Going Concern Concept Definition, Explanation Examples and Importance

Regardless of its weak financial standing, the National Company is still considered a going concern. An organization produces a compound called Chemical X. Unexpectedly, the federal government imposes a limitation on the production, export, import, sale, and marketing of this compound in the country. This is because it would make it impossible for the business to carry out its present contractual commitments or to use its resources according to a predetermined plan of operation. At this stage, it may also be necessary to take account of all legal obligations that may not have been previously brought to books.

After the FASB updated its guidance on the going concern assessment, the Auditing Standards Board (ASB) unanimously voted to issue a final going concern standard. The ASB’s Statement on Auditing Standards (SAS) No. 132, The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern, was designed to promote consistency between the auditing standards and accounting guidance under U.S. After management identifies that a going concern issue exists, it should consider whether any mitigating plans will alleviate the substantial doubt. Examples of corrective actions include plans to raise equity, borrow money, restructure debt, cut costs, or dispose of an asset or business line.

Going Concern Principle in Accounting: Definition & Example

This credit crunch may trickle down to suppliers who may be unwilling to sell raw materials or inventory goods on credit. Entity is considered a going concern if it is considered capable of continuing its operation for the foreseeable future and is not expected to go out of business unless an evidence proves otherwise. If there is an issue, the audit firm must qualify its audit report with a statement about the problem. If a company’s liquidation value – how much its assets can be sold for and converted into cash – exceeds its going concern value, it’s in the best interests of its stakeholders for the company to proceed with the liquidation. In particular, around three-quarters (~75%) of the total implied value from a DCF model can typically be attributable to the terminal value, which assumes the company will remain growing at a perpetual rate into the far future.

• The concept of going concern states that all records are made on the assumption that the business will continue for the foreseeable future.
• Here, it should also be noted that the assumption is not made that the business will be profitable throughout its existence.
• An example of the application of going concern concept of accounting is the computation of depreciation on the basis of expected economic life of fixed assets rather than their current market value.
• There has been a misconception that only the publicly traded business should adhere to the going concern.
• Under GAAP standards, companies are required to disclose material information that enables their viewers – in particular, its shareholders, lenders, etc. – to understand the true financial health of the company.
• As an accounting principle, the going concern principle serves as a guideline which allows readers of a business’s financial statements to assume that the business will continue to operate long enough to carry out its current obligations, objectives and commitments.

This assumption also provides some justification for accountants to follow the cost principle. As an accounting principle, the going concern principle serves as a guideline which allows readers of a business’s financial statements to assume that the business will continue to operate long enough to carry out its current obligations, objectives and commitments. 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.

Footnotes (AS 2415 – Consideration of an Entity’s Ability to Continue as a Going Concern):

When you hit the ‘on,’ button, your expectation was that the vacuum would power to life, because you had no evidence that it wouldn’t. You didn’t have to leave the vacuum on 24/7 for it to be considered an operational vacuum; if you left it in your closet and never used it, you would assume that it was still in working condition until the day you took it out and found it no longer worked. In order for a company to be a going concern, it usually needs to be able to operate with a significant debt restructuring or massive financing overhaul. Therefore, it may be noted that companies that are not a going concern may need external financing, restructuring, asset liquidation, or be acquired by a more profitable entity.

In the absence of evidence to the contrary, an entity is viewed in operation indefinitely. 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. Moreover, relative valuation such as comparable company analysis and precedent transactions value companies based on how similar companies are priced.

Consideration of Financial Statement Effects

Without the going concern principle, businesses would be forced to wind down operations and liquidate their assets immediately upon experiencing financial problems. If a company is not a going concern, the company may be revalued at the request of investors, shareholders, https://www.bookstime.com/ or the board. This revaluation may be used to price the company for acquisition or to seek out a private investor. There are often certain accounting measures that must be taken to write down the value of the company on the business’s financial reports.

When using the going concern method, businesses can step up to their profits or losses by transfers to equity account. If the net income is zero or negative, it may be better for a company not to report any figures at all. This will help prevent the investors from getting pessimistic forecasts about future losses. The business is not a going concern as, according to the available evidence, it will not be able to continue its operations for a long time in the future. For this reason, for purposes of accounting, business enterprises are presumed to carry on their operations indefinitely until such time as they are in fact liquidated.

Instructions for an Auditor

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. The underlying article Going Concern Concept Example DEPICTS a fundamental principle in https://www.bookstime.com/articles/going-concern accounting that assumes a business will continue to operate for the foreseeable future. This principle is based on the belief that the business will NOT be forced to liquidate its assets or cease operations due to financial difficulties or other factors.