Going Concern Assumption

Definition

The going-concern assumption is the default basis on which financial statements are prepared. Management assumes the corporation will continue its operations for the foreseeable future and will not be forced to liquidate or materially curtail its activities. Under this assumption, assets are reported at amortized cost or depreciated value rather than at liquidation value, and liabilities are classified based on normal operating cycles.

Key rules

• Management must assess the corporation's ability to continue as a going concern at each reporting date, looking out at least twelve months.
• If management concludes that going concern is appropriate but there are material uncertainties, those uncertainties must be disclosed in the notes.
• If going concern is not appropriate, the statements are prepared on a liquidation basis and the change in basis must be disclosed prominently. This is a significant departure from normal presentation.
• Typical warning indicators: recurring operating losses, negative operating cash flows, working-capital deficiency, loan defaults, loss of a key customer or key-person dependency, and inability to meet filing deadlines.
• In an assurance engagement, the practitioner evaluates management's assessment. Under CAS 570 the auditor has specific reporting responsibilities when there is substantial doubt.

Example

A one-person BC consulting corporation has lost its main client, has three months of cash reserves, and has no signed contracts beyond the next month. The shareholder intends to continue seeking work and has capacity to inject personal funds if needed.

Going-concern assessment summary
- Cash runway: ~3 months at current burn
- Pipeline: two prospects, no signed contracts
- Mitigating factors: owner funding commitment in writing
- Conclusion: going concern remains appropriate, but a
  material uncertainty exists

Disclosure: note to financial statements describing the
uncertainty, the mitigating factors, and the owner's
written commitment to inject capital if required.

The statements are still prepared on the normal (going-concern) basis, but a note alerts the reader to the uncertainty.

Common mistakes

• Skipping the assessment altogether in small-corporation compilations. The assumption still applies and still requires thought.
• Overreliance on the shareholder's verbal promise to inject cash. A written commitment is far stronger.
• Using liquidation values for assets without changing the stated basis of preparation. If liquidation is expected, the entire basis must change and be disclosed.
• Ignoring working-capital deficiencies that the shareholder plans to cover through personal credit. Personal credit is not a corporate resource.
• Failing to reassess when circumstances change materially between year-end and the date the statements are issued. Subsequent events can push an entity out of going concern.

Related concepts

The going-concern assumption works with conservatism (impairments become more likely when the future is doubtful) and materiality (a going-concern issue is qualitatively material regardless of dollar size). It underlies the current-versus-non-current classification on the balance sheet and is a specific disclosure topic under ASPE.