CPA REG: Business Law

CPA means Certified Public Accountant. REG means Taxation and Regulation. Use this focused page when your CPA REG misses are about contracts, agency, debtor-creditor rules, business structures, or legal consequences. Drill this topic before returning to mixed practice.

Topic snapshot

What this topic tests

This topic tests legal relationships and consequences that affect business decisions. Strong answers identify the parties, the authority or obligation created, and the remedy or priority rule before choosing a legal label.

Common traps

• confusing actual authority, apparent authority, and ratification in agency questions
• treating every contract defect as a complete defense instead of checking materiality, performance, and remedy
• missing debtor-creditor priority, attachment, perfection, or bankruptcy timing facts
• choosing a business-entity answer without considering liability, tax, control, and continuity separately

How to reason through these questions

Start by naming the relationship: principal-agent, buyer-seller, debtor-creditor, partner-partner, shareholder-entity, or third party. Then ask what changed legally. If an answer states a general rule but ignores the party status in the stem, it is usually too broad.

Sample questions

These questions are original Mastery Exam Prep practice items aligned to this topic area. They are designed for self-assessment and are not official exam questions.

Question 1

Topic: Business Law

A property owner hired BuildCo to renovate an office suite. Review the contract and project facts:

Which conclusion is best supported by the exhibit?

• A. BuildCo materially breached, so the owner is excused from paying any part of the final installment.
• B. BuildCo substantially performed, so the owner must pay the final amount subject to an offset for the $2,500 cost to cure.
• C. BuildCo may recover the full $24,000 final payment because minor defects never reduce the contract price.
• D. BuildCo failed an express condition because the work was not perfectly completed before occupancy.

Best answer: B

What this tests: Business Law

Explanation: The facts show substantial performance rather than material breach. The suite can be used for its intended purpose, the certificate condition was satisfied, and the remaining defects are minor and curable, so the owner’s remedy is an offset for the cost to cure.

Under common law contract principles, a party that substantially performs has not committed a material breach merely because performance is incomplete or defective in minor respects. Substantial performance usually requires that the essential purpose of the contract has been met and that any defects can be compensated with damages. Here, the city certificate of occupancy was issued, the owner began using the suite, and the defects do not impair safety or intended use. Because the cost to cure is $2,500 and the defects were not intentional, the owner should pay the final installment reduced by that amount rather than refuse payment entirely.

• Treating the defects as a material breach overstates their significance because they do not defeat the contract’s essential purpose.
• Claiming failure of an express condition is incorrect because the stated certificate of occupancy condition was satisfied.
• Paying the full final installment ignores the owner’s right to damages for the cost to cure minor defects.

Minor, unintentional defects that do not defeat the contract’s purpose generally permit recovery of the contract price less damages for correction.

Question 2

Topic: Business Law

Ridge LLC hired BuildCo to renovate a storefront for a fixed price. The contract states that the final $40,000 payment is due “only after the city issues a certificate of occupancy.” BuildCo finished the renovation except it installed an exit system that does not meet the building code, and the city refused to issue the certificate until the exit system is corrected. Ridge has not occupied the space or waived the certificate requirement. Which conclusion is most appropriate?

• A. Ridge must pay the final payment, reduced only by the cost to repair, because BuildCo substantially performed most of the work.
• B. Ridge must pay the final payment in full because the renovation is almost complete and the city’s refusal is caused by a government action.
• C. Ridge may withhold the final payment because the certificate condition has not occurred and the uncured code defect is material.
• D. Ridge may treat the contract as automatically discharged by impossibility because the city refused to issue the certificate.

Best answer: C

What this tests: Business Law

Explanation: Substantial performance generally applies when defects are minor and the essential purpose of the contract has been met. Here, the contract made the certificate of occupancy a condition to final payment, and the contractor’s code defect prevented that condition from occurring.

In contract law, substantial performance can require the other party to perform while allowing a damages offset for minor defects. However, a material breach or failure of an express condition can excuse or suspend the other party’s duty to perform. The certificate of occupancy was an express condition precedent to Ridge’s final payment obligation. Because BuildCo’s noncompliant exit system caused the city to refuse the certificate, the defect is not merely cosmetic or minor; it prevents lawful occupancy and defeats an important purpose of the renovation contract. Ridge has not waived the condition by accepting or occupying the space, so Ridge may withhold the final payment until the condition is satisfied or the defect is cured.

• Treating the work as substantial performance ignores that the defect prevents the required certificate and lawful use of the space.
• Requiring full payment treats the city’s refusal as unrelated, but the refusal resulted from BuildCo’s defective performance.
• Impossibility does not apply because the certificate can be obtained by correcting the code violation.

The express certificate requirement is an unsatisfied condition to final payment, and the code defect goes to the usability and legality of the project.

Question 3

Topic: Business Law

A CPA is classifying creditors in a client’s debt schedule. Green LLC owns manufacturing equipment. Under Article 9, no purchase-money or fixture rules apply.

• April 1: North Bank lends Green $30,000; Green signs an authenticated security agreement describing the equipment as collateral; North does not file a financing statement.
• April 10: East Finance lends Green $20,000; Green signs an authenticated security agreement describing the same equipment as collateral; East files a UCC-1 financing statement covering the equipment the same day.

Both creditors claim the equipment after Green defaults. Which conclusion is correct?

• A. North Bank is unsecured because a security interest is not enforceable against the debtor until a financing statement is filed.
• B. North Bank has priority because it was the first creditor to attach a security interest, even though East Finance perfected before default.
• C. East Finance is unsecured because a later security agreement cannot attach to collateral already described in an earlier security agreement.
• D. Both creditors are secured, but East Finance generally has priority because its attached security interest was perfected and North Bank’s was not.

Best answer: D

What this tests: Business Law

Explanation: A creditor can be secured even if it has not perfected its security interest. North Bank had attachment through value, Green’s rights in the equipment, and an authenticated security agreement, but East Finance also attached and then perfected by filing, giving it priority over North’s unperfected interest.

Under Article 9, attachment makes a security interest enforceable against the debtor. Attachment generally requires value given, the debtor’s rights in the collateral, and an authenticated security agreement that reasonably describes the collateral. North Bank satisfied those requirements, so it is a secured creditor even though it did not file. Perfection is a separate concept that protects the secured party against competing claimants and often is achieved by filing a financing statement. East Finance also satisfied attachment requirements and perfected by filing a UCC-1 covering the equipment. When one secured party is perfected and the other is unperfected, the perfected secured party generally has priority in the same collateral.

• Filing is not required for attachment or enforceability against the debtor; it is generally a perfection step.
• Collateral may be subject to more than one security interest, so East Finance’s later agreement can still attach.
• First attachment alone does not beat a later creditor that perfected when the first creditor remained unperfected.

North Bank’s interest attached and is enforceable, but East Finance’s attached and perfected interest generally has priority over North Bank’s unperfected interest.

Question 4

Topic: Business Law

Lane and Morris operate LM Associates as a general partnership. On March 1, the partnership borrowed $90,000 from a bank. On June 1, Rivera was admitted as an equal partner and contributed $30,000 cash to the partnership; the bank did not agree to release any partner or substitute Rivera as obligor. The partnership later defaulted on the March 1 loan. Which business-law conclusion is correct regarding Rivera’s exposure?

• A. Lane and Morris were released from the bank loan when Rivera was admitted as an equal partner.
• B. Rivera is not personally liable for the bank loan, but partnership property, including Rivera’s capital contribution, may be used to pay it.
• C. Rivera has no exposure to the bank loan because the debt arose before Rivera became a partner.
• D. Rivera is personally liable for the bank loan because admission as an equal partner makes Rivera liable for all existing partnership debts.

Best answer: B

What this tests: Business Law

Explanation: Rivera’s admission does not create personal liability for a partnership debt incurred before admission. However, Rivera’s cash contribution is now partnership property, so it may be reached by partnership creditors along with other partnership assets.

In a general partnership, partners are generally personally liable for partnership obligations arising while they are partners. A person admitted to an existing partnership, however, is not personally liable for obligations incurred before admission merely because that person becomes a partner. The new partner’s economic risk is still real: the contributed capital becomes partnership property and can be used to satisfy partnership debts. Here, the bank loan arose on March 1, before Rivera’s June 1 admission, and the bank did not obtain a novation or separate assumption of liability from Rivera. Therefore, Rivera has no personal liability on the pre-admission loan, but Rivera’s contributed capital is exposed as partnership property.

• Treating Rivera as personally liable ignores that the loan was incurred before Rivera was admitted.
• Saying Rivera has no exposure at all overlooks that the $30,000 contribution became partnership property available to creditors.
• Releasing Lane and Morris would require creditor agreement, such as a novation; admission of a new partner alone does not discharge existing partners.

An incoming partner is not personally liable for pre-admission partnership obligations, although the contribution becomes partnership property available to creditors.

Question 5

Topic: Business Law

Apex LLC appointed Dana as purchasing manager and notified Stone Supply that Dana could sign routine supply contracts for Apex up to $25,000. Apex later privately told Dana that her purchasing authority was revoked, but Apex did not notify Stone and continued listing Dana as purchasing manager on Apex’s website. Dana then signed an $18,000 supply contract with Stone on Apex’s standard purchase form. Stone had no knowledge of the revocation. How should Dana’s authority to bind Apex be classified?

• A. Implied actual authority, because the contract was for routine supplies within the ordinary course of business.
• B. No authority, because Apex privately revoked Dana’s authority before the contract was signed.
• C. Apparent authority, because Apex’s manifestations reasonably led Stone to believe Dana still had authority.
• D. Express actual authority, because Dana originally was appointed as purchasing manager.

Best answer: C

What this tests: Business Law

Explanation: Dana did not have actual authority after Apex privately revoked it. However, Apex’s manifestations to Stone made it reasonable for Stone to believe Dana still could sign the contract, so Dana had apparent authority.

Actual authority depends on communications from the principal to the agent, and it ended when Apex privately revoked Dana’s authority. Apparent authority depends on manifestations from the principal to the third party and the third party’s reasonable belief. Apex had previously told Stone that Dana could sign supply contracts up to $25,000 and continued to hold Dana out as purchasing manager. Because Stone lacked notice of the revocation and the $18,000 contract fit the prior authority limits, Apex is bound under apparent authority.

• Original appointment does not create express actual authority after Apex revoked it internally.
• Routine supplies might support implied actual authority only if actual authority still existed.
• Private revocation alone does not end apparent authority as to a third party who lacks notice.
• Apparent authority is based on Apex’s manifestations to Stone, not merely Dana’s own statements.

Apex is bound because its prior notice, course of dealing, and public listing created reasonable apparent authority despite the private revocation.

Question 6

Topic: Business Law

A CPA is reviewing whether an equipment lease signed for a client binds the client as principal. The LLC’s manager emailed Taylor, “Please negotiate and sign a copier lease for the LLC, but do not agree to payments over $600 per month.” Taylor replied, “I will handle this for the LLC,” told the vendor Taylor was acting for the LLC, and signed a lease in the LLC’s name for $575 per month. Taylor was not paid and was not an LLC employee. Which business-law conclusion is correct?

• A. An agency relationship existed because Taylor consented to act on the LLC’s behalf and subject to the LLC’s control.
• B. No agency relationship existed because Taylor was not an employee of the LLC.
• C. No agency relationship existed because Taylor did not receive compensation from the LLC.
• D. No agency relationship existed because the agency agreement was not in a separate written contract.

Best answer: A

What this tests: Business Law

Explanation: An agency relationship may be formed by conduct and does not require compensation, employment status, or a formal written agreement. The key facts are mutual consent, action on behalf of the principal, and the principal’s right to control the agent’s actions.

For an agency relationship to exist, the principal must consent that another person will act on the principal’s behalf, the agent must consent to act, and the principal must have the right to control the agent’s conduct for the assigned task. Here, the LLC gave Taylor authority to negotiate and sign a lease within a stated monthly payment limit. Taylor accepted the assignment, represented the LLC to the vendor, and signed in the LLC’s name. Those facts establish an agency relationship even though Taylor was unpaid and not an employee.

• Lack of compensation does not prevent agency; gratuitous agents can still be agents.
• Employee status is not required; independent contractors and other nonemployees may be agents.
• A separate written contract generally is not required to form an agency relationship when consent and control are shown.

Agency exists when the principal and agent consent that the agent will act on the principal’s behalf and subject to the principal’s control.

Question 7

Topic: Business Law

Lake LLC has three full-time administrative employees who are classified and paid as employees. In May, Lake paid each employee a $4,000 retention bonus through accounts payable and coded the payments as “contract services.” No federal income tax, Social Security tax, or Medicare tax was withheld; no employer payroll taxes were accrued; and the Form 941 for the quarter has not yet been filed. The employees ask whether they can simply report the $4,000 on their individual returns instead. What should Lake’s CPA advise Lake to do next?

• A. Wait for an IRS payroll tax notice and then request an IRS Appeals conference before making any payroll tax deposits.
• B. Process the bonuses as wages for the quarter, account for required withholding and FICA, pay applicable federal payroll taxes, report the wages on Form 941 and Forms W-2, and tell employees the amounts are wage income.
• C. Have the employees increase their Form W-4 withholding for future wages and take no payroll reporting action for the bonuses already paid.
• D. Issue Forms 1099-NEC to the employees and instruct them to report the bonuses as self-employment income.

Best answer: B

What this tests: Business Law

Explanation: The retention bonuses were paid to common-law employees for services, so they are wages. Lake’s employer payroll tax duties are not avoided because employees agree to report the amounts on their individual returns.

Cash bonuses paid to employees are wages for federal employment tax purposes. The employer is responsible for federal income tax withholding, employee and employer FICA, applicable employer unemployment tax obligations, timely deposits or payments, and reporting on Form 941 and Forms W-2. Employees report the amounts as wage income, not self-employment income, and generally receive credit only for withholding actually reported. Because the quarterly payroll return has not yet been filed, the next step is to correct the payroll treatment for the quarter rather than issue contractor forms or wait for an IRS examination.

• Issuing Forms 1099-NEC treats employees as independent contractors, which conflicts with the stated employee classification.
• Increasing future Form W-4 withholding may affect later paychecks but does not correct the payroll tax treatment of bonuses already paid.
• Waiting for an IRS notice and going to Appeals skips the required compliance step; Appeals is for resolving disputes, not routine payroll correction.

Bonuses paid to employees are wages, so the employer must handle payroll withholding, deposits, and reporting even if employees will report the income.

Question 8

Topic: Business Law

Hatch Co. had allowed Lee, its purchasing agent, to place orders with Delta Supply for several years, and Delta knew Lee was acting for Hatch. Hatch and Lee signed an agreement on June 1 terminating Lee’s agency immediately. On June 12, Lee placed another order with Delta in Hatch’s name. Hatch wants to support the conclusion that it is not bound because Lee’s apparent authority had ended before the order. Which evidence best supports that conclusion?

• A. A June 15 announcement on Hatch’s public website stating that Lee had left the company.
• B. A June 2 email from Hatch to Delta, with Delta’s acknowledgment, stating that Lee no longer had authority to place orders for Hatch.
• C. The June 1 written termination agreement between Hatch and Lee, kept in Hatch’s internal personnel file.
• D. A June 12 invoice from Delta addressed to Hatch for the order Lee placed.

Best answer: B

What this tests: Business Law

Explanation: The best support is evidence that Delta received notice before Lee placed the June 12 order. Termination by agreement ends Lee’s actual authority, but apparent authority as to a prior-dealing third party generally continues until that third party has notice.

Agency authority can terminate between principal and agent by agreement, but that does not automatically eliminate apparent authority in the eyes of third parties who previously dealt with the agent. Because Delta had a history of accepting Lee’s orders for Hatch, Hatch needs evidence that Delta was notified before the disputed transaction. A pre-order email acknowledged by Delta directly supports that Delta had notice and could no longer reasonably rely on Lee’s apparent authority. Internal records do not notify Delta, and later or transaction-confirming documents do not show that apparent authority ended before the order.

• The internal termination agreement ends actual authority between Hatch and Lee, but it does not by itself notify Delta.
• The invoice supports that Delta treated the order as Hatch’s obligation, not that Delta knew Lee lacked authority.
• The website announcement was posted after the June 12 order, so it cannot show notice before Delta relied on Lee’s authority.

Prior-dealing third parties must receive notice of termination before apparent authority is cut off as to them.

Question 9

Topic: Business Law

A CPA is helping a client evaluate whether it can compel a landowner to close on a planned purchase of commercial land. The client and the landowner orally agreed to a $750,000 purchase price, but neither party signed any memorandum identifying the property and price. The client has not paid any purchase price, taken possession, or made improvements to the property. Which business-law conclusion is most appropriate?

• A. The agreement is unenforceable against the landowner because a sale of real property generally must be evidenced by a signed writing or an applicable exception.
• B. The agreement is void because an oral agreement to sell real property is illegal.
• C. The agreement is enforceable because the parties orally agreed to the property and purchase price.
• D. The agreement is voidable by either party because the parties made a mutual mistake about a material fact.

Best answer: A

What this tests: Business Law

Explanation: A contract for the sale of real property is subject to the statute of frauds. Because there is no signed writing and no facts showing an exception such as part performance, the oral agreement is not enforceable against the landowner.

The statute of frauds does not make every oral agreement invalid, but it does require certain agreements to be evidenced by a signed writing before they can be enforced in court. Contracts for the sale of real property are a classic category covered by the rule. A writing typically must identify the parties, the property, and the essential terms, and be signed by the party against whom enforcement is sought. Here, no memorandum was signed, and the buyer did not take possession, pay the purchase price, or make improvements that could support a part-performance exception. Therefore, the client generally cannot compel the landowner to close based only on the oral agreement.

• Oral assent and an agreed price may show basic contract formation, but the statute of frauds can still bar enforcement.
• The oral agreement is not illegal or void merely because it involves land; it is generally unenforceable without the required writing or exception.
• Mutual mistake is not supported because the facts do not indicate both parties were mistaken about a material existing fact.

A real property sale is within the statute of frauds, and the facts provide neither a signed writing nor part performance.

Question 10

Topic: Business Law

Lena, a purchasing employee for Harbor Print LLC, has authority only to approve repair contracts up to $5,000. Without actual or apparent authority, Lena signs an $18,000 contract with PressFix to repair Harbor’s printing press. Harbor’s owner learns all material terms and knows Lena lacked authority before the repair work is completed, but allows PressFix to finish the work and then uses the repaired press. PressFix demands payment. What is the correct business-law conclusion?

• A. Harbor is not bound because Lena lacked actual and apparent authority when the contract was signed.
• B. Harbor may keep the repair benefit while rejecting payment because ratification can be limited to favorable terms.
• C. Lena alone is bound because an unauthorized agent’s act cannot later bind the principal.
• D. Harbor ratified the contract by knowingly accepting the repair services, so Harbor is bound to pay PressFix.

Best answer: D

What this tests: Business Law

Explanation: Harbor became bound because it accepted the benefit of PressFix’s work after learning the material facts and Lena’s lack of authority. Ratification can make an originally unauthorized act effective as though it had been authorized from the start.

Ratification occurs when a principal, with knowledge of the material facts, affirms or accepts the benefits of an agent’s unauthorized act. The affirmation may be express or implied through conduct. Here, Harbor’s owner knew Lena lacked authority and knew the material terms before the repair was completed, yet allowed PressFix to finish and used the repaired press. That conduct is an implied ratification of the entire contract, making Harbor liable to PressFix.

• Lack of actual or apparent authority does not end the analysis because later ratification can still bind the principal.
• The agent is not necessarily the only liable party once the principal ratifies the unauthorized transaction.
• Ratification applies to the transaction as a whole; the principal cannot accept the benefits while avoiding the related payment obligation.

A principal may ratify an unauthorized act by accepting its benefits with knowledge of the material facts.

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Related focused pages

• Free CPA REG Full-Length Practice Exam
• CPA REG: Ethics and Federal Tax Procedures
• CPA REG: Federal Taxation of Property Transactions
• CPA REG: Federal Taxation of Individuals
• CPA REG: Entity Taxation and Tax Preparation

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