1
Accounting for Lawyers
Professor Bradford
Fall 2008
Exam 2008
The following answer outlines are not intended to be model answers, nor are they
intended to include every issue that students discussed. They merely attempt to identify
the major issues in each question and some of the problems or questions arising under
each issue. They should provide a pretty good idea of the kinds of things I was looking
for. If you have any questions about the exam or your performance on the exam, feel free
to contact me to talk about it.
I graded each question separately. Those grades appear on the front cover of your
blue books or, if you didn’t use blue books, at the top of your exam answers. To
determine your overall average, each question was then weighted in accordance with the
time allocated to that question. The following distribution will give you some idea how
you did in comparison to the rest of the class:
Question 1: Range 3-9; Average = 6.89
Question 2: Range 0-9; Average = 6.57
Question 3: Range 2-9; Average = 5.96
Question 4: Range 0-9; Average = 4.86
Total (of exam, not final grades): Range; Average = 6.28
2
Question 1
See separate Excel files.
3
Question 2
The total amount paid in the structured settlement is greater than $1.6 million, but
that’s not a fair comparison because of the time value of money. The $1.6 million will be
paid immediately; Stan won’t receive some of the money paid in the structured settlement
until well into the future. To compare the two offers, we must first determine the present
value of the structured settlement payments and compare that present value to the $1.6
million.
The present value of the first $200,000 payment is $200,000, since it’s paid
immediately. The payments from 2009 to 2012 are a four-year annuity in arrears. Table
IV indicates that the conversion factor for a four-year annuity in arrears, given a 6%
discount rate, is 3.46511. The present value of those four payments is therefore $200,000
x 3.46511 = $693,022.
We can determine the present value of the final $1 million payment using Table
II. The present value of a dollar payable in five years, assuming a 6% discount rate, is
.74726. Thus, the present value of this final payment is $1 million x .74726 = $747,260.
The total present value of the structured settlement is $200,000 + $693,022 +
$747,260 = $1,640,282. This is greater than the $1.6 million offer, so the structured
settlement is better in present value terms. However, the present value calculation
doesn’t take into account the risk of non-payment. Stan will receive the $1.6 million
immediately upon settlement, so there’s no risk he won’t be paid. Unless the promise of
future payment is secured in some way, there’s no guarantee Stan will actually receive
the future payments promised in the structured settlement. Stan needs to consider this
risk in deciding which offer to accept, especially given the relatively small difference
between the two offers’ present values.
4
Question 3
1/1/08
Truck
Cash
12/31/08
Depreciation Expense
Accumulated Depreciation: Truck
$14,000
$14,000
$6,000
$6,000
Replacement of the truck’s engine looks more like a capital expenditure than a repair.
The amount, $14,000, is large in relation to the original $31,000 cost of the truck. A
truck’s engine is replaced infrequently, if at all; this is not a recurring expense. And the
expenditure increases the useful life of the truck by 33%, from six years to eight years.
Therefore, this cost should be capitalized into the cost of the truck.
As a result of the capital expenditure, the total cost of the truck is now $45,000.
The salvage value is $1,000, so the total depreciable cost is $44,000. The remaining
useful life is 4 years. Accumulated depreciation to this point is $20,000, so $24,000 of
the cost remains to be depreciated over the four years. Therefore, using the straight-line
method of depreciation, depreciation expense for this year is: $24,000/4 = $6,000.
5
Question 4
Absent a supplemental request from Careless, I cannot discuss the potential claim
involving Jane Doe. The ABA Statement of Policy Regarding Lawyers’ Responses to
Auditors’ Requests for Information (1975) indicates that an attorney may comment on
unasserted claims only if the client has specifically identified them and requested
comment. Careless’ request does not identify the Doe matter. Therefore, even though
Careless has requested an evaluation that includes unasserted claims, I should not
comment. I should tell Careless I can comment if it sends me a supplemental request
specifically identifying the Doe matter. They can do so under the ABA Statement of
Policy because it is probably that a claim will be asserted (“almost certain”) and, given
the similarity to the Smith claim, there’s at least a “reasonable possibility” that the
outcome would be unfavorable. If Careless does not make a supplemental request, to
avoid misleading the auditor, my response should indicate that I am not commenting on
unasserted claims because none was specifically identified.
I clearly may provide core information about the Smith claim: “an identification
of the proceeding or matter, the stage of proceedings, the claim(s) asserted, and the
position taken by the client.” To provide anything beyond that, I must contact the client,
warn them of the legal consequences of my disclosure, and get their specific consent to
proceed.
The ABA Statement of Policy only allows me to provide two additional items of
information: (1) my judgment as to the possible outcome; and (2) an estimate of the loss.
It’s unclear if I can provide an evaluation of the outcome. I can do so if the
prospects of Smith losing are “extremely doubtful” and the prospects of Careless winning
are “slight.” It’s unclear if a 5-10% chance of Careless winning is slight; this clearly
approaches that level, but may be too substantial to be “slight.” Therefore, I probably
shouldn’t comment on the outcome.
I probably can comment on the amount or range of loss, at least in part. If
Careless loses, the $100,000 liability appears certain, so the probability of inaccuracy on
that part of the damages is slight. The pain and suffering damages are much more
uncertain, but I probably can give a range: $0 to $1 million. It’s not clear if the ABA
Statement allows one to comment on one aspect of damages but not another. The
accounting standard in FASB No. 5 envisions something like this, and I can’t see why it
would pose any more risk in the auditing setting. Therefore, I can probably say
something such as this: “If Careless loses, it will be liable for $100,000 for medical
treatment. Smith is also claiming $1 million for pain and suffering; I am unable to
comment on Careless’ liability for these additional damages.”
The ABA Statement is meant to be exhaustive, so I cannot provide any
information other than that discussed above.