What are Adjusting events ?

Adjusting events are defined as those events after the reporting period that provide evidence of conditions that existed at the end of the reporting period. The amounts recognized in the financial statements are adjusted to reflect adjusting events after the reporting period.

It is an adjusting event (that is, an event that provides additional evidence relating to conditions that existed at the balance sheet date). The event indicates that it is not appropriate to apply the going concern basis of accounting.

The general principle established by IAS 10 is that financial statements should be prepared so as to reflect events occurring up to the end of the reporting period and conditions existing at the end of the reporting period. Because adjusting events provide additional evidence of conditions existing at the end of the reporting period, the amounts recognised in the financial statements are adjusted for their effect.

Examples of adjusting events include:

The bankruptcy of a customer

that occurs after the balance sheet date that confirms that the customer was credit-impaired, or the sale of inventories after the period end that gives evidence about their net realizable value at the balance sheet date. The determination, after the balance sheet date, of the consideration for assets sold or purchased before the balance sheet date. The determination, after the balance sheet date, of profit-sharing or bonus arrangements, if the entity had a present legal or constructive obligation to make such payments as a result of events before the balance sheet date. The discovery of fraud or errors that show that the financial statements are incorrect.

Settlement of a court case

The result of a court case after the period end is considered, not only in determining whether changes in measurements are required, but also in determining, as at the balance sheet date, whether a provision should be recognized.

An entity should re-measure the amount of a provision for an obligation if the result of a court case after the balance sheet date requires such re-measurement. The result of a court case might also affect the degree of probability of an outflow of economic benefits.

For example, an entity might not have recognized a provision at the balance sheet date because, at that time, it considered that it was not probable that an outflow of future economic benefits would occur. The entity should recognize a new provision as at the balance sheet date where the outcome of a court case clarifies that such an outflow was probable at the balance sheet date. This is consistent with the requirement of IAS 37 for provisions.

In rare cases (for example, with litigation), it might be difficult to assess whether certain events have occurred or whether those events result in a present obligation. An entity determines whether a present obligation exists at the balance sheet date by taking account of all available evidence, including the opinion of experts. The settlement of a court case after the period end could also provide evidence of conditions existing at the balance sheet date.

Where an entity is claiming damages, an asset is not recognized unless an inflow of economic benefits is virtually certain at the balance sheet date (in accordance with IAS 37).

It would be rare for the outcome of the court case to be virtually certain until the final court judgment is given. Only when the final judgment is received should the asset, and the related profit, be recognized in the financial statements of the period in which the change occurs.

In effect, where an entity is claiming for damages, a judgment received after the balance sheet date but before the date of approval of the financial statements is normally a non-adjusting event. The receivable, when recognized, is then subject to a normal impairment assessment.

Information that indicates impairment or provides evidence of net realizable value

An entity should consider an impairment loss if it becomes aware, after the balance sheet date, of conditions that existed at the balance sheet date (adjusting events). A restructuring and discontinuance of operations by sale or closure occurring after the balance sheet date are not in themselves adjusting events.

However, they often provide evidence of impairment at the balance sheet date. An impairment might be a cause, rather than a consequence, of those post balance sheet events. Entities should review carrying values of assets in the light of post balance sheet events, and they should make impairment write-downs as appropriate.

Example 1 – Impairment of trade receivables

A customer’s insolvency after the period end often provides evidence that, at the balance sheet date, the customer was credit-impaired. This is because the customer was unable to pay as at the balance sheet date. This type of event is typically treated as an adjusting post balance sheet event, because it would be unusual for a customer’s business to fail only as a result of events occurring after the balance sheet date and before approval of the financial statements.

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Example 2 – Destruction or expropriation of an asset

Destruction or expropriation of an asset after the balance sheet date represents an indicator of impairment arising after the balance sheet date that is a non-adjusting event. The event is not indicative of a condition existing at the balance sheet date. However, management should disclose the nature of such an event and an estimate of its financial effect.

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Example 3 – Goodwill impairment review

A goodwill impairment review, based on management-approved budgets at the year-end, might not indicate an impairment. Sometimes, management might revise a budget a few months later but before the financial statements are signed (for example, to reflect a recessionary environment). The revised budget could indicate an impairment. Market deterioration is not defined by a specific event, but occurs gradually over time. It is not an adjusting event where such decline occurs entirely after the balance sheet date (that is, no impairment would be recognized). Management should assess whether the budgets in existence at the year-end truly represented their best estimate of the future outlook at the year-end date and were based on reasonable and supportable assumptions, given market conditions.

Example 4 – Post balance sheet restructuring

A post balance sheet restructuring might provide evidence of impairment at the balance sheet date; but, in accordance with IAS 37, provision is not made for future restructuring costs until a legal or constructive obligation exists.

Example 5 – Impairment of current assets

Impairments of current assets resulting from post balance sheet events are often fairly straightforward to identify and quantify. This is because they are usually the direct result of an insolvency of a debtor or the sale of inventory. Sale of a current or fixed asset at a loss or a downward revaluation after the balance sheet date might also provide additional evidence of a diminution in value that existed at the balance sheet date. This would also indicate that an impairment review should be carried out in accordance with IAS 36.

Example 6 – Impairment of inventory

An entity supplies parts to a car manufacturer in respect of a particular model of car. The entity has a high level of inventory of parts, due to low order levels, at the balance sheet date. After the balance sheet date, the car manufacturer announces that the specific model will no longer be produced. There is no alternative market for the inventory.

Does the subsequent event trigger a write-down of inventory to net realizable value?

Estimates of net realizable value are based on the most reliable evidence available at the time when the estimates are made. These estimates consider fluctuations of price or cost directly relating to events occurring after the end of the period, to the extent that such events confirm conditions existing at the end of the period. The inventory should be written down to net realizable value. The high inventory level indicated slow demand from the manufacturer.

The post balance sheet announcement confirmed the excess stock at year end. If the level of inventory was appropriate for the order levels being achieved up to the balance sheet date, the car manufacturer’s post balance sheet announcement is a non-adjusting event, and the inventory is not written down.

Example 7 – Impairment of properties

An entity in trading difficulties obtained after the balance sheet date a valuation of its properties for the purpose of providing additional security to its bankers. The entity is also considering selling certain properties to generate cash. The amount shown by the valuation is materially lower than the historical cost carrying amount attributed to the properties in the balance sheet.

How should this be reflected in the financial statements?

The valuation provides evidence of an impairment that had occurred before the balance sheet date. An impairment review should be carried out in accordance with IAS 36. A provision to write down the properties would be regarded as an ‘adjusting event’, with the values attributed to the properties in the balance sheet being adjusted accordingly.

Example 8 – Losses for internal control failures

There are also instances where losses on current assets are incurred before the period end, as a result of internal control failures, but are only discovered after the period end. These types of events are also adjusting events.

Asset sales near the period end

The recognition of the sale of an item of property, plant and equipment in the financial statements will depend on whether the sale is conditional or unconditional at the balance sheet date.

For example, the sale of property is often conditional on planning permission being granted. Planning permission is granted and the sale is completed, with both these events occurring after the balance sheet date but before the financial statements are authorized for issue.

The receipt of planning permission does not permit the sale to be recognized at the period end, because there is no existing condition, at the balance sheet date, for which the grant of planning permission provides additional evidence. Instead, the sale is recognized in the period in which planning permission is granted (that is, in the period in which the sale becomes unconditional).

Fraud, error and other irregularities

Fraud, error and other irregularities that occur before the balance sheet date, but are only identified after the balance sheet date, are adjusting items. This type of adjusting event might give rise to uncertainties about the entity’s ability to continue its operations. Often, the consequences of failures in internal controls extend back to earlier years, necessitating not only adjustments to the current year figures but also an adjustment for a prior year error.

Where entities invest in investment funds or other marketable securities that suffer a diminution in value, due to fraud discovered by the underlying entity after the period end (that is, the fraud is external to the entity) it is necessary to determine whether such a discovery is an adjusting or a non-adjusting event.

The entity should assess if the underlying investment held at the balance sheet date existed, and had a value on that date, determined by reference to market activity.

In this case, the post year-end loss, as a result of the discovery of fraud by the underlying entity, would be a non-adjusting event. This is because the reporting entity could have sold its underlying investment on the balance sheet date without suffering loss. The fraud might have been such that the underlying investment never actually existed.

In this case, the reporting entity would not have been able to avoid the loss at the balance sheet date, and the post year-end discovery of fraud would be an adjusting event. This is because it provides further evidence of conditions existing at the balance sheet date (that is, that the investment did not exist).