Going Concern Assumption Accounting Concept + Examples
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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. Going concern is an accounting term used to identify whether a company is likely to survive the next year. Companies that are not a going concern may not have enough money to survive, and this fact must be publicly disclosed when an auditor audits their financial statements.
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In order for a company to be a going concern, it usually needs to be able to operate with a significant debt restructuring or massive financing overhaul. Therefore, it may be noted that companies that are not a going concern may need external financing, restructuring, asset liquidation, or be acquired by a more profitable entity. A company may not be a going concern based on the financial position on either its income statement or balance sheet. For example, a company’s annual expenses may so vastly outweigh its revenue that it can’t reasonably make a profit. 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.
The ever-evolving complexities attributable to economic uncertainty may disrupt business as usual. When forecasting becomes less reliable and the past no longer predicts the future, the going concern assessment becomes much harder to document and update, and robust disclosures much more critical. The articles and research support materials available on this site are educational and are not intended to be investment or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.
This latest edition includes illustrative application of going concern’s most significant complexities. Going concern is important because it is a signal of trust about the longevity and future of a company. Without it, business would not offer nearly as much credit sales as suppliers, vendors, and other companies may not pay the company if there is little belief these companies will survive. 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.
A current definition of the going concern assumption can be found in the AICPA Statement on Auditing Standards No.1 Codification of Auditing Standards and Procedures, Section 341, “The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern” (AU Section 341). 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. Going concern value is a value that assumes the company will remain in business indefinitely and continue to be profitable. This differs from the value that would be realized if its assets were liquidated—the liquidation value—because an ongoing operation has the ability to continue to earn a profit, which contributes to its value.
Unless it is known that the business will close down at a future time, all transactions are recorded in a routine manner and there is no need for any special valuation or adjustment. A going concern is often good as it means a company is more likely than not to survive for the next year. When a company does not meet the going concern criteria, it means that a company may not have the resources needed to operate over the next 12 months. There are also a number of quantifiable, measurable indicators that auditors use to measure going concern. Companies with low liquidity ratios, high employee turnover, or decreasing market share are more likely to not be a going concern. For the past 52 years, Harold Averkamp (CPA, MBA) hasworked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online.
Part 2: Your Current Nest Egg
PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors. If a company’s liquidation value – how much its assets can be sold for and converted into cash – exceeds its going concern value, it’s in the best interests of its stakeholders for the company to proceed with the liquidation. In addition, management must include commentary regarding its plans on how to alleviate the risks, which are attached in the footnotes section of a company’s 10-Q or 10-K.
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The calculation of goodwill takes into account the fair value of the net assets acquired less any adjustments for purchase price, encumbrances or unusual conditions that will not affect the future operations. New lenders will likely be reluctant to issue new credit, or any new credit issued will be prohibitively expensive. This credit crunch may trickle down to suppliers who may be unwilling to sell raw materials or inventory goods on credit.
Economic uncertainty has been prevalent in global markets over the last several years due to many unexpected macro events – from COVID-19 and the related supply chain disruptions to international conflicts and rising interest rates. While some companies thrive from uncertainty, others may see their financial performance, liquidity and cash flow projections negatively impacted. These vulnerabilities continue to shine what is adjusted gross income a bright light on management’s responsibility for a going concern assessment. KPMG explains how an entity’s management performs a going concern assessment and makes appropriate disclosures. Q&As, interpretive guidance and illustrative examples include insights into how continued economic uncertainty may affect going concern assessments.
Table of Contents
- The articles and research support materials available on this site are educational and are not intended to be investment or tax advice.
- If a company is not a going concern, the company may be revalued at the request of investors, shareholders, or the board.
- For this reason, for purposes of accounting, business enterprises are presumed to carry on their operations indefinitely until such time as they are in fact liquidated.
- The calculation of goodwill takes into account the fair value of the net assets acquired less any adjustments for purchase price, encumbrances or unusual conditions that will not affect the future operations.
- KPMG has market-leading alliances with many of the world’s leading software and services vendors.
Continuation of an entity as a going concern is presumed as 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[1]).
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Certain red flags may appear on financial statements of publicly traded companies that may indicate a business will not be a going concern in the future. Listing of long-term assets normally does not appear in a company’s quarterly statements or as a line item on balance sheets. 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. A firm’s inability to meet its obligations without substantial restructuring or selling of assets may also indicate it is not a going concern.
However, generally accepted auditing standards (GAAS) do instruct an auditor regarding the consideration of an entity’s ability to continue as a going concern. Accountants use going concern principles to decide what types of reporting should appear on financial statements. Companies that are a going concern may defer reporting long-term assets at current value or liquidating value, but rather at cost. A company remains a going concern when the sale of assets does not impair its ability to continue operation, such as the closure of a small branch office that reassigns the employees to other departments within the company.
