Closely Held Firms As Going Concerns

This current GAAP determination of a going concern is shortsighted for two important reasons. The most important deals with creditors and other stakeholders involved with the business. Do they enter into contracts with the business or with the individual owner/manager? Currently, they contract with both since, in reality, they make no determination whether a separate firm (entity) exists. The second deals with valuing a business. If the business is not really a separate going concern, it would typically be valued as the sum of its individual assets instead of the present value of its future cash flows. Many times when buying a business, the acquirer is really just buying the assets to start his own business. This is particularly true in most service businesses. The purpose of this paper is to advocate reintroducing a qualification to the going concern audit opinion when an entity separate from its owner/manager does not exist. Criteria for determination are also proposed. Arguably, this will make audited accounting statements more meaningful for closely-held firms. More important, this should produce information useful for potential creditors and outside owners. Traditionally, banks have extended loans to small, closely-held firms with only compiled statements; there was no need to provide audited statements. However, the process of lending is changing from a direct, face-to-face process between borrower and lender to an indirect one where credit scoring systems are used. Audited statements can provide better, higher quality information to lenders extending credit.