What is a going concern?

Explanation of going concern

The going concern assumption underpins the preparation of financial statements. It assumes that a business will continue trading and realise its assets and settle its liabilities in the normal course of business.

Under the UK Companies Act 2006, directors are required to assess whether it is appropriate to prepare accounts on a going concern basis. Accounting standards such as FRS 102 and UK IFRS, including IAS 1 Presentation of Financial Statements, require management to consider all available information about the future, typically covering at least twelve months from the date of approval of the financial statements.

In periods of economic uncertainty or market turbulence, the assessment becomes more complex. Factors such as reduced revenues, liquidity pressures, covenant compliance and access to funding must be considered, and, where material uncertainties exist, the financial statements require appropriate disclosures.

Key characteristics of going concern

Key characteristics of going concern include the following:

• It is a fundamental assumption in financial reporting.
• It assumes continuation of normal trading activities.
• It affects asset valuation and liability recognition.
• It requires forward-looking assessment by management.
• It may require specific disclosure where material uncertainties exist.

How going concern works

The going concern assessment typically involves the following steps:

1. Management prepares forecasts and cash flow projections.
2. Key assumptions, including revenue, costs and financing are evaluated.
3. Liquidity, debt covenants and funding arrangements are reviewed.
4. Potential mitigating actions are considered where pressures are identified.
5. A conclusion is reached on whether the going concern basis remains appropriate and whether disclosures are required.

Auditors also evaluate management’s assessment as part of the statutory audit process.

Example of going concern in practice

A UK retail business experiences declining sales due to adverse market conditions. Directors prepare detailed cash flow forecasts covering the next twelve months, considering cost reductions and revised financing terms. Although pressures exist, available funding is sufficient to meet liabilities as they fall due. The accounts are prepared on a going concern basis with additional disclosure explaining the uncertainties.