Going concern principle - What is the going concern principle?

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.

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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.

The importance of the going concern principle

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.

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!