What is Going Concern Concept?
Accounting concepts have many theory bases, which are the basic ideas that hold foundational accounting concepts. These theory bases are considered for general practices in all accounting activities. These include the business entity concept, accounting period concept, money measurement concept, cost concept, and the going concern concept.
The book of accounts (which holds all financial information of a business entity) is generally prepared by following some accounting assumptions. Going concern concept in accounting is one such assumption where it is assumed that an organization will carry out its operations for the foreseeable future. It implies that there will be no force on the firm to discontinue its operations and liquidate its assets at very low costs.
We will explain going concern concept in this article where you will understand the significance of going concern concept and also get to see some going concern concept examples to clarify this assumption.
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Going Concern Concept in Accounting:
Going concern concept is an assumption that a business entity will not be forced to halt its operations in the near term and will not need to liquidate its assets. The business is expected to operate for the foreseeable future or at least for the next twelve months.
The going concern concept assumes that the organization will be able to generate income and meet its obligations.
The importance of going concern concept is huge in general accounting principles (GAAP) as it is one of the key assumptions of GAAP.
Going concern assumption allows an accountant to defer recognition of specific expenses to a later point in time since the entity will still be in business in the future. This is another major significance of going concern concept which allows assets to be used most effectively.
The term foreseeable future is defined by IAS 1 and Presentation of Financial Statements gives the foreseeable future to be a time span of at least twelve months (which is calculated from the end of the last reporting period).
Determining the Going Concern of a Business:
The leadership team or the business owners determines if the company is able to continue its operations in the future or not. Upon determining the stability of the company, the firm then applies the going concern basis of accounting to prepare its financial statements. If the management of an organization concludes that there is no other way but to either liquidate assets or curtail the scale of its operations, then they need to prepare their financial statements on some other basis (for example break-up basis) but not growing concern basis.
During an economic crisis, the concept of growing concern becomes all the more important and relevant.
It is the management’s duty to estimate if their financial statements can be prepared on a growing concern basis or not.
To determine if the company is able to continue its business for the foreseeable future, the business entity’s management needs to evaluate various uncertain future events, conditions, or outcomes.
As per International Standards on Auditing, ISA 570, there are three factors any management must consider to figure out if they can prepare their financial statements based on the growing concern basis or not:
The further into the future an event or condition occurs, the greater is the degree of uncertainty associated with it. Due to this reason, the financial reporting framework (that requires management assessment explicitly) in general specifies the timeframe for which the firm’s management needs to consider all available information.
The judgment about the outcome of an event depends on the complexity and size of the business entity, the degree to which external factors affect the entity, and the nature and condition of the business.
The judgment about the future is based on all the information available when the judgment is being made. There could be subsequent events that result in outcomes that are not consistent with judgments that were reasonable when they were made.
Going Concern Concept Examples:
Let us see some examples of the going concern concept:
A company ABC Ltd. makes a specialized chemical and sells it in the market. All of a sudden the government of the country where ABC operates puts a ban on the manufacture, import, export, and sale of this specific chemical. If manufacturing this chemical is the only operation of ABC Ltd. then the firm will no longer be a going concern.
A company owned by the state is struggling financially. The government grants a bailout to the company and guarantees all pending payments to the company’s creditors. Despite the poor financial situation, the state-owned company is still a going concern.
Hence, the article has included all the essential information regarding the going concern concept.