EXAM 2

true

-An accountant in public practice "shall not disclose any confidential client information without the specific consent of the client." -Improper disclosure of client confidential information is an act discreditable to the profession and subject to discipline.

when independence is required

-Any time you provided an attestation service o External Audit (positive assurance) o Review of Financial Statements (negative assurance0 o Review of prospective Financial Statements o In some cases - compilation of Financial Statements

Psychological Factors That Influence Taxpayer Honesty

-Civic Duty - Tax Morale; appreciate public projects -Intrusive audits & high tax penalties may weaken compliance if it tax payers lose faith that money is spent wisely. -Horizontal equity: similar situated taxpayers pay the same amount of taxes. -Vertical equity: degree of social consensus that rich pay their fair share relative to those further down the income scale. -Bomb crater effect: after a bad experience like an audit may feel safe that it won't happen again. -Other possibility: less fearful after an audit because it was not as bad as expected.

identifying who is a client

-Current Clients o If the client is an individual, it is straightforward to determine confidentiality o If the client is a larger organization, then discretion must be used in sharing information within that organization. -Prospective and Past Clients o If you discover information about a prospective client, and they never become a client, you still have to keep their confidence. o You have to keep confidential information private FOREVER.

true

-Disclosing the existence of a Client Relationship o Generally it is fine to disclose that a person or firm is your client o But, in some instances that disclosure could inform an outsider about the nature of the clients business with you -Using Client Information for Personal Gain o You cannot do this. It would be the same as if you sold the information to someone else to profit from the information.

detecting tax fraud

-Don't go outside of the lines -The IRS has a set of red flags to indicate who they should audit -IRS could look at: o Cash inflows into a person's bank account. o Expenditures made looking at credit card bills and other records of expenditures.

failure to return client records

-Everything the client gives you is theirs, if they ask you to return it, you have to -Things you have prepared for the client including final work product, and that they have already paid for, are also theirs -Internal working papers, the notes to future accountants working on the client, are not the clients, they have no right to see them, e.g., audit program, analytical tests, results of statistical audit samples. -May agree with client to alter these rules. Example 8-8 page 164

Manipulating Income Tax Reporting

-Hard for wage earners o Wage earners abuses: overstate deductions (home office, meals, entertainment, auto expenses, charitable donations, exemptions and credits (earned income credit)). -Easier for business o Cash (nonfarm proprietorship, gambling winnings) o Multi-state o Multi-national

true

-If a court requests the information you have to comply; i.e., valid court subpoena. -If you are involved in peer review. o A State Board might ask your firm to review the work of another. The firm being reviewed has to give information to the firm reviewing. -Specific laws require you to divulge information. o The Private Securities Litigation Reform Act (1995), if client doesn't take appropriate remedial actions. -In order to follow GAAP, could insist on disclosure

The Duty to Disregard GAAP Rules

-If following GAAP would lead to a result that is misleading o You have to explain why you did it, what the effect was, and why it would have been misleading -Continental Vending (Lybrand, Ross, Brothers and Montgomery) o They were able to follow GAAP with a carefully crafted footnote o The results were still found to be misleading o Only a presidential pardon kept them out of jail

true

-If your clients could not trust you to keep their information private, they would not share information and you would be at a disadvantage providing service. -Because this is the basis of the success of the profession, confidentiality applies to all accountants.

Hiding debts

-Operating Leases -Repos: o Before BS date: sell poor performing assets, pay down debt. o After: reverse transactions -Unconsolidated finance subsidiaries -SPEs o Now we call these "Variable Interest Entities" and we do not have a "bright line" standard to see who must consolidate the entity

The Duty to Place Facts in Context

-Profits went up! Yea! -You have to disclose why o You change inventory method o Your competitor went out of business o You changed your fiscal year and are reporting a 14 month year - one time -Tennyson: "A lie that is half-truth is the darkest of all lies."

Situations in Which Disclosure is Permitted Without Client Consent

-Selling an Accounting Practice o Identifying information can be redacted o Acquiring client signs a nondisclosure agreement o Prospective acquirer is forbidden from using to their own advantage any information learned. -Litigation-Related Disclosures o If you have to discuss your clients' business to defend your self in court. Or to pursue a claim in court against a client.

The Accountant-Client Privilege

-States That Treat Client Communications as Privileged o Some States have broader law that protects the clients' confidentiality o In some cases the law prevents State courts from forcing an accountant to testify -Federal Rules That Treat Client Communications as Privileged o Shields the accountant in some situations on giving routine tax advice o If your clients want a more confidential tax advisor, they should hire an attorney - Their privilege is broader at the Federal level

confidentiality in tax practice

-Taxpayer Self-Disclosure o Strong Federal law prevents the IRS from disclosing your tax return -Preparer Disclosure of Client Tax Information o Only if a court orders you to disclose o If you disclose, you can be fined, if it is intentional, you can be jailed -IRS Disclosure of Taxpayer Information o The IRS can only disclose to the states in some situations

Flaws in the Rational Model of Tax Cheating

-Taxpayers with higher incomes are less likely to underreport earnings than those with lower incomes. o Even though with a progressive tax system, there is more benefit to cheating at higher brackets. -People really underestimate the cost of being caught o The IRS will stick to you for the rest of your life

Other Discreditable Acts

-The Discreditable to the Profession Standard o View from the perspective of a reasonable and informed 3rd party. o Is it just breaking a law related to accounting, or any law? o The institute of Internal Auditors use the any law standard -The Duty to Report Others' Misconduct o Not in the AICPA code o It is explicitly covered in Financial Executive Institute's code -Can accountants private activities subject them to discipline for discrediting the profession of accounting?

DISCREDITABLE ACTS IN TAX PRACTICE

-To be allowed to represent clients dealing with the IRS you must be a CPA, Attorney, or an Enrolled Agent. -The controlling regulation is called "Circular 230" -Must not have committed a discreditable act

Improper Limitations on Malpractice Liability

-To keep from bearing the full cost of a lawsuit, accountants often will have their clients agree to share in the responsibility. This is called indemnification. -Generally permissible, but these agreements are sometimes banned in certain cases.

Manipulating Expenses (Cookie Jar Accounting)

-Using adjusting entries, turn as many dials as you can: change expected life of assets, adjust valuation reserves (LCM, bad debts, contingent liabilities, depreciation) -Big Bath o In year of acquisition or in a bad year, when bonuses will not be earned, write off as much as you can o Future years look much better -Hide current expenses as a future benefit: capitalize expenses

The Duty to Not Omit or Obscure Important Information

-We have to disclose something that we do not want to. -Firms might try to bury the disclosure in with other complex, redundant, or immaterial information

The Adverse Interest Threat

-When your client and the accountant are in a dispute -When you have an interest that is adverse to your client o You own a competing business

Modifications to the Accounting Principles Rules

-You can display non-GAAP measures if you follow the three rules -Prominently display GAAP -Reconcile non-GAAP to GAAP -The information is not misleading

Misrepresenting Professional Qualifications and ExperienceAdvertising and Solicitation Rule

-You cannot make false or misleading statements to attract clients -You cannot use a business name that is misleading -May have non-CPAs as owners in most jurisdictions but not in firm name -So...Optima Tax is acceptable, but, No Audit Tax, or Largest Return Tax would not be

B

1. A CPA has multiple office locations. In evaluating whether a CPA firm satisfies the independence rules with regard to an audit client, the concept of a "covered member" includes: a. An administrative assistant who assists the principal partner in charge of the audit b. A second audit partner who provides a concurring opinion on an audit and is located in a different office from the partner in charge of the audit c. An audit partner who works in a different office from the partner in charge of the audit and does not influence a particular audit d. An information systems partner who spent four hours on a consulting project for an audit client

D

1. A CPA observed another CPA engaging in an act that was undeniably discreditable to the profession. The Acts Discreditable Rule of the AICPA: a. Requires the observing CPA to report this violation to a designated officer of the AICPA b. Requires the observing CPA to report this violation to a designated officer of the applicable state's accountancy licensing board c. Expressly states that a CPA has no duty to report the observed misconduct d. Does not express an opinion on whether the observing CPA does, or does not, have a reporting duty

A

11. "Big bath accounting" describes a company's actions when it: a. Manages its earnings in a downward direction in the year of a major acquisition or restructuring or a year of major losses b. Optimizes the amount of Goodwill recognized upon paying a premium to acquire another company c. Manages its earnings by maintaining such a large number of discretionary items that it could "fill a bathtub," so to speak d. "Cleans its books," so to speak, of improperly recorded items in anticipation of a rigorous audit examination

D

11. A CPA firm billed for audit services performed for a client more than one year ago. The client has paid a portion of the fees outstanding, but it has not been able to pay the remaining balance due to cash flow problems. The CPA firm has verified that the cash flow problems are authentic and expects the client to be able to pay the remainder of the bill, but the CPA firm cannot reasonably estimate the timing of such payments. As a result, the CPA firm: a. Remains independent if the amounts that remain owing are immaterial to the CPA firm b. Remains independent if the client has paid over 50% of the total invoice outstanding c. Can preserve its independence if the client willingly signs a Note Payable for these services and the note bears a reasonable market rate of interest d. Lacks the independence to perform further attestation services

C

12. "Cookie jar accounting": a. Always sweetens, or increases, a company's reported profits, as its name suggests b. Sets aside questionable but desirable items in a jar, so to speak, and reports conservative results c. Allows a firm to manipulate the trend in its earnings, making earnings less volatile d. Allows a firm to boost its long-run, total reported earnings from a financial accounting perspective

D

12. The Accounting Principles Rule states that financial statements: a. Always must comply with GAAP b. Never should contain a departure from GAAP c. May contain a departure from GAAP for administrative reasons, as long as the departure is clearly disclosed d. May contain a departure from GAAP if adherence to GAAP would result in the statements being misleading

C

13. "Round trip" transactions primarily are utilized by companies: a. To commit tax fraud b. To substantially change the overall composition of their assets c. To recognize accounting gains in the current period and immediately reverse in the next period d. To return capital that previously was contributed by shareholders, often through the use of treasury stock repurchases

B

15. Which of the following is most likely to be considered "material," even if the amounts involved are small? a. Amounts that cause an upward earnings trend to become even larger b. Amounts that cause an earnings trend to swing from slightly positive to slightly negative c. Amounts that cause reported Gross Profit to be larger than Net Income d. Amounts that mask a retailer's inability to control its Cost of Goods Sold

C

6. For many years, a partner in a CPA firm worked on the audit of Grossnomics, Inc. This partner now has retired from the CPA firm and serves as a consultant to Grossnomic's Audit Committee. This partner's former CPA firm: a. No longer maintains the independence to audit Grossnomics, unless the CPA firm demonstrates to the AICPA that it remains independent in fact and in attitude b. No longer maintains the independence to audit Grossnomics under any circumstance c. Maintains the independence to audit Grossnomics as long as this former partner no longer has any actual or apparent financial ties to his former CPA firm d. Maintains the independence to audit Grossnomics as long as the former partner does not participate in the preparation of Grossnomics' financial statements

true

All of these are going to get you in trouble Steal your clients refund Charge too large a fee Personally break a tax law Lie to the IRS, or State tax authority Withhold client prepared records Try to intimidate, or coerce, or be abusive to an IRS agent Pattern of providing false and incompetent tax opinions

attitudes and rationalizations

Auditors should look for: -Indifference toward candor & honesty -Unrealistic earnings forecasts -Micromanaging accounting -Lavish lifestyles Rationalizations are seldom openly discussed -Once someone is caught they will try to deflect to minimize their guilt

true

Client permission should be specific to the information you need to share with a third party. The text book says that permission can be either written or oral. Suggestion: CYA, and get it in writing. Generalized, all encompassing authorization is unacceptable.

true

Covered Members -People who serve on the attest team (including partner with concurring second opinion) -Firm members who can influence the attest team (including QC) -Senior members of the firm, who provide at least 10 hours a year of non-attest services for the attest client -All partners who work in the same office as the lead attest partner

self review threat

External Auditors cannot review any of their own work Any activity that leads to the creation of the financial statements Systems design Internal audit Compilation Any management decision

gifts and entertainment

Gifts from the client, and to the client The rule is "Reasonable under the circumstances" Ask yourself - What would it look like on the front page of the local newspaper IFAC: "an audit firm or audit team member should not accept gifts or hospitality, unless value is trivial and inconsequential."

moral seduction

Gradual process by which people unconsciously adopt the perspectives of others with whom they regularly interact. Indulge a client's minor ethical infraction and then, overtime, fails to contest escalating client improprieties. It is very easy for us to become connected to a person, place or an organization Experiment - Value the lost inventory Those who were told they worked for the company valued it higher than those who were told they work for the insurer People often focus selectively on facts that favor peer group or employer and filter out conflicting information.

independence in tax practice

If you have a stand-alone tax client, you can act as an advocate You can try to avoid tax expense, you cannot cross the line to evasion of tax expense Extra care is needed when you are serving as both the auditor and the tax advisor when providing tax advice to avoid unacceptable advocacy , self-review, or management participation threat.

external disclosures

If you need to go outside your firm to perform the work for a client, you should ask the client for permission. If the services performed by a third party do not put client information at risk, the client does not need to be informed. Can use general industry knowledge & sophistication learned from past experiences.

true

Independence and confidentiality are the two most important ethical guidelines for the accounting profession Audit is what holds the accounting profession together, without it we would be consultants and tax preparers, no CPA needed

the cooperation preference

Most of us prefer to get along Conflict is uncomfortable - avoiding conflict is often seen as a goal Why we let people take advantage of us Auditor's duty: professional skepticism

true

Non-covered Members -Those people in the firm who can not be considered as "covered members" - Except.... o If they own, or control through family members 5% of the attest client's stock o They are currently employed by the client in a influential financial reporting position.

true

Non-public companies might use non-GAAP accounting The statements must very clearly state that they were Not Prepared According To GAAP

Protected categories in various laws

Race Color Religion Sex National origin Workers over 40 Disabled

when information is confidential

The General Nature of Confidential Information -Information not known to the general public, reasonable expectation that it will be kept secret, and, if known, might hurt or harm a client.

true

There are a variety of rules that govern discreditable acts These will vary by State Your firm will probably have their own set of rules They will change over time

Independence in Consulting and Outsourced Internal Audit Services

These relationships are controlled by the PCAOB for public companies They are generally not allowed For private companies, you have to walk the tightrope Management participation threat Self interest Threat Undue interest Threat

Providing Tax and Other Nonattest Services to an Audit Client

This is allowed, because it makes economic sense It must meet the following criteria Client makes all management decision Client has adequate knowledge to make those decisions Client accepts responsibility for those decisions Everyone agrees in writing to the nature and scope of the arrangement

the management participation threat

This is an extension of the self review threat (auditors cannot impartially evaluate their own work). Forbidden from serving as a client's officer or director, overseeing a client's internal controls, signing checks, disbursing funds, making client personnel decisions. Any decision that leads to the financial statements must be made by management Journal entries Valuation Estimates

self serving bias

We are very adept at excusing our bad behavior when it benefits us Book recommendation "Blind Spots - Why we Fail to do What's Right and What to do About It"

discounting

We discount the effect of an event in the future while weighting the immediate effect very heavily We do this for both good things and bad things It is why we procrastinate Confront client now or wait for potential negative consequences 2 or 3 years from now?

The Duty to Present Material Facts

What is material? The judgement of a reasonable person relying on the report would have been changed or influenced by the inclusion of the item The SEC has guidance

confirmation bias

When we want to come to a conclusion we will seek out information that supports that conclusion Even given the same information, people on two sides of an argument will interpret that information in their favor Also known as motivated blindness

the advocacy threat

When you take your client's side in a dispute You cannot be an auditor and an advocate at the same time Confirmation bias: consciously or subconsciously you will look for evidence supporting your client. This is why performing tax services for an attest client is a tricky issue

the undue influence threat

When your client has too much power over you, i.e., intimidation threat. A client group accounts for 15% (per SEC guidance) of the accountants revenue Accountants' insurers will ask about influential clients every year

internal disclosures

You can talk to your partners and co-workers about clients' issues. You should be vigilant that those who you share information with are aware of the confidential nature of the information.

A

4. Enron used special-purpose entities to: a. Keep large amounts of debt off of its balance sheet b. Create the appearance of activities that fooled inspectors c. Distort its reported Accounts Receivable d. Avoid the use of accelerated depreciation on assets for which this method was required to be applied

A

12. A CPA's mother-in-law owns stock in one of the CPA's audit clients. The CPA just learned this fact. In all likelihood, the CPA's independence is: a. Not impaired b. Impaired if the mother-in-law's stock holdings are material to her net worth c. Impaired if the mother-in-law owns sufficient stock to be able to significantly influence the governance of the audit client d. Automatically impaired, unless the mother-in-law immediately disposes of her share holdings

D

2. In applying independence rules, the concept of a "covered member" on an audit applies to: a. Only the principal audit partner on an audit b. Only the principal audit partner and the concurring partner, if any, on an audit c. Only the principal audit partner, the concurring audit partner, and senior staff exercising managerial responsibilities on an audit d. All accounting professionals who provide audit services to an audit client

C

2. Under the Advertising and Other Forms of Solicitation Rule of the AICPA's Code of Professional Conduct, a CPA may not engage in advertising that is: a. Undignified b. Unprofessional c. Deceptive d. All of the above

B

2. Your employer operates in an industry in which company pre-tax earnings are expected to increase by 5% next year. Your employer, however, has issued earnings guidance in which it declared that it expects its pre-tax earnings to increase by 11% next year. As a result, which of the following elements of the Fraud Triangle are present? a. Attitudes b. Pressure to understate expenses c. Opportunity to overstate revenues d. All three elements are present

D

24. CPAs who are full-time employees of a corporation and focus on the preparation of earnings forecasts and projections invariably learn confidential information about their employer's future prospects. Is such an employee subject to the duty of confidentiality? a. Yes, if the employment agreement between the employer and employee establish the duty of confidentiality b. Yes, but they would not be subject to this duty if they performed their services as part-time employees c. No, because employees in key financial oversight roles are not subject to the duty of confidentiality d. Yes, because all CPAs are subject to the duty of confidentiality

corporate governance weakness

Lax internal controls Change of auditors

B

4. An accountant generally has an obligation to prepare statements for a publicly-traded corporation in "accordance with GAAP." What does this mean? a. An accountant must always follow the mandates of rules established by the FASB and not apply international accounting standards b. An accountant may follow either the rules of the FASB or the rules of IFRS, depending on the jurisdiction in which the intended readers of the financial statements are located c. An American accountant must follow both the rules of the FASB and the rules of the AICPA's Code of Professional Conduct d. Any well-recognized, systematic framework of accounting may be applied, as long as the framework is prominently disclosed

A

5. In accordance with the Independence Rule, an ownership interest in an audit client is considered to be an indirect interest if: a. An auditor benefits from it, but cannot meaningfully influence or control it b. A partnership of which the auditor is a member owns the interest c. The benefits from the interest have accrued in the form of price appreciation but realization of this appreciation has not occurred d. An immediate family member owns the interest and shares the financial benefits of the interest with the auditor

D

5. Preparing financial statements for an unincorporated business on a basis that does not comply with GAAP usually will result in: a. A CPA being suspended from membership in the AICPA b. A professional accountant suffering adverse professional consequences if the accountant practices in a country that has adopted IFRS c. A CPA being permanently disqualified from continuing membership in the AICPA d. No professional discipline as long as the noncompliance with GAAP is adequately disclosed

C

5. To curb potential abuse, publicly traded companies: a. May not do business with related parties b. May not have related parties serve on their Boards of Directors c. May do business with related parties, as long as such relationships and transactions are clearly disclosed d. May do business with related parties as long as such transactions occur at fair market value, as determined by the company's independent auditors

D

6. Some commentators have suggested that Enron would not have collapsed if it: a. Had enacted a Code of Conduct b. Had enacted a standard Code of Conduct rather than the weak one that it in fact had c. Had the CEO and CFO certify the financial statements d. Had not unduly focused on short-term stock performance

C

6. Winkelberg, a CPA, has been retained to prepare unaudited financial statements for a company, on an income tax reporting basis, for a privately-held company owned by her best friend, Stinkelberg. WInkelberg has a professional obligation to: a. Withdraw from this engagement because of her friendship with Stinkelberg b. Withdraw from this engagement because of the basis on which these financial statements are presented c. Use due care in preparing these statements d. Inform her client that this basis of reporting violates SEC filing requirements, but she does not necessarily have a duty to withdraw from this engagement

D

7. By serving on the Board of Directors of various charities, Bernie Madoff was able to: a. Utilize their tax-exempt status to his advantage b. Invest funds in a nontaxable manner c. Hide his profits through the use of nonprofit organizations that were highly unlikely to be audited by the IRS d. Gain their trust

D

7. Status as a "covered member" is important in determining independence because CPAs who are classified as a "covered member" lack the independence to conduct an audit if: a. They have an indirect ownership interest in even a single share of stock outstanding in an audit client b. They refuse to subordinate their best judgment to the wishes of their client c. Their college-age, dependent child works in the client's warehouse during the summer as a shipping clerk d. Their sister is an attorney who works as the company's General Counsel

B

7. When unaudited financial statements prepared on a basis that does not conform to GAAP are disseminated by a CPA, the CPA should: a. Directly contact intended recipients of these statements to inform them about the nonconformity with GAAP b. Mark the statements as "Unaudited" and state that they are "Not prepared in accordance with GAAP" c. Not be involved in the physical or digital transmission of these statements d. Not sign any reports or statements indicating her status as a CPA

B

8. A CPA recently was presented with the opportunity to bid to become the auditor for a corporation. This CPA's husband owns stock in that company. Does this CPA satisfy the independence requirement to audit this company? a. No, if the stock is held in a joint brokerage account b. No, even if the stock is held in an individual brokerage account and was purchased solely with funds earned by her husband c. Yes, if her husband owns a small number of shares and the corporation is publicly-traded d. Yes, as long as she maintains objectivity and professional skepticism in performing the audit

B

8. When a person's net cash flow exceeds his or her reported taxable income, the IRS: a. Has an automated system that identifies a taxpayer as a possible tax cheater b. Presumes, upon examination, that the taxpayer is underreporting his or her income c. Conclusively recognizes that the taxpayer is underreporting his or her income d. Conclusively recognizes that the taxpayer has underreported both income and tax payments

B

8. Which of the following acts is clearly discreditable? a. Creating and posting a youtube video in which a CPA berates the IRS for incompetence b. Refusing to return client records, even if a CPA is owed unpaid fees, if these records are needed by the client to prepare its tax return c. Commenting on "how graceful" an administrative assistant is when she wears high-heeled shoes d. Mentioning on your CPA firm's website that you formerly worked for the IRS, if a reader might conclude from this statement that you are better able to negotiate favorable settlements with the IRS for clients

A

9. A CPA firm has an office in New York and an office in San Francisco. The CPA firm's New York office has been retained to audit the financial statements of a new bank client based in New York. The bank is a very large provider of consumer loans. As a result, numerous professionals who work at the CPA firm have outstanding loan and credit card balances owed to this bank. Which of the following loans potentially will impair the CPA firm's independence to audit this bank? a. A New York tax partner, who will not work on the audit, has a large mortgage loan owing to the bank b. A New York tax partner who will work on the audit has a standard automobile loan owing to the bank c. A San Francisco audit partner who only audits governmental entities has a large credit card balance owing to the bank d. A New York audit partner who will serve as the concurring partner on this bank audit engagement uses a credit card issued by this bank but routinely pays off the full outstanding balance monthly

C

9. A CPA prepared financial statements that reflect a company's expected financial position, operating results, and cash flows and were based on one or more hypothetical assumptions: This CPA has: a. Violated the ethical standards of the accounting profession, as reflected in the IFAC Code of Conduct b. Violated the ethical standards of the accounting profession, as reflected in both the AICPA's and IFAC's standards of conduct c. Prepared financial projections, which is not an ethical violation d. Prepared financial forecasts, which is not an ethical violation

C

9. The LIBOR scandal was primarily caused by: a. Bad debt losses on bank loans that were biased downward to avoid inquiry by European banking regulators b. Excessive reliance by banks on loans the bear adjustable loan interest rates c. A lack of candor by certain banks d. A lack of integrity by large corporate borrowers

D

A "covered member" of a CPA firm owns 4% of the bonds outstanding in an audit client. In accordance with the Independence Rule, does this CPA firm have the independence to audit this client? a. Yes, as long as the CPA's immediately family does not have any additional financial interests in this client b. Yes, as long as the bonds are not convertible into common stock c. No, unless the CPA agrees to not directly participate in the audit d. No, because of the self-interest threat

D

14. The judge's decision in the "Continental Vending" court case: a. Made GAAP mandatory for all financial statements b. Held that compliance with international accounting standards, rather than American accounting standards, was acceptable in the presentation of audited financial statements if the statements would predominantly be distributed to readers outside the United States c. Held that compliance with international accounting standards, rather than American accounting standards, was acceptable in the presentation of audited financial statements if the statements would exclusively be distributed to readers outside the United States d. Made deviation from GAAP-based presentations mandatory if the application of GAAP would be misleading

C

15. From the perspective of accounting, the downfall of Lehman Brothers was primarily attributable to: a. The company's undue focus on short-term earnings b. The company's blatantly deceptive revenue recognition policy on complex financial products and services c. Debt repayment transactions that lacked enduring economic substance d. A subtle variation on cookie jar accounting

B

15. If a CPA prepares a few sales invoices on behalf of an audit client without charge because the client does not want to have to pay overtime to the workers who normally perform this task, the CPA's independence is: a. Impaired due to the management participation threat b. Impaired due to the self-review threat c. Impaired due to the self-interest threat d. Not impaired because the threat, if any, is immaterial

B

16. Upon returning home after a long workday, a CPA told her husband that she "had a lunch meeting earlier that day with the Controller of her new client, Abnomacious, Inc., and that the Controller ate a really expensive seafood platter." Disclosure of this information to her husband: a. Likely violated the duty of confidentiality b. Likely did not violate the duty of confidentiality c. Could not have violated the duty of confidentiality because communications between spouses are protected by the marital exemption d. Could not have violated the duty of confidentiality because this duty applies only to individuals, not to corporations

B

17. During the course of working on a complex project, a client shared confidential information with its CPA. The CPA did a superb job, but the client, however, has never paid the CPA for her services. The CPA anticipates that, if she initiates a lawsuit to collect the amount due, the client will claim that the task was simple and the CPA's performance was below standard. If the CPA wants to introduce the nature of the work done as evidence in her court action to collect unpaid fees: a. She may not do so because she has a duty to not reveal confidential information b. She may do so because the complexity of the tasks performed by her is a critical fact in her lawsuit c. She may not reveal confidential information unless the court issues a protective order d. She may discuss confidential information only if her client reveals it first or if she obtains the consent of her client, the opposing party

A

17. The advocacy threat to independence exists when: a. A member of an auditing firm publicly speaks out on behalf of his client b. A member of an auditing firm makes a clear recommendation to the client c. A member of an auditing firm makes a recommendation to a client that is skewed in favor of a particular position or outcome d. A member of an auditing firm confronts an audit client and expresses an opinion that results in a significant disagreement with the client

D

18. A paid tax return preparer is allowed to have: a. An indirect financial interest in a client, but not a direct financial interest b. A direct financial interest in a client, but not an indirect financial interest c. Both direct and indirect financial interests in a client, as long as the interests are not material d. Both direct and indirect financial interests in a client, even if these interests are material

D

18. The duty of confidentiality arises when: a. A professional accountant and client agree to it in their contract for services b. A professional accountant expressly agrees to abide by the AICPA's Code of Professional Conduct c. Automatically for a professional accountant under the IFAC Code of Conduct, but not under the AICPA's Code of Professional Conduct d. Automatically for a professional accountant, under both the IFAC and AICPA Codes of Conduct

B

19. An auditor is allowed to have: a. An indirect financial interest in a client as long as the interest constitutes an immaterial stake in the client b. An indirect financial interest in a client as long as the interest is immaterial to the auditor's net worth c. Any financial stake in a client as long as the interest is immaterial d. A direct interest in a client as long as safeguards on independence are satisfactory to the client

D

19. The duty of confidentiality applies to: a. Spoken communications only b. Written documents only, whether or not they are in digital or physical form c. Only written documents that are marked with the word "Confidential" or an equivalent phrase d. All documents, communications, and observed facts

C

21. A CPA wishes to mention the names of her most prominent clients on her website. The mere existence of a professional relationship between a CPA and a small business client: a. Never may be disclosed due to the duty of confidentiality b. Never may be disclosed unless the client gives it specific consent c. Generally may be disclosed by a CPA as long as the substance of the communications between them is not disclosed d. Always may be disclosed, but it is advisable to first request the client's permission to avoid jeopardizing the client's goodwill

D

22. During the cold winter months, a Nebraska corn farmer discussed hiring a CPA to maintain his books and records. During the course of their discussions, the farmer told the CPA about various proprietary techniques that he uses to maximize the yield from growing corn and maximize the revenue his business generates. Thereafter, the farmer got busy operating his business and never contacted the CPA again. For what period of time, if any, does this CPA owe a duty of confidentiality to this farmer? a. No duty at all because the duty of confidentiality only continued until the time at which it became reasonably certain that the farmer would not become the CPA's client b. Expired after the end of the farmer's busy growing and harvesting season, if not sooner c. One year d. Forever

C

23. A CPA specializes in helping businesses evaluate their future prospects and create successful budgets. As part of this process, the CPA invariably learns confidential information about a company's future. To avoid potential liability, the CPA's engagement letter states upfront that "all information learned after the commencement of services shall not be subject to the duty of confidentiality." This CPA: a. May utilize for its own benefit information learned from this budgeting engagement because of this express waiver provision b. May utilize for its own benefit information learned from this budgeting engagement because the duty of confidentiality does not apply to management consulting engagements c. May not utilize information learned from this client relationship because the client did not give its specific consent d. May not utilize information learned from this client relationship because the duty of confidentiality can never be waived

A

23. The term "safeguard," as it used in determining auditor independence, refers to: a. Actions or other preventative measures that reduce threats to auditor independence to an acceptable level b. Actions or other preventative measures that eliminate all known threats to auditor independence c. Actions or other preventative measures that eliminate all threats, known and unknown, to auditor independence d. Actions taken by a client to protect confidential information from subsequent disclosure by an audit team

C

24. To preserve their independence regarding audit clients, CPAs should not: a. Prepare suggested year-end adjusting entries b. Prepare suggested year-end closing entries c. Negotiate office leases on behalf of these clients d. Prepare financial projections that are based on management's assumptions

A

25. A CPA firm audits Zaxstation, Inc. To avoid impairing the CPA firm's independence, members of this CPA firm may never: a. Authorize capital expenditures for the company, even if the projects are worthwhile b. Authorize junior staff members who have not yet passed the CPA exam to perform required audit procedures c. Evaluate whether the company's internal controls have weaknesses or deficiencies d. Suggest changes to the company's selection of accounting policies

B

25. During the course of working as an external auditor, you discovered that your audit client is going to build a new luxury ski resort in rural Utah. As a result, you purchased a vacation home near that resort in the expectation that housing prices will benefit from the announcement of a luxury resort being built nearby. Your action: a. Was unethical only if it precluded your client from pursuing this opportunity to earn a profit on nearby real estate b. Was unethical even though it caused no harm to your client c. Was ethical because the insider trading laws only concern purchases of securities d. Was ethical because your action was expressly allowed by the IFAC code of conduct

D

36. A CPA may utilize information obtained during the course of a professional accountant-client relationship for personal gain: a. Only if the CPA does not disclose this information to others b. Only if the source of this information cannot reasonably be discovered by others c. Only if the use of this information does not preclude the client from pursuing any opportunities that it otherwise would have desired to pursue d. Never

C

37. A client called a CPA at her home one evening to discuss an urgent matter. The client called at a time when the CPA was eating dinner with her family. Due to the unexpected and potentially urgent nature of the call, the CPA answered the phone call while sitting at the dinner table. As a consequence, some of the CPA's family members overheard key aspects of the phone call. Did the CPA violate the duty of confidentiality? a. No, because the client reasonably should have known that the CPA was not conducting business from her office b. No, because the client had a reasonable expectation that a call to a CPA's house after business hours might be overheard c. Yes, because CPAs are specifically warned to guard against inadvertent disclosures in social settings d. Yes, even though a CPA's immediate family members are subject to the same duty of confidentiality that applies to the CPA herself

A

4. According to the AICPA's Code of Professional Conduct, if a CPA renders more than ten hours of nonaudit services to an audit client, the CPA : a. Automatically is a covered member on the audit b. Automatically prevents the CPA firm from satisfying the independence requirement under all circumstances c. Automatically prevents the CPA firm from satisfying the independence requirement if the CPA is a partner in the CPA firm performing the audit d. Automatically prevents the CPA firm from satisfying the independence requirement if the CPA has a friend who works in the compilation, processing, or presentation of the audit client's financial statements

pressure

Delay failure: forestall bankruptcy Pay off debt Hang on to power

Enron's Business Model

Public vs private ethical culture -Publicly: RICE: Respect, Integrity, Communication & Excellence -Privately: ruthless, win at all costs attitude; relentless pursuit of short-term profit. Extreme loyalty demanded from employees -Rank and yank: lowest ranked employees were fired

enron and theatrics

Smoke and mirrors Hollywood style set on trading floor to fool analysts.

Enrons deceptive accounting practices

Special purpose entities (SPEs) -When they collapsed they had 3,507 special purpose entities SPEs are unconsolidated subsidiaries -To qualify they had to have 3% independent ownership -Many were controlled by Enron managers -Implications: -Not included in consolidated statements. -Kept debt off of books, although Enron guaranteed repayment. -Sales of underperforming assets from Enron to SPEs were recognized in financials. -Issue stock from Enron to SPEs (not allowed by GAAP). -Sold barges at profit to Merrill Lynch, contracted to buy back later.

A

The undue influence threat exists when: a. A client threatens to terminate a CPA firm during the course of performing an audit of the client's books b. An auditor provides a 10% fee reduction to a client who complained about the auditor's staff being inadequately trained c. An auditor pays the entire restaurant bill for a client business lunch at which interpersonal conflicts between one audit staff member and a client employee were addressed d. An auditor sends an exceedingly generous gift to the CEO of a client to celebrate her fifth-year anniversary as the CEO

C

The undue influence threat is most likely to be present when: a. A client and a CPA disagree over whether a change in accounting principle has a material effect on the client's reported results b. A client and a CPA disagree over whether the valuation model selected by the client for expensing compensation costs associated with employee grants of stock options adequately reflects the economic costs associated with this expense c. A CPA firm generates 19% of its total revenues from services provided to a corporation and its seven subsidiaries d. A CPA gives its client a "one-time only" 20% discount on fees so the CPA firm can acquire a new audit client

cooking the books

o If you want more income, start with the top line of the income statement o COSO has a report every 10 years -60% of firms have some type of accounting manipulation -The methods do not change much from 1980 to 2010 -Do anything you can to put more revenue in the current period, even if it means reversing it in a future period

manipulating revenues

-Revenue recognition games o Fictitious customers, phony sales invoices, channel stuffing, recording revenues before goods shipped, under report expected returns or discounts, exaggerated mark-to-market gains, understating uncollectible accounts. -Round-trip transactions: sells and buys back essentially same assets -Side agreements: secret deal to undermine scope of main agreement; difficult to detect if there is collusion

B

33. The AICPA's Code of Professional Conduct recognizes that the duty of confidentiality is: a. Absolute b. Subject to various exceptions, even without client consent c. Cannot be waived by a client d. Cannot be waived by a client if the public interest is best served by a particular client's information remaining confidential

D

34. If a CPA provides professional services to a large corporation, it should discuss confidential client information: a. Only with the corporation's Audit Committee and General Counsel b. Only with the corporation's Audit Committee and Board of Directors c. Only with the corporation's General Counsel to preserve the attorney-client privilege concerning such communications d. With any corporate employee who, in the CPA's professional judgment, is an appropriate recipient of such information

The Enron Scandal & Arthur Andersen

-Andersen prior to Enron was 1 of the Big 5 -Consulting fees were higher than audit fees -Found guilty of obstructing justice -Banned from SEC clients

Manipulating Multi-Item Allocations

-Combine dissimilar items into bundles for both purchases and sales o This gives you some flexibility in both revenue and expense recognition o Purchase land and depreciable assets: allocate -higher amount to depreciable assets -The FASB has tightened standards

true

-Enron went into the highest growth business model it could find - managing the trading of everyday products -They expanded into as many distinct markets as they could find -The rapid growth led to their high stock market valuation -The only way to sustain that valuation was to continue to grow

COSO and fraud

-Fraud starts at the top; 89% were controlled by CEO or CFO -People are convicted, but only around 12% -The methods used are common and well known -Shareholders pay the price -An auditor switch is a red flag

The Rational Model of Tax Cheating

-Goes back at least to Babylonian days. -Cost benefit model: weigh financial reward of cheating vs. probability of getting caught and magnitude of punishment. -17% of taxable income is not reported -Rarely under report: wages, interest, dividends, & stock related transactions (easy to check). -People who get paid in cash cheat at ten times a higher rate.

D

35. A CPA' duty of confidentiality ends when: a. A professional relationship with a client ends b. A client dies c. A client's is acquired by another company in a merger or purchase d. Never

B

1. Your employer operates in an industry in which company sales are expected to increase by 5% next year. Your employer, however, has issued earnings guidance in which it declared that it expects its sales to increase by 13% next year. As a result, which of the following elements of the Fraud Triangle are present? a. Rationalization b. Pressure to engage in channel stuffing c. Opportunity to exceed expectations d. Opportunity to garner above-market stock performance gains

B

14. A "side agreement": a. Allows a company to charge a lower selling price to attract a new customer, without existing customers discovering this reduction b. A secondary agreement that overrides a primary agreement, for the purposes of committing accounting fraud c. An comparatively minor agreement that forensic investigators set aside during the course of conducting a fraud examination of major improprieties d. A technique used by Certified Fraud Examiners and others to deter potentially fraudulent actions

A

14. The adverse interest threat exists when: a. A client sues its auditor for incompetence b. A CPA testifies in court, in response to a valid court subpoena, that it observed illegal activity taking place at the client's place of business c. A CPA voluntarily testifies in court that its client incorrectly recorded cash proceeds as nontaxable loan proceeds rather than as a taxable sale d. A CPA, in response to a formal SEC inquiry, states that it has serious concerns about the trustworthiness and candor of an audit client's CFO

B

10. A CPA firm has multiple locations in Europe, Asia, and North America. The principal partner overseeing the audit is located in Dallas, Texas. Are all partners who commute to offices in Dallas, Texas considered to be covered members? a. Yes, if they are audit partners b. Yes, even if they are not audit partners c. No, as long as they are not in a position to influence the audit d. No, as long as they are not in a position to supervise, manage, or evaluate the performance of any of the audit partners or audit team members who participated in the audit engagement

C

10. Financial statements prepared on the cash basis: a. Comply with GAAP but are complex to prepare b. Comply with GAAP and are relatively easy to prepare c. Do not comply with GAAP and are relatively easy to prepare d. Do not comply with GAAP and, therefore, are not subject to being audited

D

10. When a person's net cash flow exceeds his reported taxable income, the presumption that this individual has misreported his income to taxing authorities can be rebutted by showing that: a. The cash flow was attributable to the receipt of a nontaxable inheritance b. The cash flow was attributable to loan proceeds c. The cash flow was attributable to the receipt of nontaxable gifts d. All of the above

B

11. A CPA is in partnership with three non-CPAs. The CPA wants to sign a report. Her signature will appear at the bottom of the report and the signature block will mention that she is a CPA and is affiliated with this partnership. This CPA: a. May do so as long as the non-CPAs comply with the standards set forth in the AICPA's Code of Professional Conduct b. May do so as long as the report would not lead a reasonable reader to believe that the entire partnership is comprised solely of CPAs c. May not do so because the use of the entire firm's name would imply to a reasonable reader that all partners in the firm participated in the submission and preparation of the report d. May not do so because a CPA who is in partnership with non-CPAs may not use the entire partnership's name in connection with reports submitted to clients or third parties

C

13. The "Continental Vending Machine" court decision was a landmark ruling because: a. It authorized CPA firms to both prepare a client's financial statements and then audit these same financial statements b. It held that, for consistency, all financial statements must comply with GAAP, regardless of the industry in which a company operates c. Auditors can be held liable for misconduct, even if financial statements comply with GAAP d. Auditors may recoup from an audit client all of the litigation losses that the auditor sustains from certifying misleading financial statements if the audit client solely was responsible for the statement presentation being misleading

C

20. In the business world, sellers often sell goods on credit. In the auditing world, due to the independence requirement, CPAs: a. Are required to collect payment in full for an audit no later than the submission date of the CPA's audit report b. May not give their clients more than 60 days in which to pay the full outstanding invoice owing for audit services c. Remain independent as long as audit fees do not remain unpaid for more than one year d. Never may require clients to pay interest on unpaid fee balances

A

20. The duty of confidentiality applies to: a. All communications between a CPA and a client b. All communications between a CPA working in industry and his employer or designated employer representative c. Only information exchanged between tax return preparers and their clients d. All CPAs and their clients until the time that a CPA retires from the active practice of accounting

B

32. The AICPA Code of Professional Conduct has established for professional accountants: a. A duty of confidentiality only if this duty has been adopted or ratified by a particular state's accountancy licensing board b. A duty of confidentiality , but not an accountant-client privilege c. An accountant-client privilege, but not a duty of confidentiality d. Both a duty of confidentiality and an accountant-client privilege

C

26. A car tire manufacturer guarantees that its tires will last for 50,000 miles and, if they do not, it will replace the tires at no cost. A CPA working for this manufacturer of car tires is in charge of determining the liability account entitled "Liability for Warranty Repairs." Historically, this warranty account has had a balance equal to 2% of sales. However, due to a drastically high level of defects at the company's offshore manufacturing facility, this liability account needs to be increased by millions of dollars to roughly equal 9% of sales. To avoid negative publicity, this CPA's employer does not want this revised amount to be disclosed in its financial statements. The employer: a. Can keep this fact confidential because the CPA knows, or reasonably should know, that it will cause harm to the employer b. Cannot keep this fact confidential because the duty of confidentiality does not apply to the relationship between an employer and an employee c. Cannot keep this fact confidential because the CPA has a primary duty to ensure that a company's financial statements are accurate d. Can keep this fact confidential because the duty of confidentiality does apply to the relationship between an employer and a CPA-employee

A

26. Under ordinary circumstances, both the CFO and CEO of a particular company authorize and sign check disbursements exceeding $10,000. However, when the CEO of this audit client is unavailable for an extended period due to her travel schedule, the client's CPA co-signs checks that exceed $10,000 only after these checks first have been authorized and signed by the client's CFO. The CPA: a. Has created a management participation threat that impairs his independence b. Has created an undue influence threat that impairs his independence c. Has created an advocacy threat that impairs independence, unless appropriate safeguards are put into place d. Should be commended for assisting the client and has not affected his independence

D

27. A CPA firm is comprised of 100 audit partners. Three of these partners own stock in one of the CPA firm's audit clients, with each such partner owning 2% of the outstanding shares in this client. Does this CPA firm retain the independence to audit this client? a. Yes, as long as none participate in the audit as the primary or concurring partner b. Yes, as long as none render non-audit services to this client c. Yes, as long as none is a "covered member' with respect to this client d. No

C

27. A CPA's client base includes both publicly traded corporations and smaller privately-owned clients. Some of these clients require audits, and others only require bookkeeping and tax compliance services. If the CPA wishes to sell her professional practice to another CPA firm, she may disclose to the prospective buyer information concerning: a. only the publicly traded clients b. only the clients for whom she issues an audit opinion c. all information requested, as long as she takes reasonable precautions to ensure that the prospective buyer does not disclose sensitive client information shown to it d. none of these clients, due to the duty of confidentiality

A

28. Due to its international expansion, a privately-held company ended its relationship with its local CPA firm and retained a larger, multi-office CPA firm. The newly-retained CPA firm has asked the former CPA firm to "forward all client records, financial statements, and workpapers still in its possession." The former CPA firm, however, has refused to do so. The former CPA firm: a. Definitely is not in violation of the AICPA's Code of Professional Conduct b. Is in violation of professional standards if all outstanding fees owed to it have been paid by its client c. Is in violation of professional standards if the newly-retained CPA firm has offered to pay all reasonable costs associated with the transmission of documents d. Is in violation of professional standards if the newly-retained CPA firm has, in good faith, communicated that receipt of these records is urgent due to a time-sensitive governmental filing that is overdue

C

29. if a paid tax return preparer discloses a client's Social Security Number, the preparer is subject to monetary penalties: a. Only if the disclosure was intentional b. Only if the disclosure was intentional or reckless c. If the disclosure was intentional, reckless, or inadvertent d. Only if the client can demonstrate that he or she suffered monetary damages

B

3. Can a tax partner in a CPA firm with multiple offices be a "covered member" on an audit? a. Yes, but only if the partner renders more than 10 hours of tax services to an audit client ???????????? b. Yes, if the tax partner works out of the same office as the audit partner in charge, even if she does not render any services to the audit client c. Yes, all partners in a CPA firm automatically are "covered members," even if they do not work out of the same office as the audit partner or render any services to the audit client d. No, tax partners are not subject to the independence rules

D

3. Enron's use of Special Purpose Entities led to: a. Widespread, and wholly unexpected, embezzlements of funds b. Widespread embezzlements of funds that could had, and should have, been readily anticipated c. The accounting profession developing the concept of consolidated financial statements d. Rule changes in GAAP related to requirements for consolidation

B

3. The name of a CPA firm may: a. Include the name of a founder who is retired, as long as he or she remains an active member of the AICPA b. Include the name of a founder who is deceased c. Not include the name of a CPA unless that CPA is a member in good standing of the AICPA d. May include the name of a non-CPA without needing to identify the non-CPA as being, in fact, a non-CPA

C

30. Before disclosing confidential information, a CPA generally must obtain client consent. This consent must be: a. Included in the original engagement agreement signed at the outset of an accountant-client relationship b. Included in the original engagement agreement or in a subsequent amendment to that document c. Specific to a particular fact or set of facts d. In writing, but the parties have substantial flexibility in deciding on the form and content of such a consent document

C

31. A CPA cannot be held liable for violating the duty of confidentiality if: a. He receives an urgent phone call from a client and responds to that message while standing in a crowded elevator b. He places a phone call to a client from his home office and a family member accidentally overhears the conversation c. The client did not have a reasonable expectation of confidentiality for the type of information being communicated d. Information was disclosed after an ongoing client relationship had terminated

B

An auditor may not perform an audit unless threats to independence are: a. Agreed to by the audit client b. Reduced to an acceptable level c. Nonexistent d. Eliminated entirely by the client prior to commencement of the audit

opportunity

Corporate governance weaknesses -Lax internal controls -Change of auditors Complexity -As many adjusting entries as you can find Coconspirators -Related parties -Other organizations with similar incentives -Overly complex transactions

D

Cyndi's husband Larry works as a cashier at Starstrucks, a chain of coffee shops. Cyndi, a CPA, may: a. Not serve as the main partner in charge of the audit of Starstrucks b. Not serve as a senior staff member on the audit of Starstrucks c. Not serve in any capacity as a member of the audit team engaged to audit Starstrucks d. Definitely may serve in any capacity as a member of the audit team engaged to audit Starstrucks

the fraud triangle

Incentive Opportunity Rationalization

incentives

Make more money: year end bonus, Ex. 7-1 stock options Gain power Meet investor expectation

lessons learned from enron

Sarbanes-Oxley (2002) -Ethical culture & internal controls matter -Cozy relationship between auditors & client are not a good idea -Tighter auditing standards were needed: created the Public Company Accounting Oversight Board (PCAOB) -Bright lines for SPEs are not a good idea