Learning outcome: After attempting this activity, students will be able to understand the concept of “Going Concern Principle”.
Background: Going concern principle states that the business should be treated as it will continue to operate for an indefinite period.
Suppose that a company named Haider Limited is in a business of textile. Its financial statements for the year ended December 31, 2017, show that the company is suffering from substantial loss of Rs. 16 Million. Along with this loss, the company has an accumulated deficit of Rs. 70 Million caused at the development stage. The company has cash of Rs. 7 lac and short-term securities of Rs. 1.2 Million at the end of the fiscal year 2017. It is expected that the company will face additional losses in the future as it needs to complete the Spinning Mill project for expansion. The management of the company is optimistic about the prospects of the company and expects to earn profits once the project is complete. However, the time required by the company to reach the profitability stage is highly uncertain and there is no assurance that the company will be able to sustain such profits.
The company is facing negative cash flows since its inception. Although, it is expected that the company’s existing funds are adequate to fund the project. However, in case, if additional funds are required, the management is confident that they will be able to raise capital through one or a combination of financing. But, there is no assurance that the company’s financing efforts will be successful. If adequate funds are not available than there is quite a chance that the financial condition and results of the operations will be materially and adversely affected.
- Will Haider Limited prepare financial statements using the going concern assumption?
- What is the significance of this disclosure for financial statement users that the company may not be able to continue as a going concern?