Going Concern Assumption
Going concern assumption is the concept which the company expects to continue its operation within a specific time frame from the reporting date. The company has enough resources to run the business, and it will not go bankrupt at any time soon. We assume that the company will not voluntary or forced to discontinue the operation.
The accountant prepares financial statements on a going concern basis under “ IAS1, Presentation of Financial Statements” that require to assess the company’s ability to continue business within 12 months after the reporting date.
If the company is not going concern, mean that it will bankrupt, liquidate assets or reduce the significant scale of operation in the near future. So the financial statement must be prepared under difference assumptions such as “Break-Up Basis.”
Management Responsible for Company Going Concern
The company going concern is a critical analytic during the recession or in some situations that the company is not making any profit, which can lead to a cash flow problem. Most companies will go bankrupt due to insufficient cash to pay for suppliers, employees, and debtors.
Therefore, managements need to access the company’s ability to operate as going concern and make a disclosure on many factors that may impact. They have to make a judgment on some various factors such as:
- The degree of uncertainty associated with the outcome of an event. It means that managements have to assess the possible outcome of any event which can be lead to a going concern issue for the company.
- Size and complexity of business that can be impacted by the external factor. For example, the eCommerce that imports most of its products from China and sells to customers in the US. It means that the company relies on Chinese manufacturing if something happens such as trade war, they will not be able to import from China, and business will be in trouble. Another example is Huawei, the Chinese company who heavily hit by the US and China trade war.
- The conclusion on the future base on currently available information. The subsequent event result may be different, however, it is reasonable for the time it is conducted.
How Going Concern Impact Audit Report
The auditor is responsible for access the appropriateness of management judgment going concern assumption on the basics of financial statement preparation. They have to conclude if any material uncertainty regarding the company able to continue as going concern, which necessary to disclose in the financial statement for all stakeholders. Auditors need to access management assessment in the same period, 12 months after the balance sheet date.
However, the auditors are not predicting the future or guarantee the company’s ability to operate as going concern. They just evaluate the management assumption of going concern by using available information.
In order to do so, the auditor may use some procedure such as:
- Review the minute meeting of shareholders: during the shareholder meeting, there must be a discussion such as a lack of cash flow raise by the management to the shareholder. At the same time, it may also contain another point regarding company profitability
- Review any report of the company’s regulatory: some companies are operating under strict regulations such as Central Bank. If they break the regulations, the regulatory will be able to withdraw license and the company will out of business at no time.
- Discuss with the company’s legal advisor: The auditors have to access all the outstanding lawsuits against the company by understanding the management reasonableness of each possible outcome and the financial impact.
Indicator of Business is not a Going Concern
Some factors may show that the company is not a going concern, there is a high probability of bankruptcy within a certain time. These are the indicators of going concern problems:
| Factors | Indicator |
|---|---|
| Future obligation and liquid | The company may require to pay a certain amount of loan, lawsuit, or even the account payable. However, they do not have enough cash available. They can request a loan from other lenders or call for a capital injection from the shareholder, it depends on the amount and the company’s financial health. |
| Company profitability | The shareholders expect to make a profit from their investments. However, if it is continuing loss, they may be reconsidering the project, but it depends on the type of business and long term goals of the company. |
| Non-Compliance | The company operates under some regulations such as Government, Tax Department and other. If they have a serious compliance issue, they will face with these regulators. Loan covenant also a problem as the company may require to pay the long term debt to the bank and it will cause the liquidation issue. |
| Haven’t pay a dividend | Usually, company has a fixed schedule to pay a dividend to shareholders. If it fails to do so, it means that the company is struggling with cash flow. |
| Adverse key financial ratio | Some financial ratios such as Quick and Current ratio indicate the company’s ability to pay the current debt. The adverse sign indicates the cash flow problem for the company. |
| Lose financial support | The lender such as bank keeps a close look at their customers. If they withdraw support it shows the negative of company financial health and it will be worst when other obligations have arrived. |
Going Concern Disclosure
The entity needs to access and disclose the potential issue which leads to the inability to continue as going concern. Managements also required to disclose when there is any substantial doubt about their ability to continue business operations. When managements have identified the substantial doubt, they need to disclosure which include the following:
- Condition or event: they need to detail the principle of the event which leads to the possible impact on company. It should include the possible outcome of the event.
- Management Evaluation: Management should evaluate the likelihood of result that may cause damage to company.
- Management Plan: management should detail plan to encounter any possible outcome.