Ziyi Wang

ACCT 532, Section 002

Professor Mark Ingram

March 25, 2018

To: The Audit Partner of an accounting firm

From: An associate of an accounting firm
Date: March 25, 2018
Subject: Accounting for the loss contingency of M International

Executive Summary

M International (“M”) and W Inc. (“W”, a competitor of M) have involved in a long-term

litigation related to a patent infringement matter. In May 2007, W filed a patent infringement

claim with M for the patent infringement matter. On December 31, 2007, management of M

found the loss of this litigation was probable and estimated that the loss was in the range of $15

million to $20 million, but $17 million would be the most likely amount of loss. Subsequently, in

September 2009, the judgment from a jury trial required M to pay W $18.5 million. However, M

filed a Notice of Appeal with the Court of Appeals after that. In December 2010, the judgement

from the Court of Appeals was in favor of M’s appeal and overturned the judgement from the

jury trial that required M to pay $18.5 million to W. Even though W filed a petition for a re-

hearing, the appellate judges declined the petition for a re-hearing. On February 28, 2011,

management of M determined this patent infringement matter was disclosed when discussing

with in-house legal counsel. In that case, M should record $17 million as contingent liability in

financial statement on December 31,2007 and increase its liability by $1.5 million ($18.5 million

- $17 million) on December 31,2009. Moreover, M should also keep this record of loss

contingency in 2010 and record the reduction of the liability in 2011.

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Analysis

ASC 450, Loss Contingency, specifies the recognition of a loss contingency. ASC 450-

20-20 defines a loss contingency as “an existing condition, situation or set of circumstances

involving uncertainty as to possible loss to an entity that will ultimately be solved when one or

more future events occur or fail to occur”. That means the entity will face a potential loss if some

future events will probably occur and the amount of loss will be estimated. In the case,

management of M determined that a loss for the patent infringement matter was probable and

estimated that $17 million was the most likely amount of loss in the range of $15 million to $20

million. According to ASC 450-20-30-1, if some amount of estimate will be the most likely

amount of loss within the range, that amount should be accrued. Therefore, M should record $17

million as a liability in financial statement for the year-end December 31, 2007, because $17

million appears to be more likely than any other amount within the range.

Nevertheless, on September 24, 2009, the judgement from a jury trial required M to pay

W $18.5 million. That means the loss of $18.5 million will probably be incurred and this amount

of payment, based on verdict on September 24, 2009, was related to current period. ASC 450-20-

25-2 states that the loss contingency should be accrued if one or more future events will probably

occur and the amount of losses are reasonably estimable and relate to the current and prior

period. Therefore, for the year-end December 31,2009, M should adjust its liability and increase

by $1.5 million ($18.5 million - $17 million) because M had already recorded the liability of $17

million on December 31, 2007. In addition, this amount of the adjustment should be considered a

2009 event instead of a prior period adjustment, since ASC 450-20-25-7 indicates that the loss

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should be charged to the income in the period when the loss can be reasonably estimated and

should not be charged to an earlier period.

In December 2010, the verdict from the Court of Appeals overturned the judgement of

jury that required M to pay W $18.5 million. However, M should not record the reduction of the

previously recorded loss contingency in 2010. The reason is that the verdict from the Court of

Appeals did not mean M’s liability had been extinguished because W was likely to file a petition

for re-hearing. ASC 405-20-40-1 illustrates that “the debtor should derecognize a liability if and

only if it has been extinguished”. Thus, M should record the reduction of the previously recorded

loss contingency in 2011 since the appellate judges declined W’s petition for a re-hearing on

February 10, 2011, and management of M determined this matter was closed when discussing

with in-house legal counsel.

Conclusion

W and M have been involved in long-term litigation related to the patent infringement

matter. ASC 450, Loss Contingency, specifies the recognition of a loss contingency. Therefore,

M should record and adjust the amount of liability in different period of time. On December 31,

2007, M should record $17 million as a liability because the loss of $17 million was probable

and estimable. Subsequently, M should adjust its liability and increase by $1.5 million on

December 31, 2009 since the judgement from the jury trial required M to pay W $18.5 million.

Finally, M should record the reduction of the previously recorded loss contingency in 2011

instead of in 2010 because the appellate judges declined W’s petition for re-hearing and the

patent infringement matter was closed in 2011.

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Bibliography

FASB. (2018, 3 26). Liabilities. Retrieved from FASB ACCOUNTING STANDARDS

CODIFICATION: https://asc.fasb.org/section&trid=2127165