Burying the Hatchet
To: Pat Tyler
Re: Mighty Mufflers Corp. (MMC) Loss Contingencies
The complexity of MMC’s accounting for its litigation liability must be addressed in three components. First, we must determine the amount necessary to be accrued as of December 2012 from the First Settlement. Next, we must determine the placement of the aforementioned accrual from the First Settlement on the income statement. Finally, we must determine how to account for the True-Up Payment as of December 2012.
In the First Settlement, MMC agreed to a total settlement of $30 million; $10 million of this is due in 2013, $10 million will be issued as a rebate on 2013 purchases made by plaintiffs, and the final $10 million will …show more content…
Application of Codification
Taking FASB Codification 450-20-55-10 and 450-20-25-2 into account, we have assessed that the cause of action for litigation has already occurred in a prior period, that the outcome is already unfavorable since a multimillion-dollar settlement has been reached, and the reasonable estimates of loss have been determined. As FASB Codification 450-20-55-10 and 450-20-25-2 are applied, the full $30 million from the First Settlement must be accrued as of December 2012. The accrual is recognized with a debit to accrued loss from litigation and a credit to accrued liabilities from litigation.
FASB Codification 225-20-45-2, per 225-20-55-1 and 225-20-55-2, requires that an item must be unusual in nature and infrequent in occurrence. As far as we are able to discern, MMC has not indicated that lawsuits and settlements are commonplace for the company (thus meeting the criteria for an extraordinary item). The debit resulting from accrual of the First Settlement should be classified by MMC as an Extraordinary Loss on the statement of income. (Should signs point to the settlements becoming an ordinary occurrence, the codification would not apply.)
We have yet to determine when the True-Up Payment is to be disbursed, as the trial has yet to conclude, and only