QUESTION 3 (18 marks) Indicate in each case the required treatment of these even

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QUESTION 3 (18 marks) Indicate in each case the required treatment of these events after reporting date, in the financial statements. Each of the cases is independent and is to be considered separately. Justify your answer. A lawsuit is settled for a different amount than was accrued. A sale of inventory below carrying value provides evidence that the net realizable value was less than cost at year end. i) ii) i) Information becomes available that provides evidence about the valuation of an estimate or reserve that had been accrued at year end. A major customer files for bankruptcy during the subsequent period. The cause is a deteriorating financial condition of which the client and auditor were not aware until learning of the bankruptcy filing. But the deteriorating financial condition existed as of the client's yearend. iv) v) Loss of a major facility after the balance sheet date due to a natural disaster, such as fire, earthquake, or flood. A material change in the value of investment securities. vi) QUESTION 4 (24 marks) The following are independent situations for which you will recommend an appropriate audit report. State the appropriate audit report from the following alternatives: Unqualified Qualified opinion Disclaimer of opinion Adverse opinion And explain the reasoning for your answer

Explanation / Answer

Answering all parts of Question 3. Complete Question 4 is not uploaded and hence not answered:

All events occuring after the balance sheet date but before the accounts are signed are considered as adjusting events, if conditions relating to those events existed at the balance sheet date. Adjusting events need to be recorded in the books of account. For non adjusting material events, a disclosure is generally sufficient. In this context, above queries are replied as follows:

1. A lawsuit, for which an accrual has been made, is surely an adjusting event, as the conditions relating to the liability existed at the balance sheet date. Therefore, on account of additional evidence, i.e. finalisation of amount of lawsuit, after reporting date but before financial statements are signed, the liability for the law suit needs to be adjusted in the books of accounts based on the actual liability. Differential amount will be recorded in the profit and loss account.

2. Sale of inventory at less than cost provides evidence that the net realisable value (NRV) of inventory might be lower than the carrying value of inventory. The sale happened after the balance sheet date. There does not seem to be any evidence as on the balance sheet date to suggest that the net realisable vaue will be lower than cost. Evidence have to be considered based on the situation existing as on balance sheet date. The fall in price seems to have been triggered post the Balance Sheet date. Therefore, in this case, the transaction is not an adjusting event. If material, the entity may want to disclose the amount in Notes.

3. In the third case, as the accrual or reserve had been created, this suggests that the coonditions existed as on the balance sheet date. Therefore, these generally become adjusting events and any additional information pertaining to such transactions are generally adjusted in the books of accounts.

4. In the fourth case, the deteriorating financial condition of the customer was a condition that existed as at the balance sheet date, as the auditor and company were aware of the situation. Further evidence regarding this situation, i.e. the client filing for bankruptcy, therefore, will make this an adjusting event and the balance will be written down based on the company's estimate of the recoverable amount as a part of bankruptcy proceedings.

5. Major disaster after the balance sheet date is a non-adjusting event, as conditions pertaining to the same are not known at the balance sheet date. Therefore, losses on account of natural disaster post the balance sheet date will generally not be adjusted in the books. In case they are material, these will be dsclosed as a part of the notes to accounts.

6. Material change in value of securities will be an event which gets trigered post the balance sheet date. Conditions regarding the fall in market value did not exist on the balance sheet date. Therefore, the fall in value will not be adjusted. The change will be recorded in the books as and when the valuation changes. If material, the management may consider disclosing any such changes in the notes to accounts.

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