R5-4 Flashcards
Which of the following statements is (are) correct regarding a CPA employee of a CPA firm taking copies of information contained in client files when the CPA leaves the firm?
I.
A CPA leaving a firm may take copies of information contained in client files to assist another firm in serving that client.
II.
A CPA leaving a firm may take copies of information contained in client files as a method of gaining technical expertise.
a.
Both I and II.
b.
I only.
c.
II only.
d.
Neither I nor II.
Choice “d” is correct. Information contained in client files (“workpapers”) are the property of the CPA firm. Although the accounting firm owns the workpapers, the firm and its employees are generally prohibited from showing the workpapers to anyone without the client’s permission. Furthermore, an employee of a CPA firm may not take information contained in client files when leaving the firm. Workpapers produced by the firm for, or on behalf of a client, may not be copied and removed by an employee for personal use.
Which of the following statements is correct regarding an accountant’s working papers?
a.
The client owns the working papers but, in the absence of the accountant’s consent, may not disclose them without a court order.
b.
The accountant owns the working papers but generally may not disclose them without the client’s consent or a court order.
c.
The client owns the working papers but the accountant has custody of them until the accountant’s bill is paid in full.
d.
The accountant owns the working papers and generally may disclose them as the accountant sees fit.
Choice “b” is correct. While a CPA owns his or her workpapers, the ownership rights are very limited. Generally, a CPA may not reveal client workpapers to third parties without the client’s consent.
To which of the following parties may a CPA partnership provide its working papers without either the client’s consent or a lawful subpoena?
~~The IRS
~~The FASB
a.
Yes
Yes
b.
No
No
c.
No
Yes
d.
Yes
No
Choice “b” is correct. An accountant is prohibited from showing the workpapers to anyone without the client’s permission, except:
Lawful subpoena.
Surviving member of the firm.
Quality control panel.
AICPA/State Trial Board.
Court proceedings.
Which of the following statements is(are) correct regarding the common law elements that must be proven to support a finding of constructive fraud against a CPA?
I.
The plaintiff has justifiably relied on the CPA’s misrepresentation.
II.
The CPA has acted in a grossly negligent manner.
a.
II only.
b.
Both I and II.
c.
Neither I nor II.
d.
I only.
Choice “b” is correct.
The elements of constructive fraud:
Misrepresentation of a material fact.
Defendant acts with gross negligence or recklessly.
Intent to induce plaintiff’s reliance.
Actual and justifiable reliance by plaintiff.
Damages.
Actual fraud requires intent to deceive.
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?
a.
The CPA is liable to anyone in a class of third parties whom the CPA knows will rely on the opinion.
b.
The CPA is only liable to those third parties who are in privity of contract with the CPA.
c.
The CPA is liable to all possible foreseeable users of the CPA’s opinion.
d.
The CPA is only liable to the client.
Choice “a” is correct. The majority rule (the law followed in the majority of the states) is that accountants are liable to anyone in a class (such as potential lenders or investors) of third parties whom the CPA knows will rely on the opinion of the financial statements.
Choice “b” is incorrect. This describes a more limited extent of CPA liability than is the case under the majority rule.
Choice “d” is incorrect. In all states, the CPA’s liability extends beyond the client.
Choice “c” is incorrect. This describes a broader extent of liability than is the case under either the majority rule or the minority rule.
Under the “Ultramares” rule, to which of the following parties will an accountant be liable for negligence?
~~Parties in privity
~~Foreseen parties
a.
Yes
Yes
b.
No
Yes
c.
Yes
No
d.
No
No
Choice “c” is correct. Ultramares limits the accountant’s liability for negligence to: (i) parties in privity and (ii) intended third party beneficiaries; parties who are merely “foreseen” cannot recover.
When performing an audit, a CPA will most likely be considered negligent when the CPA fails to:
a.
Warn a client of known internal control weaknesses.
b.
Include a negligence disclaimer in the client engagement letter.
c.
Warn a client’s customers of embezzlement by the client’s employees.
d.
Detect all of a client’s fraudulent activities.
Choice “a” is correct. A CPA has a duty to warn clients of known weaknesses in internal controls. The failure to communicate the known weakness to the client constitutes negligence.
Choice “d” is incorrect. A CPA is not required to actively search for frauds. Thus, a CPA is not liable for failure to discover all frauds.
Choice “b” is incorrect. While the disclaimer probably would not be effective, in itself, the disclaimer does not constitute negligence, i.e., a departure from the ordinary due care for CPAs.
Choice “c” is incorrect. A CPA is not expected to warn outsiders of client matters. In fact, such a disclosure would violate the CPA’s duty of confidentiality.
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?
a.
Contributory negligence on the part of the client.
b.
Lack of scienter.
c.
A disclaimer contained in the engagement letter.
d.
Lack of privity.
Choice “b” is correct. A suit for common law fraud may succeed only if the accountant acted with scienter (knew that the statement was wrong or recklessly disregarded the truth).
Choice “a” is incorrect. Contributory negligence is a defense to negligence in some jurisdictions, but it is not a defense to fraud.
Choice “c” is incorrect. A disclaimer against committing fraud would violate public policy and would not be enforceable.
Choice “d” is incorrect. Privity is not required in an action for fraud.
Ocean and Associates, CPAs, audited the financial statements of Drain Corporation. As a result of Ocean’s negligence in conducting the audit, the financial statements included material misstatements. Ocean was unaware of this fact. The financial statements and Ocean’s unqualified opinion were included in a registration statement and prospectus for an original public offering of stock by Drain. Sharp purchased shares in the offering. Sharp 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 Drain’s financial statements becoming known. Under which of the following acts is Sharp most likely to prevail in a lawsuit against Ocean?
~~Securities Exchange Act of 1934, Section 10b, Rule 10b-5
~~Securities Act of 1933, Section 11
a.
Yes
No
b.
No
Yes
c.
Yes
Yes
d.
No
No
Choice “b” is correct. A plaintiff under Rule 10b-5 must prove reliance on a misstatement and that the defendant acted with scienter (intent to deceive or reckless disregard for truth). Here, neither element can be proved because Sharp did not read the offering statement (and so could not have relied on it) and because Ocean did not act with scienter (the CPA did not know of the error; rather, the CPA made the error negligently). An action under Section 11 will be successful because the plaintiff need only show that the plaintiff acquired the stock, that there was a misstatement in the registration statement, and that the plaintiff suffered damages. Because Ocean acted negligently, it cannot prove the defense of due diligence.
Which of the following statements is correct regarding a CPA’s working papers? The working papers must be:
a.
Turned over to any government agency that requests them.
b.
Transferred to another accountant purchasing the CPA’s practice even if the client hasn’t given permission.
c.
Transferred permanently to the client if demanded.
d.
Turned over pursuant to a valid federal court subpoena.
Choice “d” is correct. Client working papers must be turned over pursuant to a valid federal court subpoena because generally there is no federal privilege in client working papers.
Choice “b” is incorrect. Working papers cannot be turned over to a successor purchasing the CPA’s practice if the client objects. However, a prospective purchaser of the CPA’s practice may review the workpapers if confidentiality is assured.
Choice “c” is incorrect. Client working papers belong to the accountant, not to the client. They need not be turned over to the client.
Choice “a” is incorrect. Unless subpoenaed, generally the working papers cannot be turned over to a government agency without the client’s permission (there is an exception for requests from the Public Company Accounting Oversight Board with respect to working papers for clients that are publicly held).
Thorp, CPA, was engaged to audit Ivor Co.’s financial statements. During the audit, Thorp discovered that Ivor’s inventory contained stolen goods. Ivor was indicted and Thorp was subpoenaed to testify at the criminal trial. Ivor claimed accountant-client privilege to prevent Thorp from testifying. Which of the following statements is correct regarding Ivor’s claim?
a.
Ivor can claim an accountant-client privilege only in states that have enacted a statute creating such a privilege.
b.
The accountant-client privilege can be claimed only in civil suits.
c.
The accountant-client privilege can be claimed only to limit testimony to audit subject matter.
d.
Ivor can claim an accountant-client privilege only in federal courts.
Choice “a” is correct. The accountant-client privilege can be claimed only in those states that recognize the privilege.
Choice “d” is incorrect. Generally, there is no federal accountant-client privilege. There is a limited federal privilege for noncriminal tax proceedings other than tax shelter matters, but here the engagement was for audit services, and the proceeding is a criminal proceeding.
Choice “b” is incorrect. If a state has enacted the privilege, the privilege is not limited to civil cases.
Choice “c” is incorrect. Where the privilege exists, it would prevent testimony about the audit, not limit testimony to the audit.
A CPA is permitted to disclose confidential client information without the consent of the client to:
I.
Another CPA firm if the information concerns suspected tax return irregularities.
II.
A state CPA society voluntary quality control review board.
a.
Both I and II.
b.
II only.
c.
I only.
d.
Neither I nor II.
Choice “b” is correct. A CPA may reveal confidential information without the client’s consent in a number of situations (e.g., when subpoenaed, when requested by a CPA society voluntary quality control review board). However, there is no exception to the duty of confidentiality merely because tax irregularities are suspected.
In a common law action against an accountant, lack of privity is a viable defense if the plaintiff:
a.
Is the client’s creditor who sues the accountant for negligence.
b.
Bases the action upon fraud.
c.
Is the accountant’s client.
d.
Can prove the presence of gross negligence that amounts to a reckless disregard for the truth.
Choice “a” is correct. A creditor of a client generally cannot sue the client’s accountant for negligence unless the accountant had reason to know that the creditor would be relying on the accountant’s work.
Choice “d” is incorrect. If the plaintiff can prove gross negligence, privity is not a defense; the accountant generally is liable to anyone who is injured by gross negligence.
Choice “c” is incorrect. The client is always in privity of contract with the accountant.
Choice “b” is incorrect. If the action is based on fraud, privity is not a defense; the accountant generally can be held liable to anyone who is injured by the accountant’s fraud.
Under common law, which of the following statements most accurately reflects the liability of a CPA who fraudulently gives an opinion on an audit of a client’s financial statements?
a.
The CPA probably is liable to any person who suffered a loss as a result of the fraud.
b.
The CPA probably is liable to the client even if the client was aware of the fraud and did not rely on the opinion.
c.
The CPA is liable only to third parties in privity of contract with the CPA.
d.
The CPA is liable only to known users of the financial statements.
Choice “a” is correct. A CPA who commits fraud is liable to anyone who is injured by the fraud.
Choice “c” is incorrect. A CPA’s liability for fraud is not limited by privity.
Choice “d” is incorrect. A CPA’s liability for fraud is not limited to known users of the CPA’s work product.
Choice “b” is incorrect. Actual and justifiable reliance are necessary elements of fraud.
Under the provisions of Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934, which of the following activities must be proven by a stock purchaser in a suit against a CPA?
I.
Intentional conduct by the CPA designed to deceive investors.
II.
Negligence by the CPA.
a.
I only.
b.
II only.
c.
Both I and II.
d.
Neither I nor II.
Choice “a” is correct. Under Rule 10b-5, a purchaser must prove scienter (either an intent to deceive or gross negligence, which is the reckless disregard for the truth); negligence is insufficient to establish scienter.
Under Section 11, which of the following must be proven by a purchaser of the security?
~~Reliance on the financial statements
~~Fraud by the CPA
a.
Yes
No
b.
No
No
c.
No
Yes
d.
Yes
Yes
Choice “b” is correct. Under Section 11, a plaintiff need only prove that: (i) the plaintiff acquired (not necessarily bought) the security, (ii) there was a material misstatement in the financial statements included in the registration statement that was signed by the defendant, and (iii) the plaintiff suffered a loss. The plaintiff need not prove reliance or fraud.
