What is the Going Concern Assumption? Definition Meaning Example

They do this by reviewing the company’s financial statements and evaluating the factors that may impact its ability to continue operations. Your primary responsibility is to obtain sufficient appropriate audit evidence about the appropriateness of management’s use of the going concern basis of accounting in the preparation of the financial statements. The going concern assumption shapes how financial statements are prepared and presented, influencing financial metrics and disclosures. When a company is considered a going concern, assets and liabilities are valued to reflect their long-term utility.

This involves evaluating factors such as cash flow projections, debt obligations, and market conditions to identify uncertainties that may cast doubt on the entity’s viability. The going concern concept is a vital principle that underpins financial reporting, ensuring that businesses are evaluated based on their ongoing operations rather than immediate liquidation. By assuming continuity, it provides stability and clarity to financial statements, fostering stakeholder confidence and supporting long-term planning. While challenges to the going concern assumption can arise during periods of financial distress or uncertainty, adhering to this principle ensures that businesses maintain transparency and accountability. Ultimately, the going concern concept is not just an accounting assumption—it is a reflection of the enduring potential and resilience of organizations in the face of changing circumstances.

Remember, it’s essential to use a combination of procedures to generate sufficient appropriate audit evidence, rather than relying on a single procedure like discussion with management or obtaining a written representation. In severe cases, unresolved going concern issues can lead to insolvency or bankruptcy. Companies may need to restructure, sell assets, or liquidate, affecting shareholders and causing broader economic repercussions, such as job losses. Industries like airlines or energy, which are highly leveraged, are particularly vulnerable during economic downturns. Proactively addressing going concern risks through robust planning and transparent communication can help businesses tax write off mitigate these consequences and improve recovery prospects. In the AA exam candidates may be required to describe the audit procedures that the auditor should perform in assessing whether or not a company is a going concern.

What is the Going Concern Assumption?

The auditor’s responsibility is not to determine whether the company can prepare its financial statements using the going for-profit organization definition concern basis of accounting, but to obtain sufficient audit evidence about the appropriateness of management’s use of this basis. If auditors identify uncertainties that cast doubt on a company’s viability, they must include an emphasis-of-matter paragraph in their report to highlight risks for stakeholders. Severe uncertainties, coupled with inadequate management plans, may lead auditors to issue a qualified or adverse opinion, potentially eroding stakeholder confidence and attracting regulatory scrutiny.

• 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.
• The “going concern” concept assumes that the business will remain in existence long enough for all the assets of the business to be fully utilized.
• In financial reporting, the going concern assumption is embedded in frameworks like the International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP).

For instance, inventory is valued at cost or net realizable value, whichever is lower, assuming it will be sold in the normal course of business. This ensures assets are not overstated, offering a realistic view of financial health. The auditor will consider the adequacy of the disclosures made in the financial statements by management. 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.

A negative judgment may also result in the breach of bank loan covenants or lead a debt rating firm to lower the rating on the company’s debt, making the cost of existing debt increase and/or preventing the company from obtaining additional debt financing. They can help business review their internal risk management along with other internal controls. An auditor’s responsibilities include obtaining sufficient appropriate audit evidence about the appropriateness of management’s use of the going concern basis of accounting. They must conclude whether there is a material uncertainty about the entity’s ability to continue as a going concern.

Businesses rely on the going concern assumption to plan for investments, resource allocation, and growth strategies over extended periods. Under the going concern concept, the machinery is depreciated over its useful life, reflecting its contribution to ongoing operations rather than its liquidation value. The business is expected to meet its liabilities as they fall due over time, assuming normal operations continue. The going concern concept accounting reveals the true financial integrity of an organization. It is an action an organization conducts to ensure a clearer picture of their financial and growth related concerns. Another instance where there might not be constant top-line and bottom-line growth, and increased margin is when the demand for the product is ‘cyclical’ in nature.

The going concern principle

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?

• 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.
• Before this situation, it was considered a going concern by the auditors and accountants.
• Going concern is a term that refers to a company’s ability to make enough money to stay afloat or to avoid bankruptcy.
• By assuming continuity, it provides stability and clarity to financial statements, fostering stakeholder confidence and supporting long-term planning.

#2 – Margin, Growth, and Volumes

A financial auditor is hired by a business to evaluate whether its assessment of going concern is accurate. After conducting a thorough review (audit) of the business’s financials, the auditor will provide a report with their assessment. At the end of the day, awareness of the risks that place the company’s future into doubt must be shared in financial reports with an objective explanation of management’s evaluation of the severity of the circumstances surrounding the company. However, when the result of management assessment ongoing concern shows that the entity has no going concern problem, and auditors’ reviews also conclude the same thing while the actual is different.

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. 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. The going concern concept is one of the most fundamental principles in accounting, shaping how financial statements are prepared and interpreted. It assumes that a business will continue its operations for the foreseeable future, allowing it to meet its obligations, fulfill its objectives, and maintain its assets without the need for liquidation.

Practical Applications of the Going Concern Concept

It’s given when an auditor has no concerns about the financial statements of a business or its ability to operate in the future. 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 prepared using the going concern basis of accounting. The going concern concept is a key assumption under generally accepted accounting principles, or GAAP. It can determine how financial statements are prepared, influence the stock price of a publicly traded company and affect whether a business can be approved for a loan.

If and when an entity’s liquidation becomes imminent, financial statements are prepared under the liquidation basis of accounting (Financial Accounting Standards Board, 20141). An adverse opinion states that the financial statements do not present fairly (or give a true and fair view). This opinion will be expressed regardless of whether or not the financial statements include disclosure of the inappropriateness of management’s use of the going concern basis of accounting. The auditor’s role is to assess whether a company’s assessment of being a going concern is accurate.

D. Compliance with Accounting Standards

This plan can include selling assets to pay off debts, obtaining contributions to equity, reducing expenses, or obtaining additional financing. Continuation of an entity as a going concern is presumed as the basis cash surrender value 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.

Similarly ISA 580, Written Representations recognises that while written representations do provide necessary audit evidence, they do not provide sufficient appropriate audit evidence on their own about any of the matters with which they deal. If there are any material uncertainties relating to the going concern assumption, then management must make adequate going concern disclosures in the financial statements. If there’s significant evidence that a privately held business might not be viable under the going concern assumption, the auditor must disclose it in the audit report. Even if the business’s financials aren’t audited, an accountant who has concerns about the business’s viability should disclose those concerns to the business owner.