Imagine yourself walking into your local bank. With business plan neatly tucked away in your briefcase, you recall the long hard hours it took you to put it together. The small business loan you are about to apply for will determine whether your business can grow. Is your business a going concern?
What is the Going Concern Assumption?
Going concern is one of the four assumptions that are part of the accounting conceptual framework. Its meaning is really quite simple. The going concern assumption applies to almost any business that intends to operate as a business for a reasonable period of time. This is usually defined as operating for more than one year. When using the going concern assumption, what we are really saying is that our business is not in danger of folding. It will continue to operate and the financials prove that.
The going concern assumption is one that underlies the preparation of financial financial statements. Most businesses who show financials to an investor are automatically intimating that the business is going to continue operations in the foreseeable future.
If the business is in danger of closing and this danger is not apparent in the financial statements then there is a departure from GAAP. Part of an auditor's responsibility is to determine whether the financials were prepared properly and any issues with going concern properly disclosed. If not, then the auditor may give an adverse or qualified (not the good kind) opinion.
Who Uses the Assumption?
Auditors directly look for going concern while performing an audit. There are several procedures an auditor will perform in order to determine going concern. Their main objective when performing these procedures is to look for any hint that the business is not a going concern.
In order to do this an auditor will review the minutes of the board directors. He or she will look for discussions that pertain to problems paying debt and closing the business. Auditors also perform analytical procedures. These usually involve crunching the numbers and verifying documents. Auditors will also contact third parties in order to verify financial agreements. If the business has a lawyer, an auditor will contact the lawyer to discuss any possible litigations and other legal issues the company is facing.When an auditor looks for going concern, he is mainly trying to determine that the business will be operating for longer than one year.
Investors and lenders--especially investors--will use the going concern assumption on more of an indirect basis. When, for example, someone purchases stock he or she is investing in the business that the stock belongs to. Most investors make their decisions using the assumption that the business taking their money will continue to operate. Most people do not want to invest in a company that is going to fold. Remember the Enron scandal?
Lenders also use going concern. A lender reviews the financial statements of a company to make sure that the business will be able to service its loan, i.e., make the payments when they are due.