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The Going Concern Principle

The going concern principle states that the financial statements of an entity should be prepared as if the firm will continue its operations for the foreseeable future. This means that the financial statements should not be prepared as if the firm would halt operations and have to liquidate its assets in the near-term.

If an accountant believes that an entity may no longer be a going concern, then this brings up the issue of whether assets are impaired, and should be written down to the amount that would be realizable if they were liquidated. As a result, the value of an entity that is assumed to be a going concern will be higher than one reported at its break-up value.  

The going concern principle is not clearly defined any where in US GAAP. However, it was one of the main principles used in the famous Paton and Littleton monograph An Introduction to Corporate Accounting Standards, of 1940, that is viewed by many as the basis of modern accounting standards

In their monograph, the going concern principle justifies deferring revenue or expenses until later periods, the matching of these in the future, and thus the deferal of unrealized gains and losses until the time that objective evidence is available or they can be appropriately matched with revenue (for example, in the case of depreciation). As a result, the going concern principle provides strong justification for the use of a historical cost basis in accounting.

As well, while the going concern principle is not clearly defined in GAAP, it is recognized by generally accepted auditing standards (GAAS), which instruct an auditor to evaluate different factors to give her opinion about whether or not the firm will be a going concern for a period of not greater than a year. If the auditor believes there to be a problem, she must qualify the audit report with a statement. 

A business can mitigate this auditor's statement by having a third party gaurantee the debts of the business or to provide additional funds if needed. In this way, the auditor is reasonably assured that the business will continue to operate for the duration of the one-year period. 


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