Date: September 21, 2011
To: The Audit Files
Re: Accounting for Loss Contingencies
Our new client, Danle Corporation (Danle), has two outstanding lawsuits regarding the use ofasbestos in the manufacturing of their products. The purpose of this memo is to determine if the omission of disclosures regarding the lawsuits was appropriate in the 2009 annual report. According to ASC450-20 Contingencies: Loss Contingencies, and based on the facts, management and legal representations at the end of 2009, Danle should have disclosed the lawsuits.
In the past three years,mechanics and surviving family members have filed claims against Danle for severe illnesses resulting from exposure to asbestos during the manufacture of their automobile parts. In November 2008, thefirst class-action lawsuit sought damages totaling approximately $100 million. In October 2009, a second claim sought damages totaling approximately $250 million for additional infected mechanics.In December 2009, Danle’s external counsel discovered evidence regarding the first class-action lawsuit. This evidence led management to believe that there was a potential loss. Two similar lawsuitsagainst auto parts manufacturers were filed within the past five years; therefore, the counsel related the result of those claims with the current litigations. The external counsel could not estimatethe exact percentage but based on historical precedence, they believed that the amount of potential loss was going to be less than 50% of the amount claimed.
According to ASC450-20-25-1, a loss contingency can range from probable to remote. A probable loss contingency must be accrued and disclosed if the amount can be reasonably estimated. If there is a possible loss, the companymust disclose the information and an estimated amount. If the loss is remote, the company can include an optional disclosure but it is not mandatory.
Danle’s external counsel stated that there was...
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