Going concern principle

Going concern principle
See also

The going concern principle specifies that in preparing the financial statements it is assumed that the establishment will continue its business for the foreseeable future with neither the intention nor the necessity of liquidation, ceasing trading or seeking protection from creditors according to laws or regulations. Accordingly, assets and liabilities are recorded on the basis that the entity will be able to realise its assets and discharge its liabilities in the normal course of business [1].

This is an essential assumption because much of accrual accounting measurement is based on allocating expenses over different future periods. If the business is unlikely to be there in the future this approach is invalid and prudence would require many commodities to be written off at once as valueless. This is, of course, often a bone of contention with auditors when an establishment whose financial statements they have signed then goes out of business a few months later. People who have relied on financial statements find the figures become meaningless when the establishment is no longer in business. The going concern assumption is used to justify the valuation procedures and is, therefore, a major assumption which should be considered by every person analysing the financial statements[2].

In fact, IAS 1, Presentation of Financial Statements, requires management to make an assessment of the establishment's ability to continue as a going concern when it prepares the financial statements. If management is aware of material uncertainties related to occurrences or conditions that may cast significant doubt upon the establishment's ability to continue as a going concern, those uncertainties have to be disclosed. If one concludes that the going concern basis is no longer appropriate, this would have a major impact on the carrying value of assets and liabilities. These would have to be revised considering the need to liquidate or curtail significantly the scale of the establishment's operations [3].

Implications

It is because of the going concern assumptions that[4]:

  • Assets are classified as current assets and fixed assets
  • Liabilities are classified as short-term liabilities and long-term liabilities
  • Unused resources are presented as unutilised costs as against the break-up values as in case of liquidating enterprise. Accordingly, the earning power and not the break-up value evaluates the continuing enterprise.

Footnotes

  1. Dr Kan E., 2013 p.331
  2. Walton P., Aerts W., 2006 p.75
  3. Walton P., Aerts W., 2006 p.75
  4. Tulsian P., 2007 S.no. 6.2

References

Author: Jakub Irauth