Question

Case 15-2 Burying the Hatchet Mighty Mufflers Corp. (MMC)manufactures exhaust systems that automakers use in the productionof new vehicles. Competition in this market has waned in recentyears. Many competitors exited the business in the economicdownturn and few have returned because of the capital-intensivenature of the manufacturing process. In 20X1, the Department ofJustice (DOJ) launched an investigation involving MMC and twoadditional auto parts suppliers, alleging anticompetitive behaviorinvolving price collusion between suppliers. Shortly after the DOJinvestigation commenced, a number of customers formed aclass-action lawsuit against the three suppliers, alleging that thesuppliers fixed prices and overcharged customers as a result ofthese anticompetitive behaviors. Certain entities opted out of theclass-action lawsuit and separately undertook legal action againstthe individual suppliers, including MMC. These entities areexisting customers of MMC. In 20X2, MMC reached a settlement (the“First Settlement”) with several of those entities that opted outof the class action lawsuit (the “Plaintiffs”). The terms of theFirst Settlement provide that MMC will pay the Plaintiffs paymentsof: • $20 million — consisting of $10 million due in 20X3 and $10million due in 20X4. • $10 million — structured in the form of avolume incentive payment whereby the Plaintiffs, as a group, willreceive a 5 percent rebate on their purchases during 20X3 in anamount not to exceed $10 million. All payments are paid to the lawfirm representing the Plaintiffs, which disburses the funds at itsdiscretion. MMC believes it is reasonably assured the Plaintiffs,as a group, will earn the maximum $10 million volume incentivepayment, since the sales volume required is only a fraction of thePlaintiffs’ annual purchasing. Further, if the Plaintiffs, as agroup, do not achieve the maximum $10 million incentive payment asa result of any action of MMC (e.g., plant closure, inventoryshortage), then the full $10 million will be deemed to be earned bythe Plaintiffs. Finally, a separate amount (the “True-Up Payment”)will be payable from MMC to the Plaintiffs, or vice versa,depending on the settlement (the “Second Settlement”) MMC reacheswith the remaining entities that opted out of the class-actionlawsuit but were not party to the First Settlement. This amount,and whether it is owed by MMC or the Plaintiffs, will be determinedbased a formula applied to the Second Settlement amount and iscapped at $5 million. Required: 1. How much should MMC accrue forthe First Settlement as of December 20X2? 2. How should MMCclassify the debit resulting from accrual of the First Settlementin the statement of income? 3. How should MMC account for theTrue-Up Payment as of December 20X2?

Can someone tell me which ASC sections areinvolved?

There is a posted solution:

1. How much should MMC accrue for the First Settlement as ofDecember 20X2? Amount Accured for the first settlement = $10million + $10Millionx (1-5%) = $10,000,000 + 9,500,000 =$19,500,000

2. It will treat as an expenses,will be added to the concernedexpense and it will be treated as current liability.

3. True up Payment = $10,000,000 - $9,500,000 = $500,000,

But this doesn't explain where the backup for thesecalculations came from.