The going concern assumption is becoming an increasing source of concern for users of financial statements. There are instances of companies filing for bankruptcy several months after issuing their annual audited financial statements. The question is, Why didn't the financial statements predict the problem? A friend has just arrived on your doorstep; you realize she is very angry. After calming her down, you ask what the problem is. She tells you that she had inherited $40,000 from an uncle and invested the money in the common shares of Outdoor Sports Equipment Corp. (OSEC). She had carefully examined OSEC's financial statements for the latest year end and had concluded that the company was financially sound. This morning, she had read in the local paper that the company had gone bankrupt and her investment was worthless. She asks you why the financial statements valued the assets at values that are in excess of those the trustee in bankruptcy expects to realize from liquidating the assets. Why have the assets suddenly lost so much of the value they had six months ago?
Required
Explain to your friend why assets are valued on a going concern basis in the financial statements and why they are usually worth less when the company goes out of business. Use inventory and accounts receivable as examples.