CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS CA5106-2ndTerm-AY201920

MODULE 3: PAS 10, EVENTS AFTER THE REPORTING PERIOD

PAS 10 defines “events after reporting period” as any event that happens after the end of
the reporting period (e.g. December 31, 2019) but before the date when the Board of
Directors authorizes the financial statements for issue to the shareholders (e.g. March 31,
2020). The reason for the time lag between the preparation and the issuance of the
financial statements may be due to several factors such as (1) time needed to post year-
end adjustments and to prepare the complete set of financial statements, (2) the audit of
the financial statements by an independent auditor, and (3) the final review to be done by
the Board of Directors, particularly, the audit committee of the Board, before authorizing
it for issue.

Note: “SE” refer to subsequent events, or the other term for “events after reporting period”.

In assessing whether the event after the reporting period is an adjusting event or not,
answer the following question: “Are there any conditions that existed on or before the
end of the reporting period that will require the financial statements to be
adjusted?” If your answer is a YES, then it qualifies as an adjusting event, otherwise, it
will only require a disclosure in the notes to the financial statements.

1. In 2015, SIMBA Company took a 10-year loan from a bank. The loan agreement
requires the Company to maintain a current ratio of 2:1. If the current ratio falls
below what is required by the bank, the loan will become payable on demand. On
December 31, 2018, the Company’s current ratio was 1.5:1. The financial
statements of the Company for the year ended December 31, 2018 were
authorized for issue on March 30, 2019.

a. If on January 10, 2019, the bank gives the Company a chance to rectify the
breach in the loan agreement within the next 12 months and promises not to
demand immediate payment within this period, how will the long-term loan be
classified in the Company’s statement of financial position as of December 31,
2018? CURRENT LIABILITY.

b. If on December 31, 2018, the bank gives the Company a chance to rectify the
breach in the loan agreement within the next 12 months and promises not to
demand immediate payment within this period, how will the long-term loan be
classified in the Company’s statement of financial position as of December 31,
2018? NON-CURRENT LIABILITY.

Loan covenants are conditions imposed in a commercial loan that requires the borrower
to fulfill certain conditions, or forbids (or otherwise, restricts) the borrower from
undertaking certain actions (e.g. declaration of dividends) in order for the lender’s interest
to be protected. Hence, in case any of the covenants imposed by the lender is violated,
the loan becomes immediately due and demandable.

DE CASTRO, K.M. 1|Page

CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS CA5106-2ndTerm-AY201920

Provided that SIMBA faithfully complies with the loan covenants, the lender (or the bank)
will not demand payment; hence, the loan is still classified as non-current in the financial
statements. However, if it violates any of the loan covenants, it will be reclassified as
current.

Loan Covenants

There is no breach in loan There is a breach in loan

covenants? covenants?

Loan is classified as Loan is classified as

NON-CURRENT LIABILITY. CURRENT LIABILITY.

However, there are circumstances wherein the bank provides an opportunity for the
borrower to rectify (or correct) the breach within twelve months from the end of the
reporting period, in which the bank will not demand payment for the loan. Thus, determine
when did the bank agree to allow the borrower to rectify the breach.

Bank agrees to allow the borrower to

rectify the breach

On or before the end of the

After the reporting period?
reporting period?

The original term of the There were no conditions existing

on or before the end of reporting
loan will just continue;
period that the bank will allow the
hence, the loan is classified borrower to rectify the breach;
as NON-CURRENT hence, the loan is classified as
LIABILITY. CURRENT LIABILITY.

Take note that the length of the period to rectify the breach is irrelevant to your analysis.
What is important here is when did the agreement to rectify the breach happen.

DE CASTRO, K.M. 2|Page

CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS CA5106-2ndTerm-AY201920

2. On January 1, 2010, PUMBA Company took a 10-year loan from a bank maturing
on December 31, 2019. The financial statements were authorized for issue on
March 30, 2019.

a. How will the long-term loan be classified on PUMBA’s statement of financial

position as of December 31, 2018?

Since the loan is due to be settled within one year from the end of the reporting
period, it is presented in the statement of financial position as a CURRENT
LIABILITY.

b. Suppose on January 30, 2019, PUMBAA enters into a refinancing agreement

to extend the maturity date of the loan to December 31, 2021, how will the long-
term loan be classified on PUMBAA’s statement of financial position as of
December 31, 2018? CURRENT LIABILITY.

c. Suppose on December 15, 2018, PUMBAA enters into a refinancing agreement

to extend the maturity date of the loan to December 31, 2021, how will the long-
term loan be classified on PUMBAA’s statement of financial position as of
December 31, 2018? NON-CURRENT LIABILITY.

However, if the borrower assesses that he/she is not financially capable of settling the
loan on maturity date, he/she may renegotiate the terms of the loan, or otherwise known
as refinancing or modification of terms. Example of terms that may modified in relation to
the loan are: (1) extension of maturity date, (2) reduction in the principal amount, or (3)
reduction in interest rate. In case of the above example, it is an extension of the maturity
date for more than twelve months from the end of the reporting period. Thus, determine
when did the bank agree to refinance the loan.

Bank agrees to refinance the loan

(e.g. extend the maturity date)

On or before the end of the

After the reporting period?
reporting period?

The term of the loan is There were no conditions

deemed to be more than existing on or before the end of
twelve months from the reporting period that the bank
end of the reporting will agree to extend the
period; hence, the loan is maturity date of the loan;
hence, the loan is still classified
classified as NON-
as CURRENT LIABILITY.
CURRENT LIABILITY.

DE CASTRO, K.M. 3|Page

CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS CA5106-2ndTerm-AY201920

3. As of December 31, 2018, NALA Company has a pending court case with the
Manila Regional Trial Court regarding its alleged violation of the city’s
environmental policies. According to the Company’s legal counsel, the probability
that the Company will be assessed for damages is more than likely; however, at
the end of the reporting period, the amount of damages cannot be determined with
reasonable certainty. On January 15, 2019, the court has rendered its final
judgment and assessed the Company P600,000 as damages. The financial
statements for the year ended December 31, 2018 were authorized for issue on
March 30, 2019.

How will the damages be reported on NALA Company’s statement of financial

position as of December 31, 2018? As a liability amounting to P600,000.

In our previous discussion, we define a liability as “a present obligation of the entity to

transfer an economic resource as a result of past events.” In addition, to recognize a
liability on the face of the financial statements, it must meet the following criteria: (1) it
must meet the definition of a liability, (2) the outflow of economic benefits should be
“probable” (more than likely), and (3) the amount can be measured reliably.

In determining the reliable measurement of a liability, it need not be the exact amount of
economic resources to be transferred. What is important is that there should be a “best
estimate” for the liability. In case of a given range of amount where the likelihood of each
amount to be assessed as the amount of the liability is equal, then the midpoint can be
used as the best estimate.

In this example, it meets the definition of a liability. The present obligation arose from the
company’s violation of the city’s environmental policies, which is also the obligating event
(or the past event that gave rise to a liability). Moreso, the likelihood that it will transfer
economic resources to another party is probable, meaning, there is a high likelihood that
it will lose the case, and therefore, will pay the damages. However, as of December 31,
2018, the amount of the liability cannot be determined with reasonable certainty; hence,
it cannot be recognized in the financial statements just yet, as its best estimate cannot be
determined.

On January 15, 2019, when the court rendered its final decision on the case and require
the company to pay P600,000 for damages, the liability now becomes measurable. Given
that there is an existing condition on or before the end of the reporting period that will
require the company to adjust its financial statements (the damages to be paid in the
future meet the definition of a liability), it should be classified as an adjusting event.
Hence, an adjusting entry is to be made as if it is already measurable on December 31,
2018:

Loss on litigation P 600,000

Estimated liability for damages P 600,000

Therefore, the entity will recognize an expense in its income statement and a liability in
its statement of financial position as of December 31, 2018.

DE CASTRO, K.M. 4|Page

CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS CA5106-2ndTerm-AY201920

4. As of December 31, 2018, MUFASA Company has an outstanding receivable with

SCAR Company amounting to P1,000,000. As of the same date, SCAR Company
is in serious financial deterioration, but has not yet filed for bankruptcy. However,
on February 10, 2019, SCAR already filed for bankruptcy owing to its financial
condition which already existed at the previous calendar year. The financial
statements of MUFASA for the year ended December 31, 2018 were authorized
for issue on March 30, 2019.

How much is MUFASA’s outstanding receivables in its statement of financial

position as of December 31, 2018? Zero.

In assessing whether the receivables are doubtful of collection, the actual bankruptcy of
the customer need not be determined. For as long as there are indicators that the
customer is already experiencing financial difficulty in meeting its obligations as they fall
due, doubtful accounts should be provided.

In this example, if MUFASA already had indicators that it cannot collect its receivable from
SCAR owing to the latter’s serious financial deterioration, it should already record a
doubtful accounts expense for the year ended December 31, 2018 with the following
entry:

Doubtful accounts expense P 1,000,000

Allowance for doubtful accounts P 1,000,000

However, if there was no adjusting entry made at December 31, on February 10, 2019,
once the information was already available that SCAR is already bankrupt, that is only a
confirmation of an existing condition that already existed on or before the end of the
reporting period (which is the inability of MUFASA to collect on the receivable due to
SCAR’s serious financial deterioration); hence it should be classified as an adjusting
event, and the above adjusting entry should still be made as if it occurred on December
31, 2018.

Therefore, at MUFASA’s statement of financial position, the accounts receivable should

be presented as ZERO, with the corresponding note disclosure as follows:

Accounts receivable P 1,000,000

Allowance for doubtful accounts ( 1,000,000)
Amortized cost P - .

DE CASTRO, K.M. 5|Page

CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS CA5106-2ndTerm-AY201920

5. A fire broke out at the warehouse of RAFIKI Company on January 2, 2019 which
practically consumed all of its perishable inventory items. As of December 31,
2018, the inventories had a carrying value of P1,500,000. The financial statements
of the Company for the year ended December 31, 2018 were authorized for issue
on March 30, 2019.

How much inventories will be presented by RAFIKI as a current asset in its

statement of financial position as of December 31, 2018? P1,500,000, with a
disclosure in the notes to the financial statements about the non-adjusting
event.

The company has no ability to predict on or before the end of the reporting period that a
fire will happen on its warehouse after December 31; hence, there is no existing condition
that will require the financial statements to be adjusted. Therefore, the fire is considered
as a non-adjusting event. However, since the 2018 financial statements is not yet issued
and there are users of financial information who may rely on the company’s inventory as
a basis for their economic decisions, the fire that destroyed all of the company’s inventory
items should be disclosed in the notes to the financial statements.

6. In its meeting on January 15, 2019, the Board of Directors of TIMON Company
has declared a P5 cash dividend per share for stockholders on record as of
February 28, 2019. The dividends will be paid on March 30, 2019. The source of
the cash dividends declared was TIMON’s profit for the year ended December 31,
2018. The financial statements of the Company for the year ended December 31,
2018 were authorized for issue on March 30, 2019.

How much is TIMON’s dividends payable to be presented as a current liability in

its statement of financial position as of December 31, 2018? Zero.

As previously discussed in your “Accounting for Corporations”, the corporation will

recognize a liability for dividends to its shareholders only at the date of declaration.
Hence, there is no existing condition on or before the end of the reporting period that will
require the financial statements to be adjusted. Therefore, it is considered as a non-
adjusting event; thus, no dividends payable is to be recognized at the end of the
reporting period.

Lastly, the dividends to be declared by the corporation is always based on the

corporation’s past profits, therefore, it is irrelevant to the analysis.

7. On January 9, 2019, while reviewing the financial statements of ZAZU Company

for the year ended December 31, 2018, the Board of Directors has discovered a
material error in the 2018 financial statements due to the incorrect application of
an accounting policy. The error was an overstatement of the Company’s ending
inventory by P2,500,000. The financial statements of the Company for the year
ended December 31, 2018 were authorized for issue on March 30, 2019.

a. What financial statements, if any, will be affected by the overstatement of

ZAZU’s ending inventory? All of the financial statements are affected.
b. Based on your response in question (a), should ZAZU adjust its financial
statements even if the error was discovered after the end of the reporting
period? Yes, errors should be adjusted.

DE CASTRO, K.M. 6|Page

CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS CA5106-2ndTerm-AY201920

If the 2018 ending inventory is overstated:

Sales not affected

Cost of sales understated
Gross profit overstated
Operating expenses not affected
Net income overstated

Retained earnings, ending overstated

Hence, regardless of whether the error was discovered after the end of the reporting
period but before the financial statements are authorized for issue, errors should be
adjusted in the financial statements.

- END OF HANDOUT -

DE CASTRO, K.M. 7|Page