Contingent losses arising from litigation can be
especially difficult to learn how to report in the financial
statements. Companies don't want to admit to the loss as it might
hurt their case in court, but they can't mislead the users of their
financial statements either by ignoring what could be a significant
financial impact.
Instructions - You are the Chief Financial Officer
(CFO)of a firm that is being sued for damages it caused. It is the
end of your fiscal year, and you are trying to determine the
appropriate treatment of this matter. Your boss, the Chief
Executive Officer (CEO) acknowledges (privately) that your firm is
responsible for the damages and that the judgement will be made
against your firm. Your legal counsel estimates that the penalty
levied by the court will be in the range of $2 million to $6
million, with a most likely amount of $4 million.
The CEO's posture on the matter is that because of the
wide variance in the range of possible outcomes (i.e. penalties
levied) that the best thing to do is to simply wait until the case
is settled (next year), and record at that time the actual damages
assessed by the court.
Answer the following questions:
1. What are some possible reasons that the CEO may
hold his viewpoint?
2.What should be your response to the CEO?
3.Do you think it is necessary to make an accrual for
an estimated amount of the assessment or settlement? If so, what
amount do you think is appropriate? Explain.
4. Would your answer to any of the above questions be
different if the financials are being prepared under IFRS instead
of U.S. GAAP?
1. The CEO can hold to not record in the books the penalty amount because the case is not settled during the financial year and the penalty amount not known on or before finalization of the books of accounts of the relevant financial year.
2. My response is record the amount of $ 4 million in the current financial year because the concept of record in the books all possible losses in the financial year in which the company knows. Even the company not recorded current financial year and record in next financial years then also the financial position will impact.
3. Yes accrual expenses to be booked for estimated amount of settlement of $ 4 million.
4. In US GAAP the Losses or settlement amount shown as extrodinary items in the Income statements while IFRS does not differentiate between normal loss and extrodinary loss.
Contingent losses arising from litigation can be especially difficult to learn how to report in the...
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