Question

Exercise 13-19 Unasserted assessment [LO13-6]

At April 1, 2019, the Food and Drug Administration is in the process of investigating allegations of false marketing claims by Hulkly Muscle Supplements. The FDA has not yet proposed a penalty assessment. Hulkly’s fiscal year ends on December 31, 2018. The company’s financial statements are issued in April 2019. Required: For each of the following scenarios, determine the appropriate way to report the situation.

1. Management feels an assessment is reasonably possible, and if an assessment is made an unfavorable settlement of $13 million is reasonably possible.

2. Management feels an assessment is reasonably possible, and if an assessment is made an unfavorable settlement of $13 million is probable.

3. Management feels an assessment is probable, and if an assessment is made an unfavorable settlement of $13 million is reasonably possible.

4. Management feels an assessment is probable, and if an assessment is made an unfavorable settlement of $13 million is probable.

Answer 1

As per FASB No 5, in case of litigations or assessments, first it is to be judged whether the assessment is probable or not and if it is probable then only second judgment must be made as to the degree of probability of an unfavorable outcome.

1. As per IFRS, if an assessment is reasonably possible but not probable, then the company is neither required to accrue or make provision of such uncertain event nor it is required to disclose the same as Contigency loss. In the given case, management feels that assessment is reasonably possible i.e. it is more remote to occur but less likely to happen and therefore it is not probable. As a result no accrual or disclosure is required to be made in the books. Refer FASB no 5. line item 38.

2. In the given case also since assessment is not probable, it is not required to make any accrual or disclosure.

3. In the given case since it is probable that assessment will be made, we have check second judgement as to the degree of probability of unfavorable outcome. If an unfavorable outcome is reasonably possible but not probable, disclosure would be required as Contigency Liabilities according to paragraph 10.

4. If an unfavorable outcome is probable and the amount of loss can be reasonably estimated, accrual of a loss is required to be charged to income statement as loss. In the given case, amount is estimated and unfavorable outcome is probable. therefore Management should accrue the loss in income statement.