Question

M International (“M”) and W Inc. (“W,” a competitor of M) have been engaged in longstanding litigation over a specific patent infringement matter. Below is a summary timeline of specific events that have taken place related to this matter: 1. In May 2007, W filed a claim against M for patent infringement. 2. For the year ended December 31, 2007, management of M determined that a loss for this matter was probable and represented that the estimate of loss was in the range of $10 million to $15 million, with $12 million being the most likely amount of loss within the range. 3. A jury trial took place in September 2009. 4. The jury reached a verdict on September 24, 2009, and a judgment was ordered infavor of W. The judgment required M to pay W $14 million. 5. In November 2009, M filed a Notice of Appeal with the Court of Appeals. 6. In December 2010, the Court of Appeals issued a ruling in favor of M’s appeal and reversed the lower court’s ruling on the matter. This meant that the Court of Appeals overturned the jury verdict and the $14 million judgment against M. 7. On December 20, 2010, management of M determined this matter was closed upon discussions with in-house legal counsel. Required: 1. For the year-end December 31, 2007, financial statements, what amount should M record as a liability? 2. For the year-end December 31, 2009 financial statements, should M adjust its liability? If so, what amount should be recorded; and should the amountof the adjustment be considered a 2009 event or a prior period adjustment? 3. For the year-end December 31, 2010 financial statements, what amount should M record as a liability?

Answer 1

a)For the year ended Dec 31 2007, M should record a liability of $ 12 million.

As per ASC 450 a loss contingency has to be recognized if the loss is deemed to be probable and the amount of loss can be reasonably estimated. Under US GAAP if a range of losses from the lawsuit claim is estimated and if a best estimate is available within that range, then the best estimate within that range is recognized as a liablility. If a best estimate is not avaialable within that range then the low end of the range has to be recorded. In the given case since the best estimate within the range is available $ 12 million is recognized as liablilty.

b)For the year ended Dec 31 2009 an additional liability of $ 2 million has to be recorded based on the judgement of the lower court.. The liability amount has to be increased from $ 12 million to $ 14 million.

The adjustment should be considered as a 2009 event and not cas a prior period adjustment.The reason being the original estimation was a reasonable estimation and was made in good faith. The notes to financial statements of year 2007 would have already disclosed the nature of the lawsuit and the range of any reasonably possible losses. Hence the users of the financial statements would have already realized that the loss reported is not a precise measue but only a reasonable estimate.

c) For the year ended Dec 31 2007 , M need not record any liablilty as a favourable judgement has been received from the Court of Appeals. The liability has to be reversed.

Since the loss from lawsuit is no longer probable due to the favoruable verdict of Appeals court and as per the opinion of the in house legal counsel referring to the matter as closed, the liability is no longer required and hence to be reversed.