Going Concern

Updated on April 5, 2024
Article byWallstreetmojo Team
Edited byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

Meaning of Going Concern

The Going Concern is an assumption made in financial statements that a company will not go bankrupt in the foreseeable future—usually referring to a period of 12 months. It is a fundamental accounting principle.

In other words, a gong concern will continue to exist in the long run, with no intention to shut down. There is no immediate uncertainty. When management considers such assumptions inappropriate, financial statements are prepared based on a break up basis.

Key Takeaways

  • A going concern is an accounting assumption that a business will continue its operations for the foreseeable future. It is reflected in the financial statements of the company.
  • The continuity of a business is determined by positive solvency position and enterprise values.
  • According to Generally Accepted Accounting Standards (GAAS), the going concern assumption is a crucial parameter for ascertaining business longevity.
  • Alarming signs that question the continuity of a business include low liquidity, decreasing market share, poor credibility, lawsuits, business losses, employee turnover, and outdated product itinerary.

Going Concern Explained

Going-Concern

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Going Concern (wallstreetmojo.com)

The going concern assumption is a fundamental accounting concept, similar to Consistency PrincipleConsistency PrincipleAccording to the Consistency Principle, all accounting treatments should be followed consistently throughout the current and future periods unless compelled by law to change or the change provides a better accounting presentation. This concept prevents accounting fraud and ensures that financial statements are comparable across historical periods.read more and accrual assumptionAccrual AssumptionAccrual Accounting is an accounting method that instantly records revenues & expenditures after a transaction occurs, irrespective of when the payment is received or made. read more. According to this principle, financial statements are prepared, assuming the company intends to continue operations for the foreseeable future and has no motive or need to shut down.

On the other hand, if a company intends to close operations, financial statements will reflect such an intent—the company must disclose it. Unless disclosed, it is assumed by default that the company will realize its assets and settle its liabilitiesLiabilitiesLiability is a financial obligation as a result of any past event which is a legal binding. Settling of a liability requires an outflow of an economic resource mostly money, and these are shown in the balance of the company.read more.

Going-Concern-Concept-Assumptions

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Going Concern (wallstreetmojo.com)

Although the going concern assumption holds no place in the Generally Accepted Accounting Principles (GAAPGAAPGAAP (Generally Accepted Accounting Principles) are standardized guidelines for accounting and financial reporting.read more), it is recognized by Generally Accepted Accounting Standards (GAAS). GAAS considers this principle a crucial parameter for determining the longevity of a business.

So, when managements consider such an assumption inappropriate, they prepare financial statements using the breakup basis. The breakup basis reports assets based on the amount that is likely to be realized from the sale and liabilities—the net realizable valueNet Realizable ValueNet Realizable Value is a value at which the asset may be sold in the market by the company after deducting the expected cost of selling the asset in the market. It is a crucial metric for determining the value of a company's ending inventory or receivables.read more. For example, seasonal businesses like firecracker companies opt for the breakup basis.

Going Concern Concept in Video

 

Going Concern Example 

 Let us understand the application of this principle using examples.

Example #1 

AB Ltd. is a construction company that incurred a loss of $700,000 in a housing project— due to government stay and legal action. As a result, the company missed five installments of debtDebtDebt is the practice of borrowing a tangible item, primarily money by an individual, business, or government, from another person, financial institution, or state.read more worth $60,000 (total non-repayment in 5 years).

The company lost its creditworthinessCreditworthinessCreditworthiness is a measure of judging the loan repayment history of borrowers to ascertain their worth as a debtor who should be extended a future credit or not. For instance, a defaulter’s creditworthiness is not very promising, so the lenders may avoid such a debtor out of the fear of losing their money. Creditworthiness applies to people, sovereign states, securities, and other entities whereby the creditors will analyze your creditworthiness before getting a new loan.read more in the debt market; it was on the verge of insolvency—bankrupt within 1.5 years. Before this situation, it was considered a going concern by the auditorsAuditorsAn auditor is a professional appointed by an enterprise for an independent analysis of their accounting records and financial statements. An auditor issues a report about the accuracy and reliability of financial statements based on the country's local operating laws.read more and accountants. 

Accounting for Financial Analyst (16+ Hours Video Series)

–>> p.s. – Want to take your financial analysis to the next level? Consider our “Accounting for Financial Analyst” course, featuring in-depth case studies of McDonald’s and Colgate, and over 16 hours of video tutorials. Sharpen your skills and gain valuable insights to make smarter investment decisions.

Example #2

Let us assume Douglas purchased a manufacturing plant & equipment for his business by paying $400,000 out of the $500,000 investment. He also paid installation expensesExpensesAn expense is a cost incurred in completing any transaction by an organization, leading to either revenue generation creation of the asset, change in liability, or raising capital.read more, amounting to $2,000. If he is still willing to continue his business, his financial position will be as follows: 

going 1

If Douglas decides to sell the manufacturing plant and equipment, he might get more or less than $402,000, which will change his financial position.

However, when we consider the concept of going concernConcept Of Going ConcernGoing Concern concept is an accounting principle which states that the accounting statements are formulated with a belief that the business will not be bankrupt or liquidated for the foreseeable future, which generally is for a period of 12 months.read more, such a change in asset value will be ignored in the short runShort RunA Short Run in economics refers to a manufacturing planning period in which a business tries to meet the market demand by keeping one or more production inputs fixed while changing others.read more. The principle highlights the assumption that companies intend to keep assets and generate profits in the future—assets won’t be sold in between.

Therefore, the change in value is not realizable; Douglas and his company must not consider the going concern assumption. They must opt for the breakup basis.

Importance 

The going concern assumption is crucial for the companies due to the following reasons: 

Indicators of Going Concern Problems

The following red flags indicate that a company is unable to continue as a going concern:

Frequently Asked Questions (FAQs)

What is a Going Concern?

It is an accounting assumption that defines the longevity of a business operation. By default, financial statements reflect this assumption. Unless the company discloses, it is assumed that it possesses adequate assets for fulfilling long-term liabilities.

What does it mean when a property is sold as a going concern?

It refers to properties sold for income-generating activities—on the registration date. Also, both property sellers and buyers must have VAT registration—registered as vendors. On such a transaction, the VAT charged is 0%. Also, the transaction should involve all the related assets that facilitate income generation. 

What are some going concern red flags?

Warning signs include falling market share, poor creditworthiness, employee turnover, low liquidity, lawsuits, excessive business loss, and inability to innovate.  

This article has been a guide to Going Concern Assumption and its meaning. Here we discuss Going Concern definition, accounting principles, audits, basis, values, and examples. You can learn more about it from the following articles –

Reader Interactions

Comments

  1. Krishna says

    Very nice information. It helped a lot

Leave a Reply

Your email address will not be published. Required fields are marked *