Importance Of The Going Concern Assumption In Accounting
Under the going concern assumption or otherwise going concern concept, an entity will continue its business operation for an indefinite time period or up to its liquidation. Alternatively, we can say, the going concern assumption believes that the entity will have a long life and not shutdown or be sold in the immediate or near future. The entities which are supposed to be closed in a near future, are not considered as a going concern.
Again, the going concern assumption is a vital one to the GAAP (generally accepted accounting principles. In absence of it companies would not be able to make any prepayment or create any accrual of expenses. The going concern assumption is more important in the measures of performance and financial position and all classifications in a statement of financial position as current and non-current. It implicitly assume that the entity is going to continue. Furthermore, valuation of assets on the basis of cost is sometimes justified on the grounds of the going concern assumption.
The depreciation of assets, amortization of intangibles is based on going concern assumption (going concern concept) deeming that the businesses will uninterruptedly step into the future. Assets are presented on the Statement of Financial Position (balance sheet) at historical costs because of the going concern assumption.
The accrual basis assumption is made in the preparation of general purpose financial reports. Under this assumption, the effects of all transactions and other events are recognized in the accounting records when they occur, rather than when cash or its equivalent is received or paid.
Financial reports prepared on the accrual basis to inform readers not only of past transactions involving the receipt and payment of cash but also of obligations to pay cash in the future. It also informs the user of financial statements of amounts owing to the entity in the form of receivables. It is argued that the accrual basis therefore provides better information for users in their decision-making processes.
Key Notes Underlying The Going Concern Assumption:
- The going concern assumption is said to be the basic principle related to the preparation of FS (financial statements). If an entity is not a going concern, no financial statements will require preparing.
- It is the Management of an entity who will prove an entity’s ability to continue as a going concern.
- The suitability of the application of the going concern assumption is a substance for the external auditor to consider on audit engagement.
- International Standard on Auditing (ISA) 570 establishes the relevant guidance and requirements relating to the auditor’s consideration of the suitability of the application of the going concern assumption.