chapter 40 - nacm - national association of credit...

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Indicate whether the statement is true or false.

1. Professionals are required to adhere to certain standards of performance within their profession. a. True b. False

2. Professionals are required to deliver services but the competency of the services is never an issue. a. True b. False

3. Professionals are governed by the contracts they enter into with their clients. a. True b. False

4. Accountants and other professionals do not face liability under the common law for any breach of contract. a. True b. False

5. Generally, an accountant must exercise the degree of care that an ordinarily prudent accountant would exercise. a. True b. False

6. An accountant normally will not be held liable to the client for incorrect judgment. a. True b. False

7. Negligence cases against professionals often focus on the standard of care exercised by the professional. a. True b. False

8. An accountant who performs an audit may be liable for failing to detect misconduct if a normal audit would have revealed it.

a. True b. False

9. An accountant is not required to discover every impropriety, defalcation, and fraud in a client’s books.

a. True b. False

10. In an opinion, an auditor can include a general statement disclaiming any liability for false or misleading financial statements. a. True b. False

11. Under rules of professional conduct, committing a criminal act that reflects adversely on a person’s “honesty” is Copyright Cengage Learning. Powered by Cognero.

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professional misconduct. a. True b. False

12. Under rules of professional conduct, a lawyer should not engage in conduct involving “dishonesty.” a. True b. False

13. Attorneys are required to find relevant law that is applicable to a case and can be discovered through a reasonable amount of research. a. True b. False

14. In all cases involving allegations of negligence, the plaintiff must prove that the professional’s breach of the duty of care actually caused some injury. a. True b. False

15. Constructive fraud may be found when an accountant is grossly negligent in performing his or her duties. a. True b. False

16. A professional can be liable for constructive fraud only if he or she acted with fraudulent intent. a. True b. False

17. To obtain damages for fraud, an innocent party does not need to have been injured. a. True b. False

18. Traditionally, a professional owed a duty only to those with whom the professional had a direct contractual relationship. a. True b. False

19. In some states, in the absence of privity, a party cannot recover from an accountant for negligence. a. True b. False

20. In most courts, accountants are subject to liability for negligence only to their clients. a. True b. False

21. Generally, an attorney is not liable to a non client unless the attorney has committed fraud or malicious conduct. a. True b. False

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22. The Sarbanes-Oxley Act applies only to domestic public accounting firms that provide auditing services to “issuers.” a. True b. False

23. Under the Sarbanes-Oxley Act, accountants must surrender possession of working papers relating to an audit or review to the party for whom the work was performed. a. True b. False

24. Working papers are the documents through which a court orders an accountant to audit a public company. a. True b. False

25. Under the Sarbanes-Oxley Act, accountants need not retain working papers relating to an audit or review. a. True b. False

26. An accountant may be liable for a misstatement or omission of material fact in a registration statement. a. True b. False

27. A failure to follow generally accepted accounting principles and generally accepted auditing standards is proof of a lack of due diligence. a. True b. False

28. An accountant is not liable for an omission in a registration statement to a purchaser of securities if the omission had no causal connection to the purchaser’s loss. a. True b. False

29. An accountant is not liable for a false statement that affects the price of a security if the buyer or seller of the security knew the statement was false. a. True b. False

30. An accountant is always liable for a misleading statement that affects the price of a security, even if the accountant acted in good faith. a. True b. False

31. For a plaintiff to recover damages from an accountant under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, ordinary negligence is not enough. a. True b. False


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32. For a plaintiff to recover damages under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, proof of intent is necessary. a. True b. False

33. An accountant’s liability under the Securities Act of 1933 requires privity of contract with the purchaser of a security. a. True b. False

34. Penalties for aiding or assisting in the preparation of false tax returns are limited to one penalty per taxpayer per tax year. a. True b. False

35. In all states, communications between an accountant and his or her client are privileged. a. True b. False

Indicate the answer choice that best completes the statement or answers the question.

36. Odette, an accountant, contracts to perform services for Percy. Odette acts in good faith and conforms to generally accepted accounting principles, but makes an incorrect judgment. Odette is most likely a. liable if Odette failed to discover a defalcation. b. liable if Odette failed to discover a fraud. c. liable if Odette failed to discover an

impropriety. d. not liable.

37. Kiana can be described as “a reasonably competent general practitioner of ordinary skill, experience, and capacity.” This is the normal standard for judging the performance of a. any individual. b. an accountant. c. an attorney. d. a tax preparer.

38. Ricardo, an accountant, contracts to conduct an audit for Sensei Sushi Restaurants. In performing the audit, Ricardo fails to detect certain misconduct. Ricardo is most likely a. liable if a normal audit would have revealed the misconduct. b. liable if Ricardo issues a specifically qualified opinion. c. not liable if Ricardo generally disclaims any liability. d. not liable if the misconduct was due to Sensei Sushi’s negligence.

Nelson, an accountant, enters into a contract to provide services to Operational Processes, Inc. (OPI). Nelson does not finish the work within the contract’s deadline. This causes OPI to fail to meet certain other deadlines owed to Prime Bank, which results in the firm’s payment of penalties to the bank.

39. Nelson isCopyright Cengage Learning. Powered by Cognero.

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a. liable for breach of contract. b. not liable, because Nelson is a professional. c. not liable, because Nelson’s failure must have been OPI’s fault. d. not liable, because the work took longer than foreseen.

40. OPI may be entitled to a. payment from Nelson of the amount of the penalties in damages. b. specific performance of any future contract with Nelson. c. an injunction against future breaches of contract by Nelson. d. no damages or other relief because Nelson is not liable.

41. Nguyen Imports, Inc., accuses Ogilvie, an accountant, of committing defalcation. This is a. embezzlement. b. general misconduct. c. professional negligence. d. misrepresentation of professional

expertise.

42. Norman is an accountant. Norman’s violation of generally accepted accounting principles and generally accepted auditing standards a. does not indicate that Norman was negligent. b. is prima facie evidence that Norman was negligent. c. precludes Norman from raising any defense against a negligence

claim. d. is embarrassing but will never subject Norman to liability.

43. Delaney is an accountant charged with negligence by Estimation & Valuation Services Inc., a client. Delaney may successfully defend against the claim if he can show that a. scienter was lacking. b. he complied with all International Financial Reporting Standards. c. the negligence was not the proximate cause of the client’s losses. d. the negligence was only contributory.

44. Lauren is an attorney. Like the conduct of all attorneys, Lauren’s conduct is governed by rules of professional conduct established by the state in which she is licensed, and the Model Rules of Professional Conduct of a. the Securities and Exchange Commission. b. the American Bar Association. c. the American Institute of Certified Public

Accountants. d. the International Accounting Standards Board.

45. Tyson accuses Ulman, an attorney, of committing malpractice. Malpractice is a. constructive fraud. b. a defalcation. c. none of the choices.Copyright Cengage Learning. Powered by Cognero.

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d. professional negligence.

46. Edward, an attorney, allows a statute of limitations to lapse on a claim by Fabrication Company, a client. Edward a. can be held liable for malpractice. b. has violated an ethical standard but cannot be held liable. c. is subject to criminal penalties under the statute of

limitations. d. will be automatically disbarred.

47. Ezra, an accountant, intentionally misstates a material fact to mislead Fruit Packing, Inc., a client. Fruit Packing justifiably relies on the misstatement to its detriment. Ezra is most likely liable for a. actual fraud. b. constructive fraud. c. destructive fraud. d. virtual fraud.

48. Commerce Bank files a suit against Drake, its former accountant, alleging constructive fraud. Drake may be held liable a. if Commerce Bank cannot prove actual fraud. b. if Drake was grossly negligent in the performance of his duties. c. only if Drake acted with fraudulent intent. d. only if Drake impersonated someone who could be liable for fraud.

49. Digital Systems Corporation files a suit against Ethan, its former accountant, alleging constructive fraud. Digital Systems need not prove a. misstatement of a material

fact. b. intent to deceive. c. justifiable reliance. d. an injury.

50. Farley, an accountant, intentionally misstates a material fact to mislead Global Industries, Inc., a client. Global justifiably relies on the misstatement to its detriment. Farley is most likely liable for a. fraud. b. malpractice. c. negligence. d. none of the choices.

51. Copper Piping Company’s liabilities exceed its assets, but its books falsely reflect a positive net worth. Copper hires Dart & Dash, an accounting firm, to prepare a balance sheet, which is certified to show a net worth. Equity Bank relies on the balance sheet to make a loan to Copper. Copper defaults on the loan. Under the Ultramares rule, Dart & Dash is most likely not liable because the firm a. did not owe a duty of care to any third party. b. is not responsible Copper’s false books. c. finished its work before Copper’s loan and default.


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d. was not in privity with Equity.

52. Everett is an accountant whose clients include Finance & Capital, Inc. Under the Ultramares rule, if Everett is negligent in his work for Finance & Capital, he could be liable to Finance & Capital and a. any third party. b. no third party with whom the accountant is not in privity or “near privity.” c. third parties who are foreseen users of the work. d. third parties who are reasonably foreseeable users of the work.

53. Brenda is an attorney whose clients include Capital Finance Company. If Brenda is negligent in her work for Capital, under the Restatement (Third) of Torts, Brenda may be liable to Capital and a. any third party. b. no third party. c. third parties who are foreseen users of the work. d. third parties who are reasonably foreseeable users of the

work.

54. Gift Basket Company’s liabilities exceed its assets. Gift Basket hires Hill & Dale, an accounting firm, to prepare a balance sheet. Through Hill & Dale’s negligent omissions, the sheet shows a net worth. Investment Bank relies on the balance sheet to make a loan to Gift Basket. When Gift Basket defaults, the bank files a suit against Hill & Dale. Under the Restatement (Third) of Torts, Hill & Dale is most likely a. liable because Hill & Dale owed a duty of care to Gift Basket. b. liable because Hill & Dale owed a duty to any foreseeable user. c. liable if Hill & Dale knew that the bank would rely on the balance sheet. d. not liable because Hill & Dale and the bank were not in privity.

55. April is an accountant whose clients include Bistro Restaurants Inc. If April is negligent in her work for Bistro, most courts would hold her liable to Bistro and a. any third party. b. no third party with whom the accountant is not in privity or “near privity.” c. third parties who are foreseen users of the work. d. third parties who are reasonably foreseeable users of the work.

56. Taylor is an accountant whose clients include Universal Metrics Corporation. Velma is Taylor’s attorney. Working papers that Taylor develops when preparing financial reports for Universal Metrics are owned by a. Taylor. b. Universal Metrics. c. Velma. d. no one—the papers must be destroyed immediately after use.

57. Rollo is an accountant whose clients include Systems Analysis Corporation. Tyra is Rollo’s attorney. Under the common law and by statute in many states, working papers that Rollo develops when preparing financial reports for Systems Analysis are owned by a. Rollo. b. Systems Analysis. c. Tyra.Copyright Cengage Learning. Powered by Cognero.

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d. no one—the papers must be destroyed immediately after use.

58. Hadley, an accountant, accumulates working papers while performing an audit for Ilene. After the audit, these documents belong to a. Hadley, with Ilene having a right of access to the papers. b. Ilene, with Hadley having a right of access to the papers. c. neither Hadley nor Ilene—the papers must be disposed

of. d. the Public Company Accounting Oversight Board.

59. Root & Branch is a Registered Public Accounting Firm. Root & Branch performs auditing services for Sales & Service Company. Under the Sarbanes-Oxley Act, at the same time, for the same company, Root & Branch can also perform a. bookkeeping. b. none of the choices. c. appraisal services. d. financial systems

design.

60. Dougal, an accountant, prepares for Econo Enterprise, Inc., a financial statement that omits a material fact. The statement is included in Econo’s registration statement with the Securities and Exchange Commission. Felicia, who relies the statement, and Graham, who does not, each buy Econo stock. Under Section 11 of the Securities Act of 1933, Dougal may be liable to a. no one. b. Felicia only. c. Felicia and Graham. d. Graham only.

61. Odell, an accountant, prepares for Pronto Tacos Corporation a financial statement that omits a material fact. The financial statement is included in Pronto Tacos’s registration statement, which Qiana reads. Qiana buys Pronto Tacos stock. Under Section 11 of the Securities Act of 1933, for Odell to be liable for the omission, Qiana must show that she a. relied on the omission. b. suffered a loss on the stock. c. knew about the omission before making her purchase. d. is a sophisticated investor.

62. Reliant Funds, Inc., files a suit against Saul, an accountant, under the anti fraud provisions of the Securities Exchange Act of 1934 and Rule 10b-5 of the Securities and Exchange Commission. To succeed, Reliant Funds must show that Saul a. acted with scienter. b. bought or sold a security. c. is incompetent. d. knows nothing about securities.

63. Randi, an accountant, includes a false statement in a report for Social Media Marketing, Inc., that is filed with the Securities and Exchange Commission. When Theo buys stock in Social Media and loses money on the investment, he files a suit against Randi, alleging fraud under the 1934 Securities Exchange Act. To avoid liability, Randi can show that


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she a. intended to defraud Social Media, not Theo. b. intended to profit on stock trades generally, not only

Theo’s. c. is an otherwise competent accountant. d. had no knowledge that her statement was false.

64. Cathy is an accountant with Discount Retail Corporation. Efrem buys Discount Retail stock and loses money on the investment. To recover from Cathy under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, Efrem must prove a. only the purchase and sale of a security. b. fraud, reliance, materiality, and lack of knowledge about

securities. c. fraud, reliance, materiality, and incompetence. d. fraud, reliance, materiality, causation, and scienter.

65. Hernando, an accountant, helps Industrial Equipment & Supplies Company prepare and file a false federal corporate income tax return. Under the Internal Revenue Code, this is a. a felony punishable by a fine and imprisonment. b. no violation. c. a misdemeanor punishable only by a fine. d. a civil violation subject to a liability suit but not a crime.

66. Silvia prepares federal corporate income tax returns for Trade & Pawn Stores, Inc., and other firms. Under the Internal Revenue Code, with respect to an understatement of a client’s tax liability, Silvia may be liable for a. negligent or willful misconduct. b. none of the choices. c. only negligent misconduct. d. only willful misconduct.

67. Reed prepares federal corporate income tax returns for Shopping Malls, Inc., and other firms. Under the Internal Revenue Code, with respect to an understatement of a client’s tax liability, Reed may be liable for a. negligent or willful misconduct. b. no misconduct. c. only negligent misconduct. d. only willful misconduct.

68. Beck is an accountant who prepares her clients’ tax returns. Cole is not an accountant, but he also prepares tax returns for clients. Under the Internal Revenue Code, liability for preparing a false return may be imposed on a. Beck and Cole. b. Beck only. c. Cole only. d. none of the choices.

69. Geoff is an attorney, whose clients include Hydroponic Superstores, Inc. Unless Hydroponic has violated securities law, the contents of Geoff’s file on Hydroponic may be disclosed to someone other than the firmCopyright Cengage Learning. Powered by Cognero.

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a. under no circumstances. b. only under a court order (with or without Hydroponic’s consent). c. only with Hydroponic’s consent. d. under any circumstances.

70. Diderot’s accountant is Esteban and his attorney is Figaro. All states protect, as privileged information, Diderot’s communications with a. Esteban and Figaro. b. Esteban only. c. Figaro only. d. none of the choices.

71. Finola, a certified public accountant, provides accounting services to Global Trade Corporation. The services include preparing Global Trade’s financial reports and issuing opinion letters based on the reports. In 2014, Global Trade falls into serious financial trouble, but neither Finola’s reports nor her opinion letters indicate this situation. Relying on Finola’s portrayal of Global Trade’s financial situation, the firm borrows a large sum of money to build a new shipping facility. In lending Global Trade the money, Harbor City Bank relies on Finola’s opinion letter. Finola is aware of this reliance. If Finola did not engage in intentional fraud but was negligent, what is her potential liability?

72. Miriam is an accountant. Natalie is an attorney. Which professional is most restricted from disclosing her or his client’s communication?


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Answer Key

1. True

2. False

3. True

4. False

5. True

6. True

7. True

8. True

9. True

10. False

11. True

12. True

13. True

14. True

15. True

16. False

17. False

18. True

19. True

20. False

21. True

22. False

23. False

24. False

25. False


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26. True

27. True

28. True

29. True

30. False

31. True

32. True

33. True

34. True

35. True

36. d

37. c

38. a

39. a

40. a

41. a

42. b

43. c

44. b

45. d

46. a

47. a

48. b

49. b

50. a

51. dCopyright Cengage Learning. Powered by Cognero.

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52. b

53. c

54. c

55. c

56. a

57. a

58. a

59. b

60. c

61. b

62. a

63. d

64. d

65. a

66. a

67. a

68. a

69. c

70. c

71. Regarding the accountant’s potential liability to the bank, most courts would hold her liable for negligence, but the standard for imposing this liability varies.There are three different views. The traditional rule (the Ultramares rule) states that accountants owe a duty of care only to those persons for whose primary benefit the accountant prepares reports or issues opinion letters. In the absence of privity, a party could not recover from an accountant. Under that rule, the accountant in this problem would not be held liable to the bank.Under a slight modification of this rule, some courts hold that if a third party has a sufficiently close relationship or nexus (link or connection) with an accountant, then the privity requirement may be satisfied without establishing an accountant-client relationship. Under this modification, the accountant would be held liable because he knew that the bank relied on her letter.The majority of courts have adopted the position taken by Section 552 of the Restatement (Second) of Torts, under which an accountant’s liability extends to persons for whose benefit the accountant “intends to supply the information or knows Copyright Cengage Learning. Powered by Cognero.

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that the recipient intends to supply it” and to those persons whom the accountant “intends the information to influence or knows that the recipient so intends.” Under this rule, the accountant will be held liable to the bank for negligent misstatements or omissions, because he knew that the bank was relying on her work product when deciding whether to make the loan.A few other courts hold accountants liable to any users whose reliance on an accountant’s statements or reports is reasonably foreseeable. Of course, under this standard the accountant in the hypothetical would clearly be held liable.

72. Most professionals are restrained by the ethical tenets of their professions from disclosing communications with their clients. In some instances, professional-client communications are even privileged under state and federal law.Of the two professionals named in this question, the attorney is the most restricted professional. Without a client’s permission, an attorney cannot disclose the client’s communication. Disclosure is prohibited under federal law, state law, and the ethical tenets of the legal profession.In a few states, accountant-client communications may not be revealed even in court without the client’s permission. But these communications are not protected—and state-provided rights are not recognized—under federal law. In cases involving federal law, in response to a court order, an accountant must provide the information sought.


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