Going concern is a fundamental accounting assumption. It means the enterprise is viewed as:
Continuing in operation for the foreseeable future
Having neither the intention nor the necessity of liquidation or materially curtailing the scale of operations
### Going Concern Basis of Accounting
Under this basis:
Assets and liabilities are recorded assuming the entity will realise assets and discharge liabilities in the normal course of business
General purpose financial statements are prepared on this basis unless management intends to liquidate, cease operations, or has no realistic alternative but to do so
### When Going Concern is NOT Appropriate → Liquidation Basis
Inventories may need to be written down (lower realisable price in forced sale)
Assets are recorded at likely realisable prices (not historical cost or carrying value)
### Financial Indicators That Cast Doubt on Going Concern
Category
Indicator
Liability/Funding
Net liability or net current liability position
Funding
Fixed-term borrowings approaching maturity without realistic prospects of renewal or repayment
Funding
Excessive reliance on short-term borrowings to finance long-term assets
Cash Flow
Negative operating cash flows (historical or prospective)
Payments
Inability to pay trade payables on due dates
Payments
Inability to comply with terms of loan agreements
Payments
Change from credit to cash-on-delivery transactions with suppliers
Financial Performance
Adverse key financial ratios
Financial Performance
Substantial operating losses or significant deterioration in asset values
Dividends
Arrears or discontinuance of dividends
Support
Indications of withdrawal of financial support by trade payables
Investment
Inability to obtain financing for essential new product development or other essential investments
### Auditor's Responsibilities
1. Evaluate management's use of the going concern basis of accounting
2. Identify events or conditions that cast significant doubt on the entity's ability to continue as a going concern
3. Perform specific procedures (e.g., reviewing cash flow forecasts, post-balance-sheet events, inquiry of management about plans)
4. Evaluate management's plans to mitigate identified issues
5. If doubt remains, consider the impact on the audit report (emphasis of matter or modified opinion)
Worked example
### Example 1
Financial Indicators Casting Doubt on Going Concern (MTP 1)
The following financial events or conditions may individually or collectively cast significant doubt on an entity's ability to continue as a going concern:
#
Indicator
1
Net liability or net current liability position
2
Fixed-term borrowings approaching maturity without realistic prospects of renewal or repayment; or excessive reliance on short-term borrowings to finance long-term assets
3
Indications of withdrawal of financial support by trade payables
4
Negative operating cash flows indicated by historical or prospective financial statements
5
Adverse key financial ratios
6
Substantial operating losses or significant deterioration in value of assets used to generate cash flows
7
Arrears or discontinuance of dividends
8
Inability to pay trade payables on due dates
9
Inability to comply with terms of loan agreements
10
Change from credit to cash-on-delivery transactions with suppliers
11
Inability to obtain financing for essential new product development or other essential investments
Exam tip: These are financial indicators. SA 570 also recognises operational indicators (e.g., loss of key management, loss of a major market) and other indicators (e.g., non-compliance with capital requirements, pending legal proceedings). The question only asked for financial events — always note the qualifier.
Runs a nutrition/food app with revenues expected to grow
Reflected net losses in FS for both years
Has managed to meet all financial commitments in both years
Management wants to continue on going concern basis in current year
Analysis:
Under SA 570, management's use of the going concern basis is appropriate when the enterprise has neither the intention nor the necessity of liquidation or materially curtailing operations.
Net losses alone do NOT disqualify going concern — ability to meet financial commitments is the key test
The company has been meeting all financial commitments → no inability to pay creditors
Revenue is expected to grow → no prospect of curtailing operations
Management has neither the intention nor necessity to liquidate
Conclusion: Management's decision to continue on going concern basis is appropriate.
How going concern affects preparation of FS:
On going concern basis: assets/liabilities recorded assuming normal course of business realisation and discharge
If NOT going concern: switch to liquidation basis — inventories written down to forced-sale values, assets at likely realisable prices
Key takeaway for exams: Two years of net losses in a start-up is not automatically a going concern problem if financial commitments are being met and future prospects are positive.
### Example 3
Labour Shortage and Liquidity Crunch — Operational + Financial Indicators (MTP 6)
Facts:
Company faces significant skilled labour shortages → operations hampered
Lost orders and decreased revenues
Fixed costs remain high → margin squeeze
Liquidity crunch → unable to pay creditors on time
Bankers unwilling to provide additional support
Indicators present:
Operational: Skilled labour shortage disrupting manufacturing; lost contracts
Financial: Inability to pay trade payables on due dates (financial indicator)
Financial: Bankers unwilling to help = withdrawal of financial support
Financial: Decrease in revenues with high fixed costs → likely operating losses
How management can address auditor's concerns:
Present a cash flow forecast showing ability to continue
Evidence of alternative labour sourcing (e.g., automation, outsourcing, retraining)
Show new orders or customer contracts replacing lost business
Provide evidence of revised financing arrangements or new banking facilities
Demonstrate plans to reduce fixed costs or restructure operations
Audit procedures in such a situation:
Review cash flow forecasts prepared by management
Review post-balance-sheet events for evidence of improvement or deterioration
Inspect correspondence with bankers and creditors
Inquire of management about their plans to address liquidity
Review legal/regulatory correspondence for any additional threats
Evaluate the reasonableness of management's assumptions in forecasts
⚠️ Common exam mistakes
Assuming net losses automatically mean an entity is NOT a going concern — the key test is the ability to meet financial commitments and management's intentions, not just profitability.
Not distinguishing between financial indicators (net losses, negative cash flows), operational indicators (labour shortages, loss of major customer), and other indicators (regulatory non-compliance) — exams often specify a category.
Failing to consider management's mitigating plans before concluding on going concern — the auditor must evaluate whether management's plans to address doubts are feasible.
Applying going concern basis to a company clearly headed for liquidation, which misstates asset values and liabilities by not writing them down to realisable amounts.
Confusing going concern assumption (an accounting concept) with the auditor's reporting obligation when going concern is in doubt — these are separate issues even though both arise from SA 570.
Bare-Act text SA 570 · SA 570 – Going Concern · click to expand
Going concern is one of the fundamental accounting assumptions. 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 the operations. Under the going concern basis of accounting, the financial statements are prepared on the assumption that the entity is a going concern and will continue its operations for the foreseeable future. General purpose financial statements are prepared using the going concern basis of accounting, unless management either intends to liquidate the entity or to cease operations, or has no realistic alternative but to do so.