Going Concern Concept

Going Concern Concept is the basic concept behind the preparation of financial statements. Every year, when financial statements are prepared, they are made on the assumption that the operation of the company will continue for the foreseeable future. 

However, if the management has decided to close its operation or it is required by law to close its business, the management has to report its financial statement over the break-up basis. In such a non-going concern situation, the company has to prepare its financial statements using fetch up value. Fetch up value is the one which the company can attain if it is sold right away.

It is the management’s responsibility to assess whether the company is a going concern or not. In addition, auditors of the company are well aware of the matters of the company. So, they can easily identify the going concern problems for the company. 

Non-Going Concern Indicators

There are some factors which indicate the non-going concern of the company. These are:

1. Liabilities are more than assets,

2. Continuous cash outflows or negative cash flows,

3. Tax penalties,

4. Default is loan payment,

5. Severe court order

Examples

Identify in the following cases, whether the company can prepare its financial statements over the going concern concept:

1. ABC Company is facing severe cash flows since over the year. It does not have fund to pay suppliers, staff for salaries and rent payments.

2. National Electric Power Company is suffering severe cash flows due to non availability of funds. Government of the country has approved request for funding to National Company in a senate session to improve National Electric cash flow problems.

 Solution

1. ABC Company should prepare its financial statements over the non-going concern.

2. As the Government has approved the funding to National Electric Power Company, it should prepare its financial statements over the going concern assumption.

Example

ADX is involved in manufacturing shoes for supply in south Asian countries. It has various machines that it uses in its manufacturing process. Due to a recent growth in shoes industry, the market values of these machines have raised a lot. This implies that the market values of these machines are much higher than its book value in the books of accounts. Book value is calculated by charging annual depreciation over the cost of the machines. Due to charging depreciation every year, the value of the machine diminishes which results in lower asset value on the face of the balance sheet. However, if market value is obtained for the same second hand machine, it might be higher than this. Under this case, going concern concept comes into action. This guides accountant to record fixed asset / machinery at the book value rather than market value / fair value.

Question

The book value of the PU Machine as on 31st Dec 2016 is $180,000. The depreciation rate on machine is 10 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c}. The market value of this machine on 31st Dec is 200,000. Suggest at what value, PU machine should be recognized.

Solution

Book value as on 31st Dec, 2016 = $180,000

Depreciation for 2017 = 10 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} x 180,000 = $18,000

Book value as on 31st Dec, 2017 = 180,000 – 18,000 = $162,000

Market value = $200,000

Though, the market value of the PU machine is higher than the book value. Accountant has to follow the going concern assumption and record the machinery at $162,000. Because, it is not involved in the business of selling machine.

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