Going Concern Assumption Accounting Concept + Examples

It could tell us whether the company has any cash problems in the next twelve months or not. If the cash flow forecasting indicates that the company does has any cash flow problems. However, when the result of management assessment ongoing concern shows that the entity has no going concern problem, and auditors’ reviews also conclude the same thing while the actual is different. The going concern assessment is inherently complex and judgmental and will be under heightened scrutiny for many companies this year due to COVID-19.

  1. The following are the key procedures that management should do to assess the going concern problems.
  2. Some or all of the services described herein may not be permissible for KPMG audit clients and their affiliates or related entities.
  3. Going concern value is a value that assumes the company will remain in business indefinitely and continue to be profitable.
  4. It follows that when this is not the case, a detailed analysis will be necessary, which likely includes robust cash flow forecasts and a review of existing and forthcoming financial obligations.
  5. That means the quality of audit procedures is the place that should be questioned.

Plummeting cash flow and ballooning debt can be obvious signs of trouble, but nonfinancial factors can also sink a business, like legal issues, changes in regulation or the resignation of a key executive. 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. Disclosures addressing these requirements may need to be expanded, with added focus on the company’s response to the effects of COVID-19. For example, under US GAAP, the look-forward period for a company with a December 31, 20X0 balance sheet date and financial statements issued on March 31, 20X1 is the 12-month period ended March 31, 20X2. US GAAP requires management’s plans to meet certain conditions to be considered in the assessment. This includes information known or reasonably knowable at the date the financial statements are issued (or available to be issued).

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However, in our view, there is no general dispensation from the measurement, recognition and disclosure requirements of the Standards in this case, and these requirements are applied in a manner appropriate to the circumstances. Accounting standards try to determine what a company should disclose on its financial statements if there are doubts about its ability to continue as a going concern. In May 2014, the Financial Accounting Standards Board determined financial statements should reveal the conditions that support an entity’s substantial doubt that it can continue as a going concern. Statements should also show management’s interpretation of the conditions and management’s future plans.

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. The procedures are the key procedures and additional procedures might be required. That means the management of the entity is the one who has the main roles and responsibilities to assess whether the entity is operating without facing the going concern problems.

The going-concern value of a company is typically much higher than its liquidation value because it includes intangible assets and customer loyalty as well as any potential for future returns. The liquidation value of a company will even be lower than the value of the company’s tangible assets, because the company may have to sell off its tangible assets at a discount—often, a deep discount—in order to liquidate them before ceasing operations. Examples of tangible assets that might be sold at a loss include equipment, unsold inventory, real estate, vehicles, patents, and other intellectual property (IP), furniture, and fixtures.

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Given the significant effects of COVID-19, management may need to reassess the company’s access to financing sources; they may not be easily replaced and the costs may be higher in the current circumstances. Further, other actions such as deferring capital expenditures or adjusting the workforce may be needed to generate enough cash flow to meet the company’s financial obligations. Under Step 1, management determines whether events and conditions raise substantial doubt about the company’s ability to continue as a going concern.

If there is uncertainty as to a company’s ability to meet the going concern assumption, the facts and conditions must be disclosed in its financial statements. In accrual accounting, the financial statements are prepared under the going concern assumption, i.e. the company will remain operating into the foreseeable future, which is formally defined as the next twelve months at a bare minimum. Management typically develops plans to address going concern uncertainties – e.g. refinancing of debt, renegotiating breached covenants, and sale of assets to generate sufficient liquidity to continue to meet its obligations as they fall due. IFRS Standards do not prescribe how management should evaluate its plans to mitigate the effects of these events or conditions in the going concern assessment. The effects of COVID-19 are negatively affecting many companies’ financial performance and liquidity in some way.

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Then we should consider whether auditors put all possible procedures that should be performed or not. That means the quality of audit procedures is the place that should be questioned. This question is asked mainly when we talk about the roles and responsibilities of management and auditor related to going concerns of the company, and to answer this question, we should refer to the audit standard ISA 570.

Listing of long-term assets normally does not appear in a company’s quarterly statements or as a line item on balance sheets. Listing the value of long-term assets may indicate a company plans to sell these assets. 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. 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. However, generally accepted auditing standards (GAAS) do instruct an auditor regarding the consideration of an entity’s ability to continue as a going concern.

Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. In effect, equity shareholders and other relevant parties can then make well-informed decisions on the best course of action to take with all material information on hand. The formal definition of the term common components of grant proposals “going concern” per GAAP / FASB can be found below. These examples are programmatically compiled from various online sources to illustrate current usage of the word ‘going concern.’ Any opinions expressed in the examples do not represent those of Merriam-Webster or its editors.

Key Takeaways

For example, a company may have a profitable track record or prior success at refinancing. However, market conditions have changed as a result of COVID-19 – e.g. financing may be significantly more difficult and more costly to obtain now. Disclosures of material uncertainties that may cast doubt on a company’s ability to continue as a going concern as well as significant judgments involved in close-call scenarios may be more frequent as a result of COVID-19, given the continued economic uncertainty. Management should critically assess the disclosure requirements of IAS 1 and consider drafting required disclosure language early in the financial reporting process. US GAAP includes a two-step process that first determines whether substantial doubt about the company’s ability to continue as a going concern is raised.

If so, the auditor must draw attention to the uncertainty regarding the entity’s ability to continue as a going concern, in their auditor’s report. Separate standards and guidance have been issued by the Auditing Practices Board to address the work of auditors in relation to going concern. To meet these disclosure https://simple-accounting.org/ requirements, in our view, similar information to that in respect of material uncertainties may be relevant to the users’ understanding of the company’s financial statements, as appropriate. Similarly, US GAAP financial statements are prepared on a going concern basis unless liquidation is imminent.

Going concern is not included in the generally accepted accounting principles (GAAP) but is included in the generally accepted auditing standards (GAAS). 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. 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. 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.

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