Accounting Principles - Events after the Balance Sheet Date - Case Study Example

Accounting Principles: Events After the Balance Sheet 8 April Table of Contents Introduction Events after the balance sheet date, formerly known as post balance sheet events, are an important part of accounting. They are handled under IAS 10 Events after Balance Sheet Date (Ramachandran & Kakani, 2009). This area of accounting standards is related to events, both favourable and unfavourable, that occur after the financial statements are prepared and are relevant to the contents of the financial statements. This paper examines some key elements of IAS 10. It begins by identifying the background and basis for the Accounting Standard, and goes on to identify its practical application, and in so doing, identifies some key components of Events after Balance Sheet Date. The paper also reports comparative analyses between the IAS and the US Generally Accepted Accounting Practice (GAAP). Background of IAS 10 Generally, accounts are prepared over a period of 12 months (Accounting Coach, 2011). However, in practice, the people who are ultimately responsible for the accounts are the board of directors (Accounting Coach, 2012). Therefore, the authorization of the accounts by the board of directors is the most important validation point of the financial statement prepared by the accounting department. In most situations, accounts are authorized two to three months after the end of the period. It is typical that accounts prepared for December in a given year will be authorized in February or March by the board of directors. The International Accounting Standards Board emphasizes the need for cut-offs and consistency in financial statements (2009). Paragraph 63 of IAS 1, issued in 1997, indicates that the original term of the balance sheet is 12 months, and that it must be prepared to show the long-term nature or asset position of the business (IASB, 2009). Additionally, IAS 1 states that any relevant issues must be adequately captured in financial statements. This means that financial statements need to capture events that occur within the 12 month period as well as relevant events that occur after the accounting cut-off period before the accounts are laid out before the board of directors for authorization. Events After the Balance Sheet Date “Events after balance sheet date are events occurring between the balance sheet date and the date on which the finalised statements are approved by the board of directors” (Ramachandran & Kakani, 2009, p. 412). This means that they are the incidents and events that occur between the cut-off period for the financial statements and the time the accounts are approved by the board of directors, including activities that give further explanation and understanding of the information captured within the period. IAS 10 provides two broad headings under which events after balance sheet date could fall. First, there are events that provide evidence of the conditions that existed at the balance sheet date. Second, there are events that are indicative of conditions that arise after the balance sheet date. Adjusting and Non-Adjusting Events Some events require that some aspects of the balance sheet are changed. Other events require that the balance sheets are maintained; however, they are essential and might require some kind of disclosure to give the users of the financial statements better information and insight about the financial position of the company during the period. Adjusting events are events that give additional information about evidence of the conditions that existed at the balance sheet date. In other words, they provide important information about figures recorded within the cut off period [i.e., the period for which the financial statements were prepared]. Non-adjusting events are those events that are indicative of conditions that came into existence after the cut-off period. In other words, they are events that provide insight into the activities that occurred after the financial statements were prepared. However, they do not significantly alter the information that exists in the period for which the accounts were prepared, meaning that the figures for the period under review are not significantly changed. However, due to the importance of such information, it might be necessary to inform those reading the statement since this event might be necessary for understanding future accounts. This is vital because as identified in Paragraph 63 of IAS 1, balance sheets must show the asset base of a company in a continuous fashion. Therefore, it is necessary to provide all information of relevant events that occurred in the period that could significantly alter the asset base of the organisation in question. Disclosure and Presentation As identified above, adjusting events require modifications to the affected figures in the account prepared over the 12 month period. Thus, the modifications and adjustments must be identified and recognised accordingly in the financial statement. An example is where the bankruptcy of a debtor is confirmed in the period between the cut-off period and the authorization of the accounts. Previous provisions made for bad debts would be confirmed when the information on the bankruptcy is acquired. This will mean that every provision must be cancelled and the bad debts should be entered. This will reduce the figure for debtors and have an effect on the profit and loss account because there will be the need to recognize the loss. In addition, non-adjusting events that occurred outside the balance sheet date should be disclosed. For example, if a warehouse or office building burnt down in the period after the preparation of the financial statements, it would be significant. Since it did not occur within the cut-off period, it cannot be deducted from the asset base of the previous period. However, the reader of the accounts, whatever his or her interest might be, should be made aware of the fact that the next period would include the write-off of the destroyed asset. The disclosure of non-adjusting events promotes the fundamental elements of financial statements: relevance, reliability, understandability and consistency. This is because timely disclosure ensures that all users of financial statements reflect the reality in the business’ operations. Also, a reader has a better understanding when comparing the figures on a year-by-year basis. Greeining (2009) identifies that in the disclosure of both adjusting and non-adjusting events, there is some important information that must be disclosed: the date of authorization, the name of persons who authorized the account and the persons who amended the balance sheet after the issues were identified and raised. The notes should ideally include some information about the modifications and some background. For non-adjusting events, there is the need for extra information to give the reader a better understanding of events (Greening, 2009). The information that must be disclosed is related to the nature of the events. There should also be some disclosure of the estimations of the financial effects of the event and the future effects of the events. Thus, as adjusting events require that changes are made with corresponding disclosures of the parties involved, the disclosure of non-adjusting events requires a strong emphasis on the estimation and future implications of the event at hand. Practical Example of Events After the Balance Sheet Date In order to illustrate how events after the balance sheet date work, a few hypothetical cases will be examined. Business X prepared its accounts from January 1, 2005 to December 31, 2005. This is in sync with the essence of the IAS. This is because in the 12 month period between January and December, 2005, they hope to capture the asset position of the business and its changes within the period as well as the profits and losses within the period. However, the board of directors of Business X approve their accounts in mid-March each year. In this context, the accounts prepared between January and December 2005 will be authorized in March 2006. After that, the authorized accounts are presented to the shareholders [who actually own the business] at the annual general meeting [AGM, which is most likely to be in April, four months after the period]. Technically, this means that the shareholders need to be given the most current information about the affairs of Business X. It is the responsibility of the directors to ensure that everything that is presented at the AGM is in sync with the latest updates of activities in the business. In this hypothetical case, let us assume that Business X was involved in a copyright infringement and they were sued for £15 million by the aggrieved business. In the process, Business X made a provision of £10 million for the settlement on the advice of their lawyers. However, in February, the court decided to award £14 million to the aggrieved party. This will mean that the provision made for the infringement will be £4 million less than the actual damages they suffered, and that the accounts of Business X will need to be adjusted appropriately. The provision of £10 million, which will be under contingent liabilities, will be written off. In its place, a liability of the actual amount of £14 million will be recognised. The balance of £4 million will be written off in the profit and loss account, reducing the profit within the period. These adjustments should be made before the accounts are signed in mid-March. In contrast, if we consider the case of the burning down of a warehouse worth £10 million on 2 January 2006, the facts will be different. This is because although the warehouse is important to Business X’s future, it did not affect the financial accounts of 2005, because 2 January was outside the period. Therefore, it would be wrong to match the £10 million against any activity in 2005. However, it will be vital for the management of Business X to disclose this event in the 2005 financial statements before they are authorized. This is a non-adjusting event. According to Everingham et al. (2008), the event must be disclosed and all relevant details must be mentioned. In addition, the estimated financial effects must be disclosed. Thus, the extent of the loss on operations in 2006 should be disclosed because financial statements are meant to give information to their users. As such, significant information like this will have to be disclosed to the owners of the business. Comparison with US GAAP As of 1998, there were no standards in the US GAAP for events after the balance sheet date (Baley & Wild, 1998). However, with contemporary events like major scandals, US financial authorities have created laws to cover post balance sheet events. “There is no difference of principles between IASB GAAP & US GAAP [on events after balance sheet date]. However, IAS 10 now requires that dividends proposed or declared after the balance sheet date are not adjusting events” (Alexander & Archer, 2009, p. 9.108). Gupta however identifies that in practice, there might be some minor differences relating to the definition of terminology and other procedures (2004). The current system used in the United States is Statement 165, Subsequent Events. This standard has made the IFRS and the US GAAP to become closer in outlook and operation (SEC, 2011). IFRS requires that each financial statement must disclose the date that the accounts where authorised and the person who authorised it, but the US GAAP does not have any such requirements in relation to authorisation (SEC, 2011). Due to this, the strict disclosure requirements in the IFRS a financial statement that did not have issues between authorisation date and authorisation date might not need some disclosures. Conclusion Events after the balance sheet date are events that occur after the cut-off period for which the accounts are prepared but before the board of directors authorize the account. There are adjusting and non-adjusting events, which have different disclosure requirements. Adjusting events require modifications to figures in the account to give readers the basic principle of completeness in accounts. Non-adjusting events, on the other hand, do not require changes in values and figures. Rather, there is the demand to make a disclosure to provide clarity and reliability to the account users. There is no significant difference between the IAS 10 and US GAAP on the matter. References Accounting Coach (2011) “What is Meant by Events after Balance Sheet Date?” Available online at: http://blog.accountingcoach.com/subsequent-events-post-balance-sheet/ Accessed: April 4, 2012. Alexander, D. & Archer, S. (2008) International Accounting/Financial Reporting Standards Guide. Amsterdam: CCH Press: Kluwer Publishing. Baley, G. & Wild, K. (1998) International Accounting Standards: A Guide to Preparing Accounts New York: Accountancy Books, Cornell University. Basu (2009) Auditing: Principles & Techniques. New Delhi: Pearson Education. Eveningham, G., Kleynhans, K., & Posthumus, L. (2008) Principles of Generally Accepted Accounting Practice. Cape TownL Juta & Co Ltd. Gee, P. (2006) UK GAAP For Business & Practice. London: Butterworth-Heinemann. Greening, H. V. (2009) International Financial Reporting Standards: A Practical Guidance. New York: The World Bank. Gupta, S. (2004) Contemporary Auditing New Delhi: Tata McGraw-Hill. IASB (2009) International Financial Reporting Standards. Netherlands: Kluwer Publishing. Mirza, A., Orrell, M., & Holt, G. (2010) Wiley IFRS: Practical Implementation Guide & Workbook. Hoboken, NJ: John Wiley & Sons. Ramachandran, N. & Kakani Ram K. (2009) Financial Accounting for Management. New Delhi: Tata McGraw-Hill Education. Security & Exchange (2011) Workplan on the Co-ordination of Integration between the IFRS and US GAAP Office of the Chief Accountant. Available online at: http://www.sec.gov/spotlight/globalaccountingstandards/ifrs-work-plan-paper-111611- gaap.pdf Walton, P. (2011) An Executive Guide to IFRS: Content, Costs & Benefits to Business. Hoboken, NJ: John Wiley & Sons Ltd. Read More