of a material misrepresentation made with scienter and an intent to induce reliance. The misstatement also must have proximately caused damage to a plaintiff who justifiably relied upon it. Scienter exists when the defendant makes a false representation with knowledge of its falsity or with reckless disregard as to its truth. For constructive fraud, the scienter requirement is met by proof of gross negligence (reckless disregard for the truth).
Which of the following statements is correct regarding disclosure of working papers prepared by a CPA related to tax practice?
A. Working papers may not be disclosed under a federal court subpoena without the client’s permission.
B. Working papers may not be turned over to a CPA quality review team without the client’s permission.
C. Working papers may not be transferred to another accountant without the client’s permission.
D. Working papers may not be disclosed to any third parties without the client’s permission.
C. Working papers may not be transferred to another accountant without the client’s permission.
The CPA may be liable for malpractice if (s)he allows a third party, including a purchaser of the practice, access to working papers without specific consent of the client. However, this rule does not prohibit review of the CPA’s practice, including a review in conjunction with the purchase, sale, or merger of the practice, if appropriate precautions are taken. One means of protecting the client’s information is to enter into a written confidentiality agreement with the prospective purchaser.
