A Business as a Going Concern

Business as Usual or Liquidation

Business associates negotiating deal, cropped Credit: PhotoAlto/Eric Audras
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A going concern, also knows as a going concern assumption or a going concern principle, is an accounting assumption that states that a business will stay in operation for the foreseeable future - there is no threat of liquidation for the foreseeable future (usually seen as 12 months). When the financial statements are prepared for the annual report, it is the job of the Board of Directors to decide if the company is still a going concern.

The Board must put this information into the footnotes to the financial statements and state any factors that may threaten that status.

The going concern principle allows the company to defer some of its prepaid expenses until future accounting periods

A Going Concern Opinion

Further, the fact that the business is a going concern means that it can pay its liabilities and realize its assets. The company's auditor is responsible to the Board of Directors and must determine whether or not the company is still a going concern. The auditor is required to disclose any negative trends in the company's business operations. Negative trends would be lower operating income, loan denials, loan defaults, repossession of assets, and more. The auditor then must issue a "going concern opinion" which means that the entity has neither the intention nor the need to liquidate or curtail materially the scale of its operations.

If an auditor issues a negative going concern opinion in the annual report, investors may have second thoughts about holding the stock of the company. A business valuation may be done on the business to determine what it is really worth. A going concern asset-based approach is one method of business valuation in use.

If the auditor believes there is substantial doubt about the ability of the entity to continue as a going concern for a reasonable period of time, he should consider management's plans for dealing with the adverse effects of the conditions and events. The auditor's considerations relating to management plans may include the following:

  • Plans to dispose of assets
  • Plans to borrow money or restructure debt
  • Plans to reduce or delay expenditures
  • Plans to increase ownership equity

Concern

Because the issuance of a negative going concern opinion is feared to be a self-fulfilling prophecy, auditors may be reluctant to issue one. A going-concern opinion may lower stockholders’ and creditors’ confidence in the company; ratings agencies may then downgrade the debt, leading to an inability to obtain new capital and an increase in the cost of existing capital.

Also, and this is troubling, auditors might fail to issue a negative going concern opinion because of the lack of auditor independence. Management determines the auditor’s tenure and remuneration and can hire and fire at will. The threat of receiving a negative going concern opinion may motivate management to go “opinion shopping,” as was alluded to in the WorldCom and Enron business failures.

Moreover, if an auditor issues a negative going concern opinion and the company goes under, the auditor loses future audit fees.