Going Concern: An assumption that a business will continue operations for the foreseeable future, typically defined as at least the next 12 months.
Key Points
Businesses are assumed not to shut down or liquidate.
Financial statements are prepared on the basis that the entity is a going concern.
This means operations will continue without interruption.
Foreseeable Future
No exact definition; generally interpreted as at least 12 months but can extend to several years.
Financial Statements Preparation
Financial statements are created under the assumption of going concern.
If an entity is deemed a going concern, it will not be liquidated.
Valuation of Assets
Normally, assets are valued based on historical cost (cost at which they were acquired).
If a business is not a going concern (i.e., it is going to be shut down), financial statements must be prepared on a Breakup Basis.
Breakup Basis
Breakup Basis: Financial statements are prepared considering the liquidation of the business.
Assets are measured at their Net Realizable Value (NRV), which is the amount that can be recovered from selling the asset after deducting selling costs.
Example:
Machinery cost: $50,000
Depreciation: $10,000
Carrying Value: $40,000 (historical basis)
If sold, its selling price might be $20,000 with a selling cost of $1,000.
Net Realizable Value: $20,000 - $1,000 = $19,000.
Under breakup basis, assets cannot be recorded at historical values; they must reflect current market realizable amounts.
Conclusion
The going concern assumption underpins the preparation of financial statements and asset valuation, ensuring that they reflect the reality of ongoing operations unless liquidation is imminent.
Note
Understanding the distinction between going concern and breakup basis is crucial for accurate financial reporting.