Question

In 2015, Slim Drug Company began to notice problems with its obesity drug. The company stopped selling the drug near the end of 2015. In the last six months of 2016, the company was sued by 1,000 people who had an allergic reaction to the company’s obesity drug. At the end of 2016, the company’s attorneys believe there is a 60% chance the company will need to make payments in the range of $1,000 to $5,000 to settle each claim. At the end of 2017, while none of the cases have been resolved, the company’s attorneys now believe there is an 80% chance the company will need to make payments in the range of $2,000 to $7,000 to settle each claim. In 2018, 400 claims were settled at a total cost of $1.2 million. Based on this experience, the company believes 30% of the remaining cases will be settled for $3,000 each, 50% will be settled for $5,000 and 20% will be settled for $10,000 each. Using US GAAP and IFRS, show what journal entries would be required in 2015, 2016, 2017 and 2018

Answer 1

Date	Particular	Debit	Credit
2015	Lawsuit expenses	$5,000,000 ($5,000*$1,000)
	Estimated lawsuit liability		$5,000,000
	(To record provision for lawsuit)
2016	Lawsuit expenses	$5,000,000
	Estimated lawsuit liability		$5,000,000
	(To record provision for lawsuit)
2017	Lawsuit expenses	$7,000,000 ($7,000*$1,000)
	Estimated lawsuit liability		$7,000,000
	(To record provision for lawsuit)
2018	Estimated lawsuit liability	$1,200,000
	Case		$1,200,000
	(To reverse provision for 400 people)
	Lawsuit expenses.	$540,000 (600*30%*3,000)
	Lawsuit expenses	$1,500,000 (600*50%*5,000)
	Lawsuit expenses	$1,200,000 (600*20%*10,000)
	Estimated lawsuit liability		$3,240,000
	(To record provision for lawsuit)

As per US GAAP and IFRS, provisions for liability needs to be created when there is reasonable certainty of cash outflows. The probability of more than 50% clearly tells so.

The question is about what amount of range shall be taken. Taking prudent principle of accounting, the highest provision is provided in the journal entries.

In 2018, the provision needs to be closed as the case has been settled for 400 people.