Going Concern Definition
In view of accounting principles where an entity is taken as a third ‘artificial person’ accounting assumes that the business unit will continue its operations for an infinite or long enough time. Going concern concept is also called ‘going concern assumption. When a business is started, except for terminable or temporary projects inaugurated for a specific purpose, it is assumed that the business unit will continue to operate for a long time in pursuit of its objectives. This accounting principle also validates the fact that the business unit is not for sale and will run into the foreseeable future.
Explanation of Going Concern Concept
Under this accounting concept we assume that the business is to remain in existing for as long as possible time period, unless we have some strong footings suggesting otherwise. By looking other way around, this concept compels to draw up the balance sheet and profit and loss account of the business entity on the assumption that this will continue functioning in coming future. Therefore, due to the implementation of going concern concept, assets are recorded on historical cost instead their market values. We can regard this concept supporting the valuation of assets on historical or replacement cost. When there is no more concept of going concern remains, the business unit will have to carry out revaluation of fixed assets to find out assets’ market values. Based on revaluation’s findings assets will be shown on the face of balance sheet at their current market values or net realizable values NRV instead historical cost. Moreover, when the business is no more a going concern, fixed assets recorded on current market values automatically become the current assets of the business. We can say that this concept provides basis for conventional classification of balance sheet’s items such as fixed/current assets, long term/short term liabilities.
Similarly based on this accounting concept, expenses are recorded on accrual basis. In other words, the recording of accruals (expenses incurred but not yet paid for) certifies that the business is supposed to continue its operations for long enough time.
Back in 2000s General Motors was facing great financial crisis that shut down its operations throughout the world. GM was near to declare bankruptcy. The Government intervene and gave both bailout and guarantee. It will be considered going concern because GM will not cease its operations after government intervention.
The Eastern Company manufactures the only Chemical which is known as Chemical X. The company shut downs its operation due to government restrictions on this chemical manufacturing and marketing. The company will no more be a going concern if chemical-X is the only manufacturing and marketing product of Eastern Company.
Factors Affecting Going Concern Assumption
The going concern concept assumes that the entity will continue performing its operations under same economic conditions and in the same general environment, but this concept does not assume that the business will be profitable as long as it exists. This concept also does not imply that the business will continue forever. More importantly this concept is related to future which by definition is uncertain. Therefore, there are many factors which are needed to be taken into consideration while determining whether business unit is a going concern. These factors can be the following:
Liquidity. The current ratio of the business must be healthy. Current assets should be enough to settle the current liabilities of the business unit. A shortage in current assets as compared to current liabilities may lead to insolvency. And when there is insolvency or even chance of it, the business unit cannot be assumed as going concern.
Capital structure. In order to be a going concern, the business unit must have a sound capital structure to deal with long as well short-term problems/difficulties. A sound capital structure refers to the best composition of business’ sources of funds particularly long term.
The Market. The market place in which the business operates have direct effects on business continuity. For a business to be a going concern, there should be a stable demand for goods or services in which the business unit deals.