A going concern, also known as a going concern assumption or going concern principle, is an accounting assumption stating that a business will stay in operation for the foreseeable future. In essence, that means that there is no threat of liquidation for the foreseeable future, which is usually perceived as a period of time lasting for 12 months. When the financial statements are prepared for the annual report, it is the job of the Board of Directors to decide if the company is still a going concern. The Board must put this information into the footnotes included in the financial statements and state any factors that may threaten that status.
The going concern principle allows the company to defer some of its prepaid expenses until future accounting periods
What Is a Going Concern Opinion?
Also significant is the fact that if a business is determined to be a going concern that means that it can pay its liabilities and realize its assets. The company's auditor is the employee who must determine whether or not the company is still a going concern and they report their findings to the Board of Directors. The auditor is required to disclose any negative trends in the company's business operations. Negative trends include such things as lower operating income, loan denials, loan defaults, repossession of assets, and more. Once this is done, the auditor must issue a "going concern opinion" which means that the entity has neither the intention (nor the need) to liquidate or curtail in any material way the scale of its operations.
Consequences of a Negative Going Concern Opinion
If an auditor issues a negative going concern opinion in the annual report, investors may have second thoughts about holding the stock of the company. A business valuation may be performed on the business in order to determine what it is actually worth. A going concern asset-based approach is one method of business valuation in use.
How Management Handles Substantial Doubt
If the auditor believes there is substantial doubt about the ability of the entity to continue as a going concern for a reasonable period of time, they should consider management's plans for dealing with the adverse effects of the conditions and events. The auditor's considerations relating to management plans may include the following:
- Plans to dispose of assets
- Plans to borrow money or restructure debt
- Plans to reduce or delay expenditures
- Plans to increase ownership equity
Auditors Concerns Over a Negative Opinion
Because the issuance of a negative going concern opinion is feared to be a self-fulfilling prophecy, auditors may be reluctant to issue one. A going-concern opinion may lower stockholders’ and creditors’ confidence in the company and rating agencies may downgrade the debt which leads to an inability to obtain new capital and an increase in the cost of existing capital.
Most troubling is that auditors might fail to issue a negative going concern opinion because of the lack of auditor independence. Management determines the auditor’s tenure and remuneration and can hire and fire the auditor at will. The threat of receiving a negative going concern opinion may motivate management to go “opinion shopping,” as was alluded to in the WorldCom and Enron business failures.
Moreover, if an auditor issues a negative going concern opinion and the company goes under, the auditor loses future audit fees.