There are certain events about which the evidence did not exist at the date of the financial statements but arose after that date. Such events do not usually require adjustments in the financial statements. However, some of these events are of significant nature and therefore, it is required by the AU 560 to make a disclosure of them in order to avoid the financial statements from being misleading. Examples of such events include issuance of capital stock or sale of long-term bonds and debentures, mergers or acquisition of business, loss of inventory due to flood or fire, and legal dispute giving rise to the claims (Delaney & Whittington, 2010).
In the given scenario, the financial statements date has passed, and the audit report is being prepared which indicates that it is a subsequent event. The auditor has evaluated that due to lack of liquidity, the client may face a difficulty in paying of its binds that are due after six months, and there are chances that it may lead to the bankruptcy of the company. The client has therefore decided to issue the common stock in exchange for the bonds.
Providing the pro forma financial data supplementing the historical financial statements shall make a disclosure. The disclosure shall give the effect as if the event has occurred before the date of the financial statements. Pro forma statements should be presented in columnar form on the face of the historical financial statements (AU Section 560: Subsequent Events, 2006).
Moreover, due to the material impact of the event, the auditor shall include an explanatory paragraph in his report that should direct the attention of the readers towards the event and its effect.
Certain events provide the evidence that conditions existed at the date of the balance sheet that could affect the process of preparation of financial statements. According to the AU 560, the management shall use all the information that becomes available before the issuance of the financial statements (AU Section 560: Subsequent Events, 2006). However, in the given case, the information became available to the management after the issuance of the audit report. These events are affecting the realization of an asset and liabilities and should be adjusted in the financial statements. Any change in the estimates and amounts should be made accordingly.
The auditor shall issue the new audit report and shall include an explanatory paragraph that should be referred to the note to the financial statement. The explanatory paragraph should discuss the reasons for the amendments, errors in the previous financial statements, and the impact of the adjustments to the overall financial statements (AU Section 560: Subsequent Events, 2006).
In the given case, the competitor released a new product that resulted in the client’s inventory getting obsolete. Since the competitor issued the new product after the end of the client’s reporting period, it is not indicative of the evidence that condition existed before the date of the financial statements. Hence, it is not the adjusting event, and the financial statements would not require any amendments. However, disclosure shall be made which should supplement the historical financial information with pro forma financial statements. This pro forma data should be presented in columnar form along with the primary financial statements (AU Section 560: Subsequent Events, 2006).
Given the significantly material impact of the event, the auditor should include an explanatory paragraph in his auditor report which should provide the explanation of the event arising after the reporting date and its possible effect thereon on the going concern assumption of the company (Delaney & Whittington, 2010).
References
AU Section 560: Subsequent Events. (2006, December 15). Retrieved from http://www.aicpa.org/Research/Standards/AuditAttest/DownloadableDocuments/AU-00560.pdf
Delaney, P. R., & Whittington, O. R. (2010). Wiley CPA Examination Review, Outlines and Study Guides. New Jersey: John Wiley & Sons.
