Question

The following selected circumstances relate to pending lawsuits for Erismus, Inc. Erismus's fiscal year ends on December 31 . Financial statements are issued in March 2022 . Erismus prepares its financial statements according to U.S. GAAP.

Required:

Indicate the amount of asset or liability that Erismus would record, and explain your answer.

1. Erismus is defending against a lawsuit. Erismus's management believes the company has a slightly worse than \(50 / 50\) chance of eventually prevailing in court, and that if it loses, the judgment will be \(\$ 1,000,000\).

2. Erismus is defending against a lawsuit. Erismus's management believes it is probable that the company will lose in court. If it loses, management believes that damages could fall anywhere in the range of \(\$ 2,000,000\) to \(\$ 4,000,000\), with any damage in that range equally likely.

3. Erismus is defending against a lawsuit. Erismus's management believes it is probable that the company will lose in court. If it loses, management believes that damages will eventually be \(\$ 5,000,000\), with a present value of \(\$ 3,500,000\).

4. Erismus is a plaintiff in a lawsuit. Erismus's management believes it is probable that the company eventually will prevail in court, and that if it prevails, the judgment will be \(\$ 1,000,000\).

5. Erismus is a plaintiff in a lawsuit. Erismus's management believes it is virtually certain that the company eventually will prevail in court, and that if it prevails, the judgment will be \(\$ 500,000\).

Answer 1

1. No liability is to be recognized by Erismus. As per GAAP, liability should be recorded for a probable contingency. As the given situation is more of a reasonably possible contingency, only a disclosure note would be warranted.

2. This is a probable contingency, and a liability of $ 2,000,000 should be recognized, because, as per GAAP, the low end of a range of equally likely outcomes should be accrued as a liability. A disclosure in the notes should also be made relating to the circumstances leading to the liability accrual.

3. As the management of Erismus believes that it is probable that it will lose in court, liability of $ 5,000,000 should be recognized, and a disclosure note would also be required. Litigation claims are not to be discounted to their present values, and therefore, the present value of $ 3,500,000 is not relevant here.

4. This is a gain contingency, and gain contingencies are not to be recognized as per U.S. GAAP. But a disclosure should be made in the notes to accounts.

5. This too is a gain contingency, and U.S. GAAP does not allow recognition of a gain contingency prior to settlement of the underlying event. Therefore, no contingent gain is to be recognized, though a disclosure note would be appropriate,