Accountants use the term —going concern—in a narrow sense. They say that an entity is a going concern if it is unlikely to liquidate its operations in the foreseeable future. The assets and liabilities of a going concern are measured using the principles and methods laid down in accounting standards. For example, fixed assets are measured at cost less accumulated depreciation and accumulated impairment loss and inventories are measured at the lower of cost and realisable value. If, the entity is not a going concern, in the sense that it will liquidate its operations in the foreseeable future, willingly or otherwise, assets are measured at liquidation value. The dictionary meaning of foreseeable is ‘that you can predict will happen’. It is difficult, if not impossible, to predict liquidation of an entity in a distant future. Accountants usually take the view that an entity is a going concern if it is unlikely to cease its operations within one year from the balance sheet date.
When preparing financial statements, management makes an assessment of an entity’s ability to continue as a going concern. In assessing whether the going concern assumption is appropriate, management takes into account all available information about the future, which is at least, but is not limited to, twelve months from the end of the reporting period. An entity with a history of profitable operation is not required to prepare detailed analysis. An entity, which has the history of making losses, should prepare a detailed analysis. IAS-1, which deals with presentation of financial statements, requires that when management is aware, in making its assessment, of material uncertainties related to events or conditions that may cast significant doubt upon the entity’s ability to continue as a going concern, the entity should disclose those uncertainties. There is no such requirement in extant Indian accounting standards (AS). The auditor’s responsibility is to frame his/her judgement on the appropriateness of the ‘going concern’ basis.
In the case of the airline, the auditor, in his report, commented that the appropriateness of the ‘going concern’ assumption was dependent on the company’s ability to infuse requisite funds for meeting its obligation. This drew media attention, presumably because such comments usually do not appear in the audit report. Such an audit comment is unusual because once the auditor agrees that the going concern basis is appropriate, he or she is not required to comment on the same. However, if he/she does not agree to the management’s assessment and considers that the ‘going concer’ basis is inappropriate, he/she qualifies the audit report.
The company disclosed the factors, which it had taken into consideration in arriving at the conclusion that the going concern basis was appropriate. The auditor stated the obvious. Any diligent analyst would come to the same conclusion by examining the figures in the balance sheet. Therefore, the kind of attention it received from media is surprising. Perhaps, many of the users of financial statements do not appreciate that neither the auditor nor the management takes long-term view on the ability of the entity to continue as a going concern. Consequently, entities, whose financial statements are prepared on a going concern basis, might fail within a short period after the balance sheet date. The value of investment in the equity capital of a company depends on the ability of the company to generate cash flows over a long period in future. Companies go through financial stress in different stages in its operation. Financial stress does not necessarily lead to liquidation of the company. Astute management finds ways to tide over the situation. Similarly a healthy company might fail due to events that could not be predicted.
In the context of capitalisation of expenditure on repairing and overhauling, some readers raised the question whether the accounting should be different if the expenditure relates to an item of asset that is under operating lease. My understanding is that the accounting will not change. Asset recognised from the expenditure has an identity separate from the asset, which is repaired and overhauled. Therefore, in determination of whether the expenditure has resulted in creation of an asset, the nature of the transaction through which the right to use the asset was acquired is irrelevant. This is similar to recognising a building constructed on a piece of land, which is acquired under operating lease, as an asset separate from the land.
The author is Director, International Management Institute, Kolkata
E mail: asish.bhattacharyya@gmail.com
