However, generally accepted auditing standards (GAAS) do instruct an auditor regarding the consideration of an entity’s ability to continue as a going concern. 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. 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.

In accrual accounting, the financial statements are prepared under the going concern assumption, i.e. the company will remain operating into the foreseeable future, which is formally defined as the next twelve months at a bare minimum. 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 straightforward example of the going concern principle in action is when a company preparing its financial statements includes a footnote disclosing any material uncertainties that could impact its ability to continue operating as a going concern. Disclosing these risks helps investors and other users of the financial statements assess the company’s long-term viability. Going concern is not included in the generally accepted accounting principles (GAAP) but is included in the generally accepted auditing standards (GAAS).

Consideration of the Effects on the Auditor’s Report

The benefits of going concern are pretty straightforward – it gives businesses peace of mind and investors confidence. A firm’s inability to meet its obligations without substantial restructuring or selling of assets may also indicate it is not a going concern. If a company acquires assets during a time of restructuring, it may plan to resell them later. Consider how a single substantial lawsuit, default on a loan, or defective product can jeopardize the future of a company.

The going concern concept is extremely important to generally accepted accounting principles. Without the going concern assumption, companies wouldn’t have the ability to prepay or accrue expenses. If we didn’t assume companies would keep operating, why would be prepay or accrue anything? The going concern principle is the assumption that an entity will remain in business for the foreseeable future. Conversely, this means the entity will not be forced to halt operations and liquidate its assets in the near term at what may be very low fire-sale prices. By making this assumption, the accountant is justified in deferring the recognition of certain expenses until a later period, when the entity will presumably still be in business and using its assets in the most effective manner possible.

What if a business has permanently closed down?

If a company sells assets that do not impair its ability to operate effectively, it is still a going concern. Accounting professionals across the world across the world use the term when referring to an operating and viable business. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years. StockMaster is here to https://www.bookstime.com/articles/going-concern help you understand investing and personal finance, so you can learn how to invest, start a business, and make money online. If you turned your vacuum cleaner on and it started smoking and shooting sparks, you would assume that it was not going to run the next time you wanted to use it, either. You would need to either have it repaired or buy a new one and dispose of the old one.

In other words, the going concern concept assumes that businesses will have a long life and not close or be sold in the immediate future. The going concern concept states that a business will continue its operations for the foreseeable future. This implies that the company will not be forced to discontinue its operations and liquidate its assets at extremely low costs. With increased market volatility, rising inflation, supply chain disruptions, https://www.bookstime.com/ labor shortages and skyrocketing interest rates, the going concern assumption can’t be taken for granted. Management must take current and expected market conditions into account when making this call — and be prepared to provide auditors with the appropriate documentation. A Retail Store that has experienced a DECLINE in sales due to Increased Competition or Economic Downturn may have a NEGATIVE net income for a certain period.

Red Flags Indicating a Business Is Not a Going Concern

However, there are instances whereby the business may fall victim to being unable to meet its financial obligations. It can easily be detected from the business’s financial statements and could push investors into selling their shares. The going concern principle is the assumption that a business will continue to exist in the near future, in other words, that it will not liquidate or be forced out of business. Management has taken steps to address these issues and is working to improve the company’s financial performance. If the company is unable to generate sufficient revenue or secure additional financing, it may be unable to meet its obligations and may be forced to cease operations.

• If such was not the situation, a company would basically be acquiring assets when it knows that it will be shutting down its activities and reselling those assets to another organization.
• – Assume Microsoft is currently suing a small tech company for copyright violation over its software package.
• However, the company’s ability to continue as a going concern is dependent on its ability to generate sufficient revenue and secure additional financing as needed.
• In the case there is substantial, yet unreported doubt about the company’s continuance after the date of reporting (i.e. twelve months), then management has failed its fiduciary duty to its stakeholders and has violated its reporting requirements.
• Listing the value of long-term assets may indicate a company plans to sell these assets.

Therefore, it is assumed that the entity will realize its assets and settle its obligations in the normal course of the business. 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. If the auditor concludes that the entity’s disclosures with respect to the entity’s ability to continue as a going concern for a reasonable period of time are inadequate, a departure from generally accepted accounting principles exists. Reporting guidance for such situations is provided in section 508, Reports on Audited Financial Statements. An example of the application of going concern concept of accounting is the computation of depreciation on the basis of expected economic life of fixed assets rather than their current market value. Companies assume that their business will continue for an indefinite period of time and the assets will be used in the business until fully depreciated.

Going Concern Concept

The auditor’s evaluation is based on his or her knowledge of relevant conditions and events that exist at or have occurred prior to the date of the auditor’s report. Information about such conditions or events is obtained from the application of auditing procedures planned and performed to achieve audit objectives that are related to management’s assertions embodied in the financial statements being audited, as described in Auditing Standard No. 15, Audit Evidence. The auditor evaluates an entity’s ability to continue as a going concern for a period not less than one year following the date of the financial statements being audited (a longer period may be considered if the auditor believes such extended period to be relevant). The auditor considers such items as negative trends in operating results, loan defaults, denial of trade credit from suppliers uneconomical long-term commitments, and legal proceedings in deciding if there is a substantial doubt about an entity’s ability to continue as a going concern. If so, the auditor must draw attention to the uncertainty regarding the entity’s ability to continue as a going concern, in their auditor’s report. Separate standards and guidance have been issued by the Auditing Practices Board to address the work of auditors in relation to going concern.

Suddenly, the government imposes a restriction on the manufacture, import, export, marketing and sale of this chemical in the country. If Chemical-X is the only product that company manufactures, the company will no longer be a going concern. Our team of reviewers are established professionals with decades of experience in areas of personal finance and hold many advanced degrees and certifications.