Identify And Classify Subsequent Events
Help Questions
CPA Financial Accounting and Reporting (FAR) › Identify And Classify Subsequent Events
Which of the following best describes a recognized subsequent event (Type I)?
An event that provides evidence about conditions that did not exist at the date of the balance sheet but arose subsequent to that date.
An event that is material in nature and requires pro forma financial statements to be presented.
An event that occurs after the financial statements have been issued to external stakeholders.
An event that provides additional evidence about conditions that existed at the date of the balance sheet.
Explanation
A recognized subsequent event, also known as a Type I event, provides new or better evidence about conditions that were already in existence at the balance sheet date. These events require an adjustment to the amounts in the financial statements. An example is the settlement of a lawsuit for a different amount than accrued, where the cause of the lawsuit existed at year-end.
A non-recognized subsequent event (Type II) requires disclosure in the financial statements but no adjustment. What is the primary characteristic of such an event?
It confirms a loss contingency that was previously deemed remote at the balance sheet date.
It results from conditions that arose after the balance sheet date and did not exist at that date.
It corrects a material error discovered from the prior year's financial statements.
It involves a change in an accounting estimate based on new information about conditions existing at the balance sheet date.
Explanation
A non-recognized subsequent event, or Type II event, pertains to conditions that did not exist at the balance sheet date but arose afterward. These events do not result in adjustments to the financial statements but may require disclosure to prevent the financial statements from being misleading. Examples include fires, floods, or issuance of debt after the balance sheet date.
How should the company account for this event in its Year 1 financial statements?
Reclassify the receivable as a non-current asset.
Adjust the Year 1 allowance for doubtful accounts to reflect the loss.
Record a loss in the Year 2 income statement.
Disclose the bankruptcy in the notes but make no adjustment to the financial statements.
Explanation
The customer's bankruptcy is a recognized (Type I) subsequent event because it confirms a condition—the customer's deteriorating financial health and the uncollectibility of the receivable—that existed at the December 31, Year 1 balance sheet date. Therefore, the company must adjust its Year 1 financial statements by increasing the allowance for doubtful accounts and recognizing the related bad debt expense in Year 1.
What is the proper accounting treatment for the fire loss in the company's December 31, Year 1 financial statements?
Record the loss as a prior period adjustment to retained earnings.
Disclose the nature of the event and the estimated financial impact in the notes to the Year 1 financial statements.
Neither adjust the financial statements nor provide any disclosure for the event.
Record a loss of \$5,000,000 on the Year 1 income statement.
Explanation
The fire is a non-recognized (Type II) subsequent event because the condition (the fire) did not exist at the balance sheet date. It arose entirely in the subsequent period. Therefore, no adjustment should be made to the Year 1 financial statements. However, because the loss is material, it must be disclosed in the notes to the Year 1 financial statements to prevent them from being misleading. The disclosure should include the nature of the event and an estimate of the financial effect.
How should the bond issuance be reflected in the December 31, Year 1 financial statements?
The transaction should be recorded as a prior period adjustment to retained earnings in the Year 1 financial statements.
No recognition or disclosure is required in the Year 1 financial statements because the transaction occurred in Year 2.
The transaction should be disclosed in the notes to the December 31, Year 1 financial statements.
The bond liability and related cash should be accrued on the December 31, Year 1 balance sheet.
Explanation
The issuance of bonds is a non-recognized (Type II) subsequent event because the obligation to repay the debt did not exist at the balance sheet date. The transaction does not affect the financial position at December 31, Year 1. However, a significant issuance of debt is typically a material event that should be disclosed in the notes to the Year 1 financial statements to inform users about significant changes in the company's capital structure.
What amount of loss from this lawsuit should be reported in the company's Year 1 income statement?
\$750,000
\$150,000
\$0
\$900,000
Explanation
The settlement of the lawsuit is a recognized (Type I) subsequent event as it provides a more precise measurement of a condition that existed at the balance sheet date. Therefore, the financial statements for Year 1 must be adjusted to reflect the actual settlement amount. The total loss to be recognized in the Year 1 income statement is the full \$900,000.
As a result of this subsequent event, what is the additional bad debt expense the company should recognize for Year 1?
$40,000
$80,000
$120,000
$0
Explanation
Alpha Co.'s bankruptcy is a recognized (Type I) subsequent event because it confirms the uncollectibility of a receivable that existed at year-end, stemming from a condition (financial distress) that also existed at year-end. The company must adjust its Year 1 financials. The entire $120,000 receivable from Alpha is now deemed uncollectible. Since the company already has a $40,000 allowance for doubtful accounts that can be applied to this loss, the additional bad debt expense needed is $80,000 ($120,000 total loss - $40,000 existing allowance).
Under U.S. GAAP, through which date must the company evaluate subsequent events?
The date the 10-K is first read by an investor.
February 28, Year 2
December 31, Year 1
March 12, Year 2
Explanation
For an SEC filer (a public business entity), subsequent events must be evaluated through the date the financial statements are issued. The date of issuance for an SEC filer is the date the financial statements are filed with the SEC. In this case, that date is March 12, Year 2.
A company experiences a material subsequent event related to a condition that arose after the balance sheet date. If nondisclosure of the event would cause the financial statements to be misleading, which of the following is required?
An adjustment to the financial statement balances and disclosure in the notes.
A pro forma presentation of the balance sheet only, as if the event had occurred at the balance sheet date.
Disclosure of the nature of the event and an estimate of its financial effect, or a statement that an estimate cannot be made.
A retrospective restatement of the financial statements in the following reporting period.
Explanation
For a non-recognized (Type II) subsequent event, no adjustment is made to the financial statement balances. However, if the event is material and nondisclosure would make the financial statements misleading, the entity must disclose the nature of the event and an estimate of its financial effect. If an estimate cannot be made, a statement to that effect is required.
How should the \$5 million note be presented on the December 31, Year 1 balance sheet?
As a current liability, with no disclosure required until the Year 2 financial statements.
The liability should be removed from the balance sheet and disclosed only.
As a current liability, with disclosure of the refinancing agreement.
As a noncurrent liability, with disclosure of the refinancing agreement.
Explanation
Under U.S. GAAP, a short-term obligation may be reclassified as noncurrent if the company has the intent and ability to refinance it on a long-term basis. A binding refinancing agreement that is executed after the balance sheet date but before the financial statements are issued provides evidence of this ability. Therefore, the note should be reclassified as a noncurrent liability on the December 31, Year 1 balance sheet, and the nature of the agreement must be disclosed in the notes.