An auditor is reviewing subsequent events and discovers that a major customer declared bankruptcy two weeks after the balance sheet date. The customer's accounts receivable balance was material. This event likely requires:
- AAdjustment to the financial statements for the uncollectible receivable.
- BA qualified opinion due to the uncertainty of collection.
- CDisclosure in the notes to the financial statements, but no adjustment to the financial statements.
- DNo action, as the event occurred after the balance sheet date.
Show answer & explanationAnswer & explanation
Correct answer: A. Adjustment to the financial statements for the uncollectible receivable.
The bankruptcy of a major customer after the balance sheet date but before the auditor's report date, when the customer's financial condition was already deteriorating at the balance sheet date, is a Type I subsequent event (adjusting event). It provides additional evidence about conditions that existed at the balance sheet date and requires an adjustment to the financial statements (e.g., increasing the allowance for doubtful accounts).
Why the other options are wrong
- B. A qualified opinion is not typically used for a known adjustment; rather, the financial statements should be adjusted.
- C. Disclosure alone is typically for Type II subsequent events, not for conditions existing at year-end.
- D. Subsequent events occurring before the auditor's report date must be evaluated for their impact on the financial statements.
Type I Subsequent Events (Adjusting Events)
Events that provide additional evidence about conditions that existed at the balance sheet date and affect the estimates inherent in the financial statements. They require adjustment to the financial statements.
- Examples include resolution of litigation for an amount different from the estimate, or a customer bankruptcy indicating uncollectibility of specific receivables existing at year-end.
- The financial statements are adjusted to reflect the new information.
- Occur between the balance sheet date and the date of the auditor's report.
Memory trick: Subsequent Events: Type I Adjusts, Type II Discloses.