Judgement on Going Concern Basis

You all must have heard a statement at least once in your life that the financial statements are prepared on the principles of going concern. If not then I am here to explain to you what going concern is.

Definition:

Going concern assumption implies that company should be able to continue its business for foreseeable future. Foreseeable future is defined under IAS 1 presentation of financial statements which says 12 months forward from the reporting date is basically the foreseeable future (ACCA, n.d.).

Factors to consider when assessing Going Concern:

Paragraph 26 of IAS 1 states that when examining whether the entity is a going concern or not management should look into current and future profitability along with repayment and replacement of financing. There are other factors as well which affect the going concern of the entity such as government factors (IFRS, 2021). Each factor is discussed further below.

Profitability:

Let us assume a company namely Y. Company Y has been in loss from 2 years and we are doing its audit. The company says that according to our estimations we will be profitable next year. Should we trust that statement? The answer is no. The answer lies on the what grounds the company is saying that they will become profitable. For example, the management says that they will increase their revenue by 50%. The auditor should ask why do they think that. If they have entered into contracts from which they are likely to increase their revenue then it can be said that it is a valid basis. If they can’t provide something solid then they are not a going concern and should prepare their financial statements on break up basis. Obviously impact of factors is interconnected and one can not say that company is not a going concern based off single factor only. Here factors are being considered in isolation.

Financing:

The company Y is in loss and there is no expectation of future profitability. Is the company not a going concern? Let’s not jump to conclusions and look the matter in further detail. For example, the company has good financing and can fund the losses for foreseeable future. What would you say now? Now try to look for more data and after some research we found out that the company also has sufficient funds to pay its liabilities. This is another positive point. Upon digging more into the industry, we found out that the industry is in a phase of recession and is likely to come out of it in foreseeable future. Would you still give that judgement that the company is not a going concern? Obviously, the factors are very judge-mental but are indicating that the company is a going concern. This is an example of how factors are interconnected and the complete picture is something else when we stop looking at factors in isolation. An auditor should always be sceptical and never blindly trust the words of the management.

Other Factors:

Government factors also affect the ability of the company to be a going concern. For example, the company Y was receiving government grants as a subsidy so the company sells its products at a lower price. The government now has made a statement that no further subsidy will be provided. The going concern will now depend on how significant the impact will be. If without subsidy the price of the products will become too high that it will lead to loss of market competitiveness if the company is operating in a price sensitive market. Then going concern is in fact questionable. Thus, things are very judgmental and require further information which management might not be willing to provide. Such factors sometime go undetected as on the outer surface such as the financial statement the things are going smooth. The financial statements focus on past data and thus have their limitations.

Disclaimer:

The purpose of this article is to explain what going concern is and to aid understanding of people. But this article is not a professional advice and to find more on the subject here, kindly seek professional assistance. Also, the company name chosen was random and is not an indication towards any specific company.

References

ACCA. (n.d.). Retrieved 6 8, 2024, from ACCA: https://www.accaglobal.com/pk/en/student/exam-support-resources/fundamentals-exams-study-resources/f8/technical-articles/going-concern.html

IFRS. (2021, January). Retrieved 6 8, 2024, from https://www.ifrs.org/content/dam/ifrs/news/2021/going-concern-jan2021.pdf