Going concern concept

Definition and explanation

The going concern concept of accounting implies that a business entity will continue its operations in the future and will not liquidate or be forced to discontinue operations due to any reason. A company is a going concern if no evidence is available to believe that it will or will have to cease its operations in the foreseeable future.

An example of the application of going concern concept in business is the computation of depreciation on the basis of the expected economic life of fixed assets rather than their current market value. Companies assume that their business will continue for an indefinite period of time and that the assets will be used in business until they are fully depreciated. Another example of this concept is the prepayment and accrual of various business expenses. Companies can prepay and accrue expenses only when they and their trade partners believe that they will not shut down operations in the foreseeable future.

The concept is applicable to a company’s business as a whole. If, for example, a company closes a small business segment or discontinues one of its products and continues with others, it does not mean that the company is no longer a going concern because the going concern concept is applicable to the entity as a whole and not to a particular segment of business or product.

The going concern concept of accounting is of great importance for accountants because if a company is a going concern, it must prepare its financial statements in accordance with applicable financial reporting frameworks such as generally accepted accounting principles applicable in the United States of America (US-GAAP) and international financial reporting standards (IFRS) applicable in many other countries.

The auditors conduct their own evaluation to see whether or not the going concern assumption is appropriate for the company while auditing its financial statements, even if the company claims to be a going concern.

Examples of going concern concept

To make you better understand, let’s take a few examples of going concern concept:

1. Deluxe Company manufactures a chemical known as Chemical-X. Suddenly, the government imposes a restriction on the manufacture, import, export, marketing, and sale of this chemical in the country. If Chemical-X is the only product that the company can manufacture, the company can no longer be considered a going concern.
2. National Company is in serious financial trouble and cannot pay its obligations. The government gives a bailout to the company and announces a guarantee for all the payments to its creditors. The company would still be considered a going concern despite its current weak financial position.
3. Eastern Company closes one of its branches and decides to continue with others. The company is still a going concern because shutting down a small part of business does not impair its ability to operate as a going concern.
4. Murphy Company is unable to make payments to its creditors due to a weak liquidity position. At the request of one of Murphy’s creditors, the court grants an order to liquidate the company. Murphy loses its going concern status immediately after the liquidation order because sufficient evidence is available to believe that the company will not be able to continue its operations in the future.