Subsequent events and going concern - Events after the repor...

Learning Outcomes

After reading this article, you will be able to identify and classify subsequent events as adjusting or non-adjusting in line with ISA 560 and IAS 10. You will understand the audit and reporting implications of events after the reporting period, the auditor's and directors' responsibilities for going concern, and the procedures required to assess going concern and subsequent events. You should be able to explain common exam scenarios and respond to reporting requirements involving these topics.

ACCA Audit and Assurance (AA) Syllabus

For ACCA Audit and Assurance (AA), you are required to understand the recognition and treatment of subsequent events under ISA 560 and IAS 10, and your audit responsibilities regarding going concern. Focus your revision on:

• The purpose and process of a subsequent events review under ISA 560 and IAS 10.
• Audit procedures to identify subsequent events and determine the correct financial statement treatment.
• The distinction between adjusting and non-adjusting events and their disclosure or adjustment requirements.
• Directors’ and auditors’ responsibilities in relation to going concern.
• How to identify indicators of going concern issues.
• The audit procedures for assessing going concern and the impact on the auditor’s report.
• The reporting implications if subsequent events or going concern issues are not dealt with appropriately.

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. What is the difference between an adjusting and a non-adjusting event after the reporting period? Give an example of each.
2. What period does the auditor’s active duty to identify subsequent events cover?
3. If a material subsequent event provides evidence of a condition that existed at the reporting date, what is the correct accounting treatment?
4. List two possible indicators that a company may not be a going concern.
5. What should an auditor do if management refuses to make necessary adjustments for a material subsequent event?

Introduction

Events can occur after the reporting period but before the financial statements are approved. Some of these events require the financial statements to be adjusted or disclosed, while others have no impact. An effective review of subsequent events ensures the financial statements present a true and fair view and comply with the applicable framework.

ISA 560 and IAS 10 provide guidance for the identification, evaluation, and reporting of subsequent events. In addition, ISA 570 and accounting standards address the going concern assumption, which is fundamental to audit reporting. A robust understanding of these issues is essential when finalising the audit and before issuing your report.

Key Term: subsequent event
An event occurring between the end of the reporting period and the date the financial statements are authorised for issue, or facts discovered after that date.

Identifying Subsequent Events

The time between the reporting period end and the date the auditor's report is signed is critical. Events identified within this period may indicate the need for adjustment or disclosure.

Periods of Auditor Responsibility

• Active period: From period end to the date the auditor's report is signed. The auditor must perform procedures to identify events needing adjustment or disclosure.
• Passive period: After the auditor's report is signed, but before the financial statements are issued. The auditor has no duty to seek out events, but must act if relevant facts are discovered.

Key Term: adjusting event
An event after the reporting period that provides further evidence of conditions existing at the reporting period end and requires adjustment to the financial statements.

Key Term: non-adjusting event
An event after the reporting period that relates to conditions that arose after the reporting date. It is not adjusted in the financial statements but may require disclosure if material.

Worked Example 1.1

A company’s year end is 31 December 20X4. On 10 February 20X5, a major customer owing $100,000 at year end is declared bankrupt after negotiations about overdue payments. Should this be treated as adjusting or non-adjusting, and what are the financial statement implications?

Answer:
This is an adjusting event. The customer’s financial difficulties existed at 31 December 20X4 and the bankruptcy provides further evidence on recoverability. The receivable should be written off or an allowance recognised at year end.

Types of Subsequent Events

• Adjusting events: Provide more evidence about conditions at the reporting date. Examples include settlement of litigation started before year end, insolvencies of debtors, or correction of errors.
• Non-adjusting events: Arise from new conditions after the reporting period. Examples are natural disasters, major acquisitions, or new significant litigations.

Worked Example 1.2

A company’s factory burns down on 20 January 20X5 (year end 31 December 20X4), destroying inventory. Is this an adjusting or non-adjusting event? What action should management take?

Answer:
This is a non-adjusting event as the fire is unrelated to year-end conditions. If material, disclose the nature and financial effect in a note. Do not adjust the inventory balance as of 31 December 20X4.

Auditor’s Subsequent Events Procedures

• Read board minutes and enquire with management about new events.
• Review interim reports, budgets, management accounts, and correspondence with legal advisors after year end.
• Inspect after-date receipts, payments, and other relevant documents.
• Obtain written representations from management confirming all subsequent events have been identified and accounted for properly.

If an identified event is adjusting, ensure the financial statements are amended. If a material non-adjusting event has occurred, check for adequate disclosure.

Exam Warning

A frequent error is adjusting the financial statements for all events after year end. Only adjust if the event provides evidence of conditions that existed at the reporting date.

Auditor’s Duty After Report Signature

After the auditor’s report is signed but before financial statements are issued, you have no duty to perform procedures. If you become aware of facts that would have led to a modified opinion, you must take suitable action:

• Ask management to amend the financial statements.
• If not amended and the auditor’s report not yet issued, withhold the report.
• If the financial statements have already been issued, seek legal advice and act to prevent reliance on the old auditor’s report (for example, by issuing a new report with clear explanation).

Going Concern

Key Term: going concern
The assumption that an entity will continue its operations for the foreseeable future, with no intention or necessity of liquidation or ceasing trading.

The going concern basis underpins the preparation of financial statements. The review of going concern covers at least 12 months from the date the financial statements are approved.

Directors’ and Auditor’s Roles

• Directors: Responsible for assessing the entity’s ability to continue as a going concern and for making appropriate disclosures if there is significant doubt.
• Auditor: Must evaluate the reasonableness of management’s assessment, identify indicators of going concern problems, and form a conclusion. Report implications if there is significant uncertainty or inappropriate use of the going concern basis.

Key Term: material uncertainty
Circumstances where the outcome of events or conditions is uncertain and could cast significant doubt on an entity’s ability to continue as a going concern.

Indicators That May Suggest Going Concern Problems

• Overdrafts approaching the limit or defaulted loans.
• Net liabilities or losses for the period.
• Significant overdue debts or legal claims.
• Unrenewed borrowing facilities.
• Major loss of customers or suppliers.

Worked Example 1.3

A company’s cash flow forecast shows consistently negative monthly cash, and its major customer became insolvent after year end, leaving an unpaid material amount. What steps should the auditor take?

Answer:
The auditor should review management’s going concern assessment, including revised cash flow forecasts, inspect correspondence with lenders, assess the impact of the customer’s insolvency, and discuss with management the adequacy of disclosures. If significant doubt exists, ensure adequate disclosure and determine if a material uncertainty section or modified opinion is needed in the auditor’s report.

Audit Procedures for Going Concern

• Analyse cash flow forecasts and assess key assumptions.
• Review post-year-end financial performance and new borrowings or repayments.
• Read board minutes for decisions affecting going concern.
• Assess whether management’s plans are realistic and adequate.
• Obtain written representations regarding going concern.

If material uncertainties exist, confirm disclosures are adequate. Otherwise, ensure the financial statements are prepared on the going concern basis. Inappropriate basis or insufficient disclosures will require a modified opinion.

Reporting Implications

• If financial statements are misstated because of incorrect treatment of subsequent events or going concern, modify the opinion as material misstatement.
• If unable to obtain sufficient appropriate evidence, issue a qualified or disclaimer of opinion.
• If material uncertainties about going concern are disclosed, include a “Material Uncertainty Related to Going Concern” section.

Summary

Subsequent events review ensures that important events after the reporting period are correctly reflected or disclosed in the financial statements. Accurately distinguishing between adjusting and non-adjusting events is critical for correct financial reporting. Carefully assess going concern, especially when there are indicators of doubt, and apply suitable audit procedures well before finalising your report.

Key Point Checklist

This article has covered the following key knowledge points:

• Define subsequent events and distinguish between adjusting and non-adjusting events.
• State the auditor’s responsibilities during the active and passive subsequent events periods.
• Outline procedures to identify subsequent events and evaluate their impact.
• Describe the directors’ and auditor’s responsibilities for going concern, and typical indicators of going concern risks.
• Explain required audit procedures for assessing going concern and the reporting implications if issues are identified.
• Indicate appropriate reporting modifications for failures to address subsequent events or going concern uncertainties.

Key Terms and Concepts

• subsequent event
• adjusting event
• non-adjusting event
• going concern
• material uncertainty