Definition of the 'going concern' concept

The 'going concern' concept directs accountants to prepare financial statements on the
assumption that the business is not about to go broke or be liquidated (i.e. where the business
closes and sells all the assets for whatever price they can get).[1]

So, unless there is significant evidence to the contrary, accountants will base their valuations and
their reporting of financial data on the assumption that the business will remain in existence for
an indefinite period.

An indefinite period means the foreseeable future or long enough for the business to meet its
objectives and to fulfill its commitments. It is important to note that the 'going concern' concept
does not imply or guarantee that the business is profitable and will remain so for the foreseeable
future.

So, 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. Utilized assets means obtaining the complete
benefit from their earning potential. (i.e. if you recently purchased equipment costing $5,000 that
had 5 years of productive/useful life, then under the going concern assumption, the accountant
would only write off one year's value $1,000 (1/5th) this year, leaving $4,000 to be treated as a
fixed asset with future economic value for the business). The 'going concern' concept supports
the assumption that when a business buys assets like land, equipment, and buildings, it does so
with the intent that these assets will produce income over a number of years. In other words, the
business did not purchase these assets with the intention to close operations soon after and then
resell these assets.

The opposite view to this 'going concern' assumption is that the business will cease trading
shortly and that all the assets will be sold off within the current year.[1]

Use in Accounting
In accounting, "going concern" refers to a company's ability to continue functioning as a
business entity (concern being an early-20th century term for "business" or "enterprise"). It is the
responsibility of the directors to assess whether the going concern assumption is appropriate
when preparing the financial statements. A company is required to disclose in the notes to the
Financial Statements whether there are any factors that may put the company's status as a going
concern in doubt.

Financial statements are prepared on the assumption that the entity is a going concern, meaning it
will continue in operation for the foreseeable future and will be able to realize assets and
discharge liabilities in the normal course of operations. This is one of the fundamental concepts
of accounting.[2] Different bases of measurement may be appropriate when the entity is not
expected to continue in operation for the foreseeable future.[3] Where a company is not a going
concern, the break-up basis is used where all assets and liabilities are stated at Net Realizable
Value.
The company's auditor must consider whether the use of the going concern assumption is
appropriate, and whether there are material uncertainties about the entity's ability to continue to
operate as a going concern that need to be disclosed in the financial statements.[4] An auditor
considers such items as negative trends in operating results, loan defaults, and denial of trade
credit from suppliers in deciding if there is a substantial going concern issue.[5] An auditor who
concludes that substantial doubt exists with regard to the appropriateness of the going concern
assumption is required to issue an opinion reflecting this; a modified opinion if the company has
appropriately disclosed the doubt and risks; and a qualified opinion if the company has not made
appropriate disclosures.[6] These are called "going concern" opinions.

Auditors can make two types of errors in such opinions - issuing a modified report for a
company that remains viable and failing to issue a modified report for a company that becomes
bankrupt before the next audit. Research has shown that only a small fraction of companies
receiving modified reports become bankrupt, and that receiving such a report increases the
likelihood that the company will change auditors. Through 2001, roughly half of companies that
do become bankrupt had a modified opinion on their immediately prior financial statements,
though this percentage has since risen higher. Auditors are at risk of being sued by financial
statement users if a company that did not receive a modified opinion becomes bankrupt, although
litigation reform in the 1990s lowered the risk of being sued and the liability if such a suit is
successful.[7][8]

Use in Risk Management

If a public company reports that its auditors have doubts about its ability to continue as a going
concern, investors may take that as a sign of increased risk, although an emphasis of matter
paragraph in an audit report does not necessarily indicate that a company is on the verge of
insolvency.[9] Despite this, some fund managers may be required to sell the stock to maintain an
appropriate level of risk in their portfolios. 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. Because of such responses to expressed concerns by auditors, in the 1970s, the
American Institute of Certified Public Accountants' Cohen commission concluded that an
auditor's expression of uncertainty about the entity's ability to continue as a going concern "tends
to be a self-fulfilling prophecy. The auditor’s expression of uncertainty about the company’s
ability to continue may contribute to making its failure a certainty."[6]

Notes to financial statements (notes) are additional information added to the end of financial
statements. Notes to financial statements help explain specific items in the financial statements
as well as provide a more comprehensive assessment of a company's financial condition. Notes
to financial statements can include information on debt, going concern criteria, accounts,
contingent liabilities or contextual information explaining the financial numbers (e.g. to indicate
a lawsuit).

The notes clarify individual statement line-items. For example, if a company lists a loss on a
fixed asset impairment line in their income statement, notes could corroborate the reason for the
impairment by describing how the asset became impaired. Notes are also used to explain the
accounting methods used to prepare the statements and they support valuations for how
particular accounts have been computed.

In consolidated financial statements, all subsidiaries are listed as well as the amount of
ownership (controlling interest) that the parent company has in the subsidiaries. Any items
within the financial statements that are valuated by estimation are part of the notes if a
substantial difference exists between the amount of the estimate previously reported and the
actual result. Full disclosure of the effects of the differences between the estimate and actual
results should be included

Contingent liabilities are liabilities that may or may not be incurred by an entity depending on
the outcome of a future event such as a court case. These liabilities are recorded in a company's
accounts and shown in the balance sheet when both probable and reasonably estimable. A
footnote to the balance sheet describes the nature and extent of the contingent liabilities. The
likelihood of loss is described as probable, reasonably possible, or remote. The ability to estimate
a loss is described as known, reasonably estimable, or not reasonably estimable.

Examples
 outstanding lawsuits
 Legal liability
 Liquidated damages
 Tort
 Bills Discounted with bank
 Unliquidated damages
 Destruction by Flood
 product warranty
 Income Tax Disputed
 Sales Tax Disputed
 Net realizable value (NRV) is a method of evaluating an asset's worth when held in
inventory, in the field of accounting. NRV is part of the Generally Accepted Accounting
Principles and International Financial Reporting Standards (IFRS) that apply to valuing
inventory, so as to not overstate or understate the value of inventory goods. Net realizable
value is generally equal to the selling price of the inventory goods less the selling costs
(completion and disposal). In formula:
 Inventory Sales Value - Estimated Cost of Completion and Disposal = Net
Realizable Value
 Companies need to record the cost of their Ending Inventory at the lower of cost and
NRV, to ensure that their inventory and income statement are not overstated. For
example at a company's year end, if an unfinished good that already cost $25 is expected
to sell for $100 to a customer, but it will take an additional $20 to complete and $10 to
advertise to the customer, its NRV will be $100-$20-$10=$70. In this year's income
statement, since the cost of the good ($25) is less than its NRV ($70), the cost of the good
will get recorded as the cost of inventory. In next year's income statement after the good
was sold, this company will record a revenue of $100, Cost of Goods Sold of $25, and
 Cost of Completion and Disposal of $20+$10=$30. This leads to a profit of $100-$25-
$30=$45 on this transaction.
 Suppose we changed the example so that it costs $60 to advertise to the customer. Now
the good's NRV will be $100-$20-$60=$20. In this year's income statement, since the
NRV ($20) is less than the cost of the good ($25), the NRV will get recorded as the Cost
of Ending Inventory. To do so, an inventory write down of $25-$20=$5 is done, and
hence a decrease of $5 in this year's income statement. In the next year's income
statement after the good was sold, this company will record a revenue of $100, Cost of
Goods Sold of $20, and Cost of Completion and Disposal of $20+$60=$80. This leads to
the company breaking even on this transaction ($100-$20-$80=$0).
 Inventory can be valued at either its historical cost or its market value. Because the
market value of an inventory is not always available, NRV is sometimes used as a
substitute for this value