The Financial Accounting Standards Board (FASB) issued a brand new accounting pronouncement last month, FAS No. 165, Subsequent Events. According to the standard setting organization, the rule will be applied to the accounting for, and disclosure of, subsequent events not addressed in other applicable Generally Accepted Accounting Principles (GAAP).
For this purpose, subsequent events are defined as “events or transactions” that occur after the balance sheet date, but before financial statements are issued or are “available to be issued.”
The statement observes that there are two varieties of subsequent events:
• Events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet (so-called “recognized” subsequent events); and
• Events that provide evidence about conditions that did not exist at the date of the balance sheet, but arose after that date (so-called “non-recognized” subsequent events).
FAS 165 also lays out several definitions about timing that are particularly important. For example, corporate financial statements are considered issued when they are widely distributed to shareholders and other financial statement users for “general use and reliance” in a form and format that complies with GAAP. Further, financial statements are considered available to be issued when they are complete, which again means that they are in a form and format that complies with GAAP, and all approvals necessary for issuance have been obtained.
The rule calls on management for some discretion. That is, the rule states that a company that has a “current expectation” of widely distributing its financial statements, including a “public entity,” should evaluate subsequent events through the date on which the financial statements are issued. All other entities, by contrast, should evaluate subsequent events only through the date on which the financial statements are available to be issued.
Keeping those definitions in mind, FAS 165 goes on to say that companies should recognize in the financial statementsthe effects of all subsequent events that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements. The settlement of litigation (after the balance sheet date, but before the date the financial statements are issued or available to be issued) falls within this category of subsequent events in cases where the events which “gave rise to” the litigation had taken place before the balance sheet date.
“With respect to this type of subsequent event, a company would be constrained to disclose: (1) the nature of the event, and (2) an estimate of its financial effect or an affirmative statement that such an estimate cannot be made.” — Robert Willens
Another example of this variety of subsequent events is a customer’s bankruptcy filing. The rule states that the effect of such a filing “shall beconsidered” in determining the amount of uncollectible trade accounts receivable recognized in the financial statements at the balance sheet date.
Conversely, a company does not recognize subsequent events that provide evidence about conditions that did not exist at the date of the balance sheet – but instead arose after the balance sheet date, and before the date on which financial statements are issued or are available to be issued. Examples of this type of subsequent event includes the sale of a bond or capital stock; a business combination; and a loss of property or inventories as a result of a fire or natural disaster that occurs after the balance sheet date.
FAS 165 also says that some non-recognized subsequent events may be “of such a nature” that they must be disclosed to keep the financial statements from being characterized as misleading.
With respect to this type of subsequent event, a company would be constrained to disclose:(1) the nature of the event, and (2) an estimate of its financial effect or an affirmative statement that such an estimate cannot be made.
Moreover, FAS 165 provides that, in the case of a re-issuance of financial statements, a company should not recognize events occurring between the time the financial statements were issued or available to be issued, and the time the financial statements were re-issued, unless the adjustment is required by GAAP or by regulatory requirements.
The new rule has an “accelerated” effective date: It will apply with respect to interim or annual reporting periods ending after June 15, 2009.