Accounting for a Loss Contingency for a Verdict Overturned on Appeal M Internati
ID: 2459720 • Letter: A
Question
Accounting for a Loss Contingency for a Verdict Overturned on Appeal
M International (“M”) and W Inc. (“W,” a competitor of M) have been engaged in long-standing litigation over a specific patent infringement matter. Below is a summary timeline of specific events that have taken place related to this matter:
• In May 2007, W filed a claim against M for patent infringement.
• For the year ended December 31, 2007, management of M determined that a loss for this matter was probable and represented that the estimate of loss was in the range of $15 million to $20 million, with $17 million being the most likely amount of loss within the range.
• A jury trial took place in September 2009.
• The jury reached a verdict on September 24, 2009, and a judgment was ordered in favor of W. The judgment required M to pay W $18.5 million.
• In November 2009, M filed a Notice of Appeal with the Court of Appeals.
• In December 2010, the Court of Appeals issued a ruling in favor of M’s appeal and reversed the lower court’s ruling on the matter. This meant that the Court of Appeals overturned the jury verdict and the $18.5 million judgment against M.
• On January 6, 2011, W filed a petition for a re-hearing before the same panel of appellate judges against the reversal of ruling by Court of Appeals.
• On February 10, 2011, the appellate judges declined the petition for a re-hearing.
• On February 28, 2011, management of M determined this matter was closed upon discussions with in-house legal counsel.
Required:
1. For the year-end December 31, 2007, financial statements, what amount should M record as a liability?
2. For the year-end December 31, 2009, financial statements, should M adjust its liability? If so, what amount should be recorded; and should the amount of the adjustment be considered a 2009 event or a prior period adjustment?
3. Should M record the reduction of the previously recorded loss contingency in 2010 (upon the Court of Appeals overturning the verdict of the jury) or 2011 (once the appellate judges declined W’s petition for a re-hearing)?
Explanation / Answer
As per GAAP, we must recognize a liability when it is probable and estimable. The facts in this case state, that management has ascertained that a loss is probable. They go on to state that there is a range of the estimated loss which is $15,000,000 to $20,000,000, with $17,000,000 being the most likely amount of loss within the range. Hence M should accrue the loss in 2007 for the amount of $17,000,000. The amount is determined with guidance from GAAP, which states to accrue the low end of a range, unless one estimate is more likely than another. That entry would be:
Lawsuit Loss Debit $17,000,000
Lawsuit Liability Credit $17,000,000
Yes, M should adjust its liability for additional $150,000 to reach $1,850,000, it should be 2009 event.
M should reverse the liability adjustment only after 2011 (once the appellate judges declined W’s petition for a re-hearing).