The essence of the going concern principle determined in the Polish Accounting Act
The essence of the going concern principle comes down to the fact that based on the available information, it is possible to assume that the entity will continue its operations in the foreseeable future.
Assessment of the entity’s ability to continue its operations
The going concern principle requires a verification whether the entity’s operations are safe in an unchanged scope within a period of at least one year from the balance sheet date. The assessment of the entity’s ability to continue its economic activity is carried out by the head of the entity. He or she must take into consideration all the events and circumstances that might affect the assessment.
The entity should not draw up the financial statement with the assumed continuation of operations, if there are events after the end of the reporting period but before the date of preparation of the financial statement, which indicate that the assumption of the going concern principle is unjustified.
Selected events or circumstances that, individually or collectively, might indicate a significant uncertainty as to the continuation of the entity’s operations.
Circumstances that might indicate a risk to the continuation of operations include, among others:
- inability to settle liabilities on a timely manner;
- loss of key managerial personnel;
- shortage of important raw materials;
- loss of a basic market, a key customer.
Any other?
Of formal nature:
- the entity is officially put into liquidation by means of an adopted resolution by its partners or a legally-binding decision of the court to dissolve the company
- the court announces bankruptcy
- when according to the assessment of the head of the entity, it is certain that the entity will not continue its operations in the foreseeable future
- a significant reduction of the scope of operations due to the lack of a true alternative for liquidation or discontinuation of operations
Of financial nature:
- a situation when liabilities exceed the assets,
- an upcoming maturity date of loans with specific payment deadlines, with the lack of a realistic chance of extending or repaying them, or an excessive dependence on short-term loans to finance long-term assets,
- signs indicating that creditors might withdraw their financial support,
- negative cash flows on operating activity recognized in past and planned financial statements,
- an unfavorable situation of key financial indicators,
- considerable operating losses or considerable depreciation of assets that generate cash flows,
- a delayed or withheld payment of dividends,
- inability to settle liabilities on a timely manner,
- inability to fulfill the conditions of credit agreements,
- a change of the method of settlement with suppliers from a trade credit to an immediate payment upon delivery,
- lack of possible financing for development works regarding a key product or other necessary investments.
Of operational nature:
- intent of the head of the entity to liquidate the entity or cease its operations,
- loss of key personnel that cannot be replaced,
- inability of the manager to manage a considerable business risk or cope with an increased responsibility,
- an unsuccessful expansion, control or diversification of the operations,
- an unsuccessful attempt to eliminate the shortcomings of internal audit that might increase the risk of significant
- irregularities caused by fraud, embezzlement of inventory, uncontrolled costs and errors in reporting,
- loss of a basic market, key customers, a franchise agreement, a license or a main supplier,
- the success highly depends on a specific project or a new product,
- lack of personnel, interruptions in production or provision of services due to employee disputes,
- shortage of important raw materials,
- emergence of a highly successful competitor,
- main business activity is in the declining industry sector,
- business activity takes place in countries experiencing a recession, civil unrest or hyperinflation,
- loss of value in the company’s equity or other intangible assets.
Other events or circumstances:
- non-compliance with obligations concerning capital requirements or other statutory requirements, such as requirements for financial institutions within the scope of solvency or liquidity,
- pending court or administrative proceedings against the entity that, if resolved unfavorably for the entity, might result in claims the satisfaction of which will probably be impossible,
- changes in the law, regulations or the policy of the government that might have a negative impact on the entity,
- no insurance or insufficient insurance against outcomes of catastrophes,
- negative reports of analysts,
- the entity’s accounting value is higher than the market value.
The declaration regarding the continuation of operations is expressed in the introduction to the financial statement, whereby the head of the entity is obligated to take into consideration all the available information about the future. If there is a risk to the continuation of operations but the lack of continuation has not been determined yet, then the “Additional information and explanations” must indicate the risk for the continuation as well as the effort taken to maintain further functioning of the entity without considerable changes in their scope.
The very intent of the owners or the head of the entity, without facts that would confirm it such as putting the entity into liquidation, is insufficient to decide that the entity will not continue its operations without considerable changes in their scope.
If, as a result of an analysis carried out by the head of the entity, it becomes almost certain that the entity will not continue its operations in the foreseeable future, then the financial statement is drawn up with the assumption of lack of continuation of operations.
Putting or the risk of putting the entity into liquidation or bankruptcy means that the going concern principle is not met and it results in preparing a non-standard financial statement. In such a situation, the entity’s assets are valued at the achievable net sales prices lower than their accounting value.
It is stipulated in Art. 29 of the Polish Accounting Act
- If the assumed continuation of operations referred to in Art. 5 section 2 is unjustified, then the entity’s assets are valuated at the obtainable net sales prices not higher than their prices of purchase or manufacture, reduced by existing amortization or depreciation write-downs as well as impairment write-offs. In such cases, the entity is also obligated to establish a reserve for expected additional costs and losses caused by omission or loss of capacity to continue operations.
- The valuation at net sales prices and the establishment of the reserve take place, in particular, one day before the date when the entity is put into liquidation or its bankruptcy is announced, at the end of the financial year, if as of the date of approval of the financial statement for that financial year the entity will not continue its operations, at the end of the financial year falling within the period of liquidation or bankruptcy proceedings, as well as one day before the entity is transferred, divided or sold, if a relevant agreement does not allow accepting settlements of the value of assets determined upon assumption that the entity will continue its business activity.
2a. The difference resulting from the valuation and the establishment of the reserve referred to in section 1 influences the revaluation capital.
- Opening of restructuring proceedings or a change of the legal form of the entity do not constitute an obstacle for the assumption that the business activity will be continued.
Author: Bożena Wodarska – Accounting Manager at the MDDP Outsourcing branch in Katowice
Source:
Art. 5 section 2, Art. 29 and appendices (“additional information”) to the Polish Accounting Act.
National Accounting Standard no. 14 “Continuation of operations and accounting of entities upon lack of continuation of operations” (Official Journal of the Minister of Finance, Funds and Regional Policy of 2021, item 119)
