Continuity

Continuity is often cited as a basic accounting
postulate that affects how a company presents information in published
financial statements.

Required:

  1. How did Sprouse and Moonitz describe continuity?

b. Given
the presumption of continuity, if you are planning to buy a business, would the
historical cost of the company’s assets be relevant to your decision to invest?
Explain. If your answer is no, what asset values would be relevant to your
decision to invest?

c. If a company is
bankrupt and plans to liquidate its assets, can continuity still be presumed?
Explain. If your answer is no, how do you think the lack of continuity should
affect the measurement of assets reported in a company’s balance sheet?

Case 2-4 Answer

Continuity is often cited as a basic accounting postulate that affects how a company presents information in published financial statements. Required: a. How did Sprouse and Moonitz describe continuity? They described it as the absence of evidence to the contrary; the entity should be viewed as remaining in operation indefinitely. While the entity has a limited life in the presence of evidence, shouldn’t be viewed as remaining in operation indefinitely. In describing continuity, Sprouse and Moonitz stated that in the absence of evidence to the contrary, the entity should be viewed as remaining in operation indefinitely. In the presence of evidence that the entity has a limited life, it should not be viewed as remaining in operation indefinite.

Since a business is presumed to continue indefinitely, the value relevant to a purchaser is fair market value. This value measures the present value of future cash flows to the buyer.  It is relevant for the buyer because the buyer presumes that the business will continue and thus will generate those future cash flows.

A bankruptcy provides evidence that the business is not expected to remain in operation indefinitely.  In this case, the assets that are reported in the company’s balance sheet should be measured at net realizable….

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