It is the responsibility of the business owner or leadership team to determine whether the business is able to continue in the foreseeable future. If it’s determined that the business is stable, financial statements are prepared using the going concern basis of accounting. The going concern concept is a key assumption under generally accepted accounting principles, or GAAP.
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. More specifically, companies are obligated to disclose the risks and potential events that could impede their ability 12 things you need to know about financial statements to operate and cause them to undergo liquidation (i.e. be forced out of business). The Going Concern Assumption is a fundamental principle in accrual accounting, stating that a company will remain operating into the foreseeable future rather than undergo a liquidation. A financial auditor is hired by a business to evaluate whether its assessment of going concern is accurate. After conducting a thorough review (audit) of the business’s financials, the auditor will provide a report with their assessment.
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. If managers or auditors believe that a company is at risk of going bust within 12 months, they are required to formally express that doubt in their financial accounts. 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 https://www.bookkeeping-reviews.com/5-best-tools-for-kickstarting-operational/ 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. By contrast, the going concern assumption is the opposite of assuming liquidation, which is defined as the process when a company’s operations are forced to a halt and its assets are sold to willing buyers for cash.
This influences which products we write about and where and how the product appears on a page. This may influence which products we review and write about (and where those products appear on the site), but it in no way affects our recommendations or advice, which are grounded in thousands of hours of research. There is “a lot of gray area” when judging whether a company is a going concern, said Denise Dickins, a former partner at an auditing firm who is now professor emeritus at East Carolina University and a board member at public companies. The going concern approach utilizes the standard intrinsic and relative valuation approaches, with the shared assumption that the company (or companies) will be operating perpetually. Under the going concern principle, the company is assumed to sustain operations, so the value of its assets (and capacity for value-creation) is expected to endure into the future. A group of investors in Silicon Valley Bank is suing KPMG, the lender’s audit firm, because it did not raise doubts about a going concern in a filing a few weeks before the bank’s sudden and spectacular collapse.
If a business is not a going concern, it means it’s gone bankrupt and its assets were liquidated. As an example, many dot-coms are no longer going concern companies after the tech bust in the late 1990s. Because the issuance of a negative going concern opinion is feared to be a self-fulfilling prophecy, auditors may be reluctant to issue one. A going-concern opinion may lower stockholders’ and creditors’ confidence in the company and rating agencies may downgrade the debt which leads to an inability to obtain new capital and an increase in the cost of existing capital.
How Does the Going Concern Approach Impact Valuation?
By doing so, the auditor is reasonably assured that the business will remain functional during the one-year period stipulated by GAAS. This makes it easy for a parent company to ensure that its subsidiaries are always classified as going concerns. If there is an issue, the audit firm must qualify its audit report with a statement about the problem.
One of larger repercussions of not being a going concern are potential credit challenges. 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. Accountants who view a company as a going concern generally believe a firm uses its assets wisely and does not have to liquidate anything. Accountants may also employ going concern principles to determine how a company should proceed with any sales of assets, reduction of expenses, or shifts to other products. 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.
The threat of receiving a negative going concern opinion may motivate management to go “opinion shopping,” as was alluded to in the WorldCom and Enron business failures. At the end of the day, awareness of the risks that place the company’s future into doubt must be shared in financial reports with an objective explanation of management’s evaluation of the severity of the circumstances surrounding the company. If there’s significant evidence that a privately held business might not be viable under the going concern assumption, the auditor must disclose it in the audit report. Even if the business’s financials aren’t audited, an accountant who has concerns about the business’s viability should disclose those concerns to the business owner.
- 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.
- Management determines the auditor’s tenure and remuneration and can hire and fire the auditor at will.
- 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 going concern is an accounting term for a business that is assumed will meet its financial obligations when they become due. It functions without the threat of liquidation for the foreseeable future, which is usually regarded as at least the next 12 months or the specified accounting period (the longer of the two). Hence, a declaration of going concern means that the business has neither the intention nor the need to liquidate or to materially curtail the scale of its operations. 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. Accountants use going concern principles to decide what types of reporting should appear on financial statements.
How a going concern qualification affects a business
This can protect investors from continuing to risk their money on a business that may not be viable for much longer. 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.
If a company is not a going concern, the company may be revalued at the request of investors, shareholders, or the board. This revaluation may be used to price the company for acquisition or to seek out a private investor. There are often certain accounting measures that must be taken to write down the value of the company on the business’s financial reports. Going concern is an accounting term for a company that has the resources needed to continue operating indefinitely until it provides evidence to the contrary. This term also refers to a company’s ability to make enough money to stay afloat or to avoid bankruptcy.
Use in risk management
Often, management will be incentivized to downplay the risks and focus on its plans to mitigate the conditional events – which is understandable given their duties to uphold the valuation (i.e. share price) of the company – yet the facts must still be disclosed. 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. When an auditor issues a going concern qualification, the way their opinion is disclosed depends on the structure of the business. 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.
However, generally accepted auditing standards (GAAS) do instruct an auditor regarding the consideration of an entity’s ability to continue as a going concern. 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]). If an auditor issues a negative going concern opinion in the annual report, investors may have second thoughts about holding the stock of the company. A business valuation may be performed on the business in order to determine what it is actually worth.
What is the Going Concern Principle in Accounting?
Usually, liquidation value is applied when investors feel a company no longer has value as a going concern, and they want to know how much they can get by selling off the company’s tangible assets and such of its intangible assets as can be sold, such as IP. A company or investor that is acquiring a company may compare that company’s going-concern value to its liquidation value in order to decide whether it’s financially worthwhile to continue operating the company, or whether it is more profitable to liquidate it. It’s given when an auditor has no concerns about the financial statements of a business or its ability to operate in the future.
A company should always be considered a going concern unless there is a good reason to believe that it will be going out of business. Thus, the value of an entity that is assumed to be a going concern is higher than its breakup value, since a going concern can potentially continue to earn profits. It’s given when the auditor has doubts about the company and the assumption that it is a going concern.
