Accounting for events after the reporting period

One of the most common questions I receive from practitioners relates to ‘post balance sheet events’ or ‘events after the reporting period’.

For firms of practitioners using UK GAAP these are dealt with in FRS 21 Events After the Balance Sheet Date with the international equivalent being IAS 10 Events After the Reporting Period. Users of the FRSSE (effective April 2008) are directed to section 14.

This article will take a look at some issues relating to post balance sheet events, primarily in the context of FRS 21 and the FRSSE (effective April 2008), though the principles contained in IAS 10 are essentially the same.

Favourable and unfavourable events

FRS 21 (like all the other standards) contains lots of definitions which need to be understood to ensure correct application. Paragraph 3 to FRS 21 refers to ‘favourable’ and ‘unfavourable’ events.  The standard then sub-divides these into two further categories – those of ‘adjusting’ and ‘non-adjusting’ events.  It is often the case that confusion occurs in deciphering whether a transaction or event becomes an adjusting or a non-adjusting event.

To quickly recap, an adjusting event is one which, by definition, requires the financial statements to be adjusted prior to the approval of the accounts and subsequent distribution to the shareholders.  A non-adjusting event is not adjusted for in the financial statements, but should be disclosed if it is considered a material non-adjusting event.

FRS 21 goes into some element of detail concerning the date on which the accounts are approved and authorised for issue.  The standard specifically says that the accounts are authorised for issue on the date of issue – not the date on which the shareholders approve the accounts.

Figure 1

Company A Ltd has a year-end of 31 July 2011. The accounts are presented to the board of directors on 17 September 2011 and on this date the financial statements are authorised for issue. The company announces its results on 21 September 2011 and the accounts are made available to shareholders on 1 October 2011 and they approve the accounts on 15 October 2011.

The financial statements are authorised for issue on 17 September 2011 which is the date on which the board of directors authorises them for issue.

Adjusting events

As mentioned earlier, an adjusting event is one which is reflected within the accounts. Regulatory bodies have previously cited concerns about a lack of post balance sheet events and particularly where adjusting events are concerned. The problem is that sometimes it might be the case that an adjusting event takes place, but the financial statements for the year-end in question are not changed to reflect the adjusting event. Paragraph 8 to FRS 21 specifically requires amounts within the accounts to be recognised to take into account adjusting events.

An event becomes an adjusting event when it is clear that the conditions existed at the balance sheet date. FRS 21 gives some examples of typical adjusting events at paragraph 9(a) to 9(e), specifically:

• Settlement of a court case after the balance sheet date which confirms the entity had a liability at the balance sheet date
• Receipt of information after the balance sheet date which confirms that an asset has suffered impairment
• The classic scenario of the bankruptcy of a customer after the balance sheet date which confirms the trade debtor (‘trade receivable’ if you’re speaking in international language) is irrecoverable
• Sale of stock (‘inventories’ in IFRS ‘speak’) after the balance sheet date which may give evidence relating to their net realisable value
• The cost of assets purchased after the balance sheet date, or proceeds received from the sale of assets sold prior to the balance sheet date
• Determination of profit-sharing bonus payments made after the balance sheet date
• Discovery of fraud and/or errors

All the above would be adjusting events IF their conditions existed at the balance sheet date.

Figure 2

Company B Ltd has always paid bonuses to its two directors based on 5% of profit before tax. The draft management accounts as at 31 March 2011 include a gross bonus, plus employers NIC amounting to £11,500 each following the resolution to pay a bonus based on the draft figures on 20 March 2011. This bonus is not paid until such time the accounts are approved because of various adjustments that are often incorporated in the finalised accounts. The accounts are approved four months after the year-end and because of a large stock write-down, the profits have reduced to an extent that the gross bonus, plus the employers NIC should only be £4,500 each.

This is clearly an adjusting event and the bonuses will need to be reduced because the conditions to pay the bonus existed at the balance sheet date.

Non-adjusting events

By definition, non-adjusting events do not get adjusted for in the financial statements. This is because their conditions did not exist at the balance sheet date. Instead additional disclosures may be required in the accounts in accordance with paragraph 21 of FRS 21. Paragraph 21 requires non-adjusting events to be disclosed in the accounts if they are material. This is where some practitioners come unstuck because they interpret the standard differently in that they consider that because it is non-adjusting, and the event occurs in the next financial year, then that’s all there is to it – let’s forget about it this year and worry about it next year. However, paragraph 21 to FRS 21 is specific – if non-disclosure of the non-adjusting event would influence the decisions that users make on the basis of the financial statements, then you must disclose:

• the nature of the event
• an estimate of the event’s financial effect. If an estimate cannot be made then you must disclose this fact

Figure 3

Company C Ltd is a supermarket which operates four different classes of business division: groceries, mobile telephone providers, internet service providers and domestic appliances. Each division is material to the financial statements of the company. The financial year-end is 31 March 2011 and the financial statements have not yet been approved. On 30 September 2011 the company’s directors decided that because of extremely difficult trading conditions, and a heavy loss, it would discontinue the domestic appliances division. This announcement was made on 1 October 2011.

This is a non-adjusting event because the decision to discontinue the division took place after the balance sheet date. However, because the division is considered to be material to the financial statements it would need to make disclosure within the financial statements concerning the closure of the appliances division.

Figure 4

Company D Ltd has a year-end of 31 July 2011. On 4 August 2011 it offers a bonus issue to its shareholders of one share for every five shares held. The decision to issue this bonus issue was taken because the company has recently been experiencing a few cash flow difficulties and the issue of bonus shares would be done instead of paying a dividend to its shareholders. The shareholders have agreed on the basis that the company has just recently secured a lucrative six-year contract to supply services which is likely to be very profitable. The question arises as to whether the bonus issue should be disclosed as a non-adjusting event.

FRS 21 requires major ordinary share transactions and potential ordinary share transactions which occur after the balance sheet date to be disclosed. However, FRS 21 at paragraph 22 (F) does not require disclosure as a non-adjusting event of bonus issues, share splits or reverse share splits. This is because FRS 22 Earnings per Share at paragraph 64 requires retrospective adjustment of such transactions. FRS 22 also requires that where a company makes a bonus issue, share split or reverse share split after the balance sheet date, but before the shares are issued, the earnings per share calculation will be based on the new number of shares and the fact that per share calculations reflect such changes will also require disclosure.

Dividends

Dividends which are proposed after the balance sheet date cannot be recognised in the accounts at the balance sheet date. This requirement also applies where the financial statements have not yet been authorised for issue. The reason is down to the fact that at the balance sheet date, no obligation existed, but the dividends would be disclosed within the financial statements. Seemingly some practitioners still take the view that dividends declared after the balance sheet date should be incorporated in the accounts at the balance sheet date which is actually in contravention of paragraph 12 to FRS 21.

Conclusion

FRS 21 (and the FRSSE (effective April 2008) equivalent) is not a huge standard to go through and does contain some very good examples of adjusting and non-adjusting events which might be applicable to your client’s particular circumstances, or your company’s particular circumstances. One final point to make is not to forget to disclose the date when the financial statements were authorised for issue and who gave that authorisation. The standard acknowledges this point is important because the accounts will not reflect events after this date.

Category: Accounting and standards