Introduction of Going Concern Concept
The concept of Going Concern, in terms of carrying on a business, refers to the assumption or the implied fact that the company will continue its business indefinitely or at least until the foreseeable future and will not be forced to discontinue its operations on account of any reason.
Going concern is an accounting assumption that businesses follow as part of Generally Accepted Accounting Principles while drawing up their financial statements and reports. Financial statements pertaining to any business concern, whether small or big, whether proprietorship or company, are prepared based on ongoing concern concept which implies that the business is carried on or to be carried on shall continue to operate for a foreseeable time period.
This assumption is in return verified by the auditor while auditing the financial accounts of the organization. In case there is any concern or challenge which may result in closing down or liquidation of the business, in such a scenario, the financial accounts are prepared accordingly keeping in mind the time period for which the business may continue and also the said fact shall be disclosed in the financial statements of the organization.
Examples of Going Concern Concept
Let us understand the concept with the help of examples.
Suppose there is a company named IMEXA Corp. IMEXA is based in California and is involved in the export of Cable wires. IMEXA has been in this business for a decade and plans to continue the same for a foreseeable future.
Now, in the previous year, the government announced a new regulation that restricts the quantity of export of computer machines and cable wires in a year. This regulation affected IMEXA’s business and it reported a loss in the previous year due to this.
In the present year, the management has decided to shut down its export business as continuing the same would only entail in resultant losses and thus not viable. Accordingly, till the previous year IMEXA had prepared its accounts based on the ongoing concern concept, however, this year it shall discard the going concern concept and prepare its accounts on realizable values as it does not foresee doing the business going forward.
A common example can be given for accounting of fixed assets purchased. When an asset is purchased, the organization plans to use it and reap benefits for more than a year, however, the expenditure for the same is to be incurred in the year of purchase.
Thus, in such a situation, the organization shall capitalize on the assets and claim depreciation on the assets over the years for the life of the asset. This distribution of expenditure (depreciation) is possible only because of the going concern concept, which is, the business shall be carried on for at least the life of the asset or beyond.
Assumptions of Going Concern Concept
The captioned concept is based on the very assumption that the business will continue to eternity until there is any circumstance that may result in its liquidation.
In order to make this assumption work practically, there are certain factors which are assumed to be taken care of, such as:
- Demand for the Product or Service: It is assumed that there will be a demand for the product being sold or the service being offered by the business concern. The concept considers that the company will continue to manage its existing customers and simultaneously keep on expanding.
- Profitability: Another assumption is that, although businesses may incur losses initially, it will have profitability prospects achieved on a long term basis and will continue to grow year on year.
- No Change in Law and Statute: It is assumed that the law and statute governing the business and its model continue to remain the same or positive for the business and its growth.
Importance of Going Concern Concept
The concept is important for the following factors or reasons:
- Shows the stability of the business carried on by the company;
- Helps shareholders assess the financial stability of the company;
- Helps business fetch loans or make investments on a long term basis;
- It gives comfort to creditors to do business with the company.
Advantages and Disadvantages of Going Concern Concept
Below are the advantages and disadvantages:
There are advantages of following the concept or principle in the accounting policies.
- Businesses undertake the heavy purchase of fixed assets in the initial years which entails immediate expenditure, however, the benefit for the same is spread out over the life of an asset, usually more than a year. The concept recognizes recording of such expenses over the period of the assets;
- It provides the basis of recording income or profits over the years in which pertain to;
- It provides for bifurcation of assets and liabilities as short term, usually 12-month period, and long term, more than 12 months, also instilling faith in the company that it will continue its operations in future;
- The assets and liabilities are recorded at cost in order to show the stability of the company that its very intention is not for liquidating its assets and liabilities but on continuous long-term growth.
Certain disadvantages or limitations of the captioned concept are:
- The financial statements are prepared on a cost basis and not Mark to Market basis. In the event of winding up or liquidation of the company, when the financial statements are drawn on Mark to the Market basis, the numbers may differ drastically from the one prepared under cost basis;
- In case of the business being shut down and the financial statements are drawn on going concern basis, the information so depicted shall not be correct and may mislead the stakeholders involved;
- Any change in law may have an impact on the business and the concept of going concerned may not be viable for the company and would result in sudden and immediate corrections in recording in financial transactions.
In a few words, the going concern concept implies that the business will be carried on for a foreseeable future and thus give a realistic picture of the business from a long term view.
All said and done, the concept is a universally accepted accounting principle that is recognized internationally. The concept requires disclosing the going concern aspect of the business and accordingly account for all the financial transactions from a long term perspective of the business. This concept not only helps in a systematic approach to the recording of the financial transactions but it also provides a fair idea about the business, growth and financial stability of the company.
This is a guide to Going Concern Concept. Here we discuss the introduction and assumptions of the going concern concept along with advantages and disadvantages. You may also have a look at the following articles to learn more –