Basically, the purpose of setting up a business is to earn profit and all stakeholders want to see the business is growing for foreseeable future. They don’t want to see that company encounter any problems or failure that result in liquidation or bankruptcy. Thus, going concern principle is always a key those stakeholders want to see. So what is going concern principle?
Definition of Going Concern
Going concern principle is one of the accounting concept that we normally refer to an entity’s business operation for a foreseeable future. An entity is considered as going concern when such entity can continue its operation without any indication of failure or bankruptcy. Therefore, in order for a company to continue on a going concern basis, such company shall have resources needed in order to continue its operation indefinitely despite such company is at the loss position.
As the information on going concern principle is very crucial for stakeholders; especially investors and shareholders, a company shall provide information that reflect the real situation of the company.
We normally can do the going concern assessment by analyzing some key ratios such as liquidity ratio, solvency ratio, debt to equity ratio as well as other ratio where they are necessary to assess the going concern of that company. In practice, management representation letter is needed to provide the evidence of going concern operation. In some cases, each company need to have letter of financial support to prove as going concern; especially for a group companies where there are subsidiaries facing the going concern issues.
IAS 1 Presentation of Financial Statements states that “When preparing financial statements, management shall make an assessment of an entity’s ability to continue as a going concern. An entity shall prepare financial statements on a going concern basis unless management either intends to liquidate the entity or to cease trading, or has no realistic alternative but to do so. When management is aware, in making its assessment, of material uncertainties related to events or conditions that may cast significant doubt upon the entity’s ability to continue as a going concern, the entity shall disclose those uncertainties. When an entity does not prepare financial statements on a going concern basis, it shall disclose that fact, together with the basis on which it prepared the financial statements and the reason why the entity is not regarded as a going concern.”
Practically, the standard encourage the management of each entity to be aware of any material deficiencies or uncertainty that involve with the situations where they may cast significant doubt of the ability of such entity to continue on the going concern basis. In case of significant doubt of the entity to be able to continue for foreseeable future, such entity shall disclose those uncertainties or deficiencies in preparing its financial statements and describe the reasons why such entity is not considered as going concern.
Additionally, to be able to assess the going concern of each entity, its management shall need to take into consideration of all available future information at least, but not limited to, the period of twelve months at the end of reporting period from which financial statement is issued.
For instance, in occasion where a company has historical profits from its operation, such company may initially considered that it is on the going concern basis without further detail analysis.
However, that is not the case. We need to assess further on a wide range of factors including the current and future expected profitability, the ability to pay debt as per the schedule as well as other potential sources of replacing the financing facility before we are able to satisfy that that entity is operating on a going concern.
Going concern basis is very crucial for investors and other stakeholders so that they can make decision correctly. Thus, each entity should prepare its financial statements on a going concern basis and disclose correctly where there are cast doubt of situation where indicate such company is not on the going concern.