As mentioned earlier, it is not the auditor’s responsibility to determine whether, or not, an entity can prepare its financial statements using the going concern basis of accounting; this is the responsibility of management. Similarly, US GAAP financial statements are prepared on a going concern basis unless liquidation is imminent. Disclosures are required if events and circumstances raise substantial doubt about the entity’s ability to continue as a going concern. Although the terminology varies slightly, both GAAPs share the same objective of informing users of the financial statements early about the company’s potential financial difficulties. When management becomes aware of material uncertainties related to events or conditions that may cast significant doubt on the company’s ability to continue as a going concern, those uncertainties must be disclosed in the financial statements.
Thus, in such a situation, the organization shall capitalize on the assets and claim depreciation on the assets over the years for the life of the asset. This distribution of expenditure (depreciation) is possible only because of the going concern concept, which is, the business shall be carried on for at least the life of the asset or beyond. In the present year, the management has decided to shut down its export business as continuing the same would only entail in resultant losses and thus not viable. Accordingly, till the previous year IMEXA had prepared its accounts based on the ongoing concern concept, however, this year it shall discard the going concern concept and prepare its accounts on realizable values as it does not foresee doing the business going forward. A group of investors in Silicon Valley Bank is suing KPMG, the lender’s audit firm, because it did not raise doubts about a going concern in a filing a few weeks before the bank’s sudden and spectacular collapse. But the term is rarely brought up unless a company is in trouble — that is, in cases where it has doubts it could continue as a going concern.
What Happens If a Company Is Not a Going Concern?
An example of such contrary information is an entity’s inability to meet its obligations as they come due without substantial asset sales or debt restructurings. If such were not the case, an entity would essentially be acquiring assets with the intention of closing its operations and reselling the assets to another party. Going concern is an accounting term used to identify whether a company is likely to survive the next year.
- As an example, many dot-coms are no longer going concern companies after the tech bust in the late 1990s.
- Going concern is an accounting assumption that businesses follow as part of Generally Accepted Accounting Principles while drawing up their financial statements and reports.
- The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity.
- 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.
- For instance, the value of fixed assets (PP&E) is recorded at their original historical cost and depreciated over their useful life, i.e. the expected number of years in which the fixed asset will continue to contribute positive economic value.
They can help business review their internal risk management along with other internal controls. 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). The presumption of going concern for the business implies the basic declaration of intention to keep operating its activities at least for the next year, which is a basic assumption for preparing financial statements that comprehend the conceptual framework of the IFRS. Hence, a declaration of going concern means that the business has neither the intention nor the need to liquidate or to materially curtail the scale of its operations.
Going-Concern Value vs. Liquidation Value
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. In both cases a paragraph explaining the basis for the qualified or adverse opinion will be included after the opinion paragraph and the opinion paragraph will be qualified ‘except for’ or express an adverse opinion. Founded in 1993, The Motley Fool is a financial services company dedicated to making the world smarter, happier, and richer. The Motley Fool reaches millions of people every month through our premium investing solutions, free guidance and market analysis on Fool.com, top-rated podcasts, and non-profit The Motley Fool Foundation. The going concern approach utilizes the standard intrinsic and relative valuation approaches, with the shared assumption that the company (or companies) will be operating perpetually.
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IAS 1 states that management may need to consider a wide range of factors, including current and forecasted profitability, debt maturities and replacement financing options before satisfying its going concern assessment. Unlike IFRS Standards, the going concern assessment is performed for a finite period of 12 months from the date the financial statements are issued (or available to be issued for nonpublic entities). Known or knowable events beyond the look-forward period can be ignored in the going concern assessment, although disclosure of their potential effects may still be required by other standards.
Use in risk management
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. If a company is not a going concern, that means there is risk the company may not survive the next 12 months. Management is required to disclose this fact and must provide the reasons why they may not be a going concern. Management must also identify the basis in which the financial statements are prepared and often disclose these financial reports with an audit report with a going concern opinion. 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.
What Is a Going Concern Opinion?
Candidates attempting AA will need to have a sound understanding of the concept of going concern. Among other syllabus requirements, candidates must ensure they are aware of the respective responsibilities of auditors and management regarding going concern. The provisions in ISA 570, Going Concern deal with the auditor’s responsibilities in relation to management’s use of the going concern basis of accounting in the preparation of the financial statements. However, current economic and market conditions are likely very different from those of the past. Given the significant effects of COVID-19, management may need to reassess the company’s access to financing sources; they may not be easily replaced and the costs may be higher in the current circumstances. Further, other actions such as deferring capital expenditures or adjusting the workforce may be needed to generate enough cash flow to meet the company’s financial obligations.
Our IFRS Standards resources will help you to better understand the potential accounting and disclosure implications of COVID-19 for your company, and the actions management can take now. Under Step 1, management determines whether events and conditions raise substantial doubt about the company’s ability to continue as a going concern. Continuation of an entity as a going concern is presumed as lessons from leaders on how to combat and prevent job burnout the basis for financial reporting unless and until the entity’s liquidation becomes imminent. Preparation of financial statements under this presumption is commonly referred to as the going concern basis of accounting. If and when an entity’s liquidation becomes imminent, financial statements are prepared under the liquidation basis of accounting (Financial Accounting Standards Board, 2014).