What is the going concern assumption?
Financial statements are normally prepared on a going concern basis. This means assets are valued based on their use in an ongoing business, not their forced-sale value, and liabilities are classified by their normal due dates.
Management's responsibility
Under IAS 1, management must assess whether the business can continue for at least 12 months from the reporting date. If there are material uncertainties, they must be disclosed.
Warning signs
- Recurring losses and negative operating cash flow
- Net current liabilities or negative [equity](/glossary/equity)
- Loan defaults or breached covenants
- Loss of a key customer, supplier or licence
- Inability to raise new finance
- Major legal claims
The auditor's role
Auditors evaluate management's assessment. If doubt remains, the audit report includes a "material uncertainty related to going concern" paragraph. If the business is clearly not a going concern, the statements are prepared on a different basis, such as liquidation.
Example
A retailer has lost money for three years, its bank loan is due in six months and it has no refinancing agreed. Management must disclose the uncertainty and explain its plans, such as raising equity or selling assets.