It is highly unlikely that the entity will be successful in renewing or re-financing the $10m borrowings and, in such an event, the directors will have no alternative but to cease to trade. The bank have already indicated that they are shortly going to commence legal proceedings to force the company to cease trading and sell off its assets to generate funds to pay off some of the borrowings. Many candidates fall into the trap of relying on ‘discussions with management/directors’ and ‘obtaining a written representation’. Candidates must appreciate that while discussion/inquiry is a valid audit procedure under ISA 500, Audit Evidence, such a procedure is always used in addition to other procedures – in other words, inquiry on its own will not generate sufficient appropriate audit evidence.
- Going concern is an accounting term used to identify whether a company is likely to survive the next year.
- Management may have a history of successful refinancing or carrying out other plans.
- If a business is not a going concern, it means it’s gone bankrupt and its assets were liquidated.
- As mentioned earlier, it is not the auditor’s responsibility to determine whether, or not, an entity can prepare its financial statements using the going concern basis of accounting; this is the responsibility of management.
- Click here to extend your session to continue reading our licensed content, if not, you will be automatically logged off.
Accountants use the going concern principle to create financial statements, which provide information about a company’s current and long-term financial health. In order to avoid the entity’s credit rating suffering any further decline, the directors have refused to make disclosures in the financial statements and have prepared the financial statements for the year ended 31 March 20X2 on the going concern basis. IFRS Standards do not prescribe how management performs the going concern assessment. IAS 1 only statement of owners equity states that when a company has a history of profitable operations and ready access to financial resources, management may reach a conclusion on the appropriateness of the going concern assessment without detailed analysis. It follows that when this is not the case, a detailed analysis will be necessary, which likely includes robust cash flow forecasts and a review of existing and forthcoming financial obligations. The assessment typically requires significant judgment.COVID-19 impact on the assessment.
Among other syllabus requirements, candidates must ensure they are aware of the respective responsibilities of auditors and management regarding going concern. The provisions in ISA 570, Going Concern deal with the auditor’s responsibilities in relation to management’s use of the going concern basis of accounting in the preparation of the financial statements. Under IFRS Standards, management assesses all available information about the future, considering the possible outcomes of events and changes in conditions, and the realistically possible responses to such events and conditions. Events or conditions arising after the reporting date but before the financial statements are authorized for issuance should be considered. IAS 1 states that management may need to consider a wide range of factors, including current and forecasted profitability, debt maturities and replacement financing options before satisfying its going concern assessment. These financial statements have been prepared on a going concern basis, which assumes that the company will continue to operate and generate profits in the future.
Legal Definition
Conditions that lead to substantial doubt about a going concern include negative trends in operating results, continuous losses from one period to the next, loan defaults, lawsuits against a company, and denial of credit by suppliers. The concept of going concern is an underlying assumption in the preparation of financial statements, hence it is assumed that the entity has neither the intention, nor the need, to liquidate or curtail materially the scale of its operations. If management conclude that the entity has no alternative but to liquidate or curtail materially the scale of its operations, the going concern basis cannot be used and the financial statements must be prepared on a different basis (such as the ‘break-up’ basis). In accrual accounting, the financial statements are prepared under the going concern assumption, i.e. the company will remain operating into the foreseeable future, which is formally defined as the next twelve months at a bare minimum. In our experience, if there are such material uncertainties, then the company usually provides disclosure as part of the basis of preparation note in the financial statements.
Staying Afloat: Going Concern Concept Examples & Its Pros & Cons
The effects of COVID-19 are negatively affecting many companies’ financial performance and liquidity in some way. Management will need to monitor the expected impacts on operations, forecasted cash flows, and debt covenants, with the primary focus being on whether the company will have sufficient liquidity to meet its financial obligations as they fall due. Impacts from a fall and winter COVID-19 surge may bring further uncertainty to many companies. Management should continually evaluate the effects of COVID-19 on the company’s going concern assessment, including information obtained after the reporting date and up to the date the financial statements are authorized for issuance. Accountants use going concern principles to decide what types of reporting should appear on financial statements. Companies that are a going concern may defer reporting long-term assets at current value or liquidating value, but rather at cost.
Unlike US GAAP, there is no liquidation basis of accounting under IFRS; when a company determines it is no longer a going concern, it does not prepare financial statements on a going concern basis. However, in our view, there is no general dispensation from the measurement, recognition and disclosure requirements of the Standards in this case, and these requirements are applied in a manner appropriate to the circumstances. Continuation of an entity as a going concern is presumed as the basis for financial reporting unless and until the entity’s liquidation becomes imminent.
Popular IFRS blogs
Before an auditor issues a going concern qualification, company leadership will be given an opportunity to create a plan to take corrective actions that can improve the outlook for the business. If the auditor determines the plan can be executed and mitigates concerns about the business, then a qualified opinion will not be issued. A firm’s inability to meet its obligations without substantial restructuring or selling of assets may also indicate it is not a going concern. If a company acquires assets during a time of restructuring, it may plan to resell them later.
Subscribe to the IFRS® Perspectives Newsletter
However, the company’s ability to continue as a going concern is dependent on its ability to generate sufficient revenue and secure additional financing as needed. The auditor will consider the adequacy of the disclosures made in the financial statements by management. If the auditor considers that the going concern basis is appropriate and that the disclosures are adequate, then the audit opinion will be unmodified and the auditor’s report will include a section headed ‘Material Uncertainty Related to Going Concern’ which explains the uncertainty.
Once these factors have been identified, candidates should then be able to think about the procedures the auditor may adopt to establish whether the factors mean the going concern basis of accounting is appropriate in the circumstances, or not. For a company to be a going concern, it must be able to continue operating long enough to carry out its commitments, obligations, objectives, and so on. In other words, the company will not have to liquidate or be forced out of business.
© 2024 KPMG LLP, a Delaware limited liability partnership and a member firm of the KPMG global organization of independent member firms affiliated with KPMG International Limited, a private English company limited by guarantee. The following table summarizes the five key areas of the going concern assessment that we believe are most important for management. Helping clients meet their business challenges begins with an in-depth understanding of the industries in which they work. In fact, KPMG LLP was the first of the Big Four firms to organize itself along the same industry lines as clients. Once you have viewed this piece of content, to ensure you can access the content most relevant to you, please confirm your territory. These materials were downloaded from PwC’s Viewpoint (viewpoint.pwc.com) under license.
If a company is not a going concern, that means there is risk the company may not survive the next 12 months. Management is required to disclose this fact and must provide the reasons why they may not be a going concern. Management must also identify the basis in which the financial statements are prepared and often disclose these financial reports with an audit report with a going concern opinion. Accounting standards try to determine what a company should disclose on its financial statements if there are doubts about its ability to continue as a going concern. In May 2014, the Financial Accounting Standards Board determined financial statements should reveal the conditions that support an entity’s substantial doubt that it can continue as a going concern.
Factors to consider include when the financial statements are authorized for issuance and whether there is any known event occurring after the minimum period of 12 months from the reporting date relevant to the analysis. Under Step 1, management determines whether events and conditions raise substantial doubt about the company’s ability to continue as a going concern. Our business activities, performance, strategy and risks are set out in this report. For this reason, the going concern basis has been adopted in preparing the accounts.
If there is uncertainty as to a company’s ability to meet the going concern assumption, the facts and conditions must be disclosed in its financial statements. This includes information that becomes available on or before the financial statements are authorized for issuance – i.e. events or conditions requiring disclosure may arise after the reporting period. It is the responsibility of the business owner or leadership team to determine whether the business is able to continue in the foreseeable future. If it’s determined that the business is stable, financial statements are prepared using the going concern basis of accounting. Unlike IFRS Standards, the going concern assessment is performed for a finite period of 12 months from the date the financial statements are issued (or available to be issued for nonpublic entities). Known or knowable events beyond the look-forward period can be ignored in the going concern assessment, although disclosure of their potential effects may still be required by other standards.
The going-concern value of a company is typically much higher than its liquidation value because it includes intangible assets and customer loyalty as well as any potential for future returns. The liquidation value of a company will even be lower than the value of the company’s tangible assets, because the company may have to sell off its tangible assets at a discount—often, a deep discount—in order to liquidate them before ceasing operations. Examples of tangible assets that might be sold at a loss include equipment, unsold inventory, real estate, vehicles, patents, and other intellectual property (IP), furniture, and fixtures.
It’s one of the areas auditors assess in their audit report about a company’s financial stability. The benefits of going concern are pretty straightforward – it gives businesses peace of mind and investors confidence. An entity has borrowings of $10m which became https://www.wave-accounting.net/ immediately repayable in full on 31 March 20X2. The entity is already in breach of its agreed overdraft and the bank has refused to renew the borrowings. The entity has also been unsuccessful in applying to other financial institutions for re-financing.
Use in risk management
An adverse opinion states that the financial statements do not present fairly (or give a true and fair view). This opinion will be expressed regardless of whether or not the financial statements include disclosure of the inappropriateness of management’s use of the going concern basis of accounting. When faced with such a requirement, candidates must be careful not to produce a list of generic audit procedures, but instead identify and highlight the factors from the scenario that may call into question the entity’s ability to continue as a going concern.
A financial auditor is hired by a business to evaluate whether its assessment of going concern is accurate. After conducting a thorough review (audit) of the business’s financials, the auditor will provide a report with their assessment. A current definition of the going concern assumption can be found in the AICPA Statement on Auditing Standards No.1 Codification of Auditing Standards and Procedures, Section 341, “The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern” (AU Section 341). The “going concern” concept assumes that the business will remain in existence long enough for all the assets of the business to be fully utilized.