The going concern principle is a fundamental assumption in accounting that a business will continue to operate for the foreseeable future and has no intention or necessity to liquidate or significantly curtail its operations. This assumption underpins how financial statements are prepared and is one of the most important concepts in UK accounting.
Section 1: Why Going Concern Matters
When financial statements are prepared on a going concern basis, assets are recorded at their carrying value rather than their forced-sale or liquidation value. This matters because:
- Fixed assets are carried at cost less depreciation and amortisation, reflecting their useful life to the ongoing business
- Inventory is valued at the lower of cost and net realisable value in the normal course of business
- Receivables are assessed for recoverability based on normal trading conditions
- Liabilities are classified between current and non-current based on expected settlement dates
If the going concern assumption were abandoned, all assets would need to be restated at their realisable value in a forced sale, which is typically far lower than their carrying value.
1.1 Impact on the Balance Sheet
Consider a manufacturing company with machinery carried at £500,000 on its balance sheet. If the business is a going concern, that value reflects the remaining useful life of the equipment in generating future revenue. If the business is being wound up, the same machinery might fetch only £80,000 at auction. The going concern assumption determines which figure appears in the accounts.
Section 2: Legal and Regulatory Framework
2.1 Companies Act 2006
The Companies Act 2006 requires directors to prepare financial statements on a going concern basis unless it is inappropriate to do so. Section 414C requires the strategic report to describe the principal risks and uncertainties facing the company, which often includes going concern considerations.
2.2 FRS 102
FRS 102 Section 3.8 states that when preparing financial statements, management shall assess the entity’s ability to continue as a going concern. The assessment must cover at least 12 months from the date the financial statements are authorised for issue.
If management is aware of material uncertainties that may cast significant doubt on the entity’s ability to continue as a going concern, those uncertainties must be disclosed.
2.3 ISA 570 (UK)
International Standard on Auditing 570 sets out the auditor’s responsibilities regarding going concern. The auditor must:
- Evaluate management’s assessment of going concern
- Consider whether there are events or conditions that may cast significant doubt
- Determine whether adequate disclosures have been made
- Modify the audit report if necessary
Section 3: The Directors’ Assessment
3.1 What Directors Must Consider
UK directors are required to make a formal assessment of whether the business is a going concern at each reporting date. This involves reviewing:
| Factor | Consideration |
|---|---|
| Cash flow forecasts | Can the business meet its obligations for at least 12 months? |
| Borrowing facilities | Are existing facilities adequate and likely to be renewed? |
| Order book and pipeline | Is there sufficient future revenue? |
| Debt covenants | Is the business at risk of breaching loan conditions? |
| Contingent liabilities | Are there potential claims that could threaten viability? |
| Industry trends | Is the sector facing structural decline? |
| Regulatory changes | Could new regulations make the business model unviable? |
3.2 Indicators of Going Concern Problems
Warning signs that may challenge the going concern assumption include:
- Recurring operating losses and deteriorating financial ratios
- Negative working capital or inability to pay debts as they fall due (see working capital)
- Withdrawal of credit facilities by lenders
- Loss of a major customer or key contract
- Failure to comply with debt covenants
- Outstanding litigation with potentially significant financial consequences
- Inability to obtain financing for necessary investments
3.3 Period of Assessment
While FRS 102 requires assessment for at least 12 months from the date of authorising the financial statements, the FRC encourages directors to look beyond this minimum where relevant. For businesses with seasonal cash flows or lumpy revenue patterns, a longer assessment period may be necessary to capture the full picture.
Section 4: Going Concern Outcomes
4.1 No Material Uncertainty
If the directors conclude that the business is a going concern with no material uncertainty, the financial statements are prepared on the normal basis with no special disclosures beyond the standard accounting policies note.
4.2 Material Uncertainty Exists
If there is a material uncertainty related to going concern but the directors still believe the going concern basis is appropriate, the financial statements must:
- Clearly disclose the material uncertainty
- Explain the events or conditions giving rise to it
- State that these may cast significant doubt on the entity’s ability to continue as a going concern
The auditor will include an emphasis of matter paragraph or a separate section in the audit report drawing attention to the disclosure.
4.3 Going Concern Basis Not Appropriate
If the directors conclude that the going concern basis is not appropriate, the financial statements must be prepared on a break-up basis:
- Assets are valued at expected realisable amounts
- Liabilities include all costs of winding down
- The basis of preparation is clearly disclosed
- The income statement reflects the expected costs of cessation
This situation typically arises when a business is insolvent or when a decision to liquidate has been made.
Section 5: The Auditor’s Role
5.1 Evaluating the Assessment
The auditor does not simply accept the directors’ assessment at face value. The audit procedures include:
- Reviewing and challenging management’s cash flow forecasts
- Assessing the reasonableness of key assumptions
- Checking for contradictory evidence
- Considering the adequacy of disclosures
5.2 Audit Report Modifications
| Situation | Audit report impact |
|---|---|
| Going concern, no uncertainty | Standard unmodified opinion |
| Going concern with material uncertainty, adequately disclosed | Unmodified opinion with material uncertainty section |
| Going concern with material uncertainty, inadequately disclosed | Qualified or adverse opinion |
| Going concern basis not appropriate but used | Adverse opinion |
A going concern modification in the audit report is a significant event that can affect investor confidence, credit ratings and banking relationships.
Section 6: Practical Considerations for UK Businesses
6.1 Cash Flow Forecasting
The most critical element of any going concern assessment is the cash flow forecast. This should:
- Cover at least 12 months from the date of signing the accounts
- Include realistic assumptions about revenue, costs and capital expenditure
- Model a base case and a downside scenario
- Consider the timing of major cash inflows and outflows
- Account for seasonal variations
Reviewing the cash flow statement for the current period provides a starting point for forecasting.
6.2 Banking Covenants
Many UK businesses have banking covenants requiring them to maintain certain financial ratios such as interest cover or leverage ratios. Breaching these covenants can give the bank the right to demand immediate repayment, which could threaten going concern. Directors should monitor covenant compliance closely and communicate early with lenders if a breach is anticipated.
6.3 Documentation
Directors should maintain clear documentation of their going concern assessment, including:
- The forecasts and assumptions used
- The period covered
- The sensitivity analysis performed
- Minutes of board discussions
- Any mitigating actions planned
This documentation supports both the directors’ responsibilities under the Companies Act and the auditor’s work under ISA 570.
Section 7: Going Concern in Context
The going concern principle does not operate in isolation. It interacts with other accounting concepts:
- Accrual accounting only makes sense if the business will continue long enough to realise the benefits of accrued items
- Depreciation spreads the cost of assets over their useful life, which assumes the asset will be used for that full period
- The matching principle matches costs to revenue over time, which requires an ongoing business
If the going concern assumption fails, the entire basis of financial reporting changes fundamentally. Understanding this principle is therefore essential for anyone involved in preparing, reviewing or relying on UK financial statements.