What is the amount of the liability that the company recognizes in each of the following independent cases?
a. A cereal company issues coupons that can be exchanged for boxes of cereal. It issues 1 million coupons that promise the retailer who redeems the coupons $1 per coupon. The probability of redemption of any one coupon is 8%.
b. A plaintiff files a lawsuit against the company. The probability is 80% that the company will lose. If it loses, the amount of the loss will most likely be $100,000.
a. The liability for the coupons would be measured at $80,000.
b. The expected value of the liability is $80,000 in both cases (.80 X $100,000 = $80,000;
.08 X $1 X 1,000,000 = $80,000). However, under both U.S. GAAP and IFRS, the liability from the lawsuit would be measured as $100,000, the most likely settlement amount.
The inconsistency in the answers to Part a. and Part b. seems curious since the two situations differ only with respect to the number of possible outcomes (that is, all or nothing with respect to the lawsuit, whereas the coupon redemption rate conceivably ranges from one to one million).
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