Going concern concept

Posted in: Accounting principles and concepts (explanations)

Definition and explanation

The going concern concept of accounting implies that the business entity will continue its operations in the 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 of accounting 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 the business until fully depreciated. Another example of the going concern assumption is the prepayment and accrual of expenses. Companies prepay and accrue expenses because they believe that they will continue operations in future.

The going concern concept is applicable to the company’s business as a whole. If, for example, a company closes a small business segment or discontinues one of its product 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 not to the 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).

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.

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Examples

(1). A 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 company manufactures, the company will no longer be a going concern.

(2). The National company is in serious financial trouble and cannot pay its obligations. The government gives National company a bailout and a guarantee of all payments to creditors. The national company is a going concern despite of its current weak financial position.

(3). The Eastern company closes one of its branch and will continue with others. The company is a going concern because the shutting down a small part of business does not impair the ability of the company to operate as going concern.

(4). The Small company is unable to make payments to its creditors due to a very weak liquidity position. The court grants the order of liquidating the company upon the request of one of the company’s creditors. The company is no longer a going concern because sufficient evidence is available to believe that the company cannot continue its operations in future.