When auditors have doubts about the company's ability to continue as a going concern, investors are likely to take that as a sign of increased risk.
Accounts are prepared and presented based on what are called three `fundamental accounting assumptions'. Foremost of these is the `going concern' assumption. "The enterprise is normally viewed as a going concern, that is, as continuing in operation for the foreseeable future," explains the first Accounting Standard (AS) of the Institute of Chartered Accountants of India (ICAI). Seen thus, going concerns have ``neither the intention nor the necessity of liquidation or of curtailing materially the scale of the operations''.
The other two assumptions are `consistency' (that is, accounting policies are consistent from one period to another), and `accrual' (meaning, revenues and costs are accrued, that is, recognised as they are earned or incurred). Disclosure is necessary if these assumptions are not followed.
If a public company reports that its auditors have doubts about its ability to continue as a going concern, investors are likely to take that as a sign of increased risk, states Wikipedia in a page on `going concern'. Which is what might have happened in at least ten cases of limited reviews filed by companies over the last three months. Take for instance, the limited review of Alcobex Metals Ltd, where the auditors sombrely observe, "The accumulated losses of the company have exceeded the net worth of the company and the company has been incurring cash losses for the past few years. However, the accounts of the company have been prepared on the basis of going concern assumption."
Similarly short is the observation in the case of Jamshri Ranjitsinghji Spinning & Weaving Company Ltd, as follows: "The company has been incurring continuing losses resulting in the erosion of its net worth. Despite this aspect, the financial statements of the company have been prepared on a going concern basis."
In the limited review of Switching Technologies Gunther Ltd, the company's auditors have stated, "Despite substantial erosion of net worth of the company, the accounts for the quarter have been prepared on the basis that the company is a going concern." Shriram Asset Management Company Ltd makes it briefer by simply giving a reference to a note to the accounts `regarding appropriateness of going concern assumption'.
And Tamil Nadu Telecommunications Ltd has informed BSE that in the limited review report of the company for the period ended September 30, 2006, the auditors of the company have observed: "Preparation of accounts on going concern basis despite substantial losses, which exceeds the company's net worth and consequent reference to BIFR (Board of Industrial and Financial Reconstruction), the impact of which on the financial results of the company is not ascertainable... " Time to come to terms with `going concern'.
`Going concern' defined
The phrase `going concern' is explained concisely as `a thriving business', on www.askoxford.com. Encarta says, `Successful business,' and elaborates as follows: "A business that is operating successfully and is likely to continue to do so, especially when considered as an asset to which a value can be assigned."
Oxford Dictionary of Business offers a detailed definition of `going concern concept' after the `godfather offer' entry. It runs as follows: "A principle of accounting practice that assumes businesses to be going concerns, unless circumstances indicate otherwise." This principle implies that "assets are shown at cost, or at cost less depreciation, and not at their break up values," and "liabilities applicable only on liquidation are not shown."
The `going-concern value' of a business is higher than the value that would be achieved by disposing of its individual assets, since it is assumed that the business has a continuing potential to earn profits. Another `going' phrase one comes across in the business lexicon is `going-rate pricing', which means "setting the price of products largely by following competitors' prices rather than by basing them on company costs or demand."
Going concern is the idea that a company will continue to operate indefinitely, www.investorwords.com states. "For this to happen, the company must be able to generate and/or raise enough resources to stay operational."
If a company is not a going concern, it means the company has gone bankrupt, notes www.investopedia.com. An entity is considered a `going concern' if it is able to pay its debts as and when they fall due, says www.abrema.net (`Activity Based Risk Evaluation Model of Auditing').
According to the site, matters that have the potential to affect the appropriateness of the going concern assumption (GCA), include: One, "Financial indications, such as a deteriorating accounts payable ratio, a deteriorating current ratio, fixed term borrowings approaching maturity without any prospect of replacement financing being available.
Two, "Operating indications, including loss of key management without replacement, loss of a major market segment, correspondence from suppliers requesting more stringent credit terms." And three, "Litigation, and in particular, whether there are any pending legal proceedings that could result in a judgement that may be incapable of being met."
How `going' gets tough
A little more detail, about how `going' turns questionable, emerges in the case of Alembic Glass Industries Ltd. In its limited review filed with the BSE, for the quarter ended September 30, 2006, the auditors have stated, among other observations: "No provision has been made by the company in respect of difference, if any, in the price of gas supplied by ONGC during the period January 30, 1987 to May 31, 1991 and interest for delayed payment thereon, the matter being sub-judice." And, "despite impending liability of ONGC on the company... accounts are continued to be prepared on a going concern basis." Don't ask how much, though, because the effect is `not quantified/ quantifiable'.
Fairfield Atlas Ltd notes the auditors' reservations about ``the appropriateness of the going concern basis used for the preparation of the accounts in view of substantial erosion of net worth of the company arising from operating losses.'' The company, however, justifies that `no adjustment has been made to write down the assets to net realisable value' because `the principal shareholder, Fairfield Manufacturing Company Inc, US, has informed the company of its intention of providing financial support to the company to meet its obligations, as they fall due.' Perhaps, the obligations are yet to fall due.
The tale of Ispat Profiles India Ltd is dismal. Its net worth has been fully eroded, and the production process, suspended since October 22, 2000, as one learns from the auditors' limited review. "The company has further received notice from some of its secured lenders under Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002, which the company has challenged." As a result, "The going concern concept will hold good depending upon the receipt of support from its bankers, financial institutions and promotes etc," note the auditors. "Necessary adjustment may have to be made to the value of assets and liabilities in case the going concern concept is vitiated."
Not too different is Scindia Steam Navigation Company Ltd's situation. "The shipping operations of the company stand suspended. Further, the company has continuously incurred losses (other than profit on sale of properties) during the quarter and thereby the net worth of the company has been totally eroded and a substantial loss is carried forward as at September 30, 2006." Despite this, the company's accounts have been prepared on a going concern basis, `in the absence of adequate data and information for its compilation on an alternative basis'.
A case of the tough trying to get going when the going gets tougher by the quarter?