What accounting principle assume that the company will continue indefinitely?
|
For accounting purposes, the business is regarded as an accounting entity or a business entity. It exists as a unit by itself, separate from its owner. This means that all financial information relating to the business is recorded and reported separately from the owner’s personal financial information. Show
What is the Going-Concern Concept? Going-Concern Concept – The business entity will continue to operate indefinitely.In accounting, the business is always assumed to be a going concern, i.e. to operate for an indefinite period of time. What is the Accounting Period Concept? Accounting Period Concept – The life of a business is divided into specific periods of time for the purpose of preparing financial reports. The accounting period may be a month, a half-year, a full year, or any other length of time, depending on the volume and nature of the business. What is the Historical Cost Concept? Historical Cost Concept – All transactions of a business entity are recorded at the original cost to the business. Resources are recorded at the actual values at which they were bought or sold, called ‘historical costs’. This means that a piece of land purchased years ago is still recorded at its original cost even though its value is considerably higher now. This practice is based on the assumption that the business is a going concern and is not likely to be liquidated, so the market or realizable value is not relevant. Example: Alice, owner of Courts, bought a TV at $5,000. Her friend, Miss Chew offered to buy it from her at $10,000. Based on historical cost concept, Alice should only record the TV in her books as $5,000. What is the Matching Concept? Matching Concept – Revenue earned during an accounting period has to be matched with the expenses associated with earning that revenue. Example: Impress Furniture sold a sofa set for $1,000 to a customer on 25th December 2001. The cost of the sofa set is $350. In 2002, a dining set which cost $150 was sold for $800.In this case, the sale of $1,000 should be matched with the cost of $350 for the year 2001. The sale of $800 should be matched with the cost of $150 for the year 2002. What is the Materiality Concept? Materiality Concept – This concept requests the disclosure of information which, if known to users, would seriously affect them in decision-making. Example: Impress Furniture’s book-keeper forgot to record a sale of furniture $100 made in 2001. The total sales of the business for 2001 amount to $5 million.The omission to record the $100 sale is immaterial because it has no serious effect on those who use the profit figure in decision-making. What is the Monetary Concept? Monetary concept – This concept states that only transactions which can be measured in money terms are recorded. What is the Prudence (also known as Conservatism) Concept? Meaning: If an accountant is given two alternatives of reporting an item, the alternative which gives a lower profit or lower asset value should be adopted. The following examples indicate the application of conservatism in accounting:
What is the Consistency Concept? The same accounting method should be applied in each accounting period when preparing financial reports. If a certain method of accounting treatment had been applied to an item, the same method is applied in the future. What is the Objectivity Concept? There must be objective verifiable evidence for reporting any accounting information.According to this principle, a business transaction should be supported by documentary evidence. Objectivity means the document should contain facts in an unbiased manner. Accounting should be done without prejudice. What is the Realisation Concept? This concept states that income should be recorded as earned in the period in which goods or services are provided to customers by the business. The Going Concern Assumption is a fundamental principle in accrual accounting stating that a company will remain operating into the foreseeable future, rather than undergo a liquidation.  Table of Contents
Going Concern Assumption: Fundamental Accrual Accounting PrincipleIn accrual accounting, the financial statements are prepared under the going concern assumption, i.e. the company will remain operating into the foreseeable future, which is formally defined as the next twelve months at a bare minimum. Under the going concern principle, the company is assumed to sustain operations, so the value of its assets (and capacity for value-creation) is expected to endure into the future. If a company is a “going concern,” then it’ll be capable of:
Going Concern Definition in Accounting (FASB / GAAP)The formal definition of the term “going concern” per GAAP / FASB can be found below. FASB Going Concern Disclosure Requirements (Source: FASB 205) Even if the company’s future is questionable and its status as a going concern appears to be in question – e.g. there are potential catalysts that could raise significant concerns – the company’s financials should still be prepared on a going concern basis. Under GAAP standards, companies are required to disclose material information that enables their viewers – in particular, its shareholders, lenders, etc. – to understand the true financial health of the company. More specifically, companies are obligated to disclose the risks and potential events that could impede their ability to operate and cause them to undergo liquidation (i.e. be forced out of business). In addition, management must include commentary regarding its plans on how to alleviate the risks, which are attached in the footnotes section of a company’s 10-Q or 10-K. In the case there is substantial, yet unreported doubt about the company’s continuance after the date of reporting (i.e. twelve months), then management has failed its fiduciary duty to its stakeholders and has violated its reporting requirements. How to Mitigate the Going Concern RiskAt the end of the day, awareness of the risks that place the company’s future into doubt must be shared in financial reports with an objective explanation of management’s evaluation of the severity of the circumstances surrounding the company. In effect, equity shareholders and other relevant parties can then make well-informed decisions on the best course of action to take with all material information on hand. Often, management will be incentivized to downplay the risks and focus on its plans to mitigate the conditional events – which is understandable given their duties to uphold the valuation (i.e. share price) of the company – yet, the facts must still be disclosed. The management team of a company at risk of liquidation can come up with and announce plans with actions such as:
Going Concern Value vs. Liquidation Value: What is the Difference?In the context of corporate valuation, companies can either be valued on a:
The going concern assumption – i.e. the company will remain in existence indefinitely – comes with broad implications on corporate valuation, as one might reasonably expect. Going Concern Basis Valuation MethodThe going concern approach utilizes the standard intrinsic and relative valuation approaches, with the shared assumption that the company (or companies) will be operating perpetually. The expectation of continued cash flow generation from the assets belonging to a company is inherent to the discounted cash flow (DCF) model. In particular, around three-quarters (~75%) of the total implied value from a DCF model can typically be attributable to the terminal value, which assumes the company will remain growing at a perpetual rate into the far future. Moreover, relative valuation such as comparable company analysis and precedent transactions value companies based on how similar companies are priced. However, a sizeable portion of investors in the market utilize DCF models or at least take the fundamentals of the company into consideration (e.g. free cash flows, profit margins), so comps take into account these factors, too – just indirectly as opposed to explicitly. Liquidation Valuation Method (“Fire Sale”)By contrast, the going concern assumption is the opposite of assuming liquidation, which is defined as the process when a company’s operations are forced to a halt and its assets are sold to willing buyers for cash. If the liquidation value is calculated, the context of the valuation is most likely either:
The valuation of companies in need of restructuring values a company as a collection of assets, which serves as the basis of the liquidation value. If a company’s liquidation value – how much its assets can be sold for and converted into cash – exceeds its going concern value, it’s in the best interests of its stakeholders for the company to proceed with the liquidation. What concept assumes that the business has an indefinite economic life?The concept which assumes that a business would survive for an indefinite period is called the Going concern concept.
Which assumption assumes that the business will be in operation indefinitely?The concept of going concern assumes that a business firm would continue to carry out its operations indefinitely, i.e. for a fairly long period of time and would not be liquidated in the foreseeable future.
Which accounting concept tells the business will continue to operate at an indefinite period of time?The going concern principle states that businesses should assume they will continue to operate and exist in the foreseeable future, and not liquidate. This assumption therefore allows businesses to defer some accrued expenses to future accounting periods.
When preparing financial statements you should assume that the entity will continue indefinitely what accounting principle is this?1] Going Concern
This assumption is based on the principle that while making the financial statements of an entity we will assume that the company has no plans of winding up in the near future. So the assumption is that the company will continue to exist indefinitely (far into the future), i.e. it will keep on going.
|
