ACCOUNTING RESEARCH ASSIGNMENT #7

WINTER 2021

Your accounting firm has just been hired to perform the audit of McQueen International (MCQ), a privately held company, for the fiscal year ending December 31, 2020.You have been assigned to the engagement team for MCQ.You and the engagement manager have had a meeting with the controller of MCQ to discuss the issue below.Relevant information you gathered at that meeting is provided below along with the assignment your engagement manager gave you after this meeting.This situation described below is the final audit issue to be resolved before the scheduled release of financial statements on February 18, 2021.

Lawsuit brought by MCQ competitor

MCQ and Smith, Inc. (a competitor of MCQ) have been engaged in litigation related to a patent infringement matter.The litigation was initiated in 2020.Below is a summary of specific events that have occurred related to the alleged patent infringement:

• On April 6, 2020 Smith, Inc. filed suit against MCQ alleging patent infringement.The lawsuit was scheduled for trial in early January 2021.
• For the fiscal year ended December 31, 2020, MCQ's legal department concluded that MCQ would probably not prevail in the lawsuit but were unable to reasonably estimate the dollar amount of the loss.
• A jury trial began on January 4, 2021 and concluded on January 10, 2021
• The jury reached a verdict on the latter date (January 10, 2021) and a judgment was reached in favor of Smith, Inc. that required MCQ to pay Smith $2.5 million.
• MCQ has no plans to appeal the verdict.

MCQ accountants initially elected to not accrue for the pending litigation in fiscal 2020 as they felt that there was too much uncertainty associated with the lawsuit and did not want to risk misleading financial statement users.For the same reason, they did not provide any footnote disclosure related to the lawsuit brought by Smith.However, now that the lawsuit has been settled unfavorably from MCQ's perspective before the financial statements for fiscal 2020 are issued, the accountants decided to go back and record an accrual for the lawsuit in the amount of $2.5 million.This accrual will affect fiscal 2020.However, the accountants still did not provide any footnote disclosure related to the lawsuit for the fiscal year ended December 31, 2020.

Instructions from the audit engagement manager

The audit engagement manager has assigned you the task of 1) researching the accounting issues described below by using the FASB Accounting Standards Codification and 2) preparing an accounting issue memorandum to address the issue.

Accounting Issue: Whether MCQ's accountants were initially correct in not recording an accrual for the pending litigation (the lawsuit filed by Smith, Inc) for the fiscal year ending December 31, 2020).

What we know is that the accountants for McQueen did not accrue the loss from the contingency, because the uncertainty of the case. Meaning they could not predict the outcome of the litigation.

If so, were they correct in accruing for the lawsuit in fiscal 2020 after the court had reached its decision on January 10, 2021?