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 $6,900,000 and $11,900,000, 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 $4,900,000 and $9,900,000, 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 worse 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 $4,900,000 and $10,900,000, with each amount in that range equally likely.
4. HW has $11,900,000 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?
  

Answer 1

Part 1

	U.S. GAAP		IFRS
a	Accrue liability	6900000	Accrue liability	9400000
b	Accrue liability	6900000	Accrue liability	7400000
c	Do not accrue liability		Accrue liability	7900000
d	Long-term liability	11900000	Short-term liability	11900000

(6900000+11900000)/2 = 9400000

(4900000+9900000)/2 = 7400000

(4900000+10900000)/2 = 7900000

Explanation:

a. The loss is probable and can be reasonably estimated.

U.S. GAAP = accrue a liability = 6900000

IFRS = accrue a liability = midpoint of the range = 9400000

b. U.S. GAAP = present values would not be considered due to uncertain timing of cash flows= lower end of the undiscounted range = 6900000

IFRS = present values would be used = relevant midpoint of the range = 7400000

c. only probable according to IFRS’s use of the term. IFRS = relevant midpoint of the range = 7900000

d. Financing was obtained prior to financial statement issuance but not before the balance sheet date

U.S. GAAP = long-term liability

IFRS = short-term liability

Part 2

Which set of standards helps to meet that goal?

U.S. GAAP

	U.S. GAAP		IFRS
a	Accrue liability	6900000	Accrue liability	9400000
b	Accrue liability	6900000	Accrue liability	7400000
c	Do not accrue liability		Accrue liability	7900000
d	Long-term liability	11900000	Short-term liability	11900000
	Total	25700000	Total	366000000