Key Takeaways
- Assumes business operates for next 12+ months.
- Supports asset valuation at historical cost.
- Auditors assess risks and require disclosures if doubtful.
What is Going Concern?
A going concern is an accounting principle that assumes your business will continue operating for at least 12 months from the financial statement date, without needing to liquidate assets or halt operations. This assumption is fundamental to financial reporting standards like GAAP and IFRS, allowing assets to be valued based on ongoing use rather than liquidation.
Without the going concern basis, financial statements would require a liquidation approach, significantly altering how assets and liabilities are reported.
Key Characteristics
Going concern relies on several core features that impact financial reporting and analysis:
- Continuity assumption: The business is expected to operate long enough to realize assets and settle liabilities in the normal course of operations.
- Time horizon: Typically at least one year from the reporting date, guiding auditors and management in their assessments.
- Financial statements impact: Allows deferral of expenses like amortization and depreciation, reflecting normal business operations.
- Auditor review: Auditors apply GAAS standards to evaluate going concern risks and disclose substantial doubts.
How It Works
Management evaluates the going concern assumption by analyzing liquidity, debt obligations, and funding sources for the next 12 months. This includes assessing risks such as operating losses, debt defaults, or external factors like lawsuits.
If substantial doubt arises but liquidation is not imminent, disclosures must be made in the financial statements to inform stakeholders. Auditors review these assessments in accordance with GAAS and may issue qualified opinions if concerns persist.
Examples and Use Cases
Understanding going concern is crucial across various industries and market conditions:
- Airlines: Companies like Delta have faced going concern evaluations during economic downturns, impacting investor confidence and operational decisions.
- Retail sector: Many large-cap stocks experienced going concern warnings post-2020, affecting their ability to raise capital or restructure debt.
- Dividend stocks: Firms classified under best dividend stocks often emphasize going concern stability to maintain consistent payouts.
Important Considerations
When analyzing financial statements, be aware that going concern assumptions affect asset valuations and expense recognition. A shift away from this assumption typically indicates financial distress, requiring a liquidation basis that reduces asset values.
Investors should monitor red flags such as recurring losses or cash shortages, and understand how going concern status influences company valuations, including methods like DCF analysis, which depends on future cash flow projections assuming ongoing operations.
Final Words
A business’s ability to continue as a going concern is essential for accurate financial reporting and long-term planning. Monitor key financial indicators closely and consult your auditor if you notice signs of distress to address potential risks early.
Frequently Asked Questions
Going Concern is an accounting principle that assumes a business will continue operating for at least 12 months from the financial statement date without needing to liquidate assets or significantly reduce operations.
It allows companies to value assets at historical cost and defer expenses like amortization, reflecting ongoing operations rather than liquidation values, which alters how revenues, expenses, and liabilities are reported.
Auditors review financial trends, such as recurring losses, debt defaults, and legal issues, for at least one year after the reporting date to determine if there is substantial doubt about the company's ability to continue operating.
Red flags include loan defaults, recurring losses, cash shortages, loss of major customers, denial of trade credit, lawsuits, and plans for bankruptcy or inability to refinance debt.
Management must disclose the doubt in financial statements, and if liquidation is imminent, the company must prepare financial statements on a liquidation or break-up basis instead of the going concern basis.
Typically, the foreseeable future refers to at least 12 months from the financial statement date, although auditors may extend this review period if relevant conditions exist.
Companies like Enron in 2001 and retail chains such as Bed Bath & Beyond post-2020 faced going concern warnings due to financial distress, which led to disclosures and eventual liquidation when issues were not resolved.
