Subsequent Events
1 Event after the reporting period
Now we are going to look at the effect of events which occur after the end of the reporting period but before the financial statements have been approved. These events fall into two types.
An adjusting event as its name might suggest, means that the accounts have to be adjusted in the light of what’s happened. The rule is that adjustments must be made if the event provides evidence of conditions that existed at the end of the reporting period (the reporting date).
An example would be a major customer going into liquidation, let’s say at the end of January, the year end was the end of December. That event tells us that the receivable at the end of December was probably bad and should have been written off or an allowance made. It’s very unlikely that the customer’s financial position worsened so remarkably during January. What the liquidation tells us is that the customer was in the bad situation at the end of December and if only we had known that then the receivable would have been written down.
A non-adjusting event relates to conditions which arose after the reporting date.
A good example is the company’s factory burning down, let’s say in mid-January. At the end of December the company’s factory was perfectly fine, it was standing, it was operating, it was a non-current asset. It was only after the end of the year that it was destroyed. If the statement of financial position is telling us the position at the year end, then the factory would have to appear in non-current assets. It would be, of course, important to disclose in the notes that the factory was no more. This will be a good example of an emphasis of matter paragraph in the auditor's report.
2 'Active' and 'passive' duty
2.1 Active duty
Until the auditor's report is signed auditors have an active duty to look out for events that might tell them more about the financial statements.
For example, examining cash receipts from year-end trade receivables, examine sales in the new year to see if inventory was properly valued, examining board minutes. The letter of representation would also allude to events after the period end.
2.2 Passive duty
After signing the auditor’s report, the auditors have a passive duty only. Occasionally events will occur after the accounts have been signed and issued and these come to the auditor’s attention. Exceptionally it may be important for the addressees of the auditor’s report to be made aware that something is wrong in the accounts. The auditor would then discuss with the directors the need to re-issue amended financial statements.
2.3 Amended financial statements
If management agrees to amend the financial statements, the auditor must:
withdraw the 'old' report
extend audit procedures, including subsequent review procedures, to the date of the new report
issue a new report on the amended financial statements.
If management refuses to amend the financial statements, the auditor should take legal advice and consider any legal rights or obligations to inform the shareholders that the audit opinion cannot be relied on (e.g. to speak at a general meeting).
You should appreciate why amended financial statements are very rare in practice:
Audited financial statements are published more than a few months after the reporting date (e.g. UK public companies must file accounts within 6 months), so it is unlikely that something would happen so long after the year end of such significance that it would call for amendment.
Private companies generally publish financial statements even later (e.g. within 9 months in the UK), so next year’s audit is already on the horizon or may even have started already.
Even if the subsequent event points to something that occurred before the issue of the financial statements, the risk to the auditor’s professional liability may be very low (i.e. very low risk that it affects shareholders’ reliance on the audit opinion).