What assumption states that a business is able to financially continue operations and is not planning to liquidate?

The term going concern refers to an accounting concept in which it is assumed that a company will stay in business for the foreseeable future.

As a going concern, it is assumed that the business will remain in business long enough to meet its obligations and commitments and not have to liquidate its assets.

The going concern principle is an important assumption in accounting.

The Generally Accepted Accounting Principles do not clearly state what makes a business a going concern.

However, it does require auditors to check to make sure that a company is a going concern.

The lack of a specific definition for what a going concern is does give an auditor a fair amount of leeway in deciding if a company is a going concern.

Whether or not a business is considered a going concern can have a significant impact on the business, including its stock price, its ability to obtain a loan, and the preparation of its financial statements.

Determining if a Business is a Going Concern

It is essential for the owners or managers of a business to determine whether or not the business is a going concern.

If the business is found to be a going concern, it can prepare its financial statements accordingly.

Therefore, the business can defer some prepaid expenses.

A Financial Auditor’s Role

Companies hire financial auditors to analyze whether or not their assessment of being a going concern is correct.

Once the auditor completes a review, they will give the business a review of their assessment.

Here are the possible opinions:

• Unqualified Opinion: This would be a good outcome. It would indicate that the auditor is satisfied with the business’s financial statements or with the business’s ability to continue its operations in the foreseeable future.
• Qualified Opinion: A qualified opinion is not such a good outcome. It indicates that the auditor is not confident that the business is a going concern. This could cause lenders, investors, as well as any additional stakeholders, to be concerned about the business.
• Mitigation of a Qualified Opinion: If an auditor is planning on issuing a qualified opinion, they will give the company’s management a chance to make a plan that will correct the company’s problems and improve its prospects for the future. If the auditor believes the plan can be followed and it allays their concerns, they will not issue a qualified opinion.

There are several possible plans, such as:

• Selling some assets in order to pay off debts or fund continuing operations
• Obtaining contributions to equity from stockholders or owners
• Reducing expenses as a way of saving cash and increasing profits
• Obtaining additional financing if feasible, or working with financial institutions to restructure any debt in an attempt to avoid liquidation of the business

Red Flags

There is no one specific factor that means a business will fail, but there are some things to look out for, such as:

• Cannot Obtain a Loan: If a company cannot get a loan, this shows that lenders doubt the company’s ability to pay off a loan.
• Legal Problems: Current or possible lawsuits, regulatory problems, as well as other legal issues, could cause the business financial difficulties it would have to deal with.
• Low Current Ratio: If the business has a current ratio that is below 1, it might mean that the business will not have sufficient cash to meet its short-term obligations.
• Decreasing Market Share: A business that has a lot of competition in the market along with declining demand for its services or products could have an unsure future.
• Loss of Employees: Losing important employees could make it even more difficult for the business to continue to operate.

Issuing a Going Concern Qualification

The way in which an auditor issues an opinion about a going concern qualification will depend on a business’s structure.

Private Businesses

If an auditor has significant evidence indicating that a private company may not be a going concern, the auditor will disclose this in their audit report.

If the company’s financials have not been audited, the auditor should still express any concerns they have about the business’s stability to the owners of the business.

Public Businesses

The Securities and Exchange Commission requires that auditors disclose any concerns they have about a publicly-traded company’s going concern status in the company’s financial statements.

This helps to protect investors by letting them know that company may not be a going concern.

How a Qualified Opinion Can Affect a Business

A business that has received a qualified opinion on its status as a going concern could have some difficulties, such as:

• Credit Difficulties: Financial institutions use financial statements when making decisions about granting loans. If a business may not be a going concern, the financial institution may be reluctant to loan the business any money.
• Decreasing Investments: If a business receives a qualified opinion from an auditor, investors may not want to invest in the business. Current investors may even choose to sell their shares.
• Liquidation Accounting: A business that looks as if it will fail may need to have its accountants write down the value of its assets, including its inventory, which will lower the business’s overall value.
• Business Valuation Request: Stockholders and other investors could request a business valuation in order to see the actual value of a company before deciding what action to take after learning about a qualified opinion.

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What is meant by the going concern assumption?