Certain red flags may appear on financial statements of publicly traded companies that may indicate a business will not be a going concern in the future. Listing of long-term assets normally straight line depreciation does not appear in a company’s quarterly statements or as a line item on balance sheets. Listing the value of long-term assets may indicate a company plans to sell these assets. Usually, liquidation value is applied when investors feel a company no longer has value as a going concern, and they want to know how much they can get by selling off the company’s tangible assets and such of its intangible assets as can be sold, such as IP. A company or investor that is acquiring a company may compare that company’s going-concern value to its liquidation value in order to decide whether it’s financially worthwhile to continue operating the company, or whether it is more profitable to liquidate it.
What is the Going Concern Assumption?
Accountants may also employ going concern principles to determine how a company should proceed with any sales of assets, reduction of expenses, or shifts to other products. If the accountant believes that an entity may no longer be a going concern, then this brings up the issue of whether its assets are impaired, which may call for the write-down of their carrying amount to their liquidation value. The valuation of companies in need of restructuring values a company as a collection of assets, which serves as the basis of the liquidation value. The reason the going concern assumption bears such importance in financial reporting is that it validates the use of historical cost accounting. Economic uncertainty has been prevalent in global markets over the last several years due to many unexpected macro events – from COVID-19 and the related supply chain disruptions to international conflicts and rising interest rates. While some companies thrive from uncertainty, others may see their financial performance, liquidity and cash flow projections negatively impacted.
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The auditor evaluates an entity’s ability to continue as a going concern for a period not less than one year following the date of the financial statements being audited (a longer period may be considered if the auditor believes such extended period to be relevant). If so, the auditor must draw attention to the uncertainty regarding the entity’s ability to continue as a going concern, in their auditor’s report. Separate standards and guidance have been issued by the Auditing Practices Board to address the work of auditors in relation to going concern. A negative judgment may also result in the breach of bank loan covenants or lead a debt rating firm to lower the rating on the company’s debt, making the cost of existing debt increase and/or preventing the company from obtaining additional debt financing.
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- Under GAAP standards, companies are required to disclose material information that enables their viewers – in particular, its shareholders, lenders, etc. – to understand the true financial health of the company.
- By contrast, the going concern assumption is the opposite of assuming liquidation, which is defined as the process when a company’s operations are forced to a halt and its assets are sold to willing buyers for cash.
- The valuation of companies in need of restructuring values a company as a collection of assets, which serves as the basis of the liquidation value.
- If a company is not a going concern, that means there is risk the company may not survive the next 12 months.
By contrast, the going concern assumption is the opposite of assuming liquidation, which is defined as the process when a company’s operations are forced to a halt and its assets are sold to willing buyers for cash. Often, management will be incentivized to downplay the risks and focus on its plans to mitigate the conditional events – which is understandable given their duties to uphold the valuation (i.e. share price) of the company – yet the facts must still be disclosed. In the case there is substantial yet unreported doubt about the company’s continuance after the date of reporting (i.e. twelve months), then management has failed its fiduciary duty to its stakeholders and has violated its reporting requirements. More specifically, companies are obligated to disclose the risks and potential events that could impede their ability to operate and cause them to undergo liquidation (i.e. be forced out of business). Even if the company’s future is questionable and its status as a going concern appears to be in question – e.g. there are potential catalysts that could raise significant concerns – the company’s financials should still be prepared on a going concern basis.
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Going concern value is a value that assumes the company will remain in business indefinitely and continue to be profitable. This differs from the value that would be realized if its assets were liquidated—the liquidation value—because an ongoing operation has the ability to continue to earn a profit, which contributes to its value. A company should always be considered a going concern unless there is a good reason to believe that it will be going out of business. At the end of the day, awareness of the risks that place the company’s future into doubt must be shared in financial reports with an objective explanation of management’s evaluation of the severity of the circumstances surrounding the company.
The going-concern value of a company is typically much higher than its liquidation value because it includes intangible assets and customer loyalty as well as any potential for future returns. The liquidation value of a company will even be lower than the value of the company’s tangible assets, because the company may have to sell off its tangible assets at a discount—often, a deep discount—in order to liquidate them before ceasing operations. Examples of tangible assets that might be sold at a loss include equipment, unsold inventory, real estate, vehicles, patents, and other intellectual property (IP), furniture, and fixtures. The going concern presumption that an entity will be able to meet its obligations when they become due is foundational to financial reporting.
If a company receives a negative audit and may not be a going concern, there are several implications. Companies that are not a going concern represent a significantly higher level of risk compared to other companies. However, liquidating a company means laying off all of its employees, and if the company is viable, this can have negative ramifications not only for the laid-off workers but also for the investor who made the decision to liquidate a healthy company.
An overview discussion of going concern assessments and financial reporting implications. The ever-evolving complexities attributable to economic uncertainty may disrupt business as usual. When forecasting becomes less reliable and the past no longer predicts the future, the going concern assessment becomes much harder to document and update, and robust disclosures much more critical.
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The Going Concern Assumption is a fundamental principle in accrual accounting, stating that a company will remain operating into the foreseeable future rather than undergo a liquidation. Some or all of the services described herein may not be permissible for KPMG audit clients and their affiliates or related entities.The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future.
Without it, business would not offer nearly as much credit sales as suppliers, vendors, and other companies may not pay the company if there is little belief these companies will survive. One of larger repercussions of not being a going concern are potential credit challenges. New lenders will likely be reluctant to issue new credit, or any new credit issued will be prohibitively expensive. This credit crunch may trickle down to suppliers who may be unwilling to sell raw materials or inventory goods on credit. Accountants who view a company xero guide for dummies as a going concern generally believe a firm uses its assets wisely and does not have to liquidate anything.