Final answer:
A situation where a CPA works for two clients in a legal dispute exemplifies a conflict of interest, which is a situation where competing loyalties can impact a professional's judgment. Hence, the correct answer is option (3).
Step-by-step explanation:
A situation in which a CPA performs work for two separate clients who are involved in a legal dispute is an example of a conflict of interest. A conflict of interest arises when a professional has certain competing interests or loyalties that could potentially influence their judgment or objectivity while providing services to their clients. In the field of accounting, maintaining objectivity and independence is crucial to uphold professional ethics.
In the context of this question, if a CPA is servicing both parties in a legal dispute, their ability to remain impartial could be compromised, and they may unintentionally favor one client's interests over the other. This circumstances underline the importance of CPA ethics and highlights why CPAs must diligently identify and appropriately address any potential conflicts of interest to maintain their professional integrity and trust with the clients.