2011 AICPA newly released questions – regulation

2011 AICPA Newly Released Questions – Regulation Following are multiple choice questions and simulations recently released by the AICPA These questions were released by the AICPA with letter answers only Our editorial board has provided the accompanying explanation Please note that the AICPA generally releases questions that it does NOT intend to use again These questions and content may or may not be representative of questions you may see on any upcoming exams 2011 AICPA Newly Released Questions – Regulation Under the position taken by a majority of the courts, to which third parties will an accountant who negligently prepares a client's financial report be liable? a b c d Only those third parties in privity of contract with the accountant All third parties who relied on the report and sustained injury Any foreseen or known third party who relied on the report Any third party whose reliance on the report was reasonably foreseeable Solution: Choice "c" is correct Under the majority position an accountant is liable for negligence only to third parties whom the accountant knows or should foresee will be relying on the accountant's work Choice "a" is incorrect This choice reflects the minority Utramares position In most states, an accountant's liability extends beyond those who are in privity (i.e., in a contractual relationship with) the accountant Choice "b" is incorrect This choice is too broad An accountant is not liable in negligence merely because someone relied on the accountant's work Choice "d" is incorrect This answer is too broad because it is not enough that a party could have foreseeably relied – the party must have actually relied 2011 AICPA Newly Released Questions – Regulation A company engaged a CPA to perform the annual audit of its financial statements The audit failed to reveal an embezzlement scheme by one of the employees Which of the following statements best describes the CPA's potential liability for this failure? a b c d The CPA's adherence to generally accepted auditing standards (GAAS) may prevent liability The CPA will not be liable if care and skill of an ordinary reasonable person was exercised The CPA may be liable for punitive damages if due care was not exercised The CPA is liable for any embezzlement losses that occurred before the scheme should have been detected Solution: Choice "a" is correct A CPA will be liable in negligence if he or she fails to exercise the care and prudence that an ordinary CPA would exercise in performing an audit An ordinary CPA would normally adhere to GAAS Thus, proof of adherence to GAAS may prevent liability Choice "b" is incorrect A CPA must perform an audit with the care and skill that an ordinary CPA would exercise; exercising the care and skill of an ordinary, reasonable person is not enough Choice "c" is incorrect A CPA may be liable for punitive damages for willful fraud or recklessly performing an audit While failure to exercise due care is a sufficient basis to impose liability for negligence, it is not a sufficient basis to impose liability for fraud Choice "d" is incorrect This choice sets up a strict liability standard – CPAs are liable for any embezzlement losses that should have been detected The law imposes no such liability A CPA must at least be negligent before liability will be imposed 2011 AICPA Newly Released Questions – Regulation In which of the following types of action, brought against a CPA who issues an audit report containing an unqualified opinion on materially misstated financial statements, may a plaintiff prevail without proving reliance on the audit report? a b c d An action for common law fraud An action for common law breach of contract An action brought under Section 11 of the Securities Act of 1933 An action brought under Rule 10b-5 of the Securities Exchange Act of 1934 Solution: Choice "c" is correct A plaintiff need only prove three elements to recover under section 11 – the plaintiff acquired the stock, the registration statement was signed by the CPA and contains a material misrepresentation or omission of fact, and damages All of the other causes of action listed require proof of reliance 2011 AICPA Newly Released Questions – Regulation Under the Negotiable Instruments Article of the UCC, the proper party to whom a check is presented for payment is: a b c d The drawer The maker The holder The drawee Solution: Choice "d" is correct A drawer (the check writer) draws a check payable to the payee from the drawee bank Choice "a" is incorrect The drawer is the person who writes the check Choice "b" is incorrect A maker is a person who makes a (promissory) note A note is presented to the maker for payment, but a check is not a type of note; it is a type of draft, and drafts are presented to a drawee for payment Choice "c" is incorrect A holder is someone in legal possession of a check; the holder may be the payee or some subsequent transferee of the payee In any event, a check is not presented to a holder for payment 2011 AICPA Newly Released Questions – Regulation Under the Secured Transactions Article of the UCC, which of the following statements is correct regarding a security interest that has not attached? a b c d It is effective against the debtor, but not against third parties It is effective against both the debtor and third parties It is effective against third parties with unsecured claims It is not effective against either the debtor or third parties Solution: Choice "d" is correct A security interest is not effective against anyone before it attaches to the collateral Thus, all of the other answer choices are incorrect 2011 AICPA Newly Released Questions – Regulation Which of the following transactions is subject to registration requirements of the Securities Act of 1933? a The public sale of stock of a trucking company regulated by the Interstate Commerce Commission b A public sale of municipal bonds issued by a city government c The issuance of stock by a publicly-traded corporation to its existing shareholders because of a stock split d The public sale by a corporation of its negotiable 10-year notes Solution: Choice "d" is correct No registration exemption is available for sales of long term notes Choice "a" is incorrect Securities of regulated common carriers are within a securities exemption (on the rationale that the regulating government agency will oversee the securities issuance) Choice "b" is incorrect The issuance of securities of governmental bodies generally is within a securities exemption Choice "c" is incorrect Exchanges with existing shareholders are within a transaction exemption if no sales commission is paid in connection with the sale 2011 AICPA Newly Released Questions – Regulation In the current year, Essex sold land with a basis of $80,000 to Yarrow for $100,000 Yarrow paid $25,000 down and agreed to pay $15,000 per year, plus interest, for the next five years, beginning in the second year Under the installment method, what gain should Essex include in gross income for the year of sale? a b c d $25,000 $20,000 $15,000 $5,000 Solution: Choice "d" is correct Under the installment method, revenue is reported (recognized) over the period in which the cash payments are received Included gross income is determined in steps: Step 1: Gross Profit: Sale on Installment $100,000 Cost $ 80,000 Total Gross Profit $ 20,000 Step 2: Gross Profit Percentage : Gross Profit/Sale on Installment ($20,000/$100,000) = 20% Step 3: Taxable Gross Profit: Collections ($25,000) x Gross Profit Percentage (20%) = $5,000 2011 AICPA Newly Released Questions – Regulation Sam's year taxable income was $175,000 with a corresponding tax liability of $30,000 For year 3, Sam expects taxable income of $250,000 and a tax liability of $50,000 In order to avoid a penalty for underpayment of estimated tax, what is the minimum amount of year estimated tax payments that Sam can make? a b c d $30,000 $33,000 $45,000 $50,000 Solution: Choice "b" is correct To avoid penalties, if a taxpayer owes $1,000 or more in tax payments beyond withholdings, such taxpayer will need to have paid in for taxes the lesser of: 90% of the current year's tax ($50,000 x 90%) = $45,000, or 100% of the previous year's tax ($30,000 x 100%) = $30,000 However, if the taxpayer had adjusted gross income in excess of $150,000 in the prior year, 110% of the prior year's tax liability is used to compute the safe harbor for estimated payments (Previous year's tax $30,000 x 110% = $33,000) Choice "a" is incorrect $30,000 is 100% of last year's tax This would be sufficient if the previous year's income were $150,000 or less Choice "c" is incorrect $45,000 is 90% of this year's tax, which is sufficient, but we are looking for the minimum amount Choice "d" is incorrect $50,000 is 100% of the current year's tax, which is sufficient, but more than required 2011 AICPA Newly Released Questions – Regulation On January 1, Fast, Inc entered into a covenant not to compete with Swift, Inc for a period of five years, with an option by Swift to extend it to seven years What is the amortization period of the covenant for tax purposes? a b c d years years 15 years 17 years Solution: Choice "c" is correct Intangibles such as goodwill, licenses, franchises, trademarks and covenants not to compete may be amortized using the straight line basis over a period of 15 years, starting with the month of acquisition Note, the difference for GAAP purposes: Intangible assets with indefinite lives are subject only to an impairment test, and intangible assets with finite lives are amortized over those lives and also subject to an impairment test Choice "a" is incorrect The time certain does not impact the amortization period Choice "b" is incorrect The option to extend does not impact the amortization period Choice "d" is incorrect 17 years is longer than required to amortize intangible assets 10 2011 AICPA Newly Released Questions – Regulation 32 Carter incurred the following expenses in the current year: $500 for the preparation of a personal income tax return, $100 for custodial fees on an IRA, $150 for professional publications, and $2,000 for union dues Carter's current year adjusted gross income is $75,000 Carter, who is not self-employed, itemizes deductions What will Carter's deduction be for miscellaneous itemized deductions after any limitations in the current year? a b c d $0 $750 $1,250 $2,750 Solution: Choice "c" is correct Miscellaneous itemized deductions are deductible to the extent that such miscellaneous itemized deductions exceed 2% of Adjusted Gross Income (AGI) AGI: 2% of AGI: $75,000 Tax preparation: $500 x Custodial Fees: $100 Publications: $150 Union Dues: $2,000 2% $ 1,500 Total Misc Deductions: $2,750 ($1,500) 2% of AGI $1,250 33 Allowable Misc Deductions 2011 AICPA Newly Released Questions – Regulation 33 Cole earned $3,000 in wages, incurred $1,000 in unreimbursed employee business expenses, paid $400 as interest on a student loan, and contributed $100 to a charity What is Cole's adjusted gross income? a b c d $3,000 $2,600 $2,500 $1,600 Solution: Choice "b" is correct Adjusted Gross Income (AGI) is gross income less adjustments or deductions to arrive at AGI $3,000 in wages is part of gross income The only adjustment listed is $400 in student loan interest, resulting in an AGI of $2,600 Choice "a" is incorrect Student loan interest is a deduction to arrive at AGI Choice "c" is incorrect Charitable contributions are itemized deductions subtracted from AGI Choice "d" is incorrect Unreimbursed employee business expense is an itemized deduction subtracted from AGI 34 2011 AICPA Newly Released Questions – Regulation 34 Doyle has gambling losses totaling $7,000 during the current year Doyle's adjusted gross income is $60,000, including $3,000 in gambling winnings Doyle can itemize the deductions What amount of gambling losses is deductible? a b c d $0 $3,000 $5,800 $7,000 Solution: Choice "b" is correct Gambling losses are miscellaneous itemized deductions not subject to the 2% AGI limitation The deductions for gambling losses are, however, limited to gambling winnings Choice "a" is incorrect Gambling losses are deductible up to gambling winnings Choice "c" is incorrect Gambling losses are not subject to the 2% limitation Choice "d" is incorrect The deduction for gambling losses cannot exceed gambling winnings 35 2011 AICPA Newly Released Questions – Regulation 35 Which of the following statements about qualifying shareholders of an S corporation is correct? a b c d A general partnership may be a shareholder Only individuals may be shareholders Individuals, estates, and certain trusts may be shareholders Nonresident aliens may be shareholders Solution: Choice "c" is correct This is a true statement Generally, only individuals, estates, and certain trusts can be shareholders Choice "a" is incorrect Generally, only individuals, estates, and certain trusts can be shareholders Choice "b" is incorrect Estates and certain trusts can also be shareholders Choice "d" is incorrect Generally, foreign shareholders are prohibited 36 2011 AICPA Newly Released Questions – Regulation 36 Absent an election to close the books, the allocation of nonseparately stated income or loss for an S corporation shareholder that changed his ownership interest during the year is computed based on which of the following ownership percentages? a b c d Ownership percentage at the end of the S corporation year Ownership percentage computed on a per-share per-day basis Ownership percentage at the beginning of the S corporation year Ownership percentage determined as an average of the beginning and ending ownership percentages Solution: Choice "b" is correct Allocations to shareholders are made on a per-share, per-day basis Choice "a" is incorrect Ownership in the S Corporation could change during the year Choice "c" is incorrect Ownership in the S Corporation could change during the year Choice "d" is incorrect Ownership in the S Corporation could change during the year 37 2011 AICPA Newly Released Questions – Regulation 37 Lamont signed a promissory note in favor of Roth as part of Lamont's purchase of supplies from Roth The note required that the $10,000 be repaid 90 days from the date of the note There were no conditions attached to repayment Roth endorsed the note in blank and sold it to the bank Lamont defaulted on the promissory note The bank sought a judgment ordering Lamont to pay the bank Under the Negotiable Instruments Article of the UCC, how will the court most likely rule? a The court will direct Lamont to pay the bank because the promissory note was a negotiable instrument negotiated to the bank in due course b The court will direct Lamont to pay the bank because the note was part of a transaction between merchants c The court will not direct Lamont to pay the bank because the promissory note was a negotiable instrument negotiated with Roth d The court will not direct Lamont to pay the bank because the promissory note was not a negotiable instrument Solution: Choice "a" is correct When a maker signs a negotiable promissory note, the maker enters into a contract that he will pay the note when due according to its terms when the maker signed Choice "b" is incorrect The mere fact that the note was part of a transaction between merchants is not a reason to order the maker to pay it Choice "c" is incorrect The note here appears to be negotiable – a writing, signed by the maker, containing an unconditional promise to pay a fixed amount of money at a definite time (90 days) with no unauthorized other promises (making choice "d" incorrect) The maker of a negotiable promissory note must pay it when presented for payment 38 2011 AICPA Newly Released Questions – Regulation 38 Simon, a C corporation, had a deficit in accumulated earnings and profits of $50,000 at the beginning of the year and had current earnings and profits of $10,000 At year end, Simon paid a dividend of $15,000 to its sole shareholder What amount of the dividend is reported as income? a b c d $0 $5,000 $10,000 $15,000 Solution: Choice "c" is correct Dividends are a distribution of property by a corporation out of its earnings and profits (E&P) Dividends come from current E&P and then from accumulated E&P If current E&P is positive and accumulated E&P is negative, distributions are dividends only to the extent of current E&P Any excess distribution above E&P reduces the shareholders basis in the stock, if any If the shareholder has no basis, then the excess distribution is reported as a capital gain Choice "a" is incorrect A distribution is a dividend to the extent of E&P Choice "b" is incorrect The dividend would be the distribution to the extent of E&P, not the distribution above E&P Choice "d" is incorrect The full distribution can only be a dividend if the corporation has sufficient E&P 39 2011 AICPA Newly Released Questions – Regulation 39 Campbell acquired a 10% interest in Vogue Partnership by contributing a building with an adjusted basis of $40,000 and a fair market value of $90,000 The building was subject to a $60,000 mortgage that was assumed by Vogue The other partners contributed cash only The basis of Campbell's partnership interest in Vogue is: a b c d $84,000 $34,000 $30,000 $0 Solution: Choice "d" is correct A partner's initial basis in their partnership interest is determined by, among other items, the adjusted basis of appreciated property contributed Such basis is reduced by liabilities assumed by the other partners When property that is subject to a liability is contributed to a partnership and the subsequent decrease in the partner's individual liability exceeds partnership basis, the excess amount is treated like taxable boot, which means there is a taxable gain to the partner Initial Basis: $ 40,000 (basis in asset contributed to the partnership) Less: liabilities assumed by others: ($54,000) ($60,000 in total liabilities less 10% retained) Net Basis: ($14,000) Excess liability, taxable to Campbell Campbell's basis in partnership: $0 Choice "a" is incorrect Basis determination begins with the contributed asset's basis, not fair market value Choice "b" is incorrect The incoming partner is considered as being relieved of 90% of the liability because the partner is purchasing a 10% interest Therefore, 90% of the liability is the responsibility of the other partners Choice "c" is incorrect Basis determination begins with the contributed asset's basis, not fair market value 40 2011 AICPA Newly Released Questions – Regulation AICPA 2011 Released REG Simulations Task 1714_01 41 2011 AICPA Newly Released Questions – Regulation 42 2011 AICPA Newly Released Questions – Regulation Explanations: “Partners not include the cash as income, but must reduce their basis in the partnership.” This is the general rule in partnerships Cash distributions are not taxable income but reduce basis They are only taxable if the distribution is in excess of basis, which we are told is not the case here “Treated partly as a separately stated section 1231 gain and partly as partnership ordinary business income.” The portion of the gain up to accumulated depreciation is recaptured as ordinary income The gain in excess of accumulated depreciation is a section 1231 gain “Treated as a separately stated item by the partnership and potentially deductible by the partners.” A section 179 deduction is always a separately stated item There are income limitations that must be applied at the individual level to ultimately determine if it is deductible by the partners “Treated as a separately stated item by the partnership and potentially deductible by the partners.” Charitable contributions are always separately stated items Each partner then applies the AGI limitations at the individual level to determine if it is deductible “Treated as a separately stated item by the partnership, taxable to the partner.” The sale of an investment held for less than one year at a gain would result in a short-term capital gain, which is a separately stated item The gain is then taxable to each partner “Deductible by the partnership in arriving at partnership ordinary business income.” This is an ordinary and necessary business expense Therefore, it is deductible by the partnership against ordinary business income “Deductible by the partnership in arriving at partnership ordinary business income.” This is an ordinary and necessary business expense Therefore, it is deductible by the partnership against ordinary business income “Partners are not entitled to a deduction and decrease their basis in the partnership.” In order to be deductible, a charitable contribution must be to a charitable organization registered in the United States If it is not registered in the United States, it is a non-deductible contribution A non-deductible expense, such as this one, still results in a decrease in the basis of the partners This is consistent with the fact that tax-exempt income results in an increase to basis 43 2011 AICPA Newly Released Questions – Regulation Task 3437_01 44 2011 AICPA Newly Released Questions – Regulation Explanations: Gross Receipts All business gross receipts of a self-employed individual are reported on Schedule C Secretarial Expenses Secretarial expenses are ordinary and necessary business expenses that are always reported on Schedule C Supplies Supplies are ordinary and necessary business expenses that are always reported on Schedule C Other Business Expenses Other business expenses are ordinary and necessary business expenses that are always reported on Schedule C Property Insurance Property insurance is a personal expense for the home Because the home is used 10% as the taxpayer’s primary place of business, 10% (500) may be deducted on Schedule C The remainder is a non-deductible personal expense Mortgage Interest Mortgage interest is a personal expense for the home Because the home is used 10% as the taxpayer’s primary place of business, 10% (2,400) may be deducted on Schedule C The remainder (21,600) is an allowable interest deduction on Schedule A Real Estate Taxes Real estate taxes are a personal expense for the home Because the home is used 10% as the taxpayer’s primary place of business, 10% (1,000) may be deducted on Schedule C The remainder (9,000) is an allowable tax deduction on Schedule A Furnace Repair Furnace repair is a personal expense for the home Because the home is used 10% as the taxpayer’s primary place of business, 10% (200) may be deducted on Schedule C The remainder is a nondeductible personal expense Kitchen Remodeling Kitchen remodeling is a personal capital expenditure for the home It is not an expense of operating the home Therefore, none of this expenditure is deductible at all It will, however, add to the adjusted basis of the home Utilities Utilities are a personal expense for the home Because the home is used 10% as the taxpayer’s primary place of business, 10% (600) may be deducted on Schedule C The remainder is a non-deductible personal expense Cleaning Services Cleaning services are a personal expense for the home Because the home is used 10% as the taxpayer’s primary place of business, 10% (100) may be deducted on Schedule C The remainder is a non-deductible personal expense 45 2011 AICPA Newly Released Questions – Regulation Depreciation Depreciation of the office portion of a home used as a principal place of business is deductible on Schedule C This amount is given here as 4,000 However home office deductions may not create a loss on Schedule C There is 3,000 income remaining after deducting all of the expenses in column C from the gross receipts of 50,000 Therefore, only 3,000 of the depreciation is deductible The additional 1,000 (of the 4,000 allocated to the home office) may be carried forward to the next year 46 2011 AICPA Newly Released Questions – Regulation Task 3765_01 Keywords: Gift tax and Marital deduction and Spouse not a citizen 47 ... 40 2011 AICPA Newly Released Questions – Regulation AICPA 2011 Released REG Simulations Task 1714_01 41 2011 AICPA Newly Released Questions – Regulation 42 2011 AICPA Newly Released Questions –. .. tax-exempt income results in an increase to basis 43 2011 AICPA Newly Released Questions – Regulation Task 3437_01 44 2011 AICPA Newly Released Questions – Regulation Explanations: Gross Receipts All... is not enough that a party could have foreseeably relied – the party must have actually relied 2011 AICPA Newly Released Questions – Regulation A company engaged a CPA to perform the annual audit