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Rossi Inc. Essay


Rossi Inc. is a diversified manufacturer of industrial products. In 2008, Rossi updated its asbestos litigation liability, including the costs of settlement payments and defense costs relating to currently pending claims and future claims projected to be filed against the Company through 2017 for losses incurred to date. Before 2008, the Company’s previous estimate was for claims projected to be filed through 2011. As part of the 2008 update to the asbestos litigation liability, Rossi engaged Thompson and Associates, a consulting firm, to serve as an external specialist to estimate the claims liability for December 31, 2008. As a result of the 2008 update and the external specialist claims estimate, the Company significantly increased its recorded asbestos litigation liability by $586 million, arriving at a total liability estimate of $1,055 million as of December 31, 2008. During 2009, additional payments against the reserve reduced the recorded liability to $962 million.

As of December 31, 2009, the Company performed an analysis of the asbestos litigation reserve and determined that the asbestos litigation liability should remain at $962 million. In 2009, Rossi Inc.’s average cost per claim litigation increased from $29,000 in 2008, to $34,000 due to management’s aggressive approach. This resulted in Thompson concluding that the litigation liability account should have a carrying value of $1,124 Million instead of $962 Million. Management of Rossi Inc. thinks that there aggressive approach to litigation claims in 2009 and revised defense strategy will decrease litigation cost and defense cost in the future. Research Question:

You have been asked by the engagement partner to review the client’s accounting for the asbestos litigation liability and determine the appropriate accounting literature for Rossi’s recognition and measurement of the asbestos litigation liability.

Relevant Literature

Accounting Standards Codification 450-20-25-1 & 2 Loss Contingency Recognition “25-1 When a loss contingency exists, the likelihood that the future event or events will confirm the loss or impairment of an asset or the incurrence of a liability can range from probable to remote. As indicated in the definition of contingency, the term loss is used for convenience to include many charges against income that are commonly referred to as expenses and others that are commonly referred to as losses. The Contingencies Topic uses the terms probable, reasonably possible, and remote to identify three areas within that range. 25-2 An estimated loss from a loss contingency shall be accrued by a charge to income if both of the following conditions are met: a. Information available before the financial statements are issued or are available to be issued (as discussed in Section 855-10-25) indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements. Date of the financial statements means the end of the most recent accounting period for which financial statements are being presented. It is implicit in this condition that it must be probable that one or more future events will occur confirming the fact of the loss. b. The amount of loss can be reasonably estimated.”

Management’s Application

Rossi Inc. records indicate that litigation liabilities exist and that un-asserted litigations will arise in the future for events which occurred before December 31st, 2009. These claims can be reasonably estimated based a frequency severity method used in many asbestos litigation cases. Therefore, Management of Rossi Inc. has met both conditions and correctly accrued the reasonably estimated cost of the litigation liabilities. Accounting Standards Codification 450-20-30-1 Initial Measurement “If some amount within a range of loss appears at the time to be a better estimate than any other amount within the range, that amount shall be accrued. When no amount within the range is a better estimate than any other amount, however, the minimum amount in the range shall be accrued. Even though the minimum amount in the range is not necessarily the amount of loss that will be ultimately determined, it is not likely that the ultimate loss will be less than the minimum amount.”


According to the Internal Actuarial Specialist Report, the estimated cost of litigation ranges from $907 million to $1,514 million. Accounting Standards Codification 450-20-30-1 says that Rossi Inc. must accrue the lower amount
of the range which is $907 million. The company must also create a disclosure note acknowledging that it is possible the litigation liabilities could cost as much as $1,514 million if the excess is reasonably probable. Research Question:

What additional audit procedures, if any, should you suggest to the engagement partner in order to evaluate the appropriateness of the asbestos litigation liability as of December 31, 2009?

Relevant Literature

Statements on Audit Standards No. 12- AU section 337 Paragraph 6 & 7 “.06 An auditor ordinarily does not possess legal skills and, therefore, cannot make legal judgments concerning information coming to his attention. Accordingly, the auditor should request the client’s management to send a letter of inquiry to those lawyers with whom management consulted concerning litigation, claims, and assessments. .07 The audit normally includes certain other procedures undertaken for different purposes that might also disclose litigation, claims, and assessments. Examples of such procedures are as follows: Reading minutes of meetings of stockholders, directors, and appropriate committees held during and subsequent to the period being audited. Reading contracts, loan agreements, leases, and correspondence from taxing or other governmental agencies, and similar documents. Obtaining information concerning guarantees from bank confirmation forms. Inspecting other documents for possible guarantees by the client.”


The engagement partner should ask management to send their legal counsel a letter of inquiry, outlining all litigation procedures currently in progress and claims or assertions for future litigation. Because of attorney-client confidentiality, the lawyer may refuse to response to the letter of inquiry; alternatively, the engagement partner can obtain this information from other sources. The engagement partner can read the documented minutes of meetings of directors and company committees, as well as, contracts created between Rossi Inc. and its customers for possible grounds for future lawsuits. The auditor should also strive to understand how Rossi Inc. management developed its estimate for the litigation liability, then he/she should review and test those procedures used by management. Research Question:

Considering the range of the estimated claims liabilities, do you believe that there is an uncorrected likely misstatement that the engagement partner should request the client to correct?


The engagement team has already determined that the litigation liabilities account is a material account with materiality for the audit set at $12.5 million. The litigation liabilities account currently has a balance of $962 million; however, ASC 450-20-30-1 states that account should reflect the lower amount of the reasonably measured range of possible litigation cost. The amount which should be recorded is $907 million which is $55 million less than the currently recorded amount. With materiality set at $12.5 million, the engagement partner should request Rossi Inc. correct the amount of the litigation liabilities account to fix the likely misstatement.


Rossi Inc. has met both conditions of ASC 450-20-25-2 because it is probable the company will have litigation losses in the future from events which occurred during or before this accounting period. These losses have been reasonably estimated into a range of $907 to $1,514 million. According to ASC 450-20-30-1, when a range exists and no number in the range is more likely to occur the company should accrue the lowest amount of the range. The audit should also inquiry about the accuracy of the litigation estimate. This can be accomplished by complying data obtained from inquiry letters to the client’s lawyers, reading of minutes for meetings conducted by management or directors and by evaluating contracts between the client and their customers. The auditor must also evaluate the method of estimating the litigation liability. Finally, the engagement partner must ask Rossi Inc.’s management to correct the likely misstatement due to the litigation liabilities account being overstated.

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