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Going Concern 

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Going Concern 

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Going Concern

Definition

Going concern is the assumption the entity will continue in operational existence for the foreseeable future.

Significance for the financial statements

Whether or not a company can be classed as a going concern affects how its financial statements are prepared.

  • Financial statements are usually prepared on the basis that the reporting entity is a going concern.
  • IAS1 Presentation of Financial Statements, para 25, states that 'an entity should prepare its financial statements on a going concern basis, unless
    • the entity is being liquidated or has ceased trading, or
    • the directors have no realistic alternative but to liquidate the entity or to cease trading.'
  • Where the assumption is made that the company will cease trading, the financial statements are prepared using the break-up basis under which:
    • assets are recorded at likely sale values
    • inventory and receivables are likely to require more provisions, and
    • additional liabilities may arise (severance costs for staff, the costs of closing down facilities, etc.).

Directors' responsibilities

  • It is the directors' responsibility to assess the company's ability to continue as a going concern when they are preparing the financial statements.
  • If they are aware of any material uncertainties which may affect this assessment, then IAS 1 requires them to disclose such uncertainties in the financial statements.
  • When the directors are performing their assessment they should take into account a number of relevant factors such as:
    • current and expected profitability
    • debt repayment
    • sources (and potential sources) of financing.

Auditors' responsibilities

  • ISA 570 Going Concern states that the auditor needs to consider the appropriateness of management's use of the going concern assumption.
  • The auditors need to assess the risk that the company may not be a going concern.
  • The auditor will also need to obtain sufficient appropriate evidence that the company is a going concern.
  • Where there are going concern issues, the auditor needs to ensure that the directors have made sufficient disclosure of such matters in the notes to the financial statements.

Procedures

Indicators of going concern problems

Typical indicators and explanations of going concern problems include the following:

  • Net current liabilities (or net liabilities overall!); indicates an inability to meet debts as they fall due.
  • Borrowing facilities not agreed or close to expiry of current agreement; lack of access to cash may make it difficult for a company to manage its operating cycle.
  • Defaulted loan agreements; loans normally become repayable on default, company may find it difficult to repay loan.
  • Unplanned sales of non-current assets; indicates an inability to generate cash from other means and as non-current assets generate income, will cause a decline in income and therefore profits.
  • Missing tax payments; results in fines and penalties, companies normally prioritise tax payments indicating a lack of working capital.
  • Failure to pay staff; indicates a significant lack of working capital.
  • Negative cash flow; indicates overtrading.
  • Inability to obtain credit from suppliers; suggests failure to pay suppliers on time and working capital problems.
  • Major technology changes; inability or insufficient funds to keep up with changes in technology will result in loss of custom and obsolescence of inventory.
  • Legal claims; successful legal claims may result in significant cash payments that can only be settled with liquidation.
  • Loss of key staff; may result inability to trade.
  • Over-reliance on a small number of products, staff , suppliers or customers; loss may result in inability to trade.

Disclosures

Where there is any significant doubt over the future of a company, the directors should include disclosures in the financial statements explaining:

  • the nature of and circumstances surrounding the doubts; and
  • the possible effect on the company.

Where the directors have been unable to assess going concern in the usual way (e.g. for less than one year beyond the date on which they sign the financial statements), this fact should be disclosed.

Where the financial statements are prepared on a basis other than the going concern basis, the basis used should be disclosed.

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Page Owner

Alexander Stanton 

Lifecycle Alert

11/24/2012 

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Content Type: WikiPlus Page
Version: 1.0 
Created at 10/4/2012 9:28 AM  by System Account 
Last modified at 3/15/2017 12:34 PM  by System Account 
Wiki Pages - Going Concern.aspx