A set of financial statements includes the income statement, statement of owner’s equity, balance sheet, and statement of cash flows. This chapter explains the relationship between financial statements and several steps in the accounting process. We go into much more detail in The Adjustment Process and Completing the Accounting Cycle. An adverse opinion states that the financial statements do not present fairly (or give https://intuit-payroll.org/ a true and fair view). This opinion will be expressed regardless of whether or not the financial statements include disclosure of the inappropriateness of management’s use of the going concern basis of accounting. As a result, all events that occur during an entity’s subsequent events period should be considered when evaluating whether there is significant doubt about the entity’s ability to continue as a going concern.

In this example it is clear that the going concern basis is inappropriate in the entity’s circumstances. It is essential that candidates preparing for the Audit and Assurance (AA) exam understand the respective responsibilities of auditors and management regarding going concern. This article discusses these responsibilities, as well as the indicators that could highlight where an entity may not be a going concern, and the reporting aspects relating to going concern. For example, Lynn Sanders purchases two cars; one is used for personal use only, and the other is used for business use only. According to the separate entity concept, Lynn may record the purchase of the car used by the company in the company’s accounting records, but not the car for personal use.

1. Management will need to determine whether it can do this assessment using its current processes and controls or whether it needs to modify its processes and controls or implement new ones.
2. IAS 1 explicitly states that at each reporting date, management is required to assess the entity’s ability to continue as a going concern and consider all available information about the entity’s future.
3. This is called mark-to-market accounting or fair value accounting and is more advanced than the general basic concepts underlying the introduction to basic accounting concepts; therefore, it is addressed in more advanced accounting courses.
4. If a company is not a going concern, the company may be revalued at the request of investors, shareholders, or the board.

Recall that the accounting equation can be thought of from a “sources and claims” perspective; that is, the assets (items owned by the organization) were obtained by incurring liabilities or were provided by owners. Stated differently, everything a company owns must equal everything the company owes to creditors (lenders) and owners (individuals for sole proprietors or stockholders for companies or corporations). The time period assumption states that a company can present useful information in shorter time periods, such as years, quarters, or months. The information is broken into time frames to make comparisons and evaluations easier.

Management may have a history of successful refinancing or carrying out other plans. However, current economic and market conditions are likely very different from those of the past. Given the significant effects of COVID-19, management may need to reassess the company’s access to financing sources; they may not be easily replaced and the costs may be higher in the current circumstances. Further, other actions such as deferring capital expenditures or adjusting the workforce may be needed to generate enough cash flow to meet the company’s financial obligations. Unlike IFRS Standards, the going concern assessment is performed for a finite period of 12 months from the date the financial statements are issued (or available to be issued for nonpublic entities). Known or knowable events beyond the look-forward period can be ignored in the going concern assessment, although disclosure of their potential effects may still be required by other standards.

Under Step 1, management determines whether events and conditions raise substantial doubt about the company’s ability to continue as a going concern. This includes information that becomes available on or before the financial statements are authorized for issuance – i.e. events or conditions requiring disclosure may arise after the reporting period. A potential or existing investor wants timely information by which to measure the performance of the company, and to help decide whether to invest.

Management typically develops plans to address going concern uncertainties – e.g. refinancing of debt, renegotiating breached covenants, and sale of assets to generate sufficient liquidity to continue to meet its obligations as they fall due. IFRS Standards do not prescribe how management should evaluate its plans to mitigate the effects of these events or conditions in the going concern assessment. Impacts from a fall and winter COVID-19 surge may bring further uncertainty to many companies. Management should continually evaluate the effects of COVID-19 on the company’s going concern assessment, including information obtained after the reporting date and up to the date the financial statements are authorized for issuance. The auditor is required by the Securities and Exchange Commission to disclose in the financial statements of a publicly traded company whether going concern status is in doubt.

Events after the reporting period

The economic entity assumption requires that business owners keep their personal transactions separate and do not mix them with the activities of the business. This can sometimes prove especially challenging for small and family-owned businesses. If management does have a plan to sell assets, seek additional financing, start selling a new gizmo, or raise money with new stock issuances, you’ll need to evaluate it. Auditors are required to be conservative, so it is certainly possible, although unlikely, that the plan will work.

How to determine going concern

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 the accountant believes that an entity may no longer be a going concern, then this brings up the issue of whether its assets are impaired, which may call for the write-down of their carrying amount to their liquidation value. There are situations that may arise when the auditor may request management to make an assessment, or extend their original assessment of going concern. If management refuse to make, or extend, an assessment of going concern the auditor will consider the implications for the report. An important point to emphasise at the outset is that candidates are strongly advised not to use the ‘scattergun’ approach when it comes to deciding on the audit opinion to be expressed within the auditor’s report. This is where a candidate explores all possible options rather than  coming to a conclusion as to the auditor’s opinion, depending on the circumstances presented in the question.

An entity is assumed to be a going concern in the absence of significant information to the contrary. An example of such contrary information is an entity’s inability to meet its obligations as they come due without substantial asset sales or debt restructurings. If such were not the case, an entity would essentially be acquiring assets with the intention of closing its operations and reselling the assets to another party. The ending account balance is found by calculating the difference between debits and credits for each account. You will often see the terms debit and credit represented in shorthand, written as DR or dr and CR or cr, respectively. We can illustrate each account type and its corresponding debit and credit effects in the form of an expanded accounting equation.

It should be noted that accounting assumptions are not based on subjective opinions or guesstimates. Companies must also inform investors and creditors about possible going concern issues. For instance, if a company is facing financial difficulties from an excessive debt burden or is facing a large liability lawsuit that could bankrupt the company, management must mention these cautions in the financial statement notes.

Particularly in adverse economic environments, the going concern evaluation could be a significant undertaking for management. If conditions are changing rapidly, management’s evaluation may need to be updated frequently up through the date of issuance of the related financial statements. Management must also consider the likelihood, magnitude and timing of the potential effects of any adverse conditions and events.

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Both FASB and IASB cover the same topics in their frameworks, and the two frameworks are similar. The conceptual framework helps in the standard-setting process by creating the foundation on which those standards should be based. It can also help companies figure out how to record transactions for which there may definition days sales outstanding.com not currently be an applicable standard. Though there are many similarities between the conceptual framework under US GAAP and IFRS, these similar foundations result in different standards and/or different interpretations. We recommend caution when considering the relevant period of assessment for going concern.

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Conservatism states that if there is uncertainty in a potential financial estimate, a company should err on the side of caution and report the most conservative amount. This would mean that any uncertain or estimated expenses/losses should be recorded, but uncertain or estimated revenues/gains should not. This gives stakeholders a more reliable view of the company’s financial position and does not overstate income. As you may also recall, GAAP are the concepts, standards, and rules that guide the preparation and presentation of financial statements.

This can protect investors from continuing to risk their money on a business that may not be viable for much longer. In 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. If there are any material uncertainties relating to the going concern assumption, then management must make adequate going concern disclosures in the financial statements. The separate entity concept prescribes that a business may only report activities on financial statements that are specifically related to company operations, not those activities that affect the owner personally.

When the financial statements are prepared for the annual report, it is the job of the Board of Directors to decide if the company is still a going concern. The Board must put this information into the footnotes included in the financial statements and state any factors that may threaten that status. Under IFRS Standards, financial statements are prepared on a going concern basis, unless management intends or has no realistic alternative other than to liquidate the company or stop trading. Unlike US GAAP, there is no liquidation basis of accounting under IFRS; when a company determines it is no longer a going concern, it does not prepare financial statements on a going concern basis. However, in our view, there is no general dispensation from the measurement, recognition and disclosure requirements of the Standards in this case, and these requirements are applied in a manner appropriate to the circumstances.

There has been modification to the auditing standards at a local level for some jurisdictions. They stipulate the auditor must ensure that management has considered a period of no less than 12 months from the date of approval of the financial statements. The impact of COVID-19 is expected to have a significant impact on the going concern assumption for a large number of entities. Many entities will need to apply significant judgement and will be required to consider the impact of material uncertainties in assessing the entity’s ability to continue as a going concern. If the auditor or management deems it unlikely that the business will be able to meet its obligations over the next year, the next step is evaluating the management’s plan.