Which type of subsequent events requires consideration by management and evaluation by the auditor?

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Publication date: 29 Nov 2021   

us Financial statement presentation guide 28.4

As discussed in ASC 855-10-20, there are two types of subsequent events:

Excerpt of definition from ASC 855-10-20

1. The first type consists of events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements (that is, recognized subsequent events).
2. The second type consists of events that provide evidence about conditions that did not exist at the date of the balance sheet but arose subsequent to that date (that is, nonrecognized subsequent events).

Recognized subsequent events (see FSP 28.5) are pushed backed and recorded in the financial statements to be issued. Examples include the realization of a loss on the sale of inventory or property held for sale when the subsequent act of sale confirms a previously existing unrecognized loss. See FSP 28.5 for other examples.

Nonrecognized subsequent events (see FSP 28.6) are considered for disclosure based on their nature to keep the financial statements from being misleading. An example is a natural disaster that destroys a facility after the balance sheet date. See FSP 28.6.3 and 855-10-55-2 for other examples.

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What is a Subsequent Event?

A subsequent event is an event that occurs after a reporting period, but before the financial statements for that period have been issued or are available to be issued. Depending on the situation, such events may or may not require disclosure in an organization's financial statements. The two types of subsequent events are noted below.

Additional Information

An event provides additional information about conditions in existence as of the balance sheet date, including estimates used to prepare the financial statements for that period.

New Events

An event provides new information about conditions that did not exist as of the balance sheet date.

Subsequent Event Reporting

Generally accepted accounting principles state that the financial statements should include the effects of all subsequent events that provide additional information about conditions in existence as of the balance sheet date. This rule requires that all entities evaluate subsequent events through the date when financial statements are available to be issued, while a public company should continue to do so through the date when the financial statements are actually filed with the Securities and Exchange Commission. Examples of situations calling for the adjustment of financial statements are:

• Lawsuit. If events take place before the balance sheet date that trigger a lawsuit, and lawsuit settlement is a subsequent event, consider adjusting the amount of any contingent loss already recognized to match the amount of the actual settlement.

• Bad debt. If a company issues invoices to a customer before the balance sheet date, and the customer goes bankrupt as a subsequent event, consider adjusting the allowance for doubtful accounts to match the amount of receivables that will likely not be collected.

If there are subsequent events that provide new information about conditions that did not exist as of the balance sheet date, and for which the information arose before the financial statements were available to be issued or were issued, these events should not be recognized in the financial statements. Examples of situations that do not trigger an adjustment to the financial statements if they occur after the balance sheet date but before financial statements are issued or are available to be issued are:

• A business combination

• Changes in the value of assets due to changes in exchange rates

• Destruction of company assets

• Entering into a significant guarantee or commitment

• Sale of equity

• Settlement of a lawsuit where the events causing the lawsuit arose after the balance sheet date

A company should disclose the date through which there has been an evaluation of subsequent events, as well as either the date when the financial statements were issued or when they were available to be issued. There may be situations where the non-reporting of a subsequent event would result in misleading financial statements. If so, disclose the nature of the event and an estimate of its financial effect. If a business reissues its financial statements, disclose the dates through which it has evaluated subsequent events, both for the previously issued and revised financial statements.

Consistency in Disclosing Subsequent Events

The recognition of subsequent events in financial statements can be quite subjective in many instances. Given the amount of time required to revise financial statements at the last minute, it is worthwhile to strongly consider whether the circumstances of a subsequent event can be construed as not requiring the revision of financial statements.

There is a danger in inconsistently applying the subsequent event rules, so that similar events do not always result in the same treatment of the financial statements. Consequently, it is best to adopt internal rules regarding which events will always lead to the revision of financial statements; these rules will likely require continual updating, as the business encounters new subsequent events that had not previously been incorporated into its rules.

Example of a Subsequent Events Disclosure

The following is an example of a typical disclosure of a subsequent event:

The following events and transactions occurred subsequent to December 31, 20XX:

• The company concluded acquisition discussions with ABC Corporation, and paid $10,000,000 in cash to the shareholders of ABC on February 28, 20XX to acquire 100% of the outstanding shares of ABC.

• A jury found that the company was not liable in a lawsuit brought by Smith.

• The company's largest customer, Jones & Company, declared bankruptcy on February 10, 20XX. Given this new information, the company increased its reported allowance for doubtful accounts by $100,000, which is included in these financial statements.

What are the types of subsequent events the auditor should identify?

What are Type 1 and Type 2 subsequent events?

What are subsequent events in auditing?

Why is consideration of subsequent events an important part of the audit?