Going concern
Also known as: Continuity of operations, Viability assessment
This is the accounting assumption that an entity will remain in business for the foreseeable future, typically defined as at least 12 months from the balance sheet date. It assumes the organization has neither the intention nor the necessity to liquidate its assets or cease operations. When this assumption holds, assets are recorded at their historical cost rather than their immediate liquidation value.
Why it matters
If an auditor doubts this status, they must issue a modified opinion or add a "material uncertainty" paragraph to the audit report. Failure to identify these risks can lead to investors losing capital in a company that is effectively insolvent. A collapse often results in legal action against the firm's directors and CFO for failing to disclose financial instability. Ultimately, an incorrect assumption here means the entire balance sheet is misleading because assets are overvalued relative to what they would fetch in a forced sale.
In practice
The external auditor performs this assessment during both the planning and completion phases of the engagement. They request evidence such as 12-month cash flow forecasts, signed loan facility agreements, and letters of support from parent companies. The primary artefact produced is the "Going Concern" section within the independent auditor's report. In a first-year engagement, the auditor performs deep historical trend analysis to establish a baseline for reliability. For repeat engagements, they focus on variances between last year's forecasts and actual performance to gauge management's accuracy.
Worked example
CloudScale Ltd provided its 2023 year-end financial statements to its auditors in January 2024. The auditor requested the company's cash flow projections for the next 12 months but found a projected deficit of $1.5 million by September 2024 due to an expiring government contract. CloudScale then produced a binding commitment letter from its venture capital backer promising a $2 million liquidity injection if reserves fell below $500,000. The auditor verified the backer's ability to pay via bank statements. Consequently, the audit report was issued as unmodified but included an "Emphasis of Matter" paragraph highlighting the dependency on this funding.
Common mistakes
- Confusing short-term liquidity issues with long-term insolvency, which leads to unnecessary alarms over temporary cash dips.
- Relying exclusively on management's verbal assurances without requiring written evidence or third-party confirmations.
- Ignoring non-financial triggers, such as the loss of a key CEO or a pending regulatory ban, that make financial forecasts irrelevant.
- Treating the assessment as a one-time checklist item rather than a continuous evaluation throughout the audit cycle.
Frequently asked questions
What is the difference between going concern and solvency?
Solvency refers to an entity's ability to meet its long-term debts, whereas this term describes the overall assumption that the business will continue operating. A company can be technically insolvent (liabilities exceed assets) but still be a going concern if it has sufficient cash flow or funding support.
How does an auditor test for material uncertainty?
They perform stress tests on management's forecasts, adjusting key variables like revenue growth or interest rates to see at what point the company fails. They also review loan covenants to ensure no technical defaults have occurred that would allow banks to demand immediate repayment.
What evidence proves a company is a going concern?
Key documents include updated cash flow projections, signed letters of support from shareholders, and current credit facility agreements. Auditors may also look for new secured contracts or approved lines of credit from financial institutions.
When should the assessment be performed during an audit?
It begins during planning to identify high-risk areas and is finalized just before the audit report is signed. This ensures that any events occurring after the balance sheet date but before the report date are considered.
What happens if a company is no longer a going concern?
The financial statements must be prepared on a "break-up basis" or liquidation basis. In this scenario, assets are valued at their expected net realizable value rather than historical cost, and long-term liabilities are reclassified as current.
More terms
Substantive testing · Sampling · Working papers · Segregation of duties · Right to be forgotten · IT general controls · Unqualified opinion · General-purpose AI model