Going Concern Principle

Definition

The going concern principle is an accounting concept that assumes a business will continue to operate indefinitely, without the need to liquidate or significantly curtail its operations. This principle is fundamental to the economic basis for accrual accounting, as it allows for the proper matching of revenues and expenses over time.

5 Must Know Facts For Your Next Test

1. The going concern principle allows for the deferral of certain expenses and the recognition of revenue before cash is received.
2. It enables the use of historical cost accounting, where assets are recorded at their original purchase price rather than current market value.
3. The going concern principle is a fundamental assumption that underlies the preparation of financial statements and the application of generally accepted accounting principles (GAAP).
4. If there is significant doubt about a company's ability to continue as a going concern, it may need to adjust the valuation and classification of its assets and liabilities.
5. Violation of the going concern principle can lead to significant changes in the presentation and interpretation of a company's financial statements.

Review Questions

• Explain how the going concern principle supports the economic basis for accrual accounting.
  • The going concern principle is essential to the economic basis for accrual accounting because it allows for the proper matching of revenues and expenses over time. If a business is expected to continue operating indefinitely, it can defer certain expenses and recognize revenue before cash is received, providing a more accurate representation of the company's financial performance. This principle enables the use of historical cost accounting and the application of other generally accepted accounting principles, which are fundamental to the accrual method of accounting.
• Describe the implications of a violation of the going concern principle on a company's financial statements.
  • If there is significant doubt about a company's ability to continue as a going concern, it may need to adjust the valuation and classification of its assets and liabilities. This can lead to significant changes in the presentation and interpretation of the company's financial statements. For example, long-term assets may need to be reclassified as current, and the company may need to recognize impairment losses or adjust the carrying value of its assets. Additionally, the company may need to disclose the going concern uncertainty and its plans for addressing it, which can impact the users' perception of the company's financial health and future prospects.
• Analyze how the going concern principle enables the use of historical cost accounting and the application of other generally accepted accounting principles.
  • The going concern principle is a fundamental assumption that allows for the use of historical cost accounting, where assets are recorded at their original purchase price rather than current market value. This principle also supports the application of other generally accepted accounting principles, such as the matching principle, which requires expenses to be recognized in the same period as the related revenues they helped generate. If a business is expected to continue operating indefinitely, these accounting practices can provide a more accurate representation of the company's financial performance over time. However, if the going concern principle is violated, the company may need to adjust its accounting methods, which can significantly impact the interpretation of its financial statements.

Related terms

Accrual Accounting: An accounting method that records revenue when earned and expenses when incurred, rather than when cash is received or paid.

Matching Principle: The accounting principle that requires expenses to be recognized in the same period as the related revenues they helped generate.

Continuity of Operations: The assumption that a business will continue to operate in the foreseeable future without the need to liquidate or significantly curtail its activities.