Re: Accounting for a Loss Contingency Verdict Overturned on Appeal
Date:
Relevant Facts:
• W Inc and your company have been engaged in litigation over a specific patent infringement matter.
• In May 2007, W filed a claim.
• On December 31 2007, your company determined that a loss in connection to the claim was probable.
• The company estimated a loss between 15 and $20 million USD.
• $17 million USD was named as the most likely amount of loss.
• A jury trial took place on September 2009.
• On September 24 2009 the jury found in favor of W.
• The judgment required your company to pay W $18.5 million USD.
• In November 2009, your company filed an appeal.
• In December 2010, the court of appeals overturned the jury
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Options:
a. Prior period adjustment.
b. Change in estimate (2009 event).
A prior period adjustment is a correction, for an accounting error, on the financial statements of a prior year. ASC 250-10-50-7 states that “when financial statements are restated to correct an error, the entity shall disclose that its previously issued financial statements have been restated, along with a description of the nature of the error. The entity also shall disclose …the cumulative effect of the change on retained earnings or other appropriate components of equity or net assets in the statement of financial position.” The adjustment to the estimate is not a correction due to an error. Therefore, it should not affect or restate retained earnings or liabilities recorded in prior periods
The company should report the change in the contingency accrual as a 2009 event due change in estimate. ASC 250-10-45-17 specifies that “a change in accounting estimate shall not be accounted for by restating or retrospectively adjusting amounts reported in financial statements of prior periods.” Additionally, ASC 450-20-25-7 indicates that “all estimated losses for loss contingencies shall be charged to income rather than charging some to income and others to retained earnings as prior period adjustments”.
Sample Journal Entry:
Loss (Expense)…………………………………. 1,500,000
Contingent Liability-Litigation…………………1,500,000
Specific Issue 3:
When should
M International and W Inc. have been engaged in long-standing litigation over a specific patent infringement matter. Pertains to the accounting for this contingency loss, this memo has made the following conclusions:
Whether certain allocations of partnership income, gain, loss, deductions, and credits have substantial economic effect and whether that has any impact on the partners’ distributive shares.
From the analysis, relevant requirements to CCA are AASB 112 para. 79 and 80 (a), (b), (c) and (e), which require expense components to disclose separately. Also, para. 81(ab), (c(1)), (g) and 82A, regarding separate disclosure of tax consequences of other comprehensive income, numerical representation clarifying the relationship between tax expense and accounting profit, disclosure of amount of deferred tax assets and liabilities in balance sheet and income tax expense in income statement, and potential tax consequences have been followed respectively.
* Conclusion: Changes in an acquirer’s valuation allowances that stem from a business combination should be recognized as an element of the acquirer’s deferred income tax expense (benefit) in the reporting period that includes the business combination.
An accrual is not made for a loss contingency because any of the conditions in paragraph 450-20-25-2 are not met., b. An exposure to loss exists in excess of the amount accrued pursuant to the provisions of paragraph 450-20-30-1.” Therefore, they also need to disclose the range of the possible loss with some explanation.
Howell Jewelry World entered into an at will employment contract with Jennifer Lawson (“defendant”). The company provided a legal and enforceable employment contract. The defendant read, accepted and signed the employment contract offered under no duress or coercion. A covenant not to compete nor disclose company patent secrets to Howell’s competitors the defendant initialed and signed. Jennifer Lawson was terminated from employment due to excessive tardiness. Upon termination, it was revealed to Howell Jewelry World, the defendant is an employee of Triumph Jewels, another company in competition with Howell. The defendant is liable for breach of covenant not to compete. Howell Jewelry World is pursuing legal actions against Triumph Jewels for Jennifer Howell’s breach of covenant not to compete.
M international (M) and W Inc (W) decided to enter a long term litigation, due to a patent rights violation. M being the demandant and W the respondent. Not enough information was provided in relation to the charges or the patent.
When the CEO looked at the financial statement for the previous year he found that they had a loss of $256,000 (Rakish et
All of the revenue and expense account balances in the adjusted trial balance will be extended. The statements of retained earning is prepared by entering the net income in the credit statement of retained earning column, and then add that to the beginning of the retained earning
In accordance with ASC 855-10-25-3, An entity shall not recognize subsequent events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after the balance sheet date but before financial statements are issued or are available to be issued. See paragraph 855-10-55-2 for examples of non-recognized subsequent events.
An estimated loss from a loss contingency shall be accrued by a charge to income if both of the following conditions are met:
Retained Earnings Statement shows amounts and causes of changes in retained earnings during the period. Time period is the same as that covered by the income statement. Users can evaluate dividend payment practices. This statement shows the changes in the shareholders’ equity account. The first line item is the beginning balance for common stock. The amount of newly issued common stock is added to the
The argument presented by the Tax Court did not consider factors brought to attention by the Court of Appeals. Most notably, the Tax Court did not consider all forms of compensation to the CEO when determining a formula for comparability. This is problematic as the comparability formula used to determine a reasonable compensation for Mr. Menard to receive and was the basis of the Tax Court’s argument against Mr. Menard.
For example the extra charge for maintenance accumulated from last year and for this year should be equally divided and not charged to the first quarter only. Similarly, cost of relocating the Southern Paper Sioux Springs office that has been charged to the first quarter, had been the expenditure incurred last year. It should not have been included in the first quarter. No doubt these are good accounting practices but nevertheless reverting the charges to their respective results would not compromise GAAP practice. Unrealized income would be better off transferred to the next or the last quarter as the income received would not materialize until at the end of the year. Including the dividend from the company's Brazilian unit would not help increase profitability at the end of the year unless the company is assured of its profitability. As of now it needs to balance its accounts before it can estimate correct profit level at the end of the year. With regard to the obsolete inventories, there is no alternative course of action but to write-off from this
Considering real world practices, as well as in accordance with the conceptual framework from the textbook, accrual of a loss from ongoing litigation is rare. Companies usually do not record a loss until after the ultimate settlement has been reached. For example, the Las Vegas Sands Corporation, in a recent quarterly report, disclosed but did not accrue damages from a lawsuit it lost, even after the award was affirmed by the trial court, because the company believe that it has valid bases in law and fact to overturn or appeal the verdict. Consequently, M corporation should not accrue the contingency loss but continually disclose the matter even when a judgment was reached against the corporation to pay $18.5 million in 2009, given that the