Susan Eel wants to sell you her wholesale fish store. She shows you a balance sheet with total assets of $150,000 and total liabilities of $20,000. According to the income statement, last year’s net income was $40,000.
When examining the accounting records, you notice that several accounts receivable in the $10,000 to $15,000 range are not supported by source documents. You also notice that there is no source documentation to support the $30,000 balance in the building account and the $10,000 balance in the equipment account. Susan tells you that she gave the building and refrigeration equipment to the business in exchange for stock. She also says that she has not had time to set up and monitor any paperwork for accounts receivable or accounts payable.
Required:
1. What requirements for transaction recognition appear to have been ignored when the accounts receivable, building, and equipment were recorded?
2. What would be the effect on the financial statements if the values appearing in the balance sheet for accounts receivable, building, and equipment were overstated? What would be the effect if the accounts payable were understated?
3. Assuming that you would like to purchase the company, what would you do to establish a reasonable purchase price?