Deck 32: Legal Liability of Accountants

Question 1

An accountant may be found liable for aiding and abetting if she encourages or participates in the publication of misleading information.

Answer 1

True

Question 2

A client owns the working papers prepared by an accountant in connection with services performed for the client.

Answer 2

False

Question 3

Lack of negligence can be proved by demonstrating that the accountant was in compliance with GAAP and GAAS.

Answer 3

True

Question 4

Winslow Manufacturing sought a loan from National Lending Corporation.In connection with the loan application,National required that Winslow submit certain audited financial statements.Winslow had an audit performed by an independent CPA,who submitted his report to Winslow under the presumption that his report was to be used solely for the purpose of negotiating a loan from National.After National rejected Winslow's loan application,Winslow submitted the CPA's report to other lenders in connection with its loan applications with them.It was subsequently learned that the CPA,despite the exercise of reasonable care,had failed to discover a sophisticated embezzlement scheme by Winslow's chief accountant.Under these circumstances,the CPA is:

A)liable to any creditor who extended a loan to Winslow.
B)liable to Winslow to return the audit fee because credit was not extended by National.
C)liable to Winslow for any losses Winslow suffered as a result of the CPA's failure to discover the embezzlement.
D)not liable to any of the parties.

Question 5

A CPA firm agrees to complete an audit by the 28^th of February because it has been informed of a deadline set by a prospective lender to the client.If the audit report is not finished until the end of March then:

A)the firm would be liable even though the delay was due to the client's having obstructed performance of the audit.
B)the accounting firm would not be liable if they had other deadlines to meet at the same time.This could be used as a complete defense.
C)the accountant would be liable for the client's resulting loss if the lender has no more funds available at that time.
D)the firm would not be liable if they have delegated their responsibilities to another CPA firm.

Question 6

Liability under Rule 10b-5 of the 1934 Act requires scienter.

Question 7

An accountant's duty of care is limited to their actions during the audit itself.

Question 8

An accountant who shows a reckless disregard for the truth may be said to be acting with scienter.

Question 9

An accountant may not delegate his/her duties to someone else without the consent of the client.

Question 10

The party asserting the work product privilege bears the burden of establishing that the documents he seeks to protect were prepared in anticipation of litigation.

Question 11

The privity doctrine does not limit recovery from a suit to those with a direct contractual relationship to the accountant.

Question 12

Which of the following statements is true of negligence by an accountant?

A)The failure of an accountant to discover fraud by the client's employees or others is in itself proof of negligence by the accountant.
B)The investigative techniques used by accountants will always uncover the fraud of a skillful and careful crook.
C)The traditional defenses of contributory negligence and comparative negligence can apply in a negligence action against an accountant.
D)It is not necessary to notify an appropriate person in management if an accountant has a basis for suspicion of fraud.

Question 13

State licensing boards that regulate the ethical conduct of the accounting profession,strictly regulate the accountants' right to advertise their services to the public.

Question 14

Under Section 11 of the Securities Act of 1933,a purchaser must sue the accountant within ten years after the time the misstatement or omission in the registration statement was or should have been discovered.

Question 15

Saxon Inc.entrusted Thomas Simpson,an independent CPA,to prepare an audit report to apply for a loan from Sharp Lenders.Simpson merely accepted the accuracy of the client's books without proper investigation while representing that he had completed Saxon's audit.A careful audit,however,would have discovered that an employee of Saxon's was regularly embezzling funds from him.Simpson is:

A)liable to any creditor who extended a loan to Saxon Inc.based upon the audited financial statements.
B)not liable to Saxon Inc.to return the audit fee because credit was not extended by Sharp.
C)liable to Saxon Inc.for any losses he suffered as a result of Simpson's failure to discover the embezzlement.
D)not liable to any of the parties as he does not owe them the duty of skill or care.

Question 16

An accountant's liability to third persons for negligence is generally barred by the privity doctrine unless the accountant should have foreseen that the third party would rely on the audit.

Question 17

The Restatement approach employs a "reasonably foreseeable" standard.

Question 18

An accountant is not required to reimburse a client for a penalty imposed for late filing if the delay is caused by the accountant.

Question 19

Generally accepted accounting principles:

A)limit recovery to those with a direct contractual relationship to the accountant.
B)apply to the way business transactions should be recorded.
C)give directions to accountants in auditing the books of an enterprise.
D)protect the investor who is unknown to the accountant when the financial statements are prepared.

Question 20

The failure of an accountant to discover fraud by the client's employees or others would not be considered proof of negligence by the accountant.

Question 21

After an audit,an accountant certifies the financial statement by issuing a(n):

A)certificate of audit.
B)opinion letter.
C)memorandum.
D)amicus brief.

Question 22

Rule 10b-5 prohibits any person from making a misstatement or omission of a material fact in connection with:

A)the purchase and not the sale of securities.
B)the mortgage of a property.
C)the purchase or sale of any security.
D)the purchase or sale of a property.

Question 23

The near privity approach was adopted by courts in contrast to the strict privity rule of the:

A)Balancing approach.
B)Reasonably Foreseeable Users approach.
C)Ultramares approach.
D)Restatement approach.

Question 24

Which of the following statement is true of the Sarbanes-Oxley Act of 2002?

A)It requires foreign accounting firms to register with the Public Company Accounting Oversight Board if they audit public companies.
B)The act reduces criminal penalties for securities fraud.
C)Its registration and reporting provisions apply only to U.S.companies listed on U.S.securities exchanges.
D)Section 106 of the act deals expressly with national accounting firms.

Question 25

Section 11(a)imposes liability on accountants for:

A)misstatements or omissions of material facts furnished in registration statements.
B)inadvertent error in the information provided by the client.
C)accidental miscalculations in audits.
D)statements of opinion.

Question 26

An investor seeking to recover stock market losses from a CPA firm,based upon an unqualified opinion on financial statements that accompanied a registration statement,must establish that:

A)there was a false statement or omission of a material fact contained in the audited financial statement.
B)he/she assumed the financial statements to be accurate.
C)the investor completely relied on the CPA firm's opinion for investing in the stock market.
D)the losses were the result of a downturn in the price of securities.

Question 27

Which of the following statements is true of the recovery by a creditor on the theory that the creditor was a third-party beneficiary of the contract employing the accountant?

A)To recover the creditor must show that only he stood to benefit from the contract.
B)To recover the creditor must show that the accountant was aware of the fact that the audit was ordered to satisfy the demand of the creditor.
C)To recover the creditor must prove that the accountant performed the work in a negligent fashion,to the injury of the creditor.
D)The creditor is prohibited by law,in most states,from bringing such a suit.

Question 28

Titus,a CPA,certified a client's financial statements because he believed they were correct,on the basis of his use of standard accounting and auditing practices.Later,while doing further work for the same client,Titus discovered information leading him to the conclusion that the financial statements he had certified were false and misleading.Which of the following statements is correct?

A)Titus has a duty of loyalty only to the third parties who must have reasonably relied on the accuracy of those financial statements.
B)Titus can have no liability to anyone if he chooses not to reveal the unreliability of the financial statements,because when he certified them,he had good reason to believe they were accurate.
C)Titus has a duty to disclose the unreliability of the financial statements to anyone he knows is relying on the financial statements.
D)Titus has a duty to inform his client of what he has discovered,but he has no duty to inform any third parties.

Question 29

The Restatement approach to third-party negligence suits against accountants:

A)requires that the accountant be unaware of the third parties.
B)holds that the accountant is liable only to those third parties who are unreasonably foreseeable.
C)does not protect the typical investor who was unknown to the accountant and his/her client when the financial statements were prepared.
D)requires that the accountant be unaware of the third parties reliance on the financial statements.

Question 30

An accountant's duty of care:

A)is limited to their actions during the audit.
B)extends beyond her/his actions during the audit itself.
C)has been greatly limited by the courts.
D)does not comply with GAAS and GAAP standards.

Question 31

Under the near privity approach,accountants may be liable in negligence to third parties when:

A)he/she was unaware that the financial reports were to be used for a particular purpose.
B)the identity of the third parties were unknown to the accountant but,the accountant knew that these third parties would rely on the reports.
C)the fact that the third party would rely on the reports were unknown to the accountant.
D)there has been some conduct on the part of the accountant linking him/her to the third party that evidences the accountant's understanding of the third party's reliance.

Question 32

A showing of fraud requires:

A)comparative negligence.
B)inadvertent error.
C)scienter.
D)contributory negligence.

Question 33

Rowell and Associates,a CPA firm,was engaged by American Widget Corp.to audit its annual financial statements.American Widget officials told Rowell that the company planned a new issue of stock and that Rowell's audit report would be included in the registration statement.Rowell's audit team "booked" several large sales for which no written contracts or orders appeared in the files,but for which verbal confirmations were given by "customers" during telephone conversations initiated by American Widget personnel.The customers were nonexistent; the purchases never were made.American Widget went bankrupt shortly thereafter.Several investors in the new common stock then sued Rowell.Rowell's audit team truly believed the sales in question had been made and that the customers had confirmed the validity of the sales.In view of these facts,the plaintiffs:

A)will lose their suit because they cannot show that Rowell committed a willful wrong.
B)will win their suit if it is a Rule 10b-5 suit,because Rowell was negligent.
C)will win their suit if it is brought under Section 11 of the Securities Act of 1933,because Rowell cannot prove due diligence.
D)will lose the suit because they cannot show that Rowell was aware of the oversight.

Question 34

Under the Reasonably Foreseeable Users approach:

A)the accountant could be liable to third parties who are unknown but reasonably foreseeable users.
B)a negligent accountant is exposed to lesser liability than in the Restatement approach.
C)the accountant could be liable to third parties who are specifically foreseeable users.
D)a negligent accountant is exposed to lesser liability than in the Ultramares approach.

Question 35

Under Rule 10b-5 of the 1934 Act:

A)the plaintiff must prove that the accountant acted with scienter.
B)the intent to deceive is not an element of the offense.
C)an accountant may be liable to a purchaser for a misstatement of material fact in the registration statement.
D)an accountant must prove he exercised due diligence to escape liability.

Question 36

The Ultramares approach is a:

A)strict privity approach.
B)near privity approach.
C)reasonable person approach.
D)no delegation approach.

Question 37

Under the Balancing Approach,the third party:

A)cannot recover unless in privity.
B)cannot recover unless the accountant knew the purpose of reports and the identity of user.
C)may recover when the accountant knew audited material would be used.
D)may recover if determinative factors make liability desirable.

Question 38

Which of the following is true of the criminal liabilities under 1933 and 1934 Securities Act?

A)A willful misrepresentation,including an omission,in a registration statement is made a criminal act under the 1933 Act.
B)The 1933 and 1934 Act makes it a crime to willfully make a false or misleading statement in reports that are required to be filed under the act.
C)The criminal provisions of 1933 and 1934 Act specifically mention that they will be used against accountants.
D)A willful violation of Rule 10b-5 is a crime under the 1933 Securities Act.

Question 39

Under Section 11(a)of the 1933 Act,accountants:

A)are liable only if privity of contract is with the purchaser.
B)are liable for materially defective registration statements unless they can prove that they exercised due diligence.
C)are liable only to purchasers who relied upon the omissions or falsities in the registration statements.
D)are not liable to any purchaser of securities issued pursuant to a defective registration statement.

Question 40

Section 18(a)of the 1934 Act:

A)requires that the plaintiff prove reliance.
B)makes an accountant liable for accidental mistakes in the audit.
C)is not triggered by reliance.
D)requires the accountant to prove that he exercised due diligence. Section 18(a)of the 1934 Act requires that the plaintiff prove reliance.Section 18(a)imposes liability on accountants who furnish false or misleading information in any report or document filed with the SEC.While privity is not a defense in a Section 18 action,it is still not widely used because it contains a stringent reliance requirement.The purchaser or seller must have actually read the false information.This is a major hurdle since investors seldom read many of the documents filed with the SEC.

Question 41

An accountant may have conducted a limited audit that she does not feel able to offer an opinion as to the accuracy of the client's financial statements.In such situations,the accountant may issue a(n):

A)qualified opinion.
B)disclaimer.
C)unaudited statement.
D)opinion letter.

Question 42

Bob retained Wanda,a CPA,to prepare his federal income tax return.In the course of preparing the return,Wanda had several conferences with Bob,during which conferences she made notes.In addition,Bob furnished Wanda with a number of documents concerning transactions in which Bob had been involved.The IRS ultimately brought suit against Bob,claiming that he had underpaid his actual tax liability by a substantial amount.The IRS arranged for a subpoena to be served on Wanda.The subpoena purported to require her to produce,in court,Bob's documents and the notes she had made during conversations with Bob.Wanda sought to resist the order on the basis that the conversations were held in confidence,for the purpose of preparing Bob's tax return,and that the notes were made and documents were delivered in furtherance of the same purpose.Wanda claimed,therefore,that what the IRS sought was privileged information and that since neither she nor Bob had waived the privilege,she should not have to produce what the IRS sought.Is Wanda's argument sound? Why or why not?

Question 43

List the five major judicial approaches to third-party negligence actions.

Question 44

A purchaser of securities sold on a stock exchange lost all or part of his investment as a result of an accountant's errors in preparing a corporation's financial statements.Explain why he/she would not prefer to sue the accountant under Rule 10b-5.

Question 45

When might an accountant issue a qualified opinion and a disclaimer?

Question 46

The accountant issues a(n)_____ if the audited financial statements accurately reflect the client's financial condition in compliance with GAAP.

A)unqualified opinion
B)disclaimer
C)unaudited statement
D)opinion letter

Question 47

Identify the true statement concerning communications between clients and accountants.

A)In most states,communications between clients and accountants are treated the same way communications between clients and attorneys are treated.
B)Communications between clients and accountants are treated by courts as privileged in the vast majority of states.
C)Even if a state has a statute creating an accountant-client privilege,federal courts are inclined not to give such statutes any effect in cases involving federal taxes.
D)The accountant may not be forced to testify about the client's records and about conversations that the accountant had with the client.

Question 48

The CPA firm of Knox & Knox has been subpoenaed to testify and produce its correspondence and working papers in connection with a lawsuit brought against Johnson,one of its clients.Regarding the firm's attempt to avoid having to present such evidence,which of the following is correct?

A)Federal law recognizes such a privilege if the accountant is certified.
B)The privilege of confidentiality is available regarding working papers since the accountant is deemed to own them.
C)The privilege of confidentiality is as widely available as the attorney/client privilege.
D)In the absence of a specific statutory provision,the law does not recognize the existence of the privileged communication rule between accountants and their clients.

Question 49

Which of the following statements is correct with regard to working papers prepared by an accountant?

A)They are owned by the client.
B)The accountant may need to justify his work before the IRS or a court.
C)The accountant can dispose of them as he/she pleases.
D)The client does not possess the right of access to the working papers.

Question 50

Describe the accountant-client privilege.