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. Stay on top of your financial activity by using an online invoicing software such as Debitoor. Sign up now! As an
accounting principle, the going concern principle serves as a guideline which allows readers of a business’s financial statements to assume that the business will continue to operate long enough to carry out its current obligations, objectives and commitments. Going concern is an important part of the generally accepted accounting principles. Without it, businesses would not be able to perform accrued or prepaid expenses.The going concern principle allows a business to defer some of their
prepaid expenses to future accounting periods, rather than recognising them all at once. Think about this: If we assume that a business will not be able to operate in the foreseeable future then why would we prepay or accrue anything? Well, if we assume the business might not operate long enough to realize these future expenses, then we would not prepay or accrue anything. The importance
of the going concern principle
Going concern and cost principle
The going concern principle provides some justification for accountants to follow the cost principle.
If a company is a going concern, it has no intention to liquidate, so why should it report the current value of its long term assets? Yet, if the value of an asset has been damaged or weakened, then the carrying amount of the asset could be reduced to an amount lower than its carrying value.
An example showing the application of the going concern principle is the calculation of depreciation of assets. This depreciation calculation is based on the expected economic life of the asset, as opposed to its current market value.
Businesses assume that they will continue operating for an indefinite period of time, and that their assets will therefore be used in the business until they have fully depreciated.
The significance of accounting principles
Accounting principles serve a significant purpose of standardising the way in which businesses perform their financial reporting activities.
It is important for all businesses to keep track of their financial statements, and ensure that they are correctly and efficiently drawn up. With Debitoor invoicing software you can instantly extract and download your financial statements at any point in time!
In recording business transactions, accountants rely on certain underlying assumptions or concepts. Both preparers and users of financial statements must understand these assumptions: • Business entity concept (or accounting entity concept). Data gathered in an accounting system relates to a specific business unit or entity. The business entity concept assumes that each business has an existence separate from its owners, creditors, employees, customers,
other interested parties, and other businesses. • Money measurement concept. Economic activity is initially recorded and reported in a common monetary unit of measure—the dollar in the United States. This form of measurement is known as money measurement.
• Exchange-price (or cost) concept (principle). Most of the amounts in an accounting system are the objective money prices determined in the exchange process. As a result, we record most assets at their acquisition cost. Cost is the sacrifice made or the resources given up, measured in money terms, to acquire some desired thing, such as a new truck (asset).
• Going-concern (continuity) concept. Unless strong evidence exists to the contrary, accountants assume that the business entity will continue operations into the indefinite future. Accountants call this assumption the going-concern or continuity concept. Assuming that the entity will continue indefinitely allows accountants to value long-term assets, such as land, at cost on the balance sheet since they are to be used rather than sold. Market values of these assets would be relevant only if they were for sale. For instance, accountants would still record land purchased in 1988 at its cost of USD 100,000 on the 2010 December 31, balance sheet even though its market value has risen to USD 300,000.
• Periodicity (time periods) concept. According to the periodicity (time periods) concept or assumption, an entity’s life can be meaningfully subdivided into time periods (such as months or years) to report the results of its economic activities.
Now that you understand business transactions and the five basic accounting assumptions, you are ready to follow some business transactions step by step. To begin, we divide Metro’s transactions into two groups: (1) transactions affecting only the balance sheet in June, and (2) transactions affecting the income statement and/or the balance sheet in July. Note that we could also classify these transactions as operating, investing, or financing activities, as shown in the statement of cash flows.