The meaning of ‘going concern and gone concern’ entities

In accounting parlance, a going concern is a business that is assumed to be able to meet its financial obligations when they become due. In the case of a ‘Going Concern’ entity, statutory auditors do not foresee the threat of liquidation for the foreseeable future, which is usually regarded as at least the next 12 months or the specified accounting period.

On the other hand, a ‘Gone Concern’ is an entity that is either already in such a liquidation state or is likely to enter in the near future. The “gone concern” terminology derives from declarations made by financial auditors.

The ‘going concern and gone concern’ concept is important in bank prudential regulation and capital requirements. According to capital adequacy regulations, going concern shall be fully effective as loss-absorbing capacity, capital should absorb losses when the entity is still a going concern (and not yet a ‘gone concern’). Gone-concern capital is the capital that will absorb losses only in a situation of liquidation of the bank.

Sufficient capital is required by banks to absorb any losses that arise during the normal course of the bank’s operations. The Capital of a bank is divided into different tiers according to the characteristics/qualities of each qualifying instrument. The Basel III framework tightens the capital requirements by limiting the type of capital into two categories viz. Tier I and Tier II for supervisory purposes of capital. Basel III accord also recommends the Common Equity component in Tier 1 (CET1) capital.

Basel III also introduced an explicit going- and gone-concern framework by clarifying the roles of Tier 1 capital (going concern) and Tier 2 capital (gone concern), as well as an explicit requirement that all capital instruments must be able to fully absorb losses at the so-called point of nonviability (PoNV) before the stakeholders are exposed to loss.

In addition, regulatory deductions from the capital and prudential filters have been harmonised internationally and are mostly applied at the level of common equity. To enable market participants to compare the capital adequacy of banks across jurisdictions it is essential that banks disclose the full list of regulatory requirements, aimed at improving the transparency of banks’ capital bases and in this way improving market discipline.

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