Subsequent events are in the spotlight these days. The Public Company Accounting Oversight Board (PCAOB) recently initiated a project to modernize outdated auditing standards related to these events. The PCAOB says the audit guidance hasn’t kept pace with changes in financial reporting frameworks, risk assessment methodologies and technological advancements. This has resulted in inconsistencies in how companies account for post-balance-sheet developments in their financial statements.
Deciding whether to report these events is one of the gray areas in financial reporting for public and private entities alike. Here are answers to some common questions about reporting subsequent events.
What are subsequent events?
Financial statements reflect a company’s financial position at a particular date and the operating results and cash flows for a period ended on that date. However, because it takes time to complete financial statements, there may be a gap between the financial statement date and the date the financials are available to be issued. During this period, unforeseeable events may happen in the normal course of business.
The term “subsequent events” refers to major events or transactions that happen after the reporting period ends but before financial statements are finalized. Examples include natural disasters, cyberattacks, regulatory changes and the loss of key customers.
When are subsequent events recognized on the financials?
Subsequent events are classified into two groups for accounting purposes:
1. Recognized subsequent events. These provide further evidence of conditions that existed on the financial statement date and, therefore, must be recorded in account balances reported on the financial statements. For example, the sudden bankruptcy of a major customer might require an adjustment to the company’s outstanding accounts receivables from this customer. There are usually signs of financial distress (such as late payments or staff turnover) months before a customer actually files for bankruptcy.
2. Nonrecognized subsequent events. These reflect conditions that arise after the financial statement date. Examples would be a tornado or earthquake that severely damages the business. A business usually has little or no advance notice that a natural disaster is going to happen. The details of such events may have to be disclosed in the footnotes.
When and how are subsequent events disclosed in the financials?
To decide which events to disclose in the footnotes, consider whether omitting the information about them would mislead investors, lenders and other stakeholders. Disclosures should, at a minimum, describe:
- The nature of the event,
- The estimated financial effect, if possible, and
- Potential business implications.
In some extreme cases, the effect of a subsequent event may be so pervasive that your company’s viability is questionable. This may cause your CPA to re-evaluate the going concern assumption that underlies your financial statements. Public companies should also evaluate whether subsequent events impact management’s discussion and analysis disclosures. And they need to determine whether additional risk factors should be included in filings with the U.S. Securities and Exchange Commission.
For more information
The PCAOB’s staff is currently analyzing relevant information and developing a proposal to update its guidance on subsequent events. The PCAOB sets standards for public company audits, not financial reporting standards. However, any changes to the auditing standards, if finalized, could indirectly affect financial reporting through increased auditor scrutiny. Companies may need to enhance their internal controls and documentation to meet updated auditing expectations. Moreover, PCAOB updates may influence future discussions on financial reporting standards related to subsequent events.
Contact us for the latest developments. We can help eliminate the guesswork in reporting subsequent events and ensure compliance with the accounting rules.
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