CPA Exam — AUDPerforming Further Procedures and Obtaining EvidenceEasy
During the audit of a publicly traded company, the auditor discovers that the client's largest customer, representing 15% of accounts receivable, filed for bankruptcy two weeks after the balance sheet date. The customer's financial health was deteriorating prior to year-end. How should the auditor classify this event?
- AA Type I subsequent event requiring adjustment to the financial statements.
- BA related party transaction requiring specific disclosure and auditor investigation.
- CA Type II subsequent event requiring disclosure but no adjustment.
- DAn event that does not require any action as it occurred after the balance sheet date.
Show answer & explanationAnswer & explanation
Correct answer: A. A Type I subsequent event requiring adjustment to the financial statements.
A Type I subsequent event provides additional evidence about conditions that existed at the balance sheet date. The customer's deteriorating financial health prior to year-end indicates the condition existed, making the bankruptcy filing an adjusting event.
Why the other options are wrong
- B. This is not necessarily a related party transaction; it's a subsequent event.
- C. Type II events relate to conditions arising after the balance sheet date.
- D. Subsequent events occurring after the balance sheet date often require adjustment or disclosure.
Type I Subsequent Event (Adjusting Event)
A subsequent event that provides additional evidence about conditions that existed at the balance sheet date and affects the estimates inherent in the financial statements. These events require adjustment to the financial statements.
- Conditions existed at the balance sheet date.
- Requires adjustment to financial statements.
- Examples: bankruptcy of a customer with a receivable, settlement of litigation at an amount different from the recorded liability.
Memory trick: DATE: Does it Affect The Existing conditions?