2014 WILEY CPA excel focus notes regulation

Focus onLiability under Federal Securities Regulations Auditors are liable under both the Securities Act of 1933 33 Act and the Securities Exchange Act of 1934 34 Act.. Liability under 3

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CONTENTS

Module 36: Transactions in Property 207

This publication is a comprehensive, yet simplifi ed study program It provides a review of all the

basic skills and concepts tested on the CPA exam, and teaches important strategies to take

the exam faster and more accurately This tool allows you to take control of the CPA exam

This simplifi ed and focused approach to studying for the CPA exam can be used:

• As a handy and convenient reference manual

• To solve exam questions

• To reinforce material being studiedIncluded is all of the information necessary to obtain a passing score on the CPA exam in

a concise and easy-to-use format Due to the wide variety of information covered on the exam, a

number of techniques are included:

• Acronyms and mnemonics to help candidates learn and remember a variety of rules and checklists

• Formulas and equations that simplify complex calculations required on the exam

• Simplifi ed outlines of key concepts without the details that encumber or distract from learning the essential elements

vii

• Techniques that can be applied to problem solving or essay writing, such as preparing a multiple-step income statement, determining who will prevail in a legal confl ict, or develop-ing an audit program

• Pro forma statements, reports, and schedules that make it easy to prepare these items by simply fi lling in the blanks

• Proven techniques to help you become a smarter, sharper, and more accurate test takerThis publication may also be useful to university students enrolled in Intermediate, Advanced and

Cost Accounting; Auditing, Business Law, and Federal Income Tax classes; or Economics

and Finance classes

Good luck on the exam,Ray Whittington, PhD, CPA

ABOUT THE AUTHOR

Ray Whittington, PhD, CPA, CMA, CIA, is the dean of the Driehaus College of Business at DePaul University Prior to

joining the faculty at DePaul, Professor Whittington was the Director of Accountancy at San Diego State University From

1989 through 1991, he was the Director of Auditing Research for the American Institute of Certifi ed Public Ac countants

(AICPA), and he previously was on the audit staff of KPMG He previously served as a member of the Audit ing Standards

Board of the AICPA and as a member of the Accounting and Review Services Committee and the Board of Re gents of

the Institute of Internal Auditors Professor Whittington has published numerous textbooks, articles, mono graphs, and

continuing education courses.

ABOUT THE CONTRIBUTORS

Edward C Foth, PhD, CPA, Administrator of the Master of Science in Taxation Program at DePaul University Pro fessor

Foth is the author of CCH Incorporated’s Study Guide for Federal Tax Course, Study Guide for CCH Federal Taxation:

Comprehensive Topics, and coauthor of their S Corporation Guide Professor Foth prepared the answer expla nations

ix

to the multiple-choice and task-based simulation questions in Income Taxes, wrote new questions, selected the mix of

questions, and updated items to refl ect revisions in the tax law.

Brad McDonald, JD, is an instructor of Business Law and Statistics at Northern Illinois University He has taught

business law since 1987 and has taught the Business Law section of the Northern Illinois CPA review course since

1998 He wrote and revised most of the Business Law modules He prepared and revised answer explanations for the

multiple-choice and simulation questions.

Focus on

ACCOUNTANTS’ LIABILITY

Liability under Common Law

An accountant may be liable under common law due to negligence or fraud

Negligence

A loss due to negligence occurs when an accountant violates the duty to perform professional

services in a competent manner NEGligence may consist of

• Nondisclosure of information to a client

• Errors previously discovered not being corrected

• GAAP not being followedBest defense to common law negligence is that appropriate professional standards were followed

• Defense of lack of privity may be available

• But client and intended third-party benefi ciaries have privity

• Foreseen third parties have privity in majority of states under tort law

• Foreseen third parties lack privity in states conforming to Ultramares caseGross negligence

• Reckless disregard for the truth

• Lack of privity not valid as defense

Focus on

Fraud

Fraud refers to conduct that involves all of the following:

• Material false representation of fact

• Justifi able reliance on the information

• Awareness of the false information by the accountant

• The falsity was made with the ultimate intent to deceive

• The party must have suffered damages

Scienter refers to the accountant’s knowledge of a false representation or material omission of

fact with the intent to deceive

Potential defenses against fraud include

• Lack of intent to deceive

• ImmaterialityLack of privity is not a valid defense

Focus on

Liability under Federal Securities Regulations

Auditors are liable under both the Securities Act of 1933 (33 Act) and the Securities Exchange Act

of 1934 (34 Act)

Liability under 33 Act

Accountants are liable under Section 11 of the 33 Act

• Liable if fi nancial statements contain untrue statement or material omission

• Liable to anyone acquiring security without knowledge of error

To be successful, the plaintiff need not prove

• Privity

• Scienter

• RelianceDefenses the accountant may use include

• Plaintiff’s knowledge of the error

• Due diligence in performance of services

Focus on

Liability under 34 Act

Accountants are liable under Rule 10b-5 of the 34 Act

• Liable for oral or written misrepresentations of fact

• Liable for wrongful act committed through mail, interstate commerce, or a national securities exchange

To be successful, the plaintiff must prove

• Scienter

• RelianceDefenses the accountant may use include

• Plaintiff’s knowledge of the error

• Lack of reliance by plaintiff

Focus on

Summary of Auditor Liability

Elements in action taken against an accountant

1) There is a misstatement or omission of a material fact2) Plaintiff has reasonably relied upon the information3) Plaintiff suffered a loss

4) Accountant was in error

Focus on

Auditor Common Law Liability

Anyone injured

Accountant’s error resulting in action

misconduct (scienter)

Focus on

Auditor Liability under Federal Securities Laws

1933 Act Section 11 1934 Act Rule 10b-5

Accountant’s error resulting

Focus on

Private Securities Litigation Reform Act of 1995

Requires auditor of publicly held company to include specifi c substantive procedures designed to

• Identify illegal acts, including management fraud, having a direct and material effect on the

fi nancial statements

• Identify signifi cant related-party transactions

• Determine if there is substantial doubt related to the entity’s ability to continue as a going concern

Illegal acts must be reported to management and board of directors must be notifi ed

Board of directors must

• Notify the SEC within 1 business day

• Provide auditor with copy of report to SEC

If auditor not notifi ed

• Resign from engagement

• Notify SEC within 1 business day of board’s failure to meet deadline

Focus on

Private Securities Litigation Reform Act of 1995 (continued)

Responsibilities under the Sarbanes-Oxley Act

• CPAs and CPA fi rms may be criminally prosecuted for destroying or falsifying records

• Created the Public Company Accounting Oversight Board (PCAOB)

• Registers CPA fi rms that audit public (issuer) companies

• Sets standards on auditing, quality control, independence for registered CPA fi rms

• Restricts the types of services that a CPA fi rm may perform for an issuer audit client

• Requires rotation of audit partner every 5 years

• Requires audits of internal control over fi nancial reporting

• Public companies must disclose whether they have adopted code of ethics for company’s officers

• For audit committees of the board of directors

• All members must be independent

• Must have at least one fi nancial expert

• Requires the CEO and CFO to certify to company’s fi nancial statements

Focus on

Liability as a Tax Preparer

Penalties

Actions by an accountant preparing a client’s tax return can result in penalties

• Not providing client with copy of return

• Failing to sign return as a preparer

• Endorsing and cashing client’s refund check

Liability to Client

Other actions may create a liability to a tax client

• Failing to fi le a return timely

• Not advising client of tax elections

• Neglecting evaluation of joint versus separate returns

Focus on

Regulation of Accountants

• State boards of accountancy issue licenses to practice in a state

• Investigate violations of professional standards and ethics

• May revoke license to practice

• AICPA and state societies of CPAs

• Investigate violations of professional ethics through Joint Ethics Enforcement Program (JEEP)

• May admonish, sanction, suspend, or expel a member

• The AICPA Uniform Accountancy Act (UAA)

• Provides guidance to states in establishing accountancy laws

• Contains rules for education, reciprocity, continuing education, etc

• The Securities Exchange Commission

• Investigates CPAs and CPA fi rms that violate SEC rules

• May disbar an accountant or fi rm from auditing public (issuer) companies

Focus on

Regulation of Accountants (continued)

• The Public Company Accounting Oversight Board (PCAOB)

• Registers and performs inspections of fi rms that audit public (issuer) companies

• Firms that audit more than 100 issuers are inspected every year

• Firms that audit 100 or less issuers are inspected every three years

• For substandard performance the PCAOB may:

• Prescribe remedial actions such as improvements in quality control

• Suspend an individual or fi rm from auditing issuers

Focus on

Standards for Consulting Services

When performing consulting services, a CPA must adhere to certain general standards

• Professional competence

• Due professional care

• Planning and supervision

• Obtaining sufficient relevant dataSpecifi c standards related to consulting services include

• Serving the client

• Establishing an understanding with the client as to the nature, scope, and limitation of services

• Communicate with the client about confl icts of interest, scope of services, or benefi ts to

be derived

Focus on

Standards for Tax Practice

A CPA performing tax services

• May not recommend a tax position that lacks merit

• Must make a reasonable effort to answer applicable questions on the return

• May rely on client information when preparing the return

• Must make reasonable inquiries about questionable or incomplete information

• May use estimates

Focus on

FEDERAL SECURITIES REGULATIONS

Securities Act of 1933 (33 Act)

The 33 Act requires

• Registration of securities offered for sale to the public

• Information be provided as part of that registrationNonexempt securities must be registered before being offered to sale to the public

• Through the mails

• In interstate commerceRegistration consists of a registration statement, which includes the prospectus

• The registration statement describes the use of proceeds and contains audited fi nancial

statements

• The prospectus describes the securities, the company, and the risk

Focus on

33 Act (continued)

Once registration statement is fi led

1) Oral offers to sell shares may be made2) 20 day waiting period before registration is effective3) During waiting period company may obtain an underwriter and issue a “red herring”

(preliminary prospectus)4) After waiting period, securities can be bought and sold

5) After waiting period, a tombstone ad informs investors about obtaining prospectus

In addition to federal registration laws, states require registration under “blue-sky laws”

Focus on

Securities Exempt from Registration

Certain securities are exempt from registration The 1933 Act doesn’t apply to these securities at all

Exempt securities include

Focus on

Transactions Exempt from Registration

Certain transactions may qualify for exemption from registration The securities themselves remain

subject to the 1933 Act for other purposes or subsequent transactions that aren’t exempt

Exempt transactions include

• Splits, dividends, and other exchanges with existing shareholders without charge

• Casual sales by parties other than issuers, underwriters, dealers, directors, officers, or 10% or greater shareholders

• Intrastate offers (as long as shares aren’t resold to nonresidents for 9 months)

• Private placements under Regulation D

• Small issues under Regulation A

Focus on

Transactions Exempt from Registration (continued)

Reg A

Reg D Rule 506

Reg D Rule 505

Reg D Rule 504

Accredited Investors Nonaccredited Investors

No max35

No max35

Aud bal sht to nonaccredited inv

allowed

accredited

Focus on

Securities Exchange Act of 1934 (34 Act)

The 34 Act established the SEC and made it responsible for

• Requiring disclosures concerning offerings on national securities exchanges

• Regulating activities of securities brokers

• Investigating securities fraudCompanies are required to fi le periodic reports if

• Company’s securities are traded on securities exchanges

• Company’s assets > $10,000,000 and more than 500 unaccredited shareholders or 2,000 or more total shareholders (This does not include shares obtained from a qualifi ed employee compensation plan)

Focus on

Registration

Information required upon registration

• Financial structure and nature of business

• Names of officers and directors

• Disclosure of bonus and profi t-sharing arrangements

Reporting

Required reports include

• 10-K (annual report)—includes audited fi nancial statements

• 10-Q and 8-K (periodic reports)—update information in original registration

Focus on

Proxies

Shareholders may sign proxies authorizing the company to vote their shares The company must

fi le a preliminary copy of the proxy statement with the SEC at least 10 days before it is sent to

shareholders

Insider Trading

Insider trading must be reported to the SEC

• Insiders include agents of the issuer, such as attorneys, or directors, officers, and owners

of 10% or more of any class of stock

• Short swing profi ts must be returned to the company

Focus on

Sarbanes-Oxley Act of 2002

Expands powers of SEC to regulate fi nancial reporting

• CEO and CFO must certify in writing that fi nancial reports are accurate

• Management is responsible for internal control

• Officers must disclose knowledge of internal control defi ciencies to auditor and audit committee

• Must also disclose evidence of fraud, even if immaterial, by employees involved in internal control

• Prohibits most personal loans by company to officers

• Requires insiders to report trades within 2 business days

Focus on

The Wall Street Reform and Consumer Protection

(Dodd-Frank) Act of 2010

Designed “to promote the fi nancial stability of the United States by improving accountability and

transparency in the fi nancial system”

• Created the Financial Stability Oversight Council to identify and react to emerging risks

• Increased the types of fi nancial companies that could be seized and liquidated by the FDIC

• Created the Federal Insurance Office to regulate insurance companies

• Prohibits any “banking entity” from engaging in proprietary trading

• Gives authority to the Commodity Futures Trading Commission and the SEC to regulate the derivatives (swaps) markets

Focus on

The Wall Street Reform and Consumer Protection

(Dodd-Frank) Act of 2010 (continued)

• The act includes broad changes in executive compensation policies for public companies including requiring

• The national exchanges to issue rules requiring companies to develop recovery arrangements (clawback policies)

compensation-• That all members of the compensation committee of the board of directors be independent

• A shareholder nonbinding vote on executive compensation at least every three years

• A nonbinding vote by shareholders on “golden parachutes” that result from major transactions

• Provides that the SEC will increase its compliance activities regarding securities trading, and will pay awards to whistleblowers

• The Act requires mortgages securitizers or originators to retain an economic interest in a portion of the credit risk of any securitized asset they sell

• Percentages may be specifi ed in partnership agreement

• Equal sharing of profi ts and losses when not specifi ed

• If profi ts are allocated, but losses are not, then losses will be allocated the same as profi ts

3) Property rights

Focus on

Partners’ Property Rights

Partner’s interest; this is only a partner’s right to profi ts

• Right to share of profi ts and capital upon termination

• May be sold or assigned

• Buyer or assignee does not have same rights as partnerRight to specifi c property

• Partnership purposes only

• Individual partners may not sell or assign