Fasb_Results_Client's_Lawsuit

FASB Results and Financial Impact of Client’s Lawsuit ACC 541 July 23, 2012 Bethany Kessel | |Accounting Firm | Memo |To: |Client | |cc: |Client’s Lawyer and Accounting Director | |Date: |July 23, 2012 | |Re: |FASB Research Results-Lawsuit | | | | FASB Results and Financial Impact of Client’s Lawsuit Whenever a client is subjected to a lawsuit it can be costly and it could damage the business reputation. In an effort to minimize risk and reduce potential loss to the company, the client sought advice from the firm. The client wants to know the contingencies requirements, financial statement impact, mortgage refinance, patent impairment, and Chapter 11 filing. In order to respond to the client’s questions, research was conducted and information was obtained from FASB. After the research is completed, a meeting will be held to inform the client of the results. Contingences Reporting Requirements If the client looses, the lawsuit is considered a contingent liability. A journal entry will be necessary to report all liabilities estimated amounts on the balance sheet. In addition, probable expenses must be reported on the income statement. However, if a contingent liability is possible, but not probable no journal entry is required. In this case, a disclosure in the notes to the financial statement must be presented that details the loss contingency and the potential liability if an unfavorable result. If the lawsuit is lost, and Chapter 11 is filed, a reorganization plan will need to be implemented. If the loss contingency is realized then the financial statement needs to include the liabilities that are subject to compromise as a result of filing Chapter 11. On the other hand, if the client does not lose the lawsuit then the loss contingency is not recognized. Mortgage modification impact on financial statement If the mortgage agreement needs to be modified due to filing for chapter 11, it will have impact in the financial statements. Contacting the mortgage lender and establishing a debt plan will be part of the reorganization plan. In general, mortgage accounting will impact the client’s balance sheet, income statement, and cash flow statement. A troubled debt restructuring occurs when company fails to pay the obligation on time due to either financial difficulty or legal proceeding than mortgage agreement may be modified to stop being default (FASB ASC 470-60-20). Under the loan modification, no adjustment needs to make to the original book value of the liability on the balance sheet. It is necessary to apply appropriate interest rate and determine the total future payment. Interest expense each year based on carrying value that is recorded in the income statement as interest expense. Each payment minus the interest’s expense reduces the liability for the company. Mortgage and Debt Restructuring The most important part is to establish a relationship with the mortgage. The client is deciding whether to keep the company or dissolves the company and file Chapter 11. On the other hand, the client may be able to do a troubled debt restructuring, which would help the company. If the client decides to file for Chapter 11, the mortgage is paid through the liquidation of available assets of the company. “In the event the corporation becomes bankrupt and is liquidated, the holders of mortgage bonds have first claim against proceeds from the sale of the assets secured by their debt. If the proceeds from the sale of secured assets are not sufficient to repay the debt, mortgage bond holders become general creditors for the reminder of the debt (Schroeder, Clark, & Cathey, 2011, pg. 653, para 2). Generally, the court will establish how sale of assets will meet the needs to fulfill the creditors’ claims. The debtor will need to file a plan with the Bankruptcy Court which will be reviewed by them to see if it is fair to creditors and stakeholders (FASB ASC 852-10-05). They will need to do this if they are striving to keep the business going and the plan initiates reorganization. The idea behind this is to find a way in which to meet the needs of the creditor and stakeholders and keep the business as a “viable entity with a going concern value” (FASB ASC 852-10-05-02). The plan if approved by most if not all the creditors and stakeholders and the court is a treatment for the liabilities that may result in forgiveness of the liabilities. With troubled debt restructuring, the creditor may be willing to work with the company to better assure it chances of collecting on the liability. FASB ASC 470-60-15-7 states: “Whatever the form of concession granted by the creditor in a trouble debt restructuring, the creditor’s objective is to make the best of a difficult situation. That is, the creditor expects to obtain more cash or other value from the debtor, or to increase the probability of receipt, by granting the concession than by not granting it. A troubled debt restructuring can include the transfer of receivables from debtor to creditor, issuance or granting of equity interest to the creditor, or a modification of the terms of the debt (470-60-15-9). However, if the client is able to obtain mortgage and market interest rates or higher and able to meet that demand, they will not qualify to a troubled debt restructuring (470-60-15-8). Impairment of a Patent In most cases, the impairment of a patent after losing a lawsuit will reflect negatively on the client’s financial statements. In an effort to determine fair value of the contracts, the client has identified the types of hedge contracts currently being use and will be using in the future. When hedging, investors often choose between futures and another derivative known as a forward. Forwards provide more flexibility in choosing contracts and allow investors to tailor contracts to specific needs (Kuepper). Hedge accounting rules enable companies to either defer profits and losses of hedge contracts to future periods, or bring forward the profits and losses to an earlier period (Hedge Accounting). The client will assess the ability to defer profits and losses due to the lawsuit. Hedge accounting represents a number of provisions within Financial Accounting Standard 133 that allow companies to match the changes in fair value of their hedge contracts to the changes in fair value of the item hedged. A patent impairment occurs when a company that has taken out a patent is no longer able to benefit financially from it, so the cost of the patent outweighs the gains it provides. Inventors go to exhaustive lengths to secure long-lasting, high quality patents to avoid potential lawsuits (Sephton). Effectiveness testing is one of the most daunting aspects of the hedge accounting requirements for corporate. The effectiveness of the hedge contract must be assessed prospectively at hedge inception and at each balance date using the change in fair value of the hedged item divided by change in fair value of the hedge contract (Hedge Accounting). Conclusion Base on the research results, the lawsuit will have a negative impact on the client’s financial position. If the client looses the lawsuit, all losses must be recorded and liabilities will increase. In addition, the financial statements will have a negative impact. The client will attempt mortgage modification before filing Chapter 11. Because a patent held by the company is a part of the lawsuit, it will negatively impact the financial statements. Also the client acquired a hedge contract against the impairment of the patent to secure the fair value of the asset. Reference AccountingCoach. (2012). Accounting Principles. Retrieved from http://www.accountingcoach.com/online-accounting-course/09Xpg01.html AccountingCoach. (2012). What is a contingent liability' Retrieved from http://blog.accountingcoach.com/contingent-liability/ Cornell University Law School. (2011), "Rule 3017. Court Consideration of Disclosure Statement in a Chapter 9 Municipality or Chapter 11 Reorganization Case". Retrieve from http://www.cornell.edu The Harvard Law School on Corporate Governance and Financial Regulations. (2010). "FASB Proposes Expanded Discloses Regarding Loss Contingencies". Retrieved from http://blogs.law.harvard.edu/corpgov/2010/08/26/fasb-proposes-expanded-disclosures-regarding-loss-contingencies/ Hedge Accounting. (n.d.). CNS Treasury Software, http://www.cnstreasury.com/hedge-accounting/. Financial Accounting Standards Board. (1975). Summary of Statement No. 5. Retrieved from http://www.fasb.org Kuepper, J. (n.d.). Hedging. InvestorWorld.com, http://www.investorwords.com/tips/594/hedging.html. Richard G Schroeder, M. W. (2011). Financial Accounting Theory and Analysis. Text and Cases. Tenth Edition. John Wiley & Sons Inc. Sephton, C. (n.d.). How Will The Impairment Of The Patent In The Event Of Losing A Lawsuit Be Reflected On The Financial Statements' Blurt It, http://www.blurtit.com/q340969.html.