Assumption number one in the going concern idea is that a company will be able to sustain its current level of operations until the end of the next fiscal period and beyond. The going concern principle determines how much revenue a company must be able to produce in order to stay in business and prevent insolvency.
This blog provides a comprehensive review of the going concern concept, including its significance, assessment, advantages, and disadvantages. Keep reading!
A Going Concern Concept: Why Is It Necessary?
Both GAAP and IFRS rely heavily on the going concern notion in their respective frameworks for financial reporting.
The Financial Accounting Standards Board (FASB) has produced generally accepted accounting principles (GAAP) as a framework for financial reporting. Contrarily, International Financial Reporting Standards (IFRS) was founded to create transparent, high-quality, and universally recognized standards for accounting and sustainability reporting.
This going concern idea is crucial for a company to be able to handle accrued or prepaid expenses. Instead of factoring in all of a company's prepaid expenses at once, this idea lets them spread them out over multiple accounting years.
The valuation of a business's assets also relies heavily on it. Asset depreciation and amortisation are founded on this idea, which also specifies how a business will operate in the future.
The Going Concern Model: What Does It Presuppose?
One fundamental premise is that businesses will keep running indefinitely unless they either go bankrupt or liquidate their assets. In order for this assumption to be valid, the following must be addressed:
1. Financial Success
Among the primary presumptions of a going concern is its profitability. To illustrate the point, it is quite probable that a company that is currently losing money will turn a profit and experience annual growth in the future.
2. How Well Received the Product or Service Is
The going concern notion is the foundation upon which a firm operates. To achieve this, the company's product prices need to be competitive in order to attract and keep customers.
We anticipate that there will be demand for the company's products and services. So, this idea is predicated on the company's ability to maintain product sales and customer base growth.
3. The Growing Pattern of Revenue
There may not be continuous top-line and bottom-line growth when product demand is cyclical. Because of fixed costs, this can reduce profitability and impact revenue.
Where Can I Find the Going Concern Theory?
The management team may determine the future viability of a company. There is no requirement to prepare financial statements on a going concern basis if the firm's financial status leads to the liquidation of assets or the curtailment of operations. A continuing concern basis is required for the financial statements in the event that the firm is able to maintain its activities.
A company's viability as a going concern can be ascertained by following these steps:
- Look at your company's financial situation using various ratios. The current ratio, debt ratio, and net income to net sales ratio might be used for this purpose.
- Compile all of your company's assets, liabilities, income, and costs into an annual report and draft a financial statement.
- Keep an eye on the company and if you see any bad tendencies, start fixing them.
How Are the Elements of Going Concerned Evaluated?
The auditor evaluates an entity's ability to continue operating for at least one year after the end of the accounting year. When determining if an organization can continue to operate as a going concern, auditors look at the following factors:
- Operating outcomes, including liabilities, losses, and liquidity, are trending downward.
- The company is not paying back the loan.
- The company's suppliers have refused to grant it trade credit.
- The corporation is facing legal action.
- Compliance certificate for the covenant.
- Unfeasible investments for the future.
How Does a Going Concern Concept Benefit the Company?
- Businesses often make large, upfront investments in fixed assets during their formation years. Such assets can be more accurately valued with the use of the going concern concept.
- It is the basis for keeping track of a company's financial gains and losses for a specific fiscal year.
- In order to guarantee safety and ongoing long-term development and expansion, it documents and divides the company's assets and liabilities for a cost.
Is There Anything Negative About the Going Concern Model?
- Instead of using the company's current market worth, financial reports are prepared using its cost value. Because of this, in the case of liquidation, the market value, rather than the cost value, will be used to assess the company's assets.
- The financial statements that are prepared using the going concern concept may mislead stakeholders in the event of a company's liquidation.
- There may be repercussions for the way financial transactions are recorded if the going concern idea of the organization is impacted by a change in the law.
Conclusion
Proper business foresight and operational efficiency are the main necessities for a firm to thrive and remain successful over the long run. So far as this is concerned, the assets required to maintain operations indefinitely are available to the going concern notion. The company's long-term viability is also better portrayed.
