Accounting Concept: Going Concern

Overview

The going concern principle plays one of the key roles in accounting and auditing. The term assumption is closely related to this concept. Its idea is that when forming the accounting and reporting methodology, we do not take into account the finiteness of the existence of the enterprise, we assume that it will always (or, at least in the near foreseeable future) function normally, that is, it will not close and will not significantly shorten its activities. This is precisely the going concern assumption since it is quite obvious that any business will sooner or later be closed.

The principle of continuity, as it is also known, directly determines the accounting of the financial result of an enterprise. If the management intends to liquidate the entity by ceasing its further presence on the market or the entity has no other alternative, a different basis for the preparation with the disclosure of this fact in the statements should be used.

In assessing the possibility of making the going concern assumption, management considers all available information about the future, considering at least a period of twelve months after the end of the reporting period. The depth of analysis depends on the specific facts in each case.

If an entity has been profitable for many years and has easy access to financial resources, a conclusion about the appropriateness of using such an assumption can be made without detailed analysis. In other circumstances, management may need to analyze a wide range of factors related to current and future profitability, debt repayment schedules, and potential refinancing sources.

Accounting Concept: Going Concern

Application in accounting

The main idea behind this concept is clear to any accountant – the correct reflection of the value of assets and liabilities in the Balance sheet (as well as the Income statement) is possible only under certain assumptions. In particular, both preparers and users of these documents assume that the entity intends to continue making its goods and/or providing its services as far as it is possible to predict.

At the same time, it is impossible to determine the profit received by the owners for the entire period of the company’s existence if it will exist permanently. Profit can be calculated only for a conditionally limited period of time – the reporting period. The going concern concept, hence, is closely related to the matching principle. We attribute the expenses and the resulting income as relating to a specific reporting period.

Should the accounting reports reflect in some way that such assumption cannot and should not be made? The most obvious thing is that the reporting should reflect the change in the structure of expenses and revenue, as well as (in most cases) the value of the assets owned by the business. Consequently, a different basis should be used for accounting and report compilation.

IFRS does not disclose what is meant by a different basis, except for a brief explanation in IFRS 5. It can only be assumed that in this case the company should disclose information about non-compliance with the principle of going concern and indicate that all assets and liabilities are revalued on the assumption that the company will cease operations within one year (or another period determined by the company). The GAAP has a little more guidance and companies are told to add disclosures to the reports.

Application in auditing

An important part of going concern assessment is the interaction with the company’s auditor. Auditors pay particular attention to sections of the financial statements and their preparation processes, which are based primarily on the judgment of the company’s management.

The auditor’s opinion on the continuity of the company’s existence and the compliance of the statements presented by it with this concept should express confidence that the audited entity will not stop its activities and will not significantly reduce its volumes during the next reporting period.

This statement by the auditors retains the role of the basis for making forecasts for the accounts they confirm. The auditor’s opinion on compliance with the going concern principle regarding the real state of affairs in the company instills confidence that the statements present a reliable picture of the financial position of the company and there is a possibility to cooperate with it on the long-term basis.

Why does it matter?

In the course of its activities, businesses are exposed to the unfavorable influence of internal and external factors that can cause the termination or significant reduction of their activities. Statistics confirm the fact that a number of businesses cease their activities, including due to insolvency. One of the most important aspects for the purposes of accounting and reporting, in this case, is the observance of the principle of going concern of the organization.

It is important for investors to correctly assess financial data for given periods of time, taking into account uncertain future events. Investors and analysts build their models based on the company’s current financial data, adjusted for strategic management decisions. Investors want information about what might change their assumptions and what might worsen underlying operating trends.

This is why going concern disclosure is so important to investors – it is in this disclosure that a company warns of potentially significant risks that it may face in the future. Investors would like to see a warning about likely negative events, an assessment of their impact on the company’s activities, and the measures that need to be taken to avoid negative consequences.

Accounting Concept: Going Concern

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