 Hello and welcome to this session. This is Professor Farhad and this session we would look at the going concern assumption, a topic that's covered in intermediate accounting as well as the CPA FAR section exam. As always, I would like to remind you to connect with me on LinkedIn if you haven't done so. YouTube is where you would need to subscribe. I have 1,600 plus accounting, auditing, finance and tax lectures. This is a list of all the courses that I cover, including many CPA topics. On my website, which is farhadlectures.com, you can find additional resources such as PowerPoint slides, true, false, multiple choice, exercises. If you're studying for your CPA exam, 2,000 plus CPA question. This is a list, not a complete list, of all the courses that I cover. So if you are an accounting student or a CPA candidate, especially if you're a CPA candidate and you're interested in your success on the exam, I can help you add those seven to 10 points to your score. So I strongly suggest you check it out. So let's talk about the going concern assumption. And first we wanna talk about what is the big idea? Why do, what's the big idea about the going concern? Okay, well, you have to understand that we assume that we're gonna be in business forever. Okay, that's the assumption that we make when we record financial transaction. And the presumption is fair because when you go in business, you're gonna be in business forever, okay? So you have no intention or necessity to close the business. So when we are in business, we assume, it's we assume. So notice the word assume, that's very important to understand that we assume we are in business. We have no plan on closing. Now, under what circumstances do we make another assumption? In other words, under what circumstances we say we have a substantial doubt that we're not gonna be in business. Well, here we go. If conditions and events exist, makes it more likely than not that the entity cannot meet its obligation as they come to within one year from issue report date. What does that mean? Simply put, if there are certain conditions and event, which we'll talk about those certain conditions and event shortly, if there's anything that's gonna raise suspicious, that's gonna raise doubts that we are not gonna be a going concern we're gonna be out of business. For some reason, then we have to do something. And that's why we need to talk about going concern assumption. Now, who makes this assessment? And when? Well, management. Management will have to make this assessment. Now, if you study auditing, you have to understand too that in auditing too, we have to do a going concern evaluation. But here we're not talking about the auditing part. We're talking about preparing financial statements. In this requirement is fairly new. I believe 2014, they started requiring, doing a going, requiring a going concern assumption when you are preparing financial statements. And when do you have to do this assumption? It's when you prepare your annual and not or, yeah, I mean, or, I mean, or your interim financial statements. So every, every three months when you prepare your financial statements, you have to make this assumptions. Now, often time, often time you don't have to worry about it. There's no conditions or event exists that's going to make it more likely than not. But if there is any, and we're going to talk about those, then we have to deal with those. Now the question is, why do we care about this going concern assumption? And why is this an issue in the first place? Now, think of it from your, if you are an investor or a creditor, think of it from that perspective. Well, you're looking at the business and when you invest in a business, you always, when you invest, when you make an investment, you are looking into the future. That's what you are looking. You are always looking into the future. And that's why in accounting, we have what's called capital expenditure. And that's why we have something called revenue expenditure. What does it mean capital expenditure? It means when we spend money on something, when we buy an asset, when let's not call it an asset, when we buy something, if we think it's going to provide the future benefit, we treat it as an asset. Versus, if we don't think it's going to provide future benefit, we treat that something as an expense. Now think about it. If we are not going to be in business in the foreseeable future, if we're going to go out of business, whether it's voluntary or not, let's assume it's involuntary. We're running into troubles and we have to go out of business. Well, there's no reason to hold assets because the definition of an asset is there's a future benefit in the asset. And that's why we depreciate, for example, if we have property, plant and equipment, what do we do with those? We depreciate them. We depreciate property, plant and equipment and we depreciate them over several years. Two, three, four, five years. What's implied in that is we're going to be in business in the foreseeable future. If that assumption is violated, therefore say no, we're not going to be in business, then there's no need to do, there's no need to be to have an asset, there's no need for depreciation. What else do we have to do? Well, there's no asset necessary. If we have any assets, if we have property, plant and equipment, now we need to sell them. When we need to sell them, most likely they're going to go down in value because we're going to sell everything all at once. Also inventory. When we have inventory and we need to liquidate, we have to sell them immediately. We have to put them on sale. That's going to affect devaluation. How much are they reported at? Also, when you sell those property, plant and equipment, or when you attempt to sell them, or when you write them down, you're going to have losses. And when you have losses, your gross profit will go down, you might violate your debt covenant as a result. Some of the debt may need to be reclassified from, for example, long-term into short-term because your debt becomes due. If you're closing your business, your lenders, your bankers, they want their money immediately. They want their money too. Therefore, that long-term debt, that you classified as long-term, that long-term debt, well, you have to switch it to short-term debt. So you have an issue with classification. And what happened under those circumstances when liquidation is imminent? It means that basically we're going out of business when liquidation is imminent. We have to use liquidation basis of accounting, which is kind of bankruptcy accounting. And to tell you a small story about this, when I started my career, say 2005, 2006, as a CPA, by 2007, 2008, and if you know anything about those years, this was the financial crisis. And at that time, I was planning to make a move. I was planning to go to another CPA firm and kind of planning to move. And at that time, all jobs or most jobs in CPA companies, they would say, if you have a relevant experience and liquidation basis, why? Because around that time, what's happening, most construction companies, most companies related to real estate, they were going out of business. So all the accounting that you learn, that you learn in college, it basically is irrelevant. Why? Because you need to use the liquidation basis. And I still remember, I was like, I was like, what is liquidation basis of accounting? And most jobs, I would see this ad that liquidation basis of accounting. Well, it means how much money are you gonna get out of the company? Basically, liquidate everything, bring everything at fair value, report that fair value, because investors and creditors, investors and creditors are interested in how much they're gonna get out of the business. Therefore, liquidation basis becomes more relevant to them. So this is only if bankruptcy is imminent. Now, what factors do management consider when they're evaluating this going concern? So what do they look at? They look both at qualitative and quantitative factors. What could be some factors? You would look at liquidity position, like you would look at cash ratios, cash to short-term debt, cash to long-term debt, cash to free cash flow, any cash position, your liquidity position, you look at funding to operate the business. Do you have enough money if you need property, plant and equipment? Do you have enough money to replace your old asset? Do you have enough money to operate your business? Maintain the equipment, so on and so forth. You could look at debt dues within the next 12 months. Can you pay those debt? Do you have enough cash on hand? Also, you would look at non-quantitative, like qualitative, like industry condition. Is your industry deteriorating? Well, you're gonna be in trouble. Do you have competition that's really eating your lunch? You're gonna be in trouble. Do you have any negative financial trends overall? Is sales going down constantly? Your profit is going down. You're being squeezed. Your cost is going up. Negative financial trends. You would look at all of those. Now, this is not a complete list, obviously, but the point is to tell you that that's what management would look at. And it's hard for management to admit. It's hard for management to admit. It's hard for management to admit what's going on. I mean, it's hard, but they have to face the music. They have to face reality, okay? So let's assume they did kind of determine, yes, there is a going concern issue. There's a substantial doubt. Then what needs to be done? Then this is the important thing. What needs to be done? At least you have to disclose in the financial statements. And simply put, this is the cracks of the story. Like you have to disclose. You have to tell us what's going on. Why? There are 18 reasons, reason or reasons or events that lead to the substantial doubt. Why? Is it lack of capital? Are you running out of money? You're not being financed. You cannot refinance your debt. You cannot ask for money from the capital market. Are you behind your technology? Is technology moving ahead of you and you are behind? Are you have any legal factors? Did you lose any, any battle, legal battle that's gonna affecting your company substantially? Those are events or reasons. And those are not the only one, but those are the things that I can think of that the company would evaluate, will take into consideration whether we have a serious doubt about our going concern. Three, they have, management will have to show, evaluate those reasons and event. Basically they have to tell us, what's going on with those? Not only list them, give us more information. Then they have to tell us what's the plan to mitigate those conditions and events? And this is important because what happened at the end of the day, we want to know if you're aware of these things, we're investors, we're creditors and you have potential investors and potential creditors waiting. Tell us, what is your plan? Convince us, can you convince us that you have enough plan that we're gonna get out of it, okay? And what we do is we, you have to tell us the probability of implementation and success. What is the probability of implementing what you want to do? You know, turn around sales. How are you gonna do that? Raise money, how are you gonna do that? Are you negotiating with banks? Do you have good connection to the financial industry? Is an investment bank helping you issue new stocks? And what is the success rate? Are you gonna succeed? Why? Because this is important. If you could implement and after implement, successfully execute what you want it to do. So this is basically in a nutshell, you know, the going concern, like what's next? Now, what's the issue? Again, if liquidation is imminent, we just start to use liquidation basis of accounting. And this is basically what you need to know for the CPA exam in a nutshell. I always, I would like to remind you to visit my website. Also, if you're studying for your exam, look, you're gonna study and make an investment in your lifetime. Please check out my website. You have more resources, more lectures that's gonna help supplement whatever you are doing. And if you like this video, please click on the like button. It helps me tremendously. Study hard, CPA is worth it. Good luck.