Chapter 48
Professional Liability and Accountability
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
A1. Professionals are required to deliver competent services.
A2. Accountants and other professionals do not face liability under the common law for
any breach of contract.
A3. Generally, an accountant must possess the skills that an ordinarily prudent accountant
would have.
A4. An accountant normally will be held liable to the client for a mistake in judgment.
A5. An accountant who performs an audit is liable for failing to detect misconduct even if
a normal audit would not have revealed it.
A6. Under rules of professional conduct, committing a criminal act that reflects adversely
on a person’s “honesty” is professional misconduct.
A7. 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.
A8. Under rules of professional conduct, an attorney should not engage in conduct
involving “misrepresentation.”
A9. A professional’s gross negligence in performing a duty constitutes actual fraud.
A10. An innocent professional is never liable for a co-professional’s misconduct.
A11. In some states, in the absence of privity, a party cannot recover from am accountant.
A12. In most courts, accountants are subject to liability for negligence only to their clients.
A13. An attorney may be liable in negligence to any third party.
A14. The Sarbanes-Oxley Act of 2002 applies only to domestic public accounting firms that
provide auditing services to “issuers.”
A15. Under the Sarbanes-Oxley Act of 2002, accountants must dispose of working papers
relating to an audit or review.
A16. An accountant may be liable for a misstatement or omission of material fact in a
registration statement.
A17. An accountant is not liable for a misstatement in a registration statement to a
purchaser of securities if the misstatement was not of a material fact.
A18. 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.
A19. For a plaintiff to recover damages under Section 10(b) of the Securities Exchange Act
of 1934 and SEC Rule 10b-5, ordinary negligence is enough.
A20. In no states are communications between an accountant and his or her client
privileged.
MULTIPLE CHOICE QUESTIONS
A1. 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.
A2. 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.
A3. Jim, an accountant, contracts to perform services for Kasey. Jim acts in good faith and
conforms with generally accepted accounting principles, but makes a mistake in
judgment. Jim is most likely
a. liable if Jim failed to discover a defalcation.
b. liable if Jim failed to discover a fraud.
c. liable if Jim failed to discover an impropriety.
d. not liable.
A4. 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.
A5. Penelope is an attorney. Penelope’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 drafted by
a. federal courts.
b. the American Bar Association.
c. the American Institute of Certified Public Accountants.
d. the International Accounting Standards Board.
A6. National Business Systems Corporation (NBS) files a suit against Molly, its former
accountant, alleging constructive fraud. NBS need not prove
a. detrimental reliance.
b. intent to deceive.
c. justifiable reliance.
d. materiality.
A7. Jim, an attorney, allows a statute of limitations to lapse on a claim by Midwest
Manufacturing Company, a client. Jim
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.
A8. 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.
A9. Bob, an accountant, intentionally misstates a material fact to mislead Consolidated
Industries, Inc., a client. Consolidated justifiably relies on the misstatement to its
detriment. Bob is most likely liable for
a. actual fraud.
b. constructive fraud.
c. destructive fraud.
d. virtual fraud.
A10. Lebron 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.
A11. 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 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.
A12. Faith and Gordon are accountants who work together. Faith and Gordon can limit their
potential liability for each other’s misconduct by organizing their business as
a. a foreign corporation.
b. a non-professional corporation.
c. an unincorporated corporation.
d. a professional corporation.
A13. Rollo is an attorney whose clients include Superior Credit Company. If Rollo is
negligent in his work for Superior, under the Restatement (Second) of Torts, Rollo may
be liable to Superior 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.
A14. 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.
A15. Craig is an accountant whose clients include Digby National Corporation. Elbert is
Craig’s attorney. 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.
A16. Pat, an accountant, includes a false statement in a report for Quantity, 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.
A17. Longhaul Freight, 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, Longhaul must show that Midge
a. acted with scienter.
b. bought or sold a security.
c. is incompetent.
d. knows nothing about securities.
A18. 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.
A19. 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.
A20. 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.
ESSAY QUESTIONS
A1. 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
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?
A2. Sian, an accountant, prepares a tax return for a client, Toy Sales Company. Vita, who is
not an accountant, prepares a tax return for Wu’s business, Xtra Delivery Service. Is an
accountant who prepares a tax return for a client liable for any false statements in the
return? Is a person who is not an accountant and who prepares a tax return for some–
one else liable for any false statements in the return?