Which of the following is a subsequent event that must be disclosed in the notes to the financial statements?

Events that occur after a company’s year-end period but before the release of its financial statements

What are Subsequent Events?

Subsequent events are events that occur after a company’s year-end period but before the release of the financial statements. In other words, subsequent events are events that happen between the cut-off date and the date in which the company issues its financial statements. Depending on the situation, subsequent events may require disclosure in a company’s financial statements.

Understanding Reporting Period, Cut-off, and Subsequent Events

The typical reporting period for a company is 12 months. However, a reporting period does not need to match the calendar year from January 1 to December 31. Typically, companies will choose a year-end corresponding to a period of low activity. For example, retailers usually follow a year-end at the end of January when inventory is low (post-holiday season).

The cut-off date refers to the end of the reporting period and the start of the new reporting period. It is important in accrual accounting because cash cycles may not be complete. Therefore, it is necessary to understand which events will be during the current reporting period and which events will be recorded in the next reporting period. Transactions and events are recognized up to the cut-off date.

Between the period of the cut-off date and the authorization of financial statements issuance is the subsequent events period. Depending on the type of subsequent event, it may or may not require an adjustment to the financial statements. Transactions and events that change the measurement of transactions before the cut-off date are recognized.

Example

After the cut-off period (after the company’s year-end) and before the issuance of financial statements, Company A’s major client unexpectedly goes bankrupt. It is determined that the company will only get 10% of its outstanding accounts receivable from the major client. The event will require an adjustment to the financial statements of Company A.

Types of Subsequent Events

There are two types of subsequent events:

1. Adjusting events

An event that provides additional information about pre-existing conditions that existed on the balance sheet date.

2. Non-adjusting events

A subsequent event that provides new information about a condition that did not exist on the balance sheet date.

Accounting for Subsequent Events

For subsequent events that provide additional information about pre-existing conditions that existed on the balance sheet date, the financial statements are adjusted to reflect this additional information.

For example:

• If the company faced a lawsuit before the balance sheet date and the lawsuit is settled during the subsequent-events period, the company would adjust the contingent loss amount to match the actual settlement loss.
• Assume that, due to new technology, there is a significant reduction in the market price of Company A’s inventory. This will require an adjustment to the financial statements, with inventory valued at the lower of cost or market value.

For subsequent events that are new events and thus do not provide additional information about pre-existing conditions that existed on the balance sheet, these events are not recognized in the financial statements. However, a subsequent event footnote disclosure should be made so that investors know the event occurred.

For example:

• A labor strike that could potentially threaten the company into bankruptcy should be disclosed in the financial statements.
• A fire in the company’s warehouse that destroys inventory and assets is not recognized (but disclosure is required) because the conditions did not exist prior to the balance sheet date.

Related Readings

CFI offers the Financial Modeling & Valuation Analyst (FMVA)® certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following CFI resources will be helpful:

• Financial Accounting Theory
• Projecting Income Statement Line Items
• Projecting Balance Sheet Items
• Analysis of Financial Statements