Going Concern Concept Explanation, Significance and Examples

A company or investor that is acquiring a company may compare that company’s going-concern value to its liquidation value in order to decide whether it’s financially worthwhile to continue operating the company, or whether it is more profitable to liquidate it. GAAP is a common set of accounting rules, procedures and standards issued by the Financial Accounting Standards Board (FASB) for financial reporting. On the contrary, IFRS is a non-profit and public interest organisation established to develop understandable, high-quality and globally accepted accounting and sustainability disclosure standards. It’s given when an auditor has no concerns about the financial statements of a business or its ability to operate in the future. Depreciating fixed assets according to their predicted economic life rather than their today’s market worth is an example of going concerned with how the going concern principle of accounting is applied.

If there are concerns about a company’s ability to continue as a going concern, accounting standards strive to decide what information should be disclosed on its financial statements. The Financial Accounting Standards Board decided in May 2014 that financial statements must show the circumstances that give rise to serious doubt about an entity’s ability to continue as a going concern. Statements should also include management’s assessment of the situation and its expectations for the future. US GAAP includes a two-step process that first determines whether substantial doubt about the company’s ability to continue as a going concern is raised. If substantial doubt is raised, management then assesses whether that substantial doubt is alleviated by management’s plans. Unlike IFRS Standards, if substantial doubt is raised in Step 1 about the company’s ability to continue as a going concern, the extent of disclosure depends on the outcome of Step 2 and whether that doubt is alleviated by management’s plans.

  • Management’s plans are ignored under Step 1, but considered under Step 2, to determine if they alleviate the substantial doubt raised in Step 1.
  • In general, an auditor examines a company’s financial statements to see if it can continue as a going concern for one year following the time of an audit.
  • This may influence which products we review and write about (and where those products appear on the site), but it in no way affects our recommendations or advice, which are grounded in thousands of hours of research.
  • However, dual reporters should be mindful of the differing frameworks, terminologies and potentially different outcomes in their going concern conclusions.

Liquidating a going concern can give an investor a bad reputation among potential future takeover targets. It is assumed that there will be interest in the goods or services offered by the company. Thus, this concept assumes that the company will continue to sell its product and build a consumer base.

Management typically develops plans to address going concern uncertainties – e.g. refinancing of debt, renegotiating breached covenants, and sale of assets to generate sufficient liquidity to continue to meet its obligations as they fall due. IFRS Standards do not prescribe how management should evaluate its plans to mitigate the effects of these events or conditions in the going concern assessment. Management assesses all available information about the future for at least, but not limited to, 12 months from the reporting date. This means the 12-month period is a minimum and management needs to exercise judgment to determine the appropriate look-forward period under the circumstances. Factors to consider include when the financial statements are authorized for issuance and whether there is any known event occurring after the minimum period of 12 months from the reporting date relevant to the analysis.

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At the end of the day, awareness of the risks that place the company’s future into doubt must be shared in financial reports with an objective explanation of management’s evaluation of the severity of the circumstances surrounding the company. Under US GAAP, management’s plans are ignored under Step 1 of the going concern assessment. Their mitigating effect is considered under Step 2 to determine if they alleviate the substantial doubt raised in Step 1, but only if certain conditions are met. This means management needs to run two sets of forecasts, before and after management’s plans, whereas IFRS Standards are not prescriptive in this regard. Usually, liquidation value is applied when investors feel a company no longer has value as a going concern, and they want to know how much they can get by selling off the company’s tangible assets and such of its intangible assets as can be sold, such as IP.

The auditor evaluates an entity’s ability to continue as a going concern for a period not less than one year following the date of the financial statements being audited (a longer period may be considered if the auditor believes such extended period to be relevant). If so, the auditor must draw attention to the uncertainty regarding the entity’s ability to continue as a going concern, in their auditor’s report. Separate standards and guidance have been issued by the Auditing Practices Board to address the work of auditors in relation to going concern.

  • 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.
  • Thus, in such a situation, the organization shall capitalize on the assets and claim depreciation on the assets over the years for the life of the asset.
  • Disclosures of material uncertainties that may cast doubt on a company’s ability to continue as a going concern as well as significant judgments involved in close-call scenarios may be more frequent as a result of COVID-19, given the continued economic uncertainty.
  • One of larger repercussions of not being a going concern are potential credit challenges.
  • These financial statements have been prepared on a going concern basis, which assumes that the company will continue to operate and generate profits in the future.
  • The business is expected to operate for the foreseeable future or at least for the next twelve months.

For example, the look-forward period for a company with a December 31, 20X0 reporting date is at least the 12 months ended December 31, 20X1, but it may need to be extended depending on the facts and circumstances. For example, if the company expects to lose a major customer in 15 months from the reporting date, it may be necessary to extend the look-forward period up to at least March 31, 20X2. The aspect of profitability is one of the main assumptions of a going concern business. For instance, if a business is currently making a loss, there is a high chance that it will be profitable in the long term and grow yearly.

Going concern concept

Disclosures addressing these requirements may need to be expanded, with added focus on the company’s response to the effects of COVID-19. US GAAP requires management’s plans to meet certain conditions to be considered in the assessment. Management’s plans are ignored under Step 1, but considered under Step 2, to determine if they alleviate the substantial doubt raised in Step 1. If the accountant believes that an entity may no longer be a going concern, then this brings up the issue of whether its assets are impaired, which may call for the write-down of their carrying amount to their liquidation value. The concept also defines a company’s future operations, based on which the depreciation and amortisation of assets work. It’s given when the auditor has doubts about the company and the assumption that it is a going concern.

Going Concern Value vs. Liquidation Value: What is the Difference?

The entity is already in breach of its agreed overdraft and the bank has refused to renew the borrowings. The entity has also been unsuccessful in applying to other financial institutions for re-financing. It is highly unlikely that the entity will be successful in renewing or re-financing the $10m borrowings and, in such an event, the directors will have no alternative but to cease to trade. The bank have already indicated that they are shortly going to commence legal proceedings to force the company to cease trading and sell off its assets to generate funds to pay off some of the borrowings. If the auditor concludes that the disclosures are inadequate, or if management have not made any disclosure at all and management refuse to remedy the situation, the opinion will be qualified or adverse. 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.

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When the demand for a product is cyclic in nature, there might not be constant top-line and bottom-line growth. No single factor spells imminent doom for a business, but there are red flags that can signal trouble. Hence, the article has included all the essential information regarding the going concern concept.

Under IFRS Standards, management assesses all available information about the future, considering the possible outcomes of events and changes in conditions, and the realistically possible responses to such events and conditions. Events or conditions arising after the reporting date but before the financial statements are authorized for issuance should be considered. IAS 1 states that management may need to consider a wide range of factors, including current and forecasted profitability, debt maturities and replacement financing options before satisfying its going concern assessment. 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. Preparation of financial statements under this presumption is commonly referred to as the going concern basis of accounting. If and when an entity’s liquidation becomes imminent, financial statements are prepared under the liquidation basis of accounting (Financial Accounting Standards Board, 2014[1]).

Examples of going concern

Whenever the sale of assets does not compromise a company’s capacity to run its business, as in the case of closing a minor branch office and moving the staff to other business divisions, it is still considered a going concern in accounting. Going concern is an accounting https://1investing.in/ assumption that businesses follow as part of Generally Accepted Accounting Principles while drawing up their financial statements and reports. An adverse opinion states that the financial statements do not present fairly (or give a true and fair view).

This assumption is in return verified by the auditor while auditing the financial accounts of the organization. The auditor will consider the adequacy of the disclosures made in the financial statements by management. The Material Uncertainty Related to Going Concern section will follow the Basis for Opinion paragraph and will cross-reference to the relevant disclosure in the financial statements. It will also state that the auditor’s opinion is not modified in respect of this matter.

When management becomes aware of material uncertainties related to events or conditions that may cast significant doubt on the company’s ability to continue as a going concern, those uncertainties must be disclosed in the financial statements. The terms ‘material uncertainties’ and ‘significant doubt’ are important – this standard phrasing is expected to be used in the basis of preparation note to the financial statements. Disclosures of material uncertainties that may cast doubt on a company’s ability to continue as a going concern as well as significant judgments involved in close-call scenarios may be more frequent as a result of COVID-19, given the continued economic uncertainty.

In a few words, the going concern concept implies that the business will be carried on for a foreseeable future and thus give a realistic picture of the business from a long term view. When an asset is purchased, the organization plans to use it and reap benefits for more than a year, however, the expenditure for the same is to be incurred in the year of purchase. In the present year, the management has decided to shut down its export business as continuing the same would only entail in resultant losses and thus not viable.

The concept requires disclosing the going concern aspect of the business and accordingly account for all the financial transactions from a long term perspective of the business. This concept not only helps in a systematic approach to the recording of the financial transactions but it also provides a fair idea about the business, growth and financial stability of the company. Even if the company’s future is questionable and its status as a going concern appears to be in question – e.g. there are potential catalysts that could raise significant concerns – the company’s financials should still be prepared on a going concern basis.

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