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Flashcards in CPA Legal liability Deck (29):
1

Which of the following statements is (are) correct regarding a CPA employee of a CPA firm taking copies of information contained in client files when the CPA leaves the firm?
I. A CPA leaving a firm may take copies of information contained in client files to assist another firm in serving that client.
II. A CPA leaving a firm may take copies of information contained in client files as a method of gaining technical expertise.
a. II only.
b. I only.
c. Both I and II.
d. Neither I nor II.

Neither I nor II.

Choice "d" is correct. Information contained in client files ("workpapers") are the property of the CPA firm. Although the accounting firm owns the workpapers, the firm and its employees are generally prohibited from showing the workpapers to anyone without the client's permission. Furthermore, an employee of a CPA firm may not take information contained in client files when leaving the firm. Workpapers produced by the firm for, or on behalf of a client, may not be copied and removed by an employee for personal use.

2

Which of the following statements is correct regarding an accountant's working papers?
a. The accountant owns the working papers but generally may not disclose them without the client's consent or a court order.
b. The client owns the working papers but, in the absence of the accountant's consent, may not disclose them without a court order.
c. The client owns the working papers but the accountant has custody of them until the accountant's bill is paid in full.
d. The accountant owns the working papers and generally may disclose them as the accountant sees fit.

The accountant owns the working papers but generally may not disclose them without the client's consent or a court order.

Choice "a" is correct. While a CPA owns his or her workpapers, the ownership rights are very limited. Generally, a CPA may not reveal client workpapers to third parties without the client's consent.

3

To which of the following parties may a CPA partnership provide its working papers without either the client's consent or a lawful subpoena?
The IRS The FASB
a. No No
b. Yes No
c. No Yes
d. Yes Yes

No. No.

Choice "a" is correct. An accountant is prohibited from showing the workpapers to anyone without the client's permission, except:
1. Lawful subpoena.
2. Surviving member of the firm.
3. Quality control panel.
4. AICPA/State Trial Board.
5. Court proceedings.

4

Which of the following statements is generally correct regarding the liability of a CPA who negligently gives an opinion on an audit of a client's financial statements?
a. The CPA is liable to anyone in a class of third parties whom the CPA knows will rely on the opinion.
b. The CPA is only liable to the client.
c. The CPA is only liable to those third parties who are in privity of contract with the CPA.
d. The CPA is liable to all possible foreseeable users of the CPA's opinion.

The CPA is liable to anyone in a class of third parties whom the CPA knows will rely on the opinion.

Choice "a" is correct. The majority rule (the law followed in the majority of the states) is that accountants are liable to anyone in a class (such as potential lenders or investors) of third parties whom the CPA knows will rely on the opinion of the financial statements.

Choice "c" is incorrect. This describes a more limited extent of CPA liability than is the case under the majority rule.

Choice "b" is incorrect. In all states, the CPA's liability extends beyond the client.

Choice "d" is incorrect. This describes a broader extent of liability than is the case under either the majority rule or the minority rule.

5

Thorp, CPA, was engaged to audit Ivor Co.'s financial statements. During the audit, Thorp discovered that Ivor's inventory contained stolen goods. Ivor was indicted and Thorp was subpoenaed to testify at the criminal trial. Ivor claimed accountant-client privilege to prevent Thorp from testifying. Which of the following statements is correct regarding Ivor's claim?
a. Ivor can claim an accountant-client privilege only in federal courts.
b. The accountant-client privilege can be claimed only to limit testimony to audit subject matter.
c. The accountant-client privilege can be claimed only in civil suits.
d. Ivor can claim an accountant-client privilege only in states that have enacted a statute creating such a privilege.

Ivor can claim an accountant-client privilege only in states that have enacted a statute creating such a privilege.

Choice "d" is correct. The accountant-client privilege can be claimed only in those states that recognize the privilege.

Choice "a" is incorrect. Generally, there is no federal accountant-client privilege. There is a limited federal privilege for noncriminal tax proceedings other than tax shelter matters, but here the engagement was for audit services, and the proceeding is a criminal proceeding.

Choice "c" is incorrect. If a state has enacted the privilege, the privilege is not limited to civil cases.

Choice "b" is incorrect. Where the privilege exists, it would prevent testimony about the audit, not limit testimony to the audit.

6

A CPA is permitted to disclose confidential client information without the consent of the client to:
I. Another CPA firm if the information concerns suspected tax return irregularities.
II. A state CPA society voluntary quality control review board.
a. Neither I nor II.
b. Both I and II.
c. I only.
d. II only.

II only.

Choice "d" is correct. A CPA may reveal confidential information without the client's consent in a number of situations (e.g., when subpoenaed, when requested by a CPA society voluntary quality control review board). However, there is no exception to the duty of confidentiality merely because tax irregularities are suspected.

7

In a common law action against an accountant, lack of privity is a viable defense if the plaintiff:
a. Can prove the presence of gross negligence that amounts to a reckless disregard for the truth.
b. Is the client's creditor who sues the accountant for negligence.
c. Is the accountant's client.
d. Bases the action upon fraud.

Is the client's creditor who sues the accountant for negligence.

Choice "b" is correct. A creditor of a client generally cannot sue the client's accountant for negligence unless the accountant had reason to know that the creditor would be relying on the accountant's work.

Choice "a" is incorrect. If the plaintiff can prove gross negligence, privity is not a defense; the accountant generally is liable to anyone who is injured by gross negligence.

Choice "c" is incorrect. The client is always in privity of contract with the accountant.

Choice "d" is incorrect. If the action is based on fraud, privity is not a defense; the accountant generally can be held liable to anyone who is injured by the accountant's fraud.

8

Under the provisions of Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934, which of the following activities must be proven by a stock purchaser in a suit against a CPA?
I. Intentional conduct by the CPA designed to deceive investors.
II. Negligence by the CPA.
a. Both I and II.
b. Neither I nor II.
c. II only.
d. I only.

I only.

Choice "d" is correct. Under Rule 10b-5, a purchaser must prove scienter (either an intent to deceive or gross negligence, which is the reckless disregard for the truth); negligence is insufficient to establish scienter.

9

Under Section 11, which of the following must be proven by a purchaser of the security?
Reliance on the Fraud by
financial statements the CPA
a. No No
b. Yes No
c. No Yes
d. Yes Yes

No, no.

Choice "a" is correct. Under Section 11, a plaintiff need only prove that: (i) the plaintiff acquired (not necessarily bought) the security, (ii) there was a material misstatement in the financial statements included in the registration statement that was signed by the defendant, and (iii) the plaintiff suffered a loss. The plaintiff need not prove reliance or fraud.

10

If a CPA recklessly departs from the standards of due care when conducting an audit, the CPA will be liable to third parties who are unknown to the CPA based on:
a. Criminal deceit.
b. Strict liability.
c. Gross negligence.
d. Negligence.

Gross negligence.

Choice "c" is correct. Reckless departure from standards of due care constitutes gross negligence, which is also called constructive fraud. A CPA who commits constructive fraud is liable to all plaintiffs, not just those with whom the CPA dealt or of whom the CPA knew.

Choice "d" is incorrect. Negligence connotes less of a departure from due care than does recklessness connote. If a CPA is merely negligent, liability is limited to clients and persons whom the CPA knew would be relying on the CPA's work.

Choice "b" is incorrect. Strict liability imposes liability without fault. CPAs generally are not strictly liable for departures from the standard of due care. Moreover, a fault standard (recklessness) is involved here.

Choice "a" is incorrect. Criminal acts give rise to criminal liability. Only the government can impose liability for criminal acts. Private parties must rely on a tort theory to hold a CPA liable.

11

Jay and Co., CPAs, audited the financial statements of Maco Corp. Jay intentionally gave an unqualified opinion on the financial statements even though material misstatements were discovered. The financial statements and Jay's unqualified opinion were included in a registration statement and prospectus for an original public offering of Maco stock. Which of the following statements is correct regarding Jay's liability to a purchaser of the offering under Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934?
a. Jay will be liable if the purchaser relied on Jay's unqualified opinion on the financial statements.
b. Jay will be liable if Jay was negligent in conducting the audit.
c. Jay will not be liable if the purchaser's loss was under $500.
d. Jay will not be liable if the misstatement resulted from an omission of a material fact by Jay.

Jay will be liable if the purchaser relied on Jay's unqualified opinion on the financial statements.

Choice "a" is correct. A defendant is liable under rule 10b-5 if the defendant either: (i) intentionally makes a misstatement in connection with the purchase or sale of stock or (ii) recklessly disregards the truth with respect to a statement in connection with the purchase or sale or stock and the plaintiff justifiably relies on the misstatement and suffers a loss. Here, Jay, knowing that the financial statements included material misstatements, intentionally gave an unqualified opinion. Thus, if the purchaser relied on the misstatements, Jay will be liable.

Choice "b" is incorrect. Rule 10b-5 prohibits fraud or constructive fraud in the purchase of sale of stock. The rule does not impose liability for mere negligence.

Choice "c" is incorrect. Rule 10b-5 has no minimum liability threshold.

Choice "d" is incorrect. Rule 10b-5 liability can arise both from false statements of material fact and from omissions of material statements necessary to make statements made not misleading.

12

Sun Corp. approved a merger plan with Cord Corp. One of the determining factors in approving the merger was the financial statements of Cord that were audited by Frank & Co., CPAs. Sun had engaged Frank to audit Cord's financial statements. While performing the audit, Frank failed to discover certain irregularities that later caused Sun to suffer substantial losses. For Frank to be liable under common law negligence, Sun at a minimum must prove that Frank:
a. Was grossly negligent.
b. Failed to exercise due care.
c. Acted with scienter.
d. Knew of the irregularities.

Failed to exercise due care.

Choice "b" is correct. For a cause of action for negligence, the client must prove at least that the CPA failed to exercise due care.

Choice "d" is incorrect. Knowledge of the irregularities without reporting them to the client would constitute fraud. This is not the minimum that must be proved for negligence.

Choice "a" is incorrect. A client can maintain a cause of action against a CPA for simple negligence; gross negligence need not be proved.

Choice "c" is incorrect. Scienter (either intent to deceive or reckless disregard for the truth) is not required for negligence.

13

A CPA will most likely be negligent when the CPA fails to:
a. Correct errors discovered in the CPA's previously issued audit reports.
b. Warn a client's customers of embezzlement by the client's employees.
c. Detect all of a client's fraudulent activities.
d. Include a negligence disclaimer in the CPA's engagement letter.

Correct errors discovered in the CPA's previously issued audit reports.

Choice "a" is correct. It would be negligent (i.e., a failure to exercise due care) to not correct discovered errors.

Choice "c" is incorrect. An auditor does not have a duty to discover all of a client's fraudulent activities.

Choice "d" is incorrect. A CPA is negligent if the CPA fails to use due care. Attempting to include a contract provision disclaiming liability for negligence is not itself a breach of care. In any case, the inclusion of such a disclaimer would probably be ineffective because it in essence would be an attempt to avoid responsibility to perform the audit with due care.

Choice "b" is incorrect. A CPA generally does not owe a duty to a client's customers. Indeed, reporting to the clients could violate a duty of confidentiality.

14

An accountant will be liable for damages under Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934 only if the plaintiff proves that:
a. The security involved was registered.
b. The security was part of an original issuance.
c. There was a material omission.
d. The accountant was negligent.

There was a material omission.

Choice "c" is correct. Among other things to prove a cause of action under Rule 10b-5, a plaintiff must prove that the defendant, in connection with the purchase or sale of securities, either made a false statement of a material fact or omitted a material fact.

Choice "d" is incorrect. Negligence is not a high enough standard; Rule 10b-5 requires scienter (either an intent to deceive or reckless disregard for the truth).

Choice "a" is incorrect. Section 10(b) and Rule 10b-5 apply to all sales of securities involving interstate commerce, not just those registered.

Choice "b" is incorrect. Section 10(b) of the 1934 Act primarily governs post-issuance transactions; issuance of securities generally is governed by the 1933 Act. Although Section 10(b) and Rule 10b-5 could be applied to the issuance of securities, this section and the rule do not require that the securities involved be part of an original issuance.

15

A client suing a CPA for negligence must prove each of the following factors, except:
a. Reliance.
b. Breach of duty of care.
c. Proximate cause.
d. Injury.

Reliance.

Choice "a" is correct. Negligence has 4 elements: duty of care, breach (which is lack of due care), causality and injury.

Choices "b", "c", and "d" are elements of negligence. Only choice "a" is not.

16

An accounting firm was hired by a company to perform an audit. The company needed the audit report in order to obtain a loan from a bank. The bank lent $500,000 to the company based on the auditor's report. Fifteen months later, the company declared bankruptcy and was unable to repay the loan. The bank discovered that the accounting firm failed to discover a material overstatement of assets of the company. Which of the following statements is correct regarding a suit by the bank against the accounting firm? The bank:
a. Cannot sue the accounting firm because there was no privity of contact.
b. Can sue the accounting firm for the loss of the loan because of the rule of privilege.
c. Cannot sue the accounting firm because of the statute of limitations.
d. Can sue the accounting firm for the loss of the loan because of negligence.

Can sue the accounting firm for the loss of the loan because of negligence.

Choice "d" is correct. In most states, a CPA or accounting firm is liable not only to the client for negligence, but also to any person or foreseeable class of persons whom the CPA or firm knows will be relying on the CPA's work. Here, if the accounting firm knew that the purpose of the audit was to obtain a loan from a bank, the CPA could be held liable by any bank that made a loan based on a negligently performed audit.

Choice "c" is incorrect. The statute of limitations requires that a lawsuit be brought within a specified period of time. Although states vary as to the time in which lawsuits must be commenced, no state would preclude a lawsuit brought within fifteen months.

Choice "a" is incorrect. In most states, privity of contract is not required for a negligence action against an accounting firm. In addition to the client, the firm is liable to any person or foreseeable class of persons whom the CPA or firm knows will be relying on the CPA's work. Although not clear from the facts, it is likely that the bank can show the accountant had reason to know it would rely on the accountant's work.

Choice "b" is incorrect. There is no rule of privilege in the law concerning lawsuits between accountants and banks.

17

At a confidential meeting, an audit client informed a CPA about the client's illegal insider-trading actions. A year later, the CPA was subpoenaed to appear in federal court to testify in a criminal trial against the client. The CPA was asked to testify to the meeting between the CPA and the client. After receiving immunity, the CPA should do which of the following?
a. Discuss the entire conversation including the illegal acts.
b. Take the Fifth Amendment and not discuss the meeting.
c. Discuss only the items that have a direct connection to those items the CPA worked on for the client in the past.
d. Cite the privileged communications aspect of being a CPA.

Discuss the entire conversation including the illegal acts.

Choice "a" is correct. A CPA can be compelled to disclose confidential client information if he or she is subpoenaed and if the information is relevant to the court case. The CPA's information regarding illegal insider trading would be relevant in a criminal case.

Choice "b" is incorrect. The Fifth Amendment only applies to self-incriminating evidence. A person may not claim a Fifth Amendment privilege after receiving immunity from prosecution.

Choice "d" is incorrect. The privileged communication rule for accountants does not apply at the federal level.

Choice "c" is incorrect. Since there is no privileged communication rule in federal courts (except with respect to noncriminal tax matters other than tax shelters), the CPA must reveal all relevant information if subpoenaed.

18

Which of the following penalties is usually imposed against an accountant who, in the course of performing professional services, breaches contract duties owed to a client?
a. Specific performance.
b. Punitive damages.
c. Rescission.
d. Money damages.

Money damages.

Choice "d" is correct. When a CPA breaches a contract for professional services, the client and any third party beneficiary of the contract are entitled to compensatory money damages.

Choice "a" is incorrect. Generally, specific performance (an order to perform as agreed) is available only in a contract for the sale of rare or unique property. Specific performance is not available to enforce a personal services contract, for such an order would constitute an order for involuntary servitude.

Choice "b" is incorrect. Punitive damages are not available in a contract action.

Choice "c" is incorrect. Rescission is the cancellation of a contract. It is available after a breach, but usually the nonbreaching party will choose to recover its money damages instead of canceling.

19

Spinner, CPA, had audited Lasco Corp.'s financial statements for the past several years. Prior to the current-year's engagement, a disagreement arose that caused Lasco to change auditing firms. Lasco has demanded that Spinner provide Lasco with Spinner's working papers so that Lasco may show them to prospective auditors to help them prepare their bids for Lasco's audit engagement. Spinner refused and Lasco commenced litigation. Under the ethical standards of the profession, will Spinner be successful in refusing to turn over the working papers?
a. Yes, because Spinner is the owner of the working papers.
b. Yes, because Lasco is required to direct prospective auditors to contact Spinner to make arrangements to view the working papers in Spinner's office.
c. No, because Lasco has a legitimate business reason for demanding that Spinner surrender the working papers.
d. No, because it was Lasco's financial statements that were audited.

Yes, because Spinner is the owner of the working papers.

Choice "a" is correct. Work papers belong to the accountant who prepares them, not the client. Thus, as the owner of the workpapers, Spinner does not have to disclose them to the client, Lasco.

Choice "b" is incorrect because it indicates Spinner would have to disclose if Lasko directed the new auditors to contact Spinner to view the workpapers in Spinner’s office. Spinner does not have to disclose the workpapers.

Choices "c" and "d" are incorrect. Both indicate that Spinner must disclose to Lasco and Spinner is not required to disclose the workpapers.

20

A CPA in public practice may not disclose confidential client information regarding auditing services without the client's consent in response to which of the following situations?
a. A court-ordered subpoena or summons.
b. An inquiry from the professional ethics division of the AICPA.
c. A letter to the client from the IRS.
d. A review of the CPA's professional practice by a state CPA society.

A letter to the client from the IRS.

Choice "c" is correct. A CPA is required to disclosed confidential client information if the information is subpoenaed and relevant to a court case. The IRS would have to do more than request the information in a letter. The IRS would have to subpoena the information and show that the information was relevant to an examination (audit).

Choice "d" is incorrect because a CPA is required to reveal confidential client information to a state CPA society voluntary quality control review panel when requested.

Choice "b" is incorrect because a CPA is required to reveal confidential information in an official investigation of the AICPA/state trial board.

Choice "a" is incorrect because a CPA is required to reveal confidential client information if it is subpoenaed and relevant to a court case.

21

Under the position taken by a majority of the courts, to which third parties will an accountant who negligently prepares a client's financial report be liable?
a. All third parties who relied on the report and sustained injury.
b. Only those third parties in privity of contract with the accountant.
c. Any third party whose reliance on the report was reasonably foreseeable.
d. Any foreseen or known third party who relied on the report.

Any foreseen or known third party who relied on the report.

Choice "d" is correct. Under the majority position an accountant is liable for negligence only to third parties whom the accountant knows or should foresee will be relying on the accountant's work.

Choice "b" is incorrect. This choice reflects the minority Utramares position. In most states, an accountant's liability extends beyond those who are in privity (i.e., in a contractual relationship with) the accountant.

Choice "a" is incorrect. This choice is too broad. An accountant is not liable in negligence merely because someone relied on the accountant's work.

Choice "c" is incorrect. This answer is too broad because it is not enough that a party could have foreseeably relied – the party must have actually relied.

22

A company engaged a CPA to perform the annual audit of its financial statements. The audit failed to reveal an embezzlement scheme by one of the employees. Which of the following statements best describes the CPA's potential liability for this failure?
a. The CPA is liable for any embezzlement losses that occurred before the scheme should have been detected.
b. The CPA's adherence to generally accepted auditing standards (GAAS) may prevent liability.
c. The CPA will not be liable if care and skill of an ordinary reasonable person was exercised.
d. The CPA may be liable for punitive damages if due care was not exercised.

The CPA's adherence to generally accepted auditing standards (GAAS) may prevent liability.

Choice "b" is correct. A CPA will be liable in negligence if he or she fails to exercise the care and prudence that an ordinary CPA would exercise in performing an audit. An ordinary CPA would normally adhere to GAAS. Thus, proof of adherence to GAAS may prevent liability.

Choice "c" is incorrect. A CPA must perform an audit with the care and skill that an ordinary CPA would exercise; exercising the care and skill of an ordinary, reasonable person is not enough.

Choice "d" is incorrect. A CPA may be liable for punitive damages for willful fraud or recklessly performing an audit. While failure to exercise due care is a sufficient basis to impose liability for negligence, it is not a sufficient basis to impose liability for fraud.

Choice "a" is incorrect. This choice sets up a strict liability standard – CPAs are liable for any embezzlement losses that should have been detected. The law imposes no such liability. A CPA must at least be negligent before liability will be imposed.

23

In which of the following types of action, brought against a CPA who issues an audit report containing an unqualified opinion on materially misstated financial statements, may a plaintiff prevail without proving reliance on the audit report?
a. An action for common law breach of contract.
b. An action brought under Section 11 of the Securities Act of 1933.
c. An action brought under Rule 10b-5 of the Securities Exchange Act of 1934.
d. An action for common law fraud.

An action brought under Section 11 of the Securities Act of 1933.

Choice "b" is correct. A plaintiff need only prove three elements to recover under section 11: (i) the plaintiff acquired (not necesarily bought) the stock, (ii) the registration statement was signed by the CPA and contains either a misrepresentation of a material fact or an omission of a material fact, and (iii) damages. All other causes of action listed require proof of reliance.

24

An accountant's audit documentation, created by an accountant when performing an audit for a client, is owned by:
a. Neither the accountant nor the client.
b. The client only.
c. The accountant and the client jointly.
d. The accountant only.

The accountant only.

Choice "d" is correct. The accountant's audit documentation is the sole property of the accountant. However, the information contained within the audit documentation may concern the client and in that case is confidential for the benefit of the client.

Choices "b", "c", and "a" are incorrect, per the above explanation.

25

For a CPA to be liable for damages under the anti-fraud provisions of Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934, a plaintiff must prove all of the following, except that:
a. The CPA violated generally accepted auditing standards.
b. There was a material misrepresentation of fact in the financial statements audited by the CPA.
c. The plaintiff relied on the financial statements audited by the CPA.
d. The CPA acted with scienter.

The CPA violated generally accepted auditing standards.

Choice "a" is correct. For a CPA to be liable for damages under section 10(b) of the 1934 Act, the plaintiff must prove the following:
1. The plaintiff purchased or sold securities,
2. The defendant's material misrepresentation of fact with respect to the securities,
3. Scienter (intent to deceive or reckless disregard for the truth) by the defendant,
4. The plaintiff's justifiable reliance,
5. Damages incurred by the plaintiff, and
6. A means of interstate commerce was involved.

While a violation of GAAS might help prove fault, such a violation is not a necessary element.

26

Which of the following statements is correct regarding the liability of a CPA for services performed?
a. A CPA's liability for fraud extends only to the client and no further.
b. A CPA's work is not guaranteed to be accurate even though the CPA acted in a reasonably competent and professional manner.
c. A CPA is negligent for exercising only that degree of care a reasonably competent CPA would exercise under the circumstances.
d. A CPA's liability for negligence extends only to the client and no further.

A CPA's work is not guaranteed to be accurate even though the CPA acted in a reasonably competent and professional manner.

Choice "b" is correct. A CPA does not guarantee everything to be accurate, only that the work was performed in a competent and professional manner.

Choice "c" is incorrect. A CPA who exercises the degree of care that a reasonably competent CPA would exercise under the circumstances has met his or her duty of care
and would not be found negligent.

Choice "d" is incorrect. In most states, a CPA's duty of care extends not only to the client, but also to all persons whom the CPA knows will be relying on the CPA's work.

Choice "a" is incorrect. A CPA's liability with regard to fraud is very broad, liability for fraud extends to all persons who rely on the fraudulent financial statements.

27

Under the common law, which of the following defenses, if used by a CPA, would best avoid liability in an action for negligence brought by a client?
a. The CPA's negligence was not the proximate cause of the client's losses.
b. The client was contributorily negligent.
c. The client was comparatively negligent.
d. The accuracy of the CPA's report was not guaranteed.

The CPA's negligence was not the proximate cause of the client's losses.

Choice "a" is correct. A plaintiff must show four elements to make a case for negligence against a CPA. The plaintiff must show the defendant owed a duty of care to the plaintiff, the defendant breached that duty by failing to act with due care, the breach caused the plaintiff's injury, and damages. A defense that the negligence was not the proximate cause of plaintiff's losses would be a valid defense, as the third element would not exist.

Choices "b", "c", and "d" are incorrect, per the above rule.

28

Which of the following pairs of elements must a client prove to hold an accountant liable for common law negligence?
a. Freedom from contributory negligence and privity.
b. Willful misrepresentation and breach of the accountant's duty of care.
c. Scienter and a violation of GAAP.
d. Breach of the accountant's duty of care and loss.

Breach of the accountant's duty of care and loss.

Choice "d" is correct. A plaintiff must show four elements to make a case for negligence against a CPA. The plaintiff must show that the defendant owed a duty of care to the plaintiff, the defendant breached that duty by failing to act with due care, the breach caused the plaintiff's injury, and damages.

Choices "a", "b", and "c" are incorrect, per the above rule.

29

American Corp. retained Baker, CPA, to conduct an audit of its financial statements to obtain a bank line of credit. American signed an engagement letter drafted by Baker that included a disclaimer provision. As a result of Baker's failure to detect a material misstatement in American's financial statements, the audit report contained an unmodified opinion. Based on American's audited financial statements, National extended credit to American. American filed a petition in bankruptcy shortly thereafter. National sued Baker for damages based on common law fraud. What would be Baker's best defense?
a. National was not in privity with Baker.
b. Baker included a disclaimer provision in the engagement letter with American.
c. Baker acted with due diligence in conducting the audit.
d. Baker lacked the intent to deceive.

Baker lacked the intent to deceive.

Choice "d" is correct. In order to prove fraud, National must prove the five elements of fraud. These are a misrepresentation of a material fact, intent to deceive, actual and justifiable reliance on the misrepresentation, an intent to induce that reliance, and damages. A defense by Baker that there was no intent to deceive would be a valid defense against a claim of fraud.

Choice "c" is incorrect. Conducting an audit with due diligence is not the best defense to fraud.

Choice "b" is incorrect. A disclaimer in the engagement letter is not a defense to fraud.

Choice "a" is incorrect. A lack of privity is not a defense to fraud.