What is Going Concern?
Going concern is the assumption that a company will continue operating for the foreseeable future, at least twelve months from the reporting date. Auditors must evaluate this assumption whenever there is substantial doubt about an entity's ability to survive, such as recurring losses or negative cash flows. If going concern is in doubt, the auditor must disclose it and may issue a modified opinion.
Going concern is the assumption that a business will keep operating for at least the next twelve months; auditors assess it by reviewing liquidity, debt, losses, and management's mitigation plans.
- 1↓Identify conditionsLook for recurring losses, negative equity, loan defaults, or loss of key customers.
- 2↓Evaluate management's plansReview plans to raise capital, restructure debt, or cut costs.
- 3↓Assess mitigating factorsDetermine whether the plans are feasible and can be implemented in time.
- 4Conclude and reportDecide whether substantial doubt remains and disclose or modify the audit opinion.
Step-by-step worked examples
A manufacturing company has reported losses for three consecutive years and its current liabilities exceed current assets by $2 million. How should the auditor respond?
Identify conditions: recurring losses + negative working capital are red flags Evaluate management's plan: check for a credible turnaround plan, e.g., asset sales or refinancing Assess feasibility: confirm financing commitments are documented and realistic Conclusion: if doubt remains after considering plans, add a going concern paragraph to the audit report
A retailer lost its main supplier contract and is in default on a $500,000 bank loan due in 60 days. Is going concern doubt present?
Loss of key supplier + loan default within 12 months are strong indicators Check if the bank has waived the default or extended terms Review alternate suppliers lined up If no resolution is documented, substantial doubt exists and must be disclosed
A startup has $100,000 cash, burns $20,000/month, and has no signed funding commitment. How many months of runway remain, and what does that mean for going concern?
Runway = Cash ÷ monthly burn = 100,000 ÷ 20,000 = 5 months Five months is within the 12-month assessment horizon Without a funding commitment, this is a going concern red flag requiring disclosure
Flashcards
Quick quiz
Q1.What is the standard time horizon for a going concern assessment?
Q2.Which of these is a going concern red flag?
Q3.Who first assesses going concern before the auditor?
Q4.If substantial doubt about going concern exists and is adequately disclosed, the auditor typically:
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Common mistakes
Going concern is only the auditor's job. — Correct: Management assesses going concern first; the auditor independently reviews that assessment.
One bad quarter automatically means going concern doubt. — Correct: Auditors look at trends and mitigating plans over a 12-month horizon, not a single period.
A going concern paragraph means the company will fail. — Correct: It flags substantial doubt, not certainty — many companies with such paragraphs survive.
Going concern only matters for public companies. — Correct: All audited entities, public or private, are assessed for going concern.
FAQ
What is going concern in accounting?
It's the assumption that a company will continue to operate for at least the next 12 months, which underlies how financial statements are prepared.
What are examples of going concern issues?
Recurring losses, negative working capital, loan defaults, and loss of major customers or financing sources.
How is going concern assessed by auditors?
Auditors review financial trends, liquidity, debt covenants, and management's mitigation plans against a 12-month horizon.
What happens when going concern doubt exists?
The company must disclose the uncertainty, and the auditor may add an emphasis-of-matter paragraph or modify the opinion.