Question

HolmesWatson (HW) is considering what the effect would be of reporting its liabilities under IFRS rather than U.S. GAAP. The following facts apply: a. HW is defending against a lawsuit and believes it is virtually certain to lose in court. If it loses the lawsuit, management estimates it will need to pay a range of damages that falls between $5,200,000 and $10,200,000, with each amount in that range equally likely. b. HW is defending against another lawsuit that is identical to item (a), but the relevant losses will only occur far into the future. The present values of the endpoints of the range are $3,200,000 and $8,200,000, with the timing of cash flow somewhat uncertain. HW considers these effects of the time value of money to be material. c. HW is defending against another lawsuit for which management believes HW has a slightly better than 50/50 chance of losing in court. If it loses the lawsuit, management estimates HW will need to pay a range of damages that falls between $3,200,000 and $9,200,000, with each amount in that range equally likely. d. HW has $10,200,000 of short-term debt that it intends to refinance on a long-term basis. Soon after the balance sheet date, but before issuance of the financial statements, HW obtained the financing necessary to refinance the debt. Required: 1. For each item, indicate how treatment of the amount would differ between U.S. GAAP and IFRS. 2. Consider the total effect of items a-d. If HW's goal is to show the lowest total liabilities, which set of standards, U.S. GAAP or IFRS, best helps it meet that goal? Complete this question by entering your answers in the tabs below. Required 1 Required 2 For each item, indicate how treatment of the amount would differ between U.S. GAAP and IFRS. U.S. GAAP IFRS Total liabilities < Required 1 Required 2 >

Answer 1

1)

	IFRS (provision)	US GAAP (loss contingency)
A legal claim has a 75% chance of being settled for $600 and a 25% chance of being dismissed.	$600 (most likely outcome)	$600 (most likely outcome)
A legal claim might be settled between $400 and $600. The $600 outcome has a 75% probability, 15% for $500 and 10% for $400.	$565 (expected value)1	$600 (most likely outcome)
A legal claim might be settled between $400 and $600, with all outcomes within the range being equally possible.	$500 (mid-point of range)	$400 (low end of range)
Note:
1. The $600 most likely outcome was not used because the other estimates were all lower; instead, an expected value was used as a better estimate of the expected outcome.

	US GAAP	Amount		IFRS	Amont
	Lower end of range			Mid point of range
a)		5200000		(5200000+10200000)/2	7700000
b)		3200000		8200000+3200000)/2	2010000
c)		3200000		3200000+9200000)/2	6200000
d)	Short-term loans are classified as longterm if the entity intends to refinance the loan on a long-term basis and the entity can demonstrate an ability to refinance the loan prior to when the balance sheet is issued or available to be issued	10200000	(Can be shown as longterm)	Short-term loans refinanced after the reporting period may not be classified as long-term.	10200000	Can not be shown as short term)
		21800000			26110000

2) Total liability is less, Under US GAAP, Hence US GAAP should be followed to meet the goal