A foundational idea in accounting is the going concern principle. It requires that a company will carry out its current goals, utilise its current assets, and continue to pay its debts over the upcoming fiscal period and beyond. In other words, it is a premise that the company will continue to operate and that the value of its assets will hold steady. The continuous concern concept is another name for this fundamental idea.
When a business fails, its assets frequently lose their value on the balance sheet. This occurs because some company-specific assets, including specialised software, may be less valuable when sold to outside parties than what was paid for them. Additionally, if a business needs to sell its assets quickly, it might not have the time to wait for the best possible price. An accountant must disclose in their audit report if they have any grounds to believe that a company won't be able to meet its obligations, operate as a going concern, and safeguard its assets.
Did you know? The FASB published an Exposure Draft titled "Going Concerned" in October 2008.
Going Concern Concept in Accounting
Accounting professionals decide what kinds of reporting should feature on financial statements based on the going concern principles. Companies still in business may choose to list long-term assets at cost rather than at current or liquidation value. Whenever the sale of assets does not compromise a company's capacity to run its business, as in the case of closing a minor branch office and moving the staff to other business divisions, it is still considered a going concern in accounting.
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What Is the Going Concern Concept?
The going concern concept is the belief that a company will continue to operate for some time to come. On the other hand, this implies that the corporation won't have to immediately stop operations and sell off its assets at what might be extremely low fire sale rates. By assuming this, the accountant is justified in delaying the recognition of some expenses to a later period, when it is presumed that the entity will still be operating and making the best use of its assets.
There is a great deal of debate about when an entity should disclose the going concern notion because it is not specifically stated anywhere in widely accepted accounting principles. However, generally accepted auditing standards provide an auditor with guidance regarding the need to take a company's ability to operate successfully into account.
Going Concern Assumption
An accounting principle known as the "going concern assumption" helps determine whether a company is financially sound and capable of fulfilling its long-term contractual obligations. The going concern concept, its application, what defines a negatively going concern concept, and when a corporation is no longer regarded as a going concern are all covered in this article. A key accounting theory known as the "going concern assumption" states that a company must be financially stable enough to continue operating at least through the next fiscal period. Additional traits include:
- There are lower odds of a corporation being liquidated.
- A business keeps going by paying its debts using its existing assets to stay out of bankruptcy.
- Because it does not intend to or is not compelled to do so, a business can continue to make profits in the future.
- A business is anticipated to continue operating for at least a year.
- A company's break-up value is less than its value as a continuing concern.
If there are concerns about a company's ability to continue as a going concern, accounting standards strive to decide what information should be disclosed on its financial statements. The Financial Accounting Standards Board decided in May 2014 that financial statements must show the circumstances that give rise to serious doubt about an entity's ability to continue as a going concern. Statements should also include management's assessment of the situation and its expectations for the future.
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Disclosure of Going Concern Concept
How an auditor discloses their view when they provide a going concern concept in accounting relies on how the business is set up.
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Public companies
- The Securities and Exchange Commission requires the auditor to note in public companies' financial statements whether the company's status as a continuing concern is in dispute. This can shield investors from persisting in staking their capital on a company that might not last for very long.
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Private Companies
- The auditor must include a statement in the audit report if there is substantial evidence that a privately held company could not be viable under the going concern assumption. Even if the company's books aren't audited, an auditor who is worried about the company's viability should let the owner know.
Advantages of Going Concern Concept
Here are a few benefits of the going concern concept:
- During their formative years, companies will invest in capital assets that will cost money upfront but will pay off over a long period, far longer than a single accounting period. The going concern notion, therefore, offers a means of capturing the value of such assets.
- It is the foundation for recording the company's profits and losses for the relevant fiscal year.
Disadvantages of Going Concern Concept
The going concern concept cannot counter all hindrances and has its disadvantages.
- Instead of using the current market value as the basis, financial accounts are generated at cost. In such a scenario, the company's assets would be evaluated at market value in the event of liquidation, making them different from the value established at cost.
- The accounting records will be calculated on the premise of an ongoing business if the company is liquidated, which may deceive the stakeholders.
Examples of Going Concern Concept in Accounting
Depreciating fixed assets according to their predicted economic life rather than their today's market worth is an example of going concerned with how the going concern principle of accounting is applied. Businesses anticipate that their operations will last indefinitely and that their assets will be utilised until they have fully depreciated. The accrual and prepayment of expenses is another illustration of the going concern assumption. Companies believe they will continue to operate in the future; therefore, they prepay and accrue expenses.
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Jockey India
We may infer from the following financials that Page Industries Ltd., which produces clothing under the Jockey brand, has constantly increased revenue and net profit from FY14 to FY17. From FY14 to FY17, the income climbed from ₹1194.17 Cr to ₹2152.88 Cr. The net profit increased from ₹153.78 crores to ₹266.28 crores over this time. As a result, the gross profit margin has been in the range of 50% to 60%, with the EBIT margin being over 20% and the net profit margin being between 12% and 13%. That demonstrates the viability of a business due to improved product acceptance and operational efficiency.
TATA Steel
The revenue has decreased due to the global steel market's cyclical demand. Due to the seasonal demand for steel worldwide, sales and profitability have fallen (from ₹149130.36 Cr in FY14 to ₹112826.89 Cr in FY17 and from ₹3663.97 Cr to a net loss of -₹4176.22 Cr respectively). The margin has remained strong despite rising finance costs (from ₹4336.83 Cr in FY14 to ₹5072.2 Crores and a particular extraordinary loss.
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Conclusion:
The management's competence and moral character continue to be the key components of a company. For a corporation to sustain itself and be profitable over the long term, good operational effectiveness and business foresight are essential. Recessions in the economy are also important because they determine managerial skills when significant companies cannot turn a profit.
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