Generally, the accounts of the business are prepared with the assumption that the business is going to be continued and is not to be closed in near future. This concept is known as Going concern concept. The creditors supply goods and services with the expectation that the business is to go on for a long period of time. The money lenders or financial institutions offer investments based on this principle.
When depreciation is calculated on fixed assets, it is presumed that the assets will be used in the business for a long time. At the end of the accounting year, the provision for bad debts and discount reserve are also made based on this assumption. A provision is made for future contingent liability based on the presumption. Based on the concept that the business is going to continue for a long period of time, the transactions are recorded in the books of accounts.
This concept is important in the following cases:
(1) When the benefit from a certain expense is to be received not only during that year but for a long period of time, then such expense is written off or distributed in the future years. The expense of that year is recorded in the Profit and Loss Account and the balance is shown on the Assets side of the Balance Sheet.
(2) Depreciation on the assets is written off or apportioned over the useful life of the asset. Thus according to this concept, the asset is not recorded in the books at the market price, but is recorded in the books at original cost price.
(3) If the business is to run for a specific period of time, then the total cost of the asset is treated as expense of that period and is matched against the revenue of that period, e.g., joint venture for construction of bridge or construction of dam.
(4) According to this principle, fixed assets are shown at cost less depreciation and the current assets are shown at their realisable value in the Balance Sheet.
(5) Distinction is made between ‘Capital expenditure’ and ‘Revenue expenditure’ because of going concern assumption.
In the following circumstances, this concept should not be followed :
- When the object for which a business was established is achieved or is likely to be accomplished in very short period;
- When an industrial unit is declared sick;
- When a liquidator is appointed for liquidation of a company;
- When a business is likely to be liquidated very shortly.
