Going Concern — an assumption that a business has approved the stability and liquidity after the checking of accounting or audit. If the company isn’t going concern, it has to be liquidated. Going concern isn’t included in GAAP, but it is included in GAAS. An accountant that sees the company as a going concern, believes that it will function as long as necessary.
Meaning of Going Concern
Going concern is an assumption that a certain business will continue to work for an undetermined amount of time. Usually, this status is assigned by the financial auditor. The assessment of the financial auditor is necessary to present an unqualified opinion on the company’s financial situation. The auditor checks the financial documents and transactions to see whether a company can meet its financial obligations.
This principle was created based on the theory of static balance of Schmalenbach. The main idea of this assumption is that since the management doesn’t assume the possibility of closing the enterprise when drawing up the balance sheet, its assets shouldn’t be revalued. However, today it is clear that the assessment of assets at fair value and the discounted assessment of liabilities don't contradict the principle of going concern.
The going concern is a key concept of modern accounting theory and practice. Moreover, its implementation underlies the audit confirmation of the financial statements. The principles of going concern define the perception of the company's activities in the modern economy as aimed at continuation and development and not limited in advance by a certain timeframe.
Signs of going concern:
- Change of the owner won’t entail changes in accounting.
- Values considered by the client aren't overestimated.
- Expenses that will generate income in the future are capitalized.
- Enterprise has reserves.
- Financial results are distributed by reporting periods.
- Economic life is carried out in conditions of uncertainty.
- Reporting is presented for defined equal periods.
The company needs to provide the documentation package to prove compliance with going concern. These documents show that the management is aware of the company's problems and takes steps to overcome them.
Document to prove the going concern:
- agreements with banks and other confirmations (letters, protocols) about the readiness to provide the company with a deferral of loan repayment or additional funds;
- documents confirming the ability and intention of investors to capitalize on the company or make a direct investment;
- business restructuring plans;
- plans to sell the property of the company or part of the business;
- government decisions or other documents confirming the readiness of the state to assist the company;
- data from independent sources indicating an upcoming favorable change in economic conditions.
If the company complies with the going concern principle, financial statements are prepared on the idea that a firm will continue to function in the future. General purpose financial statements are prepared using the going concern basis of accounting, except when management intends to liquidate the entity, cease operations, or has no viable alternative other than winding up or going out of business. Special purpose financial statements may be prepared with or without the use of financial reporting frameworks.
Non-compliance with Going Concern
Sometimes the business can’t meet the requirements of the going concern. The negative signs are refusal from banks and suppliers to provide a loan, bankruptcy of large debtors, and lawsuits. In this case, the company can be liquidated. If the company intends to be liquidated or significantly reduce the volume of its activities, then the accountant should indicate this in the notes to the financial statements. The financial statements should be prepared in another way. In particular, the property should be indicated at salvage value, and all items in the company's statement of financial position should be viewed as short-term.
Some factors show that the company can’t meet the requirements of going concern. They are divided into groups. The auditor should identify these factors during the checking.
Factors of inconsistency to going concern:
- Negative financial tendencies.
- continuing operating losses;
- deficit of working capital;
- negative cash flow.
- Irregularities in the activity of the organization.
- non-compliance with loan agreement conditions;
- non-compliance with the terms of contracts with counterparties;
- late payments of dividends;
- salary delays.
- Inner causes.
- problems between management and staff;
- staff conflicts;
- long-term onerous liabilities.
- External causes.
- increased tax burden on business;
- increased rates for bank loans;
- revocation of license or patent;
- loss of primary supplier or customer;
- loss of a significant share of the uninsured property.
After identifying the above conditions or circumstances, the management should analyze the activities of the company and neutralize significant uncertainties. If the company can’t neutralize the uncertainty, it should be wound up.