Question

Classify the following as either type 1 or type 2 events for a firm with a December 31st balance date.

(i) A fire on January 18th caused a material loss of inventory that was not covered by insurance

(ii) One month before balance date, the firm entered into a contract to purchase a new item of plant and equipment for $1m plus the cost of installing the item. Installation was completed on January 20th.

(iii) On January 5th a currency in which some of the firm’s sales contracts are denominated was depreciated.

Answer 1

Answer:

Type 1 Subsequent Events: These events are to be recognized in balance sheet as these events provide evidence of a condition existing before or on date of balance sheet.

Type 2 Subsequent Events: These events provide evidence regarding the conditions which did not exist on or before the date of balance sheet, Hence not recognized in Financial statements like balance sheet, P/L etc.,, rather they are just disclosed.

Classification:

(i) A fire on January 18th caused a material loss of inventory that was not covered by insurance

Event: Type 2 Event

Reason: Cannot be recognized as the conditions (Loss due to fire) before the date of balance sheet does not exist.

(ii) One month before balance date, the firm entered into a contract to purchase a new item of plant and equipment for $1m plus the cost of installing the item. Installation was completed on January 20th.

Event: Type 1 Event

Reason: This is because an agreement has been entered before the date of closing of balance sheet and that shall provide evidence regarding conditions existing before the date of balance sheet (Contract to purchase machinery entered before one month of balance sheet date closing), Hence this is a type 1 event.

(iii) On January 5th a currency in which some of the firm’s sales contracts are denominated was depreciated.

Event: Type 2 Event

Reason: Changes in the foreign exchange rate cannot be recognized in financial statements as the conditions (Change in rates after balance sheet date) about change in contract rates are not existing at the date of balance sheet, Hence cannot be recognized in financial statements, However, they are disclosed.

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