I have been using System 6 on my Macintosh and putting my applications on the Desktop (as opposed to within any folder). After installing System 7, I rebuilt the Desktop and "lost" these applications. However, they appeared again in their correct place, when I opened the hard disk icon.
The issue is that when I try to open a document created by any one of these applications, I get an error message that says, "The application cannot be found."
The fix is to move the application to the hard disk window. Then, if you want, move it back to the Desktop. This seems to "force" the Finder to update the Desktop correctly.