Three independent situations follow:

1. In preparing its financial statements, Karim Company estimated and recorded the impact of the recent death of its president.

2. Because of a “flood sale,” equipment worth $300,000 was purchased by Montigny Company for only $200,000. The equipment was recorded at $300,000 on Montigny’s books.

3. Vertical Lines Company was on the verge of filing for bankruptcy, but a turnaround in the economy has resulted in the company being very healthy financially. The company president insists that the accountant put a note in the financial statements that states the company is a real going concern now.

Instructions

a. For each of the above situations, determine if the accounting treatment of the situation is correct or incorrect. Explain why.

b. If the accounting treatment is incorrect, explain what should be done.

Taking It Further

Why is it important for companies to follow generally accepted accounting principles when preparing their financial statements?