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Case study – Continuity by Sprouse and Moonitz
Continuity is often cited as a basic accounting postulate that affects how a company presents
information in published financial statements.
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?
The theorists held that in the absence of factors and evidence against an organization as a going concern, the entity should be observed as one that has a continuous operational life. If there is evidence that the entity is short lived, it should not be observed as one that has a continuous operation life. Sprouse and Moonitz held that continuity of an entity should be determined by the state of the current nature operations. This implies that factors such as historical cost cannot be used to determine the continuity of an entity but rather the market value would be used (Staubus, 2010).
No. When making an investment decision in consideration of continuity, historical cost would not be relevant. Since continuity is indefinite business operation, the historical cost has little or no effect at all. A major factor to consider would be the market value of the entity. The market value enables one to determine the current value of the entity’s future cash flows. The cash flows enable the buyer to establish the life of the business. Determination of market value is very important since future cash flows show the profitability potential of the business in the long run (Staubus, 2010).
No. In bankruptcy it is already evident that it is not possible for the company to continue with its operations. Contrary to the going concern where the assets are reported in the balance sheet in their Net book value (NBV), in bankruptcy, assets are reported in their net realizable value (NRV). The NRV is approximated at the possible selling price of the assets less the costs of selling (Tamas et al, 2012).