IGCSE Accounting 0452 - 7.1 Accounting Principles

Going Concern

The going concern assumption is a fundamental principle in accounting. It means that an accounting entity is assumed to continue operating for the foreseeable future – typically, at least the next 12 months. This assumption allows accountants to prepare financial statements based on the premise that the business will not be liquidated or forced to cease trading in the near future.

Why is the Going Concern Assumption Important?

This assumption underpins many accounting practices. Without it, financial statements would need to reflect the potential liquidation value of assets, which would be significantly different from their historical cost. The going concern assumption provides a more realistic and useful view of the business's financial position and performance.

Indicators of Going Concern

Accountants assess whether the going concern assumption is valid by looking for various indicators. These include:

• Profitability: Consistent profitability and positive cash flows suggest the business is viable.
• Liquidity: The ability to meet short-term liabilities (e.g., paying suppliers and employees) indicates financial health.
• Solvency: The ability to meet long-term liabilities (e.g., loans) suggests financial stability.
• Operational Efficiency: Efficient operations and effective management are positive signs.
• Industry Trends: A growing industry with good prospects supports the going concern assumption.
• Legal and Regulatory Compliance: Being compliant with legal and regulatory requirements indicates stability.

When is the Going Concern Assumption Questionable?

The going concern assumption may be questionable if there are significant doubts about the entity's ability to continue operating. These doubts might arise from:

• Consistent Losses: Repeated losses can erode a company's financial resources.
• Negative Cash Flows: Difficulty in generating sufficient cash to meet obligations is a major concern.
• High Levels of Debt: Excessive debt can strain a company's finances.
• Legal Issues: Significant legal challenges can impact a business's viability.
• Economic Downturn: A severe economic downturn can negatively affect a company's performance.

Accounting Treatment When Going Concern is in Doubt

If there are substantial doubts about a company's ability to continue as a going concern, this must be disclosed in the financial statements. The disclosure should include a statement explaining the circumstances giving rise to the doubt and the actions the company intends to take.

Impact on Financial Statement Preparation

The going concern assumption affects how financial statements are prepared. For example:

Element	Impact of Going Concern Assumption
Depreciation	Depreciation is calculated over the estimated useful life of an asset, assuming the asset will be used for that period.
Amortisation	Amortisation is calculated over the estimated useful life of an intangible asset, assuming the asset will be used for that period.
Valuation of Assets	Assets are generally valued at historical cost less depreciation.
Provisions	Provisions are made for anticipated future liabilities, assuming the business will continue to operate and incur those liabilities.

If the going concern assumption is not valid, assets may need to be valued at their liquidation value, and liabilities may need to be adjusted to reflect the expected settlement amounts.

Example

Consider a company that has been consistently making losses for the past three years and has a high level of debt. This raises doubts about its ability to continue as a going concern. The company would need to disclose this in its financial statements and potentially adjust the valuation of its assets and liabilities.