Major events or transactions can happen after a reporting period ends but before financial statements are finalized. Deciding whether to report these so-called subsequent events is one of the gray areas in financial reporting. Here’s some guidance from the American Institute of Certified Public Accountants (AICPA) that CPAs use to determine the appropriate accounting treatment.
When to report it
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 might be a gap between the financial statement date and the date the financials are available to be issued. During this period, unforeseeable events — such as a natural disaster, a cyberattack, a regulatory change, or the loss of a large business contract — may happen in the normal course of business.
Guidance from the American Institute of Certified Public Accountants (AICPA) is the standard used by CPAs to make that call. The AICPA’s Financial Reporting Framework for Small- and Medium-Sized Entities classifies subsequent events into two groups:
- Recognized subsequent events. These provide further evidence of conditions that existed on the financial statement date. An example would be the bankruptcy of a major customer, highlighting the risk associated with its accounts receivable. There are often signs of a company’s financial distress — such as late payments or staff turnover — months before its bankruptcy filing.
- Unrecognized subsequent events. These reflect conditions that arise after the financial statement date. An example could be a tornado or earthquake that severely damages the business. There’s usually little or no advanced notice that a natural disaster is going to happen.
Generally, the former must be recorded in the financial statements. The latter events aren’t required to be recorded, but the details may have to be disclosed in the footnotes.
When to disclose it
When deciding which events to disclose in the footnotes, consider whether omitting the information about them might mislead investors, lenders, and other stakeholders. Disclosures should describe the nature of the event and, if possible, estimate the financial effect.
The going-concern assumption
In rare situations, the effect of a subsequent event may be so pervasive that the viability of the business is questionable. A rapid deterioration in operating results or financial position after the date of the financial statements may call into question whether it’s appropriate to use the going-concern assumption. Under U.S. Generally Accepted Accounting Principles (GAAP), financial statements are normally prepared based on the assumption that the company will continue normal business operations into the future. It’s up to the company’s management to decide whether there’s a going-concern issue and to provide related footnote disclosures. But auditors still must evaluate the appropriateness of management’s assessment.
If management identifies that a going-concern issue exists, it should consider whether any mitigating plans will alleviate the substantial doubt. Examples of corrective actions include plans to raise equity, borrow money, restructure debt, or dispose of an asset or business line. When liquidation is imminent, the liquidation basis of accounting may be used instead of the going-concern basis.
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