April 12, 2021

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What Is Going Concern Principle?

What Is Going Concern Principle?

Going concern is one of the easiest to understand accounting concepts but at the same time an important concept that every business entity should apply. This concept becomes even more important when considering the current events and conditions around the world that can significantly affect the company’s ability to continue to exist or be a going concern. Not sure what this means? Let’s look at this concept a little closer.

Meaning

Accounting has many founding principles and one of them is going concern. The meaning of this accounting concept is pretty straightforward. The word going here means continuity and the term concerns simply means business. In other words, the definition of this term is a continuity of a business. This particular principle assumes that the operating activities of an organization are normal and it will continue to operate for as long as we can predict.

What Is Going Concern Principle?

It is assumed that the financial entity is not going to and does not need to liquidate or significantly reduce the scale of its activities. Accordingly, the company records all the financial transactions of a business keeping in mind this point that a business is a going concern.

Despite the fact that this an assumption that all entrepreneurs and business owners make when starting a business and continuing to run it, businesses need this assumption because if we assume that businesses will go out of business then we really cannot assume that we can collect all of our accounts receivable and so on.

For example, a corporate unit makes investments in the form of fixed assets, it books only depreciation of the assets in its profit and loss account, not the difference of acquisition cost of assets less net realizable value of the assets. The reason is simple. The business assumes that it will use the acquired assets and earn profit in the future. Similarly, it would treat deferred revenue expenditure and prepaid expenditure.

Application

If an intention or need to liquidate or sell within the next year exists, the financial statements should be prepared on a different basis and that basis should be disclosed. The company would act as if its business is going to be liquidated.

What Is Going Concern Principle?

For example, if Maddie’s Bookstore business was doing financially well today, the accountants would be able to assume the going concern of Maddie’s Bookstore business. This means that it would continue to do well for a long period of time. If, on the other hand, this bookstore was not doing so well and the owner was selling its resources to pay off obligations, it would mean that this business would be considered not to have a going concern. This should be reflected in the financial records as follows:

  • Assets’ balance is reflected at the residual value;
  • Assets that an entity cannot receive in full must be written off;
  • Liabilities must be accrued in connection with the termination of contracts and economic sanctions.

Moreover, if such an assumption cannot be made, the banker will not provide loans, the supplier will not supply goods or services, the employees will not work properly, and the method or recording transaction will change altogether.

The principle of going concern determines the work of not only accounting employees and auditors, but also financial analysts. It should be borne in mind that unlike accountants and analysts, for whom the terms of the organization’s going concern are not clearly limited, for the auditor they are equal to twelve months.

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Author: Charles Lutwidge

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