Waiting for the other shoe to drop is an idiom that means to wait for an expected and inevitable event to occur, usually a negative one. The idiom comes from the idea of a person being disturbed by a neighbor who dropped one shoe on the floor and is waiting for the second shoe to make noise.
Auditing standards require that we look at the financial activity that took place between the year-end of the period under audit and the date of the audit opinion…waiting for that inevitable drop:
- a drop in the market;
- a drop in participants due to a spinoff or a pandemic;
- a drop in assets and participants due to a technical termination….
Auditors must disclose the effect of the second drop if it would affect a financial statement reader’s analysis of the audited entity’s financial status.
Pushback! – Auditing Subsequent Events: Is it Really Necessary?
Clients and their trusted advisors often question why we need to see financial activity that took place after the year under audit. It’s a logical question, but auditors cannot wear blinders with respect to transactions between the financial statement date and the date of the audit opinion. Some unrecognized subsequent events may be of such a nature that financial statement disclosure is required to keep the statements from being misleading.
The Audit Standards
The audit standards establish the auditor’s responsibilities with respect to two types of subsequent events:
- Type I: those that provide evidence of conditions that existed at the date of the financial statements;
- Type II: those that provide evidence of conditions that arose after the date of the financial statements.
Significant subsequent events require a note disclosure describing the nature of the event and an estimate of the financial effect or a statement that such an estimate cannot be made.
Type II Subsequent Event Disclosure Examples
Coronavirus: Financial statements disclosed the significant effects of the pandemic on the market value of plan investments, as well as significant changes in plan provisions pursuant to the Coronavirus Aid, Relief and Economic Security (CARES) Act.
Market Value Declines: Investment securities are exposed to various risks such as interest rate, market and credit risks. Due to the level of risk associated with certain investment securities, it is a least reasonably possible that changes in the values of investment securities will occur in the near term, and that such changes could materially affect the amounts reported in the statements of net assets available for benefits. The current economic environment has increased the degree of uncertainty.
Plan Termination After the 2022 Year-End: Management of Nearly-Bankrupt Holdings, Inc. terminated the Plan effective February 1, 2023. Effective with the Plan’s termination, all participants became fully vested in their account balances and all contributions to the Plan ceased. All account balances were distributed in accordance with the terms of the Plan and any remaining assets were distributed on May 5, 2023.
Delinquent Deposits Corrected After Year-End: As required by ERISA Section 2510.3-102, the Plan sponsor is required to segregate employee contributions and loan repayments to the Plan from its general assets as soon as practicable. The Plan has contributions totaling $1,349,183, representing employee salary deferrals and loan repayments that were remitted between 3 and 15 days after the related payroll date, and were determined to be late. These contributions are considered prohibited transactions. The Company has calculated lost investment earnings and filed Form 5330, as applicable, to fully correct the prohibited transactions.
The Second Shoe Can Be a Ski Boot or a Slipper
Disclosing what happened after year-end does not have to be negative. At times, the plan’s tax qualified status at year end may be jeopardized by a failure to follow plan provisions, but an EPCRS correction that reinstates the plan’s qualified status may have been completed or may be imminent by the time the financial statements are issued. I suspect the same people who push back about subsequent events that are negative or inconvenient to substantiate would be equally hopeful and eager to disclose subsequent events that present the plan sponsor in a positive light. Either way, the subsequent event disclosures strive to present relevant information through the date of the audit opinion. The second shoe can be a heavy work boot that goes “Kathunk!”, or a slipper that falls lightly, like music to the ear.
