Assessing Events After the Balance Sheet Date
As an auditor, you must address all relevant events that take place after the balance sheet date but before you issue your report. For example, your audit client may be breathing a sigh of relief because a warehouse fire or a product liability lawsuit occurred after the balance sheet date. The client may assume an event like that doesn’t have to be included in this year’s audit report, but that’s not necessarily true. This section gives you the lowdown on what types of events you may encounter, how to look for them, and how to know which ones are important.
When doing an audit, two types of subsequent events require your attention. Following is a breakdown of these two types.
Type I events: These events affect your client’s accounting estimates and are on the books (but not confirmed) as of the balance sheet date. A good example is the client’s estimate for uncollectible accounts. This estimate is on the books at the balance sheet date, but your client can’t be sure of the estimate’s resolution until a subsequent event occurs, such as a customer filing for bankruptcy. At that point, your client confirms that the amount is actually uncollectible.
If the confirming event (such as the bankruptcy) occurs after the balance sheet date but before the financial statements are finalized, your client has to adjust its financial statements. It zeroes out the allowance for uncollectible accounts relative to this customer and reduces accounts receivable for the same amount.
Type II events: These events, also called nonrecognized events, aren’t on the books before the balance sheet date and have no direct effect on the financial statements under audit. The purchase or sale of a segment of the company, losses due to a fire or flood, and big sales of stock all fall into this category.
If these events are material (that is, their inclusion or exclusion may cause a reasonable person to change his opinion about the information), they have to be disclosed as footnotes in the financial statements (and you may even want to add a paragraph to your report explaining the situation), but the financial statements don’t have to be adjusted.
If a Type II event is significant enough that the financial statements may be misleading to users, you need to prepare pro forma financial information — that is, information that reflects how the financial statements would have looked if the event had taken place before the balance sheet date. The pro forma information is supplemental in nature, meaning that you usually add it to the financial statements as a schedule or footnote.
So what type of event is important enough to require either disclosure or pro forma treatment? With experience, you’ll be able to apply your professional judgment to make that evaluation. When you first start working as an auditor, rely on your audit supervisor for help with this question.