May 29, 2022

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ACCOUNTING CONCEPT-GOING CONCERN

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ACCOUNTING CONCEPT-GOING CONCERN

Going concern concept or going concern assumption is that assumption that an entity will continue it’s business operations for a long period of time without the fear that it will reduced it size or fully liquidate in the period of one year.

This definition indicates that, in the preparation of financial statement, an entity,s management must assume that the business will remain in business forever, therefore, the management makes use of past cost as oppose to current cost in its measurement of assets. However, if the going concern assumption is threaten, say for legal litigation for bankruptcy or liquidation then the entity’s management should use current cost in preparing it’s financial reports.

When a company is certain of liquidation, it does not prepare statement of income, statement of financial position, statement of changes in equity and statement of cash flows. However, it prepares statement of affairs base on current cost.

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To measure an entity as a going concern, an entity’s management makes use of stability ratios including Acid test ratio. It also consider the business environment that the entity is operating. An environment where there is threat of war, legal proceedings that will affect negatively the product or services of the entity is a major threat to the going concern of an entity.

External auditors takes the issue of going concern seriously. Auditors assess a company using various index to understand if there is a threat to the going concern of an entity. This index includes and are not limited to : Reading the minutes of meetings of the entity’s management with shareholders’ review of previous events, entity’s compliance with debts and loan agreements,analystical procedures, pending litigations and claims on the entity’s assets,

When investing on a long term basis, it is important for potential investors to consider the going concern of the entity. Failure to consider this may put your investment in jeopardy.

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To understand if an entity is not under threat to it’s going concern, the potential investors should consider trends on the acid test ratios and liquidity ratios for various years. A continuous fall the this ratio may pose a threat to the going concern of the entity under review. Furthermore, if the asset test ratio is less than the threshold which is ratio 1:1. It is a sign of threat. However, in addition,other factors must be considered.

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