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Going Concern Principle in Accounting: Definition & Example

Instructor: Jay Wagner

Jay holds a Masters of Business Administration

One of the underlying principles in accounting is that the company, or at least the portion of the company reflected in the financial statements, is a going concern. Here we explore what a going concern is and what it means for accounting.

The Going Concern Principle

Have you ever owned a vacuum cleaner? If so, then every time you took it out of the closet to use it, you likely plugged it in and turned it on with the assumption that it would run. When you hit the 'on,' button, your expectation was that the vacuum would power to life, because you had no evidence that it wouldn't. You didn't have to leave the vacuum on 24/7 for it to be considered an operational vacuum; if you left it in your closet and never used it, you would assume that it was still in working condition until the day you took it out and found it no longer worked.

The going concern principle in accounting is much like your vacuum cleaner. You assume that your vacuum cleaner is operable because you have no evidence that it is broken. As an accountant, you might also assume that a business is a going concern (that is, in operation) unless you have evidence to the contrary. Like your vacuum cleaner, though, you also assume that the business will continue to be a going concern for a reasonable period of time. Therefore, you do not expect the business to liquidate its assets in the near future.

The Importance of the Going Concern Principle

If you turned your vacuum cleaner on and it started smoking and shooting sparks, you would assume that it was not going to run the next time you wanted to use it, either. It would make no sense to put it back into the utility closet. You would need to either have it repaired or buy a new one and dispose of the old one.

Some things in accounting would make no sense without the going concern principle. For example, if we expected a company to go out of business a few months from now, it would make no sense to record any long-term liabilities for that firm, because we wouldn't expect the business to still be there to pay them. Similarly, it would make more sense to record the company's assets at their realizable values and to not depreciate them, because we would expect them to be sold for something near their realizable values and we would have no need to depreciate them to match their expense to the periods in which they helped generate revenues.

What is Not a Going Concern?

Since we automatically assume that a business is a going concern unless we have evidence to the contrary, it is important to know what types of events might provide evidence that a company is not a going concern. Chapter 7 (liquidation) bankruptcy obviously provides such evidence, as do some other legal proceedings such as seizure to satisfy unpaid taxes or foreclosure on necessary facilities. Businesses sometimes discontinue some of their operations, and in those cases we assume that the operations that were not discontinued constitute a going concern and we simply separate the discontinued operations from the rest of the company.

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