Going Concern Assumption Definition, Accounting Principle Explained

After conducting a thorough review (audit) of the business’s financials, the auditor will provide a report with their assessment. 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 valuation of a company is important from the shareholders’ and investors’ perspective.

This assumption allows businesses to continue operating without needing to be liquidated or wound down in the event of financial difficulty. However, a sizeable portion of investors in the market utilize DCF models or at least take the fundamentals of the company into consideration (e.g. free cash flows, profit margins), so comps take into account these factors, too – just indirectly as opposed to explicitly. Often, management will be incentivized to downplay the risks and focus on its plans to https://www.bookstime.com/articles/going-concern 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. 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. A financial auditor is hired by a business to evaluate whether its assessment of going concern is accurate.

Why is the Going concern principle important?

It may be necessary to obtain additional information about such conditions and events, as well as the appropriate evidential matter to support information that mitigates the auditor’s doubt. Continuation of an entity as a going concern is assumed in financial reporting in the absence of significant information to the contrary. A going concern is an accounting term for a business that is assumed will meet its financial obligations when they become due.

• The threat of receiving a negative going concern opinion may motivate management to go “opinion shopping,” as was alluded to in the WorldCom and Enron business failures.
• Going concern is an accounting term used to identify whether a company is likely to survive the next year.
• If it’s determined that the business is stable, financial statements are prepared using the going concern basis of accounting.
• It may be valued using the discounted cash flow (DCF) method, with the assumption of future profitability.
• 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.

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. 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. It assumes that the entity will continue to remain in business for the foreseeable future. Conversely, it also means that the entity does not plan to, or expect to be forced to, liquidate its assets. Under this accounting principle, it defers revenue and expenses according to other principles of accounting.

Assumptions of the Going Concern Concept

If a business is not a going concern, it means it’s gone bankrupt and its assets were liquidated. As an example, many dot-coms are no longer going concern companies after the tech bust in the late 1990s. Unless it is categorically stated otherwise, all accounting records and income statements or balance sheets are prepared on the assumption that the business will continue to function for an indefinite future period. The financial statements (i.e., profit and loss account and balance sheet) are also prepared under this assumption, as this concept leads to a distinction being made between capital and revenue expenditures. Every business aims to remain in operation for an indefinite time, hence the high energy at the starting point.

Professionals agree that the new requirements relating to going concern evaluation and disclosure provide a critical improvement to the financial statements taken as a whole. The improvements provide for a more complete and accurate picture to financial statement users on a company’s financial health. A company’s financial statement will now be more comparable to another company’s financial statements and investors will have more confidence that going concern risk is being sufficiently addressed. After many years of working through feedback, it appears that the board has finally established proper guidance in this area.

What is a Partnership Capital Account?

Thus, the value of an entity that is assumed to be a going concern is higher than its breakup value, since a going concern can potentially continue to earn profits. A company may not be a going concern based on the financial position on either its income statement or balance sheet. For example, a company’s annual expenses may so vastly outweigh its revenue that it can’t reasonably make a profit. On the other hand, a company may be operating at a profit buts its long-term liabilities are coming due and not enough money is being made. If the accountant believes that an entity may no longer be a going concern, then this brings up the issue of whether its assets are impaired, which may call for the write-down of their carrying amount to their liquidation value. The government comes forward to give a bailout to the company and announces a guarantee of all payments to creditors.

• If there are still some assets that are still in use, these must be transferred to the new owner or sold with appropriate adjustments.
• In general, an auditor examines a company’s financial statements to see if it can continue as a going concern for one year following the time of an audit.
• It may be necessary to obtain additional information about such conditions and events, as well as the appropriate evidential matter to support information that mitigates the auditor’s doubt.
• The auditor is required to disclose any negative trends in the company’s business operations.
• This term also refers to a company’s ability to make enough money to stay afloat or to avoid bankruptcy.
• A firm’s inability to meet its obligations without substantial restructuring or selling of assets may also indicate it is not a going concern.
• The more controversial issue the board discussed was the how i.e. the actual evaluation of substantial doubt.

The Financial Accounting Standards Board (FASB) has been in deliberation for a period of time regarding the guidelines for preparers of financial statements related to the going concern matter. In 2008, there was an initiative to require entities to incorporate specific provisions with regard to financial reporting when an entity’s future is of suspect, and the FASB issued an exposure draft to provide entities with guidance in this area. This exposure draft attempted to reconcile guidelines from both Generally Accepted Auditing Standards (US GAAS) and International Financial Reporting Standards (IFRS). The going concern concept is a key assumption under generally accepted accounting principles, or GAAP. It can determine how financial statements are prepared, influence the stock price of a publicly traded company and affect whether a business can be approved for a loan.