As you gain experience, you’ll start digging through riskier investments because sometimes that’s where the value is. Understanding how and why auditors make going concern determinations can help you figure out which deals are worth it. The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity.

This situation could possibly occur with an overpayment to a supplier or an error in recording. In order to record a transaction, we need a system of monetary measurement, or a monetary unit by which to value the transaction. Without a dollar amount, it would be impossible to record information in the financial records. It also would leave stakeholders unable to make financial decisions, because there is no comparability measurement between companies. This concept ignores any change in the purchasing power of the dollar due to inflation.

  1. The ending account balance is found by calculating the difference between debits and credits for each account.
  2. Management’s plans are ignored under Step 1, but considered under Step 2, to determine if they alleviate the substantial doubt raised in Step 1.
  3. It follows that when this is not the case, a detailed analysis will be necessary, which likely includes robust cash flow forecasts and a review of existing and forthcoming financial obligations.
  4. Companies with low liquidity ratios, high employee turnover, or decreasing market share are more likely to not be a going concern.

If management conclude that the entity has no alternative but to liquidate or curtail materially the scale of its operations, the going concern basis cannot be used and the financial statements must be prepared on a different basis (such as the ‘break-up’ basis). An entity prepares financial statements on a going concern basis when, under the going concern assumption, the entity is viewed as continuing in business for the foreseeable future. The term ‘foreseeable future’ is not defined within ISA 570, but IAS 1®, Presentation of Financial Statements deems the foreseeable future to be a period of at least 12 months from the end of the reporting period. This concept is important when valuing a transaction for which the dollar value cannot be as clearly determined, as when using the cost principle.

The valuation of companies in need of restructuring values a company as a collection of assets, which serves as the basis of the liquidation value. Often, management will be incentivized to downplay the risks and focus on its plans to mitigate the conditional events – which is understandable given their duties to uphold the valuation (i.e. share price) of the company – yet the facts must still be disclosed. In addition, management must include commentary regarding its plans on how to alleviate the risks, which are attached in the footnotes section of a company’s 10-Q or 10-K. More specifically, companies are obligated to disclose the risks and potential events that could impede their ability to operate and cause them to undergo liquidation (i.e. be forced out of business).

How to navigate accounting assumptions

A general ledger is a comprehensive listing of all of a company’s accounts with their individual balances. Once an accounting standard has been written for US GAAP, the FASB often offers clarification on how the standard should be applied. When the FASB creates accounting standards and any subsequent clarifications or guidance, it only has to consider the effects of those standards, clarifications, or guidance on US-based companies. When offering interpretations or other guidance on application of standards, the FASB can utilize knowledge of the US-based legal and taxation systems to help guide their points of clarification and can even create interpretations for specific industries. This means that interpretation and guidance on US GAAP standards can often contain specific details and guidelines in order to help align the accounting process with legal matters and tax laws. Accounting assumptions form the foundation upon which GAAP can be applied; therefore, the two are closely related.

Since the company has provided the service, it would recognize the revenue as earned, even though cash has yet to be collected. An in-depth look at economic entity, going concern, monetary unit, and periodicity. The going concern assessment is inherently complex and judgmental and will be under heightened scrutiny for many companies this year due to COVID-19. Management should carefully consider the requirements of IFRS Standards and reevaluate their historical approach to the going concern analysis; it may no longer be sufficient given the current economic environment.

Management will need to monitor the expected impacts on operations, forecasted cash flows, and debt covenants, with the primary focus being on whether the company will have sufficient liquidity to meet its financial obligations as they fall due. IFRS Standards do not prescribe how management performs the going concern assessment. IAS 1 only states that when a company has a history of profitable operations and ready access to financial resources, management may reach a conclusion on the appropriateness of the going concern assessment without detailed analysis.

International accounting rules are called International Financial Reporting Standards (IFRS). Publicly traded companies (those that offer their shares for sale on exchanges in the United States) have the reporting of their financial operations regulated by the Securities and Exchange Commission (SEC). Consequently, it is important to be aware that a company would need to provide additional information in its financial statements if it does not expect to be able to fulfil its obligations in the coming year. The monetary unit assumption requires the entity to measure and record transactions, assets, and liabilities in monetary units (i.e., dollars, euros, etc.) in its financial statements, and those monetary units must be assumed to be stable over time. However, an entity may provide disclosures about inflation as recommended in Topic 255, Changing Prices, when applicable.

Normal Balance of an Account

In the AA exam candidates may be required to describe the audit procedures that the auditor should perform in assessing whether or not a company is a going concern. The customer did not pay cash for the service at that time and was billed for the service, paying at a later date. She provided the service to the customer, and there is a reasonable expectation that the customer will pay at the later date. There also does not have to be a correlation between when cash is collected and when revenue is recognized. Even though the customer has not yet paid cash, there is a reasonable expectation that the customer will pay in the future.

Because of the time period assumption, we need to be sure to recognize revenues and expenses in the proper period. This might mean allocating costs over more than one accounting or reporting period. This is an important concept to financial accounting regressive vs progressive because many other accounting principles are based on the assumption that companies will not cease to exist at the end of a period. The going concern principle is what establishes the ability for companies to accrue expenses and prepay asset.

Consequences of a Negative Going Concern Opinion

Under GAAP standards, companies are required to disclose material information that enables their viewers – in particular, its shareholders, lenders, etc. – to understand the true financial health of the company. An entity has borrowings of $10m which became immediately repayable in full on 31 March 20X2. The entity is already in breach of its agreed overdraft and the bank has refused to renew the borrowings. The entity has also been unsuccessful in applying to other financial institutions for re-financing.

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Disclosures of material uncertainties that may cast doubt on a company’s ability to continue as a going concern as well as significant judgments involved in close-call scenarios may be more frequent as a result of COVID-19, given the continued economic uncertainty. Management should critically assess the disclosure requirements of IAS 1 and consider drafting required disclosure language early in the financial reporting process. The conceptual framework sets the basis for accounting standards set by rule-making bodies that govern how the financial statements are prepared. Here are a few of the principles, assumptions, and concepts that provide guidance in developing GAAP. This involves disclosing information about the assumptions it makes about the future, and other major sources of estimation uncertainty at the end of the reporting period. In respect of the going concern assessment this is disclosing those amounts that could potentially result in a material adjustment to the carrying values of assets and liabilities within the next financial period.

The Conceptual Framework

Candidates attempting AA will need to have a sound understanding of the concept of going concern. Among other syllabus requirements, candidates must ensure they are aware of the respective responsibilities of auditors and management regarding going concern. The provisions in ISA 570, Going Concern deal with the auditor’s responsibilities in relation to management’s use of the going concern basis of accounting in the preparation of the financial statements. The procedural part of accounting—recording transactions right through to creating financial statements—is a universal process.