Professional Responsibilities and Business Law

Question 1

Common Law

Answer 1

Historically established by judicial precedents. Much is now codified into state statutes.

1. Breach of Contract
2. Ordinary Negligence (Ultramares: accountant only liable to primary beneficiaries)
3. Gross Negligence

Question 2

Constructive fraud

Answer 2

Failure to use even slight care (gross negligence). Contributory negligence not a defense. Punitive damages may be awarded.

Scienter: (1) intent to mislead with accountant’s knowledge of falsity or (2) Reckless disregard of the truth

Question 3

Contributory negligence

Answer 3

Negligence on the part of the plaintiff that contributed to the party’s loss. Will typically mitigate some or all of the defendants charges.

Question 4

Due diligence

Answer 4

Securities Act of 1933 - standard of care: reasonable investigation, reasonable grounds of belief

Question 5

Fraud

Answer 5

Misrepresentation intended to mislead, or made with reckless disregard for the truth

Question 6

Joint liability

Answer 6

Joint defendant may be forced to pay the entire amount of a judgement

Question 7

Joint and several liability

Answer 7

Joint liability where a defendant may collect from other defendants their proportionate shares of the judgement

Question 8

Joint Ethics Enforcement Program (JEEP)

Answer 8

joint program of the AICPA and state CPA societies to jointly investigate ethics violations

Question 9

Negligence

Answer 9

failure to perform with the level of skill and judgement possessed by a typical professional (ordinary negligence). Contributory negligence may be used in defense. Punitive damages not assessed.

Question 10

Primary beneficiary

Answer 10

party other than the client who primarily benefits from the contracted services provided by the CPA

Question 11

Privileged Communication

Answer 11

not subject to disclosure in court. Must be established by law. Generally accountant-client communication is not privileged

Question 12

Privity

Answer 12

a mutual relationship established between parties typically by contract (ex: client and third-party beneficiaries)

Question 13

Public Company Accounting Oversight Board (PCAOB)

Answer 13

5 member nonprofit org created by SOX Act to oversee the audits of public companies (2 CPAs, 3-non CPAs)

1. registers and inspects public accounting firms (audits of issuers)
2. sets standards on auditing, quality control, independence and preperation of audit reports

Question 14

Public Company Accounting Reform and Investor Protection Act

Answer 14

Sarbanes-Oxley Act - set a new set of enhanced standards for public company boards, management and public accounting firms. Established the PCAOB.

Workpaper retention: (1) rquires retention of workpapers for 5 - 7 years (2) makes illegal destruction or falsifying records to impeed investigations (3) imprisonment up to 20 yrs

Audit partner must change every 5 years

Question 15

Racketeer Influenced and Corrupt Organization (RICO) Act

Answer 15

allows prosecution of organized criminals. has been used to pursue CPA firms who engage in multiple instances of wrongful acts. allows Treble damages.

Question 16

Securities Act of 1933

Answer 16

Covers initial registration of securities (within 3 years of IPO).

Plaintiff must prove (1) damages were incurred and (2) there was material misstatement in the registration statement (plaintiff need not prove reliance or negligence)

Defense: due diligence, plaintiff’s knowledge of misstatement, lack of causation

Damages: difference between amount paid & market value at time of suit, not to exceed price at which security was offered to the public.

Question 17

Securities Exchange Act of 1934

Answer 17

covers secondary purchase and sale of securities and for equity securities where the corp has over $10 mill in assets and 500 stakeholders. Plaintiff must prove: (1) damages resulted (2) there was material misstatement (3) reliance (4) scienter.

Auditors must establish procedures to (a) detect matierial illegal acts (b) identify material related-party transactions and (c) evaluate ability of firm to continue as going concern.

Illegal Acts: if material, auditor must report to the Board. The Board must report to the SEC within one day. If not done, the auditor must furnish SEC with a copy of the auditor’s report.

Question 18

Several liability

Answer 18

joint defendants are responsible only for their proportionate share of the judgement

Question 19

State boards of accountancy

Answer 19

regulate practice of public accounting

Question 20

Statements on Standards for Tax Services

Answer 20

AICPA standards for CPAs that perform tax services for clients

Question 21

Treasury Department Circular 230

Answer 21

regulatory requirements regarding authority to practice before the IRS

Question 22

US Securities and Exchange Commission

Answer 22

responsible for enforcing the federal securities laws and regulating the securities industry

Question 23

Accountants Liability (Common Law)

Answer 23

Question 24

Foreseen party

Answer 24

Third party who the accountant knew would rely on financial statements

Question 25

Foreseeable party

Answer 25

Any party that accountant could reasonably foreseen would receive and use financial statements

Question 26

Auditors Liability

Federal Securities Acts

Answer 26

Question 27

Form 8-K Disclosure

Answer 27

Required by suecurities laws - discloses material events such as change in corporate control, amount of issued securities, illegal acts, reports a change in auditor (client discloses reason for the change, and the auditor agrees or states their disagreement).

must be filed within 4 days of occurance triggering the event

Question 28

Subsequent Events - Liability

Answer 28

Accountant my be held liabile if they make assurance that there are no material changes when infact there are.

Question 29

Tax Positions

Answer 29

Realistic possibility: requires as much as one-third likelihood of sucess

More likely than not standard requires more than 50% probability of sucess

Substantial authority: when the weight of authorities supporting the position is substantial in relation to the weight of those taking a contrary position. Requires at least a 40% probability of sucess.

Reasonable basis: requires at least a 20% chance of success

Question 30

Covered Opinion

Answer 30

Covered under Circular 230 - written advice involving a listed transaction or a place or arrangement with the principal purpose of tax avoidance.

Question 31

Reliance Opinion

Answer 31

Under Circular 230 - Written advice that concludes the tax position is more likely than not to be successful.

Question 32

Tax preparer penalties

Answer 32

The greater of $1,000 or 50% of the income derived

If error resulted from willful attempt to understate liability or gross negligence: The greater of $5,000 or 50% of income derived

Penalties can be avoided if there is evidence of: (1) substantial authority (40%), (2) adequate disclosure and reasonable basis for the position (20%) (3) more likely than not standard (for tax shelter positions) (50%) and (4) reasonable cause

Question 33

Uniform Accountancy Act (UAA)

Answer 33

developed by the AICPA to provide state jurisdictions a model act to regulate CPAs

1. Bachelors Degree and 150 semester hours required
2. Sets continuing education standards
3. facilitates interstate practice and free movement of CPAs between states
4. Ethical provisions: AICPA Code of Professional Conduct
5. State boards are responsible for issuing licenses

Question 34

AICPA Disciplinary Stystems

Answer 34

Professional Ethics Executive Committee (JEEP) - AICPA committee disciplinary measures may include:

a. No violation/dismissal
b. Public Admonishment
c. Corrective action (continuing education)
d. Suspension for up to two years
e. Explulsion from AICPA: for (1) having license revoked by state board, (2) conviction of a crime punishable by a sentance over one year (3) files a fraudulent tax return (4) intentionally fails to file personal return

Question 35

SEC Disiplinary actions

Answer 35

1. revoke of suspend an accountant from practicing before SEC (they cannot serve as an auditor for issuer
   a. willfull violation of federal securities laws or regulations
   b. upon conviction of felony or misdemeanor in which moral turpitude was involved
   c. can penalize with civil fines and mandates to pay profits gained from violations.
2. can prohibit an accountant or firm from doing work for an issuer
3. Criminal Liability: (a) Intentional misleading omission of material facts and (b) putting false information in the registration statement

Subject to $10k fine and 5 years in prison

Question 36

Third Party Liability

(Common Law)

Answer 36

1 .Ultramares: accountants are held liable for ordinary negligence only to parties who primarily benefit from the audit or statements.

Question 37

Private Securities Litigation Reform Act

Answer 37

Ammends the FSA of 1933 and FSEA of 1994.

1. reducess lawsuits against accountants by creating a “safe harbor” for preparation of forward-looking statements
   a. auditors must identify assumtions
   b. awards costs and attorneys’ fees against parties failing to fulfill pleading requirements
   c. accountants have several liability unless they knowingly caused harm (if knowingly then owe their porportionate share + 50%)
2. Requires auditors to establish procedures to:
   a. detect material illegal acts: must inform the Board, and SEC if Board does not
   b. identify material related-party transactions
   c. evaluate the ability of firm to continue as a going concern