What is the Going Concern Concept? Definition & Significance

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. Management should critically assess the disclosure requirements of IAS 1 and consider drafting required disclosure language early in the financial reporting process. The assumption underlying the going concern concept is that an entity will continue operations, which must be the foundation on which accountants construct financial statements. In preparing their financial statements, therefore, accountants assume that the assets and liabilities of the entity will continue to be relevant for some separate time. This enables a company to depreciate its assets and amortize its costs, thereby communicating its financial performance that reflects the long-run survival of the entity. The going concern principle has significant implications for financial reporting, including the valuation of assets, liabilities, and the presentation of financial statements.

Limitations of Going Concern Concept

• It could tell us whether the company has any cash problems in the next twelve months or not.
• Proper business foresight and operational efficiency are required for a company to sustain and stay profitable for a longer term.
• Liabilities are recognized based on contractual obligations, and the assumption is that the company will fulfill these obligations as part of its ongoing operations.
• If an accountant has reason to doubt the ability of a business to continue as a going concern and meet its obligations and protect its assets, they are duty-bound to include this in their audit report.
• 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.

We shall investigate in this blog what the going concern notion entails, why it matters, how it affects financial decisions, and what happens when it loses relevance. 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. Their assessment adds an additional layer of credibility to the company’s financial statements.

What consequences can arise for the auditor’s opinion if facts that threaten the continued existence of the company?

Preparers will need to determine an appropriate basis that provides relevant information that faithfully represents the non-going concern circumstances of the entity. A careful review of the entity’s accounting policies will be needed to ensure that all of its material accounting policies are disclosed. Some accounting policies may become material as a consequence of preparing the financial statements on a basis other than going concern. Unlike IFRS Standards, the going concern assessment is performed for a finite period of 12 months from the date the financial statements are issued (or available to be issued for nonpublic entities).

Going concern: IFRS® Standards compared to US GAAP

Disclosures are required if events and circumstances raise substantial doubt about the entity’s ability to continue as a going concern. Although the terminology varies slightly, both GAAPs share the same objective of informing users of the financial statements early about the company’s potential financial difficulties. The going concern principle, also known as the going concern assumption, is an accounting concept that assumes a company will continue its operations and going concern remain in business for the foreseeable future. This principle forms the foundation for preparing financial statements under the presumption that the entity will continue its normal operations, meet its obligations, and realize its assets. In essence, it assumes that the company is not in the process of liquidation or facing imminent financial distress. There are several indicators that may raise doubt about an entity’s ability to continue as a going concern.

• If management has significant concerns about the entity’s ability to continue, these must be disclosed in the financial statements.
• It is important that candidates understand that it is the responsibility of management to make an assessment of whether the use of the going concern basis of accounting is appropriate, or not, when they are preparing the financial statements.
• Certain accounting measures must be taken to write down the value of the company on the business’s financial reports.
• 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.
• If no assurance was given on how long a business would be around, this could make operations difficult for everyone involved.

• The assumption that a business is expected to continue in future affects the timing, nature and amount on which accounting transactions are recorded.
• 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.
• The financial statements, including the income statement, balance sheet, and cash flow statement, are prepared assuming that XYZ Manufacturing will continue its operations into the foreseeable future.
• Management must actively address any “going concern” issues by developing and implementing plans to overcome financial difficulties.
• Understanding this principle is vital for students preparing for ACCA, CMA, or CFA exams, as it underpins various accounting standards and influences decision-making, audit judgments, and financial reporting reliability.
• For instance, if the management takes the view that the company will recover from its financial troubles and it doesn’t, the financial report may not be indicating the real state of affairs regarding the company’s going concern status.

The evaluation of whether an entity can be considered a going concern is a nuanced process, involving both qualitative and quantitative analysis. This assessment is crucial as it determines the approach to financial reporting and provides insights into the entity’s future prospects. In accounting, the Accounting Periods and Methods going concern concept implies that financial statements are prepared with the assumption that a business will remain operational and meet its obligations in the normal course of business.

For instance, consistent losses exceeding revenue could indicate an unsustainable business model or poor cost management. Beyond compliance, the principle fosters transparency and trust among stakeholders, including investors, creditors, and regulators. By adhering to the going concern assumption, businesses provide a consistent basis for evaluating financial performance, which is especially relevant in industries exposed to rapid change or economic volatility. 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. Accounting standards determine what a company must disclose on its financial statements if there are doubts about its ability to continue Medical Billing Process as a going concern.