It is often said that hindsight provides new eyes. Reality looks much more obvious in hindsight than in foresight.
Events that occur post balance sheet date can provide hindsight on the conditions that existed as on the date of the financial statements. SA 560 (Revised) provides guiding principles to auditors in evaluating events that occur post the balance sheet date and the auditors’ responsibilities for facts which become known to the auditor post issuance of his report. The emphasis here is on ‘facts that become known to the auditor’ which would imply that the scope of subsequent events review transcends well beyond enquiries of management by the auditors. In the Indian context, we have observed how external investigations into the affairs of the auditee enterprises have lead auditors to withdraw their audit opinions (on account of newer facts becoming known which have resulted in the audit opinion being rendered inappropriate).
SA 560 (Revised) has been aligned with International Standards on Auditing (ISA) 560 on ‘Subsequent Events’. SA 560 (Revised) requires auditors to evaluate facts that become known to the auditor after the date of issuance of the auditor’s report, where such facts have a bearing on the financial statements covered by the audit report issued.
SA 560 (Revised) requires auditors to consider the following time periods over which facts need to be evaluated:
• from the date of the audit report but before the date when financial statements are issued
• after the date when financial statements are issued
Per SA 560 (Revised), the term ‘date when financial statements are issued’ is defined to be the date when financial statements are made available to third parties.
Financial statements may be impacted by events that occur after the date of the financial statements. Such events can be broadly classified into two categories:
(a) Those that provide evidence of conditions that existed at the date of the financial statements; and
(b) Those that provide evidence of conditions that arose after the date of the financial statements.
Adjustments to assets and liabilities are not appropriate for events occurring after the balance sheet date, if such events do not relate to conditions existing at the balance sheet date. The date of the audit report informs the reader that the auditor has considered the effect of all subsequent events and transactions which he became aware of and that occurred up to that date.
Let us understand the applicability of SA 560 (Revised) by considering an elementary case study involving an event that has occurred between the date of the financial statements and the date of the auditor’s report and the underlying responsibility of management and the auditors’ to respond to this event.
Case Study 1
XYZ Limited (‘the Company’) has a legal proceeding pending against it in a Court of Law for breach of a contract. As at the balance sheet date, 31st March 20XX, the Company represented to its auditors that it had not breached the contract and provided a legal opinion supporting its position as the most likely outcome. No provision towards damages for breach of contract was recognised in the draft financial statements for the year ended 31st March 20XX. A week prior to the board meeting (scheduled to be held on 1st June 20XX to approve the accounts for the year ended 31sts March 20XX), the Court delivered an adverse ruling and held the Company liable for damages of Rs. 10 crore. The Company does not have recourse to appeal before a higher judiciary.
In the given case, in light of the judgment which was delivered subsequent to the balance sheet date, management should adjust the financial statements by accounting for provision for damages of Rs 10 crores because the judgment provides sufficient evidence that an obligation existed at the balance sheet date. The auditor on his part would need to take cognisance of the adverse ruling and perform audit procedures to obtain sufficient appropriate audit evidence for provision of damages. These procedures would include:
• obtaining from the Company’s legal counsel, the updated status of pending litigation or the Court ruling,
• reading minutes of board meetings, if any,
• verifying that provision for damages made in the accounts is adequate,
• inquiry of management and, where appropriate, those charged with governance as to whether any other subsequent events have occurred which might require disclosure in or adjustment to the financial statements and
• obtaining written representation from management that subsequent events have been appropriately adjusted/disclosed.
Review of subsequent events essentially involves making enquiries of management about developments occurring post the balance sheet date such as those relating to recoverability of assets, measurement of estimates, updates in the litigation status, onerous commitments etc. More importantly, where events occurring post the balance sheet date cast a doubt on the ability of the enterprise to continue as a going concern, the auditor would need to weigh the appropriateness of the basis of accounting, i.e., whether the accounts should be prepared on a going concern basis or on liquidation basis.
It needs to be noted that the auditor has no obligation to perform any audit procedures regarding the financial statements after the date of the auditor’s report.
A. Auditors’ responsibilities for facts that he becomes aware of before the financial statements are issued
There could arise a situation where after the date of the auditor’s report but before the date the financial statements are issued, a fact becomes known to the auditor that, had it been known to the auditor as on the date of the audit report, the same would have caused the auditor to amend the audit report. In such a case, the auditor would need to make enquiries of the management or those charged with governance and determine whether the financial statements need amendment and, if so inquire how management intends to address the matter in the financial statements.
In a situation where management amends the financial statements, the auditor would need to perform necessary audit procedures and provide a new audit report dated no earlier than date of approval of amended financial statements.
In certain circumstances, management may not be restricted from amending the financial statements only to incorporate the effect of the subsequent events and such amended financial statements may be permitted to be approved by the approving authority to the extent of the amendment. In such cases, the auditor is permitted to restrict audit procedures to that amendment and amend the audit report by dual dating it for the specific subsequent event or provide new or amended report including an emphasis of matter (EOM) or other matter paragraph clearly conveying that the auditor’s procedures are restricted solely to the amendment of the financial statements as described in the relevant note to the financial statements.
Where amendment of financial statements is considered necessary and management refuses to do so, the auditor would need to issue a modified opinion, if the audit report is yet to be provided to the entity.
If the audit report has been provided to the entity, the auditor would need to notify management not to issue the financial statements and the auditor’s report thereon. If the financial statements are nevertheless issued by the entity, the auditor would need to take appropriate action to prevent reliance on the auditor’s report as released by the entity.
B. Auditors’ responsibilities for facts that he becomes aware of after the financial statements are issued
The auditor has no obligation to perform any audit procedures after the financial statements have been issued. Where a fact becomes known to the auditor that, had it been known to the auditor as on the date of the audit report, the same would have caused the auditor to amend the audit report, the auditor would need to perform the same procedures as explained in paragraph
(A) above. In addition, the auditor would need to review the steps taken by management to ensure that anyone in receipt of the previously issued financial statements together with the auditor’s report thereon is informed of the situation.
Case Study 2
The Board of Directors of ABC Limited (ABC) approved an equity dividend of Rs. 6 per share on the paid up equity capital of 1,000,000 equity shares of Rs. 10 each at the board meeting held on 28th May 20XX. The Company recorded proposed dividend of Rs. 6,000,000 which was subject to approval by the shareholders at the annual general meeting scheduled on 5th September 20XX. The audit opinion was signed by the auditors on 28th May 20XX. On the date of the AGM, the Board of Directors convened a board meeting to recommend an enhanced dividend of Rs. 9,000,000 (as against Rs. 6,000,000 which was recommended on 28th May 20XX). The shareholders approved the enhanced dividend of Rs. 9,000,000 in the AGM held on the same date. What would be the course of action in this case?
Consistent with the requirement of Accounting Standard 4 – Contingencies and Events Occurring after the Balance Sheet date, the recording of proposed divided at the time of approval of accounts by the board of directors of ABC was appropriate. As a usual practice, the dividend recommended by the board gets approved by the shareholders. However, in the instant case, the dividend proposed by the Board was enhanced by the Board subsequent to the approval of the accounts on 28th May 20XX. The enhanced dividend was approved by the shareholders. It is entirely within the competence of the Board of Directors to amend the accounts and resubmit them to the statutory auditors for report before the accounts are placed before the annual general meeting. Consequently, management could amend the accounts for the year ended 31st March 20XX to account for the enhanced proposed dividend (as well as dividend tax thereon). In such a case, the auditors would need to perform procedures to verify the increase and its corresponding effects on the result for the period and the net reserves. A detailed note in the financial statements explaining the facts of the case would need to be inserted. The auditor may amend the original report to include an additional date to inform users that the auditors’ procedures on subsequent events are restricted solely to the amendment of the financial statements to the extent these relate to proposed dividend (more simply known as dual dating). Alternatively, the auditor may provide a new or amended report that includes a statement in an Emphasis of Matter paragraph (EOM) or Other Matter paragraph clearly mentioning that the auditors’ procedures on subsequent events are restricted solely to the amendment of the financial statements in relation to reversal of proposed dividend.
Revision to the financial statements – a recent example
The original accounts of Essar Oil Limited (‘EOL’) for the year ended 31st March 2012 which were revised post issuance is a pertinent example of subsequent events resulting in amendment to the financial statements after these were issued. In January 2012, the Hon’ble Supreme Court of India ruled against EOL’s claim of eligibility for sales tax incentives for the financial years 2008-09 to 2010-11. The Company sought approval from the Ministry of Corporate Affairs (MCA) to reopen its books of account for the financial years 2008-09 to 2010-11 for the limited purpose of reflecting true and fair view of the sales tax incentives/ liabilities, etc. for the individual accounting years commencing 2008-09 and ending 2011-12. The MCA approval was received during the financial year 2012 -13. The original financial statements for the year ended 31st March 2012 which were approved by the board of directors and the auditors on 12th May 2012 were revised post receipt of MCA approval and approved by the shareholders in November 2012.
In the Indian context, there have also been cases where auditors have in accordance with SA 560 (Revised) informed management of the auditee enterprises that the audit reports issued should not be relied upon in view of purported crisis relating to the auditee’s business operations reported in public domain. Further, in a case where management admits to falsification of the accounts, the auditors would need to inform management as well as regulatory authorities that their opinion on the financial statements would be rendered inaccurate and unreliable.
Concluding remarks
If recent developments in India Inc. were to be diagnosed, withdrawal of audit opinions have had ramifications on reliability of financial information presented of the auditee enterprise, market capitalisation and more importantly maintenance of public trust and confidence.
With the changes in corporate regulation on the horizon and the availability of easy access to information and technology, auditors have the wherewithal to seek facts about the enterprises which they audit from sources other than the auditee. SA 560 (Revised) makes it incumbent upon auditors to assess whether based on the facts known, they have reasons to believe that the audit report which they have issued stands compromised. The standard also provides direction to auditors where management refuses to take cognisance of subsequent events that have an impact on the financial statements issued. The revised standard is in a way a welcome step in safeguarding interests of stakeholders.
