Colin Barry

Accounting for the Intel Pentium Chip Flaw / Contingent Liabilities (BAV, Tuesday, Week 10)

business-analysis-and-valuationyear-two

Accounting standards for when/how to recognize uncertain liabilities are highly subjective (unlike rules for, say, when to use a capital vs. operating lease).
Key factors: liability is probable, size of liability can be reasonably estimated.
Also, "The Contingent Liabilities" would be a great name for a band.

Big picture differences between measuring contingent liabilities under US GAAP and IFRS:
GAAP = "best estimate" of a liability --- so the outcome with the highest probability
IFRS = probability-weighted average (think about it as if you could securitize the liability), discount to a present value. Each period, recognize interest expense on value of principle and accrued interest.

In the case of Intel, real challenges because the nature of the flaw is known but management policy will determine the size of the liability.
Key uncertainty: Return rate on flawed Pentiums is unknown. But we can probably estimate it...

Impact on valuation:
Managers usually want to be conservative (err on the side of larger liability). Why?
Take a big hit early, only reach into the "cookie jar" once. Label the hit to earnings as "one-time restructuring" and avoid future guesses/downward expectations.