Question

HolmesWatson (HW) is considering what the effect would be of reporting its liabilities under IFRS rather than U.S. GAAP. The following facts apply: a. HW is defending against a lawsuit and believes it is virtually certain to lose in court. If it loses the lawsuit, management estimates it will need to pay a range of damages that falls between $6,000,000 and $11,000,000, with each amount in that range equally likely. b. HW is defending against another lawsuit that is identical to item (a), but the relevant losses will only occur far into the future. The present values of the endpoints of the range are $4,000,000 and $9,000,000, with the timing of cash flow somewhat uncertain. HW considers these effects of the time value of money to be material. c. HW is defending against another lawsuit for which management believes HW has a slightly worse than 50/50 chance of losing in court. If it loses the lawsuit, management estimates HW will need to pay a range of damages that falls between $4,000,000 and $10,000,000, with each amount in that range equally likely. d. HW has $11,000,000 of short-term debt that it intends to refinance on a long-term basis. Soon after the balance sheet date, but before issuance of the financial statements, HW obtained the financing necessary to refinance the debt. Required: 1. For each item, indicate how treatment of the amount would differ between U.S. GAAP and IFRS. 2. Consider the total effect of items a–d. If HW’s goal is to show the lowest total liabilities, which set of standards, U.S. GAAP or IFRS, best helps it meet that goal? U.S. GAAP IFRS Both are the same.

Answer 1

Answer:

1. a. When the losses are probable as is the case here, a liability is required to be reported under both US GAAP and IFRS.

Under US GAAP, the lower of the range is picked to be recorded which in this case is $6,000,000.

Under IFRS, the midpoint amount is picked as an average of the range which is,

= (6,000,000 + 11,000,000) / 2

= $8,500,000

b. In this scenario US GAAP will not use Present Value figures because the timing of the cashflows is uncertain. Since this case is identical to the first, US GAAP will use the lower bound of the first loss amount in (a) which is $6,000,000.

IFRS will use the Present Values because payment is remote. IFRS will use the midpoint here as well as average.

= (4,000,000 + 9,000,000) / 2

= $6,500,000

c. US GAAP does not recognize this as a liability as this probability only falls under the realm of IFRS.

IFRS will again use the midpoint average.

= (4,000,000 + 10,000,000) /2

= $7,000,000

d. Because financing was gained before the Financial Statement issuance date even though it was after the Balance Sheet Date, IFRS will still recognize this as a Short-Term Financing.

However, US GAAP doesn't require that the financing be acquired before the balance sheet date for it to be of effect and will classify it as Long-Term as long as it was Refinanced before the Financial Statement issuance date, which it was.  

2. Use US GAAP because it usually picks the lower end of the liability range as opposed to IFRS that requires an average of the range.