Discussion — Accounting for year-end financial statements December 31, 2009

For the year-end December 31, 2009, financial statements, should M adjust its liability? If so, what amount should be recorded? Should the amount of the adjustment, if any, be considered a 2009 event or a prior period adjustment?

Accounting Alternatives

Alternative 1 — Yes. Accrue an incremental liability of $1.5 million for the year ended December 31, 2009.

The jury reached a verdict against M in September 2009. This verdict required M to pay W Inc. (“W,” a competitor of M) $18.5 million. This contingency is now probable, and the amount of the contingency of $18.5 million is reasonably estimable (as the amount was determined by the jury as the outcome of the litigation). Thus, given that M had already accrued $17 million in a prior year, it should record an additional $1.5 million in the current period based on the change in circumstances determined by the verdict of the jury, which occurred during 2009.

Alternative 2 — Yes. Accrue an incremental liability of $1.5 million as a prior period adjustment.

This alternative is very similar to the above view; however, using this alternative, will have to restate its prior two years of financial statements. The 2007 financial statements would be restated to change the income statement charge and the amount of the accrued liability to $18.5 million. The 2008 financial statements would be restated to increase the amount of the accrued liability to $18.5 million.

Solution – Choose the Most Appropriate Alternative and Give Supporting Evidence for Your Choice Providing the Correct Pronouncement Guidance