Chapter 3-Maintaining Professional Responsibility:...

1. A CPA firm studies its personnel advancement experience to ascertain whether individuals meeting stated criteria are assigned increased degrees of responsibility. This is evidence of the firm's adherence to prescribed standards of
a. Supervision and review.
b. Continuing professional education.
c. Professional development.
d. Quality control.

2. Which one of the following, if present, would support a finding of constructive fraud on the part of a CPA?
a. Privity of contract.
b. Intent to deceive.
c. Reckless disregard.
d. Ordinary negligence.

3. The CPA firm of Knox and Knox has been subpoenaed to testify and produce its correspondence and workpapers in connection with a lawsuit brought by a third party against one of their clients. Knox considers the subpoenaed documents to be privileged communication and therefore seeks to avoid admission of such evidence in the lawsuit. Which of the following is correct?
a. Federal law recognizes such a privilege if the accountant is a Certified Public Accountant.
b. The privilege is available regarding the workpapers since the CPA is deemed to own them.
c. The privileged communication rule as it applies to a CPA/client relationship is the same as that of attorney-client.
d. In the absence of a specific statutory provision, the law does not recognize the existence of the privileged communication rule between a CPA and his client.

4. Of the following statements, which best distinguishes ordinary negligence from gross negligence?
a. Failure to detect material errors, whether internal control is strong or weak, suggests gross negligence.
b. Failure to exercise reasonable care denotes ordinary negligence, whereas failure to exercise minimal care indicates gross negligence.
c. Gross negligence is most probable when the auditor fails to detect errors that occurred under conditions of strong internal control.
d. The more material the undetected error the greater the likelihood of ordinary negligence.

5. On July 1, 2002, Kent purchased common stock of Salem Corp. in an offering subject to the Securities Act of 1933. Mane & Co., CPAs, rendered an unqualified opinion on the financial statements of Salem which were included in Salem's registration statement filed with the SEC on March 1, 2002 Kent has commenced an action against Mane based on the Securities Act of 1933 provisions dealing with omissions of facts required to be stated in the registration statement. Which of the following elements of a cause of action under the Securities Act of 1933 must be proved by Kent?
a. Kent relied upon Mane's opinion.
b. Kent was the initial purchaser of the stock and gave value for it.
c. Mane's omission was material.
d. Mane acted negligently or fraudulently.

6. The limitation of auditor liability under contract law is known as
a. Privity of contract.
b. Contributory liability.
c. Statutory liability.
d. Common law liability.

7. Under the Securities Act of 1933, the registration of securities which are offered to the public in interstate commerce is
a. Directed toward preventing the marketing of securities which pose serious financial risks to the prospective investor.
b. Not required unless the issuer is a corporation.
c. Mandatory unless the cost to the issuer is "prohibitive" as defined in the SEC regulations.
d. Required unless there is an applicable exemption.

8. The auditor's defense of contributory negligence is most likely to prevail when
a. Third party injury has been minimal.
b. The auditor fails to detect fraud resulting from management override of the control structure.
c. The client is privately held as contrasted with a public company.
d. Undetected errors have resulted in materially misleading financial statements.

9. The objective of quality control mandates that a public accounting firm should establish policies and procedures for professional development which provide reasonable assurance that all entry-level personnel
a. Prepare working papers which are standardized in form and content.
b. Have the knowledge required to enable them to fulfill responsibilities assigned.
c. Will advance within the organization.
d. Develop specialties in specific areas of public accounting.

10. A plaintiff wishes to recover damages from the issuer for losses resulting from material misstatements in a securities registration statement. In order to be successful, one of the elements the plaintiff must prove is that the
a. Plaintiff was in privity of contract with the issuer or that the issuer knew of the plaintiff.
b. Plaintiff acquired the securities.
c. Issuer acted negligently.
d. Issuer acted fraudulently.

11. A basic objective of a CPA firm is to provide professional services that conform with professional standards. Reasonable assurance of achieving this basic objective is provided through
a. A system of peer review.
b. Continuing professional education.
c. A system of quality control.
d. Compliance with generally accepted reporting standards.

12. Mix and Associates, CPAs, issued an unqualified opinion on the financial statements of Glass Corp. for the year ended December 31, 2002. It was determined later that Glass' treasurer had embezzled $300,000 from Glass during 2002. Glass sued Mix because of Mix's failure to discover the embezzlement. Mix was unaware of the embezzlement. Which of the following is Mix's best defense?
a. The audit was performed in accordance with GAAS.
b. The treasurer was Glass' agent and, therefore, Glass was responsible for preventing the embezzlement.
c. The financial statements were presented in conformity with GAAP.
d. Mix had no actual knowledge of the embezzlement.

13. Which of the following is not a condition for membership in the Division for CPA Firms?
a. Participating in peer review.
b. Employing only CPAs.
c. Conforming to specified continuing professional education requirements.
d. Maintaining adequate levels of liability insurance.

14. Gold, CPA, rendered an unqualified opinion on the 2000 financial statements of Eastern Power Co. Egan purchased Eastern bonds in a public offering subject to the Securities Act of 1933. The registration statement filed with the SEC included the financial statements. Gold is being sued by Egan under Section 11 of the Securities Act of 1933 for the misstatements contained in the financial statements. To prevail, Egan must prove

Scienter Reliance

a. No No
b. No Yes
c. Yes No
d. Yes Yes

15. The Rusch Factors and Rhode Island Hospital Trust cases further defined the doctrine of privity by stating that
a. Stockholders, as owners of the company, are also parties to the contract between auditor and client.
b. Privity extends to primary third party beneficiaries known by the auditor to be relying on the financial statements.
c. The doctrine of privity is broken when management intentionally misrepresents financial position and/or results of operations.
d. Privity extends to third parties only in cases involving auditor negligence.

16. In connection with the element of professional development, a CPA firm's system of quality control should ordinarily provide that all personnel
a. Have the knowledge required to enable them to fulfill responsibilities assigned.
b. Possess judgment, motivation, and adequate experience.
c. Seek assistance from persons having appropriate level of knowledge, judgment, and authority.
d. Demonstrate compliance with peer review directives.

17. In the case of Fischer v. Kletz (Yale Express), the auditors were charged with fraud for failing to inform users of nonexistent accounts receivable. Although the case was settled out of court, it did encourage the profession to issue a Statement on Auditing Standards relating to
a. Related party transactions.
b. Auditor responsibility for detecting illegal acts.
c. Audit risk assessment.
d. Subsequent discovery of facts existing at the date of the audit report.

18. Accounting firms should establish quality control procedures for professional development in order to provide reasonable assurance that
a. Persons promoted possess the appropriate characteristics to perform competently.
b. Personnel will have the knowledge required to fulfill responsibilities assigned.
c. The extent of supervision and review in a given instance will be appropriate.
d. Association with a client whose management lacks integrity will be minimized.

19. The factor that distinguishes constructive fraud from actual fraud is
a. Materiality.
b. Quality of internal control.
c. Type of error or irregularity.
d. Intent.

20. Gleam is contemplating a common law action against Moore & Co. CPAs, based upon fraud. Gleam loaned money to Lilly & Co. relying upon Lilly's financial statements which were audited by Moore. Gleam's action will fail if
a. Gleam shows only that Moore failed to meticulously follow GAAS.
b. Moore can establish that they fully complied with the statute of frauds.
c. The alleged fraud was in part committed by oral misrepresentations and Moore pleads the parol evidence rule.
d. Gleam is not a third party beneficiary in light of the absence of privity.

21. In the Continental Vending Machine Corporation case, the court argued that a footnote appearing in the company's annual report was confusing and misleading. As a result, the accounting profession
a. Encouraged practitioners to carry adequate liability insurance.
b. Issued a Statement on Auditing Standards defining related party transactions and assigning auditor responsibility for detecting material related party transactions and determining that the economic substance of such transactions is properly reflected in the financial statements.
c. Issued a Statement on Auditing Standards requiring auditor presence at the client's physical inventory taking and auditor confirmation of customer accounts receivable.
d. More clearly defined "privity of contract" between auditor and client.

22. Working papers prepared by a CPA in connection with an audit engagement are owned by the CPA, subject to certain limitations. The rationale for this rule is to
a. Protect the working papers from being subpoenaed.
b. Provide the basis for excluding admission of the working papers as evidence because of the privileged communication rule.
c. Provide the CPA with evidence and documentation which may be helpful in the event of a lawsuit.
d. Establish a continuity of relationship with the client whereby indiscriminate replacement of CPAs is discouraged.

23. Mead Corp. orally engaged Dex & Co., CPAs, to audit its financial statements. The management of Mead informed Dex that it suspected that the accounts receivable were materially overstated. Although the financial statements audited by Dex did, in fact, include a materially overstated accounts receivable balance, Dex issued an unqualified opinion. Mead relied on the financial statements in deciding to obtain a loan from City Bank to expand its operations. City relied on the financial statements in making the loan to Mead. As a result of the overstated accounts receivable balance, Mead has defaulted on the loan and has incurred a substantial loss. If Mead sues Dex for negligence in failing to discover the overstatement, Dex's best defense would be that
a. No engagement letter had been signed by Dex.
b. The audit was performed by Dex in accordance with generally accepted auditing standards.
c. Dex was not in privity of contract with Mead.
d. Dex did not perform the audit recklessly or with an intent to deceive.

24. Dickens, a CPA firm's personnel partner, periodically studies the CPA firm's personnel advancement experience to ascertain whether individuals meeting stated criteria are assigned increased degrees of responsibility. This is evidence of the CPA firm's adherence to prescribed
a. Standards of due professional care.
b. Quality control standards.
c. Supervision and review standards.
d. Reporting standards.

25. West & Co., CPAs, was engaged by Sand Corp. to audit its financial statements. West issued an unqualified opinion on Sand's financial statements. Sand has been accused of making negligent misrepresentations in the financial statements, which Reed relied upon when purchasing Sand stock. West was not aware of the misrepresentations nor was it negligent in performing the audit. If Reed sues West for damages based upon Section 10(b) and rule 10b-5 of the Securities Exchange Act of 1934, West will
a. Lose, because Reed relied upon the financial statements.
b. Lose, because the statements contained negligent misrepresentations.
c. Prevail, because some element of scienter must be proved.
d. Prevail, because Reed was not in privity of contract with West.

26. A CPA establishes quality control policies and procedures for deciding whether to accept a new client or continue to perform services for a current client. The primary purpose for establishing such policies and procedures is
a. To enable the auditor to attest to the integrity or reliability of a client.
b. To comply with the quality control standards established by regulatory bodies.
c. To lessen the exposure to litigation resulting from failure to detect irregularities in client financial statements.
d. To minimize the likelihood of association with clients whose management lacks integrity.

27. Which of the following statements is correct concerning corporations subject to the reporting requirements of the Securities Exchange Act of 1934?
a. The annual report (form 10-K) need not include audited financial statements.
b. The annual report (form 10-K) must be filed with the SEC within 20 days of the end of the corporation's fiscal year.
c. A quarterly report (form 10-Q) need only be filed with the SEC by those corporations that are also subject to the registration requirements of the Securities Act of 1933.
d. A monthly report (form 8-K) must be filed with the SEC after the end of any month in which a materially important event occurs.

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

29. Donn & Co. is considering the sale of $11 million of its common stock to the public in interstate commerce. In this connection, Donn has been correctly advised that registration of the securities with the SEC is
a. Not required if the states in which the securities are to be sold have securities acts modeled after the federal act and Donn files in those states.
b. Required in that it is necessary for the SEC to approve the merits of the securities offered.
c. Not required if the securities are to be sold through a registered brokerage firm.
d. Required and must include audited financial statements as an integral part of its registration.

30. Tulip Corp. is a registered and reporting corporation under the Securities Exchange Act of 1934. As such it
a. Can offer and sell its securities to the public without the necessity of registering its securities pursuant to the Securities Act of 1933.
b. Cannot make a tender offer for the equity securities of another registered and reporting corporation without the consent of the SEC.
c. Must file annual reports (Form 10-K) with the SEC.
d. Must distribute a copy of the annual report (Form 10-K) to each of its shareholders.

31. A CPA firm issues an unqualified opinion on financial statements not prepared in accordance with GAAP. The CPA firm will have acted with scienter in all the following circumstances except where the firm
a. Intentionally disregards the truth.
b. Has actual knowledge of fraud.
c. Negligently performs auditing procedures.
d. Intends to gain monetarily by concealing the fraud.

32. Which of the following conditions suggests auditor negligence?
a. Failure to detect material errors under conditions of weak internal control.
b. Failure to detect collusive fraud perpetrated by members of middle management.
c. Failure to detect collusive fraud perpetrated by members of top management.
d. Failure to detect errors occurring outside the internal control structure.

33. The registration of a security under the Securities Act of 1933 provides an investor with
a. A guarantee by the SEC that the facts contained in the registration statement are accurate.
b. An assurance against loss resulting from purchasing the security.
c. Information on the principal purposes for which the offering's proceeds will be used.
d. Information on the issuing corporation's trade secrets.

34. The principal purpose of the registration requirements of the Securities Act of 1933 is to
a. Prevent public offerings of securities in which management fraud or unethical conduct is suspected.
b. Provide the SEC with the information necessary to determine the accuracy of the facts presented in the financial statements.
c. Assure that investors have adequate information upon which to base investment decisions.
d. Provide the SEC with the information necessary to evaluate the financial merits of the securities being offered.