BACKGROUND: The term subsequent event refers to an event that occurs after the d

Question

BACKGROUND: The term subsequent event refers to an event that occurs after the date of the audited balance sheet but prior to the date of the auditors' report. Subsequent events can be divided into two broad categories. The first are those that provide additional evidence about facts that existed either on or before the balance sheet date (Type 1 events). The second are those that involve facts that came into existence after the balance sheet date (Type 2 events). Type 1 events require adjustment to the financial statements while Type 2 events only require financial statement disclosure. Dillon & Company CPAs are auditing the financial statements of PDQ Manufacturing as of December 31, 2009. During the fieldwork of its audit (March 2010), the auditors noted the following situations: A major customer who owed PDQ $10,000 in accounts receivable (a material amount) filed for Chapter 7 bankruptcy. A warehouse where the customer stored some of its inventory for resale had a fire. Estimated damage could not yet be quantified. In addition, the company's board treasurer was killed in a tragic plane crash. Dillon & Company is now ready to issue its audit opinion.

1.What should Dillon & Company CPAs do as a result of the customer bankruptcy?

2. What type of subsequent event is the death of the board treasurer?

3. Does the death of the board treasurer require an adjustment to the 12/31/09 financial statements?

4. What should Dillon & Company CPAs do to adjust the financial statements for the fire in the warehouse?

1.What should Dillon & Company CPAs do as a result of the customer bankruptcy?

2. What type of subsequent event is the death of the board treasurer?

3. Does the death of the board treasurer require an adjustment to the 12/31/09 financial statements?

4. What should Dillon & Company CPAs do to adjust the financial statements for the fire in the warehouse?

Explanation / Answer

Part 1)

Since, the accounts receivable due from PDQ is of material amount of $10,000, it would be treated as a Type 1 event requiring an adjustment to the financial statements. It is so because, a bankruptcy situation would be considered to be existing at the balance sheet date. The balance in the allowance for doubtful debts and accounts receivable account with respect to PDQ will therefore, be reduced to reflect the correct value of net accounts receivable in financial statements.

_________

Part 2)

The death of the board treasurer will be treated as a Type 2 event. It is so because such a situation cannot be said to be existing at the date of balance sheet. Therefore, no adjustment will be required to the financial statements.

_________

Part 3)

No adjustment is required to be made to the 12/31/09 financial statements of the company as such as even is treated as "Non Recognized Event" at the balance sheet date. If the event is considered to be material, it will only be reported as a disclosure to the financial statements.

_________

Part 4)

No adjustment will be required to the inventory balance for the year 2009 as such an event cannot be considered as existing at the balance sheet date. It will be treated as Type 2 event and will be reported as a disclosure to the financial statements. The inventory balance would, therefore, continue to be the same as it was at the balance sheet date.

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