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 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?
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Going Concern Value vs. Liquidation Value: What is the Difference?
Conversely, this means the entity will not be forced to halt operations and liquidate its assets in the near term at what may be very low fire-sale prices. By making this assumption, the accountant is justified in deferring the recognition of certain expenses until a later period, when the entity will presumably still be in business and using its assets in the most effective manner possible. If a company is not a going concern, the company may be revalued at the request of investors, shareholders, or the board.
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.
Accounting standards try to determine what a company should disclose on its financial statements if there are doubts about its ability to continue as a going concern. In May 2014, the Financial Accounting Standards Board determined financial statements should reveal the conditions that support an entity’s substantial doubt that it can continue as a going concern. Statements should also show management’s interpretation of the conditions and management’s future plans. The going concern concept is not clearly defined anywhere in generally accepted accounting principles, and so is subject to a considerable amount of interpretation regarding when an entity should report it. However, generally accepted auditing standards (GAAS) do instruct an auditor regarding the consideration of an entity’s ability to continue as a going concern.
These vulnerabilities continue to shine a bright light on management’s responsibility for a going concern assessment. KPMG explains how an entity’s management performs a going concern assessment and makes appropriate disclosures. Q&As, interpretive guidance and illustrative examples include insights into how continued economic uncertainty may affect going concern assessments. This latest edition includes illustrative application of going concern’s most significant complexities. In order for a company to be a going concern, it usually needs to be able credit note what is a credit note to operate with a significant debt restructuring or massive financing overhaul. Therefore, it may be noted that companies that are not a going concern may need external financing, restructuring, asset liquidation, or be acquired by a more profitable entity.
- Listing the value of long-term assets may indicate a company plans to sell these assets.
- 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.
- If a company’s liquidation value – how much its assets can be sold for and converted into cash – exceeds its going concern value, it’s in the best interests of its stakeholders for the company to proceed with the liquidation.
- 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.
- For a company to be a going concern, it must be able to continue operating long enough to carry out its commitments, obligations, objectives, and so on.
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.
Use in risk management
Accountants use going concern principles to decide what types of reporting should appear on financial statements. Companies that are a going concern may defer reporting long-term assets at current value or liquidating value, but rather at cost. A company remains a going concern when the sale of assets does not impair its ability to continue operation, such as the closure of a small branch office that reassigns the employees to other departments within the company. For a company to be a going concern, it must be able to continue operating long enough to carry out its commitments, obligations, objectives, and so on.
A firm’s inability to meet its obligations without substantial restructuring or selling of assets may also indicate it is not a going concern. If a company acquires assets during a time of restructuring, it may plan to resell them later. Consider how a single substantial lawsuit, default on a loan, or defective product can jeopardize the future of a company. An entity is assumed to be a going concern in the absence of significant information to the contrary. An example of such contrary information is an entity’s inability to meet its obligations as they come due without substantial asset sales or debt restructurings. If such were not the case, an entity would essentially be acquiring assets with the intention of closing its operations and reselling the assets to another party.
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.
If there is an issue, the audit firm must qualify its audit report with a statement about the problem. In addition, management must include commentary regarding its plans on how to alleviate the risks, which are attached in the footnotes section of a company’s 10-Q or 10-K. 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. Under the going concern principle, the company is assumed to sustain operations, so the value of its assets (and capacity for value-creation) is expected to endure into the future. Receive the latest financial reporting and accounting updates with our newsletters and more delivered to your inbox.
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. The “going concern” concept assumes that the business will remain in existence long enough for all the assets of the business to be fully utilized. Going concern is important because it is a signal of trust about the longevity and future of a company.
