Danle Case Case10-5 Notes

Danle Case (Case10-5) Notes At fiscal year-end December 31, 2009, Danle Corporation (Danle) was involved in two class- action lawsuits. Both lawsuits were filed by automotive mechanics claiming brake parts manufactured by Danle had exposed them to asbestos. The first suit was filed in November 2008, seeking damages of $100 million while the second suit was filed in October 2009, seeking damages of $250 million. These pending lawsuits are considered a loss contingency which is defined by FASB as, “An existing condition, situation, or set of circumstances involving uncertainty as to possible loss to an entity that will ultimately be resolved when one or more future events occur or fail to occur.” The uncertainty for Danle is whether or not they will lose the suits causing the company to incur a loss by paying for the damages. This will be resolved when the pending litigations are either settled or decided upon in court. However, until these future confirming events take place, Danle must account for the loss contingency in their financial statements using one of the three accounting treatments: accruing a liability and disclosing in a note, disclosing only, or neither disclosing or accruing. In Danle’s Form 10-K for the year ended December 31, 2009, Danle chose the non-disclosure treatment. The proper treatment to be used depends on the likelihood a loss is to occur and the company’s ability to estimate the amount of the loss. Their decision to omit the disclosure is not appropriate because Danle’s management deemed that a loss resulting from the lawsuits was reasonably possible.In order to determine the proper accounting treatment, the likelihood that a confirming event will occur must be determined. There are three categorizations that describe the likelihood that a future confirming event will occur. These categorizations are probable, reasonably possible,

and remote. FASB defines these three categorizations as follows:

·Probable – The future event or events are likely to occur ·Reasonably possible – The change of the future event or events occurring is more than remote but less than likely ·Remote – The chance of the future event or events occurring is slight Danle’s management did not specifically say a confirming event was reasonably possible.Instead, management stated they “did not believe that it was probable a loss would occur.” By stating that a loss is not probable, management is saying a loss is less than likely which qualifies for the definition of reasonably possible.The second issue that must be considered in determining proper accounting treatment is whether or not the loss is reasonably estimable. Danle’s management “could not reasonably estimate an exact amount of the risk of potential loss as a result of the two law suits.” Accordingly, the loss is not reasonably estimable.When considering the potential loss is reasonably possible but not reasonably estimable, FASB offers clear instructions as to the accounting treatment required for this particular type of loss contingency. Specifically, FASB paragraph 450-20-50-3 states, “Disclosure of the contingency This study source was downloaded by 100000868141277 from CourseHero.com on 09-13-2023 11:45:52 GMT -05:00 https://www.coursehero.com/file/7534721/acct-316-danle-case-fml/ 1 / 2

shall be made if there is at least a reasonable possibility that a loss or an additional loss may have

been incurred and either of the following conditions exists:

·a. An accrual is not made for a loss contingency because of any of the conditions in paragraph 450-20-25-2 are not met.·b. An exposure to loss exists in excess of the amount accrued pursuant to the provisions of paragraph 450-20-30-1.” One of the conditions of paragraph 450-20-25-2, (mentioned in part (a) above), is that “The amount of loss can be reasonably estimated.” Thus, paragraphs 450-20-50-3 and 450-20-25-2 conjunctively state a disclosure shall be made in the case that a loss is reasonably possible but an accrual is not made because the amount of the loss is not reasonably estimable. This is the exact situation Danle is facing; the loss is reasonably possible, but not reasonably estimable.Therefore, according to FASB paragraph 450-20-50-3, Danle should have made a disclosure of the contingency in its Form 10-K for the year ended December 31, 2009.In the disclosure that Danle mistakenly omitted, according to FASB paragraph 450-20-50-4, they

should have disclosed both:

·a. The nature of the contingency, and ·b. An estimate of the possible loss or range of loss or a statement that such an estimate cannot be made.As of the release of the 2009 10-K, the amount of the loss was not reasonably estimable. Thus, at this time the disclosure should have included the nature of the contingency and a statement explaining why Danle was unable to estimate the amount of the potential loss. In the financial statements following the 2009 10-K, more information becomes available and Danle discloses an estimated range of losses. The estimated range of potential losses as of March 31, 2010, as stated in the Form 10-Q, is approximately $50 million to $350 million while in the Form 10-K it is stated that range of potential losses are about $200 million to $350 million.While Danle does include the estimated range of the possible loss, there are still some issues regarding the disclosure notes of which the SEC would be likely to make a comment. First, pursuant to FASB paragraph 450-20-50-4, Danle should have disclosed the nature of the contingency. In both the 10-Q and 10-K they should have indicated whether or not they thought the losses were probable, reasonably possible, or remote. If the losses had been described as probable, Danle would also have needed to accrue the estimated loss pursuant to FASB paragraph 450-20-25-2 which requires an accrual if both (a), “Information available before the financial statements are issued or are available to be issued indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements,” and (b), “The amount of the loss can be reasonably estimated.” Danle was able to reasonably estimate the loss and therefore depending on the nature of the loss, an accrual may have also been necessary in the 10-Q or 10-K. The SEC likely would have commented that Danle needs to disclose the nature of the contingency, and dependent on the chosen nature, it may have become necessary to also accrue the loss. This study source was downloaded by 100000868141277 from CourseHero.com on 09-13-2023 11:45:52 GMT -05:00 https://www.coursehero.com/file/7534721/acct-316-danle-case-fml/

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