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, for at least the next 12 months from the balance sheet date.

Importance of the Going Concern Assumption

This assumption underpins many accounting practices. It allows us to prepare financial statements based on the idea that the business will not be liquidated or cease trading in the near future. Without this assumption, financial reporting would be significantly more complex and less useful.

Key Implications of the Going Concern Assumption

• Assets are valued at historical cost: We assume assets will be used to generate revenue over their useful lives.
• Liabilities are recognised as present obligations: We assume the business will have ongoing obligations to pay back debts.
• Depreciation is charged: The cost of using assets is spread over their useful lives.
• Financial statements are prepared on a basis of continuity: The financial statements reflect the business's expected future operations.

When the Going Concern Assumption May Be in Doubt

An auditor or accountant needs to assess whether the going concern assumption is still valid. Factors that might indicate doubt include:

• Recurring losses: Consistent losses can erode a company's capital.
• Working capital deficiencies: Difficulty meeting short-term obligations.
• Loss of key customers or suppliers: Significant impact on revenue or operations.
• Legal proceedings: Potential financial burdens.
• Economic downturn: Reduced demand for products or services.

Disclosure of Going Concern Issues

If there is substantial doubt 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 indicating the nature of the doubt
• Any relevant events or conditions that have led to the doubt
• Any actions the company plans to take to address the doubt

Accounting Treatment if Going Concern is Doubtful

If the going concern assumption is no longer valid, the financial statements must be prepared on a liquidation basis. This means:

• Assets are valued at their net realizable value (the amount they could be sold for)
• Liabilities are settled in the order they become due
• The financial statements reflect the proceeds of asset sales and the settlement of liabilities

Example

A company has been making consistent losses for the past three years and has a significant amount of debt. This raises concerns about its ability to continue as a going concern. The company would need to disclose this in its financial statements and potentially prepare them on a liquidation basis.

Factor	Impact on Going Concern
Recurring Losses	Erodes capital; increases risk of insolvency.
Working Capital Deficiencies	Difficulty meeting short-term obligations; potential for cash flow problems.
Loss of Key Customers	Reduces revenue; impacts profitability.
Legal Proceedings	Potential for significant financial liabilities.
Economic Downturn	Reduced demand; impacts profitability and cash flow.