BUS601: Financial Management

Financial statements are defined very precisely in terms of time periods. Whereas balance sheets report financial position as at a specific date, income and cash flow statements report results for a period of time ending on a specific date. It would be understandable to think that events occurring after the reporting period are not relevant, as they do not occur within the precisely defined period covered by the financial statements.However, remember that investors and other readers often use financial statements to make predictions about the future. As such, if an event occurs after the reporting date,but before the financial statements are issued, and if the event could have a material impact on the future operations of the business, it is reasonable to expect that investors would want to know about it. For this reason, IAS 10 takes into account the reporting requirements where material events occur after the reporting period.

IAS 10 specifically defines the relevant reporting period as the time between the reporting date and the date when the financial statements are authorized for issue. Although the date of authorization will depend on the legal and corporate structure relevant to the entity, a common scenario is that the financial statements are authorized for issue when the board of directors approves them for distribution to the shareholders. This may be several weeks or even months after the reporting date.

The treatment of events after the reporting period will depend on whether they are adjusting or non-adjusting events. While adjusting events are those that provide further evidence of conditions that existed at the reporting date, non-adjusting events are those that are indicative of conditions that arose after the reporting date. As suggested by the nomenclature, when adjusting events occur, the accounts should be adjusted to reflect the effect of those events, while non-adjusting events will not result in any adjustments to the accounts.

The logic of this treatment is clear. If the event after the reporting date provides further evidence of a condition that existed at the reporting date, then the amount should be adjusted to reflect all available information. If the event only provides evidence of a new condition that arose after the reporting date, then adjustment would not be appropriate,as the condition didn’t exist at the reporting date.

In many cases, the appropriate treatment will be obvious. For example, if a provision for an unsettled lawsuit was included in current liabilities on the reporting date, but the lawsuit was later settled for a different amount before the approval of the financial statements, it makes sense to adjust the provision to the actual settlement amount. Similarly, if an error in the accounts is subsequently discovered before the financial statements are approved, then the error should be corrected.

In some cases the treatment of non-adjusting events is clear. For example, if the company’s warehouse burns to the ground after the reporting period, this is clearly not indicative of a condition that existed at the reporting date, and no adjustment should be made.

In other cases, however, the treatment is less clear. For example, if a significant customer goes bankrupt after the year-end, and no provision had been made for any bad debts, should the accounts be adjusted? Although the customer’s bankruptcy occurred after the reporting date, there may have been prior evidence of the customer’s financial difficulties. One would need to look at account aging, payment patterns, and other evidence that would have been available at the reporting date to determine if the condition existed. If the balance of evidence suggests that the customer’s financial troubles already existed at the reporting date, then an adjustment would be appropriate. In cases like these, the accountant will need to apply sound judgment in evaluating all the evidence.

Even when an event is determined to be a non-adjusting event, disclosure may still be appropriate if the event is anticipated to have a material effect on future economic decisions. In our previous example, the destruction of a company’s warehouse may have a serious impact on the company’s future ability to deliver products and to earn profits. Thus, disclosure of the nature of the event, and the estimated financial effect of the event on future results, should be made.

In rare cases, a company’s financial condition may deteriorate so quickly after the reporting period that it may be impossible for the company to continue operating. Although events after the reporting period may not necessarily provide evidence of conditions that existed at the reporting date, the going concern assumption will override the normal procedure. Because financial statements are presumed to be prepared on a going concern basis, any change in this fundamental assumption would create the need for a complete change in the basis of accounting. This would obviously have a profound effect on all aspects of the financial statements.

The guidance in IAS 10 provides another example of how the principle of full disclosure is employed to help financial statement readers make more informed decisions.