Going Concern Assumption and Principles Explained

Going concern is a financial reporting term that describes companies whose balance sheets show a firm company valuation and ability to avoid potential bankruptcy for a reasonable period. Companies not in this status may have assets going through liquidation. When companies are no longer going concern, there are more disclosure requirements; financial statements must show more information such as liabilities, audit reports, and other expenditures. Legal proceedings, adverse opinions of the company, and poor management plans can all lead a business out of going concern.

Certified public accountants (CPAs) rely on going concern principles to determine whether or not a company shows working capital adequacy. Generally accepted auditing standards (GAAS) includes going concern, but the generally accepted accounting principles (GAAP) do not. In accounting standards, a going concern assumption is that a company’s sale of assets does not inhibit its ability to continue operations. For example, restructuring (closing one small branch to enhance another) can still be a part of going concern.

In auditor’s considerations, the going concern basis of accounting shows firms that use assets and do not have to rely on liquidation values for financial support. Audit procedures can also help inform how a company progresses once deemed a going concern; management’s evaluations and auditor’s reports may determine how a company should move forward with asset sales, expense reductions, or product strategy shifts.

In 2014, the Financial Accounting Standards Board (FASB) said financial statements must reveal substantial doubt that it can continue as a going concern. At the time of an audit, CPAs will determine an entity’s ability to continue as a going concern for the following year. Companies must transparently show upward trends, lack of legal matters, and approval of credit to maintain going concern status.

In consideration of an entity, some red flags and audit evidence may point to a company no longer being a going concern. Some indicators include:

1. 1. Bad legal standing: Lawsuits can decrease stock value and change the public’s consideration of management. This can negatively impact sales.
2. 2. Liquidation basis: If companies sell assets, they may be in greater need of liquid funds, which is not a good sign of business progress, investment, and growth.
3. 3. Low current ratio: If a company has difficulty punctually paying its liabilities and debts, it may have a low current ratio that can also trigger financial instability. A low current ratio means the company is not a going concern; a current ratio of anything under one is a cause for concern.
4. 4. Loss of employees: Losing employees can lead to losing internal control and talent that propels a company. Poor employee retention can signal a company is not in good standing, as high turnover can mean employee dissatisfaction, lack of fair pay, or unpleasant working conditions.

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