Question 1

Tory researched a position that her tax client wished to take and concluded in good faith that there was a 25% chance that the IRS would sustain the position if it reviewed it. Which of the following is true? 1. Tory may sign a return taking this position with or without disclosure. 2. Tory may sign a return taking this position, but she should disclose it. 3. Tory may take the position, even if it involves a tax shelter transaction. 4. All of the above.

Accepted Answer

Tory may sign a return taking this position, but she should disclose it. Because the position meets the "reasonable basis" test, but not the "substantial authority" test, Tory may sign a return taking this position only if she discloses it.

Question 2

Which of the following bodies ordinarily would have the authority to suspend or revoke a CPA's license to practice public accounting? The SEC. The AICPA. A state CPA society. A state board of accountancy.

Accepted Answer

A state board of accountancy. While certain types of punishments may be meted out by the SEC, the AICPA, and state CPA societies, only a state board of accountancy truly has the power to revoke a CPA's license to practice public accountancy. Nonetheless, the SEC may, for example, prevent an accountant from appearing before it or doing any attest work for a public company. The AICPA may revoke an accountant's membership, as may a state CPA society. But only the state board of accountancy may revoke a license to practice.

Question 3

When an ethics complaint carrying national implications arises, which entity typically handles it? SEC. PCAOB. State CPA society. AICPA.

Accepted Answer

AICPA. The AICPA handles ethical complaints with national implications. The State's will handle more regional lower profile issues.

Question 4

What is JEEP?

Accepted Answer

JEEP is the _Joint Ethics Enforcement Program_ that divides ethics complaints and investigations between the AICPA and state societies.

Question 5

Which of the following statements is generally correct regarding the liability of a CPA who negligently gives an opinion on an audit of a client's financial statements? The CPA is only liable to those third parties who are in privity of contract with the CPA. The CPA is only liable to the client. The CPA is liable to anyone in a class of third parties who the CPA knows will rely on the opinion. The CPA is liable to all possible foreseeable users of the CPA's opinion.

Accepted Answer

There are three general viewpoints regarding an accountant's liability to third parties. 1. One view requires privity of contract for a third party to recover. 2. Another view allows all reasonably foreseeable users of an accountant's report to sue. 3. But the majority view, known as the Restatement view, limits an accountant's liability to a limited class of actually foreseen users. This question obviously asks the student to apply the majority (Restatement) view.

Question 6

A company engaged a CPA to perform the annual audit of its financial statements. The audit failed to reveal an embezzlement scheme by one of the employees. Which of the following statements best describes the CPA's potential liability for this failure? The CPA's adherence to generally accepted auditing standards (GAAS) may prevent liability. The CPA will not be liable if care and skill of an ordinary reasonable person was exercised. The CPA may be liable for punitive damages if due care was not exercised. The CPA is liable for any embezzlement losses that occurred before the scheme should have been detected.

Accepted Answer

The CPA's adherence to generally accepted auditing standards (GAAS) may prevent liability. If a CPA adhered to GAAS, he or she acted according to professional standards and likely was not careless so as to create negligence-based liability. 2nd choice is incorrect because CPAs doing audits are held to professional standards and must obviously do a better job than the "ordinary reasonable person" off the street.

Question 7

Under the position taken by a majority of the courts, to which third parties will an accountant who negligently prepares a client's financial report be liable? Only those third parties in privity of contract with the accountant. All third parties who relied on the report and sustained injury. Any foreseen or known third party who relied on the report. Any third party whose reliance on the report was reasonably foreseeable.

Accepted Answer

Any foreseen or known third party who relied on the report. Although the AICPA lists this as the correct answer, it is poorly worded. The majority view is the Restatement "limited class" approach, which generally allows recovery by third parties where the CPA had prior knowledge of the existence of a limited class of potential users (but not necessarily of their individual identities) and of the general purpose of their use of the audit. Prior knowledge is the key, so mere foresee ability is not enough, although this answer implies the contrary.

Question 8

Hark CPA, failed to follow generally accepted auditing standards in auditing Long Corp.'s financial statements. Long's management had told Hark that the audited statements would be submitted to several banks to obtain financing. Relying on the statements, Third Bank gave Long a loan. Long defaulted on the loan. In a jurisdiction applying the Ultramares decision, if Third sues Hark, Hark will: Win because there was no privity of contract between Hark and Third. Lose because Hark knew that banks would be relying on the financial statements. Win because Third was contributorily negligent in granting the loan. Lose because Hark was negligent in performing the audit.

Accepted Answer

Win because there was no privity of contract between Hark and Third. The Ultramares rule is applied in only a few jurisdictions. It normally allows recovery by a third party only if there was privity of contract between the accountant and third party. B is incorrect...normally, Hark will lose if he has this knowledge, because the bank is then a foreseeable user. However, under the Ultramares rule, which is applied in only a few jurisdictions, recovery is normally allowed by a third party only if there was privity of contract between the accountant and third party.

Question 9

Which of the following is the best defense a CPA firm can assert in a suit for common law fraud based on its unqualified opinion on materially false financial statements? Contributory negligence on the part of the client. A disclaimer contained in the engagement letter. Lack of privity. Lack of scienter.

Accepted Answer

Lack of scienter. _Scienter_ involves whether or not a person or company has a "guilty mind." One of the requirements of fraud is an intent to deceive. Therefore, if a firm did not intentionally make a misrepresentation and has no "guilty mind," no fraud has occurred.

Question 10

Which of the following elements, if present, would support a finding of constructive fraud on the part of a CPA? Gross negligence in applying generally accepted auditing standards. Ordinary negligence in applying generally accepted accounting principles. Identified third party users. Scienter.

Accepted Answer

Gross negligence in applying generally accepted auditing standards. Fraud usually involves intentional deception. This question, however, asks about a close cousin of fraud -- constructive fraud. In a constructive fraud case, gross negligence (sometimes referred to as recklessness) acts as a substitute for intentional deception. Ordinary negligence or carelessness is not serious enough to act as a substitute for intent.

Question 11

Cable Corp. orally engaged Drake & Co., CPAs, to audit its financial statements. Cable's management informed Drake that it suspected the accounts receivable were materially overstated. Though the financial statements Drake audited included a materially overstated accounts receivable balance, Drake issued an unqualified opinion. Cable used the financial statements to obtain a loan to expand its operations. Cable defaulted on the loan and incurred a substantial loss. If Cable sues Drake for negligence in failing to discover the overstatement, Drake's best defense would be that Drake did not: Have privity of contract with Cable. Sign an engagement letter. Perform the audit recklessly or with an intent to deceive. Violate generally accepted auditing standards in performing the audit.

Accepted Answer

Violate generally accepted auditing standards in performing the audit. In a negligence case, the plaintiff must show that the CPA did not use reasonable care or did not act as a reasonable CPA in the circumstances. If Drake can show that he followed GAAS in preparing the report, it is strong evidence that he acted reasonably. It is not an absolute defense, but it tends to show that he did what other accountants would have done in the same situation.

Question 12

Which of the following is a correct statement about the circumstances under which a CPA firm may or may not disclose the names of its clients without the clients' express permission? A CPA firm may disclose this information if the practice is limited to bankruptcy matters, so that prospective clients with similar concerns will be able to contact current clients. A CPA firm may disclose this information if the practice is limited to performing asset valuations in anticipation of mergers and acquisitions. A CPA firm may disclose this information unless disclosure would suggest that the client may be experiencing financial difficulties. A CPA firm may not disclose this information because the identity of its clients is confidential information.

Accepted Answer

A CPA firm may disclose this information unless disclosure would suggest that the client may be experiencing financial difficulties. Generally, the mere name of clients is not confidential information. Therefore, unless the accountant knows (or has reason to know, given the circumstances) that the client wishes to keep its identity as a client confidential, this information may be disclosed. An accountant would have reason to know there was a problem if disclosure of the client's name informed the world that the client was experiencing financial difficulties.

Question 13

In accordance with the AICPA Statements on Standards for Tax Services, if after having provided tax advice to a client there are legislative changes which affect the advice provided, the CPA: Is obligated to notify the client of the change and the effect thereof. Is obligated to notify the client of the change and the effect thereof if the client was not advised that the advice was based on existing laws which are subject to change. Cannot be expected to notify the client of the change unless the obligation is specifically undertaken by agreement. Cannot be expected to have knowledge of the change.

Accepted Answer

Cannot be expected to notify the client of the change unless the obligation is specifically undertaken by agreement. After providing tax advice to a client, the CPA cannot be expected to notify the client of any subsequent legislative changes which affect the advice previously provided. If, however, the obligation for the subsequent notification is specifically undertaken by agreement, the CPA is expected to notify the client of any such changes.

Question 14

Even in circumstances where disclosure on a tax return is not required, the CPA may choose to make a disclosure. Such choice may not be made if the intent is to Avoid preparer negligence penalties. Avoid allegations of fraud. Invalidate the preparer’s declaration. Disclose a position that might be viewed as contrary to the Internal Revenue Code.

Accepted Answer

Invalidate the preparer’s declaration. A position that is viewed as contrary to the Internal Revenue Code is required to be disclosed. Some nonrequired disclosures may be in the client’s and the CPA’s best interests to avoid negligence penalties and fraud allegations. However, with regard to the preparer’s declaration, the CPA is required to sign it without modification. Therefore, no disclosure should be made with the intent to invalidate the preparer’s declaration.

Question 15

An accountant compiled the unaudited financial statements for Taylor Company, a nonissuer company. The financial statements contained a material misstatement that was not discovered in the compilation. The accountant issued a report that stated that the financial statements were fairly stated based on the limited evidence that he collected. Which of the following is true about the accountant’s liability to a third party who relies on the financial statements? The accountant will not likely be held liable because the report indicated that limited evidence was collected. The accountant will not likely be held liable because he only compiled the financial statements. The accountant will likely be held liable because an appropriately worded report was not issued. The accountant will likely be held liable because in compiling the financial statements he should have detected the misstatement.

Accepted Answer

The accountant will likely be held liable because an appropriately worded report was not issued. The report overstated the accountant's level of work. The accountant may be liable in these types of engagements if: Failure to mark each page, “unaudited,” or “See Accountant’s Compilation Report,” or “See Accountant’s Review Report.” Failure to issue a disclaimer of opinion, or an appropriately worded compilation or review report. Failure to follow appropriate AICPA Statements on Standards for Accounting and Review Services. Failure to inform client of any discovery of indications of major issues. For example, circumstances indicating presence of fraud.

Question 16

Common law fraud of accountant is established by following elements:

Accepted Answer

1. Misrepresentation of material fact or accountant’s expert opinion 2. Scienter, shown by either 1. Intent to mislead with accountant’s knowledge of falsity, or 2. Reckless disregard of the truth 3. Reasonable or justifiable reliance by injured party 4. Actual damages

Question 17

Liability to client for fraud, gross negligence, or constructive fraud

Accepted Answer

1. Elements of Common Law Fraud must be proven (see separate card) 2. Called constructive fraud or gross negligence if when proving the four elements of CLF, reckless disregard of the truth is established instead of knowledge of falsity 3. Contributory negligence of client is not a defense available for accountant in cases of fraud, constructive fraud, or gross negligence 4. Privity of contract is not required for plaintiff to prove fraud, constructive fraud, or gross negligence 5. Punitive damages may be added to actual damages for fraud, constructive fraud, or gross negligence

Question 18

A CPA partnership may, without being lawfully subpoenaed or without the client’s consent, make client workpapers available to An individual purchasing the entire partnership. The IRS. The SEC. Any surviving partner(s) on the death of a partner.

Accepted Answer

Any surviving partner(s) on the death of a partner. The ownership of a CPA’s working papers is custodial in nature. The CPA is required to preserve confidentiality of the client’s affairs with limited exceptions. The CPA may make working papers available to the client since this will not violate the confidentiality owed to the client. In the case of an audit of a partnership, all of the partners are clients, including any surviving partner(s) on the death of a partner. Answers A, B, and C are incorrect because these are not clients of the CPA.

Question 19

In a jurisdiction having an accountant-client privilege statute, to whom may a CPA turn over workpapers without a client’s permission? Purchaser of the CPA’s practice. State tax authorities. State court. State CPA society quality control panel.

Accepted Answer

State CPA society quality control panel. In a jurisdiction having an accountant-client privilege statute, the CPA generally may not turn over workpapers without the client’s permission. It is allowable to do so, however, for use in a quality review under AICPA authorization or to be given to the state CPA society quality control panel.

Question 20

Treasury Department Circular 230

Accepted Answer

Provides regulations regarding practice before the Internal Revenue Service. Merely preparing tax returns for others does not constitute practice before the IRS. preparing and filing documents, corresponding and communicating with the IRS, rendering written advice with respect to any entity, transaction, plan or arrangement, and representing a client at conferences, hearings, and meetings limited to CPAs, attorneys, enrolled agents (EAs) and for limited purposes enrolled actuaries, and enrolled retirement plan agents. Enrollment as an EA, actuary, or retirement plan agent is granted if the individual demonstrates special competence in tax by passing an IRS Enrollment Examination. Additionally, certain former employees of the IRS may be granted the right to practice as an enrolled agent

Question 21

Hall purchased Eon Corp. bonds in a public offering subject to the Securities Act of 1933. Kosson and Co., CPAs, rendered an unqualified opinion on Eon’s financial statements, which were included in Eon’s registration statement. Kosson is being sued by Hall based upon misstatements contained in the financial statements. In order to be successful, Hall must prove: Damages? Materiality of Misstatement? Kosson's Scienter?

Accepted Answer

Damages = YES Materiality of Misstatement = YES Kosson's Scienter = NO Under the 1933 Act, the plaintiff must prove that damages were incurred and that there was a material misstatement or omission in the registration statement. The 1933 Act does not require the establishment of scienter (intent to deceive or reckless disregard of the truth) on the part of the CPA.

Question 22

Auditors who audit financial statements under Federal Securities Exchange Act of 1934 are required to establish procedures to? _Note_ - the Private Securities Litigation Reform Act of 1995 amended both: 1. Securities Act of 1933, and 2. Securities Exchange Act of 1934

Accepted Answer

Detect material illegal acts, Identify material related-party transactions, and Evaluate ability of firm to continue as going concern.

Question 23

The Ultramares decision is a leading case that helps define when a CPA is liable to different parties. If a CPA has committed negligence, under this decision the CPA is liable to which of the following parties? 1. The client. 2. Third-party beneficiaries. 3. Foreseeable third parties.

Accepted Answer

1 and 2 only. Under the Ultramares case, the CPA is liable to those parties for negligence that were in privity of contract with the CPA. These parties include the client and other parties that were intended in the contract to be benefited in the contract.

Question 24

An auditor is responsible for reviewing for material subsequent events that may affect the financial statements contained in a Form S-1 filed with the SEC until The last day of fieldwork. The effective date of the registration statement. The date of the audit report. The date the form is filed with the SEC.

Accepted Answer

The auditor is responsible for reviewing for material subsequent events through the effective date of the registration statement. This is referred to as an S-1 review when made for a registration statement under securities regula­tions. _EXAMPLE_ : An accountant performed an audit and later performed an S-1 review to review events subsequent to the balance sheet date. The accountant did not detect certain material events during this S-1 review even though there was sufficient evidence to make the accountant suspicious. Further investigation was required to avoid li­ability.

Question 25

A CPA assists a taxpayer in tax planning regarding a transaction that meets the definition of a tax shelter as defined in the Internal Revenue Code. Under the AICPA Statements on Standards for Tax Services, the CPA should inform the taxpayer of the penalty risks unless the transaction, at the minimum, meets which of the following standards for being sustained if challenged? 1. More likely than not. 2. Not frivolous. 3. Realistic possibility. 4. Substantial authority.

Accepted Answer

More likely than not. When providing professional services that include tax planning, a member CPA should determine and comply with any applicable standards for reporting and disclosing tax return positions. When recommending a tax return position, a member should, when relevant, advise the taxpayer regarding the potential penalty consequences of the tax return position and the opportunity, if any, to avoid such penalties through disclosure. Statement on Standards for Tax Services No. 1 indicates a member should determine and comply with the standards, if any, that are imposed by the applicable taxing authority with respect to recommending a tax return position. In this case, IRC Sec. 6694 provides for a tax preparer penalty if the understatement of a taxpayer's tax liability is due to an unreasonable position. Additionally, Sec. 6694(a)(2)(C) provides that if the position is in respect to a tax shelter, the position will be considered unreasonable unless it is reasonable to believe that the position would be more likely than not sustained on its merits.

Question 26

Sharp & Co., CPAs, was engaged by Radar Corp. to audit its financial statements. Sharp issued an unqualified opinion on Radar’s financial statements. Radar has been accused of making negligent misrepresentations in the financial statements which Wisk relied upon when purchasing Radar stock. Sharp was not aware of the misrepresentations nor was it negligent in performing the audit. If Wisk sues Sharp for damages based upon Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934, Sharp will 1. Lose, since the statements contained negligent misrepresentations. 2. Lose, since Wisk relied upon the financial statements. 3. Prevail, since some element of scienter must be proved. 4. Prevail, since Wisk was not in privity of contract with Sharp.

Accepted Answer

Prevail, since some element of scienter must be proved. In an action brought under the Securities Exchange Act of 1934, Section 10(b) and Rule 10b-5 the plaintiff (Wisk) must prove that damages were incurred as a result of the act, that there was a material misstatement or omission, that s/he relied upon the financial information, and that scienter exists. Scienter is generally defined as the knowledge of or the intent to deceive, defraud, or manipulate. Thus, Sharp will prevail if Wisk is unable to prove that Sharp had knowledge of the misrepresentations or that Sharp had intended to deceive or defraud (scienter).

Question 27

Lawson, a CPA, discovers material noncompliance with a specific Internal Revenue Code (IRC) requirement in the prior year return of a new client. Which of the following actions should Lawson take? 1. Wait for the statute of limitations to expire. 2. Discuss the requirements of the IRC with the client and recommend that client amend the return. 3. Contact the IRS and discuss courses of action. 4. Contact the prior CPA and discuss the client's exposure.

Accepted Answer

Discuss the requirements of the IRC with the client and recommend that client amend the return.

Question 28

Under the liability provisions of Section 11 of the Securities Act of 1933, which of the following must a plaintiff prove to hold a CPA liable? 1. The misstatements contained in the financial statements certified by the CPA were material. 2. The plaintiff relied on the CPA’s unqualified opinion.

Accepted Answer

I Only Under Section 11 of the Securities Act of 1933, the plaintiff must prove damages and that the financial statements certified by the CPA contained misstatements or omissions of facts that were material. The plaintiff need not prove reliance on the financial statements certified.

Question 29

A CPA firm fails to complete the audit of a publicly traded company because the firm determines that it does not have sufficient competent personnel. As a result, the client’s Form 10-K is not filed on a timely basis. The company will likely be entitled to damages from the firm for 1. Breach of contract under common law. 2. Negligence under the Securities Exchange Act of 1934. 3. Breach of contract under the Securities Exchange Act of 1934. 4. Negligence under the appropriate state securities act.

Accepted Answer

Breach of contract under common law. The relationship between the client and the CPA is that of an employer and an independent contractor. A CPA may be held liable to a client if the accountant fails to perform substantially as agreed under contract (the engagement letter).

Question 30

The Internal Revenue Code provisions dealing with tax return preparation 1. Require tax return preparers who are neither attorneys nor CPAs to pass a basic qualifying examination. 2. Apply to all tax return preparers whether they are compensated or uncompensated. 3. Apply to a CPA who prepares the tax returns of the president of a corporation the CPA audits, without charging the president. 4. Only apply to preparers of individual tax returns.

Accepted Answer

Apply to a CPA who prepares the tax returns of the president of a corporation the CPA audits, without charging the president. The Internal Revenue Code provisions dealing with tax return preparation apply to preparers. A preparer is defined as an individual or firm who prepares returns for compensation. The compensation can be implied or explicit. This is an example of implied compensation. Preparer—an individual who prepares for compensation, or who employs one or more persons to prepare for compensation, an income tax return, or a substantial portion of return. 1. Preparer need not be enrolled to practice before the Internal Revenue Service. 2. Compensation—must be received and can be implied or explicit (e.g., a person who does neighbor’s return and receives a gift has not been compensated. Accountant who prepares individual return of the president of a company, for which he performs the audit, for no additional fee as part of a prior agreement has been compensated [implied])

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