CPA Exam — AUDPerforming Further Procedures and Obtaining EvidenceEasy
During the audit of a publicly traded company's financial statements, the auditor discovers that the client's largest customer filed for bankruptcy on January 15, subsequent to the December 31 year-end but before the audit report date. The customer's bankruptcy will significantly impact the collectibility of a material accounts receivable balance. What is the auditor's most appropriate course of action regarding this event?
- ARequire the client to adjust the financial statements for the uncollectible receivable.
- BDisclose the event in the notes to the financial statements as a non-adjusting subsequent event.
- CTake no action, as the event occurred after the balance sheet date.
- DModify the audit opinion to include an emphasis-of-matter paragraph describing the event.
Show answer & explanationAnswer & explanation
Correct answer: A. Require the client to adjust the financial statements for the uncollectible receivable.
The customer's bankruptcy provides additional evidence about conditions that existed at the balance sheet date (i.e., the collectibility of the receivable was impaired at year-end). Therefore, it is a Type I subsequent event requiring adjustment to the financial statements.
Why the other options are wrong
- B. This is a Type I (adjusting) event, not a Type II (non-adjusting) event, so disclosure alone is insufficient.
- C. Ignoring a material subsequent event that impacts year-end balances would be a failure of the auditor's responsibility.
- D. An emphasis-of-matter paragraph is used for matters appropriately presented or disclosed, not for material misstatements that require adjustment.
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 statement preparation process. These events require adjustment of the financial statements.
- Provide evidence of conditions existing at year-end.
- Require adjustment to financial statement amounts.
- Examples: bankruptcy of a customer with year-end receivable, settlement of litigation for an amount different than accrued.
Memory trick: Adjusting events tell us what WAS true.