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What is the Going Concern Concept and why is it important in Accounting?

Updated: Jun 9, 2023

A foundational idea in accounting is the going concern concept. It assumes that a firm will carry out its present goals, utilize its current assets, and continue to pay its debts over the upcoming financial period and beyond. In other words, it is the premise that the firm will continue to operate and that the value of its assets will be steady. The continuous worry notion is another name for this fundamental idea.


When a firm fails, its assets frequently lose the value they had on the balance sheet. This occurs because some company-specific assets, including specialized software, may be less valuable when sold to outside parties than what was paid for them. Additionally, if a business must sell its assets quickly, it might not have the time to wait for the best possible price. An accountant is required to disclose in their audit report if they have any grounds to believe that a company won’t be able to pay its commitments, operate as a going concern, and safeguard its assets.

Accountants use the going concern concept when creating financial statements, which provide information about a company’s financial health.


Why is Going Concern principle important?


  • It offers consistency and predictability in financial reporting, which aids creditors and investors in making wise choices about whether to lend money to a company.

  • It makes sure that balance sheets accurately and honestly reflect a company’s financial situation.

  • Suppose it becomes clear, for any reason, that a business is no longer a going concern. The accountant must take the necessary actions to include this in the financial statements. This might entail writing down fixed assets or documenting impairment losses.

  • It enables firms to carry on with regular operations even while they are having financial challenges. To give firms the chance to recover and become profitable again, this is vital.

Without going concern rule, companies would be obliged to cease operations and sell up their assets as soon as they ran into financial trouble. Economic instability and mass unemployment are expected to result from this.


Disclosure of Going Concern in the Financial Statements


Indicate the main circumstances and events that initially gave rise to the belief that there was substantial doubt about the entity’s ability to continue as a going concern for a reasonable period if substantial doubt is subsequently eliminated, primarily because of taking management’s plan into account.


Disclosure should include any mitigating factors, including management’s plan, that could affect such conditions and events.


If the auditor’s report is modifies of a going concern issue, the company must disclose in a footnote:


  • Significant concerns regarding the entity’s capacity to continue as a going concern are raised by circumstances and events that pertain to it.

  • The potential implications of these circumstances and occurrences.

  • Management assesses any mitigating circumstances and variables.

  • Possibility of operations ceasing.

  • Plans of the management (including relevant prospective financial information).

The size, nature, or recoverability of reported asset quantities, or the number or classification of liabilities.


Example of disclosure in the Director’s report


This report outlines the company’s operations, performance, strategy, and risks. This section discusses the Group’s financial status, including cash flows, liquidity, and committed facilities that are currently available.

Then the Directors reasonably anticipate that the Company and the Group have enough resources to sustain operations for the foreseeable future after conducting inquiries. Because of this, the going concern concept was used to prepare the accounts.


So, what exactly is happening, and why should you care? An important accounting theory known as “going concern” assets that a company will continue to exist for the foreseeable future.

It’s one of the aspects of a company’s financial stability that auditors evaluate in their audit report. Going concern has clear advantages for both firms and investors. It offers investors trust.

However, there are some drawbacks as well. For instance, if shareholders think a firm is no longer sustainable, there may be a chance of management fraud. Ultimately, your position within the organization will determine whether going concern is important to you.


Disclaimer


All content provided on this blog is for informational purposes only. The owner of this blog makes no representations as to the accuracy or completeness of any information on this site or found by following any link on this site.

The owner will not be liable for any errors or omissions in this information nor for the availability of this information. The owner will not be liable for any losses, injuries, or damages from the display or use of this information.



Reference


Eduyush

https://www.eduyush.com/blogs/basics-of-accounting/what-is-going-concern-concept


MaRS Startup Toolkit

https://learn.marsdd.com/article/going-concern-concept/#:~:text=The%20going%20concern%20concept%20is,to%20meet%20its%20financial%20obligations.


ACCA

https://www.accaglobal.com/pk/en/student/exam-support-resources/fundamentals-exams-study-resources/f8/technical-articles/going-concern.html


Back Office Consulting

https://www.backoffice.com.sg/accounting/why-the-going-concern-concept-is-important-in-accounting/





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