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Litigation Damages Accrual

You are the Chief Financial Officer (CFO) of a firm that is being sued for damages it caused. It is the end of your fiscal year, and you are trying to determine the appropriate treatment of this matter. Your boss, the Chief Executive Officer (CEO) acknowledges (privately) that your firm is responsible for the damages and that the judgment will be made against your firm. Your legal counsel estimates that the penalty levied by the court will be in the range of $2 million to $6 million, with a most likely amount of $4 million.

The CEO's position on the matter is that because of the wide variance in the range of possible outcomes (i.e. penalties levied) that the best thing to do is to simply wait until the case is settled (next year), and record at that time the actual damages assessed by the court.

What are some possible reasons that the CEO may hold his viewpoint? What should be your response to the CEO? Do you think it is necessary to make an accrual for an estimated amount of the assessment or settlement? If so, what amount do you think is appropriate? Explain.

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What are some possible reasons that the CEO may hold his viewpoint?
The CEO doesn't want the amount to appear on the company's balance sheet as an accrued liability because it decreases the financial stability of the balance sheet. Doing so will also adversely affect the liquidity ratios because it appears as a current liability, which also may break debt covenants that state the company must keep liquidity at or above a certain number. It also decreases additional investors from investing more when they see a ...

Solution Summary

This solution provides detailed explanations to the variance questions presented. All questions are thoroughly addressed and references are included.

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