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XYZ Inc. is a manufacturer of televisions. The domestic market for electronic goods is currently not doing well, and therefore many entities in this business
are switching to exports. As per the audited financial statements for the year ended December 31, 20XX, the entity had net losses of $2 million. At
December 31, 20XX, its current assets aggregate to $20 million and the current liabilities aggregate to $25 million. Due to expected favorable changes in
the government policies for the electronics industry, the entity is projecting profits in the coming years. Furthermore, the shareholders of the entity have
arranged alternative additional sources of finance for its expansion plans and to support its working needs in the next 12 months.
Required
Should XYZ Inc. prepare its financial statements under the going concern assumption?
Solution
The two factors that raise doubts about the entity’s ability to continue as a going concern are
1. The net loss for the year of $2 million
2. At the balance sheet date, the working capital deficiency (current liabilities of $25 million) exceeds its current assets (of $20 million) by $5 million
However, there are two mitigating factors:
1. The shareholders’ ability to arrange funding for the entity’s expansion and working capital needs
2. Projected future profitability due to expected favorable changes in government policies for the industry the entity is operating within
Based on these sets of factors—both negative and positive (mitigating) factors—it may be possible for the management of the entity to argue that the going
concern assumption is appropriate and that any other basis of preparation of financial statements would be unreasonable at the moment. However, if
matters deteriorate further instead of improving, then in the future another detailed assessment would be needed to ascertain whether the going concern
assumption is still valid.
Accrual Basis of Accounting
Excluding the cash flow statement, all other financial statements must be prepared on an accrual basis, whereby assets and liabilities are recognized when they are
receivable or payable rather than when actually received or paid.
Consistency of Presentation
Entities are required to retain their presentation and classification of items in successive periods unless an alternative would be more appropriate or if so required by
a Standard.
Materiality and Aggregation
Each material class of similar items shall be presented separately in the financial statements. Material items that are dissimilar in nature or function should be
separately disclosed.
Offsetting
Assets and liabilities, income and expenses cannot be offset against each other unless required or permitted by a Standard or an Interpretation. Measuring assets net
of allowances, for instance, presenting receivables net of allowance for doubtful debts, is not offsetting. Furthermore, there are transactions other than those that an
entity undertakes in the ordinary course of business that do not generate “revenue” (as defined under IAS 18); instead they are incidental to the main revenuegenerating
activities. The results of these transactions are presented, when this presentation reflects the substance of the transaction or event, by netting any income
with related expenses arising on the same transactions. For instance, gains or losses on disposal of noncurrent assets are reported by deducting from the proceeds on
disposal the carrying amount of the assets and related selling expenses.
Comparative Information
Comparative information (including narrative disclosures) relating to the previous period should be reported alongside current period disclosure, unless otherwise
required.
In case there is a change in the presentation or classification of items in the financial statements, the comparative information needs to be appropriately reclassified,
unless it is impracticable to do so.
STRUCTURE AND CONTENT
Identification of the Financial Statements
Financial statements should be clearly identified from other information in the same published document (such as an annual report). Furthermore, the name of the