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Going Concern Concept Definition Explanation Examples

written by Barry and Joyce Vissell June 14, 2023

Among other syllabus requirements, candidates must ensure they are aware of the respective responsibilities of auditors and management regarding going concern. The provisions in ISA 570, Going Concern deal with the auditor’s responsibilities in relation to management’s use of the going concern basis of accounting in the preparation of the financial statements. Because the US GAAP guidance is more developed in this area, it may provide certain useful reference points for IFRS Standards preparers – e.g. to identify adverse conditions and events or to assess the mitigating effects of management’s plans. However, dual reporters should be mindful of the differing frameworks, terminologies and potentially different outcomes in their going concern conclusions. Our IFRS Standards resources will help you to better understand the potential accounting and disclosure implications of COVID-19 for your company, and the actions management can take now. Under IFRS Standards, management assesses all available information about the future, considering the possible outcomes of events and changes in conditions, and the realistically possible responses to such events and conditions.

By making this assumption, the accountant is justified in deferring the recognition of certain expenses until a later period, when the entity will presumably still be in business and using its assets in the most effective manner possible. Similarly based on this accounting concept, expenses are recorded on accrual basis. In other words, the recording of accruals (expenses incurred but not yet paid for) certifies that the business is supposed to continue its operations for long enough time. An important point to emphasise at the outset is that candidates are strongly advised not to use the ‘scattergun’ approach when it comes to deciding on the audit opinion to be expressed within the auditor’s report. This is where a candidate explores all possible options rather than  coming to a conclusion as to the auditor’s opinion, depending on the circumstances presented in the question.

  1. The auditor evaluates an entity’s ability to continue as a going concern for a period not less than one year following the date of the financial statements being audited (a longer period may be considered if the auditor believes such extended period to be relevant).
  2. A sound capital structure refers to the best composition of business’ sources of funds particularly long term.
  3. The auditor will consider the adequacy of the disclosures made in the financial statements by management.
  4. 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.

Current assets should be enough to settle the current liabilities of the business unit. A shortage in current assets as compared to current liabilities may lead to insolvency. And when there is insolvency or even chance of it, the business unit cannot be assumed as going concern. Although US GAAP is more prescriptive than IFRS Standards, we would also expect under IFRS Standards that management plans are achievable and realistic, timely and sufficient to address the going concern uncertainties. Although US GAAP is more prescriptive than IFRS Standards, we do not expect significant differences in the types of events or conditions management would consider when assessing going concern under both GAAPs. 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.

What Happens If a Company Is Not a Going Concern?

There are often certain accounting measures that must be taken to write down the value of the company on the business’s financial reports. 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, https://intuit-payroll.org/ or be acquired by a more profitable entity. When an auditor issues a going concern qualification, the way their opinion is disclosed depends on the structure of the business. If the accountant believes that an entity may no longer be a going concern, then this brings up the issue of whether its assets are impaired, which may call for the write-down of their carrying amount to their liquidation value.

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As mentioned earlier, it is not the auditor’s responsibility to determine whether, or not, an entity can prepare its financial statements using the going concern basis of accounting; this is the responsibility of management. Similarly, US GAAP financial statements are prepared on a going concern basis unless liquidation is imminent. Disclosures are required if events and circumstances raise substantial doubt about the entity’s ability to continue as a going concern. Although the terminology varies slightly, both GAAPs share the same objective of informing users of the financial statements early about the company’s potential financial difficulties. When management becomes aware of material uncertainties related to events or conditions that may cast significant doubt on the company’s ability to continue as a going concern, those uncertainties must be disclosed in the financial statements. The terms ‘material uncertainties’ and ‘significant doubt’ are important – this standard phrasing is expected to be used in the basis of preparation note to the financial statements.

The term ‘foreseeable future’ is not defined within ISA 570, but IAS 1®, Presentation of Financial Statements deems the foreseeable future to be a period of at least 12 months from the end of the reporting period. In general, an auditor examines a company’s financial statements to see if it can continue as a going concern for one year following the time of an audit. Conditions that lead to substantial doubt about a going concern include negative trends in operating results, continuous losses from one period to the next, loan defaults, lawsuits against a company, and denial of credit by suppliers.

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The company will no more be a going concern if chemical-X is the only manufacturing and marketing product of Eastern Company. Candidates should generate the audit procedures specifically from information contained in the scenario to demonstrate quickbooks accounting solutions application skills Jasmine Co in the September/December 2018 Sample exam demonstrates this approach. Some or all of the services described herein may not be permissible for KPMG audit clients and their affiliates or related entities.

The auditor will consider the adequacy of the disclosures made in the financial statements by management. The Material Uncertainty Related to Going Concern section will follow the Basis for Opinion paragraph and will cross-reference to the relevant disclosure in the financial statements. It will also state that the auditor’s opinion is not modified in respect of this matter. When faced with such a requirement, candidates must be careful not to produce a list of generic audit procedures, but instead identify and highlight the factors from the scenario that may call into question the entity’s ability to continue as a going concern.

Listing the value of long-term assets may indicate a company plans to sell these assets. The auditor is required by the Securities and Exchange Commission to disclose in the financial statements of a publicly traded company whether going concern status is in doubt. This can protect investors from continuing to risk their money on a business that may not be viable for much longer. It’s given when an auditor has no concerns about the financial statements of a business or its ability to operate in the future. However, generally accepted auditing standards (GAAS) do instruct an auditor regarding the consideration of an entity’s ability to continue as a going concern.

Private companies

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. A company may not be a going concern for a number of reasons, and management must disclose the reason why. A firm’s inability to meet its obligations without substantial restructuring or selling of assets may also indicate it is not a going concern.

It is essential that candidates preparing for the Audit and Assurance (AA) exam understand the respective responsibilities of auditors and management regarding going concern. This article discusses these responsibilities, as well as the indicators that could highlight where an entity may not be a going concern, and the reporting aspects relating to going concern. In addition to IAS 1, IFRS 79 requires disclosure of information about the significance of financial instruments to a company, and the nature and extent of risks arising from those financial instruments, both in qualitative and quantitative terms.

If it’s determined that the business is stable, financial statements are prepared using the going concern basis of accounting. Unlike IFRS Standards, the going concern assessment is performed for a finite period of 12 months from the date the financial statements are issued (or available to be issued for nonpublic entities). Known or knowable events beyond the look-forward period can be ignored in the going concern assessment, although disclosure of their potential effects may still be required by other standards. The going concern concept is not clearly defined anywhere in generally accepted accounting principles, and so is subject to a considerable amount of interpretation regarding when an entity should report it.

Disclosures addressing these requirements may need to be expanded, with added focus on the company’s response to the effects of COVID-19. US GAAP requires management’s plans to meet certain conditions to be considered in the assessment. Under GAAP standards, companies are required to disclose material information that enables their viewers – in particular, its shareholders, lenders, etc. – to understand the true financial health of the company. Even if the company’s future is questionable and its status as a going concern appears to be in question – e.g. there are potential catalysts that could raise significant concerns – the company’s financials should still be prepared on a going concern basis. It is possible for a company to mitigate an auditor’s view of its going concern status by having a third party guarantee the debts of the business or agree to provide additional funds as needed. By doing so, the auditor is reasonably assured that the business will remain functional during the one-year period stipulated by GAAS.

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