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Internal Actuarial Specialist

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The 2007 claim estimate is projected through 2011. The 2008 and 2009 estimate are projected through 2017. During 2009: The reserve is reduced by payment, but no addition; Higher mesothelioma settlement amounts (Est. 29k vs Act.34K); Higher legal expenses due to: 1. More aggressive approach and use of experts (many + verdicts); 2. martin, Smith, and Jones claims; 3. higher-than-normal volume of trial activity (over 15 trails); 3. Appeal costs for Smith and Jones claims; 4. Appeal costs for certain cases (through favorable outcomes). Expectation for 2009 litigation liability: More aggressive approach and use of both In-house and general counsel; Revised strategies to understand the claims/cases earlier; More favorable trends in settlement costs; Favorable defense costs; Disincentive of plaintiffs.

External Specialist Report:

1. Total liabilities increase by $162m because the discrepancy between actual and estimated mesothelioma settlements in 2009. 2. The estimated increase in the asbestos litigation liability model does not reflect several positive factors. 3. Pending claims should be forecast using lower settlement values for future claims because of lower quality of the older claims. (pending to quantify the older claims). 4. Thompson agrees with Rossi’s assessment to maintain the 2009 liability at $962M. Internal actuarial specialist report: 1. The specialist reviewed Thompson’s methodologies and assumptions. 2. The specialist performed sensitivity tests using an internal asbestos model and data from Thompson’s database (none, 9, 10, 20, and 30 years): Some of scenarios indicate a “similar” liability amount; others indicate a “higher” amount.

The specialist confirmed the underlying assumptions. The specialist verified the calculations in the Thompson’s report. Auditor’s opinion: The recorded liability of $962m is within a reasonable range. However, if the company continues to settle mesothelioma claims for amounts similar to those observed during 2009, the company will need to adjust its recorded liability upward in the future. First, there is some merit to the company argument to favorable about the lower estimate. Then, the method used by Thompson is reasonable. Next, the assumption used by Thompson is reasonable. Finally, Company’s nine-year horizon assumption is reasonable.

Issues: Determine the appropriate accounting literature for Rossi’s recognition and measurement of the asbestos litigation liability. 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?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? (Note that you should qualitatively determine if there is a likely misstatement; a quantitative measurement of the error is not required.) What is the appropriate authoritative literature for recognizing and measuring the claims liability under IFRSs?

Is there a difference in the recognition or measurement criteria in IFRSs as compared to U.S. GAAP? Rules: ASC 450-20-25-2 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 indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements. b. The amount of loss can be reasonably estimated. ASC 450-20-30-1: 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. ASC 450-20-50-3: Disclosure of the contingency shall be made if there is at least a reasonable possibility that a loss or an additional loss may have been incurred and either of the following conditions exists: a. an accrual is not made for a loss contingency because any of the conditions in 450-20-25-2 are not met. b. an exposure to loss exists in excess of the amount accrued pursuant to the provisions of paragraph 450-20-30-1. ASC 450-20-50-4: The disclosure in the preceding paragraph shall include both of the following: a. the nature of the contingency. b. an estimate of the possible loss or range of loss or a statement that such an estimate can’t be made. Analysis: 1. Review management memo related to asbestos reserves, external specialist report, and internal actuarial specialist report.

Then, performed assessment of external specialist’s competence, capabilities and objectivity; and obtained an understanding of the work of the external specialist in accordance with firm policies. Next, auditor should test controls over the asbestos claims. And auditor should test the data and information used by the external specialist for accuracy and completeness. Finally, auditor should use an internal actuarial specialist to review the estimation calculation, and review the assumptions used by external specialists. 2. The auditor should contact Rossi’s lawyer to obtain the audit evidence to support Rossi management’s claims about the asbestos litigation liability. According to the AU 337, a letter of audit inquiry to the client’s lawyer is the auditor’s primary means of obtaining corroboration of the information furnished by management concerning litigation, claims, and assessments.

In the letter, the auditor should include all the pending asbestos litigation claims, as well as all probable future asbestos claims that would have an unfavorable outcome, that the lawyer has been or will be engaged in. Additionally, the auditor should request Rossi’s lawyer to confirm their understanding that, by exercising professional responsibility, they should inform the client that these possible claims or assessments should be disclosed in accordance with ASC 450. 3. Based on AU 342, the audit partner should evaluate the reasonableness of accounting estimates, with an attitude of professional skepticism, considering both the subjective and objective factors.

The audit partner should obtain an understanding of how management developed the estimate, review and test the process used by management to develop the estimate. When the auditor tests the management process, the auditor should consider additional key factors or alternative assumptions about the factors, evaluate whether the assumptions are consistent with each other. Finally, the partner should also inquire about any other plans, goals, and objectives of the entity, and then test the management’s calculation. The auditor should also review subsequent events. Furthermore, the auditor partner should evaluate whether the auditor’s specialist has the necessary competence, capabilities, and objectivity for the auditor’s purposes.

And the partner should obtain a sufficient understanding of the field of expertise of the auditor’s specialist to enable the auditor to evaluate the adequacy of the work for the auditor’s purposes. At last, the partner should evaluate the adequacy of the work of the auditor’s specialist for the auditor’s purpose, including the relevance and reasonableness of the findings and conclusions of the auditor’s specialist and their consistency with other audit evidence. The last but not the least, the audit partner obtain management written representations, which include plans or intentions that may affect the carrying value of the asbestos litigation liability, and unasserted claims or assessments that the entity’s lawyer has advised are probable of assertion and must be disclosed in accordance with FASB ASC 450, Contingencies.

 In order for a liability to be recognized in the financial statement, a liability must a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits. Apart from satisfying the definition of liability, the IFRS framework has also advised the following recognition criteria to be met before a liability could be shown on the face of a financial statement: 1. The outflow of resources embodying economic benefits (such as cash) from the entity is probable. 2. The cost / value of the obligation can be measured reliably. Under U.S. GAAP, asbestos litigation liability increases from $962m. And the costs will increase, which include number of cases and cost per case.

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