ACO 201 Problems Chapter 2 Solution, Spring 2013

Brief Learning Exercises Topic Objectives Skills B. Ex. 2.1 Recording transactions 3 Analysis, communication B. Ex. 2.2 Recording transactions 3 Analysis, communication B. Ex. 2.3 Computing retained earnings 4 Analysis B. Ex. 2.4 Computing total liabilities 4 Analysis B. Ex. 2.5 Computing net income 5 Analysis B. Ex. 2.6 Computing net income 5 Analysis B. Ex. 2.7 Computing change in cash 6 Analysis B. Ex. 2.8 Alternative forms of equity 8 Analysis B. Ex. 2.9 Alternative forms of equity 8 Analysis B. Ex. 2.10 Articulation of financial statements 7 Analysis Learning Exercises Topic Objectives Skills 2.1 Real World: American Airlines, 3 Communication Boston Celtics Nature of assets and liabilities 2.2 Preparing a balance sheet 4 Analysis 2.3 Preparing a balance sheet 4 Analysis 2.4 2 Communication, judgment 2.5 Using the accounting equation 3 Analysis 2.6 Accounting equation 3 Analysis 2.7 Effects of business transactions 3 Analysis 2.8 Forms of business organizations 8 Analysis 2.9 Factors contributing to solvency 4 Analysis, judgment 2.10 Professional judgment 2 Communication 2.11 Statement of cash flows 6 Analysis 2.12 Income statement 5 Analysis 2.13 Income statement 5 Analysis 2.14 Statement of cash flows 6 Analysis 2.15 Window dressing financial statement 9 Analysis 2.16 Real World: Home Depot 4–6 Analysis, communication Home Depot financial statements 2.17 Real World: Intel 5 Analysis, communication Assessing financial results CHAPTER 2 BASIC FINANCIAL STATEMENTS Accounting principles and asset valuation OVERVIEW OF BRIEF EXERCISES, EXERCISES AND CRITICAL THINKING CASES © The McGraw-Hill Companies, Inc., 2010 Overview Problems Learning Sets A, B Topic Objectives Skills 2.1 A,B 4 Analysis, communication 2.2 A,B Effects of transactions 3 Analysis 2.3 A,B Effects of transactions 3 Analysis 2.4 A,B Effects of transactions 3 Analysis 2.5 A,B Preparing a balance sheet, effects of 4 Communication, judgment transactions 2.6 A,B Preparing a balance sheet, effects of 4 Analysis, communication transactions 2.7 A,B Preparing a balance sheet and statement 3, 4, 6 Analysis, communication of cash flows, effects of transactions 2.8 A,B Preparing financial statements, effects of 4–6 Analysis, communication of transactions, evaluating solvency 2.9 A,B 4, 8 2.10 A,B 2, 4 Preparing and evaluating a balance sheet Preparing a balance sheet, discussion of GAAP Preparing a balance sheet, discussion of GAAP Analysis, communication, judgment Analysis, communication, judgment © The McGraw-Hill Companies, Inc., 2010 Overview (p. 2) 2.1 Prepare a realistic balance sheet for a 4 hypothetical entity 2.2 Real World: Company of student choice 4–6 2.3 Using a balance sheet 4 2.4 Using a statement of cash flows 6 2.5 Window dressing 9 2.6 9 (Ethics, fraud & corporate governance) 2.7 1-7 2.8 4-5 DESCRIPTIONS OF PROBLEMS AND CRITICAL THINKING CASES Problems (Sets A and B) 2.1 A,B 15 Easy 2.2 A,B 15 Easy 2.3 A,B 15 Medium 2.4 A,B 15 Medium (Internet) (Business Week) Introduction to EDGAR Locate and evaluate the financial statements of a publicly owned company Critical Thinking Cases Analysis, communication, research Analysis, communication judgment Analysis, communication, judgment Analysis, communication, judgment Communication, research, technology Ajax Moving Company/Brigal Company Smokey Mountain Lodge/Deep River Lodge Shown below are brief descriptions of each problem and case. These descriptions are accompanied by the estimated time (in minutes) required for completion and by a difficulty rating. The time estimates assume use of the partially filled-in working papers. Real World: Public Company Accounting Oversight Board Technology Evaluating Company Efficiency Analysis, communication Real World: Cisco Systems Rankin Truck Rental/Smith Trucking Show in tabular form the effects of various business transactions upon the accounting equation. (Alternate to Problem 2–3.) Prepare a balance sheet from a list of balance sheet items in random order. Determine the amount of one item as a plug figure. Also evaluate the company’s solvency. Effects of transactions upon the accounting equation are illustrated in tabular form. Students are asked to write a sentence or two explaining the nature of each transaction. Goldstar Communications/Delta Corporation Show in tabular form the effects of various business transactions upon the accounting equation. (Problem 2–4 is an alternate.) Judgment Note: Additional Internet assignments for this chapter are available both in Appendix B and on our home page: www.magpie.org/cyberlab © The McGraw-Hill Companies, Inc., 2010 Overview and Desc. of Cases Problems (cont'd) Here Come the Clowns/Circus World Wilson Farms, Inc./Apple Valley Farms The Oven Bakery/The City Butcher The Sweet Soda Shop/The Candy Shop Berkeley Playhouse/Old Town Playhouse Big Screen Scripts/Hit Scripts Critical Thinking Cases Content of a Balance Sheet Using Financial Statements *Omits time required to obtain an annual report. 2.5 A,B 20 Medium 2.6 A,B 20 Medium Preparation of a balance sheet for a circus—an entity with an unusual variety of asset accounts. Also requires students to explain the effects upon this balance sheet of a fire that destroys one of the assets. (Problem 2–6 is an alternate.) Prepare a balance sheet for a farm—an entity with a wide variety of assets. Also, explain the effects upon this balance sheet of the destruction of one of the assets. (Alternate to Problem 2–5.) 2.7 A,B 35 Medium 2.8 A,B 40 Strong Prepare a balance sheet from an alphabetical listing of accounts, and prepare a second balance sheet and a statement of cash flows after some additional transactions. Evaluate the company’s relative solvency at each date. The student is asked to prepare a balance sheet from an alphabetical list of accounts and then to prepare a second balance sheet as well as an income statement and a statement of cash flows, after several transactions. Evaluate the company’s relative solvency at each date. 35 Strong 2.10 A,B 30 Strong Given an improperly prepared balance sheet, student is asked to prepare a corrected balance sheet and to explain the proper valuation of assets, liabilities, and owners’ equity. Stresses generally accepted accounting principles. Given a balance sheet and supplementary information concerning the assets and liabilities, the student is asked to prepare a corrected balance sheet and to explain the violations that exist as to asset valuation and the entity concept. Stresses GAAP. 2.9 A,B 30 Medium 2.2 30 Strong* Students are to obtain an annual report from the library and answer questions about the company’s balance sheet, income statement, and statement of cash flows. Suitable assignment for groups or individuals. Students are to prepare a realistic balance sheet for a hypothetical business—the nature of which is specified by the instructor. Challenges the student to think about the types of assets and liabilities arising in an actual business. Suitable assignment either for groups or individuals. 2.1 © The McGraw-Hill Companies, Inc., 2010 Desc. of Prob & Cases Using a Balance Sheet Using Statements of Cash Flow on hand. Ethics and Window Dressing 2.6 Public Company Accounting Oversight Board 30 Easy Ethics, Fraud & Corporate Governance Evaluating Company Efficiency Business Week Gathering Financial Information Internet 2.5 2.3 2.4 Students locate the PCAOB and state the mission, identify the members, and describe the authority and responsibility of the PCAOB. 30 Medium A tried-and-true case in which students are to evaluate the financial position of two similar companies first from the viewpoint of a short-term creditor and then from the viewpoint of a buyer of the business. We always use this one. 35 Medium Students are presented with abbreviated cash flow information and asked to decide which is in a stronger position. An excellent way to show that how a company generates its cash is equally important to how much cash it has Students are to distinguish between legitimate window dressing and fraudulent misrepresentation. Allows introduction of ethics, securities laws, and the role of independent audits. 30 Medium 2.8 25 Easy Students are asked to explain the importance of operating efficiently to a company’s success. Visit EDGAR, the SEC’s database, and gather financial information about Cisco Systems. A user-friendly “meet EDGAR” type of problem. 2.7 20 Medium © The McGraw-Hill Companies, Inc., 2010 Desc. of Prob. & Cases 1. 2. 3. 4. 5. A financial statement is a means for communicating information about an enterprise in financial (i.e., dollar) terms. It represents information that the accountant believes is a true and fair representation of the financial activity of the enterprise. Every financial statement relates to time in one way or another. A statement of financial position, or balance sheet, represents a “picture” of the enterprise at a point in time (e.g., the end of a month or year). The income statement and statement of cash flows, on the other hand, cover activity that took place over a period of time (e.g., a month or year). Annual financial statements, as the name implies, cover a one-year period of time. Many companies use the year January 1 through December 31 as their annual period for financial reporting purposes. Interim financial statements cover a period of time less than one year, such as a month or quarter (three months). 6.  Borrowing from a bank on a note payable.  Contribution to the enterprise by the owner. SUGGESTED ANSWERS TO DISCUSSION QUESTIONS Many of these questions are well suited to classroom discussions. These discussions can stimulate students’ interest, help develop verbal skills, and provide instructors with an opportunity to introduce ideas and situations not discussed in the text. If class size permits, we also encourage instructors to review and evaluate selected written assignments throughout the course. The basic purpose of accounting is to provide decision makers with information useful in making economic decisions. A knowledge of accounting terms and concepts is useful to persons other than professional accountants because nearly everyone working in business, government, or the professions will encounter these terms and concepts. Supervisors and managers at every level will use financial statements, budgets, or other forms of accounting reports. Investment in securities or real estate also calls for the use of accounting information. In every election, propositions on the ballot and in the platforms of candidates can be much better understood by voters who are familiar with accounting. Accounting information is also useful to individuals in handling their personal financial affairs. In short, all economic activity is supported by accounting information. Financial statements reflect those events that have been recorded in the accounting records—namely, transactions. Therefore, there may be important events affecting the financial strength and prospects of a business that do not appear in the company’s financial statements, such as hiring a new employee, preparing a budget, and preparing a long-run strategic plan. A business transaction is an event that changes the financial position of an enterprise.  Purchase of assets (e.g., land, buildings, equipment) for cash or on credit.  Payment of employee wages.  Collection of a receivable from a customer. © The McGraw-Hill Companies, Inc., 2010 Q1-6 7. a. b. c. 8. 9. 10. 11. 12. 13. Creditors are interested in financial statements to assist them in evaluating the ability of a business to repay its debts. No creditor wants to extend credit to a company that is unable to meet its obligations as they come due. Potential investors use financial statements in selecting among alternative investment opportunities. They are interested in investing in companies in which the value of their investment will increase as a result of future profitable operations. They may also be interested in the flow of cash to them as the company pays dividends to its stockholders. Labor unions are interested in financial statements because the financial position of a company and its profits and cash flows are important factors in the company’s ability to pay higher wages and to employ more people. A sole proprietorship is an unincorporated business organization with a single owner. The owner is personally liable for the debts of the business. Revenues result from transactions in which goods or services are transferred (i.e., sold) to customers. Expenses are costs associated with earning revenues. Revenues already have resulted in or will result in positive cash flows, while expenses have resulted in or will result in negative cash flows. An enterprise’s net income is determined as the excess of revenues over expenses for a period of time. If expenses exceed revenues, however, the difference is called a net loss. The cost principle indicates that many assets are included in the financial records, and therefore in the statement of financial position, at their original cost to the reporting enterprise. This principle affects accounting for assets in several ways, one of which is that the amount of many assets is not adjusted periodically for changes in the market value of the assets. Instead, cost is retained as the basic method of accounting, regardless of changes in the market value of those assets. The going concern assumption states that in the absence of evidence to the contrary (i.e., bankruptcy proceedings), an enterprise is expected to continue to operate in the foreseeable future. This means, for example, that it will continue to use the assets it has in its financial statements for the purpose for which they were acquired. Business transactions affect a company’s financial position, and as a result, they change the statement of financial position or balance sheet. The other financial statements—the income statement and the statement of cash flows—are detailed expansions of certain aspects of the statement of financial position and help explain in greater detail how the company’s position changed over time. The basic accounting equation indicates that assets = liabilities + owners’ equity. Assets are resources owned by the company that are used in carrying out its business activities. Liabilities are debts owed by the enterprise, and owners’ equity is the interest of the owners in the enterprise’s assets. © The McGraw-Hill Companies, Inc., 2010 Q7-13 14. 15. 16. a. b. 17. 18. 19. Inflation is a term used to describe increasing prices, which result in a declining value in the monetary unit (e.g., dollar). Deflation is the opposite—declining prices, which result in an increasing value of the monetary unit. The stable monetary unit assumption means that in the preparation of financial statements we assume that the monetary unit is not changing in value, or that changes are sufficiently small that they do not significantly distort the accounting information included in financial statements. No, a business transaction could not affect only a single asset. There must be an offsetting change elsewhere in the accounting equation. If the transaction increases an asset, for example, it must reduce another asset, increase a liability, or increase owners’ equity (or a combination of these). On the other hand, if the transaction decreases an asset, it must increase another asset, decrease a liability, or decrease owners’ equity (or a combination of these). An example of a transaction that would cause one asset to increase and another asset to decrease without any effect on the liabilities or owners’ equity is the receipt of cash in collection of an account receivable. Another common example is the payment of cash to buy land, a building, office equipment, or other assets. Operating activities—Cash provided by and used in revenue and expense transactions. Investing activities—Cash provided by and used as a result of investments in assets, such as machinery, equipment, land, and buildings. Financial statements—the balance sheet, income statement, statement of cash flows—are all based on the same underlying transactions. They reflect different aspects of the enterprise’s activities. Their relationship is referred to as “articulation.” For example, the revenues and expenses in the income statement result from changes in the assets and liabilities in the balance sheet and their cash effects are presented in the operating activities section of the statement of cash flows. An example of a transaction that would cause both total assets and total liabilities to increase without any effect on the owners’ equity is the purchase of an asset on credit. The acquisition of the asset could be entirely on credit or could involve a partial cash payment with the balance on credit. Another example is an increase in cash by borrowing from a bank. Positive cash flows means that cash increases. Negative cash flows means that cash decreases. Generally, revenues result in positive cash flows—either at the time of the revenue transaction, earlier, or later. Expenses result in negative cash flows—either at the time the expense is incurred, earlier, or later. The three categories and the information included in each are: Financing activities—Cash provided by and used in debt and equity financing, such as borrowing and repaying loans, and new capital received from and dividends paid to the enterprise’s owners. © The McGraw-Hill Companies, Inc., 2010 Q14-19 20. 21. 22. 23. 24. A strong income statement is one that has significantly more dollars of revenue than expenses, resulting in net income that is a relatively high percentage of the revenue figure. A trend of relatively high income numbers over time signals a particularly strong income situation. A strong statement of cash flows is one that shows significant amounts of cash generated from operating activities. This means that the enterprise is generating cash from its ongoing activities and is not required to rely heavily on debt and equity financing, or the sale of its major assets to finance its daily operations. The owner’s equity of a sole proprietorship is the simplest in that it is a single line that shows the dollar balance of the owner’s financial interest in the enterprise’s assets. The owners’ equity of a partnership is more complicated because it includes more than one owner, and the total owners’ equity is the total of the individual equity of all partners. The owners’ equity of a corporation, which may have many owners, is divided into two parts—contributed equity and retained earnings. The contributed equity, usually referred to as capital stock, represents the amount paid to the company originally by the owners, and the retained earnings represents the accumulated income of the enterprise that has not been returned to stockholders. Adequate disclosure refers to the requirement that financial statements, including accompanying notes, must include information necessary for reasonably informed users of financial statements to understand the company’s financial activities. This requirement is met, in part, by the addition of notes to the financial statements. Financial statement notes include both quantitative and qualitative information that is not included in the body of the financial statements. The term “window dressing” refers to enhancing the appearance of the enterprise’s financial statements by taking certain steps near the end of the financial reporting period. While some steps that may be taken, or delayed, are appropriate, care must be taken that steps taken are not unethical or illegal. © The McGraw-Hill Companies, Inc., 2010 Q20-24 B. Ex. 2.1 B. Ex. 2.2 B. Ex. 2.3 B. Ex. 2.4 B. Ex. 2.5 B. Ex. 2.6 B. Ex. 2.7 Increases in cash: Revenues $100,000 Sale of land 10,000 Borrowing from bank 15,000 $125,000 Decreases in cash: Expenses 56,000 Purchase of truck 20,000 (76,000) Net increase in cash $49,000 B. Ex. 2.8 Joe Solway, Capital $25,000 Tom Solway, Capital 25,000 $50,000 B. Ex. 2.9 Capital stock $40,000 Retained earnings 10,000 $50,000 $65,000 (total equity) - $50,000 (capital stock) = $15,000 (retained earnings) SOLUTIONS TO BRIEF EXERCISES Green Company's assets (machinery) will increase by $10,000. The company's liabilities will also increase by $10,000 to include the new obligation the company has assumed. Foster Inc.'s assets will increase by a net amount of $25,000. Cash will decrease by $5,000 and the truck account will increase by $30,000, a net increase of $25,000. The company's liabilities will also increase by $25,000 to reflect the new obligation that has been assumed. $150,000 (assets) - $85,000 (liabilities) = $65,000 (total equity) $125,000 (revenues) - $50,000 (expenses) = $75,000 net income Note: The year-end cash balance of $35,000 does not affect the amount of net income. $780,000 (assets - [$500,000 + 150,000](equity) = $130,000 (liabilities) $300,000 (revenues) - $205,000 (expenses) = $95,000 (net income) Note: The purchase of land for $45,000 does not affect net income. © The McGraw-Hill Companies, Inc., 2010 BE2.1,9 B. Ex. 2.10 50,000 $ Add: 10,000 25,000 85,000 $ Net income for 2009……………………………… Balance, December 31, 2009………………………………… The end-of-year balance of owner’s equity in the balance sheet is $85,000. This amount articulates with the amount of net income in the income statement because net income is added to the amount of beginning owner’s equity, plus additional investment, to determine the ending balance that appears in the December 31, balance sheet. The accounting equation stays in balance because the amount of net income is reflected in changes in the balances of various assets and liabilities that are also presented in the balance sheet. John Franklin, owner’s equity: Balance, January 1, 2009……………………………………… Investment during 2009………………………… © The McGraw-Hill Companies, Inc., 2010 BE2.10 Ex. 2.1 a. 1. 2. b. 1. 2. Liabilities: $69,000 $288,000 70,000 26,000 14,000 $314,000 70,000 Owners’ equity: 80,000 92,000 165,000 62,000 $468,000 $468,000 Liabilities & Owners' Equity Notes payable …………………… Accounts payable ………………… Total liabilities……………….. Capital stock…………………….. SOLUTIONS TO EXERCISES Assets Cash ………………………. Accounts receivable ……… Supplies …………………… Land ……………………… Building ………………….. Automobiles ……………… Total ……………………… Total………………………………… Retained earnings……………….. Note to instructor: You may wish to expand this solution to include intangible assets, such as the team’s league franchise, and player contracts, the right to receive the future services of a given player. (Player contracts only appear as an asset if they have a cost—that is, if they were purchased from other teams. Advance payments to players usually are shown as prepaid expenses.) We address intangible assets in Chapter 9, but the concept is consistent with the discussion of assets in Chapter 2. Liabilities are existing debts and other obligations of the entity. Among the liabilities of American Airlines, we might expect to find accounts payable, notes payable (or mortgages or bonds payable) stemming from purchases of aircraft, salaries payable, interest payable, rent payable (for space in airports), and income taxes payable. The balance sheet of a professional sports team might include accounts payable, rent payable (for the stadium), salaries payable, interest payable, and income taxes payable. Note to instructor: In a classroom discussion, you might want to point out that both an airline and a professional sports team may have liabilities for unearned revenue. The airline sells many tickets in advance, thus incurring an obligation to render services (flights) or to refund the customers’ money. A sports team has a similar obligation with respect to advance sales of season tickets. We discuss unearned revenue in Chapter 4, but the concept can be introduced earlier at the instructor’s discretion. Ex. 2.2 DIXIE TRANSPORTATION SERVICE Balance Sheet February 28, 2009 Assets are economic resources owned by the business entity. Among the assets of American Airlines we might expect to find investments, accounts receivable (say, from travel agents), fuel (in storage), maintenance supplies, aircraft, and various types of equipment. The company also owns land and buildings—as, for example, its corporate headquarters. Among the assets of a professional sports team are investments (in stocks and bonds), notes receivable (often from players), training equipment, supplies, and office furniture. (The balance sheet of a professional sports team usually does not include land or buildings, as they generally do not own the stadiums in which they play.) © The McGraw-Hill Companies, Inc., 2010 E2.1,2 $36,300 Liabilities: 56,700 Notes payable …………………………… $207,000 90,000 Accounts payable ……………………… 43,800 210,000 $250,800 12,400 Owners’ equity: Capital stock …………………………… 75,000 79,600 $405,400 $405,400 Ex. 2.4 a. b. c. Ex. 2.5 a. b. c. The amount of retained earnings is calculated as the difference between total assets and liabilities plus capital stock: $405,400 – ($250,800 + $75,000) = $79,600 The supplies should be presented at $1,700 in World-Wide’s balance sheet. Presenting the supplies at their estimated liquidation value violates the assumption that World-Wide is a going concern, and will use these supplies in business operations, rather than sell them on the open market. The $500 amount also violates the objectivity principle, as it is largely a matter of personal opinion, and also the cost principle. $236,000: Assets $578,000  liabilities $342,000 = owners’ equity $236,000 $1,132,500: Liabilities $562,500 + owners’ equity $570,000 = assets $1,132,500 $120,300: Assets $307,500  owners’ equity $187,200 = liabilities $120,300 The presentation of the two land parcels at a combined value of $320,000 conforms to generally accepted accounting principles. This treatment illustrates both the cost principle and the stable-dollar assumption. The presentation of the computer system at $14,000 in the December 31 balance sheet conforms to generally accepted accounting principles, as this is the cost of the system, and at the balance sheet date, it was an asset owned by the company. The retail value of $20,000 is not presented in the balance sheet, as this amount is not the cost incurred by the entity, nor is it an objective measurement. However, the company’s failure to disclose the loss of the equipment subsequent to the balance sheet date may violate the principle of adequate disclosure. To properly interpret the company’s balance sheet, users may need to be aware that this asset no longer exists. Several issues must be considered in deciding whether or not disclosure of the burglary loss is necessary. For example, was the asset insured? And is a $14,000 asset significant (material) in relation to the assets and operations of this business? Is this amount large enough that it might impact investors’ and creditors’ decisions regarding the company? Balance Sheet December 31, 2009 Total………………………………………… Retained earnings ……………………… Total ………………………… Total liabilities………………………… Liabilities & Owners' Equity Cash ………………………… Ex. 2.3 MERCER COMPANY Assets Accounts receivable ………… Land ………………………… Building …………………….. Office equipment…………… © The McGraw-Hill Companies, Inc., 2010 E2.3,4,5 Ex. 2.6 Assets = Liabilities + Owners’ I I NE NE* NE NE D D NE D D NE I NE I I I NE I NE I NE* NE NE NE* NE NE Ex. 2.7 a. b. c. d. e. Ex. 2.8 a. $ 390,000 $ 240,000 150,000 $ 390,000 $ 250,000 140,000 $ 390,000 Retained earnings …………………………………………………… Total stockholders' equity ……………………………………… *Capital stock = 25  $10,000. Retained earnings = $390,000  capital stock. Total ……………………………………………………………. *Yato’s capital = $390,000  Small’s capital, $240,000 (3) Stockholders' equity: Capital Stock ………………………………………………………… Johanna Small, capital …………………………………………. *$850,000 in assets  $460,000 in liabilities (2) Partners' equity: f g h i Note to instructor: These are examples, but many others exist. (1) Owners' equity Transaction a b c d e Johanna Small, capital ……………………………………………. Mikki Yato, capital ………………………………………………… *Could be I/D offsetting The purchase of office equipment (or any other asset) on credit will cause an increase in the asset (office equipment) and an increase in a liability. The cash payment of an account payable or note payable will cause a decrease in the asset cash and a decrease in the liability paid. The collection of an account receivable will cause an increase in one asset (cash) and a decrease in another asset (accounts receivable). Other examples include the purchase of land for cash, and the sale of land for cash or on credit. The investment of cash in the business by the owners will cause an increase in an asset (cash) and an increase in the owners’ equity. The purchase of an automobile (or other asset) paying part of the cost in cash and promising to pay the remainder at a later time would cause an increase in one asset (automobile), a decrease in another asset (cash), and an increase in a liability by the amount of the unpaid portion. © The McGraw-Hill Companies, Inc., 2010 E2.6,7,8 b. Ex. 2.9 a. b. c. d. Ex. 2.10 a. b. The situations encountered in the practice of accounting and auditing are too complex and too varied for all specific answers to be set forth in a body of official rules. Therefore, individual accountants must resolve many situations, based upon their general knowledge of accounting, their experience, and their ethical standards—in short, their professional judgment. Accountants must rely upon their professional judgment in such matters as determining (three required) (1) how to record an unusual transaction that is not discussed in accounting literature, (2) whether or not a specific situation requires disclosure, (3) what information will be most useful to specific decision makers, (4) ho