Question

HolmesWatson (HW) is considering what the effect would be of reporting its liabilities under IFRS rather than U.S. GAAP. The following facts apply:

1. HW is defending against a lawsuit and believes it is virtually certain to lose in court. If it loses the lawsuit, management estimates it will need to pay a range of damages that falls between $5,000,000 and $10,000,000, with each amount in that range equally likely.
2. HW is defending against another lawsuit that is identical to item (a), but the relevant losses will only occur far into the future. The present values of the endpoints of the range are $3,000,000 and $8,000,000, with the timing of cash flow somewhat uncertain. HW considers these effects of the time value of money to be material.
3. HW is defending against another lawsuit for which management believes HW has a slightly better than 50/50 chance of losing in court. If it loses the lawsuit, management estimates HW will need to pay a range of damages that falls between $3,000,000 and $9,000,000, with each amount in that range equally likely.
4. HW has $10,000,000 of short-term debt that it intends to refinance on a long-term basis. Soon after the balance sheet date, but before issuance of the financial statements, HW obtained the financing necessary to refinance the debt.

   
Required:
1. For each item, indicate how treatment of the amount would differ between U.S. GAAP and IFRS.
2. Consider the total effect of items a–d. If HW’s goal is to show the lowest total liabilities, which set of standards, U.S. GAAP or IFRS, best helps it meet that goal?
  

1.

	U.S. GAAP		IFRS
A	ACCRUE LIABILITY	?????	ACCRUE LIABILITY	?????
B	ACCRUE LIABILITY	?????	ACCRUE LIABILITY	?????
C	DO NOT ACCRUE LIABILITY	?????	ACCRUE LIABILITY	?????
D	LONG TERM LIABILITY	?????	SHORT TERM LIABILITY	?????
	TOTAL LIABILITIES

2. Consider the total effect of items a–d. If HW’s goal is to show the lowest total liabilities, which set of standards, U.S. GAAP or IFRS, best helps it meet that goal?

A.U.S. GAAP. B.IFRS. C. BOTH ARE THE SAME

Answer 1

Part 1:

Item (a): Because the loss is probable and can be reasonably estimated, HW would be required to accrue a liability under both U.S. GAAP and IFRS, but the amount of the liability would differ between the two. Under U.S. GAAP, the liability would be for $5,000,000, the low end of the range, while under IFRS the liability would be for $7,500,000, the midpoint of the range.

Item (b): Under IFRS, present values would be used, so the relevant midpoint of the range that would be accrued as a liability would be $5,500,000. Under U.S. GAAP present values would not be used given the uncertain timing of cash flows, so HW would still use the lower end of the undiscounted range, or $5,000,000.

Item (c): This item is only probable according to IFRS' use of the term, so would only be accrued as a liability under IFRS, for the midpoint of the range ($6,000,000).

Item (d): This item would be classified as long-term under U.S. GAAP, but short-term under IFRS, given that the financing was obtained prior to financial statement issuance but not before the balance sheet date.

Part 2:

Total liabilities under U.S. GAAP equal $5,000,000 + $5,000,000 + $0 + $10,000,000 = $20,000,000.

Total liabilities under IFRS equal $7,500,000 + $5,500,000 + $6,000,000 + $10,000,000 = $29,000,000.

In this case, U.S. GAAP provides the lower total liabilities.