Definition of Going-Concern Concept
The going-concern concept is a fundamental principle in accounting that assumes an enterprise will continue its operations into the foreseeable future without any intention or necessity to liquidate or significantly reduce the scale of its operations. This assumption implies that assets are recorded at their historical cost or cost less depreciation, rather than their break-up values. Similarly, it assumes that liabilities applicable only upon liquidation are not presented in the financial statements.
Examples
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Manufacturing Company: A large manufacturing company that continues to produce goods and expand its market presence is considered a going concern. Its machinery and equipment are recorded at cost less accumulated depreciation, and liabilities are managed under the assumption that the company will fulfil its obligations in the ordinary course of business.
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Retail Chain: A national retail chain that opens new stores and maintains steady sales growth is treated as a going concern. Its inventory is valued at cost, accounting for normal operations and ongoing turnover rather than a forced liquidation scenario.
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Service Firm: A consulting firm with multiple long-term contracts and predictable cash flows is considered a going concern. The firm’s financial statements are prepared with the assumption that it will continue to provide consulting services and generate revenue.
Frequently Asked Questions (FAQs)
What happens if the going-concern assumption is no longer valid?
If the going-concern assumption is no longer valid, the financial statements are prepared on a basis other than going concern (e.g., liquidation basis). This means assets may be recorded at their net realizable value, and additional liabilities may be recognized.
How does the going-concern concept affect asset valuation?
Under the going-concern concept, assets are valued at historical cost or cost less accumulated depreciation, rather than break-up values that might be applicable in a liquidation scenario.
What is the role of auditors regarding the going-concern assumption?
Auditors assess the appropriateness of the going-concern assumption when reviewing financial statements. If there are significant doubts about the entity’s ability to continue as a going concern, auditors typically qualify their report and disclose the uncertainty.
Can the going-concern assumption affect company valuation?
Yes, the going-concern assumption can lead to a higher valuation of the company, as it includes the potential for future earnings and continued operations, often described as the “going-concern value.”
When is the auditor required to issue a qualified report regarding going concern?
An auditor issues a qualified report if there are substantial doubts about the entity’s ability to continue as a going concern and the uncertainties are not adequately disclosed in the financial statements.
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Financial Statements: Documents that present the financial performance and position of a company, including the balance sheet, income statement, and cash flow statement.
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Break-Up Values: The value of a company’s assets if they were to be sold individually rather than as part of a continuing operation.
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Depreciation: The systematic allocation of the cost of a tangible fixed asset over its useful life.
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Auditors’ Report: A formal opinion issued by an auditor after reviewing a company’s financial statements.
Online References
Suggested Books for Further Studies
- “Financial Accounting Theory” by William Scott
- “Intermediate Accounting” by Kieso, Weygandt, and Warfield
- “Accounting Made Simple: Accounting Explained in 100 Pages or Less” by Mike Piper
Accounting Basics: “Going-Concern Concept” Fundamentals Quiz
### What does the going-concern concept assume about a company's operations?
- [ ] The company will liquidate soon.
- [ ] The company will significantly reduce its operations.
- [x] The company will continue its operations for the foreseeable future.
- [ ] The company’s value is based only on its individual assets.
> **Explanation:** The going-concern concept assumes that the company will continue its operations for the foreseeable future, meaning no plan for liquidation or significant reduction in operations.
### How are assets valued under the going-concern concept?
- [ ] At their break-up value.
- [x] At historical cost or cost less depreciation.
- [ ] At their current market value.
- [ ] At twice their original cost.
> **Explanation:** Under the going-concern concept, assets are valued at historical cost or cost less depreciation, rather than their break-up value or current market value.
### What should happen if an auditor doubts a company's ability to continue as a going concern?
- [ ] Nothing; the financial statements are not affected.
- [ ] The company should immediately liquidate.
- [x] The auditor should issue a qualified report.
- [ ] The auditor should ignore the doubt.
> **Explanation:** If an auditor doubts a company's ability to continue as a going concern, they should issue a qualified report to highlight the uncertainty.
### What basis is used for preparing financial statements if the going-concern assumption is invalid?
- [x] Liquidation basis.
- [ ] Historical basis.
- [ ] Market value basis.
- [ ] Cost value basis.
> **Explanation:** If the going-concern assumption is invalid, financial statements are prepared using a liquidation basis.
### Which entity primarily uses the going-concern concept?
- [ ] Small startups.
- [x] Established businesses.
- [ ] Nonprofit organizations.
- [ ] Only government entities.
> **Explanation:** Established businesses primarily use the going-concern concept in preparing their financial statements, reflecting a stable and continuing operation.
### If the going-concern assumption ceases to be valid, how does it impact liabilities?
- [x] Liabilities applicable on liquidation are presented.
- [ ] Liabilities are reduced.
- [ ] Liabilities are not affected.
- [ ] Liabilities are ignored.
> **Explanation:** If the going-concern assumption ceases to be valid, liabilities applicable on liquidation are presented in the financial statements.
### When is a higher valuation of a business expected, based on going-concern value?
- [ ] When an entity is bankrupt.
- [x] When an entity is continuing its operations.
- [ ] When the economy is in a recession.
- [ ] When the entity is facing significant lawsuits.
> **Explanation:** A higher valuation of a business based on going-concern value is expected when the entity continues its operations, as it reflects potential for future earnings.
### Why is the going-concern assumption critical for asset valuation methods?
- [x] It supports the usage of historical cost rather than liquidation value.
- [ ] It requires assets to be revalued to their market prices.
- [ ] It mandates write-offs of all assets.
- [ ] It promotes constant reassessment of asset utility.
> **Explanation:** The going-concern assumption is critical because it supports the usage of historical cost as opposed to liquidation value for asset valuation methods.
### What are break-up values?
- [ ] Historical values of assets.
- [ ] Depreciated values of equipment.
- [x] Values of assets if sold individually in liquidation.
- [ ] Market values of liabilities.
> **Explanation:** Break-up values are the values of assets if they were to be sold individually in a liquidation scenario, rather than as part of a continuing operation.
### How should users of financial statements treat the going-concern assumption unless warned otherwise?
- [x] Assume that the going-concern assumption has been applied.
- [ ] Assume the company is facing liquidation.
- [ ] Assume all assets are overvalued.
- [ ] Assume there is significant misstatement.
> **Explanation:** Users of financial statements should assume that the going-concern assumption has been applied unless there is clear warning to the contrary.
Thank you for delving into the foundational aspect of accounting with our detailed overview and engaging quiz on the going-concern concept! Continue building your financial acumen!
