Question

In: Accounting

A lawsuit has been filed against XYZ Company. As year-end, the company’s attorney believes that there...

A lawsuit has been filed against XYZ Company. As year-end, the company’s attorney believes that there is an 85% likelihood that the company will be found liable. The attorney believes that the estimated range of the liability is between $50,000 and $150,000 and that all amounts within the range are equally likely. In addition, the company has announced a restructuring plan prior to year-end that has created a valid expectation on the part of the employees to be terminated with an estimated liability of $500,000. As of year-end, there is currently no legal obligation to make any payments to the terminated employees. Lastly, the Company issued stock options with a fair value of $200,000 on January 1st with a 2 year vesting schedule.   

  1. What would be the amount, if any, that XYZ would record on the balance sheet related to the lawsuit under IFRS and US GAAP?
  2. What would be the amount, if any, that XYZ would record on the balance sheet related to the restructuring under IFRS and US GAAP?

Solutions

Expert Solution

Answer 1) For Law suit where attorney believes that 85% likelihood that company will be found liable and liability ranges between $ 50,000 and $1,50,000

Under IFRS provision is Recognized when all of the following criteria are met:

  • A past event gives rise to a present obligation (legal or constructive).-(Here its Law suite)
  • It is probable – i.e. more likely than not – that an outflow of resources (typically a payment) will be required to fulfil the obligation.(Here its 85% Chance)
  • The amount can be estimated reliably.(It can be between $50,000-$150,000)

In the given question A legal claim might be settled between $50,000 and $1,50,000, with all outcomes within therange being equally possible.-Mid point of Range i.e.( 50,000+150,000)/2 = 1,00,000 . Therefore provision for $ 1,00,000 is made under IFRS.

Under US GAAP loss contigency is recognized when all of the following criteria are met:

  • Like IFRS, a past event gives rise to a present obligation. However, unlike IFRS, a constructive obligation is not recognized under the general model in ASC 450.
  • It is probable that an outflow of resources (typically a payment) will be required to fulfill the obligation. Probable in this context means 'likely to occur', which is a higher threshold than IFRS. In many cases, this difference will not change the practical outcome and the threshold will be met under both frameworks.
  • Like IFRS the amount can be estimated reasonably.

Here contigency liability is recognized for lower end of amount i.e. $ 50,000.

Answer 2: Restructuring

Under IFRS:

AS 37 explains that a constructive obligation for a restructuring arises only when:

  • there is a detailed formal plan specifying:
    • the business or part of a business concerned;
    • the principal locations affected;
    • the location, function and approximate number of employees whose services will be terminated;
    • the expenditures that will be undertaken;
    • when the plan will be implemented and completed; and
  • the entity has created a valid expectation in those affected that it will carry out the plan by either starting to implement the plan or announcing its main features to those affected by it.

Therefor under IFRS a provision for restructing cost is required to be recognized since above conditions are satisfied.

Under GAAP :

Restructuring liability is only rcoginized if it represents a present oblogation. An entity commitment to exit plan or disposal plan is required to recognize a restructuring liability .A liability for contract termination cost is recognized ony when the contract has been terminated pursuant to its terms or the entity has permanently ceased. Restructuring liability is measured at the fairvalue.

Threfore under US GAAP recognization will be made at fair alue when event will occured.


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