Why is it assumed that the business entity will continue to operate indefinitely?

The going concern concept states that a business will continue with its operations for the foreseeable future. The concept assumes that the company won’t be forced to discontinue its operations or liquidate due to any reason.

A perfect example of implementation of such concept in accounting is the calculation of depreciation based on the anticipated economic life of the fixed asset rather than its current value. Note that businesses assume that they will operate indefinitely and they will use their assets until they are fully depreciated. Prepayment and accrual of expenses is another example of going on concern assumption. Businesses accrue expenses and prepay expenses because they intend to operate indefinitely.

Though there is an assumption that a company will operate indefinitely, this is not always the case. You must have seen and heard of companies that terminated their operations, merged with others, and more. This means that some businesses might not operate indefinitely. If your accountant believes that company might no longer be a going concern, this raises the issue of whether your business’s assets are impaired. Impairment of fixed assets calls for the write-down of the assets’ carrying value to their liquidation amount.

This means that the value of a business that is assumed to be a going concern is usually higher than its termination value. This is because a going concern entity can continue making profits for as long as it operates.

Auditors evaluate a business’s ability to continue operating as a going concern entity for a period not greater than 12 months. There are a few things they consider to determine if the business should continue operating. These include:

• Continued negative trends especially operating results
• Violation of loan agreements by the company
• The company being denied trade credit by its suppliers
• Any legal proceeding against the company that requires it to stop operating
• The company being subjected to long-term uneconomical commitments

Therefore, it’s important to keep your business operations clean and evade anything that might make an auditor hint that your business should not continue indefinitely. Besides, it’s possible for your business to minimize an auditor’s view of the business’s going concern status. One way of doing this is by having a third party guarantee your business’s debts. This will assure the auditor that your business will continue operating effectively for the next 12 months.

Alternatively, you can consider getting accounting services in Singapore so to also obtain some valuable insight on how changes in transaction arrangement can impact the financial statements.

What is the Going Concern Principle?

The going concern principle is the assumption that an entity will remain in business for the foreseeable future. Conversely, this means the entity will not be forced to halt operations and liquidate its assets in the near term at what may be very low fire-sale prices. By making this assumption, the accountant is justified in deferring the recognition of certain expenses until a later period, when the entity will presumably still be in business and using its assets in the most effective manner possible.

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.

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. 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.

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.

Going Concern Evaluation Items

The auditor evaluates an entity’s ability to continue as a going concern for a period not greater than one year following the date of the financial statements being audited. The auditor considers (among other issues) the following items in deciding if there is a substantial doubt about an entity’s ability to continue as a going concern:

• Negative trends in operating results, such as a series of losses

• Loan defaults by the company

• Denial of trade credit to the company by its suppliers

• Uneconomical long-term commitments to which the company is subjected

• Legal proceedings against the company

If there is an issue, the audit firm must qualify its audit report with a statement about the problem.

Going Concern Mitigation

It is possible for a company to mitigate an auditor's view of its going concern status by having a third party guarantee the debts of the business or agree to provide additional funds as needed. By doing so, the auditor is reasonably assured that the business will remain functional during the one-year period stipulated by GAAS. This makes it easy for a parent company to ensure that its subsidiaries are always classified as going concerns.

What principle assume that the company will continue indefinitely?

Why is it necessary for accountants to assume that business entity will remain a going concern?

Why is the business entity assumption important?

What concept assumes that the business has an indefinite economic life?