Question

In: Accounting

At December 31, 2015, Layla’s Design Company received legal advice from an outside advisor that it...

At December 31, 2015, Layla’s Design Company received legal advice from an outside advisor that it was 75% probable that the company would be found liable in a lawsuit related to fabric used in a spring 2014 dress collection. A range of damages in the amount of $250,000 to $300,000 was equally likely. Under U.S. GAAP, should Layla’s Design Company recognize a provision for damages? If so, please record the journal entry below.

________________________________ $

_________________________________ $

Description of the journal entry:__________________________________________________________

Would your answer be different under IFRS? YES NO (circle one)

If yes, what would be the journal entry?

________________________________ $

_________________________________ $

Please explain how a decline in probability from 75% to 60% would make a difference in your analysis. _________________________________________________________________________________________ _____________________________________________________________________________________

Expert Solution

Under US GAAP:

An estimated loss from a loss contingency is recognized only if the available information indicates that (1) it is probable that an asset has been impaired or a liability has been incurred at the reporting date and (2) the amount of the loss can be reasonably estimated.

Since, probable is not defined, it is common practice to recognize contingent losses only if the probability is estimated at 70% or more. If there is a range for the estimated loss, then the lowest amount of the range is recorded.

Under IFRS:

IAS 37 requires an accrual of contingent loss if the probability is "more likely than not", interpreted as more than 50%. If there is an estimate range ,then lowest and highest amounts are to be added together and divided by 2 to get an average.

If probability 75% under US GAAP:

Litigation loss Debit $250000

Provision for Litigation loss Credit $250000

If probability 60 % under US GAAP:

No entry

If probability 75% under IFRS:( Average of 250000+300000)

Litigation loss Debit $275000

Provision for Litigation loss Credit $275000

If probability 60% under IFRS:( Average of 250000+300000)

Litigation loss Debit $275000

Provision for Litigation loss Credit $275000

ekkarill92 answered 1 year ago

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