ISA 560, “Subsequent Events,” is a standard issued by the International Auditing and Assurance Standards Board (IAASB) that provides guidance to auditors on how to deal with subsequent events during the audit process. Subsequent events are events or transactions that occur after the balance sheet date but before the financial statements are issued, and they may require adjustments or disclosures in the financial statements.
Definition of Subsequent Events:
Subsequent events are events or transactions that occur after the balance sheet date, but before the financial statements are issued or are available to be issued. These events may provide additional evidence about the financial statements and may require adjustments to the financial statements or additional disclosures. Subsequent events can be classified into two types: (1) Adjusting events, and (2) Non-adjusting events.
Adjusting Events:
Adjusting events are those events or transactions that provide further evidence of conditions that existed at the balance sheet date. Adjusting events require adjustments to the financial statements because they affect the financial position, results of operations, or cash flows of the entity as of the balance sheet date. Adjusting events are recognized and reflected in the financial statements, and appropriate disclosures are made in the financial statements.
Examples of adjusting events:
- a. Settlement of litigation that confirms or establishes the entity’s liability as of the balance sheet date.
- b. Discovery of new information that affects the valuation of assets or liabilities as of the balance sheet date, such as the determination of the collectability of receivables or the impairment of assets.
- c. Receipt of information that confirms the occurrence of an event that was uncertain as of the balance sheet date, such as the receipt of a court judgment or a tax assessment.
Case Study:
XYZ Corp., a manufacturing company, has a pending lawsuit for product liability as of its balance sheet date of December 31, 2022. The company issued its financial statements on March 31, 2023. On February 28, 2023, the court ruled in favor of the plaintiff and awarded damages of $1 million to be paid by XYZ Corp. This is an adjusting event because it confirms the liability that existed as of the balance sheet date. XYZ Corp. is required to recognize the liability and adjust its financial statements accordingly, including appropriate disclosures in the financial statements.
Non-adjusting Events:
Non-adjusting events are those events or transactions that provide evidence of conditions that did not exist at the balance sheet date, and they do not require adjustments to the financial statements. However, non-adjusting events may require additional disclosures in the financial statements to inform users about the event’s nature and financial impact.
Examples of non-adjusting events:
- a. Loss of a major customer or a major contract after the balance sheet date.
- Sale or acquisition of a subsidiary or a significant investment after the balance sheet date.
- Natural disasters or other catastrophes that occur after the balance sheet date.
Case Study:
ABC Corp., a software company, experienced a major earthquake on January 15, 2023, causing significant damage to its headquarters and resulting in the loss of key infrastructure. ABC Corp. had issued its financial statements for the year ended December 31, 2022, on January 31, 2023. The earthquake is a non-adjusting event because it occurred after the balance sheet date and does not affect the financial statements for the year ended December 31, 2022. However, ABC Corp. is required to disclose the nature of the event and its potential financial impact in the financial statements for the year ended December 31, 2022.
Explanation of ISA 560 Requirements:
ISA 560 requires auditors to perform the following procedures to identify subsequent events and determine their impact on the financial statements:
Inquire and Obtain Information: Auditors are required to inquire with management and those charged with governance about events and transactions that occurred after the balance sheet date and obtain sufficient information to identify potential subsequent events. This may include obtaining minutes of meetings, reviewing internal and external communications, and discussing with management any significant events or changes that may have occurred after the balance sheet date.
Review Procedures: Auditors are required to perform review procedures to identify subsequent events that may require adjustments or disclosures in the financial statements. This may include examining subsequent period-end transactions, reviewing subsequent interim financial statements, and comparing subsequent events with the financial statements to assess their impact on the financial statements.
Evaluate and Determine Impact: Auditors are required to evaluate the nature and financial impact of identified subsequent events. Adjusting events that provide further evidence of conditions that existed at the balance sheet date require adjustments to the financial statements. Non-adjusting events that provide evidence of conditions that did not exist at the balance sheet date may require additional disclosures in the financial statements.
Consider Implications for Audit Report: Auditors are required to consider the implications of subsequent events on the audit report. If subsequent events materially affect the financial statements and management does not make the necessary adjustments or disclosures, auditors may need to modify their audit report to include an explanatory paragraph or a qualified or adverse opinion.
Examples of ISA 560 in Practice:
Adjusting Event Example:
XYZ Ltd., a retail company, had recorded accounts receivable of $1 million as of its balance sheet date of December 31, 2022. During the subsequent event review procedures, the auditor obtained information that one of the major customers of XYZ Ltd. filed for bankruptcy on January 15, 2023, and is unlikely to pay its outstanding balance of $500,000. This event is an adjusting event as it confirms the impairment of accounts receivable that existed as of the balance sheet date. The auditor will request management to adjust the financial statements by reducing accounts receivable by $500,000 and reflecting the appropriate disclosures.
Non-adjusting Event Example:
ABC Inc., a construction company, had completed a major construction project as of its balance sheet date of December 31, 2022. After the balance sheet date, on January 10, 2023, ABC Inc. received a notification from the project owner that the project is delayed by six months due to unforeseen issues. This event is a non-adjusting event as it occurred after the balance sheet date and does not affect the financial statements for the year ended December 31, 2022. However, the auditor will request management to disclose this event in the financial statements to inform users about the potential impact on future revenues and profits.
Conclusion:
In conclusion, ISA 560 “Subsequent Events” provides guidance to auditors on how to deal with subsequent events during the audit process. It requires auditors to identify subsequent events, evaluate their impact on the financial statements, and consider the implications for the audit report. Adjusting events require adjustments to the financial statements, while non-adjusting events may require additional disclosures. Auditors need to perform thorough procedures to identify subsequent events and ensure that financial statements are presented fairly in all material respects. Compliance with ISA 560 is crucial for auditors to maintain the integrity and reliability of the financial statements and provide assurance to users of the financial statements.