What Are Basic Accounting Principles And Assumptions?

going-concern assumption

Companies assume that their business will continue for an indefinite period of time and the assets will be used in the business until fully depreciated. Another example of the going concern assumption is the prepayment and accrual of expenses. Companies prepay and accrue expenses because they believe that they will continue operations in future. For this reasonable period of time, management is required to identify whether any conditions or events are present when they’re making this evaluation that may cause significant doubt with respect to the ability to continue as a going concern. And management’s evaluation is made based on the conditions or events that are known at the time they are making that evaluation or are reasonably knowable as of that date. It essentially is, at the date of that evaluation, what do they know and then what is their conclusion around that.

Given the significant effects of COVID-19, management may need to reassess the company’s access to financing sources; they may not be easily replaced and the costs may be higher in the current circumstances. Further, other actions such as deferring capital expenditures or adjusting the workforce may be needed to generate enough cash flow to meet the company’s financial obligations. IFRS Standards do not prescribe how management performs the going concern assessment. IAS 1 only states that when a company has a history of profitable operations and ready access to financial resources, management may reach a conclusion on the appropriateness of the going concern assessment without detailed analysis. It follows that when this is not the case, a detailed analysis will be necessary, which likely includes robust cash flow forecasts and a review of existing and forthcoming financial obligations.

The practice of accounting is based on generally accepted accounting principles . These are assumptions, practices, and concepts that provide the foundation for measuring and reporting the results of business activities.

These changes have given rise to novel techniques to value and revalue assets and liabilities to make them more closely approximate their true worth at any particular date. Accounting and auditing standards have changed to address these innovative products to make financial statements more meaningful. Historical cost is no longer the only—or, in some cases, the prevalent—basis for valuing the components displayed on financial statements. Further, the information now available on virtually any subject is limited only by an individual’s skill in searching the Internet and other research sources. This timely and more comprehensive information is available to absentee owners, shareholders, and lenders who make the generally minimal effort required to access it.

going-concern assumption

In general, all companies are run with a going concern assumption and, hence, projections and, more importantly, business plans are made considering what should be the next retained earnings balance sheet action plan. The principle purports that every decision in a company is taken with the objective in mind of running the business rather than that of liquidating it.

Going concern is one the fundamental assumptions in accounting on the basis of which financial statements are prepared. Financial statements are prepared assuming that a business entity will continue to operate in the foreseeable future without the need or intention on the part of management to liquidate the entity or to significantly curtail its operational activities.

When Is A Going Concern Basis Not Appropriate?

After updating the forecasts, management will need to assess whether it expects to remain in compliance with financial covenants. Under previous guidance, the rules regarding going concern disclosures were included in the auditing literature, not in the accounting rules. The auditor going concern still has an important role to play in auditing going concern disclosures under the new standard, but the FASB standard now places the disclosure responsibility on management. Auditors will now review these disclosures along with other evidence as part of their audits.

going-concern assumption

It assessed the considerable evidence suggesting that the acquirers were fully aware of the near-insolvency of the entity they were about to purchase and concluded that the going concern disclosure would not have added to the information they already had. The court concluded that because the acquirers decided to proceed anyway, the trustee could not demonstrate that a going concern disclosure would have dissuaded them. The Small company is unable to make payments to its creditors due to a very weak liquidity position.

Statement No. 132 is aligned with the recent FASB standard’s explicit definition of substantial doubt about an entity’s ability to continue as a going concern. The FASB standard established that there would be going concern issues if it is probable that the entity will not be able to meet its obligations within a year of when financial statements are issued. However, generally accepted auditing standards doinstruct an auditor regarding the consideration of an entity’s ability to continue as a going concern. Continuation of an entity as a going concern is presumed as the basis for financial reporting unless and until the entity’s liquidation becomes imminent. Preparation of financial statements under this presumption is commonly referred to as the going concern basis of accounting. If and when an entity’s liquidation becomes imminent, financial statements are prepared under the liquidation basis of accounting (Financial Accounting Standards Board, 2014).

Proposed Changes To Ifrs® Standards Financial Statements

In addition to IAS 1, IFRS 79requires disclosure of information about the significance of financial instruments to a company, and the nature and extent of risks arising from those financial instruments, both in qualitative and quantitative terms. Disclosures addressing these requirements may need to be expanded, with added focus on the company’s response to the effects of COVID-19. US GAAP requires management’s plans to meet certain conditions to be considered in the assessment.

  • However, market conditions have changed as a result of COVID-19 – e.g. financing may be significantly more difficult and more costly to obtain now.
  • Investors or other shareholders might also call for a business valuation to determine the business’s true value before making a final decision about how to act in light of the negative opinion.
  • Disclosures about substantial doubt are different than management use of the going concern basis of accounting.
  • These are assumptions, practices, and concepts that provide the foundation for measuring and reporting the results of business activities.
  • You will not continue to receive KPMG subscriptions until you accept the changes.

Had the auditors done so, the trustee alleged, the acquisition would never have gone forward. Often management is going to be using cash flow forecasts in that evaluation, and that’s a significant factor in helping them determine whether their plans can alleviate substantial doubt.

Conditions For Going Concern

For more information on the new going concern standard, visit the Audit and Attest page at aicpa.org where you will find a link to the standard, as well as a helpful explanatory memo. You may also be interested in participating in a webcast on March 28 that will provide an overview on the new standard. fn 4 The inclusion of an explanatory paragraph in the auditor’s report contemplated by this section should serve adequately to inform the users of the financial statements.

Once an auditor examines a company’s financial statements to see if the operating conditions of the entity are suitable for the long-term continuity of the business, they will issue a certificate accordingly. Some of the conditions that create substantial doubts for the principle of going concern are defaults on loans, lawsuits, company plans to declare bankruptcy, continued losses year over year, etc. Lastly, an important aspect of this is that the disclosures are required by the financial accounting framework to be made by management. Regardless of where we end up with respect to whether substantial doubt is alleviated or not, the auditor always might be in a situation of having to qualify his or her opinion if the disclosures are not appropriate in the circumstances. Another aspect for auditors to consider is that the conditions and events we’re facing should not be considered to be an automatic going concern report for any company. It’s likely that we may see more going concern conclusions, but it’s not automatic. There are many, many businesses out there that have very strong financial statements, for example.

Under U.S. Generally Accepted Accounting Principles , the going concern assumption is normally the presumed basis for preparing financial statements, unless the entity’s liquidation becomes imminent. We don’t expect that to be common at all, but that is one requirement of the standards. When evaluating management’s plans, the auditor should identify those elements that are particularly significant to overcoming the adverse effects of the conditions and events and should plan and perform auditing procedures to obtain evidential matter about them.

The American Institute of CPAs and the Chartered Institute of Management Accountants jointly released guidance Tuesday for auditing and accounting for the risks of digital assets such as cryptocurrency. Eric Hines, a partner with StoneTurn, brings almost two decades of experience in forensic accounting, controls/compliance and dispute consulting engagements. Mark Giese, a managing director with StoneTurn, has more than 13 years of combined experience performing financial statement audits and forensic and financial consulting engagements. If a company cannot make profits or keep up with its cash outflows, it will have to resort to using alternative sources of finance to fund its projects. Rising debts can also be a red flag for the going concern assumption of a business.

going-concern assumption

If they are misleading, then include a selected disclosure regarding going concern. Also, consider adding an emphasis-of-matter paragraph to your compilation report. In our experience, if there are such material uncertainties then a company usually provides disclosure as part of the basis of preparation note in the financial statements.

SAS No. 132 contains new guidance addressing the auditor’s responsibilities when companies rely on financial support from third parties or an entity’s owner-manager. No disclosures are required when management concludes that substantial doubt isn’t raised based on their evaluation of conditions and events, prior to consideration of potential mitigating effects of management’s plans that aren’t implemented. Also significant is the fact that if a business is determined to be a going concern that means that it can pay its liabilities and realize its assets.

We have received questions from members about whether it would be prudent for management to delay the issuance of its financial statements until some of this uncertainty is resolved. First of all, this would be contingent on whether management has the flexibility to delay issuance of its financial statements. Certainly, we always have to be thinking about who the users of the financial statements are and whether a delay in the issuance of the financial statements would be acceptable or would be viewed as unacceptable by users of the financial statements. When management needs to do projections, auditors need to consider the reliability of the underlying data involved in those projections and the reasonableness of management assumptions. I think it’s generally well recognized that in the environment we face today with the pandemic, there is a heightened degree of uncertainty associated with trying to do projections for a 12-month period into the future.

The 2008 financial crisis demonstrated how quickly change can occur in the financial markets and in individual businesses, as established organizations like Lehman Brothers collapsed and other businesses, large and small, teetered on the verge of failure. The crisis was a reminder that adverse events can threaten the stability of any entity, or its ability to continue as a going concern.

The last piece of the puzzle often for management plans involves the entity’s ability to access funding from an external third party, a parent entity, an owner-manager, or some other source. If that’s part of management’s plans, then the auditor needs to assess normal balance whether those third parties have both the intent and the ability to provide that support if need be. And if the intent and ability are present, there is a requirement for the auditor to obtain written evidence about the intent, preferably from the third party.

What is meant by going concern?

The ‘going concern’ concept, or assumption, is an accountancy term that describes a company which can continue operating without the significant threat of liquidation, and therefore remain in business for the foreseeable future.

Let’s drill down on those basic objectives and consider the steps the auditor goes through in achieving those objectives. The first one, of course, is to consider, from the auditor’s perspective, whether there are any conditions or events that cause or raise substantial doubt about the ability to continue as a going concern. Just because your business isn’t subject to regulatory reporting requirements or bylaws upheld by a board of directors doesn’t mean the going concern assumption doesn’t apply to you.

IAS 1 states that management may need to consider a wide range of factors, including current and forecasted profitability, debt maturities and replacement financing options before satisfying its going concern assessment. Management’s going concern assessment may be significantly affected by the current economic environment. For example, a company may have a profitable track record or prior success at refinancing. However, market conditions have changed as a result of COVID-19 – e.g. financing may be significantly more difficult and more costly to obtain now. Similarly, US GAAP financial statements are prepared on a going concern basis unless liquidation is imminent.

If there is an issue, the audit firm must qualify its audit report with a statement about the problem. Thus, the value of an entity that is assumed to be a going concern is higher than its breakup value, since a going concern can potentially continue to earn profits. Our semi-annual outlook helps IFRS Standards preparers in the US keep track of financial reporting changes and assess relevance. The going concern assessment is inherently complex and judgmental and will be under heightened scrutiny for many companies this year due to COVID-19. Management should carefully consider the requirements of IFRS Standards and reevaluate their historical approach to the going concern analysis; it may no longer be sufficient given the current economic environment.

Author: David Paschall

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