Understanding the Going Concern Principle

The going concern principle is a fundamental concept in accounting that assumes a company will continue to operate for the foreseeable future. This assumption is crucial in preparing financial statements.

Financial statements are prepared on the basis that the company will remain in business, and its assets will continue to be used to generate revenue. This assumption is essential for investors, creditors, and other stakeholders who rely on financial statements to make informed decisions.

The going concern principle is based on the idea that a company's assets are not sold off or liquidated unless absolutely necessary. This means that the company's assets are valued at their current cost, and not at their disposal value.

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The going concern assumption is a fundamental concept in accounting, and it's essential to understand what it means. It assumes that a business will continue to operate for the foreseeable future.

The going concern principle is universally accepted by accounting professionals, but it's not formally incorporated into U.S. GAAP. This is despite the fact that the FASB issued an Exposure Draft in October 2008 to discuss possible pronouncements for the going concern.

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The going concern concept assumes that a business will remain in existence long enough for all its assets to be fully utilized. This means that assets are not written off immediately, but rather depreciated over their useful life.

For example, if you recently purchased equipment costing $5,000 with a 5-year productive life, you would only write off one year's value ($1,000) this year, leaving $4,000 to be treated as a fixed asset with future economic value for the business.

The AICPA Statement on Auditing Standards No. 1 defines the going concern concept as assuming that a business will continue to operate its business for the foreseeable future. This principle purports that every decision in a company is taken with the objective in mind of running the business rather than that of liquidating it.

The going concern assumption is crucial in accounting as it affects how assets are valued and depreciated. It's essential to understand this concept to make informed decisions about a business's financial health.

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In Australia, auditors have specific responsibilities when it comes to the going concern assumption. They must evaluate the assessment prepared by management and obtain sufficient audit evidence about the appropriateness of using the going concern basis of accounting.

Your auditor will also require a written representation from those charged with governance at the end of the audit on whether or not the use of the going concern assumption is appropriate.

The auditor's responsibilities include concluding on whether there is a material uncertainty about the entity's ability to continue as a going concern. They must also ensure that the period of the going concern assessment is at least 12 months in the future from the date of the audit report.

Here are the key auditor responsibilities related to the going concern assumption:

Accounting is a critical process in businesses and organizations, allowing them to track their financial transactions, prepare financial statements, and make informed decisions.

Financial statements, such as balance sheets and income statements, are prepared by accountants to provide a snapshot of a company's financial position.

Accountants use Generally Accepted Accounting Principles (GAAP) to ensure consistency and accuracy in financial reporting.

GAAP outlines specific rules and guidelines for recording and reporting financial transactions.

Accountants must also stay up-to-date with changing laws and regulations, such as the Sarbanes-Oxley Act, which impacts financial reporting and disclosure.

The Sarbanes-Oxley Act requires companies to maintain accurate and transparent financial records.

Auditing is a separate process that verifies the accuracy and reliability of a company's financial statements.

A qualified opinion is not what a business wants to see, it's given when the auditor has doubts about the company and the assumption that it is a going concern. This can be a concern to investors, lenders and other stakeholders.

A qualified opinion can arise from various situations, such as a low current ratio, inability to get a loan, loss of employees, legal issues, or declining market share. These red flags can signal trouble for a business.

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The auditor's responsibilities in this regard are to evaluate the assessment prepared by management, obtain sufficient appropriate audit evidence, and conclude on whether there is a material uncertainty about the entity's ability to continue as a going concern. They must also ensure that the period of the going concern assessment is at least 12 months in the future from the date of the audit report.

If an auditor issues a going concern qualification, the way their opinion is disclosed depends on the structure of the business.

In some cases, a qualified opinion can be avoided by addressing the underlying issues and demonstrating the business's ability to continue as a going concern. This might involve providing additional information or explanations to the auditor.

The auditor will also require a written representation from those charged with governance at the end of the audit on whether or not the use of the going concern assumption is appropriate. This will normally be included in the representation letter.

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The concept of going concern is not clearly defined in GAAP, leaving room for interpretation about when an entity should report it.

Generally Accepted Auditing Standards, however, require auditors to verify an entity's ability to continue as a going concern.

Without significant information to the contrary, it's always assumed that an entity will meet all its obligations without significant debt restructuring and continue as a going concern entity.

Liquidation value is relevant in situations where a company becomes insolvent and is unable to pay its bills. The value received from the sale of assets is usually the asset's market value, less sale expenses.

In such cases, creditors and stakeholders are paid out of the liquidation value. This is a crucial aspect to consider for business owners and leadership teams.

The liquidation value is determined by selling the company's assets one by one or all of them together, and it's an important consideration for creditors and stakeholders who would be paid out of this money.

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Liquidation Value is the value a company has when it's insolvent and can't pay its bills. This is a serious situation where the company may sell its assets one by one or all at once.

The value received from the sale is usually the asset's market value, less sale expenses. This is a critical consideration for creditors and stakeholders, who would be paid out of this money.

In a liquidation scenario, the company is essentially valued based on the sale of its assets, rather than its potential for future profits. This is a stark contrast to the going concern valuation method, which looks at a company's operational efficiency and potential to earn profits.

Liquidation value is a crucial consideration for stakeholders, as it determines the amount of money they'll receive if the company is unable to pay its debts.

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Determining whether a business can continue in the foreseeable future is a crucial step in accounting. The business owner or leadership team is responsible for making this determination.

It's a matter of assessing the business's stability, which can be influenced by various factors. The ability to continue operations is a key consideration.

A business is considered stable if it's able to cover its expenses and debts. This stability is what allows financial statements to be prepared using the going concern basis of accounting.

This basis of accounting allows some prepaid expenses to be deferred until a later date. It's a practical approach that can help businesses manage their finances more effectively.

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