going concern principle

Even if the company’s future is questionable and its status as a going concern appears to be in question – e.g. there are potential catalysts that could raise significant concerns – the company’s financials should still be prepared on a going concern basis. Accounting principles serve a significant purpose of standardising the way in which businesses perform their financial reporting activities. If a company is not a going concern, the company may be revalued at the request of investors, shareholders, or the board.

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. In order to avoid the entity’s credit rating suffering any further decline, the directors have refused to make disclosures in the financial statements and have prepared the financial statements for the year ended 31 March 20X2 on the going concern basis.

What is Going Concern Concept

It is the responsibility of the business owner or leadership team to determine whether the business is able to continue in the foreseeable future. If it’s determined that the business is stable, financial statements are https://www.bookstime.com/articles/how-to-create-multiple-streams-of-income prepared using the going concern basis of accounting. Accounting standards try to determine what a company should disclose on its financial statements if there are doubts about its ability to continue as a going concern.

Under GAAP standards, companies are required to disclose material information that enables their viewers – in particular, its shareholders, lenders, etc. – to understand the true financial health of the company. The Going Concern Assumption is a fundamental principle in accrual accounting, stating that a company will remain operating into the foreseeable future rather than undergo a liquidation. An example showing the application of the going concern principle is the calculation of depreciation of assets. This depreciation calculation is based on the expected economic life of the asset, as opposed to its current market value. 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.

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The auditor will consider the adequacy of the disclosures made in the financial statements by management. If the auditor considers that the going concern basis is appropriate and that the disclosures are adequate, then the audit opinion will be unmodified and the auditor’s report will include a section headed ‘Material Uncertainty Related to Going Concern’ which explains the uncertainty. The Material Uncertainty Related to Going Concern section will follow the Basis for Opinion paragraph and will cross-reference to the relevant disclosure in the financial statements. It will also state that the auditor’s opinion is not modified in respect of this matter.

This makes it easy for a parent company to ensure that its subsidiaries are always classified as going concerns. If the accountant believes that an entity may no longer be a going concern, then this brings up the issue of whether its assets are impaired, which may call for the write-down of their carrying amount to their liquidation value. If the auditor concludes that the disclosures are inadequate, or if management have not made any disclosure at all and management refuse to remedy the situation, the opinion will be qualified or adverse. Many candidates fall into the trap of relying on ‘discussions with management/directors’ and ‘obtaining a written representation’. Candidates must appreciate that while discussion/inquiry is a valid audit procedure under ISA 500, Audit Evidence, such a procedure is always used in addition to other procedures – in other words, inquiry on its own will not generate sufficient appropriate audit evidence.