CA. Charmi Shah

With the financial year coming to an end, we are approaching the closure of the financial accounts 2023-24. This means there are a bunch of things that every business must take care to prepare and a set of compliances that one needs to adhere while finalising the books of accounts.

Let us first understand the sequence of approval of financial statements

Step 1: After the financial year end, Board of Directors /Management prepare the financial statements and approve the same; in case of partnership firm, managing partners approve the financial statements.

Step 2: Auditor of the company conducts audit and issues a report on the financial statements;

Step 3: Audited financial statements are adopted by the Members of the company in the AGM.

In Sir Kikabhai Premchand v. CIT [1953]24 ITR 506 (SC), ITO v. Murlidhar Bhagwan Das [1964] 52 ITR 335 (SC), CIT v. British Paints India Ltd. [1991] 54 Taxman 499/188 ITR 44 (SC) and CIT  v. Basant Rai Takhat Singh [1933] 1 ITR 197 (PC), it is well settled that each year is separate and self-contained period, Income Tax is annual in its structure and organization. Thus, each previous year is a distinct unit of time for the purposes of assessment. The profits made; and the liabilities or losses made before or after the relevant previous year are immaterial in assessing income of a particular year; unless in accordance with proviso to Section 4(1) of I.T. Act, there is statutory provision to the contrary.

Events occurring after the balance sheet date:

There may be a time gap between the balance sheet date (reporting date) and the date on which the financial statements are approved. During this gap of time, some significant events shall take place. Such significant events are called events after the reporting period. Significant events are Material events, which can influence the economic decisions of the users of financial statements. They are also called Post- Reporting-Period events.

For Example, a company prepares its balance sheet on 31/3/2024, but it is approved by Board of Directors on 30/6/2024. Any event that occurs between 31/03/2024 and 30/6/2024 is called event after the reporting period. The main issue here is whether to adjust such events in the financial statements or not. Therefore, many Accounting standards related to events after the reporting period have been made to simplify the accounting and auditing of the same. They are IAS 10, IFRIC17- Distributions of Non-Cash Assets to owners, INDAS 10, AS -4 etc.

Due to the nature of the regulatory process, a reporting entity may receive additional information from its regulator or a final regulatory decision after the end of a reporting period but prior to releasing its financial statements. In those situations, a question arises as to whether the impact of the information or decision should be recorded in the prior period or the period in which it was received. These significant events can be favourable or unfavourable to the entity. The subsequent event occurring after Balance sheet date should be considered as held by Hon Bombay High Court Sushila Shanitlal Javeri v. UOI & Anr. (2006) 286 ITR 428 (Bom.) (HC)

Events occurring after the balance sheet date are classified into two i.e. adjusting events and non- adjusting events.

Examples of Adjusting Events :

• The court case is settled after the end of the reporting period and it confirms that an entity had a present obligation and should have created a provision in line with IAS 37.
• Bankruptcy of a customer after the end of the reporting period confirming that a client was credit-impaired and Expected Credit Loss should have been recognized in line with IFRS 9
• Sale of inventories after the end of the reporting period at below-cost price suggesting that the inventories’ NRV was lower than their cost.

  This was incorporated in Income-tax Appellate Tribunal Chennai Bench “B”, dated 11.03.2008 in I.T.A.No.684/Mds/2007 for the assessment year 2000-01 For Appellant- Ms. Sree Lakshmi Valli and Shri P. Amarnath Reddy v. The Deputy Commissioner of Income-tax, Tax Case (Appeal) No.979 of 2008, In the High Court of Judicature at Madras .But in case of CIT v. Tamil Nadu Sugar Corporation Ltd. on 31 December, 2002 Equivalent citations: [2003] 128 Taxman 179(MAD) value of the closing stock on the date which was prevailing after the end of the accounting year as the market value of the stock as at the end of the previous year was not allowed.

• Discovery of errors or fraud showing that the financial statements are incorrect. The fraud and the legal proceedings will be adjusting events that give rise to an adjustment within the financial statements as of 30 September 2024.
• Profit-sharing or bonus payments were determined after the end of the reporting period suggesting that there was a present obligation at the year-end

In case of Orissa Power Transmission Corporation v. ACIT, Corporate Circle-1(2), on 27 October, 2020 suggested provision can be made for revision of commission made after the balance sheet date. But in case of Commissioner Income tax Bangalore v. K.C.P.Ltd Vuyyur. on 1 May,2018 the provision made for increase in wages based on the Wage Board Award which became enforceable on the date of the publication of the award which was after the balance sheet date could not be accepted as a liability having accrued within the previous year.

Short illustration:

XYZ faces a court case for selling contaminated food to its customers. XYZ denied all claims and no provision was made in its financial statements on 31st March 2024. On 2nd May 2024, the court awards ₹ 1 lakh damages against XYZ. The financial statements have not yet been authorized for issue at that time. Therefore, this adjusting event must be reflected in the financial statements on 31st March 2024

DEF needs to create a provision for the damages because the present obligation existed on 31st March 2023 (they sold contaminated food prior that date):

Debit Legal costs in profit or loss: ₹ 1 Lakh Credit Provision against legal costs: ₹ 1 lakh

Examples of Non-Adjusting Events:

1. Dividends declared in this period after the Reporting Period, but before approval of the financial statements should be noted, but not shown as a liability, at the balance sheet date. The standard IAS 10 specifically says in para 12, that the dividends declared after the reporting period are NOT reported as a liability at the end of the reporting period. In other words, you need to treat them like they are non- adjusting event. The dividend liability is recognized when the shareholder’s right  to receive them has been established. As there are no conditions existing as on 31-3-2024, the subsequent proposal for dividend is a non-adjusting event. As per the Schedule III proposed dividend information should be disclosed in the Notes to Accounts separately.
2. If the company can no longer be considered a going-concern during this period, IAS 10.14 says that the financial statements should not be prepared on a going-concern basis if the management determines after the reporting period either that:
   • it intends to liquidate the entity, or
   • it intends to cease trading, or
   • it has no realistic alternative but to do one of the above two.

     Then going concern no longer applies and the entity will not operate for at least 12 months after the reporting period.

3. Acquisition of a subsidiary or disposal of a subsidiary: Announcing a plan to discontinue an operation, disposing of assets, or settling liabilities attributable to a discontinuing operation, or entering into binding agreements to sell such assets, or settle such liabilities; Announcing or commencing of major restructuring of business; Entering into significant commitments or contingent liabilities; Destruction or fire accident in plant after the balance sheet date, major purchases and disposals of assets, or expropriation of major assets by government; Natural disasters, wars, pandemics, etc. happening after the reporting period etc. Such events should be noted.

Short illustration:

XYZ owns a plant. On 15 April 2024, a huge earthquake in the area destroyed the plant.

The financial statements for the year ended 31st March 2024 have not been yet authorized for issue by the management at the time of earthquakes.

XYZ should NOT adjust the numbers in the financial statements, because the earthquake is non-adjusting event.

Instead, XYZ discloses this event and its financial effect in the notes to the financial statements.

Exceptions

Exception means even though it is a non- adjusting event it should be adjusted as on balance sheet date. There are two exceptions to the rule of adjusting events:

By its very nature Accounting Standards cannot override the Statutes (Laws). If any statute requires the accounting in a particular manner, entity should follow the guidance of the Statute. Accounting standard should not be applied in that situation.

If any event occurring after the balance sheet date affects the going concern assumption of the entity, such events should be considered and financial statements should be adjusted as on the balance sheet date. If the entity doesn’t have going concern assumption, it should prepare financial statements on liquidation basis (i.e. NRV) as discussed in AS 1.

Disclosures:

If an entity receives information, after the Reporting Period, about conditions that existed at the balance sheet date (adjusting events), it shall update disclosures that relate to those conditions, in the light of the new information.

In some cases, an entity needs to update the disclosures in its financial statements to reflect information received after the Reporting Period, even when the information does not affect the amounts that it records in its financial statements (non-adjusting events).

Instead, in line with IAS 10.21, you should disclose, for each material category of non- adjusting events after the reporting period, both:

• The nature of the event, and
• An estimate of its financial effect.

Non-adjusting events require notes to the financial statements. The financial figures remain unaltered. If non-adjusting events are significant, approving authorities (like the Board of Directors in the case of the company, and partners in the case of the partnership firm) can disclose the same in their report (Board’s Report) so as to enable the users of financial statements to make proper evaluations and decisions. If non- adjusting events after the Reporting Period are material, non-disclosure could influence the economic decisions of users taken based on the financial statements.

One example of the need to update disclosures is when evidence becomes available, after the Reporting Period, about a contingent liability that existed at the balance sheet date.

If material events occur after the approval of financial statements, they should be communicated to users in an appropriate manner.

When an entity wishes to declare dividend in the form of non-cash asset between the end of the reporting of the financial statements and the date of approval, it shall disclose:

• The difference between the carrying amount of the assets distributed and the carrying amount of the dividend payable shall be recognized as profit or loss and disclosed separately,
• The opening and closing amount of the dividend payable; and
• Any increase or decrease in the carrying amount as a result of change in the fair value of the asset.
• If the carrying amount of such an asset is different from the fair value as on that date, the fair value of the asset shall be disclosed; and
• The method used to determine the fair value of the asset.

In light of the above statements, Ind AS 10 also refers to Ind AS 1, it can be concluded that the entity will have to make disclosures on some principles such as going concern basis and the basis on which the entity prepares its financial statements. It shall include the reasons for discontinuation of this principle.

Auditor’s responsibilities

So far we have considered the financial reporting aspects relating to events after the reporting period but before date of auditors report. Now let’s consider the auditor ’s responsibility in relation to ensuring these events.

ISA 560, Subsequent Events outlines the auditor’s responsibility in relation to subsequent events. The auditor should performs audit procedures that are designed to obtain sufficient appropriate audit evidence to give reasonable assurance that all events up to the date of the auditor’s report have been identified, properly accounted for disclosed in the financial statements. The auditor should cover events after the date of the auditor’s report but before the financial statements are issued.

Certain specific procedures are applied to transactions occurring after the balance-sheet date such as

1. the examination of data to assure that proper cutoffs have been made and
2. the examination of data which provide information to aid the auditor in his evaluation of the assets and liabilities as of the balance-sheet date.

In addition, the independent auditor should perform other auditing procedures with respect to the period after the balance-sheet date for the purpose of ascertaining the occurrence of subsequent events that may require adjustment or disclosure essential to a fair presentation of the financial statements in conformity with generally accepted accounting principles. These procedures should be performed at or near the date of the auditor’s report.

The auditor generally should:

1. Read the latest available interim financial statements; compare them with the financial statements being reported upon; and make any other comparisons considered appropriate in the circumstances.
2. In order to make these procedures as meaningful as possible for the purpose expressed above, the auditor should inquire to officers and other executives having responsibility for financial and accounting matters as to:
   • whether the interim statements have been prepared on the same basis as that used for the statements under audit.
   • Whether any substantial contingent liabilities or commitments existed at the date of the balance sheet being reported on or at the date of inquiry.
   • Whether there was any significant change in the capital stock, long- term debt, or working capital to the date of inquiry.
   • The current status of items, in the financial statements being reported on, that were accounted for on the basis of tentative, preliminary, or inconclusive data.
   • Whether any unusual adjustments had been made during the period from the balance-sheet date to the date of inquiry.
   • Whether there have been any changes in the company’s related parties.
   • Whether there have been any significant new related party transactions.
   • Whether the company has entered into any significant unusual transactions.
3. Read the available minutes of meetings of stockholders, directors, and appropriate committees; as to meetings for which minutes are not available, inquire about matters dealt with at such meetings. Inquire of client’s legal counsel concerning litigation, claims, and assessments. (As per AS 2505, Inquiry of a Client’s Lawyer Concerning Litigation, Claims, and Assessments.)
4. Obtain a letter of representations, dated as of the date of the auditor’s report, from appropriate officials, generally the chief executive officer, chief financial officer, or others with equivalent positions in the entity, as to whether any events occurred subsequent to the date of the financial statements being reported on by the independent auditor that in the officer’s opinion would require adjustment or disclosure in these statements. The auditor may elect to have the client include representations as to significant matters disclosed to the auditor in his performance of the procedures. (As per AS 2805, Management Representations.)
5. Make such additional inquiries or perform such procedures as he considers necessary and appropriate to dispose of questions that arise in carrying out the foregoing procedures, inquiries, and discussions.

Circumstances may arise when the auditor becomes aware of facts that may materially affect the financial statements and, in such situations, the auditor will consider whether the financial statements need amending. The auditor is required to discuss with management how they intend to deal with events that will require the financial statements to be amended after the auditors have signed their report, but before the financial statements are issued.

Where the financial statements are amended, the auditor is required to carry out necessary audit procedures in light of the circumstances giving rise to the amendment. The auditor will also be required to issue a new auditor’s report on the amended financial statements and, therefore, must extend their subsequent events testing up to the (expected) date of the new auditor’s report. The revised auditor’s report must not be dated any earlier than the date of the amended financial statements. In situations where management refuses to make amendments to the financial statements, the auditor must take all steps required to avoid reliance by third parties on the auditor’s report. The auditor should also consider the need to resign from the audit.

Conclusion

Subsequent events are a key examinable area in auditing and it is crucial that proper types of audit evidence that the auditor should obtain to confirm that the accounting and disclosure requirements have been applied correctly within the financial statements.