The going concern concept or going concern assumption states that businesses should be treated as if they will continue to operate indefinitely or at least long enough to accomplish their objectives. In other words, the going concern concept assumes that businesses will have a long life and not close or be sold in the immediate future. Companies that are expected to continue are said to be a going concern. Companies that are expected to close in the near future are not a going concern.
The going concern concept is extremely important to generally accepted accounting principles. Without the going concern assumption, companies wouldn’t have the ability to prepay or accrue expenses. If we didn’t assume companies would keep operating, why would be prepay or accrue anything? The company might not be there long enough to realize the future expenses.
One of the most significant contributions that the going concern makes to GAAP is in the area of assets. The entire concept of depreciating and amortizing assets is based on the idea that businesses will continue to operate well into the future. Assets are also reported on the balance sheet at historical costs because of the going concern assumption. If we disregard the going concern and assume the business could be closed within the next year, a liquidation approach to valuing assets would be more appropriate. Assets would be recorded at net realizable values and all assets would be considered current assets rather than being segregated into current and long-term categories.
Some businesses, however, do close and do go bankrupt. If the business is in a financial position that suggests the going concern assumption can’t be followed (the business might go bankrupt), the financial statements should have a disclosure discussing the going concern.
Examples
– In the early 2000s, General Motors was experiencing great financial difficulties and was ready to declare bankruptcy and close operations all over the world. The Federal government stepped in and gave GM a bailout as well as a guarantee. In normal circumstances, GM would not be considered a going concern, but since the Federal government stepped in, we have no reason to believe that GM will cease to operate.
– Assume Microsoft is currently suing a small tech company for copyright violation over its software package. Since this software package is the only operation the small tech company does, losing this lawsuit would be detrimental. There is a 95 percent expectation that Microsoft will win the lawsuit. The small tech company is not a going concern because it is probable they will be out of business after the lawsuit is settled.
– In 2011, Gibson Guitar Factory was raided by the Federal government for illegally smuggling endangered wood into the country. The Federal government took more than $250,000 worth or Gibson’s inventory and slapped them with large fines for violating international laws. Gibson is still considered a going concern, because it is not likely the fines and punishment will stop its operations.
