Question

The following selected circumstances relate to pending lawsuits for Erismus, Inc. Erismus’s fiscal year ends on December 31. Financial statements are issued in March 2022. Erismus prepares its financial statements according to U.S. GAAP.
  
Required:
Indicate the amount Erismus would record as an asset, a liability or if no accrual would be necessary in the following circumstances.

1. Erismus is defending against a lawsuit. Erismus's management believes the company has a slightly worse than 50/50 chance of eventually prevailing in court, and that if it loses, the judgment will be $1,000,000.
2. Erismus is defending against a lawsuit. Erismus's management believes it is probable that the company will lose in court. If it loses, management believes that damages could fall anywhere in the range of $2,000,000 to $4,000,000, with any damage in that range equally likely.
3. Erismus is defending against a lawsuit. Erismus's management believes it is probable that the company will lose in court. If it loses, management believes that damages will eventually be $5,000,000, with a present value of $3,500,000.
4. Erismus is a plaintiff in a lawsuit. Erismus's management believes it is probable that the company eventually will prevail in court, and that if it prevails, the judgment will be $1,000,000.
5. Erismus is a plaintiff in a lawsuit. Erismus’s management believes it is virtually certain that the company eventually will prevail in court, and that if it prevails, the judgment will be $500,000.
  

Answer 1

1. Erismus is defending against a lawsuit. Erismus's management believes the company has a slightly worse than 50/50 chance of eventually prevailing in court, and that if it loses, the judgment will be $1,000,000.

Answer: Under US GAAP, provision is recognise when it is probable the outcome would result in cash outflow. US GAAP does not define the threshold of probable but usually more than 75% probability is considered as probable under US GAAP. In given case it is only 50/50 hence it is not probable. Hence no accrual is required.

2. Erismus is defending against a lawsuit. Erismus's management believes it is probable that the company will lose in court. If it loses, management believes that damages could fall anywhere in the range of $2,000,000 to $4,000,000, with any damage in that range equally likely.

Answer: Provision under US GAAP is recognised only when it is probable the outcome would result in cash outflow and the amount is reasonably measurable. In the given case the management believes it is probable that the Company will lose the case hence it should recognise the provision. However, the procivision should be recognised only when the amount is reasonably certain. In given case the amount does not seem to be reasonably certain hence no accrual can be done.

3. Erismus is defending against a lawsuit. Erismus's management believes it is probable that the company will lose in court. If it loses, management believes that damages will eventually be $5,000,000, with a present value of $3,500,000.
Answer: Since its is probable that Company will lose in the court, provision should be recognised. The liability should be recognised at the present value of the amount payable or at the amount payable ignoring the impact of discounting as per the accounting policy of the Company. Under US GAAP it is an accounting policy choice to recognise such amount at full amount or discounted amount. Hence, if it is the accounting policy of the Company to recognise such amount at a discount the Company should recognise the provision at $3,500,000 or at $5,000,0000

4. Erismus is a plaintiff in a lawsuit. Erismus's management believes it is probable that the company eventually will prevail in court, and that if it prevails, the judgment will be $1,000,000.
Answer: Under US GAAP when it is virtually certain that the there would be gain contingency then the asset is recognised. Hence no asset would be recognised in this case.

5. Erismus is a plaintiff in a lawsuit. Erismus’s management believes it is virtually certain that the company eventually will prevail in court, and that if it prevails, the judgment will be $500,000.

Answer: Under US GAAP when it is virtually certain that the there would be gain contingency then the asset is recognised. An asset if $500,000 would be recognised.