Joe McGuire is a CPA who has recently completed the audit of Nelson Repairs, Inc. The audited balance sheet and income statement follow. Chapter 4 The Measurement Fundamentals of Financial Accounting 177 Balance Sheet Income Statement Current assets $ 60,000 Long-term assets 140,000 Total assets $200,000 Liabilities $ 80,000 Stockholders’ equity 120,000 Total liabilities and stockholders’ equity $200,000 Sales $160,000 Expenses (130,000) Net income $ 30,000 During his examination Joe learned that a lawsuit is soon to be filed against Nelson. The lawsuit accuses Nelson of negligence and asks for damages over and above insurance of $60,000. If Nelson were to lose the lawsuit, the future of the business would be in jeopardy. However, as the lawyers described it to Joe, the probability that Nelson will lose the lawsuit is very low, approximately 20 percent. Joe is unsure about whether he should require Nelson to disclose the lawsuit on the finan¬ cial statements. The president of Nelson does not want it disclosed because he believes that the disclosure would cause undue concern among the company’s shareholders. Joe does not want to ignore the president’s request because Nelson is his most important client. On the other hand, Joe knows that if he does not require disclosure, and Nelson loses the lawsuit, he may be legally liable for the losses of the stockholders. Joe constructed the following framework to help him make his decision. Lawsuit Outcome Decision Win (80%) Lose (20%) Require disclosure Error 1 Correct decision Do not require disclosure Correct decision Error 2 (Appendix 4A: The value of common stock) REQUIRED:

a. Study Joe’s framework, and note that he can choose to require or not to require disclosure. Requiring disclosure and winning the lawsuit gives rise to Error