Case Summary: Best Value Hardware (BVH), Inc., a public company, is preparing th
ID: 2569985 • Letter: C
Question
Case Summary: Best Value Hardware (BVH), Inc., a public company, is preparing their balance sheet, and income statement for the calendar year-ended December 31, 2016 based on U.S. GAAP and also based on IFRS. BVH’s accountant has already recorded most of the entries at year end on the trial balance but needs your assistance in accounting for the following transactions and preparing the appropriate adjusting journal entries.
Loss Contingency:
12/31/16 Best Value Hardware is being sued by an employee who slipped on spilled milk and broke his back. BVH’s lawyers expect to lose the lawsuit and estimate the loss to be between $250,000 and $500,000 with no one outcome being assessed as more likely than the other.
Gain Contingency:
12/31/16 Best Value Hardware had a delivery truck drive through the side of one of their stores causing major damages. The delivery truck is owned by an independent party and Best Value Hardware is suing the trucking company for the $2,000,000 in damages. BVH’s lawyers are virtually certain they will win the lawsuit and receive the full amount of damages.
1. Discuss whether or not Best Value Hardware recognizes a contingent liability or Gain under U.S. GAAP and IFRS. If a contingency is recognized, determine how much.
Discuss GAAP:
Discuss IFRS:
2. Record necessary adjusting journal entries in their own adjusting journal entry for 12/31/16.
Journal Entries Transaction: Debit Credit Note:Explanation / Answer
ASC 450 applies to asset impairment and IAS 37 does not apply to asset impairment.
Under ASC 450, Recognition of contingent losses: Estimated Loss accrued for a loss contingency. Contingent loss. The Contingent loss that is not recognized as a liability. The Contingent gain.
Under IFRS Recognition of contingent losses: Provision, Contingent liability, Contingent asset.
Under ASC 450, Measurement of contingent losses/ provision range estimates: If no amount in the range is more likely than any other amount in the range, the minimum amount in the range is used to measure the amount to be accrued for a loss contingency.
Under ASC 460, IFRS, Measurement of contingent losses/ provision range estimates: If no amount in the range is more likely than any other amount in the range, the midpoint of the range is used to measure the liability.
Brief on US GAAP and IFRS:
Recognition of Contingent Losses/Provisions
Under U.S. GAAP, one of the conditions that must be met before an entity can accrue an estimated loss from a loss contingency is that "it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements" — that is, "it must be probable that one or more future events will occur confirming the fact of the loss" (ASC 450-20-25-2(a)). Under IFRS s, one of the conditions for recognizing a provision as a liability is that "it is probable that an outflow of resources . . . will be required to settle the obligation" (paragraph 14 of IAS 37).
A key difference between U.S. GAAP and IFRSs in applying the above conditions lies in the definition of "probable." Paragraph 23 of IAS 37 defines probable as "more likely than not to occur" (i.e., "the probability that the event will occur is greater than the probability that it will not"). ASC 450-20-20 defines "probable" as "likely to occur." While the assessment of these terms is subject to an entity's judgment, "likely" under U.S. GAAP typically is considered a much higher threshold (i.e., approximately 80 percent) than "more likely than not" under IFRSs (i.e., greater than 50 percent). Therefore, more contingencies may qualify for recognition as liabilities under IFRS than under U.S. GAAP.
Measurement of Contingent Losses/Provisions — Range of Estimates
Under both U.S. GAAP and IFRSs, the amount recorded as a loss contingency or provision should be the best estimate of the expenditure required to settle the obligation. If the best estimate of the expenditure is a range, and if one amount in that range represents a better estimate than any other amount within the range, that amount should be recorded (ASC 450-20-30-1 and paragraph 36 of IAS 37).
Under U.S. GAAP, if no amount in the range is a better estimate than any other amount, an entity should use the minimum amount in the range for recording the liability (ASC 450-20-30-1). In contrast, under IFRSs, if no amount in the range is a better estimate than any other amount, an entity should use the midpoint of the range for recording the liability (paragraph 39 of IAS 37). If the obligation involves a large population of items, an entity should estimate the liability by weighing all possible outcomes by their associated probabilities (i.e., the probability-weighted expected value is used to measure the liability).
In the first case, under GAAP the amount would be $250,000 minimum and under IFRS the amount would be $375,000 midrange.
In the second case, under GAAP the recognized contingent liability or gain is 80% then "more likely than not" i.e. $2,000,000* 80%= $16,00,000. Under IFRS greter than 50% i.e. $10,00,000 and more.
Journal entries for respective GAAP and IFRS:
Under GAAP
Lawsuit gain ... $13,50,000
Contingent liability gain... $13,50,000
Note: Loss recognized under GAAP is $2,50,000, minimum value and probability of gain from lawsuit is $16,00,000 (80%* $20,00,000) so $16,00,000- $2,50,000 = $ 13,50,000
Under IFRS
Lawsuit gain ... $6,25,000
Contingent liability gain... $ 6,25,000
Note: Loss recognized under GAAP is $2,50,000, minimum value and probability of gain from lawsuit is $10,00,000 (50%* $20,00,000) so $10,00,000- $3,75,000 = $ 6,25,000