Subsequent Events: Type 1 vs Type 2 Under ASC 855 and the Auditor's Procedures Under AU-C 560

Financial statements report on a date that has already passed by the time they are issued. Between the balance sheet date and the issuance date, things happen: a customer goes bankrupt, a lawsuit settles, a warehouse burns down, the company signs a new loan. Some of these events change the numbers. Others only need disclosure. Some need neither.

For US private companies, the accounting rules are in ASC 855, Subsequent Events. The auditor's responsibilities are in AU-C 560, Subsequent Events and Subsequently Discovered Facts. This guide covers both and paraphrases the standards.

What is a subsequent event?

ASC 855 defines subsequent events as events or transactions that occur after the balance sheet date but before the financial statements are issued or are available to be issued. They fall into two types.

Type 1: recognized subsequent events

Recognized subsequent events provide additional evidence about conditions that existed at the balance sheet date, including the estimates inherent in preparing the financial statements. The entity adjusts the financial statements to reflect them.

The test is whether the condition existed at year-end. The event after year-end only reveals it or confirms the amount.

Examples of Type 1 events

• Customer bankruptcy after year-end, where the customer's financial deterioration was already underway at the balance sheet date. The allowance for credit losses at year-end is adjusted.
• Settlement of litigation after year-end for an amount different from the accrual, where the event giving rise to the claim occurred before year-end. The liability is adjusted to the settlement amount.
• Sale of inventory after year-end below its carrying amount, which provides evidence about net realizable value at year-end.
• Receipt of final invoices for goods or services received before year-end, which confirms an accrual.

A useful test

Ask: "If we had known this on the balance sheet date, would the year-end number have been different?" If the answer is yes because the underlying condition already existed, it is usually Type 1.

Type 2: nonrecognized subsequent events

Nonrecognized subsequent events provide evidence about conditions that did not exist at the balance sheet date but arose after it. The entity does not adjust the financial statements. Some nonrecognized events are significant enough that disclosure is needed to keep the financial statements from being misleading.

Examples of Type 2 events

• Fire, flood or other casualty after year-end that destroys assets.
• Issuance of debt or equity after year-end.
• Business combination completed after year-end.
• Settlement of litigation where the event giving rise to the claim occurred after year-end.
• Customer bankruptcy caused by an event after year-end, such as a sudden disaster at the customer's facility.
• Significant change in the fair value of investments after year-end, caused by market movements after the balance sheet date.

Disclosure for Type 2 events

For nonrecognized events that need disclosure, ASC 855 requires:

• the nature of the event
• an estimate of its financial effect, or a statement that an estimate cannot be made

In some cases, an entity may present pro forma financial data giving effect to the event as if it occurred on the balance sheet date.

Type 1 vs Type 2 side by side

The evaluation date

Which date applies

ASC 855 sets different evaluation dates:

• An entity that is an SEC filer or a conduit bond obligor for conduit debt securities traded in a public market evaluates subsequent events through the date the financial statements are issued.
• All other entities, including most private companies, evaluate subsequent events through the date the financial statements are available to be issued.

Financial statements are available to be issued when they are complete in a form and format that complies with GAAP and all approvals necessary for issuance, such as from management, the board or significant shareholders, have been obtained.

Disclosure of the date

An entity that is not an SEC filer must disclose the date through which subsequent events have been evaluated, and whether that date is the date the financial statements were issued or the date they were available to be issued.

Reissued financial statements

When financial statements are reissued, for example in a later filing or because of a correction, the entity does not recognize events that occurred between the original issuance date and the reissuance date unless the adjustment is required by GAAP or regulatory requirements. Entities other than SEC filers disclose both the date through which subsequent events were evaluated in the originally issued statements and in the revised statements.

The auditor's procedures under AU-C 560

Objectives

The auditor's objectives under AU-C 560 are to obtain sufficient appropriate audit evidence about whether events between the date of the financial statements and the date of the auditor's report that require adjustment or disclosure are appropriately reflected, and to respond appropriately to facts that become known after the report date that might have caused the auditor to revise the report.

Period covered

The auditor performs procedures to cover the period from the date of the financial statements to the date of the auditor's report, or as near to that date as practicable. Under AU-C 700, the report is dated no earlier than the date on which the auditor has obtained sufficient appropriate evidence, which includes evidence that the financial statements, including disclosures, have been prepared and that management has asserted responsibility for them.

This is why the report date and the evaluation date in the client's note usually line up. If the note says subsequent events were evaluated through April 15 and the report is dated April 22, there is a gap that needs to be closed.

Required procedures

AU-C 560 requires procedures that take into account the auditor's risk assessment. They include:

1. Understanding management's procedures for identifying subsequent events.
2. Inquiring of management and, where appropriate, those charged with governance about whether any subsequent events have occurred that might affect the financial statements.
3. Reading minutes of meetings of owners, management and those charged with governance held after the financial statement date, and inquiring about matters discussed at meetings for which minutes are not yet available.
4. Reading the entity's latest subsequent interim financial statements, if any.

The auditor also obtains written representations from management that all events requiring adjustment or disclosure have been adjusted or disclosed, as part of the representation letter under AU-C 580.

Practical procedures that support the review

Firms may extend the required procedures with:

• reviewing cash receipts after year-end for receivables (supports valuation and existence)
• reviewing cash disbursements and unpaid invoices after year-end (supports the search for unrecorded liabilities)
• updating legal letters close to the report date under AU-C 501
• reviewing debt agreements and covenant certificates issued after year-end
• reading press releases, the entity's website and news
• updating the going concern evaluation under AU-C 570, which uses the same post-year-end evidence

Responding to identified events

When the auditor identifies events that require adjustment or disclosure, the auditor determines whether each is appropriately reflected. A misstatement found through subsequent events procedures goes on the summary of misstatements under AU-C 450 and is evaluated against materiality under AU-C 320.

Subsequently discovered facts

AU-C 560 also covers facts that become known after the report date. The auditor has no obligation to perform procedures after the report date, but must respond if facts come to the auditor's attention.

After the report date but before the report release date

If the auditor becomes aware of a fact that, had it been known at the report date, might have caused the auditor to revise the report, the auditor discusses it with management and determines whether the financial statements need revision.

If management revises the financial statements, the auditor performs procedures on the revision and either:

• dual dates the report, keeping the original date for everything except the revision, which carries a later date, or
• redates the report to the later date, extending subsequent events procedures to that date.

Dual dating limits the auditor's responsibility for events after the original date to the specific revision.

After the report release date

If a fact comes to light after the report has been released that might have caused the auditor to revise the report, the auditor discusses it with management and determines whether the financial statements need revision. If revision is needed and management revises the statements, the auditor performs procedures on the revision and issues a new or revised report, which may include an emphasis-of-matter or other-matter paragraph referring to the revision.

If management does not take the necessary steps, the auditor takes action to seek to prevent future reliance on the report, which can include notifying management and those charged with governance and, in some cases, regulators or others known to be relying on the report. Legal counsel is often involved at this stage.

Documentation

Under AU-C 230, the subsequent events workpaper should show:

1. The period covered and the date the procedures were completed, which should be close to the report date.
2. Each procedure performed, with the sources: minutes read, interim statements reviewed, inquiries made and of whom.
3. Events identified, their classification as Type 1 or Type 2, and the reasoning.
4. The resulting adjustments and disclosures.
5. The link to the representation letter and legal letters, with matching dates.
6. Any subsequently discovered facts and how they were handled.

A subsequent events checklist completed weeks before the report date needs updating; refresh inquiries in the final days before release.

FAQ

What is the difference between Type 1 and Type 2 subsequent events?

Type 1 (recognized) events give evidence about conditions that existed at the balance sheet date and require adjustment. Type 2 (nonrecognized) events relate to conditions that arose after the balance sheet date and may require disclosure but not adjustment.

Through what date does a private company evaluate subsequent events?

Through the date the financial statements are available to be issued. The company must disclose that date and state that it is the available-to-be-issued date.

Is a customer bankruptcy after year-end always a Type 1 event?

No. It is Type 1 if the customer's financial deterioration existed at the balance sheet date. If the bankruptcy was caused by an event after year-end, such as a fire at the customer's plant, it is Type 2.

Does the auditor have to look for subsequent events after the report date?

No. AU-C 560 does not require procedures after the report date. If facts come to the auditor's attention that might have changed the report, the auditor must respond.

What is dual dating?

Dual dating keeps the original report date for the report as a whole and adds a later date for a specific note or revision. It limits the auditor's responsibility for later events to that specific matter.

Sources

• FASB ASC 855, Subsequent Events (855-10-25 recognition; 855-10-50 disclosure; 855-10-55 examples)
• AICPA, AU-C Section 560, Subsequent Events and Subsequently Discovered Facts
• AICPA, AU-C Section 700, Forming an Opinion and Reporting on Financial Statements; AU-C Section 580, Written Representations; AU-C Section 501; AU-C Section 570; AU-C Section 450; AU-C Section 320; AU-C Section 230

CORAA prepares ready-to-review audit files for US CPA firms from QuickBooks books; you review and sign. See /us.

AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error