Going Concern Concept Meaning, Example, Advantages, Disadvantages, Etc.

The Going Concern Concept is a fundamental accounting principle that assumes an entity will continue its operations in the foreseeable future without the intention or necessity of liquidation or cessation of activities. This concept underpins financial reporting and influences the preparation of financial statements. It reflects the idea that businesses are typically viewed as ongoing enterprises with an indefinite life, allowing for the application of accrual accounting and the presentation of financial statements based on the assumption that the company will continue its operations.

Going Concern Concept is a very important topic to be studied for the commerce related exams such as the UGC-NET Commerce Examination.

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In this article, the learners will be able to know about the going concern concept in detail, along with certain other topics in detail.

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Defining the Going Concern Concept

The Going Concern Concept is a fundamental accounting principle. It assumes that a business will continue its operations for the foreseeable future and will not be compelled to halt operations or liquidate for any particular reason.

Simply put, for a business to be considered a going concern, it should meet the following criteria:

• The business can sustain daily operations and has the necessary capital and resources to do so.
• The company has the capacity to settle its debts within the accounting period.
• The company's products or services should have a market demand.
• There should be no legal changes that could potentially harm the business.

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Role of the Going Concern Concept in Accounting

The Going Concern Concept is crucial for the Generally Accepted Accounting Principles (GAAP) and the International Financial Reporting Standards (IFRS). It significantly influences how assets are treated in accounting.

The accounting principles of depreciation and amortization are based on the assumption that the business will continue its operations in the near future. This period is typically the 12 months following an accounting period.

Also, read about Treatment of Goodwill

Advantages of Going Concern Concept

The advantages have been stated below.

• Accrual Accounting Application: The Going Concern Concept allows for the application of accrual accounting, enabling businesses to record transactions when they occur, not just when cash is received or paid. This provides a more accurate representation of the company's financial position.
• Long-Term Planning: Businesses can engage in long-term planning and decision-making, as the assumption of continuity allows for the consideration of future cash flows, investments, and operational strategies.
• Asset Valuation: The concept allows businesses to value assets at historical cost or market value, rather than at their immediate liquidation value. This provides a more realistic reflection of the company's investment in its assets.
• Enhanced Credibility: Stakeholders, including investors, creditors, and suppliers, may have greater confidence in financial statements that assume the business will continue to operate. This can enhance the credibility of the company in the eyes of external parties.
• Comparability: Financial statements prepared under the Going Concern Concept allow for comparability across different reporting periods, as they reflect a consistent assumption of the company's continued operations.

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Disadvantages of Going Concern Concept

The disadvantages have been stated below.

• Overstating Values: In some cases, the assumption of a going concern may lead to the overstatement of asset values, especially if there are significant doubts about the business's ability to continue. This can result in a misrepresentation of the true financial position.
• Delayed Recognition of Impairments: The assumption of continuity might delay the recognition of impairments in the value of assets. If a business is unlikely to continue, certain assets may need to be valued at their expected liquidation values.
• Misleading Stakeholders: If a business is experiencing severe financial distress or is on the verge of bankruptcy, adhering to the Going Concern Concept without appropriate disclosure may mislead stakeholders who rely on financial statements for decision-making.
• Incompatibility with Certain Industries: Some industries have inherently short life cycles, and the Going Concern Concept may not align well with their nature. Businesses in such industries may need to consider alternative reporting bases.
• Assumption Challenges: Assessing the going concern assumption can be challenging, especially when there are uncertainties about a company's future viability. The subjectivity involved in this assessment can impact the reliability of financial statements.

Example for Going Concern Concept

Consider a manufacturing company that has experienced a temporary downturn in sales due to economic conditions. The company's management, after a thorough assessment of its financial position, industry outlook, and potential recovery strategies, concludes that there are no significant uncertainties that cast doubt on its ability to continue as a going concern.

In this example, the company's financial statements, prepared under the Going Concern Concept, will assume that the business will continue to operate in the foreseeable future. This means that the company will present its assets and liabilities based on the expectation that it will be able to recover from the temporary setback and continue its operations over the long term.

Conclusion

The Going Concern Concept is a cornerstone of financial reporting, providing a framework for the preparation of financial statements based on the assumption that a business will continue its operations. It influences the treatment of assets, liabilities, and financial statement presentation, ensuring that financial information is relevant, reliable, and reflects the ongoing nature of business entities. The assessment of the going concern assumption is a responsibility of management and is essential for stakeholders in making informed decisions based on financial statements.

Going concern concept is a vital topic as per several competitive exams. It would help if you learned other similar topics with the Testbook App.