Assessing Going Concern Issues and Their Financial Implications

According to this principle, financial statements are prepared, assuming the company intends to continue operations for the foreseeable future and has no motive or need to shut down. If auditors identify uncertainties that cast doubt on a company’s viability, they must include an emphasis-of-matter paragraph in their report to highlight risks for stakeholders. Severe uncertainties, coupled with inadequate management plans, may lead auditors to issue a qualified or adverse opinion, potentially eroding stakeholder confidence and attracting regulatory scrutiny. Creditors evaluate a company’s ability to meet debt obligations based on its going concern status. A strong status may result in favorable lending terms, such as lower interest rates or extended repayment periods. However, when viability is in doubt, creditors may Law Firm Accounts Receivable Management impose stricter conditions or demand collateral to mitigate default risks.

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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. Explore the concept of going concern in accounting and its implications for financial statements, investors, and auditors.

Assessing Going Concern Issues and Their Financial Implications

One of the most significant contributions that the going concern makes to GAAP is in the area of assets. The entire concept of depreciating and amortizing assets is based on the idea that businesses will continue to operate well into the future. Assets are also reported on the balance sheet at historical costs because of the going concern assumption. If we disregard the going concern and assume the business could be closed within the next year, a liquidation approach to valuing assets would be more appropriate.

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• Even without completing a full auditing process, 2020 brought to light how important it is for businesses to be prepared for the unexpected.
• Then we should consider whether auditors put all possible procedures that should be performed or not.
• Usually, liquidation value is applied when investors feel a company no longer has value as a going concern, and they want to know how much they can get by selling off the company’s tangible assets and such of its intangible assets as can be sold, such as IP.
• The Financial Reporting Council (FRC) has issued updated guidance to help companies demonstrate the assessments underlying their going concern conclusions and encourage directors to take a broader view, over a longer term, of the risks and uncertainties they face.

If a company has multiple suits or multiple judgments against them, it can be a sign of poor business practices and an indicator of instability and lack of longevity. Cash flow forecasting is also one of the most important procedures that we should use and perform to assess the going concern problem. Many, or all, of the products featured on this page are from our advertising partners who compensate us when you take certain actions on our website or click to take an action on their website. Candidates are therefore encouraged to practise as many exam standard questions as possible as the syllabus offers a variety of ways in which the concept of going concern can be examined. – In 2011, Gibson Guitar Factory was raided by the unearned revenue Federal government for illegally smuggling endangered wood into the country. The Federal government took more than $250,000 worth or Gibson’s inventory and slapped them with large fines for violating international laws.

Role of Auditors in Assessment

The principle highlights going-concern the assumption that companies intend to keep assets and generate profits in the future—assets won’t be sold in between. Availability of short term running finance may help an entity to overcome unanticipated cash flow shortage in the short term. Operational disruptions, such as regulatory changes, technological shifts, or geopolitical tensions, can also threaten viability.

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The preparation of multiple sensitivity analyses based on a variety of assumptions may be required to appropriately assess the probability of results in multiple market conditions. Management should also ensure that these assumptions are consistent with other areas of financial reporting, such as those used for estimates and impairments. An entity must include disclosures related to uncertainty about its ability to continue as a going concern in the notes to the financial statements in annual and interim periods until the conditions or events giving rise to the uncertainty are resolved. As the conditions or events giving rise to the uncertainty and management’s plans to alleviate them change over time, the disclosures should change to provide users with the most current information, including information about how the uncertainty is resolved. 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. Auditors play a critical role in assessing a company’s going concern status, which directly impacts the credibility of financial statements.