Going concern

Going concern

• Going concern refers to the assumption that the company will continue its business for the foreseeable future (normally at least 12 months from the reporting date)
• Concept assumes that the business will have a long life, that it will last long enough to fulfill their objectives and commitments.

Why the Going Concern Assumption Matters

The going concern assumption affects:

• Asset valuation (recorded at cost, not liquidation value)
• Liability classification (long-term vs short-term)
• Depreciation & amortisation
• Users’ confidence in financial statements

Without going concern, financial statements would be prepared on a break-up or liquidation basis, which changes almost everything.

Responsibility

Management - Assess whether the company is a going concern

Auditor - Evaluate management’s assessment and conclude whether GC is appropriate

Indicators of Going Concern Problems

These are red flags, not automatic failure.

(a) Financial Indicators

• Recurring operating losses
• Negative cash flows
• Net liabilities / negative equity
• Inability to pay debts when due
• Breach of loan covenants

(b) Operational Indicators

• Loss of key customers or suppliers
• Major labour problems
• Obsolete technology
• Inability to obtain financing

(c) Other Indicators

• Legal claims threatening survival
• Changes in law affecting operations
• Natural disasters with no insurance

Management’s Assessment

Management must:

Look forward at least 12 months

• Consider cash flow forecasts
• Consider financing arrangements
• Assess mitigating plans (e.g. new funding, cost cuts)

Role of the Auditor

The auditor must:

• Evaluate management’s GC assessment
• Look for material uncertainty
• Decide the impact on the audit report

Disclosure Requirements

If material uncertainty exists, financial statements must disclose:

• Conditions causing uncertainty
• Management’s plans to address them
• Statement that GC depends on successful mitigation
• Failure to disclose → modified audit opinion