CPA Exam — AUDPerforming Further Procedures and Obtaining EvidenceMedium
During the audit of a publicly traded company, the auditor discovers that one of the client's key executives resigned unexpectedly two weeks after the balance sheet date due to allegations of fraud. The fraud is alleged to have occurred in the prior fiscal year. This event is considered a:
- ANon-adjusting event that does not require disclosure or adjustment.
- BType II subsequent event (disclosure event) requiring disclosure in the financial statements.
- CGoing concern issue requiring a qualified or adverse opinion.
- DType I subsequent event (adjusting event) requiring adjustment to the financial statements.
Show answer & explanationAnswer & explanation
Correct answer: D. Type I subsequent event (adjusting event) requiring adjustment to the financial statements.
Allegations of fraud occurring in the prior fiscal year, even if discovered after the balance sheet date, provide evidence about conditions that existed at the balance sheet date. Therefore, it is a Type I subsequent event requiring adjustment to the financial statements.
Why the other options are wrong
- A. This is incorrect; fraud allegations from the prior year are material and require action.
- B. A Type II event provides evidence about conditions that *did not* exist at the balance sheet date but arose subsequently. The fraud existed prior to year-end.
- C. While it could lead to broader implications, the immediate classification is as a subsequent event that existed at year-end, which may impact the assessment of fraud risk and financial statement balances.
Type I Subsequent Event (Fraud Allegations)
A Type I subsequent event provides evidence about conditions that existed at the balance sheet date, requiring adjustment to the financial statements.
- Examples: resolution of litigation, customer bankruptcy, discovery of errors/fraud.
- Impacts balances and disclosures as of the balance sheet date.
- Requires financial statement adjustment.
Memory trick: Did it EXIST at the Date? Adjust! If NOT, just Note it.