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. Some or all of the services described herein may not be permissible for KPMG audit clients and their affiliates or related entities.The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future.
The going concern principle
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Accountants may also employ going concern principles to determine how a company should proceed with any sales of assets, reduction of expenses, or shifts to other products. 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 valuation of companies in need of restructuring values a company as a collection of assets, which serves as the basis of the liquidation value. The reason the going concern assumption bears such importance in financial reporting is that it validates the use of historical cost accounting. Economic uncertainty has been prevalent in global markets over the last several years due to many unexpected macro events – from COVID-19 and the related supply chain disruptions to international conflicts and rising interest rates. While some companies thrive from uncertainty, others may see their financial performance, liquidity and cash flow projections negatively impacted.
In accrual accounting, the financial statements are prepared under the going concern assumption, i.e. the company will remain operating into the foreseeable future, which is formally defined as the next twelve months at a bare minimum. Going concern is an accounting term used to identify whether a company is likely to survive the next year. 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. A company may not be a going concern for a number of reasons, and management must disclose the reason why.
The presumption of going concern for the business implies the basic declaration of intention to keep operating its activities at least for the next year, which is a basic assumption for preparing financial statements that comprehend the conceptual framework of the IFRS. 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. However, generally accepted auditing standards (GAAS) do instruct an auditor regarding the consideration of an entity’s ability to continue as a going concern. 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]).
This presumption may be challenged at any time, but especially during uncertain economic times. Going concern is an accounting term for a company that has the resources needed to continue operating indefinitely until it provides evidence to the contrary. This term also refers to a company’s ability to make enough money to stay afloat or to avoid bankruptcy. If a business is not a going concern, it means it’s gone bankrupt and its assets were liquidated. As an example, many dot-coms are no longer going concern companies after the tech bust in the late 1990s. The going concern principle is the assumption that an entity will remain in business for the foreseeable future.
Going Concern Assumption
Without it, business would not offer nearly as much credit sales as suppliers, vendors, and other companies may not pay the company if there is little belief these companies will survive. One of larger repercussions of not being a going concern are potential credit challenges. New lenders will likely be reluctant to issue new credit, or any new credit issued will be prohibitively expensive. This credit crunch may trickle down to suppliers who may be unwilling to sell raw materials or inventory goods on credit. Accountants who view a company as a going concern generally believe a firm uses its assets wisely and does not have to liquidate anything.
An overview discussion of going concern assessments and financial reporting implications. The ever-evolving complexities attributable to economic uncertainty may disrupt business as usual. When forecasting becomes less reliable and the past no longer predicts the future, the going concern assessment becomes much harder to document and update, and robust disclosures much more critical.
Red Flags Indicating a Business Is Not a Going Concern
They cost principle example can help business review their internal risk management along with other internal controls. 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. Conditions that lead to substantial doubt about a going concern include negative trends in operating results, continuous losses from one period to the next, loan defaults, lawsuits against a company, and denial of credit by suppliers.
The going-concern value of a company is typically much higher than its liquidation value because it includes intangible assets and customer loyalty as well as any potential for future returns. The liquidation value of a company will even be lower than the value of the company’s tangible assets, because the company may have to sell off its tangible assets at a discount—often, a deep discount—in order to liquidate them before ceasing operations. Examples of tangible assets that might be sold at a loss include equipment, unsold inventory, real estate, vehicles, patents, and other intellectual property (IP), furniture, and fixtures. The going concern presumption that an entity will be able to meet its obligations when they become due is foundational to financial reporting.
Going concern value is a value that assumes the company will remain in business indefinitely and continue to be profitable. This differs from the value that would be realized if its assets were liquidated—the liquidation value—because an ongoing operation has the ability to continue to earn a profit, which contributes to its value. A company should always be considered a going concern unless there is a good reason to believe that it will be going out of business. 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.
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- This credit crunch may trickle down to suppliers who may be unwilling to sell raw materials or inventory goods on credit.
- This latest edition includes illustrative application of going concern’s most significant complexities.
- There are also a number of quantifiable, measurable indicators that auditors use to measure going concern.
- Going concern is not officially included in the generally accepted accounting principles (GAAP) but some instruction is included in the generally accepted auditing standards (GAAS).
- 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.
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. Management must also identify the basis in which the financial statements are prepared and often disclose these financial reports with an audit report with a going concern opinion.
A going concern is often good as it means a company is more likely than not to survive for the next year. When a company does not meet the going concern criteria, it means that a company may not have the resources needed to operate over the next 12 months. There are also a number of quantifiable, measurable indicators that auditors use to measure going concern. Companies with low liquidity ratios, high employee turnover, or decreasing market share are more likely to not be a going concern.
