What is the Going Concern Assumption? Definition Meaning Example

When faced with such a requirement, candidates must be careful not to produce a list of generic audit procedures, but instead identify and highlight the factors from the scenario that may call into question the entity’s ability to continue as a going concern. Once these factors have been identified, candidates should then be able to think about the procedures the auditor may adopt to establish whether the factors mean the going concern basis of accounting is appropriate in the circumstances, or not. If an auditor issues a negative going concern opinion in the annual report, investors may have second thoughts about holding the stock of the company. A business valuation may be performed on the business in order to determine what it is actually worth. Management typically develops plans to address going concern uncertainties – e.g. refinancing of debt, renegotiating breached covenants, and sale of assets to generate sufficient liquidity to continue to meet its obligations as they fall due. IFRS Standards do not prescribe how management should evaluate its plans to mitigate the effects of these events or conditions in the going concern assessment.

  1. We also know that the employment activities performed by an employee of a company are considered an expense, in this case a salary expense.
  2. 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.
  3. Understanding how and why auditors make going concern determinations can help you figure out which deals are worth it.
  4. It will also state that the auditor’s opinion is not modified in respect of this matter.

It is essential that candidates preparing for the Audit and Assurance (AA) exam understand the respective responsibilities of auditors and management regarding going concern. This article discusses these responsibilities, as well as the indicators that could highlight where an entity may not be a going concern, and the reporting aspects relating to nonprofit fraud prevention going concern. 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.

The concept of going concern is particularly relevant in times of economic difficulties and in some situations management may determine that a profitable company may not be a going concern, for example because of significant cash flow difficulties. 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. A going concern, also known as a going concern assumption or going concern principle, is an accounting assumption stating that a business will stay in operation for the foreseeable future. In essence, that means that there is no threat of liquidation for the foreseeable future, which is usually perceived as a period of time lasting for 12 months. When the financial statements are prepared for the annual report, it is the job of the Board of Directors to decide if the company is still a going concern. The Board must put this information into the footnotes included in the financial statements and state any factors that may threaten that status.

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. Management’s plans are ignored under Step 1, but considered under Step 2, to determine if they alleviate the substantial doubt raised in Step 1. Before an auditor issues a going concern qualification, company leadership will be given an opportunity to create a plan to take corrective actions that can improve the outlook for the business. If the auditor determines the plan can be executed and mitigates concerns about the business, then a qualified opinion will not be issued.

Established by the Financial Accounting Standards Board (FASB) and the Governmental Accounting Standards Board (GASB), GAAP is a set of standardized accounting rules, requirements, and practices to guide how financial statements are prepared and presented. Any entity (i.e., for-profit companies, non-profits, and government entities) that publicly releases financial statements is required to adhere to the GAAP principles and procedures. Consequently, it is important to be aware that a company would need to provide additional information in its financial statements if it does not expect to be able to fulfil its obligations in the coming year. The periodicity assumption, often referred to as the time period assumption, means that the entity has to report on its financial position, cash flows, and results of operations on a regular basis.

US GAAP includes a two-step process that first determines whether substantial doubt about the company’s ability to continue as a going concern is raised. If substantial doubt is raised, management then assesses whether that substantial doubt is alleviated by management’s plans. Unlike IFRS Standards, if substantial doubt is raised in Step 1 about the company’s ability to continue as a going concern, the extent of disclosure depends on the outcome of Step 2 and whether that doubt is alleviated by management’s plans. A going concern is an accounting term for a business that is assumed will meet its financial obligations when they become due. It functions without the threat of liquidation for the foreseeable future, which is usually regarded as at least the next 12 months or the specified accounting period (the longer of the two).

Understanding GAAP rules

To ensure comparability over time, the reporting must be provided consistently for the same time periods. Entities usually provide periodic reporting on at least a quarterly and annual basis. The use of the principles, assumptions, and concepts in relation to the preparation of financial statements is better understood when looking at the full accounting cycle and its relation to the detailed process required to record business activities (Figure 3.2).

For example, if the company expects to lose a major customer in 15 months from the reporting date, it may be necessary to extend the look-forward period up to at least March 31, 20X2. Going concern is important because it is a signal of trust about the longevity and future of a company. 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. Going concern is an example of conservatism where entities must take a less aggressive approach to financial reporting. Often, management will be incentivized to downplay the risks and focus on its plans to mitigate the conditional events – which is understandable given their duties to uphold the valuation (i.e. share price) of the company – yet the facts must still be disclosed. More specifically, companies are obligated to disclose the risks and potential events that could impede their ability to operate and cause them to undergo liquidation (i.e. be forced out of business).

Going Concern Assumption

This makes it easy for a parent company to ensure that its subsidiaries are always classified as going concerns. “As an example, a fixed asset purchased for $50,000 in 2018 would be valued today at historical cost less accumulated depreciation in the balance sheet. The economic entity assumption requires that business owners keep their personal transactions separate and do not mix them with the activities of the business. This can sometimes prove especially challenging for small and family-owned businesses. We define an asset to be a resource that a company owns that has an economic value. We also know that the employment activities performed by an employee of a company are considered an expense, in this case a salary expense.

Disclosure of a going concern qualification

PPC’s Guide to Cash, Tax, and Other Bases of Accounting gives you clear guidance on financial statements prepared using a special purpose framework. As we can see from this expanded accounting equation, Assets accounts increase on the debit side and decrease on the credit side. This becomes easier to understand as you become familiar with the normal balance of an account. If management does have a plan to sell assets, seek additional financing, start selling a new gizmo, or raise money with new stock issuances, you’ll need to evaluate it. Auditors are required to be conservative, so it is certainly possible, although unlikely, that the plan will work.

Company

That means the auditor could determine that the business you’re evaluating is likely to continue operating as a going concern even if there are substantial problems. Management’s plan could include borrowing more money to kick the can down the road, selling assets or subsidiaries to raise cash, raising money through new capital contributions, or reducing or delaying planned expenses. An entity has borrowings of $10m which became immediately repayable in full on 31 March 20X2.

By making this assumption, the accountant is justified in deferring the recognition of certain expenses until a later period, when the entity will presumably still be in business and using its assets in the most effective manner possible. Therefore, when serving business clients, it is important that accounting professionals have the right framework to ensure that proper financial reporting procedures are in place to help with accounting assumptions. As you also learned in Introduction to Financial Statements, https://simple-accounting.org/ the accounting equation represents the balance sheet and shows the relationship between assets, liabilities, and owners’ equity (for sole proprietorships/individuals) or common stock (for companies). In Introduction to Financial Statements, we addressed the owner’s value in the firm as capital or owner’s equity. The primary reason for this distinction is that the typical company can have several to thousands of owners, and the financial statements for corporations require a greater amount of complexity.

Since the company has provided the service, it would recognize the revenue as earned, even though cash has yet to be collected. There are situations that may arise when the auditor may request management to make an assessment, or extend their original assessment of going concern. If management refuse to make, or extend, an assessment of going concern the auditor will consider the implications for the report. 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.

This concept ignores any change in the purchasing power of the dollar due to inflation. Once an asset is recorded on the books, the value of that asset must remain at its historical cost, even if its value in the market changes. She believes this is a bargain and perceives the value to be more at $60,000 in the current market. Even though Lynn feels the equipment is worth $60,000, she may only record the cost she paid for the equipment of $40,000. Get step-by-step guidance on how to invest in Tesla stock and learn the ins and outs of this electric vehicle company.

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