Salmonella Shrimp Shack had a situation where several hundred customers fell ill after dining at the shack. As a result of lawsuits, Salmonella will close its doors for good on January 1, 2025. In the meantime, Salmonella prepared their year-end December 31, 2024, financial statements using the historical cost for their assets. Which underlying assumption of Generally Accepted Accounting Principles (GAAP) is violated?

Question

Salmonella Shrimp Shack had a situation where several hundred customers fell ill after dining at the shack.  As a result of lawsuits, Salmonella will close its doors for good on January 1, 2025.  In the meantime, Salmonella prepared their year-end December 31, 2024, financial statements using the historical cost for their assets.  Which underlying assumption of Generally Accepted Accounting Principles (GAAP) is violated?

BlackTom AI · Accepted Answer

Going concern assumes the company will continue its operations for the foreseeable future, so assets and liabilities are measured and reported on that basis (typically historical cost).

1. Relevant knowledge points and concepts
- Going concern assumption: financial statements are prepared on the premise the entity will continue operating; if this is not the case, the liquidation basis of accounting is required and measurement/disclosure change.
- Historical cost: appropriate under going concern because assets are expected to be used in operations, not sold immediately.
- Other GAAP concepts listed: full disclosure (reveal all material facts), periodicity (divide operations into time periods), economic entity (separate business vs. owners), monetary unit (use a stable currency).

2. Step-by-step reasoning
- Facts: Salmonella Shrimp Shack will close permanently on January 1, 2025; year-end statements dated December 31, 2024 were prepared using historical cost.
- Implication: Imminent closure means the company will not continue as a going concern for the foreseeable future.
- GAAP consequence: If going concern is not appropriate, the company must use the liquidation basis of accounting (measure assets at net realizable value/fair value less costs to sell), not historical cost.

3. Calculations
- No numeric calculations are required here; the adjustment is conceptual (change in measurement basis from historical cost to liquidation values).

4. Why the correct answer is correct
- Using historical cost despite an imminent shutdown violates the going concern assumption because historical cost presumes continued use of assets. The appropriate GAAP response would be to adopt the liquidation basis and disclose going concern matters.

5. Why the other options are incorrect
- Full disclosure: concerns providing necessary information; Salmonella should disclose the closure, but the core violated assumption is going concern, not disclosure.
- Periodicity: relates to reporting intervals (years, quarters); not violated by choice of cost basis.
- Economic entity: concerns separating owner/business transactions; not relevant.
- Monetary unit: concerns using a stable currency; not relevant.

6. Conclusion
The underlying GAAP assumption violated is Going concern, which matches the provided answer.

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