[Eri]

So I recently got this MC question:

Which of the following subsequent events could have a negative impact on a company’s debt-to-equity ratio computed using the information reported on the company’s balance sheet for the year ended Dec. 31, Year 1?

Assume that the company files its financial statements with the SEC and that its financial statements were issued Feb. 4, Year 2.

A. The bankruptcy of a major customer on Feb. 2, Year 2

B. A lawsuit that was filed against the company on Oct. 12, Year 1, and settled on Jan. 2, Year 2.

C. A lawsuit that was filed against the company on Feb. 22, Year 2

D. A fire that destroyed all of the company’s office building and warehouses (all uninsured) on Jan. 18, Year 2.

The answer is B and while I understand why B is the answer, the reason Becker gave for why A was not the answer was that “the condition of the customer’s bankruptcy did not exist as of that date” (i.e. the bankruptcy was filed after Dec. 31, Year 1). That reasoning makes sense to me also. If the event happened after the balance sheet date you don’t adjust the financial statements.

However, one of the simulations had a question asking what you should do if a customer filed for bankruptcy after the balance sheet date (to be specific, the customer filed for bankruptcy on Jan. 2 and the financial statements were calendar-year). The solution said you had to adjust the financial statements by making a journal entry, but I thought you were not supposed to do that since the bankruptcy was AFTER the balance sheet date (Dec. 31).

So now I’m confused. I have two Becker questions telling me different things. Do you disclose AND have a journal entry for customer bankruptcies filed after the balance sheet date or do you just disclose and have NO journal entry?

[ellabella]

I'm confused too. I would think for the bankruptcy occurring as a subsequent event (but prior to the issuance of the financial statements), you could make a j/e for the A/R loss. For the lawsuit, if you knew that it would occur in the future, you would set aside a contingent amount, then do a j/e later to adjust the amount. The lawsuit settled early enough in Year 2 that you could do an adjustment prior to financial statement issuance. I am studying using UWorld Roger, and have experience in subsequent events, and I'm stumped.

[Mick]

The question is asking which one will have the most effect on debt-to-equity ratio (liabilities over equity). It’s answer C) because the entry to record effects liabilities and retained earnings (through the P&L). Answer B only effects retained earnings since the other side of the entry is against the assets on the balance sheet.

REG 55,53
AUD 80
BEC 60
FAR 74, 70

[DS]

As to when to accrue a loss based on a customer's bankruptcy it is really a matter of judgement. The question is if the condition existed at the balance sheet date. If they file for bankruptcy on January 2, obviously they were is dire straights as of the end of the year and an adjustment should be made to the prior year's financial statements. A bankruptcy on February 2nd isn't as clear cut – it could have occurred due to an event happening in January (eg a fire at their manufacturing facility) so it isn't necessarily accrued and may just be disclosed in the notes.

[Author]

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