What Does ‘Going Concern’ Mean?
Going concern is an essential accounting term representing a company’s capability to continue functioning indefinitely, barring any evidence suggesting otherwise. It encapsulates the business’s ability to generate enough revenue to avoid bankruptcy and stave off liquidation.
Such was evident when numerous dot-com companies failed to remain going concerns following the tech crash in the late ’90s.
Key Insights
- Financial Stability: Going concern signifies that a company is financially robust enough to fulfill its obligations and sustain its operations for the foreseeable future.
- Deferred Reporting: Companies assumed to be a going concern can defer reporting certain expenses and assets in their financial statements.
- Going Concern Opinion: Auditors can issue a going concern opinion if they harbor doubts regarding the company’s financial sustainability.
Grasping the Concept of Going Concern
Accountants apply going concern principles to determine the appropriate financial reporting on a company’s financial statements. A going concern can delay reporting long-term assets at current value or liquidation prices, instead recording them at cost value.
The principle assumes that efficient asset utilization within the company negates any immediate liquidation needs, emphasizing that present asset sales won’t compromise ongoing operations.
Although not a part of the Generally Accepted Accounting Principles (GAAP), going concern is pivotal in the Generally Accepted Auditing Standards (GAAS), representing a conservative approach towards financial reporting.
Warning Signs of Non-Going Concern
Certain red flags lurking within a company’s financial statements can forecast a diverting course away from a going concern status:
- Sale of Long-Term Assets: Inclusion of long-term asset sales to meet obligations suggests an inability to sustain normal operations.
- Fiscal Imbalance: Hefty annual expenses overshadowing revenues, or overwhelming long-term liabilities amidst profit may signal distress.
- Measurable Indicators: High employee turnover, decreasing market share, and low liquidity ratios reinforce unstable financial health.
Conditions Indicating Going Concern Doubts
Accounting standards recommend disclosing precarious conditions fueling doubts about a company’s going concern status, bolstered by transparency regarding these situations and management’s forward strategies.
Auditors review financial statements ensuring that a business can sustain at least a year following the audit, considering various conditions like operating losses, loan defaults, and denial of credit.
Consequences of Failing Going Concern Tests
Entities flagged with a negative going concern review may experience several setbacks:
- Investment Decline: Revalued and perceived as a deteriorating investment, they struggle to attract new capital.
- Credit Crunch: Inoperative debt covenants prompt callable debts and prohibitively expensive new credit offerings.
- Supplier Reluctance: Inability to easily acquire credit or goods on credit stymies operational fluidity.
The Double-Edged Sword of Going Concern
While a going concern status often translates positively, being financially stable for at least a year, it underscores a lack of necessary resources if unmet, indicating potential for insolvency within the next 12 months.
Significance of Going Concern
It symbolizes trust in a company’s longevity, fostering credit sales and operational confidence amongst suppliers, vendors, and business partners.
Potential Scenarios for Non-Going Concerns
Failure to achieve going concern means presenting an audit report complete with reasons and bases for the mixed financial standing, requiring transparency from management.
The Core Takeaway
In accounting, going concern is indicative of sustained corporate survival over a year. Non-going concerns demand transparent public disclosure of incapacity signs, ensuring stakeholders stay well-informed of the company’s near-term feasibility.
Related Terms: financial statements, bankruptcy, liquidation, GAAP, GAAS.
References
- American Institute of CPAs. “The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern”, Page 617.
- Financial Accounting Standards Board. “ASU 2014-09 Revenue From Contracts With Customers (Topic606)”.
