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.
With this assumption, an accountant can defer the recognition of specific expenses until a later accounting period, when the company will probably still be operating and utilizing its assets in the most efficient way possible.
A company is thought to be a going concern in the absence of noteworthy information. 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.
In the event, an accountant accepts that a company is no longer going to be a going concern, this raises the issue of whether its assets are impaired, which may require the write-down of their cost to their liquidation value. Along these lines, the value of a company that is thought to be a going concern is higher than its breakup value since a going concern can possibly keep on earning profits.
Assumptions of the Going Concern Concept
The concept is based on the assumption that the business will continue to operate endlessly until there is an event that may bring about its liquidation. So, to make this assumption work, there are some factors which are assumed to be taken care of, such as:
- Demand for the Product or Service: It is assumed that there will be an interest in the goods or services the company offers. The concept assumes that the company will continue to sell its product and build its consumer base, all the while it grows.
- Profitability: One assumption involves the profitability aspect of the business. Even if the business is, currently, making losses, there is an expectation that the business will be profitable in the long-term and will grow every year.
- No Change in Law and Statute: Another assumption is that the law that is administering the business and it’s model remain unchanged and continue to be positive for the business and its growth.
Examples of Going Concern
- XYZ Limited manufactures a special chemical that it then markets and sells. Suddenly, the US government imposes a ban on the manufacture, export, import, and sale of this special chemical in the country. If this chemical is the only product that XYZ Limited creates, then the company will no longer be a going concern.
- A state-owned company is in a tough financial situation and is struggling to pay its debt. The government gives the company a bailout and guarantees all payments to its creditors. The state-owned company is a going concern despite its poor financial position.
Advantages of Going Concern Concept
There are several advantages of the going concern concept:
- Companies undertake the substantial purchase of fixed assets in the initial years which involve immediate expenditure, however, the benefit of the asset is spread out throughout its life, which is usually more than a year. The concept recognizes recording of such costs over the life of the assets.
- It accommodates bifurcation of assets and liabilities as short term, 12-month period, and long term, usually more than 12 months, also ingraining confidence in the company that it will continue to function in the future.
- It is the basis on which income or profits are recorded over the years in which they pertain to.
- The assets and liabilities are recorded at cost in order to show the security of the company and that it does not operate as a means to liquidate its assets and liabilities but is committed to continuous long-term growth and expansion.
Disadvantages of Going Concern Concept
The going concern concept does come with downsides and limitations:
- The financial reports are prepared at cost and not at its current market value. In the event of liquidation of the company due to any unforeseen circumstance, the financial statements are then brought to their current market value. However, these figures may differ greatly from the ones prepared at cost.
- In case of the business shutting down its operations, the financial statements are drawn on-going concern basis. This may lead to incorrect information being depicted and as a result, mislead all the relevant stakeholders involved.
- Any change in law may affect the business and the idea of going concern may not be practical for the organization and would bring about abrupt and prompt solutions when recording financial transactions.
Instructions for an Auditor
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.
The auditor assesses a company’s capacity to proceed as a going concern for a period not more than one year following the date of the financial reports being audited.
On the off chance that there is an issue, the audit firm should qualify its audit report with a statement about the issue.
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 agree 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.
To sum it all up, the going concern concept implies that the business will continue for the foreseeable future and thus give a more realistic image of the business from a long-term view.
The concept is an internationally recognized accounting principle that businesses follow. 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.
This concept not only helps build a more systematic approach to the recording of the financial information, but it also provides a reasonable understanding of the business, its growth and long-term financial stability.