Question

What are subsequent events? Give 4 examples. What work is required to be performed by the auditor on these events? Differentiate between Type 1 and Type 2 subsequent events? What work is required for each type?

What two criteria must be met for the financial statements to be adjusted for a subsequent event?

Answer 1

What are subsequent events?

An independent auditor's report ordinarily is issued in connection with historical financial statements that purport to present financial position at a stated date and results of operations and cash flows for a period ended on that date. However, events or transactions sometimes occur subsequent to the balance-sheet date, but prior to the issuance of the financial statements, that have a material effect on the financial statements and therefore require adjustment or disclosure in the statements. These occurrences hereinafter are referred to as "subsequent events."

Give 4 examples. What work is required to be performed by the auditor on these events?

1. Read the latest available interim financial statements; compare them with the financial statements being reported upon; and make any other comparisons considered appropriate in the circumstances. In order to make these procedures as meaningful as possible for the purpose expressed above, the auditor should inquire of officers and other executives having responsibility for financial and accounting matters as to whether the interim statements have been prepared on the same basis as that used for the statements under audit.
2. Inquire of and discuss with officers and other executives having responsibility for financial and accounting matters (limited where appropriate to major locations) as to:

(i)	Whether any substantial contingent liabilities or commitments existed at the date of the balance sheet being reported on or at the date of inquiry.
(ii)	Whether there was any significant change in the capital stock, long-term debt, or working capital to the date of inquiry.
(iii)	The current status of items, in the financial statements being reported on, that were accounted for on the basis of tentative, preliminary, or inconclusive data.
(iv)	Whether any unusual adjustments had been made during the period from the balance-sheet date to the date of inquiry.
(v)	Whether there have been any changes in the company's related parties.
(vi)	Whether there have been any significant new related party transactions.
(vii)	Whether the company has entered into any significant unusual transactions.

1. Read the available minutes of meetings of stockholders, directors, and appropriate committees; as to meetings for which minutes are not available, inquire about matters dealt with at such meetings.
2. Inquire of client's legal counsel concerning litigation, claims, and assessments. [As amended, January 1976, by Statement on Auditing Standards No. 12.] (See section 337.)
3. Obtain a letter of representations, dated as of the date of the auditor's report, from appropriate officials, generally the chief executive officer, chief financial officer, or others with equivalent positions in the entity, as to whether any events occurred subsequent to the date of the financial statements being reported on by the independent auditor that in the officer's opinion would require adjustment or disclosure in these statements.The auditor may elect to have the client include representations as to significant matters disclosed to the auditor .
4. Make such additional inquiries or perform such procedures as he considers necessary and appropriate to dispose of questions that arise in carrying out the foregoing procedures, inquiries, and discussions.

Differentiate between Type 1 and Type 2 subsequent events? What work is required for each type?

The first type consists of those events that provide additional evidence with respect to conditions that existed at the date of the balance sheet and affect the estimates inherent in the process of preparing financial statements. All information that becomes available prior to the issuance of the financial statements should be used by management in its evaluation of the conditions on which the estimates were based. The financial statements should be adjusted for any changes in estimates resulting from the use of such evidence.

Examples of this type of subsequent event are as follows:

1. Declaration of bankruptcy by a customer with an outstanding accounts receivable balance due to the deteriorating financial condition.
2. Settlement of a litigation for an amount different from the amount recorded on the books.
3. Disposal of equipment not being used in operations at a price below the current book value.
4. Sale of investments at a price below recorded cost.
5. Sale of raw material as scrap in the period subsequent to the balance sheet date.

The second type consists of those events that provide evidence with respect to conditions that did not exist at the date of the balance sheet being reported on but arose subsequent to that date. These events should not result in adjustment of the financial statements. Some of these events, however, may be of such a nature that disclosure of them is required to keep the financial statements from being misleading. Occasionally such an event may be so significant that disclosure can best be made by supplementing the historical financial statements with pro forma financial data giving effect to the event as if it had occurred on the date of the balance sheet. It may be desirable to present pro forma statements, usually a balance sheet only, in columnar form on the face of the historical statements.

Examples include the following:

1. Decline in the market value of securities held for temporary investment or resale.
2. Issuance of bonds or equity securities.
3. Decline in the market value of inventory as a consequence of government action barring further sale of a product.
4. Uninsured loss of inventories as a result of fire.