Going Concern

Definition

Going concern is an accounting principle that assumes a business will continue to operate indefinitely and not liquidate its assets in the foreseeable future. This concept is crucial because it impacts how financial statements are prepared, as it allows for the deferral of certain expenses and the valuation of assets based on their ongoing utility rather than their liquidation value.

5 Must Know Facts For Your Next Test

1. The going concern assumption is fundamental in accounting, ensuring that financial statements reflect a company's ability to operate in the foreseeable future.
2. If there are doubts about a company's ability to continue as a going concern, it must disclose these uncertainties in its financial statements.
3. Auditors assess going concern by evaluating financial indicators such as liquidity ratios, cash flow forecasts, and overall financial health.
4. The going concern assumption affects how assets are valued; if a company is not considered a going concern, assets may be valued at liquidation prices rather than ongoing operational value.
5. Going concern considerations can be influenced by external factors like economic downturns, changes in regulations, or industry disruptions.

Review Questions

• How does the going concern principle affect the preparation of financial statements?
  • The going concern principle impacts financial statements by allowing businesses to defer certain expenses and recognize revenues in line with their ongoing operations. This means that assets are recorded based on their anticipated future benefits rather than their immediate liquidation value. If a company is expected to continue operating, its financial statements present a more favorable view of its health and sustainability.
• What indicators do auditors look for when assessing whether a company can continue as a going concern?
  • Auditors evaluate several indicators to determine if a company can continue as a going concern, including liquidity ratios such as current and quick ratios, cash flow forecasts, profitability trends, and any potential legal or regulatory issues. They also consider external factors like market conditions and economic forecasts. If significant doubts arise from these assessments, auditors must disclose these uncertainties in their reports.
• Evaluate the implications for investors if a company is not considered a going concern. What steps might they take following such disclosures?
  • If a company is not considered a going concern, it raises serious red flags for investors regarding the viability of their investment. Investors may choose to sell their shares to mitigate losses or re-evaluate their investment strategy based on the company's risk profile. Additionally, they might seek more information about the company's financial situation and consider legal actions if they believe they were misled about the company's operational status.

Related terms

Liquidation: The process of winding up a company's affairs, selling its assets, and paying off liabilities, often resulting in the cessation of business operations.

Financial Statements: Formal records that outline the financial activities and position of a business, including the balance sheet, income statement, and cash flow statement.

Valuation: The process of determining the current worth of an asset or a company based on various factors, including market conditions, earnings potential, and asset valuations.