Reg 5

Question 1

Vee Corp. retained Walter, CPA, to prepare its Year 6 income tax return. During the engagement, Walter discovered that Vee had failed to file its Year 2 income tax return. What is Walter’s professional responsibility regarding Vee’s unfiled Year 2 income tax return?
a.
Advise Vee that the Year 2 income tax return has not been filed and recommend that Vee ignore filing its Year 2 return since the statute of limitations has passed.
b.
Consider withdrawing from preparation of Vee’s Year 6 income tax return until the error is corrected.
c.
Prepare Vee’s Year 2 income tax return and submit it to the IRS.
d.
Advise the IRS that Vee’s Year 2 income tax return has not been filed.

Answer 1

Choice “b” is correct. The CPA should consider withdrawing from the preparation of Vee’s Year 6 income tax return until the error (i.e., the non-filing of the Year 2 tax return) has been corrected.
Rule: Upon discovery of an error in a previously filed return or the client’s failure to file a required return, the CPA should promptly notify the client (either orally or in writing) of the error, noncompliance, or omission and advise the client of the appropriate measures to be taken (e.g., advise the client to file the tax return). If the client does not rectify the error, the CPA should consider withdrawing from the engagement.

Question 2

A tax return preparer is subject to a penalty for knowingly or recklessly disclosing corporate return information, if the disclosure is made:
a.
Under an administrative order by a state agency that registers tax return preparers.
b.
For peer review.
c.
To enable the tax processor to electronically compute the taxpayer’s liability.
d.
To enable a third party to solicit business from the taxpayer.

Answer 2

Choice “d” is correct. Use of a taxpayer’s return information to assist a third party to solicit business subjects a return preparer to penalty.

Question 3

A tax return preparer may disclose or use tax return information without the taxpayer’s consent to:
a.
Facilitate a supplier’s or lender’s credit evaluation of the taxpayer.
b.
Be evaluated by a quality or peer review.
c.
Accommodate the request of a financial institution that needs to determine the amount of taxpayer’s debt to it, to be forgiven.
d.
Solicit additional nontax business.

Answer 3

Choice “b” is correct. A tax return preparer may disclose or use tax return information without the taxpayer’s consent to be evaluated by a quality or peer review.

Question 4

Which, if any, of the following could result in penalties against an income tax return preparer?
I.
Knowing or reckless disclosure or use of tax information obtained in preparing a return.
II.
A willful attempt to understate any client's tax liability on a return or claim for refund.
	a.	
I only.
	b.	
Neither I nor II.
	c.	
II only.
	d.	
Both I and II.

Answer 4

Choice “d” is correct. Both I and II. Knowing or reckless disclosure or use of tax information obtained in preparing a return and a willful attempt to understate any client’s tax liability on a return or claim for refund could both result in penalties against an income tax return preparer.

Question 5

A penalty for understated corporate tax liability can be imposed on a tax preparer who fails to:
	a.	
Copy all underlying documents.
	b.	
Make reasonable inquiries when taxpayer information appears incorrect.
	c.	
Examine business operations.
	d.	
Audit the corporate records.

Answer 5

Choice “b” is correct. A penalty for understated corporate tax liability can be imposed on a tax preparer who fails to make reasonable inquiries when taxpayer information appears incorrect.
Choices “d”, “c”, and “a” are incorrect. A tax return preparer is not required to:
Audit the corporate records
Examine the business operations
Copy all underlying documents

Question 6

In preparing a client’s current-year individual income tax return, a tax practitioner discovers an error in the prior year’s return. Under the rules of practice, the tax practitioner:
a.
Must file an amended return to correct the error.
b.
Is required to notify the IRS of the error.
c.
Is barred from preparing the current year’s return until the prior-year error is rectified.
d.
Must advise the client of the error.

Answer 6

Choice “d” is correct. Upon discovery of an error in a previously-filed return or the client’s failure to file a required return, the tax practitioner should promptly notify the client (either orally or in writing) of the error, noncompliance, or omission and advise the client of the appropriate measures to be taken (e.g., advise the client to file the tax return). If the client does not rectify the error, the tax practitioner should consider withdrawing from the engagement.

Question 7

Which of the following acts by a CPA will not result in a CPA incurring an IRS penalty?
a.
Failing, without reasonable cause, to provide the client with a copy of an income tax return.
b.
Failing, without reasonable cause, to sign a client’s tax return as preparer.
c.
Negotiating a client’s tax refund check when the CPA prepared the tax return.
d.
Understating a client’s tax liability as a result of an error in calculation.

Answer 7

Choice “d” is correct. The IRS does not impose a penalty on a CPA for making an error in calculating a tax return.

Question 8

Clark, a professional tax return preparer, prepared and signed a client’s federal income tax return that resulted in a $600 refund. Which one of the following statements is correct with regard to an Internal Revenue Code penalty Clark may be subject to for endorsing and cashing the client’s refund check?
a.
Clark will be subject to the penalty if Clark endorses and cashes the check.
b.
Clark may endorse and cash the check, without penalty, if the amount does not exceed Clark’s fee for preparation of the return.
c.
Clark may endorse and cash the check, without penalty, if Clark is enrolled to practice before the Internal Revenue Service.
d.
Clark may not endorse and cash the check, without penalty, because the check is for more than $500.

Answer 8

Choice “a” is correct. A tax preparer may not endorse and cash a client’s tax refund check.

Question 9

Which of the following professional bodies has the authority to revoke a CPA's license to practice public accounting?
	a.	
State board of accountancy.
	b.	
Professional Ethics Division of AICPA.
	c.	
National Association of State Boards of Accountancy.
	d.	
State CPA Society Ethics Committee.

Answer 9

Choice “a” is correct. The state board of accountancy is the only body listed that can grant a CPA license and the only body that may revoke such a license.

Question 10

Which of the following bodies ordinarily would have the authority to suspend or revoke a CPA's license to practice public accounting?
	a.	
A state board of accountancy.
	b.	
A state CPA society.
	c.	
The SEC.
	d.	
The AICPA.

Answer 10

Choice “a” is correct. Only a state board of accountancy has the authority to suspend or revoke a CPA’S license to practice public accounting.

Question 11

Which of the following statements concerning an accountant’s disclosure of confidential client data is generally correct?
a.
Disclosure may be made to any party on consent of the client.
b.
Disclosure may be made to comply with Generally Accepted Accounting Principles.
c.
Disclosure may be made to any state agency without subpoena.
d.
Disclosure may be made to comply with an SEC audit request.

Answer 11

Choice “a” is correct. An accountant may disclose confidential client information to any party if the client specifically consents to the release of information.

Question 12

A CPA is permitted to disclose confidential client information without the consent of the client to:
I.
Another CPA who has purchased the CPA’s tax practice.
II.
Another CPA firm if the information concerns suspected tax return irregularities.
III.
A state CPA society voluntary quality control review board.
a.
I and III only.
b.
II and III only.
c.
II only.
d.
III only.

Answer 12

Choice “d” is correct. The CPA generally cannot give out a client’s confidential information to anyone without the client’s consent. However, exceptions are generally made for court subpoenas and state CPA society quality control panels.

Question 13

A CPA who prepares clients’ federal income tax returns for a fee must:
a.
Indicate the CPA’s federal identification number on a tax return only if the return reflects tax due from the taxpayer.
b.
Keep a completed copy of each return for a specified period of time.
c.
File certain required notices and powers of attorney with the IRS before preparing any returns.
d.
Receive client documentation supporting all travel and entertainment expenses deducted on the return

Answer 13

Choice “b” is correct. The CPA must retain a completed copy of each return for three years after the close of the return period (IRC Section 6107).

Question 14

Which of the following acts constitute(s) grounds for a tax preparer penalty?
I.
Without the taxpayer's consent, the tax preparer disclosed taxpayer income tax return information under an order from a state court.
II.
At the taxpayer's suggestion, the tax preparer deducted the expenses of the taxpayer's personal domestic help as a business expense on the taxpayer's individual tax return.
	a.	
Neither I nor II.
	b.	
I only.
	c.	
Both I and II.
	d.	
II only.

Answer 14

Choice “d” is correct. Tax preparer penalties may be assessed for improper use or disclosure of information. Acceptable circumstances for disclosure include:
Computer processing
Peer review
Administrative order (court order)
A tax preparer penalty may be assessed for fraud and accuracy related acts. Intentional disregard of the regulations would be deducting of personal help as a business expense.

Question 15

Morgan, a sole practitioner CPA, prepares individual and corporate income tax returns. What documentation is Morgan required to retain concerning each return prepared?
a.
A power of attorney.
b.
Workpapers associated with the preparation of each tax return.
c.
An unrelated party compliance statement.
d.
Taxpayer’s name and identification number or a copy of the tax return.

Answer 15

Choice “d” is correct. For each tax return prepared, a tax preparer must retain either the taxpayer’s name and identification number, or a copy of the return.

Question 16

Which of the following statements is correct for penalties and fines with respect to exercising due diligence for the earned income credit?
a.
The penalty for each failure to be diligent in determining a client’s eligibility for the earned income credit is a minimum of 2 years imprisonment in a designated Federal Correctional Institution.
b.
The due diligence requirements address eligibility checklists, computation worksheets, and record retention.
c.
The penalty for each failure to be diligent in determining the amount of the earned income credit is $1,000 for each such failure.
d.
The penalty for failure to be diligent will not apply if the tax return preparer can demonstrate that the preparer’s normal office procedures were reasonably designed and routinely followed to ensure due diligence compliance.

Answer 16

Choice “b” is correct. The due diligence requirements for the earned income credit address eligibility checklists, computation worksheets, record retention, and also reasonable inquiries to the taxpayer.

Question 17

With respect to the penalty for aiding and abetting understatements of tax liability on a tax return:
a.
Applies only when the understatement is with the knowledge and consent of the persons authorized or required to file the return.
b.
The burden of proof shifts to the IRS from the taxpayer.
c.
The civil penalty is $10,000 for all taxpayers except corporations and $100,000 for corporations.
d.
The penalty applies to tax return preparers only.

Answer 17

Choice “b” is correct. With respect to the penalty for aiding and abetting an understatement of tax liability on a tax return, the burden of proof shifts to the IRS from the taxpayer. Unless the law expressly states otherwise, the taxpayer has the burden of proof to establish by the preponderance of the evidence that the law and the evidence do not support the position of the IRS. With respect to any criminal action, the government has the burden of proof to establish by evidence beyond a reasonable doubt that the taxpayer is guilty of the charges. Note that these burdens of proof are different; criminal (beyond a reasonable doubt) is considerably higher than civil (preponderance of the evidence).

Question 18

Circular 230:
a.
Addresses the practice before the IRS of “practitioners”, which includes only Attorneys, Certified Public Accountants, and Enrolled Agents.
b.
Prohibits referral or compensation agreements.
c.
Prohibits a practitioner from charging a contingent fee.
d.
Prohibits a practitioner from endorsing or negotiating refund checks issued to the client.

Answer 18

Choice “d” is correct. Circular 230 does prohibit a practitioner from endorsing or negotiating refund checks which the IRS has issued to the practitioner’s client.

Choice “a” is incorrect. Circular 230 addresses the practice before the IRS of “practitioners.” However, practitioners do not include just Attorneys, Certified Public Accountants, and Enrolled Agents. Practitioners can also be Enrolled Actuaries, Enrolled Retirement Plan Agents, and Appraisers.

Question 19

Under Circular 230, for tax returns:
a.
A practitioner must exercise due diligence in preparing tax returns and other documents, unless such due diligence is waived in writing by the client.
b.
A practitioner may rely on client-furnished information under any circumstances. The client is always right.
c.
A practitioner must return all client records at the request of the client.
d.
A practitioner can advise a client to take a tax return position that is frivolous only if the taxpayer is a member of an officially recognized tax protest organization.

Answer 19

Choice “c” is correct. A practitioner must return all client records at the request of the client.

Question 20

For an opinion to be a covered opinion:
a.
The opinion’s evaluation of significant tax issues cannot take into account the possibility that (1) a tax return will not be audited, (2) an issue will not be raised on audit, or (3) an issue, if raised, will be resolved through settlement.
b.
The opinion can be based on reasonable or unreasonable factual assumptions, depending on the circumstances.
c.
The opinion must reach an overall conclusion as to the likelihood of the tax treatment for each significant federal tax issue and provide the reasons for this conclusion.
d.
The opinion must set forth the likelihood that the taxpayer will prevail on the merits for each significant federal tax issue. If the likelihood for each issue cannot be determined, no opinion can be issued.

Answer 20

Choice “a” is correct. For an opinion to be a covered opinion, the opinion’s evaluation of significant federal tax issues cannot take into account the possibility that (1) a tax return will not be audited, (2) an issue will not be raised on audit, or (3) an issue, if raised, will be resolved through settlement. The evaluation must be based on the chances of success on the merits, not on these other factors.

Question 21

For an opinion to be a covered opinion:
a.
If the opinion is a limited opinion, the opinion must be limited to only one of the significant federal tax issues so that the significant tax issue may be sufficiently and clearly covered.
b.
The opinion can be limited to just some of the significant federal tax issues if the practitioner and the taxpayer agree that the opinion will be limited and that the taxpayer’s reliance on the opinion for the purpose of avoiding penalties will be similarly limited.
c.
The opinion can be limited to just some of the significant federal tax issues if the significant federal tax issues that the opinion does consider are at least 50% of all of the significant federal tax issues.
d.
The opinion must consider all significant federal tax issues.

Answer 21

Choice “b” is correct. For an opinion to be a covered opinion, the opinion can be limited to just some of the significant federal tax issues if the practitioner and the taxpayer agree that the opinion will be limited and that the taxpayer’s reliance on the opinion for the purpose of avoiding penalties will be similarly limited.

Question 22

For an opinion to be a covered opinion:
a.
The practitioner issuing the covered opinion must be knowledgeable in all aspects of federal tax law relevant to the opinion being rendered and may reasonably rely on the opinion of other practitioners for part(s) of the opinion. No identification should be made of the other practitioner or the other practitioner’s opinion since the original practitioner is responsible for the entire opinion.
b.
The practitioner issuing the covered opinion must be knowledgeable in all aspects of federal tax law and may not rely on the opinion of any other practitioner for parts of the opinion.
c.
A written advice subject to contractual protection is one where the practitioner has a written contract to issue the written advice.
d.
The practitioner issuing the covered opinion must be knowledgeable in all aspects of federal tax law relevant to the opinion being rendered and may rely on the opinion of other practitioners for part(s) of the opinion, with identification of the other practitioner’s opinion and conclusion.

Answer 22

Choice “d” is correct. The practitioner issuing a covered opinion must be knowledgeable in all aspects of federal tax law relevant to the opinion being rendered and may rely on the opinion of other practitioners for part(s) of the opinion, with identification of the other practitioner’s opinion and conclusion.

Question 23

Green & Ishade, CPAs are issuing a marketed opinion for a particular investment plan. Which of the following statements is correct for this opinion or other types of covered opinions?
a.
A listed transaction is a tax avoidance transaction.
b.
A marketed opinion is advice that will be used to promote, market, or sell an investment plan in a corporate form.
c.
A marketed opinion does not include advice which is about any arrangement the principal purpose of which is federal tax avoidance or evasion.
d.
A reportable transaction is a transaction which must be included on a separate line of a federal tax return.

Answer 23

Choice “a” is correct. A listed transaction is a tax avoidance transaction. It is a reportable transaction (a transaction that is required to be reported on a return or statement attached to that return which is the same as, or substantially similar to, a transaction specifically identified by the Secretary of the Treasury as a tax avoidance transaction). Listed transactions include sale-in/lease-out transactions, certain offsetting currency transactions solely used for losses but not gains, and loss transactions resulting in a taxpayer claiming a tax loss exceeding certain specified amounts.

Question 24

A civil fraud penalty can be imposed on a corporation that underpays tax by:
a.
Failing to report income it erroneously considered not to be part of corporate profits.
b.
Maintaining false records and reporting fictitious transactions to minimize corporate tax liability.
c.
Omitting income as a result of inadequate recordkeeping.
d.
Filing an incomplete return with an appended statement, making clear that the return is incomplete.

Answer 24

Choice “b” is correct. Imposition of the civil fraud penalty requires conduct that transcends negligence or stupidity. Maintaining false records and reporting fictitious transactions is adequate to demonstrate civil fraud, a willful and deliberate attempt to evade taxes.

Question 25

Which of the following statements is correct for the disciplinary power of the state boards of accountancy? a. The three broad categories of misconduct are misconduct while performing accounting services, misconduct outside the scope of performing accounting services, and a criminal conviction. b. Negligence, fraud, and dishonesty are types of misconduct outside the scope of performing accounting services. c. The state boards of accountancy have no disciplinary power other than the power to reprimand licensees and refer the situation to the state's Attorney General for civil prosecution. d. The failure to file a tax return is an example of misconduct outside the scope of performing accounting services.

Answer 25

Choice "a" is correct. The three broad categories of misconduct are misconduct while performing accounting services, misconduct outside the scope of performing accounting services, and a criminal conviction.

Question 26

Which of the following statements is correct for penalties that can be imposed by the SEC? a. The SEC can suspend or permanently revoke a CPA's right to practice before the SEC only if the accountant has willfully violated the federal securities laws or regulations. b. The SEC can suspend or permanently revoke an accountant's right to practice before the SEC. c. The SEC can impose fines of up to $1,000,000 for an individual and $2,000,000 if the accountant is a repeat, or serial, offender. d. The SEC can suspend or permanently revoke an accountant's license to practice public accounting.

Answer 26

Choice "b" is correct. The SEC can suspend or permanently revoke an accountant's right to practice before the SEC.

Question 27

Which of the following statements is correct for the disciplinary power of the state boards of accountancy? a. The state board of accountancy must find, by proof beyond a reasonable doubt, that the CPA's actions constituted professional misconduct. b. Adverse state board decisions cannot be reviewed by the courts. The state board's decision is final. c. The state board of accountancy can conduct a formal hearing for possible disciplinary action. d. The state board of accountancy does not have to provide due process of law.

Answer 27

Choice "c" is correct. The state board of accountancy can conduct a formal hearing for possible disciplinary action.

Question 28

Which of the following statements is correct for disciplinary action by the AICPA and state CPA societies? a. Membership in the AICPA can be suspended or terminated without a hearing. b. The Joint Trial Board of the AICPA can expel a member by majority vote. c. The AICPA cannot suspend or terminate membership for failure to pay dues but can suspend or terminate membership for failure to meet CPE requirements. d. The AICPA and state CPA societies can sanction their members and, in addition, can suspend or permanently revoke a CPA's license.

Answer 28

Choice "a" is correct. Membership in the AICPA can be suspended or terminated without a hearing for certain offenses. These offenses include but are not limited to (1) proof of conviction of a crime punishable by imprisonment for more than one year, (2) proof of conviction for willful failure to file any income tax return, (3) proof of conviction for filing a false or fraudulent income tax return or aiding in the preparation of a false or fraudulent income tax return of a client.

Question 29

Leslie Ponzi has just received written tax advice from her attorney, Dewey H. Cheatem. Cheatem has described this document as a "covered opinion." Ponzi is not exactly sure what the covered opinion covers and what its tax significance is. She has asked for your advice. Which of the following statements is correct? a. Circular 230 addresses only covered opinions and does not address any other issues. b. A covered opinion is addressed by Circular 229, not Circular 230. Circular 230 addresses only tax shelter opinions. c. The covered opinion can be invariably relied on by Ponzi to avoid penalties with respect to the significant federal tax issue(s) addressed in the covered opinion. d. If the covered opinion is a reliance opinion, it can generally be relied on by Ponzi to avoid penalties.

Answer 29

Choice "d" is correct. If the covered opinion is a reliance opinion, it can generally be relied on by Ponzi to avoid penalties, so long as the reliance opinion does not contain additional advice which is not related to the listed transactions or to the partnership, plan, or other arrangement.

Question 30

Pursuant to Treasury Circular 230, which of the following statements about the return of a client's records is correct? a. The practitioner does not need to return any client records that are necessary for the client to comply with the client's federal tax obligations. b. The existence of a dispute over fees generally relieves the practitioner of responsibility to return the client's records. c. The client's records are to be destroyed upon submission of a tax return. d. The practitioner may retain copies of the client's records.

Answer 30

Choice "d" is correct. A tax preparer should retain client records for three years.

Question 31

Louis, the volunteer treasurer of a nonprofit organization and a member of its board of directors, compiles the data and fills out its annual Form 990, Return of Organization Exempt from Income Tax. Under the Internal Revenue Code, Louis is not considered a tax return preparer because: a. He is a member of the board of directors. b. Returns for nonprofit organizations are exempt from the preparer rules. c. The return does not contain a claim for a tax refund. d. He is not compensated.

Answer 31

Choice "d" is correct. The term "tax return preparer" means any person who prepares for compensation, or who employs one or more persons to prepare for compensation, any tax return required under the IRC or any claim for refund of tax imposed by the IRC.

Question 32

To avoid tax return preparer penalties for a return's understated tax liability due to an intentional disregard of the regulations, which of the following actions must a tax preparer take? a. Audit the taxpayer's corresponding business operations. b. Examine the taxpayer's supporting documents. c. Review the accuracy of the taxpayer's books and records. d. Make reasonable inquiries if the taxpayer's information is incomplete.

Answer 32

Choice "d" is correct. A tax preparer must make reasonable inquiries if the taxpayer's information is incomplete. Rule: A compensated preparer is liable for a penalty if his understatement of taxpayer liability on a return or claim for refund is due to negligent or intentional disregard of rules and regulations. A preparer is not required to obtain supporting documentation unless he has reason to suspect the accuracy of the taxpayer's figures; however, the preparer must make reasonable inquiries if the taxpayer's information appears incorrect or incomplete.

Question 33

``` Which of the following is not considered a primary authoritative source when conducting tax research? a. Internal Revenue Code. b. Treasury regulations. c. IRS publications. d. Tax Court cases. ```

Answer 33

Choice "c" is correct. IRS publications are not considered a primary authoritative source when one is conducting tax research

Question 34

Under Treasury Circular 230, which of the following actions of a CPA tax advisor is characteristic of a best practice in rendering tax advice? a. Establishing relevant facts, evaluating the reasonableness of assumptions and representations, and arriving at a conclusion supported by the law and facts in a tax memorandum. b. Requiring the client to supply a written representation, signed under penalties of perjury, concerning the facts and statements provided to the CPA for preparing a tax memorandum. c. Requesting written evidence from a client that the fee proposal for tax advice has been approved by the board of directors. d. Recommending to the client that the advisor's tax advice be made orally instead of in a written memorandum.

Answer 34

Choice "a" is correct. Characteristic of a best practice in rendering tax advice is establishing in a tax memorandum relevant facts, evaluating the reasonableness of assumptions and representations, and arriving at a conclusion supported by the law and facts.

Question 35

A CPA prepared a tax return for a client who will receive a refund check. The client is traveling abroad and asked the CPA to pick up the check at the client's home address. Under Treasury Circular 230, any of the following actions, if taken by the CPA relating to the refund check, would be a violation of the rules of practice before the Internal Revenue Service, except: a. Endorsing the check and depositing it into the client's bank account. b. Holding the check for safe keeping and awaiting the client's return. c. Holding the check until the client is billed, then endorsing and depositing the check into the CPA's account as payment for the bill. d. Endorsing the check and depositing it into an escrow account for the client's benefit.

Answer 35

Choice "b" is correct. Circular 230 does not prohibit a practitioner's holding the check for safe keeping and awaiting the client's return.

Question 36

``` Tax return preparers can be subject to penalties under the Internal Revenue Code for failure to do any of the following, except: a. Disclose a conflict of interest. b. Keep a record of returns prepared. c. Provide a client with a copy of the tax return. d. Sign a tax return as a preparer. ```

Answer 36

Choice "a" is correct. With respect to a tax return preparer's failure to disclose a conflict of interest, the Internal Revenue Code does not set forth any penalty.

Question 37

A CPA prepares a client's tax return containing business travel expenses without inquiring about the existence of documentation for the expenses. Which statement best describes the consequence of the CPA's lack of inquiry? a. The client will not owe an understatement penalty if the return is audited and the expenses disallowed. b. The CPA may be charged with preparing a fraudulent return. c. The CPA may be assessed a tax return preparer penalty. d. The client will not be subject to a fraud penalty.

Answer 37

Choice "c" is correct. A preparer is not required to obtain supporting documentation, unless the preparer has reason to suspect the accuracy of the information provided. However, the preparer must make reasonable inquiries if the information provided by the taxpayer appears incorrect or incomplete.

Question 38

Under Treasury Circular 230, in which of the following situations is a CPA prohibited from giving written advice concerning one or more federal tax issues? a. The CPA takes into consideration assumptions about future events related to the relevant facts. b. The CPA takes into account the possibility that a tax return will not be audited. c. The CPA reasonably relies upon representations of the client. d. The CPA considers all relevant facts that are known.

Answer 38

Choice "b" is correct. A CPA should not give written federal tax advice if the CPA takes into account the possibility that a tax return will not be audited.

Question 39

A CPA prepared a tax return that involved a tax shelter transaction that was disclosed on the return. In which of the following situations would a tax return preparer penalty not be applicable? a. There was a reasonable basis for the position. b. There was a reasonable possibility of success for the position. c. It is reasonable to believe that the position would more likely than not be upheld. d. There was substantial authority for the position.

Answer 39

Choice "c" is correct. With regards to a tax shelter, a penalty for understatement of taxpayer liability could apply to a CPA unless it is reasonable to believe that the position would more likely than not be upheld on its merits. This is more stringent than a reasonable basis for the position, a reasonable possibility of success for the position, and substantial authority for the position

Question 40

Which of the following bodies has the authority to suspend or revoke a CPA's license for acts discreditable to the profession? a. The Public Company Accountancy Oversight Board. b. The state society of certified public accountants. c. The state board of accountancy. d. The American Institute of Certified Public Accountants.

Answer 40

Choice "c" is correct. A suspension or revocation of a CPA's license may only be imposed by a state board of accountancy.

Question 41

``` The Sarbanes-Oxley Act of 2002 requires that the members of the audit committee of a public company be independent. Receipt of which of the following would destroy independence within the meaning of the law? President's Salary Board Member's Salary a. Yes Yes b. No No c. No Yes d. Yes No ```

Answer 41

Choice "d" is correct. Audit committee members must be members of the public company's board of directors and may receive compensation for their service on the board. However, they cannot accept compensation from the public company or be affiliated with it in any other way. Thus, an audit committee member may receive compensation for serving as a director, but not for being the company's president. Receipt of a president's salary would destroy independence.

Question 42

Under the Sarbanes-Oxley Act of 2002, which of the following statements is correct regarding an issuer's audit committee financial expert? a. The audit committee financial expert must be the issuer's audit committee chairperson to enhance internal control. b. If an issuer does not have an audit committee financial expert, the issuer must disclose the reason why the role is not filled. c. The issuer's current outside CPA firm's audit partner must be the audit committee financial expert. d. The issuer must fill the role with an individual who has experience in the issuer's industry.

Answer 42

Choice "b" is correct. Sarbanes-Oxley requires that an issuer's audit committee have at least one financial expert, or disclose why that role is not filled. The financial expert must have an understanding of GAAP and financial statements, be able to assess the application of accounting principles, have comparable experience applying accounting principles to entities that present a similar level of complexity of the issuer, and understand both internal controls and audit committee functions.

Question 43

``` The Sarbanes-Oxley Act of 2002 was enacted in response to corporate scandals that largely centered on the quality of corporate financial disclosure and highlighted the inadequate oversight of management, auditors and the the Board of Directors of publicly held companies. The Sarbanes-Oxley Act addresses the problems related to inadequate board oversight by requiring public companies to have an: a. Internal auditor. b. Annual audit for all issuers. c. Independent Board of Directors. d. Audit committee. ```

Answer 43

Choice "d" is correct. Public companies are required to establish an audit committee comprised of board members who are otherwise independent of the company. The audit committee is directly responsible for the appointment, compensation, and oversight of the work of the public accounting firm employed by that public company.

Question 44

The Sarbanes-Oxley Act of 2002 requires that the officers of a corporation be held accountable to a code of ethics. According to the Act, codifications of ethical standards should include provisions for all of the following, except: a. Compliance with laws, rules, and regulations. b. Honest and ethical conduct. c. Prompt internal reporting of code provisions and accountability for adherence to the code. d. Full, fair, accurate, and timely disclosure in periodic financial statements.

Answer 44

Choice "c" is correct. Although the SEC proposed standards for codes of ethics to include both internal reporting of code provisions and accountability for adherence to the code, the Sarbanes-Oxley Act itself does not have this requirement.

Question 45

The Sarbanes-Oxley Act of 2002 requires that the management report on internal control include all of the following, except: a. A statement that there are no disagreements between management and the auditor as to the effectiveness of internal controls. b. A statement of management's responsibilities for establishing and maintaining adequate internal controls. c. A statement that the auditor has attested and reported on management's evaluation of internal controls. d. A conclusion about the effectiveness of the company's internal controls.

Answer 45

Choice "a" is correct. Financial statement disclosures include management's assumption of responsibility for internal control, management's assessment of internal control effectiveness and a statement that the auditor has reported on management's evaluation. Management does not describe disagreements, if any, between management and the auditor.

Question 46

Conflict of interest provisions of the Sarbanes-Oxley Act of 2002 generally prohibit the directors or executive officers of public companies from: a. Receiving a personal loan from the issuer not in the ordinary course of business. b. Owning more than 10% of common stock. c. Receiving perquisite compensation. d. Owning more than 10% of any form of equity.

Answer 46

Choice "a" is correct. Issuers are generally prohibited from making personal loans to directors or executive officers under the Sarbanes-Oxley Act of 2002. Exceptions exist for loans made in the ordinary course of business.

Question 47

The Sarbanes-Oxley Act of 2002 requires that one or more members of the audit committee be a financial expert and that the financial reports disclose: a. The existence of financial expert(s) on the audit committee or the reasons why the audit committee does not have a financial expert. b. The name of the Board member(s) serving as financial expert(s). c. Confirmation of the audit opinion by the financial expert. d. Certification of independence of the financial expert.

Answer 47

Choice "a" is correct. In the financial reports, the issuer must disclose the existence of financial expert(s) on the committee or the reasons why the committee does not have a financial expert.

Question 48

The primary benefit of having a financial expert on a company's audit committee is: a. The financial expert certifies compliance with SEC requirements and thereby reduces audit fees. b. The financial expert checks the auditor's work and verifies the appropriateness of the audit opinion. c. The expert designation conveys a higher level of due diligence on the expert and shields audit committee members and the corporation from most liabilities. d. The enhanced level of financial sophistication of the financial expert can serve as a resource for the audit committee.

Answer 48

Choice "d" is correct. The benefits of a financial expert on the audit committee relate to the expertise that the board can bring to its oversight function.

Question 49

Arnold Astor, CPA, is a local tax practitioner who has been asked to sit on the Board of BigLarge Corporation, a multinational issuer. Astor has never had any involvement either as an employee or as an auditor with publicly traded companies but does teach an accounting principles class at the community college. Under the provisions of the Sarbanes-Oxley Act of 2002: a. Astor must petition the SEC for a waiver of prior experience requirements to be considered a financial expert. b. The Board of Directors would likely evaluate Astor's qualifications to serve on the audit committee and be designated as a financial expert based on mix of knowledge and experience. c. Astor qualifies as a financial expert based on achievement of a CPA certificate. d. The audit committee would immediately certify Astor's qualifications as a financial expert based on his CPA license and academic experience with GAAP and experience with internal control.

Answer 49

Choice "b" is correct. Qualification as a financial expert is a judgmental issue is typically made by the Board of Directors. The Sarbanes-Oxley Act is silent as to what group has the authority to designate an individual a financial expert but in practice, the board most often makes that decision. The Act provides some guidance but does not prescribe specific qualifications.

Question 50

The Sarbanes-Oxley Act of 2002 seeks to improve investor confidence by providing greater transparency for all of the following issues, except: a. Means and methods for balancing risk and growth. b. Compliance of senior officers with a code of ethics. c. Adequacy of internal controls. d. Competency of audit committees.

Answer 50

Choice "a" is correct. The issues surrounding risk and growth are significant to investors and generally addressed by enterprise risk management concepts; however, the Sarbanes-Oxley Act focuses less on strategic operations and more on the financial reporting issues impacted by the audit committee's competence, the ethical behavior of senior officers and the adequacy of internal controls.

Question 51

``` How many audits of public companies per year does a CPA firm that is registered with the Public Company Accounting Oversight Board (PCAOB) have to perform in order to to be subject to mandatory annual inspection by the PCAOB? a. More than 10 audits. b. More than 100 audits. c. One audit. d. More than 50 audits. ```

Answer 51

Choice "b" is correct. The Sarbanes-Oxley Act requires the PCAOB to perform an annual inspection of each registered public accounting firm that regularly provides audit reports for more than 100 issuers.

Question 52

``` Under the provisions of the Sarbanes-Oxley Act of 2002, registered public accounting firms are required to prepare and maintain audit work papers and other information related to any audit report for a period of: a. Seven years. b. Five years. c. Three years. d. One year. ```

Answer 52

Choice "a" is correct. Registered public accounting firms are required to maintain audit work papers and supporting documentation for a period of seven years. Thus, choices "d", "c", and "b" are incorrect.

Question 53

The Sarbanes-Oxley Act of 2002 prohibits a registered public accounting firm from providing any non-audit service to an issuer contemporaneously with the audit, except: a. Appraisal or valuation services, fairness opinions, or contribution-in-kind reports. b. Bookkeeping or other services related to the accounting records or financial statements of the audit client. c. Financial information systems design and implementation. d. Tax services pre-approved by the audit committee.

Answer 53

Choice "d" is correct. Most services that audit firms previously provided to publicly traded clients have been prohibited by the Sarbanes-Oxley Act of 2002, except for approved tax services.

Question 54

``` Under the provisions of the Sarbanes-Oxley Act of 2002, the lead audit or coordinating partner and the reviewing partner must rotate off the audit: a. Every seven years. b. Each year. c. Every three years. d. Every five years. ```

Answer 54

Choice "d" is correct. The lead audit or coordinating partner and the reviewing partner must rotate off the audit every five years. Thus, choices "b", "c", and "a" are incorrect.

Question 55

``` Rules issued under the Sarbanes-Oxley Act of 2002 prohibit a registered accounting firm from performing an audit at a public company if any person serving as the public company's chief executive, chief financial or chief accounting officer, or controller or chief accounting officer worked for the registered accounting firm within the preceding: a. Within two years of the current audit. b. Within three years of the current audit. c. Within five years of the current audit. d. Within one year before the current audit. ```

Answer 55

Choice "d" is correct. To avoid conflicts of interest, a registered company public accounting firm cannot perform an audit for a public company if one of the indicated officers of the company worked at the auditing firm within a year before the audit.

Question 56

A CPA firm must do which of the following before it can participate in the preparation of an audit report of a company registered with the Securities and Exchange Commission (SEC)? a. Register with the SEC pursuant to the Securities Exchange Act of 1934. b. Register with the Financial Accounting Standards Board (FASB). c. Join the SEC Practice Section of the AICPA. d. Register with the Public Company Accounting Oversight Board.

Answer 56

Choice "d" is correct. To participate in the preparation of audit reports for a company registered with the SEC, a CPA firm must first register with the Public Company Accounting Oversight Board.

Question 57

``` A taxpayer filed his income tax return after the due date but neglected to file an extension form. The return indicated a tax liability of $50,000 and taxes withheld of $45,000. On what amount would the penalties for late filing and late payment be computed? a. $45,000 b. $50,000 c. $5,000 d. $0 ```

Answer 57

Choice "c" is correct. The penalty for failure to file a tax return by the due date is 5% per month or fraction of month (up to a maximum of 25%) on the amount of tax shown as due on the return. The penalty for failure to pay by the due date (1/2% per month) is also based on the amount due on the return.

Question 58

``` An accuracy-related penalty applies to the portion of tax underpayment attributable to: I. Negligence or a disregard of the tax rules or regulations. II. Any substantial understatement of income tax. a. Neither I nor II. b. Both I and II. c. II only. d. I only. ```

Answer 58

Choice "b" is correct. Accuracy-related penalties apply to the portion of tax underpayments attributable to negligence or disregard of tax rules and regulations as well as to any substantial understatement of income tax.

Question 59

John S. Loppe has not been particularly careful in preparing his income tax returns and, as a result, has substantially understated his tax. The negligence penalty with respect to understatement of tax might thus be applicable to him. The negligence penalty with respect to understatement of tax: a. Is an accuracy-based penalty for negligence or for disregard of tax rules and regulations. b. Is imposed in conjunction with the penalty for substantial underpayment of tax and the penalty for a substantial valuation misstatement. c. Is computed as 25% of the understatement of tax. d. Defines "disregard" as any careless, reckless, or unintentional disregard of tax rules and regulations.

Answer 59

Choice "a" is correct. The negligence penalty with respect to understatement of tax is an accuracy-based penalty for negligence or for disregard of tax rules and regulations.

Question 60

Chatham Corporation is a defendant in a lawsuit by the IRS. Which of the following statements is correct with respect to the various defenses that might be available to Chatham to avoid or reduce civil and criminal penalties that might otherwise be imposed on it? a. The substantial authority standard involves a position that has a less than 50% chance but more than a one-in-four chance of succeeding. b. The reasonable basis standard involves a position that is arguable but fairly unlikely to prevail in court. A numerical statement of this standard has at least a 10% chance of succeeding. c. The more-likely-than-not standard involves a position that has a more than 50% chance of succeeding. d. Reports issued by the U.S. Congress, IRS regulations, rules, and releases, and U.S. and foreign court case decisions constitute substantial authority for the substantial authority standard.

Answer 60

Choice "c" is correct. The more-likely-than-not standard involves a position that has a more than 50% chance of succeeding.

Question 61

John R. Fudge is an individual taxpayer in Cut and Shoot, Texas. He has been accused of understating the tax on one of his returns and is concerned about the possibility of imprisonment if he is convicted. The understatement has nothing to do with a tax shelter. Which of the following statements is correct for his situation? a. If John relied on the opinion of a reputable accountant or attorney who prepared his return and furnished all relevant information, in general, he would have a reasonable basis for the tax return position and could avoid the penalties for understatement of tax. b. If John took a reasonable position on his tax return, he is subject to the penalty for understatement of tax but not to the penalty for substantial understatement of tax. c. If there was a reasonable basis for a disclosed tax position on the tax return, and John acted in good faith, the penalty for understatement of tax would still apply if John actually did understate his tax. d. If John's understatement of tax is a substantial understatement, the penalty is double what it would have been for a simple understatement.

Answer 61

Choice "a" is correct. If John relied on the opinion of a reputable accountant or attorney who prepared his return and furnished all relevant information, in general, he would have a reasonable basis for the tax return position and could avoid the penalties for understatement of tax.

Question 62

Dewey Cheatam, Esq. is a leading candidate for the next open seat on the U.S. Supreme Court. He recently addressed the graduating class at The University of Texas Law School on the subject of the judicial process for tax issues. Which of the following statements in his address was correct? a. U.S. District Court cases are heard before one judge, not a panel of judges. b. When the U.S. Supreme Court denies a writ of certiorari, it confirms the lower court's decision. c. Judges for the U.S. Tax Court hear cases at various locations in the country as do justices for the U.S. Supreme Court. d. The U.S. Court of Federal Claims follows the decisions of the Federal Court of Appeals and the geographical Courts of Appeals

Answer 62

Choice "a" is correct. U.S. District Court cases are heard before one judge, not a panel of judges.

Question 63

J. Dewey Taxem, running for the Senate for the sixth time from a large northeastern state, has just completed a major campaign speech relating to his proposed changes to the legislative process. Which of the following excerpts from his speech is correct? a. Unlike non-tax legislation, tax legislation must be enacted in exactly the same form in both the House and the Senate so that no conference committee is necessary. b. Most tax legislation originates in the Senate as riders to other non-tax legislation. c. A presidential veto can be overridden by a vote of two-thirds of both the House and the Senate. d. If the President does not like some of the provisions of a specific tax bill approved by both the House and the Senate, he can veto those specific parts and sign the rest.

Answer 63

Choice "c" is correct. A presidential veto (other than a pocket veto) can be overridden by a vote of two-thirds of both the House and the Senate.

Question 64

John Q. Dillinger is the outgoing Commissioner of the Internal Revenue Service. In his final public meeting with IRS employees, he addressed changes that he would like to see made in the IRS audit and appeals process. Which of the following statements that he made at this meeting is correct? a. Tax returns are checked for mathematical accuracy, but only if the returns indicate a refund. b. Office audits are normally performed at the national office of the IRS in Washington, DC. c. A revenue agent and the Appeals Division can both settle an unresolved tax issue based on the probability of winning the case in court. d. Following an audit, if agreement is reached with the taxpayer, the taxpayer signs Form 870.

Answer 64

Choice "d" is correct. Following an audit, if agreement is reached with the taxpayer, the taxpayer signs Form 870 (Waiver of Restrictions on Assessment and Collection of Deficiency in Tax).

Question 65

Which of the following are returns that are not normally selected for audit by the IRS's Discriminant Inventory Function System (DIF) or by other means? a. Self-employed individuals with substantial business income and deductions. b. Cash businesses. c. Individuals with gross incomes greater than $50,000. d. Individuals whose itemized deductions are in excess of norms established for income levels.

Answer 65

Choice "c" is correct. The DIF generally selects for audit returns of individuals with gross incomes greater than $100,000, not $50,000.

Question 66

Which of the following statements is correct for the judicial process when a taxpayer and the Internal Revenue Service cannot reach agreement on a tax issue using the administrative appeals process? a. The U.S. Tax Court is a specialized trial court that hears Federal tax and other Federal cases. b. The U.S. Court of Federal Claims has jurisdiction over most claims for money damages against the United States. c. The IRS bears the burden of proof in civil tax cases because the IRS can readily afford expensive lawyers and thus should be able to bear a greater burden. d. The Supreme Court often hears tax cases because tax issues are extremely important to the economic health of the nation.

Answer 66

Choice "b" is correct. The U.S. Court of Federal Claims has jurisdiction over most claims for money damages against the United States, one type of which is tax refunds.

Question 67

``` Which Senate committee considers new tax legislation? a. Budget. b. Finance. c. Appropriations. d. Rules and Administration. ```

Answer 67

Choice "b" is correct. Most tax legislation begins in the House Ways and Means Committee of the U.S. House of Representatives. Tax legislation goes from the U.S. House of Representatives to the U.S. Senate Finance Committee.

Question 68

An IRS agent has just completed an examination of a corporation and issued a "no change" report. Which of the following statements about that situation is correct? a. The IRS may not reopen the examination. b. The taxpayer may not amend the tax return for that taxable year. c. The IRS may not examine any other tax return of the corporation for a period of one year. d. The IRS generally does not reopen the examination except in cases involving fraud or other similar misrepresentation.

Answer 68

Choice "d" is correct. The IRS generally does not reopen the examination except in cases involving fraud or other similar misrepresentation.

Question 69

Which of the following statements is correct with respect to penalties? a. The taxpayer can generally avoid penalties if he/she acted in good faith, if there was a reasonable basis to support the tax return position, and if the taxpayer did not have willful neglect. b. The taxpayer can generally avoid penalties if he/she acted in good faith and if there was a reasonable basis to support the tax return position. c. The taxpayer can generally avoid penalties if he/she acted in good faith. d. The taxpayer cannot avoid penalties under any circumstances.

Answer 69

Choice "a" is correct. The taxpayer can generally avoid penalties if he/she acted in good faith, if there was a reasonable basis to support the tax return position, and if the taxpayer did not have willful neglect.

Question 70

Which of the following correctly lists the order, from earliest to latest, that U.S. legislative bodies consider new tax legislation? a. House of Representatives, Joint Conference Committee, U.S. Senate. b. House of Representatives, U.S. Senate, Joint Conference Committee. c. U.S. Senate, Joint Conference Committee, House of Representatives. d. Joint Conference Committee, House of Representatives, Senate Finance Committee.

Answer 70

Choice "b" is correct. The correct order for all new tax legislation is the House of Representatives, the Senate, the Joint Conference Committee to resolve differences (if necessary), and presidential action.

Question 71

``` 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. Both I and II. b. I only. c. II only. d. Neither I nor II. ```

Answer 71

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.

Question 72

Which of the following statements is correct regarding an accountant's working papers? a. The client owns the working papers but, in the absence of the accountant's consent, may not disclose them without a court order. b. The accountant owns the working papers but generally may not disclose them without the client's consent or 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.

Answer 72

Choice "b" 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.

Question 73

``` 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. Yes Yes b. No No c. No Yes d. Yes No ```

Answer 73

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

Question 74

``` Which of the following statements is(are) correct regarding the common law elements that must be proven to support a finding of constructive fraud against a CPA? I. The plaintiff has justifiably relied on the CPA's misrepresentation. II. The CPA has acted in a grossly negligent manner. a. II only. b. Both I and II. c. Neither I nor II. d. I only. ```

Answer 74

``` Choice "b" is correct. The elements of constructive fraud: Misrepresentation of a material fact. Defendant acts with gross negligence or recklessly. Intent to induce plaintiff's reliance. Actual and justifiable reliance by plaintiff. Damages. Actual fraud requires intent to deceive. ```

Question 75

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 those third parties who are in privity of contract with the CPA. c. The CPA is liable to all possible foreseeable users of the CPA's opinion. d. The CPA is only liable to the client.

Answer 75

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.

Question 76

``` Under the "Ultramares" rule, to which of the following parties will an accountant be liable for negligence? Parties in privity Foreseen parties a. Yes Yes b. No Yes c. Yes No d. No No ```

Answer 76

Choice "c" is correct. Ultramares limits the accountant's liability for negligence to: (i) parties in privity and (ii) intended third party beneficiaries; parties who are merely "foreseen" cannot recover.

Question 77

When performing an audit, a CPA will most likely be considered negligent when the CPA fails to: a. Warn a client of known internal control weaknesses. b. Include a negligence disclaimer in the client engagement letter. c. Warn a client's customers of embezzlement by the client's employees. d. Detect all of a client's fraudulent activities.

Answer 77

Choice "a" is correct. A CPA has a duty to warn clients of known weaknesses in internal controls. The failure to communicate the known weakness to the client constitutes negligence.

Question 78

Which of the following is the best defense a CPA firm can assert in a suit for common law fraud based on its unqualified opinion on materially false financial statements? a. Contributory negligence on the part of the client. b. Lack of scienter. c. A disclaimer contained in the engagement letter. d. Lack of privity.

Answer 78

Choice "b" is correct. A suit for common law fraud may succeed only if the accountant acted with scienter (knew that the statement was wrong or recklessly disregarded the truth).

Question 79

Which of the following statements is correct regarding a CPA's working papers? The working papers must be: a. Turned over to any government agency that requests them. b. Transferred to another accountant purchasing the CPA's practice even if the client hasn't given permission. c. Transferred permanently to the client if demanded. d. Turned over pursuant to a valid federal court subpoena.

Answer 79

Choice "d" is correct. Client working papers must be turned over pursuant to a valid federal court subpoena because generally there is no federal privilege in client working papers.

Question 80

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 states that have enacted a statute creating such a privilege. b. The accountant-client privilege can be claimed only in civil suits. c. The accountant-client privilege can be claimed only to limit testimony to audit subject matter. d. Ivor can claim an accountant-client privilege only in federal courts.

Answer 80

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

Question 81

``` 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. Both I and II. b. II only. c. I only. d. Neither I nor II. ```

Answer 81

Choice "b" 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.

Question 82

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

Answer 82

Choice "a" 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.

Question 83

Under common law, which of the following statements most accurately reflects the liability of a CPA who fraudulently gives an opinion on an audit of a client's financial statements? a. The CPA probably is liable to any person who suffered a loss as a result of the fraud. b. The CPA probably is liable to the client even if the client was aware of the fraud and did not rely on the opinion. c. The CPA is liable only to third parties in privity of contract with the CPA. d. The CPA is liable only to known users of the financial statements.

Answer 83

Choice "a" is correct. A CPA who commits fraud is liable to anyone who is injured by the fraud.

Question 84

``` 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. I only. b. II only. c. Both I and II. d. Neither I nor II. ```

Answer 84

Choice "a" 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.

Question 85

``` 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. Gross negligence. b. Negligence. c. Strict liability. d. Criminal deceit. ```

Answer 85

Choice "a" 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.

Question 86

``` Beckler & Associates, CPAs, audited and gave an unqualified opinion on the financial statements of Queen Co. The financial statements contained misstatements that resulted in a material overstatement of Queen's net worth. Queen provided the audited financial statements to Mac Bank in connection with a loan made by Mac to Queen. Beckler knew that the financial statements would be provided to Mac. Queen defaulted on the loan. Mac sued Beckler to recover for its losses associated with Queen's default. Which of the following must Mac prove in order to recover? I. Beckler was negligent in conducting the audit. II. Mac relied on the financial statements. a. II only. b. Both I and II. c. I only. d. Neither I nor II. ```

Answer 86

Choice "b" is correct. Although a CPA generally is liable to third parties only for fraud or constructive fraud (gross negligence), where the CPA knows that the third party will be relying on the audit, the CPA can be liable to the third party for mere negligence (the CPA owes the third party a duty of care since the third party is an intended beneficiary of the engagement). An action for gross negligence requires both reliance on a misstatement and negligence.

Question 87

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 Jay was negligent in conducting the audit. b. Jay will not be liable if the misstatement resulted from an omission of a material fact by Jay. c. Jay will be liable if the purchaser relied on Jay's unqualified opinion on the financial statements. d. Jay will not be liable if the purchaser's loss was under $500.

Answer 87

Choice "c" 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.

Question 88

Which of the following is the best defense a CPA firm can assert in defense to a suit for common law fraud based on their unqualified opinion on materially false financial statements? a. Contributory negligence on the part of the client. b. Lack of scienter. c. Lack of privity. d. A disclaimer contained in the engagement letter.

Answer 88

Choice "b" is correct. Common law fraud requires a showing of intent to deceive, which is scienter.

Question 89

``` 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. Acted with scienter. c. Knew of the irregularities. d. Failed to exercise due care. ```

Answer 89

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

Question 90

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. Detect all of a client's fraudulent activities. c. Include a negligence disclaimer in the CPA's engagement letter. d. Warn a client's customers of embezzlement by the client's employees.

Answer 90

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

Question 91

``` 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 accountant was negligent. c. The security was part of an original issuance. d. There was a material omission. ```

Answer 91

Choice "d" 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.

Question 92

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

Answer 92

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

Question 93

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. Cannot sue the accounting firm because of the statute of limitations. c. Can sue the accounting firm for the loss of the loan because of negligence. d. Can sue the accounting firm for the loss of the loan because of the rule of privilege.

Answer 93

Choice "c" 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.

Question 94

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. Cite the privileged communications aspect of being a CPA. c. Take the Fifth Amendment and not discuss the meeting. d. Discuss only the items that have a direct connection to those items the CPA worked on for the client in the past.

Answer 94

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.

Question 95

``` 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. Money damages. c. Punitive damages. d. Rescission. ```

Answer 95

Choice "b" 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.

Question 96

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. No, because Lasco has a legitimate business reason for demanding that Spinner surrender the working papers. c. No, because it was Lasco's financial statements that were audited. d. Yes, because Lasco is required to direct prospective auditors to contact Spinner to make arrangements to view the working papers in Spinner's office.

Answer 96

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.

Question 97

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. A review of the CPA's professional practice by a state CPA society. c. An inquiry from the professional ethics division of the AICPA. d. A letter to the client from the IRS

Answer 97

Choice "d" 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).

Question 98

Able, CPA, was engaged by Wedge Corp. to audit Wedge's financial statements. Wedge intended to use the audit report to obtain a $10 million loan from Care Bank. Able and Wedge's president agreed that Able would give an unqualified opinion on Wedge's financial statements in the audit report even though there were material misstatements in the financial statements. Care refused to make the loan. Wedge then gave the audit report to Ranch to encourage Ranch to purchase $10 million worth of Wedge common stock. Ranch reviewed the audit report and relied on it to purchase the stock. After the purchase, Able's agreement with Wedge's president was revealed. As a result, Wedge stock lost half its value and Ranch sued Able for fraud. What will be the result of Ranch's suit? a. Ranch will lose because Ranch is not in privity with Able. b. Ranch will lose because Ranch is not a foreseen user of Able's audit report. c. Ranch will win because Able is strictly liable for errors made in auditing Wedge's financial statements. d. Ranch will win because Able intentionally gave an unqualified opinion on Wedge's materially misstated financial statements.

Answer 98

Choice "d" is correct. This question is about to whom a CPA owes a duty. A CPA's duties are broadest with regard to fraud. A duty to refrain from fraud is owed to anyone who can make out the elements of a fraud case (misrepresentation, intent to deceive, reliance, intent to induce reliance, and damages). Because Able intentionally made the false statement and Ranch was harmed as a result, Ranch can hold Able liable for his damages.

Question 99

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. Only those third parties in privity of contract with the accountant. b. All third parties who relied on the report and sustained injury. c. Any third party whose reliance on the report was reasonably foreseeable. d. Any foreseen or known third party who relied on the report.

Answer 99

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.

Question 100

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 may be liable for punitive damages if due care was not exercised. 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 is liable for any embezzlement losses that occurred before the scheme should have been detected.

Answer 100

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.

Question 101

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 fraud. 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 breach of contract.

Answer 101

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.

Question 102

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

Answer 102

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.

Question 103

``` Arthur Old employs Darleen, an accountant, who recklessly misstates a material fact in Arthur's financial statements that misleads Arthur's bankers. The bankers justifiably relied on the misstatement to their detriment. Darleen may be liable for: a. Actual fraud only. b. Actual fraud and constructive fraud. c. Constructive fraud only. d. None of the answer choices are correct. ```

Answer 103

Choice "c" is correct. Constructive fraud does not require intent. Constructive fraud only requires reckless disregard for truth or falsity. Actual fraud, on the other hand, requires intent in making a material misstatement, upon which the plaintiff justifiably relies (and that the plaintiff suffers damages). We did not have such intent here. Thus, Darleen can be liable only for constructive fraud.

Question 104

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 acted with scienter. 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 violated generally accepted auditing standards.

Answer 104

Choice "d" is correct. For a CPA to be liable for damages under section 10(b) of the 1934 Act, the plaintiff must prove the following: The plaintiff purchased or sold securities, The defendant's material misrepresentation of fact with respect to the securities, Scienter (intent to deceive or reckless disregard for the truth) by the defendant, The plaintiff's justifiable reliance, Damages incurred by the plaintiff, and A means of interstate commerce was involved. While a violation of GAAS might help prove fault, such a violation is not a necessary element.

Question 105

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

Answer 105

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

Question 106

Which of the following statements is correct regarding disclosure of client working papers prepared by a CPA? a. Working papers may not be disclosed to any third parties without the client's permission. b. Working papers may not be disclosed under a federal court subpoena without the client's permission. c. Working papers may not be turned over to a CPA quality review team without the client's permission. d. Working papers may not be transferred to another accountant without the client's permission.

Answer 106

Choice "d" is correct. As a general rule, although a CPA owns his or her working papers, because of confidentiality issues, the working papers cannot be turned over to another accountant without the client's permission

Question 107

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 client was contributorily negligent. b. The accuracy of the CPA's report was not guaranteed. c. The CPA's negligence was not the proximate cause of the client's losses. d. The client was comparatively negligent

Answer 107

Choice "c" 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.

Question 108

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

Answer 108

Choice "a" 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.

Question 109

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. Baker lacked the intent to deceive. b. Baker included a disclaimer provision in the engagement letter with American. c. National was not in privity with Baker. d. Baker acted with due diligence in conducting the audit.

Answer 109

Choice "a" 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.

Question 110

Tork purchased restricted securities that were issued pursuant to Regulation D of the Securities Act of 1933. Which of the following statements is correct regarding Tork's ability to resell the securities? a. Tork may not resell the securities if the certificates contain a legend indicating that they are unregistered securities. b. Tork may not resell the securities unless Tork obtains a written SEC exemption. c. Tork may resell the securities so long as the sale does involve interstate commerce. d. Tork may resell the securities as part of another transaction exempt from registration.

Answer 110

Choice "d" is correct. Under Regulation D of the Securities Act of 1933, Tork may only resell if the resale transaction continues to fall under the registration exemptions found in Section 3 of the 1933 Act.

Question 111

The prospectus for the sale of securities of a not-for-profit corporation contained material misrepresentations due to the negligence of the person who prepared the financial statements. As a result of the misrepresentations, purchasers of the shares lost their investment. Do the anti-fraud provisions of the Securities Act of 1933 apply in this situation? a. Yes, because the securities are required to be registered. b. Yes, because the misrepresentations were material. c. No, because the securities are exempt from registration. d. No, because only the issuer was negligent.

Answer 111

Choice "b" is correct. While the securities of a not-for-profit corporation are indeed exempt from registration (making choice "c" a tempting choice), where a prospectus is issued and contains material misrepresentations, liability can be imposed under the 1933 Act.

Question 112

An original issue of transaction exempt securities was sold to the public based on a prospectus containing intentional omissions of material facts. Under which of the following federal securities laws would the issuer be liable to a purchaser of the securities? I. The anti-fraud provisions of the Securities Act of 1933. II. The anti-fraud provisions of the Securities Exchange Act of 1934.

Answer 112

Choice "a" is correct. The issuer could be liable for issuing securities by means of a false statement under the 1933 Act and can be liable for making false statements under the 1934 Act.

Question 113

``` Dean, Inc., a publicly traded corporation, paid a $10,000 bribe to a local zoning official. The bribe was recorded in Dean's financial statements as a consulting fee. Dean's unaudited financial statements were submitted to the SEC as part of a quarterly filing. Which of the following federal statutes did Dean violate? a. Federal Trade Commission Act. b. Securities Exchange Act of 1934. c. Securities Act of 1933. d. North American Free Trade Act ```

Answer 113

Choice "b" is correct. Publicly traded corporations must register with the SEC and make certain periodic reports under the 1934 Act. These reports include business reports (10K, 10Q & 8K), insider trading tender offers & proxy solicitations. The unaudited financials, which are part of the company's 10Q filing, fraudulently described the bribe.

Question 114

``` Under the liability provisions of Section 11 of the Securities Act of 1933, an auditor may help to establish the defense of due diligence if: I. The auditor performed an additional review of the audited statements to ensure that the statements were accurate as of the effective date of a registration statement. II. The auditor complied with GAAS. a. I only. b. Both I and II. c. Neither I nor II. d. II only. ```

Answer 114

Choice "b" is correct. Due diligence is an affirmative defense that requires the CPA to prove that the CPA made a reasonable investigation and had reasonable grounds to believe that the financial statements were true and that no material facts were omitted. In essence, the CPA must prove that he or she followed GAAS.

Question 115

Under the Securities Act of 1933, which of the following statements most accurately reflects how securities registration affects an investor? a. The investor is provided with information on the stockholders of the offering corporation. b. The investor is provided with information on the principal purposes for which the offering's proceeds will be used. c. The investor is assured by the SEC against loss resulting from purchasing the security. d. The investor is guaranteed by the SEC that the facts contained in the registration statement are accurate.

Answer 115

Choice "b" is correct. One piece of information required in a registration statement is a statement of how the funds received will be used.

Question 116

Which of the following securities would be regulated by the provisions of the Securities Act of 1933? a. Securities issued by savings and loan associations. b. Securities issued by not-for-profit, charitable organizations. c. Securities guaranteed by domestic governmental organizations. d. Securities issued by insurance companies.

Answer 116

Choice "d" is correct. There is an exemption for insurance policies [Securities Act 3(a)(8)], but other securities issued by insurance companies must generally be registered.

Question 117

Under the Securities Act of 1933, which of the following statements concerning an offering of securities sold under a transaction exemption is correct? a. Resales of the offering are exempt from the provisions of the 1933 Act. b. The offering is subject to the registration requirements of the 1933 Act. c. The offering is exempt from the anti-fraud provisions of the 1933 Act. d. Resales of the offering must be made under a registration or a different exemption provision of the 1933 Act.

Answer 117

Choice "d" is correct. A transaction exemption applies only to the particular transaction. Subsequent sales must qualify for their own exemption, or they must be registered.

Question 118

Which of the following facts will result in an offering of securities being exempt from registration under the Securities Act of 1933? a. The sale or offer to sell the securities is made by a person other than an issuer, underwriter, or dealer. b. The securities are nonvoting preferred stock. c. The securities are AAA-rated debentures that are collateralized by first mortgages on property that has a market value of 200% of the offering price. d. The issuing corporation was closely held prior to the offering.

Answer 118

Choice "a" is correct. The 1933 Act generally is concerned with sales by issuers, underwriters, or dealers. Sales by other persons are exempt.

Question 119

Which of the following statements concerning an initial intrastate securities offering made by an issuer residing in and doing business in that state is correct? a. The offering would be exempt from the registration requirements of the Securities Act of 1933. b. The offering would be regulated by the SEC. c. The offering would be subject to the registration requirements of the Securities Exchange Act of 1934. d. The shares of the offering could not be resold to investors outside the state for at least one year.

Answer 119

Choice "a" is correct. Intrastate securities offerings are exempt from the registration requirements of the Securities Act of 1933

Question 120

Which of the following statements concerning the prospectus required by the Securities Act of 1933 is correct? a. The prospectus must be filed after an offer to sell. b. The prospectus should enable the SEC to pass on the merits of the securities. c. The prospectus is prohibited from being distributed to the public until the SEC approves the accuracy of the facts embodied therein. d. The prospectus is a part of the registration statement.

Answer 120

Choice "d" is correct. The registration statement is divided into two parts. Part I is the prospectus; Part II contains other information about the securities being issued.

Question 121

``` A preliminary prospectus, permitted under SEC Regulations, is known as the: a. Unaudited prospectus. b. "Red-herring" prospectus. c. Qualified prospectus. d. "Blue-sky" prospectus. ```

Answer 121

Choice "b" is correct. The regulations allow the use of a "red herring" prospectus in certain circumstances. A "red herring" prospectus may be missing certain information that is not yet available.

Question 122

A tombstone advertisement: a. Notifies prospective investors that a previously offered security has been withdrawn from the market and is therefore effectively "dead." b. Makes known the availability of a prospectus. c. May contain an offer to sell securities. d. May be substituted for the prospectus under certain circumstances

Answer 122

Choice "b" is correct. A tombstone ad can be placed before a registration statement is effective. Only certain information, such as the nature of the security, the price, and the availability of a prospectus, may be included in the ad.

Question 123

Which of the following factors, by itself, requires a corporation to comply with the reporting requirements of the Securities Exchange Act of 1934? a. Six hundred employees. b. Shares listed on a national securities exchange. c. Four hundred holders of equity securities. d. Total assets of $2 million.

Answer 123

Choice "b" is correct. A corporation must register under the 1934 Act if either: (i) the corporation's securities are traded on a national exchange or (ii) the corporation has more than 2,000 shareholders (or 500 unaccredited shareholders) in any outstanding class and more than $10 million in assets.

Question 124

``` Which of the following transactions will be exempt from the full registration requirements of the Securities Act of 1933? a. Any resale of a security purchased under Regulation D offering. b. All offerings made under Regulation A. c. All intrastate offerings. d. Any stockbroker transaction. ```

Answer 124

Choice "b" is correct. Regulation A provides an exception from the full registration requirements. It provides a more simplified form of registration.

Question 125

``` Under the Securities Exchange Act of 1934, which of the following types of instruments is excluded from the definition of "securities?" a. Investment contracts. b. Certificates of deposit. c. Nonconvertible debentures. d. Convertible debentures. ```

Answer 125

Choice "b" is correct. Certificates of deposit issued by a bank are not deemed to be securities. A certificate of deposit is an instrument issued by a bank noting a deposit of funds and containing a promise to repay them at a later date.

Question 126

One of the elements necessary to recover damages if there has been a material misstatement in a registration statement filed under the Securities Act of 1933 is that the: a. Issuer failed to exercise due care in connection with the sale of the securities. b. Plaintiff suffered a loss. c. Plaintiff gave value for the security. d. Issuer and plaintiff were in privity of contract with each other.

Answer 126

Choice "b" is correct. Under Section 11, all a plaintiff must prove is a false statement in the registration statement and damages.`

Question 127

An offering made under the provisions of Regulation A of the Securities Act of 1933 requires that the issuer: a. Provide investors with a proxy registration statement. b. Provide investors with the prior four years' audited financial statements. c. File an offering circular with the SEC. d. Sell only to accredited investors.

Answer 127

Choice "c" is correct. Under Regulation A, an offering circular must be filed with the SEC.

Question 128

Adler, Inc. is a reporting company under the Securities Exchange Act of 1934. The only security it has issued is voting common stock. Which of the following statements is correct? a. It is unnecessary for the required annual report (Form 10K) to include audited financial statements. b. Because Adler is a reporting company, it is not required to file a registration statement under the Securities Act of 1933 for any future offerings of its common stock. c. Any person who owns more than 10% of Adler's common stock must file a report with the SEC. d. Adler need not file its proxy statements with the SEC because it has only one class of stock outstanding.

Answer 128

Choice "c" is correct. Persons who own more than 10% of a corporation's stock must file an annual report with the SEC.

Question 129

Which of the following persons is not an insider of a corporation subject to the Securities Exchange Act of 1934 registration and reporting requirements? a. An attorney for the corporation. b. An owner of 5% of the corporation's outstanding debentures. c. A stockholder who owns more than 10% of the outstanding common stock. d. A member of the board of directors.

Answer 129

Choice "b" is the correct choice. Officers, directors, and more than 10% stockholders are required to register and report under Section 16(a) of the 1934 Act. Holders of debt securities are not considered insiders and are not subject to the registration and reporting requirements.

Question 130

``` Pix Corp. is making a $6,000,000 stock offering. Pix wants the offering exempt from registration under the Securities Act of 1933. Which of the following provisions of the Act would Pix have to comply with for the offering to be exempt? a. Regulation D, Rule 505. b. Regulation A. c. Regulation D, Rule 504. d. Regulation D, Rule 506. ```

Answer 130

Choice "d" is correct. Rule 506 allows offerings of an unlimited amount to be made as long as all the other requirements of this rule are satisfied. Choice "b" is incorrect. Regulation A offerings are limited to $5 million. Choice "c" is incorrect. Rule 504 offerings are limited to $1 million. Choice "a" is incorrect. Rule 505 offerings are limited to $5 million.

Question 131

``` Pix Corp. is making a $6,000,000 stock offering. Pix wants the offering exempt from registration under the Securities Act of 1933. Which of the following requirements would Pix have to comply with when selling the securities? a. Accredited investors only. b. No more than 35 unaccredited investors. c. No more than 35 investors. d. Unaccredited investors only. ```

Answer 131

Choice "b" is correct. There can be no more than 35 unaccredited investors under a Rule 506 offering. Note that the 35 unaccredited investors must be sophisticated investors.

Question 132

Frey, Inc. intends to make a $2,000,000 common stock offering under Rule 505 of Regulation D of the Securities Act of 1933. Frey: a. May sell the stock to an unlimited number of investors. b. Must provide all investors with a prospectus. c. Must notify the SEC within 15 days after the first sale of the offering. d. May make the offering through a general advertising.

Answer 132

Choice "c" is correct. Under Regulation D, the SEC must be notified within 15 days after the first sale of the offering.

Question 133

Which of the following disclosures must be contained in a securities registration statement filed under the Securities Act of 1933? a. A list of all existing stockholders. b. The principal purposes for which the offering proceeds will be used. c. A copy of the corporation's latest proxy solicitation statement. d. The names of all prospective accredited investors.

Answer 133

Choice "b" is correct. Under sections 6 and 7 of the 1933 Act, a registration statement must include specific financial information such as a balance sheet and a profit and loss statement, and "other material facts." One such material fact is the principal purpose(s) for which the proceeds of the issuance will be used.

Question 134

``` Which of the following is least likely to be considered a security under the Securities Act of 1933? a. Stock options. b. General partnership interests. c. Warrants. d. Limited partnership interests. ```

Answer 134

Choice "b" is correct. An investment is a security if it is generally recognized as a security, mentioned in the Securities Act, or represents a profit-making investment, transaction, or scheme whereby one invests in a business and expects to make a profit from the efforts of others. A general partnership interest is not included within this definition because the partners take part in running the business and are not passive investors.

Question 135

``` Corporations that are exempt from registration under the Securities Exchange Act of 1934 are subject to the Act's: a. Proxy solicitation provisions. b. Antifraud provisions. c. Provisions dealing with the filing of annual reports. d. Provisions imposing periodic audits. ```

Answer 135

Choice "b" is correct. The Securities Exchange Act's antifraud provisions apply to all schemes to sell stock in interstate commerce and are not limited to registered corporations.

Question 136

Under the Securities Exchange Act of 1934, a corporation with common stock listed on a national stock exchange: a. Is subject to having the registration of its securities suspended or revoked. b. Must submit Form 10-K to the SEC except in those years in which the corporation has made a public offering. c. Is prohibited from making private placement offerings. d. Must distribute copies of Form 10-K to its stockholders.

Answer 136

Choice "a" is correct. A reporting company is subject to having its registration revoked for willful violation of the securities laws.

Question 137

Regulation D of the Securities Act of 1933: a. Is limited to offers and sales of common stock that do not exceed $1.5 million. b. Restricts the number of purchasers of an offering to 35. c. Permits an exempt offering to be sold to both accredited and unaccredited investors. d. Is exclusively available to small business corporations as defined by Regulation D.

Answer 137

Choice "c" is correct. Under Regulation D's rules 504, 505, and 506, sales may be made to both accredited and unaccredited investors, although under rules 505 and 506 the unaccredited investors may not number more than 35, and under rule 506 the unaccredited investors must also be sophisticated investors.

Question 138

Under the liability provisions of Section 18 of the Securities Exchange Act of 1934, for which of the following actions would an accountant generally be liable? a. Negligently approving a reporting corporation's incorrect internal financial forecasts. b. Intentionally failing to notify a reporting corporation's audit committee of defects in the verification of accounts receivable. c. Intentionally preparing and filing with the SEC a reporting corporation's incorrect quarterly report. d. Negligently filing a reporting corporation's tax return with the IRS.

Answer 138

Choice "c" is correct. Section 18 of the Securities Exchange Act of 1934 subjects a defendant to liability for false or misleading information in the registration statement or other required reports (i.e., 10K, 10Q, or 8K). The defendant is not liable if the defendant can prove a lack of scienter. Because quarterly reports (10Q) are required under the 1934 Act, a defendant who intentionally prepared and filed an incorrect quarterly report would be liable under Section 18.

Question 139

``` Under the Securities Act of 1933, which of the following statements is(are) correct regarding the purpose of registration? I. The purpose of registration is to allow for the detection of management fraud and prevent a public offering of securities when management fraud is suspected. II. The purpose of registration is to adequately and accurately disclose financial and other information upon which investors may determine the merits of securities. a. I only. b. II only. c. Both I and II. d. Neither I nor II. ```

Answer 139

Choice "b" is correct. The principal purpose of the Securities Act of 1933 is to provide investors with sufficient information to make an informed investment decision. The act accomplishes this goal by requiring registration of new issues of securities. Thus, II is a correct statement. The SEC does not guarantee the accuracy of this information, evaluate the offering's financial merits or give assurances against loss. Thus, I is an incorrect statement.

Question 140

``` Which of the following securities is exempt from registration under the Securities Act of 1933? a. Securities sold by a discount broker. b. Municipal bonds. c. Pre-incorporation stock subscriptions. d. One-year notes issued to raise working capital. ```

Answer 140

Choice "b" is correct. Municipal bonds are securities issued by the government and are generally exempt from registration.

Question 141

Which of the following circumstances is a defense to an accountant's liability under Section 11 of the Securities Act of 1933 for misstatements and omissions of material facts contained in a registration statement? a. The absence of scienter on the part of the accountant. b. Nonreliance by purchasers on the misstatements. c. The absence of privity between purchasers and the accountant. d. Due diligence on the part of the accountant.

Answer 141

Choice "d" is correct. To establish a case under Section 11, a plaintiff need only prove that the plaintiff acquired the stock; there was a material misstatement in a registration statement signed by the defendant, and damages. However, an accountant can avoid liability by raising the defense of due diligence.

Question 142

Under Section 12 of the Securities Exchange Act of 1934, in addition to companies whose securities are traded on a national exchange, what class of companies is subject to the SEC's continuous disclosure system? a. Companies with annual revenues in excess of $10 million and 500 or more shareholders. b. Companies with assets in excess of $10 million and 500 or more shareholders. c. Companies with assets in excess of $5 million and 300 or more shareholders. d. Companies with annual revenues in excess of $5 million and 300 or more shareholders.

Answer 142

Choice "b" is correct. Under Section 12, a company must register (is subject to continuous disclosure requirements) if it is listed on a national securities exchange or if it has at least 500 shareholders in any outstanding class and has more than $10 million in assets.

Question 143

``` Under Regulation D of the Securities Act of 1933, what is the maximum time period during which an exempt offering may be made? a. Twelve months. b. Three months. c. Twenty-four months. d. Six months. ```

Answer 143

Choice "a" is correct: twelve months. Under Rule 504 the issuance of securities may not exceed $1 million dollars in a 12-month period. Under Rule 505 the issuance of securities may not exceed $5 million dollars in a 12-month period. Rule 506 permits an unlimited amount of stock to be issued. 506 is often referred to as a private placement because that rule exempts transactions not involved in a public offering.

Question 144

Under the liability provisions of Section 11 of the Securities Act of 1933, a CPA who certifies financial statements included in a registration statement generally will not be liable to a purchaser of the security: a. Unless the purchaser can prove scienter on the part of the CPA. b. If the CPA can prove due diligence. c. Unless the purchaser can prove privity with the CPA. d. If the financial statements were materially misstated.

Answer 144

Choice "b" is correct. Under Section 11 of the Securities Act of 1933, a CPA who certifies financial statements is generally liable if the purchaser can prove the purchaser acquired the stock, the purchaser suffered a loss, and in the registration statement there was a misrepresentation of, and/or an omission of, a material fact. The purchaser does not have to prove scienter or negligence on the part of the CPA. The purchaser does not have to prove reliance. However, the CPA is not liable if the CPA can prove "due diligence."

Question 145

``` What is the standard that must be established to prove a violation of the anti-fraud provisions of Rule 10b-5 of the Securities Exchange Act of 1934? a. Criminal intent. b. Strict liability. c. Intentional misconduct. d. Negligence. ```

Answer 145

Choice "c" is correct. A violation of Rule 10b-5 will be found only if the person acted with scienter (intent to deceive or reckless disregard for the truth).

Question 146

``` Under the anti-fraud provisions of Section 10(b) of the Securities Exchange Act of 1934, a CPA may be liable if the CPA acted: a. Without due diligence. b. Negligently. c. With independence. d. Without good faith. ```

Answer 146

Choice "d" is correct. Section 10(b) prohibits fraud in connection with the sale of securities. If a CPA acts without good faith, the CPA is probably acting fraudulently.

Question 147

Which of the following transactions is subject to registration requirements of the Securities Act of 1933? a. The public sale by a charitable organization of 10-year bearer bonds. b. The public sale by a corporation of its negotiable 10-year notes. c. Issuance of stock by a publicly-traded corporation to its shareholders because of a stock split. d. The sale across state lines of municipal bonds issued by a city.

Answer 147

Choice "b" is correct. The Securities Act of 1933 requires registration of issuances of securities unless an exemption applies. Long-term notes (with maturity dates beyond nine months) are considered securities, and there is no exemption for 10-year notes of corporations. Thus, the sale must be registered.

Question 148

``` What defense must an accountant establish to be absolved from civil liability under Section 18 of the Securities Exchange Act of 1934 for false or misleading statements made in reports or documents filed under the Act? a. Lack of privity with an injured party. b. Lack of gross negligence. c. Good faith and lack of knowledge of the statement's falsity. d. Exercise of due care. ```

Answer 148

Choice "c" is correct. Section 18 of the Securities Exchange Act of 1934 imposes civil liability on persons who intentionally make false statements in a registration statement or any other document required to be filed under the act. Since the act proscribes only intentional misconduct, lack of intent to deceive is a defense. Good faith and lack of knowledge of the statement's falsity would show that the false or misleading statement was not made with an intent to deceive.

Question 149

According to the Securities Act of 1933, which of the following statements is correct regarding an issuer of securities? a. If an issuer sells a security and fails to meet certain disclosure requirements, the purchaser may sell it back to the issuer and recover the price paid. b. An issuer is permitted to advertise an initial offering of securities only through distribution of the prospectus. c. All securities issuers must register the securities offering with the Securities and Exchange Commission (SEC). d. All securities issuers must provide potential investors with a prospectus containing specified information.

Answer 149

Choice "a" is correct. A purchaser has a right to rescind under section 12 of the 1933 Act if the issuer fails to meet disclosure requirements.

Question 150

Which of the following transactions is subject to registration requirements of the Securities Act of 1933? a. A public sale of municipal bonds issued by a city government. b. The public sale by a corporation of its negotiable 10-year notes. c. The issuance of stock by a publicly-traded corporation to its existing shareholders because of a stock split. d. The public sale of stock of a trucking company regulated by the Interstate Commerce Commission.

Answer 150

Choice "b" is correct. No registration exemption is available for sales of long term notes.

Question 151

Sam's Retail Outlet's certified public accountant prepares financial statements that omit a material fact. The financial statements are part of Sam's registration statement. An investor purchases Sam's stock. Under Section 11 of the Securities Act of 1933, the accountant can avoid liability by showing that she: a. None of the answer choices are correct. b. Exercised due diligence in preparing the financial statements. c. Was not in privity of contract with the Investor. d. Lacked criminal intent in preparing the financial statements.

Answer 151

Choice "b" is correct. A CPA's best defense to a 1933 Section 11 action is that the CPA exercised due diligence by performing the audit in accordance with generally accepted auditing standards.

Question 152

``` KMC, Inc., is issuing $7 million of stock in a single offering. If KMC does not want to provide investors with any material information about itself, its business, or its securities, it may only do so if: a. Any of the investors are accredited. b. All of the investors are accredited. c. At least 35 investors are accredited. d. All of the investors are sophisticated. ```

Answer 152

Choice "b" is correct. An offering of the type described can only be made under Rule 506. Under Rule 506 an offering can be made of any amount of securities without registering the offering if it is made to any number of accredited investors and no more than 35 unaccredited investors who are sophisticated in investing. If only accredited investors purchase the securities, the issuer is not required to make any disclosures, but if any unaccredited investors purchase any of the securities, all investors must receive at least an annual report containing audited financial statements.

Question 153

Under Regulation D, Rule 505, of the Securities Act of 1933, which of the following statements is correct regarding a $3,000,000 stock offering sold only to accredited investors? a. The issuer must notify the SEC within 15 days after the first sale of the offering. b. The issuer may make the offering through a general advertising. c. The issuer may sell the stock to only 35 accredited investors. d. The issuer must supply all accredited investors with financial information.

Answer 153

Choice "a" is correct. This is a private offering because it is offered only to accredited investors. Therefore, Rules 504, 505, and 506 will apply. A general condition that applies to Rules 504, 505, and 506 is that the issuer must notify the SEC within 15 days after the first sale of the offering.

Question 154

``` Under the liability provisions of Section 11 of the Securities Act of 1933, which of the following must a plaintiff prove to hold a CPA liable? I. The misstatements contained in the financial statements certified by the CPA were material. II. The plaintiff relied on the CPA's unqualified opinion. a. Neither I nor II. b. II only. c. Both I and II. d. I only. ```

Answer 154

Choice "d" is correct. Under Section 11 of the '33 Act, the plaintiff merely needs to prove that he acquired the stock, and that there was a material misstatement of fact in a registration statement signed by the defendant and damages.

Question 155

Pick, CPA, was engaged by Edge Corp. to audit Edge's financial statements. Pick, in performing the audit and rendering an unmodified opinion, intentionally ignored several material omissions in the financial statements. Edge included Pick's audit report in its annual filing with the SEC and in its annual stockholders' report. Drane purchased shares of Edge stock based on Drane's review of the past performance of the stock and current-year financial statements. When the omissions in the financial statements became known, the value of Edge stock declined and Drane suffered a loss. Under the provisions of Rule 10b-5 of the Securities Exchange Act of 1934, what will be the result of a suit by Drane against Pick? a. Drane will win because Pick was negligent. b. Drane will lose because only Edge is liable. c. Drane will win because Pick acted with intent. d. Drane will lose because the stock purchased was not part of a new issue.

Answer 155

Choice "c" is correct. To recover damages for violation of Rule 10b-5, a plaintiff must prove all of the following: the plaintiff bought or sold the securities, the plaintiff suffered a loss, there was a material misrepresentation or material omission of fact, scienter (intent to deceive or reckless disregard for the truth), the plaintiff relied on the misrepresentation, and interstate commerce was involved.