What are the two types of subsequent events that an auditor should consider how is each type treated in the financial statements?

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Publication date: 29 Nov 2021   

us Financial statement presentation guide 28.4

As discussed in ASC 855-10-20, there are two types of subsequent events:

Excerpt of definition from ASC 855-10-20

1. The first type consists of events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements (that is, recognized subsequent events).
2. The second type consists of events that provide evidence about conditions that did not exist at the date of the balance sheet but arose subsequent to that date (that is, nonrecognized subsequent events).

Recognized subsequent events (see FSP 28.5) are pushed backed and recorded in the financial statements to be issued. Examples include the realization of a loss on the sale of inventory or property held for sale when the subsequent act of sale confirms a previously existing unrecognized loss. See FSP 28.5 for other examples.

Nonrecognized subsequent events (see FSP 28.6) are considered for disclosure based on their nature to keep the financial statements from being misleading. An example is a natural disaster that destroys a facility after the balance sheet date. See FSP 28.6.3 and 855-10-55-2 for other examples.

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Subsequent Events Definition

The definition of a subsequent events are generally defined as events that occurs after the year end period but before the financial statements have been issued. A subsequent event falls underneath the disclosure principle and can be confusing to many accountants that encounter them. However, the codification provides guidance under ASC 855 subsequent events. This allows accountants to distinguish separate events and how to write subsequent events disclosure.

Subsequent Events Meaning

The problem arises for companies because subsequent event accounting could dramatically alter an investor’s opinion. It might be misleading to issue the statements as they are at period end. There are generally two types of subsequent events.
1)The first is a recognized event whereas the second is a non-recognized event. Recognized or type 1 subsequent events are typically events that occurred at the financial statement date. But that may have concluded after the year end. The financial statements must then be altered to include this event because it would be misleading not to list the event.
2) Type 2 or non-recognized events are then events that were not ongoing and occurred after the year end. These accounting subsequent events should not be disclosed within the current financials, but a subsequent event footnote disclosure should be made in the financials so that investors know that the event did occur.

Subsequent Events Examples

Type 1 event (recognized)

Honyota Inc., a car manufacturer, has had some ongoing litigation proceedings concerning the safety of its cars in the United States. Year end occurred a month ago but the financials have not been issued at this date, the litigations proceedings have finally concluded after months and Honyota will be required to pay $50 million in damages to various customers around the U.S. Honyota has accrued for this event since the litigation proceedings began and has gone ahead and paid the amount needed. Then recognize the event as a type 1 event because this has been ongoing for months. In addition, conclude the final amount paid.

Type 2 event (non-recognized)

After year end, Welder supply has lost one of its customers due to bankruptcy. Welder Supply has not issued it statements yet. Owen, an accountant, is trying to determine if he should recognize this event in the year end financials issued within a few days. Owen determines that the company does not need to recognize the change in accounts receivable because Welder Supply had no indication that its customer was in financial distress. Therefore, Owen should not recognize the event in the year end financials. Owen should however make a subsequent event note disclosure within them stating the event that did occur to prevent litigation from presenting misleading statements.
Note: An event of this type would include a small customer that suddenly declared bankruptcy. And the company had no idea before the year end date. This would cause the accounts receivable to change as the company expects not to collect.
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See Also:
Accounting Principles
Probable Losses
Contingent Liability
Accounting Changes

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