A going concern is an accounting term for a business that is assumed will meet its financial obligations when they become due. It functions without the threat of liquidation for the foreseeable future, which is usually regarded as at least the next 12 months or the specified accounting period (the longer of the two). Hence, a declaration of going concern means that the business has neither the intention nor the need to liquidate or to materially curtail the scale of its operations. For a company to be a going concern, it must be able to continue operating long enough to carry out its commitments, obligations, objectives, and so on. In other words, the company will not have to liquidate or be forced out of business. If there is uncertainty as to a company’s ability to meet the going concern assumption, the facts and conditions must be disclosed in its financial statements.
A financial auditor’s role is to evaluate a business’s assessment of being a going concern. They do this by analyzing the company’s financial statements and assessing whether the business can continue its operations in the foreseeable future. A financial auditor’s role is to analyze whether a company’s assessment of being a going concern is correct. They will review the company’s financial statements and operations to determine if they can continue in the foreseeable future.
- In many ways going concern is one of the most basic and easily understood accounting concepts but it can be quite difficult to apply.
- In this article, we explore the meaning, applications, and significance of the going concern concept, along with real-world examples to illustrate its importance.
- By making this assumption, the accountant is justified in deferring the recognition of certain expenses until a later period, when the entity will presumably still be in business and using its assets in the most effective manner possible.
- In the context of corporate valuation, companies can be valued on either a going concern basis or a liquidation basis.
Company
These include decreasing sales revenue, economic slowdown, loss of key importance management, payment of long-term debt, or interest payable. The company going concern is a critical analytic during the recession or in some situations that the company is not making any profit, which can lead to a cash flow problem. Most companies will go bankrupt due to insufficient cash to pay for suppliers, employees, and debtors. Accounting frameworks like GAAP and IFRS require the use of the going concern concept when preparing financial statements, ensuring consistency and comparability across organizations. By assuming continuity, the going concern concept fosters confidence among investors, creditors, and employees, reassuring them of the business’s ability to operate and fulfill commitments.
For investors, a stable going concern status signals potential for growth and profitability, encouraging capital commitments. Conversely, doubts about viability may deter investment or prompt divestment due to perceived risks. The concept of going concern is an underlying assumption in the preparation of financial statements, hence it is assumed that the entity has neither the intention, nor the need, to liquidate or curtail materially the scale of its operations. If management conclude that the entity has no alternative but to liquidate or curtail materially the scale of its operations, the going concern basis cannot be used and the financial statements must be prepared on a different basis (such as the ‘break-up’ basis). The going concern assumption is a fundamental accounting concept, similar to Consistency Principle and accrual assumption. According to this principle, financial statements are prepared, assuming the company intends to continue operations for the foreseeable future and has no motive or need to shut down.
Publicly-traded companies are required to disclose any concerns about their going concern status in their financial statements. Auditors must assess whether the going concern assumption is appropriate, especially when there are doubts about the business’s ability to continue operations. The auditors conduct their own evaluation to see whether or not the going concern assumption is appropriate for the company while auditing its financial statements, even if the company claims to be a going concern.
Impact on Financial Statements
Beyond compliance, the principle fosters transparency and trust among stakeholders, including investors, creditors, and regulators. By adhering to the going concern transposition error assumption, businesses provide a consistent basis for evaluating financial performance, which is especially relevant in industries exposed to rapid change or economic volatility. The concept of “going concern” is a fundamental principle in accounting, shaping how businesses report their financial health and longevity.
Qualified opinion
In both cases a paragraph explaining the basis for the qualified or adverse opinion will be included after the opinion paragraph and the opinion paragraph will be qualified ‘except for’ or express an adverse opinion. An important point to emphasise at the outset is that candidates are strongly advised not to use the ‘scattergun’ approach when it comes to deciding on the audit opinion to be expressed within the auditor’s report. This is where a candidate explores all possible options rather than coming to a conclusion as allowance for doubtful accounts to the auditor’s opinion, depending on the circumstances presented in the question. In the case there is substantial yet unreported doubt about the company’s continuance after the date of reporting (i.e. twelve months), then management has failed its fiduciary duty to its stakeholders and has violated its reporting requirements.
#3 – Cyclical Revenue Growth and Profitability
Thus, the value of an entity that is assumed to be a going concern is higher than its breakup value, since a going concern can potentially continue to earn profits. There are situations that may arise when the auditor may request management to make an assessment, or extend their original assessment of going concern. If management refuse to make, or extend, an assessment of going concern the auditor will consider the implications for the report.
When faced with such a requirement, candidates must be careful not to produce a list of generic rate of return ror meaning formula and examples audit procedures, but instead identify and highlight the factors from the scenario that may call into question the entity’s ability to continue as a going concern. Once these factors have been identified, candidates should then be able to think about the procedures the auditor may adopt to establish whether the factors mean the going concern basis of accounting is appropriate in the circumstances, or not. However, if the auditor has concerns about the business’s ability to continue as a going concern, they may issue a qualified opinion. The auditor will give the company’s management a chance to make a plan to correct the business’s problems and improve its prospects for the future. If an auditor is planning to issue a qualified opinion, they will give the company’s management a chance to develop a plan to correct the company’s problems and improve its prospects for the future.
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This approach provides a more accurate financial picture compared to a liquidation basis, which would require immediate recognition of all expenses and revenues. In financial reporting, the going concern assumption is embedded in frameworks like the International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP). Management must assess a company’s ability to continue as a going concern, typically for at least 12 months from the reporting period’s end.
In this article, we explore the meaning, applications, and significance of the going concern concept, along with real-world examples to illustrate its importance. The going concern principle ensures financial statements are prepared with the assumption that a business will continue operating indefinitely. This affects the valuation of assets and liabilities, enabling the deferral of expenses and recognition of revenues over time. For example, long-term assets like property, plant, and equipment are depreciated over their useful lives, reflecting the ongoing nature of operations.
- The following are the key procedures that management should do to assess the going concern problems.
- For example, changes in trade policies may disrupt supply chains, impacting production and customer fulfillment.
- If we didn’t assume companies would keep operating, why would be prepay or accrue anything?
- Operational disruptions, such as regulatory changes, technological shifts, or geopolitical tensions, can also threaten viability.
Indicator of Business is not a Going Concern
For example, when a business ceases trading and deviates from its principal business, the concern would likely stop delivering profits in the near-term future. Conversely, a healthy business shows revenue growth, profitability growth with margin improvement, and growth in product sales. The auditor is required by the Securities and Exchange Commission to disclose in the financial statements of a publicly traded company whether going concern status is in doubt.
The principle highlights the assumption that companies intend to keep assets and generate profits in the future—assets won’t be sold in between. It could tell us whether the company has any cash problems in the next twelve months or not. If the cash flow forecasting indicates that the company does has any cash flow problems.
