Going Concern Assumption Accounting Concept + Examples

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Accounting standards try to determine what a company should disclose going concern concept meaning on its financial statements if there are doubts about its ability to continue as a going concern. In May 2014, the Financial Accounting Standards Board determined financial statements should reveal the conditions that support an entity’s substantial doubt that it can continue as a going concern. Statements should also show management’s interpretation of the conditions and management’s future plans. They can help business review their internal risk management along with other internal controls. However, generally accepted auditing standards (GAAS) do instruct an auditor regarding the consideration of an entity’s ability to continue as a going concern.

A case of such information is a company’s inability to continue operating without significant asset sales or debt restructurings. If such was not the situation, a company would basically be acquiring assets when it knows that it will be shutting down its activities and reselling those assets to another organization. Continuation of an entity as a going concern is presumed as the basis for financial reporting unless and until the entity’s liquidation becomes imminent.

Understanding Going Concern in Accounting and Financial Statements

A startup company in the technology sector has been consistently generating revenues, reinvesting in its products, and expanding into new markets. Despite high initial costs and some short-term losses, the company’s investors and management expect continued operations and profitability. Under the going concern concept, the startup continues to report its assets and liabilities using conventional accounting methods, projecting long-term viability. If a company is not a going concern, that means there is risk the company may not survive the next 12 months. Management is required to disclose this fact and must provide the reasons why they may not be a going concern.

Learn about emerging trends and how staffing agencies can help you secure top accounting jobs of the future. The stakeholder damage from going concern failure underlines the importance of proactive financial management, solvency protection, and turnaround planning. So while specifics may vary, the overall requirement to assess and disclose going concern uncertainties is consistent across accounting frameworks. So in summary, although being a going concern is good, operating too close to the threshold may undermine confidence in the business. The optimal situation is maintaining a comfortable buffer above the going concern threshold.

This allows the company to recognize long-term assets and liabilities on its balance sheet. The going concern concept is not clearly defined anywhere in generally accepted accounting principles, and so is subject to a considerable amount of interpretation regarding when an entity should report it. However, generally accepted auditing standards (GAAS) do instruct an auditor regarding the consideration of an entity’s ability to continue as a going concern.

It assumes that the entity will continue to remain in business for the foreseeable future. Conversely, it also means that the entity does not plan to, or expect to be forced to, liquidate its assets. Under this accounting principle, it defers revenue and expenses according to other principles of accounting. If the going concern assumption did not hold true, then it would not be possible to record prepaid or accrued expenses as such. The going concern idea is not plainly characterized anywhere in generally accepted accounting principles, and so has a wide amount of interpretations in regards to when a company should report it. Generally accepted auditing standards (GAAS), however, do have instructions for an auditor in regard to a company’s ability to function as a going concern.

A business runs on the going concern basis of the products/services offered to the consumers. The pulse of an industry from a fruit seller to a multi-national company selling IT services will be the same. The owner or the top management has found new customers and maintained its existing ones to keep the company’s organic and inorganic growth. Retention of old customers and expansion through recent customer acquisition would help make the business profitable and aids toward the volume growth of the product. The product should be reasonably priced and innovative to beat its peers and retain value for the customers.

When Auditors Issue Disclaimers and Modified Opinions

The first step is always to disclose the going concern aspect of the business and then keeping that in mind, account for all the financial transactions through a long-term perspective of the business. It is possible for a business to alleviate an auditor’s perspective on its going concern status by ensuring a third-party guarantee the debts of the company or agreeing to give extra funding when needed. By doing this, the auditor is assured that the business will continue to be operational during the one-year time frame specified by GAAS. The valuation of companies in need of restructuring values a company as a collection of assets, which serves as the basis of the liquidation value.

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Proper business foresight and operational efficiency are required for a company to sustain and stay profitable for a longer term. In addition, economic recessions are crucial, which determine management’s ability when major firms fail to generate profits. By contrast, the going concern assumption is the opposite of assuming liquidation, which is defined as the process when a company’s operations are forced to a halt and its assets are sold to willing buyers for cash. Under GAAP standards, companies are required to disclose material information that enables their viewers – in particular, its shareholders, lenders, etc. – to understand the true financial health of the company. The Going Concern Assumption is a fundamental principle in accrual accounting, stating that a company will remain operating into the foreseeable future rather than undergo a liquidation.

1. Our writing and editorial staff are a team of experts holding advanced financial designations and have written for most major financial media publications.
2. Users of financial statements, like investors and creditors, rely heavily on these standards being followed to analyze performance.
3. Conversely, this means the entity will not be forced to halt operations and liquidate its assets in the near term at what may be very low fire-sale prices.
4. Companies that are a going concern may defer reporting long-term assets at current value or liquidating value, but rather at cost.
5. Therefore, it may be noted that companies that are not a going concern may need external financing, restructuring, asset liquidation, or be acquired by a more profitable entity.

An analyst values the business after looking at the recent trend of the business and the company’s potential to earn profits. A going concern will be valued according to operational efficiency, market share, the ability to influence the market, technology advantages, and so on. It may be valued using the discounted cash flow (DCF) method, with the assumption of future profitability. The going concern principle assumes that any organization will continue to operate its business for the foreseeable future. The principle purports that every decision in a company is taken with the objective in mind of running the business rather than that of liquidating it. 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.

The Implications of Going Concern Failure and Financial Distress

In case the auditor decides to qualify their audit report, it may raise the issue of whether assets are already impaired, which may highlight the need to write down the value of the assets from their carrying value to liquidation value. However, a company can choose to justify their decisions and attempt to make the auditor believe that poor business operating conditions are only temporary. The going concern concept states that a business will continue its operations for the foreseeable future. This implies that the company will not be forced to discontinue its operations and liquidate its assets at extremely low costs. Going concern is an accounting term used to identify whether a company is likely to survive the next year.

1. The pulse of an industry from a fruit seller to a multi-national company selling IT services will be the same.
2. If and when an entity’s liquidation becomes imminent, financial statements are prepared under the liquidation basis of accounting (Financial Accounting Standards Board, 20141).
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4. If reorganizing under bankruptcy is not feasible, companies may be forced to sell property, inventory, equipment, and other assets before dissolving.
5. Companies that are not a going concern may not have enough money to survive, and this fact must be publicly disclosed when an auditor audits their financial statements.

The company has accumulated significant losses and debts that have raised questions about its ability to continue as a going concern. A company’s financial health, operational stability, external environment, and legal position are analyzed to assess whether it can continue as a going concern. In simple words, it implies that when accountants create financial accounts, they presume that the firm will remain functioning and operating as it has been, without any intentions to close down or sell off its assets. If there is an issue, the audit firm must qualify its audit report with a statement about the problem. As you can see there is a heavy focus on financial modeling, finance, Excel, business valuation, budgeting/forecasting, PowerPoint presentations, accounting and business strategy. The valuation of a company is important from the shareholders’ and investors’ perspective.