Definition
The Going Concern Concept is a fundamental accounting assumption that asserts a company’s financial capability to continue its operations in the foreseeable future. It implies that the firm will not go into liquidation soon and has neither the intention nor the need to halt its activities. This concept is critical in determining the value of assets and liabilities while preparing financial statements.
Key Takeaways
- The Going Concern Concept is an accounting principle that encourages businesses to operate as if they will continue indefinitely, or at the very least, long into the foreseeable future. This concept affects financial decisions about depreciation, amortization, and resource management.
- Under the Going Concern Concept, it is assumed that a company has neither the intention nor the need to liquidate or to significantly curtail its operational activities. Therefore, assets are not listed as the amount they would be sold for, but rather on a depreciation basis.
- The Going Concern Concept has implications for the financial health of a company. If a company is not considered a going concern, it can be a sign of potential bankruptcy or financial insolvency, and therefore, it’s a crucial factor for investors, creditors, and other stakeholders when they are making decisions.
Importance
The Going Concern Concept in finance is important because it allows businesses, stakeholders, and analysts to make key assumptions about the future viability of the entity.
This concept assumes that a company will continue its operations for the foreseeable future without any intention of liquidation or ceasing operations.
This assumption is critical because it underpins financial decision-making, strategic planning, and auditing processes.
When financial statements are prepared, they are done so under the presumption that the business is a going concern, which affects asset valuation and liability management.
Furthermore, if a company is not seen as a going concern, it can drastically change its risk assessment for investors and creditors, potentially altering its ability to secure funds or continue operations.
Explanation
The Going Concern Concept plays a crucial role in the field of accounting and finance by facilitating the assessment and prediction of a business’s future financial health. Primarily, its purpose is to provide an assumption that a business will continue its operations for the foreseeable future without any intent or necessity to cease operations or liquidate its assets.
As such, it is largely pertinent to investors, creditors and other stakeholders making long-term financial decisions. These decisions could include, among others, investing in a company’s stocks or bonds, granting loans, or entering a long-term contract with the company.
The use of the Going Concern Concept allows, especially when analyzing financial statements, for the differentiation between the current, or short-term, obligations of a company and its long-term commitments. This provides a more accurate picture of the company’s financial stability by forecasting future profitability and cash flows, rather than focusing solely on its current financial status.
Ultimately, this concept reassures stakeholders that the company will be able to meet its financial obligations, and that their faith in the company’s longevity is well-placed. If any uncertainty surrounds this assumption, auditors are required to express their concerns in their audit reports, serving as an early warning signal about the company’s potential inability to continue its current operations.
Examples of Going Concern Concept
General Motors: During the 2008 financial crisis, General Motors (GM) was on the brink of bankruptcy due to severe financial difficulties. However, with governmental help in the form of a bailout, it managed to stay afloat. Under the going concern concept, despite its immediate financial woes, GM was expected to continue its operations and overcome its financial challenges in the near future.
Kodak: In past decades, Kodak was unable to adapt to the rapid technological changes in photography, eventually filing for bankruptcy in
Prior to this, in their financial statements, uncertainties were expressed about the company’s ability to continue as a going concern due to consistent losses and negative cash flows. But it managed to survive. Now, Kodak is functioning on a smaller scale as a technology company focused on imaging for business.
Apple Inc.: In the late 1990s, Apple was close to bankruptcy and had significant doubts over its ability to stay in business. Under the going concern concept, these concerns were alleviated to an extent as the Company still had the ability to continue its operations. The return of Steve Jobs as CEO led to significant organizational changes and innovative products like the iPod and iPhone, causing a turnaround in Apple’s business prospects. Today, Apple is one of the most profitable companies globally, demonstrating the accuracy of the going concern assessment during tough times.
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Frequently Asked Questions about Going Concern Concept
What is the Going Concern Concept?
The Going Concern Concept is an accounting principle that guides companies to prepare financial statements as if they will continue to exist, conduct its operations, and meet its financial obligations into the foreseeable future. In simple terms, this concept assumes a business will continue to operate for a long time.
Why is the Going Concern Concept important?
The Going Concern Concept is crucial as it helps in providing a realistic and fair view of a company’s financial standing. It helps investors and creditors analyze the financial worthiness of a business. If a business is considered a going concern, it means unless there’s evidence to the contrary, the financial statements are prepared with the assumption that the business will continue to operate indefinitely.
What are the implications of the Going Concern Concept?
If there are uncertainties about a company’s ability to continue as a going concern, those concerns need to be disclosed in the notes to the financial statements. This is critical information for investors, creditors, and others who rely on the financial statements to assess the firm’s financial health.
How is the Going Concern Concept evaluated?
The Going Concern Concept is evaluated based on an entity’s ability to generate sufficient profits to cover its expenses, its level of indebtedness, its ability to obtain financing, and other significant factors. Generally, the entity’s management will perform this assessment during the preparation of financial statements. If the management has substantial doubt about the company’s ability to continue as a going concern, it must be disclosed.
When can a company no longer be seen as a going concern?
A company is no longer considered a going concern when it is facing bankruptcy, liquidation, or when it’s anticipated that it will stop its operations in the near future. At this point, the company must change its basis of accounting, and its assets and liabilities are usually accounted at liquidation values.
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Related Entrepreneurship Terms
- Financial Statements
- Liquidity Risk
- Solvency
- Auditor’s Report
- Bankruptcy
Sources for More Information
- Investopedia: This site provides a vast amount of financial information, including the definition and in-depth explanation of the Going Concern Concept.
- Accounting Tools: A comprehensive resource for all accounting terms and concepts, including the Going Concern Concept. Very detailed explanations are provided for each term.
- Corporate Finance Institute (CFI): This institute offers a wide range of educational materials and certifications for finance professionals. They explain complex finance terms, including the Going Concern Concept, in an easy to understand way.
- Accounting Coach: This site offers free and premium courses on accounting. Their informative content covers all the important accounting concepts, including the Going Concern Concept.
