Which accounting assumptions are related to the presumption of continuous and indefinite operations of a business?

Inhaltsverzeichnis Show

Going Concern Concept: Explanation
Frequently Asked Questions
Is the concept of going concern justifiable?
Is there any way to calculate goodwill?
What if a business has permanently closed down?
Can you give an example of when it's better to use going concern?
What does goodwill refer to?
About the Author True Tamplin, BSc, CEPF®
Which assumption assumes that the business will be in operation indefinitely?
Which accounting concept is about assuming that a business has an indefinite life?
Which of the following concepts it is assumed that business will exist for an indefinite time period?
What are the 3 main assumptions of accounting?

3

                                                                             C H A P T E R



                     Generally Accepted Accounting


                     Principles (GAAP) and Basic


                     Accounting Concepts





                                  MEANING OF KEY TERMS USED IN THE CHAPTER

                       1.  Generally Accepted     Generally Accepted Accounting Principles are basic or fundamental
                        Accounting Principles     propositions based on which transactions and events are recorded
                        (GAAP)                    in the books of account and financial statements are prepared.
                       2.  Fundamental Accounting
                        Assumptions
                          (i)  Going Concern      Under this assumption, it is presumed that the business will continue
                            Assumption            for a foreseeable future and there is no intention to close down the
                                                  business or scale down its operations significantly.
                         (ii)  Accrual Assumption   Under this assumption, a transaction is accounted at the time when it is
                                                  entered into and not when settlement takes place.
                         (iii)  Consistency       Under this assumption, accounting practices once adopted should
                            Assumption            be applied consistently year after year. They may be changed under
                                                  following three conditions:
                                                  (a)  If law requires the change,
                                                  (b)  If Accounting Standard requires the change, or
                                                  (c)  If it results in more fair presentation of financial affairs of the business.


                                                  CHAPTER SUMMARY

                       •  Accounting Principles. Accounting is the language of business and every language has certain rules of
                       grammar. Similarly, in order to understand accounting information and for maintaining uniformity and
                       consistency, certain principles are needed in accounting.
                        Accounting Principles are the norms or rules which are to be followed in treating various items of assets,
                       liabilities, expenses, incomes, etc.
                       •  Generally Accepted Accounting Principles (GAAP) refers to the rules or guidelines adopted for recording
                       and reporting business transactions, in order to bring uniformity and consistency in the preparation and
                       presentation of financial statements.
                       •  Accounting Concepts
                         (i)  Going Concern Concept. The business will continue for an indefinite period and there is no intention
                           to close the business or reduce its size of operations significantly.
                        (ii)  Accounting (Business) Entity Concept. Business is treated as a separate entity distinct from its owners.
                        (iii)  Money Measurement Concept. Transactions and events that can be expressed in money or in money
                           terms are recorded in the books of account.

The concept of going concern states that all records are made on the assumption that the business will continue for the foreseeable future.

Unless it is known that the business will close down at a future time, all transactions are recorded in a routine manner and there is no need for any special valuation or adjustment.

Going Concern Concept: Explanation

Under this concept, it is assumed that the business will operate for a long period of time. When a business is started, it is assumed that it will not be dissolved in the near future.

The financial statements (i.e., profit and loss account and balance sheet) are also prepared under this assumption, as this concept leads to a distinction being made between capital and revenue expenditures.

Here, it should also be noted that the assumption is not made that the business will be profitable throughout its existence.

As this concept relates to the future, which is inherently unpredictable, several factors can be used to determine whether a business is a going concern. These include:

Strong capital structure
Ability to overcome short-term risk
Possession of reasonable liquid assets
Continuous demand for products

However, if it is known that a business will close down in, for example, the next two or three months, it would be more appropriate to state its assets not at cost but at the value at which these can be sold on the closure of the business.

At this stage, it may also be necessary to take account of all legal obligations that may not have been previously brought to books.

Unless it is categorically stated otherwise, all accounting records and income statements or balance sheets are prepared on the assumption that the business will continue to function for an indefinite future period.

The laws that bind corporations in all countries state that a company is presumed to have an uninterrupted existence with continuing activity until such time as it is legally liquidated.

If the results of the operations of the business enterprise were to be accounted for based on expected liquidation, it would be impossible for suppliers to supply goods and services, for employees to offer their services, and for other businesses to transact with the business entity.

For this reason, for purposes of accounting, business enterprises are presumed to carry on their operations indefinitely until such time as they are in fact liquidated.

A corollary to the going concern concept is the assumption that a business enterprise will not be liquidated within the foreseeable future.

This is because it would make it impossible for the business to carry out its present contractual commitments or to use its resources according to a predetermined plan of operation.

The going concern concept is best summarized as follows:

The enterprise is normally viewed as a going concern, that is, as continuing in operation for the foreseeable future. It is assumed that the enterprise has neither the intention nor the necessity of liquidation or of curtailing materially the scale of its operations.

Examples

Example 1

An organization produces a compound called Chemical X. Unexpectedly, the federal government imposes a limitation on the production, export, import, sale, and marketing of this compound in the country.

Given these circumstances, if Chemical X is the only product the company produces, the business will no longer be classified as a going concern.

Example 2

The National Company has fallen into serious financial problems and cannot cover its duties. Due to this, the federal government provides the company with a bailout package and also a guarantee to clear all its credit payments.

Regardless of its weak financial standing, the National Company is still considered a going concern.

Example 3

The Eastern Company has closed a division but will continue working in its other divisions as usual. The business is a going concern because the closing down of a small portion of business does not impair the capacity of the enterprise to continue indefinitely in the future.

Example 4

A small business cannot make payments to its creditors due to an extremely poor liquidity position. The court grants the purchase price of liquidating the company upon the petition of one of the firm’s creditors.

The business is not a going concern as, according to the available evidence, it will not be able to continue its operations for a long time in the future.

Frequently Asked Questions

Is the concept of going concern justifiable?

Yes. It is not possible to close down a business permanently at one go. This would be against the law in most countries, and it makes no sense. This concept helps legal entities to continue with their operations in a more or less smooth manner without any serious hassles due to sudden litigation or liquidation.

Is there any way to calculate goodwill?

The calculation of goodwill takes into account the fair value of the net assets acquired less any adjustments for purchase price, encumbrances or unusual conditions that will not affect the future operations.

What if a business has permanently closed down?

If a business has permanently closed down, the assets should be removed from the books and all liabilities are settled. If there are still some assets that are still in use, these must be transferred to the new owner or sold with appropriate adjustments.

Can you give an example of when it's better to use going concern?

When using the going concern method, businesses can step up to their profits or losses by transfers to equity account. If the net income is zero or negative, it may be better for a company not to report any figures at all. This will help prevent the investors from getting pessimistic forecasts about future losses.

What does goodwill refer to?

Goodwill refers to the value of an acquired company which exceeds its purchase price. It can also be referred to as intangible assets like patents, copyrights, licenses and trademarks.

About the Author True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, his interview on CBS, or check out his speaker profile on the CFA Institute website.

Facebook
LinkedIn
Instagram
Twitter
YouTube

Which assumption assumes that the business will be in operation indefinitely?

The going concern principle is the assumption that a business will continue to exist in the near future, in other words, that it will not liquidate or be forced out of business.

Which accounting concept is about assuming that a business has an indefinite life?

What Is Going Concern? Going concern is an accounting term for a company that has the resources needed to continue operating indefinitely until it provides evidence to the contrary.

Which of the following concepts it is assumed that business will exist for an indefinite time period?

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.