Question

Z Corp. filed a claim for patent infringement against M Corp. in October 2019. In preparing its financial statements for the year ending December 31, 2019, M Corp. financial accounting group obtained the following information related to this claim:

• M Corp’s Risk Management Department believes that M will incur a loss from this lawsuit. They estimate the loss will be in a range from $15 million to $20 million, but cannot give a more precise estimate.

• The trial will likely not take place for two years, in 2021 or 2022.

• M Corp’s CFO insists that the company will fight this claim “until the end of time.” Based on that,

  the CFO maintains that no loss need be recorded because none will be incurred ... ever!

• M Corp’s legal department believes the case will be resolved within four years, if appeals are necessary. They do not dispute Risk Management’s assessment.

  Your Assignment

  Assume that you are the Controller of M Corp (you are the top accounting officer and report directly to the CFO. What do you say to the CFO about this matter? You must resolve this issue now so that financial statements can be prepared. You can literally write what you would say, or you can do it in the form of a brief message. But you must state your opinion on how this should be handled (not forgetting that your boss thinks nothing needs to be done).

Answer 1

In the given situation, a loss contingency may be incurred by the entity based on the outcome litigation.Loss contingencies should be reported immediately as long as they are probable and can be reasonably estimated.

The Risk Management Department believes that M Corp. will incur a loss from the lawsuit, and M Corp does not dispute Risk Management's assessment. Therefore, the loss is probable.

The Risk Management Department estimates the loss will be in a range from $15 million to $20 million, but cannot give a more precise estimate. Therefore, the loss cannot be reasonably estimated. Furtther, four years is a long time.

As the loss is probable, but cannot be reasonably estimated, it can neither  be recognized as a loss on the income statement nor reported as a liability on the balance sheet as at December 31, 2019. But a disclosure needs to be made on the contingency on the notes to accounts.