What is a Going Concern?

Source: PWC

Going concern assumption Under the going concern assumption, a company is viewed as continuing in business for the foreseeable future. Financial statements are prepared on a going concern basis, unless management either intends to liquidate the company or to cease operations, or has no realistic alternative but to do so. When the use of the going concern assumption is appropriate, assets and liabilities are recorded on the basis that the company will be able to realise its assets and discharge its liabilities in the normal course of business. If management considers that the company will not continue to operate for the foreseeable future, the financial statements must be prepared on a ‘liquidation’ (or ‘break-up’) basis—meaning that the value of their assets must take account of potential forced sales which will likely be significantly lower and their liabilities may be significantly higher.

Whether or not the going concern assumption is appropriate is therefore fundamental to the values at which the assets and liabilities are recognised in the company’s balance sheet. Thus, going concern refers to the basis on which the financial statements are prepared. It is not a guarantee of the company’s solvency. In order to determine whether the going concern assumption is appropriate, management must consider the prospects for the business in the light of what the foreseeable future might bring. This requires significant judgement as no statement about the future can be guaranteed. It is management’s responsibility to make a judgement on going concern. It is the auditor’s responsibility to consider whether there are any material uncertainties affecting management’s assessment and whether or not management's judgement is appropriate. These judgements can be made only on the basis of what is known at the time, and facts and circumstances can quickly change in the current business and economic environment. What may be a reasonable assumption today, particularly in a fast-changing environment, may no longer be so a short time later. The most common recent form of such uncertainty is where additional financing is needed to continue to develop a company’s business and fully fund its working capital. While management may be confident of obtaining additional funding in order to meet these needs, if there is no firm agreement with potential suppliers of finance, there is inherent uncertainty as to whether such funding will be raised. If the auditors consider that there are any material uncertainties, even if clearly disclosed in the financial statements, then they must include an emphasis of matter paragraph in their audit report. If the auditors disagree with management’s assessment that the going concern assumption is appropriate for the company’s financial statements or if adequate disclosure of material uncertainties is not made, then their audit opinion will be modified.