Fortbestehen

What Is Fortbestehen?

Fortbestehen, often translated as "going concern" in English, is a fundamental principle in Financial Accounting that assumes a business will continue to operate indefinitely, or at least for the foreseeable future, without the intention or necessity of liquidation. This assumption underpins the preparation of a company's Financial Statements, guiding how assets and liabilities are valued, and how revenues and expenses are recognized. If a company is considered a Fortbestehen, it means it is expected to meet its financial obligations as they become due in the ordinary course of business.

The Fortbestehen concept is crucial because it dictates that a company's Assets and Liabilities are recorded at historical cost rather than at their potential liquidation value. This avoids the immediate revaluation of every item on the Balance Sheet to its "fire sale" price, which would otherwise be necessary if the business was expected to cease operations. It also allows for the deferral of certain expenses, such as depreciation, over the useful life of assets, aligning with the ongoing operation of the entity.

History and Origin

The concept of a "going concern," or Fortbestehen, has deep roots in accounting, though its formalization within Accounting Standards is more recent. Historically, the idea of a business continuing its operations was an implicit understanding in the development of double-entry bookkeeping systems, dating back to the Renaissance period. Early accounting practices implicitly recognized that businesses were ongoing entities, not merely temporary ventures.

While the Fortbestehen assumption has long been recognized by accounting professionals, its explicit incorporation and the assignment of responsibility for its assessment to management within U.S. Generally Accepted Accounting Principles (GAAP) came with the issuance of Accounting Standards Update (ASU) No. 2014-15 by the Financial Accounting Standards Board (FASB) in August 2014. This standard, effective for annual periods ending after December 15, 2016, formally required management to assess a company's ability to continue as a going concern and provide related disclosures⁴. Similarly, International Accounting Standard (IAS) 1, "Presentation of Financial Statements," sets forth the requirement for management to make an assessment of an entity's ability to continue as a going concern when preparing financial statements under International Financial Reporting Standards (IFRS)³.

Key Takeaways

• Fortbestehen (going concern) is a fundamental accounting principle assuming a business will continue operating indefinitely.
• This assumption allows assets and liabilities to be valued at historical cost, not liquidation value.
• Management is responsible for assessing the company's ability to remain a Fortbestehen.
• Auditors evaluate management's assessment and provide an opinion on the financial statements, which may include a disclosure if significant doubt exists about the entity's ability to continue as a Fortbestehen.
• Factors like recurring losses, Liquidity issues, or defaults on Debt obligations can raise substantial doubt about a company's Fortbestehen.

Interpreting the Fortbestehen

Interpreting the Fortbestehen status of a company is critical for investors, creditors, and other stakeholders. When financial statements are prepared under the Fortbestehen assumption, users can infer that the company has a reasonable expectation of generating future cash flows, continuing its operations, and realizing its Assets and discharging its Liabilities in the normal course of business.

Conversely, if there is substantial doubt about a company's ability to continue as a Fortbestehen, this indicates significant financial distress. Such a determination typically means that conditions and events, when considered collectively, suggest it is probable the entity will be unable to meet its obligations as they become due within one year after the date the financial statements are issued. This situation often triggers additional disclosures in the financial statements, alerting users to the risks. An external Auditor will also evaluate management's assessment and may issue a modified Audit Opinion or add an emphasis-of-matter paragraph to highlight a Material Uncertainty related to the going concern.

Hypothetical Example

Consider a hypothetical company, "Alpha Innovations Inc.," a small tech startup. For several years, Alpha Innovations has reported consistent losses on its Income Statement, and its Cash Flow Statement shows negative cash flow from operations. The company's management, in preparing its latest annual financial statements, must assess its Fortbestehen status.

Management performs a detailed Risk Assessment, reviewing its financial forecasts, existing loan agreements, and available credit lines. They determine that without significant new funding, Alpha Innovations will be unable to meet its payroll and supplier payments within the next six months. This raises substantial doubt about the company's ability to continue as a Fortbestehen.

To address this, management outlines a plan: secure a new round of equity financing, significantly reduce operating expenses, and defer non-essential projects. If, after implementing these plans, management concludes that the substantial doubt about the Fortbestehen has been alleviated, they will disclose the original conditions, their evaluation, and the mitigating plans in the footnotes to the financial statements. If the doubt remains, even with the plans, they must explicitly state that substantial doubt exists.

Practical Applications

The Fortbestehen principle has broad practical applications across various financial domains:

• Financial Reporting: It is the foundational assumption for preparing Financial Statements under accrual accounting. Without it, companies would have to report assets at liquidation value, drastically altering financial representations.
• Auditing: Independent auditors are required to assess management's Fortbestehen evaluation. Their findings can impact the auditor's report, potentially leading to a qualified or adverse opinion or an emphasis-of-matter paragraph, which signals concerns to investors and creditors.
• Lending and Investment Decisions: Lenders and investors heavily rely on the Fortbestehen assumption. A company's inability to maintain this status can severely restrict its access to new capital. For instance, Power Solutions International Inc. resolved a previous "going concern" status by reducing its debt, which helped alleviate investor fears and boosted its stock value².
• Corporate Planning: Management uses the Fortbestehen assumption in long-term strategic planning, budgeting, and assessing the viability of new projects or investments. It influences decisions regarding Solvency and capital structure.
• Regulatory Oversight: Regulatory bodies like the Securities and Exchange Commission (SEC) monitor Fortbestehen disclosures to ensure transparency and protect investors from unexpected business failures.

Limitations and Criticisms

Despite its foundational role, the Fortbestehen assumption and its assessment face several limitations and criticisms:

• Subjectivity and Judgment: The determination of "substantial doubt" involves significant management and auditor judgment, making it susceptible to differing interpretations. The evaluation often relies on forecasts and plans, which inherently contain uncertainty.
• Look-Forward Period: Both U.S. GAAP and IFRS generally require an assessment for a period of at least 12 months from the financial statement date. Critics argue that this relatively short look-forward period may not capture longer-term risks that could affect a company's survival.
• Comparability Issues: Different interpretations and varying levels of disclosure among companies can lead to a lack of comparability in Fortbestehen assessments across entities, even those facing similar conditions¹.
• Late Warning Signal: A common criticism is that a Fortbestehen warning often comes too late to be truly useful to investors, as the underlying financial distress may already be widely known or reflected in market prices. Auditors are not responsible for predicting future events, and the absence of a Fortbestehen modification does not guarantee the company's survival.
• Mitigating Plans: Management's plans to alleviate substantial doubt are often prospective and may not always be successfully implemented, yet the alleviation of the doubt based on these plans may lead to less prominent disclosures.

Fortbestehen vs. Insolvency

Fortbestehen (going concern) and Insolvency represent two contrasting states of a business's financial health.

While Fortbestehen signifies a healthy and ongoing business, insolvency indicates a severe financial predicament where a company cannot fulfill its financial commitments. An Fortbestehen assessment identifies conditions that might lead to insolvency, serving as an early warning system. However, a determination that a company is not a Fortbestehen implies that it is on the path toward or is already experiencing conditions akin to insolvency, often necessitating a shift to a liquidation basis of accounting.

FAQs

Q1: What is the primary purpose of the Fortbestehen assumption?

The primary purpose of the Fortbestehen assumption is to provide a sensible basis for preparing Financial Statements. It allows accountants to value assets at their cost and defer expenses, reflecting the expectation that the business will continue its operations and realize the value of its assets over time, rather than liquidating them immediately.

Q2: Who is responsible for assessing a company's Fortbestehen status?

Under current Accounting Standards, management holds the primary responsibility for assessing a company's ability to continue as a Fortbestehen. External auditors then evaluate management's assessment and provide an opinion on whether the financial statements fairly present the company's financial position, including appropriate disclosures related to any Fortbestehen uncertainties.

Q3: What happens if a company is no longer considered a Fortbestehen?

If a company is no longer considered a Fortbestehen, it implies that its liquidation is imminent or unavoidable. In such cases, the company may be required to prepare its financial statements on a liquidation basis of accounting, which involves revaluing its Assets and Liabilities at their estimated realizable or settlement values, typically lower than historical cost. This provides a more accurate picture of what creditors and Shareholders might expect to receive.

Q4: Can a company recover its Fortbestehen status after receiving a warning?

Yes, a company can recover its Fortbestehen status. Management must develop and implement credible plans to mitigate the conditions that raised substantial doubt. These plans might include securing new financing, selling non-essential assets, restructuring Debt, or significantly cutting costs. If these plans successfully alleviate the doubt about the company's ability to continue operating, its Fortbestehen status can be restored, and future financial statements will reflect this improved outlook.

Q5: How long does the Fortbestehen assessment period typically cover?

The Fortbestehen assessment period typically covers at least 12 months from the date the financial statements are issued or available to be issued. This "look-forward" period is a key component of the assessment criteria established by major accounting bodies.