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Response to Client Request 2 By Debra Meyer

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Response to Client Request 2 Debra Meyer, Elizabeth Pinzon, Nora Farland, Jennifer Pinzon ACC541 Accounting Theory and Research April 4, 2011 Delphine Agnor Wolsker Response to Client Request 2 Memo To: Client XYZ From: Learning Team B Date: April 4, 2011 Re: Lawsuit Loss Impact on Financial Statements Confidential Litigation is a stressful time for a business entity and the leaders of the business as well. The firm is in close contact with your attorney James Shannon on a weekly basis and more frequently as necessary to continually update the information pertaining to the business financial statements. This enables the firm to advise the best course of action to financially benefit XYZ. As with any lawsuit, there are concerns regarding an unfavorable outcome and the potential impact a loss will

have on the businesses financial statements and overall financial health of the business. The concerns with a litigation loss in this instance include contingency reporting requirements, mortgage reporting with potential debt restructuring versus Chapter 11 bankruptcy, and patent impairment and the effects of each on the business financial statements. Contingencies Appropriately a loss contingency, exists when there is a possibility that an asset will be impaired in the near future. As a result a liability occurs for which you are responsible (ASC- 450-20-25-1, Loss Contingencies). A loss contingency charges against your income if certain conditions are met: 1. The probability of the loss occurs prior to the issuance of the financial statements. 2. The estimable amount of your loss is reasonable. Meeting these conditions requires the reporting the accrual of losses so that they relate to the current or prior financial period (ASC 450-20-25-2, Loss Contingencies). Additional conditions to consider before disclosing the pending lawsuit are the degree of probability of an adverse outcome which is unfavorable. The unfavorable result estimable amount of the loss must also be determined for reporting purposes (ASC 450-20-55-10, Loss Contingencies Litigation, Claims, and Assessments). A loss occurring before the date of the financial statements charges against income and accrual is appropriate (ASC 450-20-55-11, Loss Contingencies). However, if the loss occurs after the date on the financial statement but prior to issuance of the financial statements required disclosures are recorded in the footnotes. Footnotes describing the nature of your loss and the estimate of the loss are sufficient if the exact amount of the loss is unknown (ASC 450-20-50-9, Loss Contingencies). A loss arising after the date of the financial statements is reasonably estimated, a business discloses this information by supplementing historical data with pro forma financial data retroactive to the date of the loss (ACS 450-20-50-10, Loss Contingencies). Impact on Mortgage According to FASB Codification 450-10-05-5, the "[resolution] of an uncertainty may confirm the acquisition of an asset, the reduction of a liability, the loss or impairment of an asset, and the incurrence of a liability (Financial Accounting Standards Board, 2010)." In this case, it is the incurrence of a liability. FASB Codification 450-10-05-6 further states, "[not] all uncertainties inherent in the accounting process give rise to contingencies (Financial Accounting Standards Board, 2010)." If this lawsuit against our client gives rise to a contingency, additional steps must be taken. With the current situation and under the FASB Codification 470, the debt may be forgiven. This depends on what is written in the new mortgage contract the company could possibly negotiate with its mortgage lender. If the new contract results in the identification of a gain or loss, then such a gain or loss has to be noted in the current period. When the pre- restructure carrying amount surpasses the total cash flows under the modification, ASC Topic 470 states the debtor records a gain on the restructuring date. The business recognizes the gain as the difference of pre-restructure carrying amount and future cash flows (ASC 47010-50-1, Disclosure of Long-Term Obligations). Another avenue allowing a business to refinance shortterm debt on long-term basis is filing Chapter 11 bankruptcy, business reorganization or debtor in possession. This provides an opportunity for reduced payments during a period that a business reorganizes for a long term solution. When a business files for Chapter 11 bankruptcy, the debt that is written off is based on the new contract terms agreed on with the lender. Writing off the mortgage or any debt, is not guaranteed. In theory, the mortgage is discharged, but the lender can then take back the collateral through foreclosure. If the business chooses to voluntarily return the property to the lender, they select Surrender on the Statement of Intentions. The lender takes the property back and any remaining funds due after the lender sells it will be discharged in bankruptcy (Schroeder, Clark, & Cathey, 2011). If the business wishes to keep the property in question, a reaffirmation of terms is completed and the business continues to pay as agreed in the mortgage contract. If the payments are current at the time of the Chapter 11 bankruptcy filing, and they are able to continue meeting the payment obligation, they can keep the property. If the business does not wish to forfeit the property but are not current on the payments, typically Chapter 13 reorganization is the only alternative. Nevertheless, the business must continue making the previously agreed upon mortgage payments (Schroeder et al, 2011). Impairment of Patents Losing the lawsuit will result in changes in the businesses assets and revenues. Losing the lawsuit will reduce the value of the patent or impairment. The impairment creates a difference between the faith value and moving value of the patent. The result of impairment loss in the value of a patent is recorded as a loss in your income statement similarly to other impaired losses (Codification 350-30-35-11,

Intangibles, Goodwill and Other). In contrast, the value of a patent is most probable to decrease in the financial statements. Impairment is determined by reviewing the value of the intangible assets for amortized depreciation. Your business holds a hedge contract against the impairment of this patent. The recovery of this hedge as a result of impairment of patent will be included as earnings revenue in the financial statements in the period of the loss for the company (Codification 350-30-35-14, Intangibles, Goodwill and Other). Conclusion The financial well-being of a business and the impact of a pending litigation loss greatly concern business owners. An unfavorable outcome impacts the financial reporting requirements associated with the financial statements of the business. Areas of concern with a potential litigation loss include contingency reporting requirements, mortgage reporting with potential debt restructuring versus Chapter 11 bankruptcy, and patent impairment and the effects of each on the business financial statements. The firm continues to remain in contact with the business' attorney James Shannon to provide advice and stay abreast of current information as it relates to the XYZ Company litigation. Sincerely, Learning Team B Financial Accounting Standards Board. (2009, July). ASC 450-20-25-1, ASC 450-20-25-2, ASC 450-20-55-10, ASC 450-20-55-11, ASC 450-20-50-11, ASC 450-20-50-10, ASC 450-20-50-9, Loss Contingencies Retrieved from www.fasb.org. Financial Accounting Standards Board. (2009, July). ASC 450-10-05-5, ASC 450-10-05-6, Loss Contingencies Retrieved from www.fasb.org. Financial Accounting Standards Board. (2009, July). ASC 350-30-35-11, ASC 350-30-35-14, Intangibles, Goodwill and Other Retrieved from www.fasb.org. Schroeder, R. G., Clark, M. W., & Cathey, J. M. (2011). Financial accounting theory and analysis (Tenth ed ed.). Hoboken, NJ: John Wiley & Sons, Inc. Running head: RESPONSE TO CLIENT REQUEST 2 1 RESPONSE TO CLIENT REQUEST 2 2 RESPONSE TO CLIENT REQUEST 2 3 RESPONSE TO CLIENT REQUEST 2 4 RESPONSE TO CLIENT REQUEST 2 5