1
Chapter 41
Liability of Accountants and
Other Professionals
N.B.: TYPE indicates that a question is new, modified, or unchanged, as
follows.
N A question new to this edition of the Test Bank.
+ A question modified from the previous edition of the Test Bank.
= A question included in the previous edition of the Test Bank.
TRUE/FALSE QUESTIONS
1. Professionals are obligated to adhere to standards of performance generally
accepted within their profession.
2. Accountants and other professionals do not face liability under the common law
for any breach of contract.
3. Accountants and other professionals may not be held liable for negligence in
the performance of their service.
4. Generally, an accountant must exercise the degree of care that an ordinarily
prudent accountant would exercise.
2 UNIT SIX: GOVERNMENT REGULATION
5. An accountant normally will be held liable to the client for incorrect judgment.
6. An accountant is required to discover every impropriety, defalcation, and fraud
in a client’s books.
7. A qualified opinion must be specific and identify the reason for the qualification.
8. An opinion that disclaims any liability for false or misleading financial
statements is too general.
9. An accountant can avoid liability by proving that his or her negligence was only
the proximate cause of the client’s loss.
10. A client’s negligence is never a defense to a charge of negligence against an
accountant.
11. Attorneys are required to be familiar with well-settled principles of law
applicable to a case.
12. Each state establishes rules that govern the conduct of attorneys
13. Under rules of professional misconduct, an attorney should not engage in
conduct involving deceit.
14. Malpractice is professional negligence.
15. A professional can be liable for fraud whether or not he or she acted with
fraudulent intent.
16. A professional’s gross negligence in performing a duty constitutes actual fraud.
17. If a third party will be affected by a contract, the parties to the contract are in
privity with the third party.
18. In most courts, auditors cannot be held liable to third parties for negligence in
the performance of their duties.
19. Under the Restatement (Third) of Torts, accountants can be held liable for
negligence to any third parties.
4 UNIT SIX: GOVERNMENT REGULATION
20. An attorney may be liable to a third party who relies on the attorney’s legal
opinion to the third party’s detriment
21. An attorney may be liable in negligence to any third party who the attorney
knows will rely on the attorney’s work.
22. The Sarbanes-Oxley Act applies to domestic, but not foreign, public accounting
firms that provide auditing services to “issuers.”
23. An accountant’s working papers are the documents that are used and
developed during an audit.
24. Working papers are the documents through which a court orders an accountant
to audit a public company.
25. Under the Sarbanes-Oxley Act, accountants must retain working papers
relating to an audit or review for a certain period of time.
26. An accountant’s liability under the Securities Act of 1933 requires privity of
contract with the purchaser of a security.
27. A failure to follow generally accepted accounting principles and generally
accepted auditing standards is proof of a lack of due diligence.
28. An accountant is not liable for a misstatement to a purchaser of securities who
knew of the misstatement but invested anyway.
29. An accountant who prepares a financial statement in good faith may avoid
liability under Section 18 of the Securities Exchange Act of 1934.
30. An accountant is not liable for a misleading statement that affects the price of a
security if the accountant acted in good faith.
31. An accountant’s liability under the Section 10(b) and Rule 10b-5 of the
Securities Exchange Act of 1934 requires privity of contract.
32. A tax preparer that fails to give a taxpayer a copy of his or her tax return may
be subject to a penalty under the Internal Revenue Code.
33. Accountants may be subject to criminal penalties for violations of federal
securities laws.
34. Penalties for aiding or assisting in the preparation of false tax returns are
limited to one penalty per taxpayer per tax year.
35. In no states are communications between an accountant and his or her client
privileged.
CHAPTER 41: LIABILITY OF ACCOUNTANTS & OTHER PROFESSIONALS 7
MULTIPLE CHOICE QUESTIONS
1. Lucille, an accountant, is subject to the accounting conventions, rules, and
procedures that constitute generally accepted accounting principles (GAAP).
GAAP are determined by
a. the International Accounting Standards Board.
b. the American Bar Association.
c. the American Institute of Certified Public Accountants.
d. the Financial Accounting Standards Board.
2. Rex, an accountant, enters into a contract to provide services to Sofi. Rex does
not finish the work within the contract’s deadline. Sofi pays a penalty as a result
of the missed deadline and hires Trey to complete the job. Rex is most likely
liable for
a. nothing.
b. Sofi’s penalty and the cost to hire Trey.
c. Sofi’s penalty only.
d. the cost to hire Trey only.
3. Leslie, an accountant, enters into a contract to provide services to Marty. Leslie
does not finish the work within the contract’s deadline. Leslie is
a. liable for breach of contract.
b. not liable, because Leslie is a professional.
c. not liable, because Leslie’s failure must have been Marty‘s fault.
d. not liable, because the work took longer than foreseen.
4. Tiny is an accountant. Tiny’s violation of generally accepted accounting
principles and generally accepted auditing standards
a. does not indicate that Tiny was negligent.
b. is prima facie evidence that Tiny was negligent.
c. precludes Tiny from raising any defense against a negligence claim.
d. will never subject Tiny to liability.
5. Jaime, an accountant, contracts to perform services for Kase. Jaime acts in
good faith and conforms to generally accepted accounting principles, but
makes a mistake in judgment. Jaime is most likely
a. liable if Jaime failed to discover a defalcation.
b. liable if Jaime failed to discover a fraud.
c. liable if Jaime failed to discover an impropriety.
d. not liable.
6. Estes, an accountant, contracts to perform services for Frasier. In performing
those services, Estes uncovers a suspicious financial transaction. Estes is
most likely not liable if he
a. acted negligently in failing to discover the transaction sooner.
b. conceals the discovery and otherwise finishes the work.
c. investigates and reports the discovery to Frasier.
d. obtains restitution from the perpetrator without Frasier’s knowledge.
7. Pluto accuses Quark, an accountant, of committing defalcation. This is
a. embezzlement.
b. general misconduct.
c. professional negligence.
d. throwing something out of a window.
8. Gert, an accountant, contracts to conduct an audit for Hailey. In performing the
audit, Gert fails to detect certain misconduct. Gert is most likely
a. liable if a normal audit would have revealed the misconduct.
b. liable if Gert issues a specifically qualified opinion.
c. not liable if Gert generally disclaims any liability.
d. not liable if the misconduct was due to Hailey’s negligence.
9. Yves is an accountant charged with negligence by Zesty Soup Company, a
client. Yves 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.
10. Dwayne 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. a client.
b. an accountant.
c. an attorney.
d. a tax preparer.
11. Lebron, an attorney, allows a statute of limitations to lapse on a claim by
Midwest Metal Fabrication Company, a client. Lebron
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.
12. Lars accuses Moe, an attorney, of committing malpractice. Malpractice is
a. a breach of ethics.
b. a defalcation.
c. a mistake in judgment.
d. professional negligence.
13. Ezra, an accountant, intentionally misstates a material fact to mislead Fruit
Packing Industries, 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.
14. Filtration Products, Inc., files a suit against Emmett, its former accountant, al–
leging constructive fraud. Emmett may be held liable
a. if Filtration cannot prove actual fraud.
b. if Emmett was grossly negligent in the performance of his duties.
c. only if Emmett acted with fraudulent intent.
d. only if Emmett impersonated someone else who could be liable for
fraud.
15. Grover Nut Company files a suit against Hud, its former accountant, alleging
actual fraud. Grover must prove
a. intent to deceive.
b. misrepresentation of a non-material fact.
c. the lack of an injury.
d. unjustifiable reliance.
16. Marquis Company’s liabilities exceed its assets, but the firm’s employees falsify
its books to reflect a positive net worth. Marquis hires Nan & Ollie, an
accounting firm, to prepare a balance sheet, which is certified to show a
positive net worth. Pure Credit Corporation relies on the balance sheet to make
a loan to Marquis. When the firm defaults, Pure Credit files a suit against Nan &
Ollie. Under the Ultramares rule, the accounting firm is most likely
a. liable because Nan & Ollie owed a duty of care to all third parties.
b. liable because Nan & Ollie owed a duty of care to Marquis.
c. liable because Nan & Ollie owed a duty to any foreseeable user.
d. not liable because Nan & Ollie and Pure Credit were not in privity.
17. Doug is an accountant whose clients include Everyday Products, Inc. (EPI).
Under the Ultramares rule, if Doug is negligent in his work for EPI, he could be
liable to
a. EPI and any third party.
b. EPI and third parties who are foreseen users of his work for EPI.
c. EPI and third parties who are reasonably foreseeable users of his work
for EPI.
d. EPI only.
18. Toby is an accountant whose clients include U-All Company. If Toby is
negligent in his work for U-All, most courts would hold him liable to U-All 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.
19. Quibble Game Company’s liabilities exceed its assets. Quibble hires Roo &
Slay, an accounting firm, to prepare a balance sheet. Through Roo & Slay’s
negligent omissions, the sheet shows a positive net worth. Town Bank relies on
the balance sheet to make a loan to Quibble. When Quibble defaults, Town
CHAPTER 41: LIABILITY OF ACCOUNTANTS & OTHER PROFESSIONALS 13
files a suit against Roo & Slay. Under the Restatement rule, Roo & Slay is most
likely
a. liable because Roo & Slay owed a duty of care to Quibble.
b. liable because Roo & Slay owed a duty to any foreseeable user.
c. liable if Roo & Slay knew that Town would rely on the balance sheet.
d. not liable because Roo & Slay and Town were not in privity.
20. Bruno is an accountant. Under the Sarbanes-Oxley Act, the degree of
government oversight over the public accounting practices of Bruno and other
accountants was
a. decreased.
b. increased.
c. eliminated.
d. unchanged.
21. Craig is an accountant whose clients include Digby Excavation Corporation.
Elbert is Craig’s attorney. Under the common law and by statute in many
states, working papers that Craig develops when preparing financial reports for
Digby are owned by
a. Craig.
b. Digby.
c. Elbert.
d. no one—the papers must be destroyed immediately after use.
22. 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.
14 UNIT SIX: GOVERNMENT REGULATION
23. Lulu, an accountant, conducts an audit of Microstuff Toys, Inc. After the conclu–
sion of the audit, the working papers created in preparing the audit must be
a. disposed of immediately.
b. kept until the Public Company Accounting Oversight Board’s review.
c. maintained for seven years.
d. retained forever.
24. Quin, an accountant, prepares for Reddy, Inc., a financial statement that omits
a material fact. The statement is included in Reddy’s registration statement with
the Securities and Exchange Commission. Timor, who reads the statement,
and Ubi, who does not, each buy Reddy stock. Velma reads the statement but
does not buy the stock. Under Section 11 of the Securities Act of 1933, Quin
may be liable to
a. no one.
b. Timor and Ubi.
c. Timor, Ubi, and Velma.
d. Ubi only.
25. Mona, an accountant, prepares for NuTech Corporation a financial statement
that omits a material fact. The financial statement is included in NuTech’s
registration statement, which Pam reads. Pam buys NuTech stock. Under
Section 11 of the Securities Act of 1933, for Mona to be liable for the omission,
Pam must show that
a. Pam relied on the omission.
b. Pam suffered a loss on the stock.
c. Pam knew about the omission before making her purchase.
d. the omission had no causal connection to her loss.
26. Pat, an accountant, includes a false statement in a report for Quantity
Overstock, Inc., that is filed with the Securities and Exchange Commission.
Quantity publishes a misleading ad about its future prospects. Rita sees the ad
and calls Stan, who buys stock in Quantity. Under Section 18 of the Securities
Exchange Act of 1934, liability may attach to
a. Pat’s report.
b. Quantity’s ad.
c. Rita’s call.
d. Stan’s purchase.
27. Meri, an accountant, includes a false statement in a report for Novelty Paper
Products, Inc. (NPPI) that is filed with the Securities and Exchange Com–
mission. When Otho buys stock in NPPI and loses money on the investment,
he files a suit against Meri, alleging fraud under the 1934 Securities Exchange
Act. To avoid liability, Meri can show that she
a. intended to defraud NPPI, not Otho.
b. intended to profit on stock trades generally, not only with Otho.
c. is an otherwise competent accountant.
d. was not aware her statement was false.
28. Beth is an accountant with Coffee Sales Corporation. Doral buys Coffee Sales
stock and loses money on the investment. To recover from Beth under Section
10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, Doral must
prove
a. none of the choices.
b. fraud and reliance only.
c. fraud, reliance, and materiality only.
d. scienter, fraud, reliance, materiality, and causation only.
29. Longway Trucking, Inc., files a suit against Midge, an accountant, under the
antifraud provisions of the Securities Exchange Act of 1934 and Rule 10b-5 of
the Securities and Exchange Commission. To succeed in recovering damages,
Longway must show that Midge
a. acted with scienter.
b. bought or sold a security.
c. is incompetent.
d. knows nothing about securities.
30. Jerzy is an accountant whose clients include Kopper Kettle Restaurants, Inc.
For a violation of securities laws, Jerzy may be subject to
a. comprehensive liability.
b. corporate liability.
c. criminal liability.
d. no liability.
31. Lacy is an accountant who prepares her clients’ tax returns. Muff 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. Lacy and Muff.
b. Lacy only.
CHAPTER 41: LIABILITY OF ACCOUNTANTS & OTHER PROFESSIONALS 17
c. Muff only.
d. neither Lacy nor Muff.
32. Feder prepares federal corporate income tax returns for Giant Stores, Inc., and
other firms. Under the Internal Revenue Code, with respect to an
understatement of a client’s tax liability, Feder may be liable for
a. negligent or willful misconduct.
b. no misconduct.
c. only negligent misconduct.
d. only willful misconduct.
33. Pace is an attorney, whose clients include Quikfeet Running Shoes Company.
Unless Quikfeet has violated securities law, the contents of Pace’s file on
Quikfeet may be disclosed to someone other than Quikfeet
a. only to a third party who is a foreseeable user of the information.
b. only under a court order (with or without Quikfeet’s consent).
c. only with Quikfeet’s consent.
d. under any circumstances.
34. Flynn, an accountant, helps Grange Supply 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. a felony punishable only by a fine.
c. a misdemeanor punishable only by a fine.
d. a civil violation subject to a liability suit but not a crime.
35. Bryce’s accountant is Caleb and his attorney is Delilah. All states protect, as
privileged information, Bryce’s communications with
a. Caleb and Delilah.
b. Caleb only.
c. Delilah only.
d. neither Caleb nor Delilah.
ESSAY QUESTIONS
1. Dominique, a certified public accountant, provides accounting services to Eagle
Corporation. The services include preparing Eagle’s financial reports and
issuing opinion letters based on the reports. In 2008, Eagle falls into serious
financial trouble, but neither Dominique’s reports nor her opinion letters indicate
this situation. Relying on Dominique’s portrayal of Eagle’s financial situation,
Eagle borrows a large sum of money to build a new shipping facility. In lending
Eagle the money, First National Bank relies on Dominique’s opinion letter.
Dominique is aware of this reliance. If Dominique did not engage in intentional
fraud but was negligent, what is her potential liability?
2. Bowie, a certified public accountant, prepares and certifies Candy Products
Corporation’s financial statements. These statements are included in Candy’s
registration statement filed with the Securities and Exchange Commission
before Candy’s offering of securities. Dona buys a security covered by the
registration statement. Based on this transaction, Dona files a suit against
Bowie under Section 11 of the Securities Act of 1933 and Section 10(b) of the
Securities Exchange Act of 1934. To succeed in the suit, what must Dona
prove? Bowie responds that Dona was not in privity with him and that even if
she had been in privity, she cannot prove his lack of due diligence. Can Bowie
prevail on these grounds? Why or why not?
