Going concern is the concept that the entity’s Financial Statements are prepared based on the assumption that the entity operation is still operating normally in the next foreseeable period. This foreseeable period normally has twelve months from the ending period of Financial Statements.
In order to assume that the entity has no going concern problem, the managements have to perform the proper assessment by including all relevance indicators that could cause the entity to close its business in the next twelve months period.
These include decreasing in sales revenue, economic slowdown, loss of key importance management, payment of long term debt or interest payable. Cash flow problems also included.
If the entity’s Financial Statements are prepared in accordance with IFRS, the standard dealing with going concern is IAS 1. The standard requires the Financial Statements to properly disclose the basis of preparation of Financial Statements.
IAS 1 required management to assess whether their company is able to run for the foreseeable period or not. If the result of the assessment found or management feels doubt about the stability of the entity, then management needs to disclose all of that significant importance in the financial statements so that users or readers could understand the situation in the company.
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The Indicators of Going Concern:
There are many indicators that indicate whether the entity’s business or their financial position could possibly face going concern problems or not. Those indicators include:
- Significantly Decrease in Sales Revenue. Decreasing in the sales revenue indicates that the business is not running well. The probably because of the economic downturn, or loss of the market shares to its competitors. Whatever reason, it is one of the key point management needs to assess if this leads to entity close its operation soon or not.
- Large Amount of Debt or Interest Payable Overdue. In some situation, managements are forced to borrow money from the bank. Or increase the credit term for their business as the result of operating losses or lack of cash flow. A large amount of debt or interest payable is one of the going concern indicators. In this case, management will have to assess how well the entity solves these problems and whether this problem could lead to close of operation or not.
- A large amount of Overdraft. A large amount of overdraft is the result of the lack of cash flow. And this might significantly affect the operation as well as an increase in the interest payable. Another risk is that the bank might stop providing the overdraft facilities and will subsequently affect the entity operation. The seriousness of going concern problem is depending on how likely the bank still continue providing an overdraft.
- Lack of Fund in Research and Development. The entity requires research and development in order could make sure that its products or services are comparable in the market. Lacking funds in research and development will lead to loss of market shares and subsequently affect the entity business.
- Lost of Key Management. Lost of key management is also the indicator of going concern problems. Yet, it might be depending on the nature of business and where are those key management going to if those key management is going to work for the competitors. And the entity does not have any resource to replace, then of the cause, the majors’ customers will also be lost.
- Cash Flow Problems. The cash flow problem is a link from the other factors that list above, but probably we can see it in the cash low statements while as well as a balance sheet in terms of reporting. Another indicator that indicates that the cash flow problem is liquidity ratios analysis.
- Lost of the Big Project. Lost of a big project is the primary indicator of going concern. let say the business is operating several different projects and fifty percent of those projects are lost to competitors, then the entity will face the going concern.
Who Responsible for Assessing the Going Concern?
This question is asking mainly when we talk about the roles and responsibilities of management and auditor related to going concern of the company, and to answer this question, we should refer to the audit standard ISA 570.
The standard said on a yearly basis, at the time of preparing Financial Statements, if those Financial Statements are prepared based on IFRS, management is responsible for assessing the Going Concern of their company.
We will discuss late on how to assess these. That means management of the entity is the one who has the main roles and responsibilities to assess whether the entity is operating without facing the going concern problems.
Auditor responsibilities relate to going concern
Related to the going concern of the company, auditors are not responsible for assessing the going concern of the company; however, audits are responsible for reviewing the management assessment and consider if those assessments are in the line with their understanding or not.
For example, if management said that the company is operating well, but auditors noted that the sales revenue is decreasing significantly. Then, questions should be asked and answers should be assessed again.
However, when the result of management assessment ongoing concern shows that the entity has no going concern problem, and auditors’ reviews also conclude the same thing while the actual is different.
Then we should consider whether auditors put all possible procedures that should be performed or not. That means the quality of audit procedures is the place that should be questioned. If the negligence found, then the auditor might have a legal case against.
The procedures to assess going concern
Assessing the going concern problems in the company are the main Roles and Responsibilities of the management of the company. The following are the key procedures that management should do to assess the going concern problems.
Please be aware that there is no standards say about what are the things that management need to assess. Management needs to incorporate in their assessment based on their knowledge and awareness about what going on in the business.
We put environmental analysis in the first point because sometimes most of the management consider mainly about the financial problems when performing going concern analysis.
However, financial figures are the results of how the company is affected by non-financial figures especially the environment.
PESTEL is one of the best environmental analysis tools that we recommend. It is not difficult to understand and most of the managements are familiar with.
PESTEL includes political, environmental, social, technology, economic, and legal. In the dynamic market, the environment affects the business hardly than financial.
Performance Financial Statements Analysis is an important procedure in assessing the going concern. This analysis includes performing financial ratios analysis, as well as trend analysis.
Group of Financial Ratios that management should use to assess going concern are probabilities ratios and as well as Liquidity Ratios
Cash Flow Forecasting:
Cash flow forecasting is also one of the most important procedures that we should use and perform to assess the going concern problem. It could tell us whether the company has any cash problem in the next twelve months or not.
If the cash flow forecasting indicates that the company does has any cash flow problem. Then the company might face going concern.
The procedures about are the key procedures and additional procedure might be required.
Written by Sinra