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). If so, were

they correct in accruing for the lawsuit in fiscal 2020

after the court

had reached its decision on January 10, 2021

? Also, are there any

disclosures that should be prepared for the fiscal year ended December 31 2021