Going Concern

Definition

Going concern refers to the assumption that a company will continue its operations in the foreseeable future, typically defined as at least the next 12 months. This concept is fundamental to accounting and financial reporting, as it influences how assets and liabilities are valued, and whether they are classified as current or non-current. A going concern assumption impacts the auditor's evaluation of financial statements, especially regarding the company's ability to meet its obligations and sustain operations.

5 Must Know Facts For Your Next Test

1. The going concern assumption is crucial for preparing accurate financial statements, as it affects how assets and liabilities are recognized and measured.
2. If there are doubts about a company's ability to continue as a going concern, auditors are required to disclose this uncertainty in their reports.
3. Indicators of potential going concern issues include recurring losses, negative cash flow, and significant debt obligations that cannot be met.
4. Management is responsible for assessing the company's ability to continue as a going concern and must regularly evaluate relevant factors such as market conditions and operational performance.
5. In cases where a company is not considered a going concern, financial statements must be prepared under liquidation accounting principles, impacting asset valuations significantly.

Review Questions

• How does the going concern assumption influence the financial reporting of a company?
  • The going concern assumption significantly influences financial reporting by affecting the way assets and liabilities are valued. When a company is assumed to be operating indefinitely, its assets can be reported at historical cost or fair value. However, if there are doubts about the company's future viability, it may need to revalue its assets based on liquidation values, which could present a much less favorable picture of its financial health.
• What are the auditor's responsibilities regarding the going concern assumption during an audit?
  • During an audit, auditors are responsible for evaluating whether there are any indicators that suggest the company may not continue as a going concern for at least 12 months from the audit report date. If such indicators exist, auditors must assess management’s plans to mitigate these issues and consider whether sufficient disclosures have been made in the financial statements. The auditor’s report must clearly communicate any concerns regarding the company's ability to continue operations.
• Evaluate the impact of failing to appropriately assess and disclose going concern issues on stakeholders' decisions.
  • Failing to assess and disclose going concern issues can have serious implications for stakeholders, including investors, creditors, and employees. If stakeholders are unaware of potential financial distress or operational challenges, they may make decisions based on inaccurate information, such as investing in or lending money to a failing company. This lack of transparency can lead to significant financial losses and damage trust in financial reporting. Therefore, proper assessment and disclosure are essential for informed decision-making by all parties involved.

Related terms

Liquidation: The process of winding up a company's affairs, selling off assets to pay creditors, which occurs when a company is unable to continue as a going concern.

Auditor's Report: A formal opinion issued by an auditor on the accuracy and fairness of a company's financial statements, which may include considerations of the going concern assumption.

Financial Distress: A condition where a company cannot meet or has difficulty paying off its financial obligations, raising concerns about its ability to continue as a going concern.