Going Concern

Definition

Going concern is an accounting principle that assumes a business will continue its operations indefinitely, without the intention or necessity of liquidation. This assumption is fundamental to the preparation of financial statements, as it affects the valuation of assets and liabilities and informs how financial information is presented. If there are doubts about a company’s ability to continue as a going concern, it can lead to significant implications for investors, creditors, and the overall financial reporting process.

5 Must Know Facts For Your Next Test

1. The going concern assumption is critical for preparing financial statements under both IFRS and GAAP, as it influences how assets are valued and reported.
2. If management identifies substantial doubt about a company's ability to continue as a going concern for at least one year, they must disclose this uncertainty in the financial statements.
3. The assessment of going concern is typically conducted annually or when significant events occur that could affect the company's viability.
4. If a business is not deemed a going concern, its assets may need to be valued at liquidation value rather than fair market value, affecting reported financial results.
5. Auditors are required to evaluate whether there are any indicators that cast doubt on a company's ability to continue as a going concern when conducting their audit.

Review Questions

• How does the going concern assumption influence the preparation of financial statements?
  • The going concern assumption impacts the way assets and liabilities are valued in financial statements. When a company is considered a going concern, assets are reported at their expected value in ongoing operations, whereas if there are concerns about its viability, assets may need to be reported at liquidation values. This difference can significantly alter the perceived financial health of the company and inform stakeholders' decisions.
• What steps must management take if they have doubts about their company's ability to continue as a going concern?
  • If management has substantial doubts regarding the company's ability to continue as a going concern, they must assess the situation thoroughly and disclose this uncertainty in the financial statements. They should also evaluate their plans to mitigate these risks, including operational changes or financing strategies. Proper disclosure ensures transparency for investors and other stakeholders regarding potential risks affecting the company's future.
• Evaluate how an auditor determines whether there is substantial doubt about an entity's ability to continue as a going concern, and discuss the implications for financial reporting.
  • An auditor assesses various indicators such as negative cash flows, loan defaults, or management's plans for future actions when determining if there is substantial doubt about an entity's ability to continue as a going concern. If such doubts exist, auditors may issue a qualified opinion or emphasize a paragraph in their report. This evaluation impacts financial reporting by necessitating disclosures that inform stakeholders of potential risks related to the entity's ongoing viability, thereby influencing investment and lending decisions.

Related terms

Liquidation: The process of winding up a company's operations, selling its assets, and distributing the proceeds to creditors and shareholders.

Financial Reporting: The process of preparing and presenting financial statements that provide information about a company's financial performance and position.

Audit Opinion: A statement issued by an auditor indicating whether the financial statements of a company are free from material misstatements and prepared in accordance with applicable accounting standards.