A qualified opinion can be a concern to investors, lenders and other stakeholders. The company will be required to write down the value of its assets if liquidation value is lower than the current value on the balance sheet. The write-down process includes taking a loss on the income statement, so net income already doing badly will get even worse. For private companies, outside investors may look to unload their shares to wash their hands of the company at any price possible, especially if there are legal problems. This will include a business valuation to attempt to value the company as a going concern and to value the assets at liquidation value. This may not actually hurt the stock price that much since auditors usually will only make a negative going concern determination when there have been problems for a while.
Economic uncertainty has been prevalent in global markets over the last several years due to many unexpected macro events – from COVID-19 and the related supply chain disruptions to international conflicts and rising interest rates. While some companies thrive from uncertainty, others may see their financial performance, liquidity and cash flow projections negatively impacted. These vulnerabilities continue to shine a bright light on management’s responsibility for a going concern assessment. If management does have a plan to sell assets, seek additional financing, start selling a new gizmo, or raise money with new stock issuances, you’ll need to evaluate it.
Relevant dates
Once a business goes bankrupt or otherwise liquidates, it is no longer considered a going concern. If a company is not a going concern, the company may be revalued at the request of investors, shareholders, or the board. This revaluation may be used to price the company for acquisition or to seek out a private investor. There are often certain accounting measures that must be taken to write down the value of the company on the business’s financial reports. If the accountant believes that an entity may no longer be a going concern, then this brings up the issue of whether its assets are impaired, which may call for the write-down of their carrying amount to their liquidation value. KPMG explains how an entity’s management performs a going concern assessment and makes appropriate disclosures.
If the plan isn’t good enough, liquidation principles must be applied to the reporting of all assets. It is then assumed that the company will not be a going concern, and the assets will be liquidated to pay off the debts. Going concern is a determination that a company has sufficient assets and revenue to continue operating for the foreseeable future. Businesses that are expected to remain afloat are referred to as going concerns.
Mitigation of a qualified opinion
Even if the company’s future is questionable and its status as a going concern appears to be in question – e.g. there are potential catalysts that could raise significant concerns – the company’s financials should still be prepared on a going concern basis. The reason the going concern assumption bears such importance in financial reporting is that it validates the use of historical cost accounting. KPMG handbooks that include discussion and analysis of significant issues for professionals in financial reporting.
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On the other hand, a company may be operating at a profit buts its long-term liabilities are coming due and not enough money is being made. Accountants who view a company as a going concern generally believe a firm uses its assets wisely and does not have to liquidate anything. Accountants may also employ going concern principles to determine how a company should proceed with any sales of assets, reduction of expenses, or shifts to other products. The valuation of companies in need of restructuring values a company as a collection of assets, which serves as the basis of the liquidation value. By contrast, the going concern assumption is the opposite of assuming liquidation, which is defined as the process when a company’s operations are forced to a halt and its assets are sold to willing buyers for cash.
What is the Going Concern Principle in Accounting?
- Without it, business would not offer nearly as much credit sales as suppliers, vendors, and other companies may not pay the company if there is little belief these companies will survive.
- Separate standards and guidance have been issued by the Auditing Practices Board to address the work of auditors in relation to going concern.
- An example of such contrary information is an entity’s inability to meet its obligations as they come due without substantial asset sales or debt restructurings.
Accounting standards try to determine what a company should disclose on its financial statements if there are doubts about its ability to continue as a going concern. In May 2014, the Financial Accounting Standards bond issue costs Board determined financial statements should reveal the conditions that support an entity’s substantial doubt that it can continue as a going concern. Statements should also show management’s interpretation of the conditions and management’s future plans.
Auditors are required to be conservative, so it is certainly possible, although unlikely, that the plan will work. Management’s plan could include borrowing more money to kick the can down the road, selling assets or subsidiaries to raise cash, raising money through new capital contributions, or reducing or delaying planned expenses. In the first step, evaluate whether or not it is probable that the business will be able to meet all obligations during the next year. This means the business can pay all debt payments, fixed expenses, and operating expenses using its existing cash and a reasonable estimate of new cash flow during the year. In the case there is substantial yet unreported doubt about the company’s continuance after the date of reporting (i.e. twelve months), then management has failed its fiduciary duty to its stakeholders and has violated its reporting requirements. Under GAAP standards, companies are required to disclose material information that enables their viewers – in particular, its shareholders, lenders, etc. – to understand the true financial health of the company.
Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. If a company’s liquidation value – how much its assets can be sold for and converted into cash – exceeds its going concern value, it’s in the best interests of its stakeholders for the company to proceed with the liquidation. In addition, management must include commentary regarding its plans on how to alleviate the risks, which are attached in the footnotes section of a company’s 10-Q or 10-K. More specifically, companies are obligated to disclose the risks and potential events that could impede their ability to operate and cause them to undergo liquidation (i.e. be forced out of business).
That means the auditor could determine that the business you’re evaluating is likely to continue operating as a going concern even if there are substantial problems. One of larger repercussions of not being a going concern are potential credit challenges. New lenders will likely be reluctant to unit cost definition issue new credit, or any new credit issued will be prohibitively expensive. This credit crunch may trickle down to suppliers who may be unwilling to sell raw materials or inventory goods on credit. A company may not be a going concern based on the financial position on either its income statement or balance sheet. For example, a company’s annual expenses may so vastly outweigh its revenue that it can’t reasonably make a profit.
Public companies
The going-concern value of a company is typically much higher than its liquidation value because it includes intangible assets and customer loyalty as well as any potential for future returns. The liquidation value of a company will even be lower than the value of the company’s tangible assets, because the company may have to sell off its tangible assets at a discount—often, a deep discount—in order to liquidate them before ceasing operations. Examples of tangible assets that might be sold at a loss include equipment, unsold inventory, real estate, vehicles, patents, and other intellectual property (IP), furniture, and fixtures. In accrual accounting, the financial statements are prepared under the going concern assumption, i.e. the company will remain operating into the foreseeable future, which is formally defined as the next twelve months at a bare minimum.
The going concern concept is not clearly defined anywhere in generally accepted accounting principles, and so is subject to a considerable amount of interpretation regarding when an entity should report it. However, generally accepted auditing standards (GAAS) do instruct an auditor regarding the consideration of an entity’s ability to continue as a going concern. Auditors and management are required to make this determination using generally accepted accounting principles (GAAP) during an audit. If the auditor determines that the company is no longer a going concern, assets normally reported at cost on the balance sheet will instead be reported at a calculated liquidation value. If a company is not a going concern, that means there is risk the company may not survive the next 12 months.
This differs from the value that would be realized if its assets were liquidated—the liquidation value—because an ongoing operation has the ability to continue to earn a profit, which contributes to its value. A company should always be considered a going concern unless there is a good reason to believe that it will be going out of business. If there’s significant evidence that a privately held business might not be viable under the going concern assumption, the auditor must disclose it in the audit report. Even if the business’s financials aren’t audited, an accountant who has concerns about the business’s viability should disclose those concerns to the business owner. It’s given when the auditor has doubts about the company and the assumption that it is a going concern.