Just in Case: FASB to Clarify Bankruptcy Issues

Amid the credit crunch, FASB releases new exposure drafts on "going concern" and "subsequent event" to clarify the issues.

Further, as a result of current economic conditions, there likely will be an increase in the number of “going concern” opinions auditors will be issuing. Indeed, it is generally believed that the issuance of such an opinion is, as a practical matter, a self-fulfilling prophecy. An entity receiving such an opinion will almost always be denied access to credit at the same time that the investment community shuns its stock.

Subsequent Events

Subsequent events are events or transactions that occur after the balance sheet date, but before the date on which financial statements are issued or “available to be issued.” The second exposure FASB issued, entitled “Subsequent Events,” says that there are two distinct types of subsequent events. The first variety encompasses events or transactions that provide additional evidence about conditions that existed as of the date listed on the balance sheet. These subsequent events are identified as “recognized subsequent events.”

The second variety includes events that provide evidence about circumstances that did not exist at the date of the balance sheet, but instead arose subsequent to that date. These subsequent events are referred to as “non-recognized subsequent events.” For this purpose, financial statements are regarded as “issued” when they are widely-distributed to users for general use and reliance in a form and format that complies with generally accepted accounting principles (GAAP).

By contrast, financial statements are “available to be issued” when they are complete in a form and format that complies with GAAP, and all approvals necessary for issuance have been obtained. According to the exposure draft, a company that has an “historical practice” or “current expectation” of widely distributing its financial statements shall examine subsequent events through the date the financial statements are issued. All other reporting entities shall examine such events through the date on which the statements are available to be issued.

A company should recognize its financial statements the effects of all subsequent events that provide additional evidence about conditions that existed at the date of the balance sheet. For example, recognized subsequent events might include the settlement of a lawsuit in which the events that gave rise to the litigation had taken place before the balance sheet date. Another example of a recognized subsequent event would be a loss on an uncollectible account receivable as a result of a customer’s deteriorating financial condition that led to bankruptcy after the balance sheet date. In such a case, the bankruptcy filing represents the culmination of conditions that existed over a “relatively long period of time,” as noted in the exposure draft.

In contrast, a company should not recognize subsequent events that provide additional evidence about conditions that did not exist at the date of the balance sheet, but instead arose subsequent to that date. Examples of non-recognized subsequent events include, the sale of a bond or common stock issuance after the balance sheet date. It also may include business combination that occurs after the balance sheet date, or a loss of plant or inventories as a result of a natural disaster that occurred after the balance sheet date.

Although these non-recognized subsequent events are not recognized in the financial statements, they may be of such significance that their disclosure is required. Moreover, the exposure draft provides that, occasionally, a non-recognized subsequent event “may be so significant” that disclosure thereof can “best be made” by means of pro-forma financial data, which would supplement the historical financial statements.

Once they are approved as accounting standards, both exposure drafts will be effective for interim or annual financial periods ending after the rule codification, and will be applied prospectively. Nevertheless, as a practical matter, we fully expect the principles ingrained in these pronouncements to be applied without delay.

Contributor Robert Willens, founder and principal of Robert Willens LLC, writes a weekly tax column for CFO.com.

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