For the year-end December 31, 2007, financial statements, what amount should M record as a liability?

M international company has its competitor W Inc. The two companies have been a
part of prolonged litigation due to patient infringement that took place between the years 2007
and 2011. W Inc. went to court and filed a case against M company for infringement. The M
company’s management determined that the loss in the case was probable and gave a stipulation
that the loss ranged between $15 million and $ 20 million. $17 million was the average
amount of the likely loss from the case. The patient’s infringement was later on taken to court in
the year 2009, and that was after a jury trial had been done. The jury came to a consensus, and
the verdict given was in favor of W corporation. Thus, M company was instructed by the court to
pay W corporation an amount of $18.5 million. In November, M corporation files for an appeal,
and when a verdict was given in December 2010, it was in favor of M corporation. The judge’s
judgment, where M company paid W corporation a total of $18.5 million, was overruled. W
corporation took a step to file a petition to re-hear the case, but their plea was not acknowledged
or granted. The executive management for M corporation closed the matter when they agreed
with the legal counsel.
For the year ended December 31, 2007, M should consider recording approximately $17
million in their financial statement. The amount should be registered as a liability as it was
possible to make the loss and the potential amount of the loss is worth $17 million. According to
IAS 37.10, an organization is expected to recognize the provision if the current obligations have
increased due to past events. Also, the payment needs to be probable, and the estimation of the
amount should be reliable. The guidelines provide by ISA37.10 support the claim that M

WEEK 3 – CASE 13-8 3
company needs to make a recognition of $17 million as the liability. The provisions by the
lawsuits need to be recorded, most likely at a similar amount. M Corporation was a part of a
litigation case in the year 2007 due to patient infringement. All matters of litigation are perceived
as charges against the income of the company. Thus, M international company needs to
recognize the expenses and losses resulting from the litigation in its financial documents. The
recording should be done under contingencies according to FASB Code ASC 450-20-25-1.
ISA 37 stipulates that the contingent liability needs to be recognized in the financial
statements under only two scenarios. 

1. Suppose there is a possible obligation that is coming from past events. The confirmation
   of the events should take place through the occurrences or the non-occurrences of one or
   more events that are uncertain in the future. There is no full control of such entities in the
   event. 
2. Suppose there is a current obligation resulting from medieval events that have not been
   recognized. Failure to acknowledge the events is due to a lack of probability that the
   resources’ outflow is connected with economic resources. There is a need to settle the
   obligation failure to which the amount of the obligation will not be measured as reliable. 
      
   For the year-end December 31, 2009, financial statements, should M adjust its liability? If
   so, what amount should be recorded; and should the amount of the adjustment be
   considered a 2009 event or a prior period adjustment?
   M company should consider making adjustments to their liability for the years ended
   December 31, 2009. The company should record an additional penalty of $1.5 million. The
   amount is a change in the estimation and should be an event for the 2009 financial year. The

WEEK 3 – CASE 13-8 4
amount should not be considered as a prior adjustment for the period. For December 31, 2009, M
company needs to ensure the liabilities’ adjustment is according to that of November 2009. The
company had taken a strategic stem to file an appeal against the court ruling outcomes regarding
November 2009. The request makes the obligation a possible one, and it is not a probability
obligation. Thus, the results should be a contingent liability and not any provision, as indicated in
ISA 37. Therefore, an adjustment of the penalty is the most effective solution. The recording of
the adjustment may not occur now, but they are free to make the disclosure.  
The breakdown of what M corporation should do with the financial statements in the
respecting time is as follows

1. As of December 31, 2007
   The company should recognize and make a recording of the following amount as a
   contingent liability. The amount for the probable outflow that needs to be recorded is $17
   million. The recording is done since the amount arises for past events, which means that they
   infringe on the rights of the patients. 
2. As of December 31, 2009
   The company needs to make adjustments on the contingent liability. The probable
   outflow of the penalty for the stated period is $18.5 million. The amount is following the verdict
   given on September 24, 2009, by the judge, and the outcome is in favor of M corporation. The
   liability adjustment will result in an increase in the amount by $1.5 million from the previous
   liability.
   Adjustment = $18.5 million – $17.0 million = $1.5 million. 
   The adjustment needs to be considered an event for the 2009n financial year, and it is not an
   error or omission that took place in past events. 

WEEK 3 – CASE 13-8 5

1. As of December 31, 2010
   M corporation needs to focus and continue with the contingent liability. Because
   company W has the legal right to file for a petition for the re-hearing of the case, and the verdict
   that the judge may provide might be different. 
2. As of December 31, 2011
   M company needs to record the decrease that has taken place on the liability due to the
   decline in the petition that was filed. 
   Should M record the reduction of the previously recorded loss contingency in 2010 (upon
   the Court of Appeals overturning the verdict of the jury) or 2011 (once the appellate judges
   declined W’s petition for a re-hearing)?
   According to conservatism, there is a need for M company to reduce the amount recorded
   as a contingency for the 2011 financial year. The adjustment should be made when the appellate
   judge declines the petition of the re-hearing for the case. The ruling provided in 2010 by
   appellate is in favor of M company. But there is always a chance to re-appeal for the hearing of
   the case. However, the loss in contingency should not be reduced unless the judgment provided
   in favor of M company or the contingency loss becomes remote. According to ASC 310-20-25-1,
   there is a loss of contingency since the amount is probable, and the amount is just an estimate.
   The management of M corporation was responsible for determining the losses, and that
   ascertains the matter. The loss in contingency needs to be accrued, and the charges should be
   towards the income. Such is because M corporation took a step in filing the claim in May 2007,
   and they, if before any of the financial statements was issues. The recording of $17 million by M
   company is because if any amount that has a wide range appears like a much better estimate than
   any other amount within the field, an accrual process must occur. In the scenario, M corporation

WEEK 3 – CASE 13-8 6
needs to accrue the loss in contingency to curb any misleading information in its fiscal
statements.
ASC 450-30-25-1 stipulates that a contingency that will again need to be reflected in the
various fiscal statements. The reflection is a way of recognizing the revenue before the
realization takes place. The contingency in the case will make M corporation gain, and thus the
liability should not be recorded in the 2010 financial year. The company needs to register a
previous reduction and make the recording a loss contingency for the 2011 financial year. The
recording should take place simultaneously with the disclosure in 2010 since the estimation can
change any time from the contingent’s liability when the case is overturned. ASC 450-30-50-1
suggests that there is a need to make adequate disclosure if the contingency results again. But
there is a need for the management to be careful as there might be a misleading impact when the
realization is taking place. M company needs to disclose the data of the viable contingency plan
in the 2010 financial year. Once the judge declines the re-hearing, the M company should be free
to record the reduction for the past recorded loss in contingency.

WEEK 3 – CASE 13-8 7

References

ASC 310, Receivables (ASC 310)
ASC 410-30, Asset Retirement and Environmental Obligations: Environmental Obligations
(ASC 410-30)
ASC 450, Contingencies (ASC 450)
FASB Concept Statement No. 6, Elements of Financial Statements (Con 6)
ASC 855, Subsequent Events (ASC 855) (formerly FASB Statement No. 165, Subsequent
Events (Statement 165))