Question

Which of the following is the best example of a Type I subsequent event?

a. A related-party transaction occurs during the course of the audit.

b. The company defaults on its line-of-credit with the bank subsequent to year-end but previous to the release of the audit opinion.

c. Litigation that was accrued as a liability in the year under audit is settled subsequent to year-end for an amount in excess of estimates.

d. The company initiates an initial public offering subsequent to year-end

Answer 1

The best example of a Type I subsequent event is when a company defaults on its line of credit with the bank after year-end but before the audit opinion is released, as it reflects the company's financial condition at the balance sheet date.

Step-by-step explanation:

The best example of a Type I subsequent event is b. The company defaults on its line-of-credit with the bank subsequent to year-end but previous to the release of the audit opinion. Type I subsequent events provide evidence of conditions that existed at the balance sheet date and require adjustment of the financial statements. The company's default on its line of credit provides evidence of the company's financial condition at year-end that likely existed at the balance sheet date but was only revealed subsequent to that date. Events like a related-party transaction occurring during the audit or an initial public offering after year-end are not indicative of conditions that existed at the balance sheet date and thus would not be considered Type I subsequent events. However, the settlement of litigation for a higher amount than previously accrued could potentially be a Type I event if it provides additional evidence about conditions existing at year-end.