For Wizard Kim - CS-2

Case 12-2: To Recognize or Not to Recognize, That Is the Question

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Professor’s Discussion Materials

Objective of the Case

This case gives the students an opportunity to apply the key concepts of the subsequent events guidance in ASC 855, Subsequent Events.

Applicable Professional Pronouncements

ASC 855, Subsequent Events (ASC 855) (formerly FASB Statement No. 165, Subsequent

Events (Statement 165))

ASC 855-10, Subsequent Events: Overall (ASC 855-10)

ASU 2010-09, Amendments to Certain Recognition and Disclosure Requirements (ASU

2010-09)

AICPA Statement on Auditing Standards Section 560, Subsequent Events (AU Section

560)

IAS 10, Events After the Reporting Period (IAS 10)

Discussion 1 — Medical Benefits Payable

Should the information pertaining to actual claims incurred as of the balance sheet date that became available after the balance sheet date be considered in determining management’s best estimate of the medical benefits payable? If so, how does this information impact the amount recognized or disclosed?

Accounting Alternatives

Alternative 1 — Recognized subsequent event

Yes, the claims data should be considered. The actual claims data provides additional evidence about conditions that existed as of the balance sheet date and should be recognized in the financial statements. The IBNR estimate recorded should reflect the actual amount. Because all claims are historically received within two months of the service being performed, the claims received as of March 18, 2012, most likely represent the entire population of IBNR claims as of December 31, 2011.

Alternative 2 — Nonrecognized subsequent event

No, the claims data do not need to be considered. Management has a process in place that

(1) has a history of accurately estimating the IBNR liability using objective historical data and actuarial techniques as performed by third-party specialists and (2) is clearly disclosed in the “Significant Accounting Policies” footnote. Management must rely on this process for its best estimate of the IBNR liability to timely close the books and issue financial statements. Finally, the results from this process (1) produce a “conservative” result from the actual claims data received after the balance sheet date and (2) provide “cushion” for any remaining claims incurred before December 31 but not reported within the typical lag time. Because the data are not deemed relevant for consideration in recording the liability, it is not a significant event that would need to be disclosed to keep the financial statements from being misleading.

Solution 1 — Medical Benefits Payable

Discussion 2 — Line of Credit Modification

How, if at all, is the modification to the line of credit recognized or disclosed in the financial statements?

Accounting Alternatives

Alternative 1 — Nonrecognized subsequent event that requires disclosure (without supplemental pro forma financial data)

The modification of the line of credit does not provide evidence about changes to the conditions that existed as of the balance sheet date and should not be recognized in the financial statements as of December 31, 2011. Disclosure of the nature of the event and the estimate of its effect on the financial statements in the future are required to keep the financial statements from being misleading (in light of the current disclosures of the significant terms on its debt arrangements and capacity to borrow).

On their own (i.e., ignoring the $10 million that was drawn to finance the acquisition), the modified terms do not have an effect on Shakespeare’s financial position. Rather, they provide significant financial information to users on the availability of a new source of cash to finance business activities as well as a reduction in the working capital needed to cover interest payments and commitment fees (because of lower rates, as modified). As such, the financial statements should disclose the key modified terms. The effect on the financial statements of the $10 million draw on the line of credit only impacts one line item in the financial statements and would be clear for a user to understand in the footnotes (thus, would not require supplemental pro forma financial data).

Alternative 2 — Nonrecognized subsequent event that requires disclosure, supplemented with pro forma financial data

This alternative is very similar to the above view; however, using this alternative, the disclosure conclusions for the modification and $10 million draw are inseparable from the disclosure conclusions for the acquisition. As such, management concludes that it is most appropriate to disclose the nature of the event and estimated effect on the financial statements in the footnotes with disclosure of pro forma financial information on the basis of the following:

1. Management’s estimate of its allocation to the acquired assets and liabilities is known at the date the financial statements are issued. The due diligence, negotiations, and purchase transaction were all authorized and completed before the issuance of the financial statements.

2. While ASC 855-10-50-3 does not provide guidance on what would meet the criteria of “so significant that disclosure can best be made by means of pro forma financial data” (emphasis added), the effect on the financial statements is very significant with fluctuations in key balance sheet line items with changes ranging from 28 to 73 percent (because of both the acquisition and draw on the line of credit):

a. Current assets increased by 31 percent.

b. Noncurrent assets increase by 28 percent (total assets by 29 percent).

c. Noncurrent liabilities increased by 73 percent (total liabilities by 55 percent).

3. The impact of the acquisition is fairly straight-forward; however, it is clearer for a user to easily understand the significant changes to the balance sheet for these events by disclosing pro forma financial information. It is a judgment call if this pro forma information would be included in the footnotes or in columnar form on the face of the historical statements (either view is supportable).

Alternative 3 — Nonrecognized subsequent event that does not require disclosure

The modification itself has no impact on events or conditions that existed as of the balance sheet date. The modification and related draw, on their own, are not of such a

nature that excluding the disclosure would be misleading in financial statements as of

December 31, 2011.

Solution 2 — Line of Credit Modification

Discussion 3 — Acquisition of a New Publishing Company

How, if at all, is the acquisition of Hamlet recognized or disclosed in the financial statements?

Accounting Alternatives

Alternative 1 — Nonrecognized subsequent event that requires disclosure

The estimated impact of the acquisition increased total assets by $10 million (or approximately 29 percent). Management may conclude that it is appropriate to disclose the nature of the event and estimated effect on the financial statements in the footnotes without disclosure of pro forma financial information on the basis of the following:

1. ASC 855-10-50-3 does not provide any guidance on what is “so significant that disclosure can best be made by means of pro forma financial data” (emphasis added) and thus, is a matter of professional judgment.

2. The purchase price allocation has not been completed as of the date the financial statements were issued.

3. The estimated impact of the acquisition is straight-forward and sufficiently clear to a user of the financial statements without pro-forma disclosure in the footnote (or face of the balance sheet).

This disclosure would include its estimate of the effect on the financial statements and would likely include a statement that the purchase price allocation is not complete.

Alternative 2 — Nonrecognized subsequent event that requires disclosure, supplemented with pro forma financial data

See Alternative 2 in Question 2; this view would not be as meaningful without concurrently disclosing the impact from the modification of the line of credit (since the entire purpose and use of the draw from this modification was used to finance the acquisition).

Alternative 3 — Nonrecognized subsequent event that does not require disclosure

The acquisition is of a company in the same line of business that will primarily serve to benefit expanded future operations. However, because private company financial statements typically do not include information about forward-looking information (and there was no impact to events or conditions that existed as of the balance sheet date), excluding specific disclosure of this event does not result in misleading financial statements.

Alternative 4 — Recognized subsequent event

The due diligence for the acquisition started before the balance sheet date. Therefore, the acquisition represents conditions that existed as of the balance sheet date and should be recognized in the financial statements.

Solution 3 — Acquisition of a New Publishing Company

Discussion 4 — Disclosure of Issuance Date

What should Shakespeare state in its disclosure about the date through which the financial statements were evaluated for subsequent events? How would this disclosure change if Shakespeare was an SEC filer?

Solution 4 — Disclosure of Issuance Date

Discussion 5 — IFRSs

Shakespeare is contemplating adopting IFRSs in the coming year. What guidance in IFRSs addresses events that occur after the balance sheet date but before the financial statements are issued? What does this guidance state about the recognition, measurement, or disclosure of such events?

Solution 5 — IFRSs

Recognition and Measurement

Disclosure

Date of Authorization for Issue

Updating Disclosure About Conditions at the End of the Reporting Period

Nonadjusting Events After the Reporting Period

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