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Financial Resilience - The Going Concern -Principles- How Might TheyChange?

romanhaluszczak4

Updated: Apr 13, 2021



So what are the Going Concern Principles?


The going concern principles are the assumption that an entity will remain in business for the foreseeable future. Conversely, this means the entity will not be forced to halt operations and liquidate its assets in the near term at what may be very low fire-sale prices.


By making this assumption, the accountant is justified in deferring the recognition of certain expenses until a later period, when the entity will presumably still be in business and using its assets in the most effective manner possible.


An entity is assumed to be a going concern in the absence of significant information to the contrary.


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.


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.


Thus, the value of an entity that is assumed to be a going concern is higher than its breakup value, since a going concern can potentially continue to earn surpluses.


The auditor evaluates an entity’s ability to continue as a going concern for a period not greater than one year following the date of the financial statements being audited.


The auditor considers (among other issues) the following items in deciding if there is a substantial doubt about an entity’s ability to continue as a going concern:


  • Negative trends in operating results, such as a series of deficits

  • Loan defaults by the company

  • Denial of credit to the company by its suppliers

  • Uneconomical long-term commitments to which the entity is subjected to

  • Legal proceedings against the company

  • Declining cash flow problems

  • Unaffordable, imprudent and unsustainable borrowing

  • Poor capital option appraisal and risk management

  • Declining and unsustainable reserves

  • Capital expenditure which does not match the entity's capital programme

  • Excess stocks and poor project management

  • Aborted schemes

  • Poor expenditure control


If there is an issue, the auditor must qualify the audit report with a statement about the problem of an entity not meeting the going concern principles.


In reality, presently, very few auditors state in their annual reports that an entity is not a going concern!


Often they should but they don't. This is because such a statement currently applies to the12 months since an annual report is published.


But


The latest UK government consultation on corporate governance is advising that an entity should prepare resilience reports on the going concern principles covering three time periods, namely:


  1. Up to 3 years

  2. 3 to 5 years

  3. Over 5 years


This to also include 2 stress tests over the aforementioned periods.


If Going Concern principles will be applied to longer periods then it is far more likely that auditors will find them being breached!


These principles form the basis upon which future financial resilience indicators will be based!


If these new time periods come into force for entities then going concern principles will be much more important than they are bow!


I will consider more detailed financial resilience indicators in a future blog but they will need to be reported on the basis of the changing nature of the going concern principles!


We all need to be aware of that!








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