Major events or transactions may happen after the reporting period ends but before financial statements are finalized. The decision of whether to report these so-called 鈥渟ubsequent events鈥 is one of the gray areas in financial reporting. Here鈥檚 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鈥檚 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 鈥 such as a natural disaster, a cyberattack, a regulatory change or the loss of a large business contract 鈥 may happen in the normal course of business. Should these items be reported on your financial statements?
Chapter 27 of the AICPA鈥檚 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 usually signs of financial distress (such as late payments or staff turnover) months before a bankruptcy filing.
- Nonrecognized subsequent events. These reflect conditions that arise after the financial statement date. An example would be a tornado or earthquake that severely damages the business. There鈥檚 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鈥檛 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 would mislead investors, lenders and other stakeholders. Disclosures should, at a minimum, describe the nature of the event and estimate the financial effect, if possible.
In some extreme cases, the effect of a subsequent event may be so pervasive that your company鈥檚 viability is questionable. This may cause your CPA to re-evaluate the going-concern assumption that underlies your financial statements.
When events affect the going-concern assumption
In rare situations, the effect of a subsequent event may be so pervasive that the viability of the whole business (or a part of it) is questionable. A rapid deterioration in operating results or financial position after the date of the financial statements may call into question whether it鈥檚 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鈥檚 up to the company鈥檚 management to decide whether there鈥檚 a going-concern issue and to provide related footnote disclosures. But auditors still must evaluate the appropriateness of management鈥檚 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.
When in doubt
In today鈥檚 uncertain marketplace, conditions are ever-changing. By the time your company issues its year-end financial statements, you may be dealing with a major development that鈥檚 affecting the company鈥檚 performance. If you鈥檙e unsure how to handle a subsequent event, contact your accounting professional for guidance to help clarify matters.
漏 2023