Going Concern Assumption l Intermediate Accounting l CPA Exam FAR

Summary

In this lecture, Professor Farhat discusses the going concern assumption, a fundamental concept in accounting that assumes a business will operate indefinitely. This assumption is crucial for financial statement preparation, impacting how assets are valued. Management is tasked with assessing the company’s ability to continue, considering both quantitative factors like liquidity and qualitative factors such as industry conditions. If doubts arise about the company's viability, these must be disclosed, along with management’s mitigation plans. In cases of imminent liquidation, the company must adopt a liquidation basis of accounting, reflecting the true financial condition for investors and creditors.

Takeaways

• 😀 The going concern assumption is a key principle in accounting that presumes a business will continue its operations indefinitely.
• 😀 Management is responsible for assessing whether there are conditions that raise substantial doubt about the entity's ability to continue as a going concern.
• 😀 Conditions that could lead to substantial doubt include liquidity issues, inability to meet obligations, and negative financial trends.
• 😀 Investors and creditors look at the going concern assumption to evaluate the future viability of a business and the safety of their investments.
• 😀 Financial statements must disclose any substantial doubts regarding going concern, along with the reasons behind it and plans for mitigation.
• 😀 If a business is deemed to have substantial doubt about continuing, it may need to transition to a liquidation basis of accounting.
• 😀 Quantitative factors in assessing going concern include cash flow ratios and current debt obligations.
• 😀 Qualitative factors include industry health, competitive pressures, and overall financial trends.
• 😀 The need for the going concern evaluation is emphasized during the preparation of annual and interim financial statements.
• 😀 Understanding the going concern assumption is crucial for accounting professionals, especially CPA candidates, to ensure accurate financial reporting.

Q & A

What is the going concern assumption in accounting?

The going concern assumption is the belief that a business will continue operating indefinitely unless there is substantial evidence to suggest it will not. This assumption is essential for preparing financial statements.

Who is responsible for assessing the going concern assumption?

Management is responsible for assessing the going concern assumption, evaluating whether there is substantial doubt about the company's ability to continue operating.

What are some quantitative factors management should consider when evaluating going concern?

Management should consider liquidity ratios, debt obligations due within the next 12 months, and overall cash position as quantitative factors.

What qualitative factors are important in assessing the going concern assumption?

Qualitative factors include industry conditions, competition, and negative financial trends, such as declining sales and profits.

What must management do if they identify substantial doubt about going concern?

If substantial doubt exists, management must disclose this in the financial statements, detailing the reasons or events leading to this assessment and outlining their plans to mitigate the issues.

What is the liquidation basis of accounting?

The liquidation basis of accounting is used when liquidation is imminent, where assets are reported at their fair value to reflect how much creditors and investors might recover.

Why is the going concern assumption important for investors and creditors?

The going concern assumption is vital for investors and creditors because it affects their assessment of the business's risk and potential returns on their investments.

How does the assumption impact the treatment of assets?

If there is doubt about the going concern status, the business may not hold assets or depreciate them, as the definition of an asset requires a future benefit, which may not be realizable if the business is not expected to continue.

What should management communicate to investors regarding their plans to address going concern issues?

Management should communicate their plans to mitigate risks, including the probability of success in implementing these plans and any negotiations with financial institutions or other stakeholders.

When did the requirement for disclosing going concern assumptions become mandatory in financial statements?

The requirement for disclosing going concern assumptions in financial statements became mandatory in 2014.