Going Concern Concept Extensive Look With Examples

The valuation of companies in need of restructuring values a company as a collection of assets, which serves as the basis of the liquidation value. 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. 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. Some or all of the services described herein may not be permissible for KPMG audit clients and their affiliates or related entities.The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation.

Why You Can Trust Finance Strategists

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. For information pertaining to the registration status of 11 Financial, please contact the state securities regulators for those states in which 11 Financial maintains a registration filing. A copy of 11 Financial’s current written disclosure statement discussing 11 Financial’s business operations, services, and fees is available at the SEC’s investment adviser public information website – from 11 Financial upon written request. A small business cannot make payments to its creditors due to an extremely poor liquidity position.

Going Concern Concept

This will help prevent the investors from getting pessimistic forecasts about future losses. If a company receives a negative audit and may not be a going concern, there comparable store sales are several implications. Companies that are not a going concern represent a significantly higher level of risk compared to other companies.

The Eastern Company has closed a division but will continue working in its other divisions as usual. The business is a going concern because the closing down of a small portion of business does not impair the capacity of the enterprise to continue indefinitely in the future. Here, it should also be noted that the assumption is not made that the business will be profitable throughout its existence. Click here to extend your session to continue reading our licensed content, if not, you will be automatically logged off. KPMG has market-leading alliances with many of the world’s leading software and services vendors. At Finance Strategists, we partner with financial experts to ensure the accuracy of our financial content.

What is the Going Concern Assumption?

A company may not be a going concern for a number of reasons, and management must disclose the reason why. An entity is assumed to be a going concern in the absence of significant information to the contrary. An example of such contrary information is an entity’s inability to meet its obligations as they come due without substantial asset sales or debt restructurings. If such were not the case, an entity would essentially be acquiring assets with the intention of closing its operations and reselling the assets to another party. The going concern presumption that an entity will be able to meet its obligations when they become due is foundational to financial reporting. This presumption may be challenged at any time, but especially during uncertain economic times.

Unless it is categorically stated otherwise, all accounting records and income statements or balance sheets are prepared on the assumption that the business will continue to function for an indefinite future period. The financial statements (i.e., profit and loss account and balance sheet) are also prepared under this assumption, as this concept leads to a distinction being made between capital and revenue expenditures. 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.

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. 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. For instance, the value of fixed assets (PP&E) is recorded at their original historical cost and depreciated over their useful life, i.e. the expected number of years in which the fixed asset will continue to contribute positive economic value. 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.

For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. © 2024 KPMG LLP, a Delaware limited liability partnership and a member firm of the KPMG global organization of independent member firms affiliated with KPMG International Limited, a private English company limited by guarantee. Helping clients meet their business challenges begins with an in-depth understanding of the industries in which they work. In fact, KPMG LLP was the first of the Big Four firms to organize itself along the same industry lines as clients. Someone on our team will connect you with a financial professional in our network holding the correct designation and expertise. Our team of reviewers are established professionals with decades of experience in areas of personal finance and hold many advanced degrees and certifications.

If a company is not a going concern, that means there is risk the company may not survive the next 12 months. Management is required to disclose this fact and must provide the reasons why they may not be a going concern. Management must also identify the basis in which the financial statements are prepared and often disclose these financial reports with an audit report with a going concern opinion. For a company to be a going concern, it must be able to continue operating long enough to carry out its commitments, obligations, objectives, and so on. 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.

1. The reason the going concern assumption bears such importance in financial reporting is that it validates the use of historical cost accounting.
2. The business is a going concern because the closing down of a small portion of business does not impair the capacity of the enterprise to continue indefinitely in the future.
3. When forecasting becomes less reliable and the past no longer predicts the future, the going concern assessment becomes much harder to document and update, and robust disclosures much more critical.
4. Going concern is an example of conservatism where entities must take a less aggressive approach to financial reporting.
5. New lenders will likely be reluctant to issue new credit, or any new credit issued will be prohibitively expensive.
6. 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.

In the context of corporate valuation, companies can be valued on either a going concern basis or a liquidation basis. In the absence of the going concern assumption, companies would be required to recognize asset values under the implicit assumption of impending liquidation. However, liquidating a company means laying off all of its employees, and if the company is viable, this can have negative ramifications not only for the laid-off workers but also for the investor who made the decision to liquidate a healthy company. Liquidating a going concern can give an investor a bad reputation among potential future takeover targets. A financial professional will offer guidance based on the information provided and offer a no-obligation call to better understand your situation.

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. 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. 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 reason the going concern assumption bears such importance in financial reporting is that it validates the use of historical cost accounting. KPMG handbooks that include discussion and analysis of significant issues for professionals in financial reporting.

Statements should also show management’s interpretation of the conditions and management’s future plans. 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). The presumption of going concern for the business implies the basic declaration of intention to keep operating its activities at least for the next year, which is a basic assumption for preparing financial statements that comprehend the conceptual framework of the IFRS. 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.

The court grants the purchase price of liquidating the company upon the petition of one of the firm’s creditors. However, if it is known that a business will close down in, for example, the next two or three months, it would be more appropriate to state its assets not at cost but at the value at which these can be sold on the closure of the business. If there is an issue, the audit firm must qualify its audit report with a statement about the problem. Accountants who view a company as a going concern generally believe a firm uses its assets wisely and does not have to liquidate anything.

Given these circumstances, if Chemical X is the only product the company produces, the business will no longer be classified as a going concern. This is because it would make it impossible for the business to carry out its present contractual commitments or to use its resources according to a predetermined plan of operation. are subject to The laws that bind corporations in all countries state that a company is presumed to have an uninterrupted existence with continuing activity until such time as it is legally liquidated. At this stage, it may also be necessary to take account of all legal obligations that may not have been previously brought to books.