Going concern concept
Definition: What is Going Concern Concept?
The going concern concept states that all records are made on the assumption that the business will continue for the foreseeable future. Unless it is known that the business will close down at a determinable time, all transactions are recorded in a routine manner and there is no need for any special valuation or adjustment.
Explanation of Going Concern Concept
Under this concept, it is assumed that the business will operate for a long period of time. When a business is started it is assumed that it will not be dissolved in the near future. The financial statements i.e. Profit & Loss Account and Balance Sheet are also prepared under this assumption, as this concept leads in making the distinction between Capital and Revenue Expenditures. Here it should be noted that it is not assumed that business will be profitable throughout its existence.
As this concept relates to future which is unpredictable, therefore some factors can be used to determine that a business is a Going Concern e.g. A Going Concern must have a strong capital structure & should be able to overcome any short-term risk or it should have reasonable liquid assets or its product should have a continuous demand, etc.
However, if it is known that business will close down in say next two or three months, it would be more appropriate to state its assets not at cost but at the value at which these can be sold on the closure of the business. At that stage, it may also be necessary to take account of all legal obligations that may not have been previously brought to books.
Unless it is categorically stated otherwise, all accounting records and income statement or balance sheets are prepared on the assumption that the business will continue to function for an indefinite future period.
In corporation laws of all countries, a company is presumed to have uninterrupted existence with continuing activity till such time as it is legally liquidated. If the results of the operations of business enterprises were to be accounted for on the basis of expected liquidation, it would be impossible for suppliers to supply goods and services, employees to offer their services and for other business enterprises to engage in any economic transactions with the business entity. It is for this reason that for purposes of accounting, business enterprises are presumed to carry on their operations indefinitely till such time as they are in fact liquidated.
A corollary to the going concern concept is the assumption that a business enterprise will not be liquidated within the foreseeable future since this would make it impossible for it to carry out its present contractual commitments or to use its resources according to a predetermined plan of operation.
The position relating to the going concern concept is best summarized as follows:
The enterprise is normally viewed as a going concern, that is, as continuing in operation for the foreseeable future. It is assumed that the enterprise has neither the intention nor the necessity of liquidation or of curtailing materially the scale of its operations.
1. An organization produces a compound called Chemical-X. Unexpectedly, the federal government imposes a limitation on the production, export, import, sale and marketing of this compound in the country. In case Chemical-X could be the only product that the company produces, the business will no longer be determined as a going concern.
2. If the National company falls in some serious economic problem and cannot cover its duties. The federal government provides National company bailout package and also a guaranty to clear all its credit payments. The national company is still a going concern regardless of its present weak financial standing.
3. Even the Eastern company closes among its division and also certainly will keep on together with other folks. The business is a going concern as the closing down a little portion of business doesn’t impair the capacity of the enterprise to use as going concern.
4. The small business is not able to make payments to its own creditors due to an extremely poor liquidity position. The court grants the purchase price of liquidating the company upon the petition of 1 of their firm’s creditors. The business is not a major concern as satisfactory evidence can be found to feel that the corporation can’t endure its operations within the future.