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. The auditors conduct their own evaluation to see weather the going concern assumption is appropriate or not at the time of auditing financial statements even if the company claims to be a going concern. A company manufactures a chemical known as Chemical-X. If Chemical-X is the only product that company manufactures, the company will no longer be a going concern.
The National company is in serious financial trouble and cannot pay its obligations. The government gives National company a bailout and a guarantee of all payments to creditors. The national company is a going concern despite of its current weak financial position. The Eastern company closes one of its branch and will continue with others. The company is a going concern because the shutting down a small part of business does not impair the ability of the company to operate as going concern.
The Small company is unable to make payments to its creditors due to a very weak liquidity position. As already mentioned, under such assumption an entity is viewed as continuing in business for the foreseeable future and therefore it accounts for its assets and liabilities on the basis that it will be able to realise and discharge them in the normal course of business rather than in a winding up.
In particular under the provisions of both UK GAAP and IFRS specifically IAS 1, Presentation of Financial Statements financial statements are prepared on a going concern basis unless the management or directors either intend to liquidate the entity or cease operations, or have no realistic alternative but to do so. In accordance with both frameworks, directors are required to satisfy themselves that it is reasonable for them to conclude that it is appropriate to prepare financial statements on a going concern basis.
The going concern assessment required to be performed by directors should consider all the facts and circumstances about the foreseeable future of a company known at the date of approval of the accounts. The level of detail of the assessment and extent of procedures required would vary in accordance with the size and complexity of the entity.
What is a Going Concern?
Larger companies or those with more complex business models may need substantially more procedures as part of the going concern assessment, such as annual reviews of medium and long-term plans, analysis of the major aspects of the economic environment in which they operate market size, market share, competitors etc and financial and operational risk management. The period of time that needs to be considered by directors for assessing going concern is not set at a maximum by the accounting standards. However the FRSSE provides that management should disclose in the accounts where the period considered in making its assessment is less than twelve months from the date of the approval of the accounts.
FRS instead mandates consideration of a period of at least twelve months from the approval of the accounts.
Under IAS 1 there is a requirement that the period considered should not be less than twelve months from the end of the reporting period. While the review period under the FRSSE may be less than twelve months from the balance sheet date, when that is the case, ISA requires the auditor to request management to extend its assessment period to at least twelve months from the balance sheet date.
Additionally management should duly take into account relevant events and conditions beyond the minimum period of assessment prescribed by the standards to satisfy themselves as to whether the use of the going concern basis is appropriate. When conducting their going concern assessment, the directors will have to evaluate which of three potential conclusions is appropriate to the circumstances of the company.
In particular they may conclude that:. A material uncertainty is one whose potential impact and possibility of occurrence is so significant that appropriate disclosures of the uncertainty are necessary for the financial statements to give a true and fair view, ie one whose omission would be misleading for the users of the accounts.
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The specific disclosures that should be made are not codified in the standards but they should outline the facts and circumstances that create the uncertainties in a clear manner and should also include an indication that the company may be unable to realise its assets and discharge its liabilities in the normal course of business.
Directors should also indicate on what grounds they consider the use of the going concern basis to be appropriate in view of the identified uncertainties.
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Difficult economic conditions actually impact companies in different ways and provide additional challenges to all the parties involved in preparing financial statements. Each company should be subject to a going concern assessment that is rigorous and balanced and takes into accounts its specific circumstances in light of the general economic conditions.
ISA clearly outlines the objectives of the auditor in respect of the use of the going concern basis in the accounts:. ISA requires the auditor to consider going concern at the early stages of the audit, in particular when performing risk assessment procedures at the planning stage. At that point the auditor should consider whether there are events or conditions that may cast significant doubt about the going concern assumption. In order to do so the auditor should discuss with management their preliminary assessment of going concern, ascertain whether they have identified issues that may have a significant impact on going concern and how they plan to address them.
Use 'going concern' in a Sentence
If management has not performed such a preliminary assessment, the auditor shall discuss with them the grounds on which they intend to use the going concern basis and ask them whether there are events and conditions that may significantly affect going concern. Such discussion normally takes place at the preliminary meeting with the client that is set to update the permanent information about the entity and to identify changes in the business since the last audit that are relevant to the current year audit. The discussion with management about going concern issues helps the auditor to determine whether the use of the going concern assumption is likely to result in a significant risk of material misstatement and to plan audit procedures in response to such a risk.
Events and conditions that may cast doubt about the going concern assumption could be of financial, operating or other nature.
ISA highlights a number of such events and conditions that are commonly encountered in real life and that the auditor should be familiar with. It is worthwhile listing them as a helpful aide memoire:. In respect of events and conditions that may affect the going concern assumption for smaller entities, the auditor should bear in mind that size may negatively affect their ability to withstand adverse conditions.
The auditor should give attention to circumstances that are of particular relevance to small entities, like:. The auditor of a small entity should invariably question management as to whether the above circumstances exist or are likely to materialise and document such enquiries in the planning documentation. The examples indicated are not an exhaustive list of possible events and conditions capable of affecting going concern, as such a list could not be possibly compiled given that various issues may be more or less significant depending on the specific circumstances of an entity.
The importance of identifying events and conditions that may impact going concern at the planning stage, via discussion with management, is that risks of material misstatement can be identified and assessed so that necessary further audit work can be designed and performed to respond to such risks.
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ISA recognises that the auditor may have to deal with an assessment by management that is not supported by a detailed process or examination. When that is the case the auditor will still have to question the grounds on which management have assumed that the entity will continue as a going concern and should also discuss the type of going concern assessment that would be relevant to the circumstances of the client, in order to conclude whether the use of the going concern is appropriate. Notwithstanding the above, a detailed assessment of going concern based on formal procedures like budgets, cash flow forecasts etc.
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