Definition and explanation
The going concern concept of accounting implies that a business entity will continue its operations in future and will not liquidate or be forced to discontinue operations due to any reason. A company is a going concern if no evidence is available to believe that it will or will have to cease its operations in foreseeable future.
An example of the application of going concern concept in business is the computation of depreciation on the basis of expected economic life of fixed assets rather than their current market value. Companies assume that their business will continue for an indefinite period of time and the assets will be used in business until they are fully depreciated. Another example of going concern assumption is the prepayment and accrual of various business expenses. Companies can prepay and accrue expenses only when they and their trade partners believe that they will not shut down operations in foreseeable future.
The concept is applicable to a company’s business as a whole. If, for example, a company closes a small business segment or discontinues one of its products and continues with others, it does not mean that the company is no longer a going concern because the going concern concept is applicable to the entity as a whole and not to a particular segment of business or product.
The going concern concept of accounting is of great importance for accountants because if a company is a going concern, it must prepare its financial statements in accordance with applicable financial reporting framework such as generally accepted accounting principals applicable in United States of America (US-GAAP) and international financial reporting standards (IFRS) applicable in many other countries.
The auditors conduct their own evaluation to see weather the going concern assumption is appropriate or not at the time of auditing financial statements, even if the company claims to be a going concern.
Examples of going concern concept
To make you better understand, let’s take a few examples of going concern concept:
(1). Deluxe Company manufactures a chemical known as Chemical-X. Suddenly, the government imposes a restriction on the manufacture, import, export, marketing and sale of this chemical in the country. If Chemical-X is the only product that the company is licensed to manufacture, the company can no longer be considered a going concern.
(2). National Company is in serious financial trouble and cannot pay its obligations. The government comes forward to give a bailout to the company and announces a guarantee of all payments to creditors. The National Company would still be considered a going concern despite of its current weak financial position.
(3). Eastern Company closes one of its branches and will continue with others. The company is a going concern because shutting down a small part of business does not impair its ability to operate as going concern.
(4). Murphy Company is unable to make payments to its creditors due to a very weak liquidity position. Upon request of one of the Murphy’s creditors, the court grants an order to liquidate the company. The company loses its going concern status immediately after the liquidation order because sufficient evidence is available to believe that the company would not be able to continue its operations in future.