Going Concern Concept: Understanding its Significance in Accounting

The going concern concept is a fundamental principle in accounting that assumes a business will continue to operate indefinitely, without any intention or necessity of liquidation or cessation of operations.

In simpler terms, it implies that a company is expected to remain in operation for the foreseeable future, allowing it to fulfill its commitments and realize its assets.

Explanation

Imagine you own a bakery.

When you started your business, you didn’t plan to shut down after a short period.

Instead, you invested in equipment, hired staff, and leased a space with the expectation that your bakery would operate for many years to come.

This assumption that your bakery will continue operating as a going concern is essential for accounting purposes.

Importance

Financial Reporting Stability

The going concern concept provides stability to financial reporting by assuming that the business will continue to operate.

This allows for the preparation of financial statements that reflect the company’s ongoing operations and financial position.

Asset Valuation

Assets are typically recorded at their historical cost under the going concern assumption.

This means that long-term assets, such as property, equipment, and investments, are not immediately valued at their liquidation or fire-sale prices, but rather at their cost, assuming they will continue to contribute to the business’s operations.

Accrual Basis Accounting

The going concern concept supports the use of accrual basis accounting, where revenues and expenses are recognized when earned or incurred, regardless of when cash is received or paid.

This method provides a more accurate representation of the company’s financial performance over time.

Examples

Inventory Valuation

A company that assumes it will continue operating will value its inventory at cost or net realizable value, rather than at a lower liquidation value.

Long-Term Investments

Investments in stocks or bonds of other companies are recorded at their purchase cost, assuming the company will hold onto them for the long term unless evidence suggests otherwise.

Loan Repayment

When a company takes out a long-term loan, it plans to repay the loan over time, assuming it will continue generating revenue to meet its repayment obligations.

FAQs

Why is the going concern concept important in accounting?

The concept provides a framework for preparing financial statements that reflect the company’s ongoing operations and financial position, ensuring their relevance and reliability for users.

What happens if a company is no longer considered a going concern?

If there are significant doubts about a company’s ability to continue operating, its financial statements may need to be adjusted, and additional disclosures may be required to inform stakeholders about the risks involved.

How do auditors assess the going concern assumption?

Auditors evaluate a company’s financial statements, management forecasts, and other relevant factors to assess whether there are any material uncertainties about the company’s ability to continue as a going concern.

Does the going concern concept apply to all businesses?

Yes, the concept applies to all businesses, regardless of their size, industry, or ownership structure.

It is a fundamental assumption underlying the preparation of financial statements according to generally accepted accounting principles (GAAP).

Can a company change from being a going concern to not being one?

Yes, significant changes in economic conditions, operational performance, or management’s plans could lead a company to transition from being considered a going concern to facing doubts about its ability to continue operating.