On February 1, you sent audit inquiry letters to the X Financial Services Compan
ID: 2493940 • Letter: O
Question
On February 1, you sent audit inquiry letters to the X Financial Services Company`s General Counsel (inside counsel) and to ABCD, the company outside legal counsel, who have both devoted substantial attention to an investing by the state banking commissioner alleging that the company has engaged in illegal lending activities.
In its response to the audit inquiry letter, the company`s General Counsel informs you that he believes the company likely will have to settle the case by paying 20,000,000 without admitting or denying that it has engaged in illegal lending activities.
In its response to the audit inquiry letter, ABCD informs you that it believes the commissioner`s allegation is totally without merit and is just a political ploy to further the commissioner`s political ambitions of being elected the state`s next governor and that after he is elected his successor will recognize that the allegation is without merit and be willing to settle it for about 1,000,000 to “save face”.
You are aware that X has accrued 25,000,000 for this investing based upon the general counsel`s recommendation in the prior year when the general counsel had exclusive response for the matter.
Question:
What, if anything, would you do in this situation?
Prepare any necessary adjusting journal entries.
Explanation / Answer
Accrual for Legal Case is allowed if cash outflow is probable and amount is certain . If cash outflow is not probable or amount is not certain then instead of providing accrual, contigent liability has to be created and shown below the financial statements. In this case, as per both the counsel cash outlow is certain that company will have to pay to settle the case and as per both the counsel amount is certain. But both the counsel have different opninions about the amount. As a auditor, third party i.e ABCD's opinion will be taken into consideration so amount would be 1,000,000. Company can make a accrual of 1,000,000. Jounral entry to adjust the accrual: Accrual for Legal Dispute Dr 24,000,000 To Legal Claim Expense a/c Cr 24,000,000
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