[M.]

Hello everyone,

I’m totally lost in the following question – II.

I think this lawsuit should be recognized (accrued) because the 20% probability of successful means that we have 80% probability that the suit will be lost, which meets the criteria of the contingent liability recognization. Can anyone please help me on this? The solution really doesn’t make sense to me.

Which of the following contingencies that exist on the acquisition date should be recognized by the acquirer in a business combination?

I. A contractual contingency to provide warranty services to prior customers of the acquiree.

II. An outstanding lawsuit against the acquiree for which an expert legal authority believes there is a 20% probability that the suit will be successful.

Neither I nor II.
I only.
II only.
Both I and II.

Item I would be recognized; Item II would not be recognized. Contractual contingencies (contingencies related to existing contracts) are recognized by the acquirer and measured at fair value. Noncontractual contingencies (contingencies that do not result from an existing contract), including lawsuits, are recognized only if it is more likely than not that the contingency will give rise to a liability (or an asset). A probability of 20% that the suit will be lost is not more likely than not, and the lawsuit would not be recognized.

Thanks!

[Paul]

You thinking backward about it. In order to have to recognize the lawsuit, it have to be more likely that not which is 50 % or greater. Being there is only 20% success, at most you might disclose it in the notes but that is even unlikely to be done by most companies being chances that lawsuit will be lost and company will have to pay out is only 20%

[M.]

Thanks Paul for your response. However, I still don't understand why a 20% success can be translated into a 20% lost. Doesn't the 20% success means 80% lost, which means it's more likely than not?

[Paul]

Try looking at it from the other point of view. Company A is getting sued by company B Company A got 80% chances of winning the lawsuit, company A doesn't need to recognize the liability. If it was reverse and company A had 80% of losing the lawsuit then yes they would need to recognize and record the liability.

In your second example there is only 20% probability that lawsuit will be lost.

In the first example its the opposite, it's 20% that you will win the lawsuit. They are playing around with wording

[M.]

Okay, maybe I can understand in this way: “An outstanding lawsuit against the acquiree for which an expert legal authority believes there is a 20% probability that the suit will be successful.”

This 20% probability success is our original guess, if the result reverses, then we'll lose, which means the lost probability is 20% as well. A 20% probability success doesn't mean a direct 80% probability success, right?

[Paul]

You can look at it from the other company perspective and say they have 80% of not winning the lawsuit

[M.]

I guess you're saying the following logic:

Our 20% success —> Their 80% lost, then they should recognize the contingent loss, but not us.

I'm thinking the following logic:

From the total 100% probability of success, our 20% success —> Their 80% success, then it means we have 20% lost. So we don't recognize the liability. Now I know from our perspective, a 20% probability of success doesn't equal an 80% lost. Do you think my logic makes sense to you?

Thanks,

[CH89]

I think you are getting tripped up on the wording for that scenario. I hope I am understanding your correctly, but please feel free to correct me if I am misunderstanding you. I do not think that statement is saying that the acquiree has a 20% chance of being successful in our favor, you refer to it as “our success,” but I believe it means that we have a 20% chance of losing this lawsuit, not winning. That's how I am looking at that statement, because there is a lawsuit against us, not the other way around. We aren't suing anyone, we are being sued which has a 20% chance of being successful, or us losing that lawsuit. I hope that helps clarify.

[M.]

Thank you CH89 for pointing my confusion. Now I know the 20% success is not in “our” favor, it's for the party who sued us. So there's only 20% probability that we'll lose to recognize this liability.

I really appreciate your response!

[Author]

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