What does Type 2 subsequent event mean on the CPA exam?
Last reviewed
Type 2 subsequent event. A nonrecognized subsequent event: the condition came into existence after the balance sheet date, so it is disclosed and never adjusted.
Defined against ASC 855-10-25.
Worked example
A privately held manufacturer closes its year on December 31, and expects to make its statements available for issue on March 15. Two things happen in between. On February 5 it settles, for $450,000, a lawsuit over a customer injury that occurred in October. On February 10 a fire destroys a warehouse carried at $1.1 million and the $2.4 million of inventory inside.
How does each event affect the December 31 statements?
- The lawsuit arose from an injury in October, so the condition already existed at the balance sheet date. The February settlement is evidence about that condition, a recognized event, and the liability is adjusted to $450,000.
- The fire is a new condition that arose after December 31. Nothing about the warehouse was wrong at year end, which makes it a nonrecognized event and the balance sheet is not adjusted.
- Because the fire is significant, the notes disclose its nature and an estimate of the financial effect, covering the building as well as the inventory, or say that no estimate can be made.
Answer: The settlement is recognized in the December 31 statements; the fire is disclosed but not recognized.
The trap: Sorting the events by when they happened. Both happened after year end; what decides the treatment is when the underlying condition arose. A settlement reached in February can still belong to December.
Based on ASC 855-10-25-1; ASC 855-10-25-3; ASC 855-10-50-2.
Which CPA exam sections use Type 2 subsequent event?
Type 2 subsequent event appears in the FAR section of the CPA exam.
What is the difference between Type 2 subsequent event and Type 1 subsequent event?
A Type 1 (recognized) event gives evidence about a condition that ALREADY EXISTED at the balance sheet date, so the statements are adjusted. A Type 2 (nonrecognized) event arises from a condition that came into existence AFTER the balance sheet date, so it is disclosed and never adjusted. The test is when the underlying condition arose, not when the entity found out. (ASC 855)
Other terms defined against ASC 855-10
- balance sheet date: The last day of the reporting period.
- subsequent event: Something that happens between the balance sheet date and the date the statements are issued.
- Type 1 subsequent event: A recognized subsequent event: it gives evidence about a condition that already existed at the balance sheet date, so the statements are adjusted.
Related terms
- balance sheet: A snapshot at one date of what the entity owns, what it owes, and the owners' residual.
- loss contingency: An existing condition involving uncertainty that may produce a loss, resolved by a future event.
- carrying amount: What an asset or liability is currently shown at on the balance sheet: its original amount adjusted for depreciation, amortization, impairment or accrual.
- income statement: The statement of what was earned and spent over a period, ending in net income.
- financial statements: The formal set an entity publishes: balance sheet, income statement, statement of cash flows, statement of changes in equity, and the notes.