Question 1

Which of the following is correct with respect to an accountant's working papers?

Accepted Answer

An accountant's working papers are considered the accountant's property, but they contain confidential client information. Therefore, the accountant cannot disclose the contents of these papers without the client's consent or a court order, making option C correct. Options A and B are incorrect because they suggest the client owns the working papers and can demand their surrender, which is not typically the case in the accounting profession.

Question 2

An accountant's legal responsibility under state law may be based upon:

Accepted Answer

An accountant's legal responsibility under state law may be based upon contract law (if they have a signed engagement letter or contract with a client), tort law (if the accountant is negligent and causes harm or damages to a client), and criminal law (if the accountant engages in illegal activities such as fraud or embezzlement). Therefore, the best choice is D, all of these.

Question 3

Henry prepared a registration for the first issuance of stock of the Winzell Corporation. Henry took the assignment very seriously and spent a great deal of time preparing the statement. Two years after the statement was filed, the SEC began to investigate the company and claims that the information in Henry's statement was misleading, because some of the information given to him by the corporation was false. Henry had tried to verify the information, but was not able to do so. An investor is now suing Henry claiming that he violated the 1933 act. Is Henry liable?

Accepted Answer

The answer of Henry prepared a registration for the first...

Question 4

The Sarbanes-Oxley Act was enacted in response to:

Accepted Answer

The Sarbanes-Oxley Act was enacted in response to the business scandals involving companies such as Enron, WorldCom, and the Arthur Andersen accounting firm. It was intended to improve corporate governance and financial transparency, and to restore public trust in financial reporting.

Question 5

Audit working papers would include all but:

Accepted Answer

Audit working papers typically include information related to the audit engagement such as information disclosed during the audit, conclusions reached, and records of accounting and auditing procedures and tests performed. However, accountant fees accrued for the year from all accounts would not typically be included in the audit working papers.

Question 6

Sara holds 1,000 shares of stock in B B & B, Inc., which she purchased, based upon the financial statements that Adam had prepared. She now realizes that the statements were false and wants to sue Adam for common law fraud. What is Adam's best defense?

Accepted Answer

The answer of Sara holds 1,000 shares of stock in...

Question 7

Anna has a contract to perform accounting services for Interior Corporation. She breaches her contract in a nonmaterial way. Which of the following is correct with respect to Anna's right to be paid for her work?

Accepted Answer

When a nonmaterial breach occurs, the party who has breached is still entitled to compensation for the work completed, but the nonbreaching party may be entitled to pay any damages or losses caused by the breach. Therefore, Anna is entitled to the contractually agreed upon fee less any damages or loss her breach has caused her clients. Option A is incorrect because Anna is entitled to compensation for her work completed. Option B is incorrect because the type of contract is not specified, and even in a satisfaction contract, Anna may still be entitled to some compensation for her services. Option D is incorrect because even though the breach is nonmaterial, Anna is not entitled to full compensation without accounting for any damages or losses her breach caused.

Question 8

The Public Company Accounting Oversight Board can impose sanctions in its disciplinary proceedings, including:

Accepted Answer

The PCAOB can impose a permanent ban on a person's associating with any registered firm in its disciplinary proceedings. While the PCAOB can also revoke an accounting firm's registration, it is not limited to a temporary basis. The PCAOB can impose monetary penalties on both natural persons and accounting firms, but the amounts vary and are not limited to $1 million or $10 million.

Question 9

Tom decides to invest in the stock of Triad Television after he reads Edgar's audit, which includes a statement, known by Edgar to be false, as to the value of numerous worthless securities held as corporate assets. If Tom sues Edgar in a state using the broadest test for determining an accountant's liability for negligence to third parties, he will be entitled to:

Accepted Answer

Under the broadest test for determining an accountant's liability for negligence to third parties, a plaintiff is entitled to damages if they are a reasonably foreseeable plaintiff. In this case, Tom was an intended beneficiary of the audit contract and it was foreseeable that his investment decision would be based on the audited financial statements. Therefore, he can sue Edgar for damages. Option A is incorrect because Tom is not an incidental beneficiary in this case. Option C is incorrect because completing a new audit would not address the harm already suffered by Tom. Option D is also incorrect as rescission of the purchase contract would not provide a remedy for the damages suffered by Tom.

Question 10

Barbara works for Chevco but owns no Chevco stock. She buys 10 shares of a new issue of company stock as a savings plan and afterward receives the signed registration statement, which contains an untrue statement of material fact. Because she works for Chevco, she recognizes the error. Can she sue the auditor?

Accepted Answer

Under Section 11 of the Securities Act of 1933, a plaintiff is not required to prove reliance on the untrue statement of material fact in order to bring a lawsuit. Therefore, Barbara can sue the auditor for the untrue statement in the registration statement even though she did not rely on it.

Question 11

Which of the following is correct with regard to an accountant's contractual liability?

Accepted Answer

All three statements are correct. An accountant is bound to perform all the duties she explicitly agrees to perform and also implicitly agrees to perform a contract in a competent and professional manner. Additionally, if an accountant breaches their contract with a client, they may also be liable to a third-party intended beneficiary, depending on the circumstances.

Question 12

Which of the following would NOT constitute scienter contributing to liability under Rule 10b-5?

Accepted Answer

Negligent conduct would not constitute scienter contributing to liability under Rule 10b-5. Scienter requires a mental state of recklessness or intent, and negligence is a lower standard of care.

Question 13

The accountant-client privilege is recognized:

Accepted Answer

The accountant-client privilege is recognized only in those states that have enacted statutes creating such a privilege. Unlike the attorney-client privilege, which is widely recognized in both state and federal courts, the accountant-client privilege is not a common law privilege and thus only exists where specifically established by statute.

Question 14

An accountant can ethically disclose a client's confidential information if the accountant complies with:

Accepted Answer

An accountant may ethically disclose a client's confidential information if the client provides consent, if the disclosure is in compliance with Generally Accepted Auditing Standards, or if a court order is obtained. Therefore, all of the choices are correct.

Question 15

Under the Private Securities Litigation Reform Act of 1995, those who audit financial statements required by the 1934 Securities Exchange Act must establish procedures capable of:

Accepted Answer

The Private Securities Litigation Reform Act of 1995 requires auditors to establish procedures capable of detecting material illegal acts, identifying material related party transactions, and evaluating whether there is a substantial doubt about the issuer's ability to continue as a going concern during the next fiscal year.

Question 16

Accountants would be subject to criminal liability where they:

Accepted Answer

Accountants would be subject to criminal liability if they willfully omit a material fact on a securities registration statement, as this would be a violation of securities laws. Negligently performing an audit may result in civil liability, but not criminal. Refusing to turn over working papers to a client or breaching a contract may also result in civil liability, but not necessarily criminal.

Question 17

Baxsen, Inc. wanted to acquire the common stock of the Acme Corporation and hired Clark to audit the financial statements of Acme. Clark failed to discover a large embezzlement by Acme's chief financial officer. In a common law action by Baxsen against Clark, Baxsen must at a minimum prove:

Accepted Answer

Baxsen must at a minimum prove ordinary negligence on Clark's part, which means Clark failed to exercise the care that a reasonably prudent auditor would have exercised under the same circumstances. This is the basic level of fault required in a common law action for negligence.

Question 18

Pam certified a statement prepared by John, her employee, without checking John's work. He was never known to be anything but diligent and his integrity had never been questioned. The audit contained gross misstatements. Pam defends a suit against her claiming "due diligence." She will:

Accepted Answer

Due diligence requires a reasonable investigation, which Pam did not do by failing to check John's work. She cannot simply rely on his reputation and must ensure the accuracy of the statement before certifying it. Therefore, she would not succeed in defending the suit against her.

Question 19

Wurst & Wurst is the accounting firm that has been used by the Intercontinental Bank for over twenty years. Ben approached Alfred, a Wurst partner, at a cocktail party. Ben asked about the Bank's stability. Although Alfred knew that the bank's stock was overvalued because of some loans to third world countries, he felt a considerable amount
of loyalty to the bank for being a good customer of his accounting firm. Alfred told Ben that Wurst had just finished an audit of the bank, and that the bank was as sound as the Rock of Gibraltar. The next day Ben bought 1,000
shares of Intercontinental. One month later, the bank's losses became the subject of a major financial scandal. Ben is angry and wants to sue. Does Ben have a case?

Accepted Answer

The answer of Wurst & Wurst is the accounting firm...

Question 20

If an auditor of financial statements required by the 1934 Act becomes aware of an illegal act, the auditor must:

Accepted Answer

According to the PCAOB, if an auditor becomes aware of an illegal act during the audit of financial statements required by the 1934 Act, the auditor must inform the issuer's management and make sure the audit committee or the board of directors is adequately informed. The auditor should also evaluate the effect of the illegal act on the financial statements and the auditor's report. Resignation is only required if the issuer fails to notify the SEC of the illegality within ten business days. The auditor is not required to notify the SEC within one day of discovering the illegal act, but failure to report it to management and the audit committee may result in criminal penalties.

Quiz 44: Accountants Legal Liability