Financial statements generally report on a company’s financial position for a specified period of time or reporting period. However, sometimes transactions will occur after the reporting period has ended and the point in time when the financial statements are ready to be issued. These transactions may influence a user of the financial statements opinion on the financial health of the company or be of such significance that it would be important to the users of the financial statements. These transactions qualify as subsequent events and may require adjustment and/or disclosure in the statements if they have a material effect on the financial statements. There are two types of subsequent events.
The first type consists of transactions or events that provide evidence of conditions that existed at the balance sheet date. An example of this type of event would be a loss on an uncollectible receivable due to a customer’s deteriorating financial condition leading to bankruptcy subsequent to the balance sheet date. Since the conditions (customer’s deteriorating financial condition) that lead to this event (customer filing for bankruptcy) existed at the balance sheet date, an adjustment should be recorded to the company’s financial records at the period-end or year-end reporting date.
The second type of event is one that provides evidence of conditions or events that existed after the balance sheet date. If the same company mentioned above ends up going bankrupt due to an unusual circumstance such as a natural disaster (instead of deteriorating financial conditions) that occurs after the balance sheet date, the circumstances leading to the bankruptcy would not have existed at the balance sheet date. Therefore, this would not qualify as a subsequent event that would require adjustment of the financial statements. However, this type of event may need to be disclosed if the lack of disclosure would cause the financial statements to be misleading.
Ultimately, the decision to adjust the financial statements is pretty cut and dry. If the circumstances surrounding the event existed at the balance sheet date and the event or transaction has a material effect, adjustment will be required. However, more judgement is involved when deciding whether or not to disclose a subsequent event when conditions that lead to the event or transaction did not exist at the balance sheet date. It is often better to disclose more in this case as this will prevent the financial statements from becoming misleading.