Recall that accrual accounting is a generally accepted accounting (GAAP) basis of accounting for company operations. The income statement presents a company’s results of operations as measured following the tenets of accrual accounting. There are several assumptions behind the accrual practice of how we record accounting events and how we measure those events. Today, I’ll write about the going concern assumption.

The going concern assumption enables a company to match the cost of an asset across its useful life. The word “going” should be interpreted as one might expect, namely “continuing.” The word “concern” can be a bit more confusing, however. It does not mean an “anxiety” or “worry.” The word “concern” actually refers to a “company” or “business.” So, the going concern assumption refers to the notion that a company will continue indefinitely.

Following the going concern assumption, we observe that companies depreciate fixed assets over long time horizons. This practice of allocating the cost of an asset to expense over many years is possible via application of the going concern assumption.

Sometimes, the balance sheet can weaken and lack adequate liquidity to carry on operations, make necessary interest payments and settle debt on a timely basis. If it becomes substantially doubtful that the company can continue beyond the coming year in the auditor’s opinion, the auditor will render a going concern warning. The auditor’s report will be modified to note the CPA’s doubt about the company’s ability to continue as a going concern (a continuing business).

A company with a very healthy balance sheet is a going concern but if its balance sheet becomes problematic due to failing business, for example, it could cease to be a going concern. If the auditor evaluates the situation and believes there is substantial doubt about the company’s ability to carry on operations beyond the next 12 months, a going concern warning becomes appropriate.

Certainly, a going concern warning can be a red flag although some companies may see a change in business fortunes that puts it back on the going concern path again. So, remember that a “going concern” is a good thing; a “going concern warning” is not a good thing.