[Ethics] Summit CPA firm is auditing the financial statements of SolarWave Inc., a renewable energy company. Recent legislation was adopted that provides for a new tax incentive for solar panel installations. Applying GAAP in the usual, literal manner would not reflect this new incentive and could render SolarWave’s financial statements misleading. Under the AICPA Code of Professional Conduct, there is a presumption that adhering to GAAP would almost always result in financial statements that are not misleading. However, the Accounting Principles Rule recognizes that in unusual circumstances—such as new legislation—the literal application of GAAP could make financial statements misleading. In such cases, a CPA should exercise professional judgment and apply an appropriate accounting treatment that avoids misleading financial statements.

Question

[Ethics] Summit CPA firm is auditing the financial statements of SolarWave Inc., a renewable energy company. Recent legislation was adopted that provides for a new tax incentive for solar panel installations. Applying GAAP in the usual, literal manner would not reflect this new incentive and could render SolarWave’s financial statements misleading. Under the AICPA Code of Professional Conduct, there is a presumption that adhering to GAAP would almost always result in financial statements that are not misleading. However, the Accounting Principles Rule recognizes that in unusual circumstances—such as new legislation—the literal application of GAAP could make financial statements misleading. In such cases, a CPA should exercise professional judgment and apply an appropriate accounting treatment that avoids misleading financial statements.

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In this scenario, the question presents a guidance framework under the AICPA Code of Professional Conduct regarding when GAAP should be applied literally versus when professional judgment should override literal GAAP to avoid misleading financial statements.
Option 1: True. The context describes a presumption in which adhering to GAAP would almost always result in financial statements that are not misleading, which reflects the general rule that GAAP should be followed. However, it also notes that the Accounting Principles Rule recognizes extraordinary or unusual circumstances—such as new legislation—where the literal application of GAAP could render statements misleading. In these cases, a CPA is expected to exercise professional judgment and apply an appropriate accounting treatment to avoid misleading financial statements. This aligns with the rule that deviation from literal GAAP is permissible (and sometimes required) when necessary to prevent misleading financial reporting and to present fairly, in accordance with the conceptual framework. Therefore, under the described circumstances, choosing to apply professional judgment and an accounting treatment that avoids misleading statements is consistent with GAAP and the AICPA guidance.
Option 2: False. If one chose false, the claim would assert that GAAP should never be bent even in unusual circumstances, or that the Accounting Principles Rule does not permit deviations to avoid misleading statements. This contradicts the explicit description given, which states that in unusual circumstances, the literal application of GAAP could be misleading and that professional judgment should be exercised to avoid such misleading outcomes. The premise acknowledges that there are exceptions to the strict literal application, so marking the statement as false would ignore the recognized professional standard for exceptional cases and would imply a rigid, one-size-fits-all approach that GAAP itself does not endorse in practice.
Additional nuance: The scenario emphasizes that the objective is to prevent financial statements from being misleading, not to rigidly adhere to GAAP without regard to context. An auditor or practitioner must assess the specific legislation, the impact on measurement, and the overall presentation to ensure faithful representation. The key misconception in choosing false would be assuming that GAAP’s presumption against deviation is absolute, disregarding the acknowledged exception for unusual circumstances where professional judgment is required to avoid misstatement.
In sum, the statement in option 1 correctly reflects the balance: a strong general presumption to follow GAAP, coupled with recognized exceptions requiring professional judgment to prevent misleading statements in light of new legislation or other unusual events. The false option would misstate this nuanced approach by denying the permissible deviation when necessary to present fairly.

ACCT:4300:0001 Fall25 Examination #2 - Accounting Ethics and Law- Requires Respondus LockDown Browser

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