Question :

In summer 2005, TimeWarner Inc. announced they were "setting aside" $3 billion to settle lawsuits from shareholders who alleged that they were wrongfully mislead by executives at TimeWarner and AOL at the time of the AOL/Time Warner "merger". This all dates back to the height of the dot-com "bubble" in early 2000 when the combined market evaluations of both companies (outstanding common stock times market price of the stock) exceeded more than $300 billion; now, the Company's market evaluation is much less.

The lawsuits were really brought against TimeWarner in 2003 and early 2004 at which time the organization had said the lawsuits were "without merit", and they were "forcefully" defending the lawsuits.

Suppose that "setting aside" meant that the Company set-up a liability for the ultimate settlement of the lawsuits with a corresponding charges that was run through the 2005 income statement. Also consider that when this amount is actually paid-out it will then be deductible for tax purposes. Please answer the given questions.

a) What kind of an accounting change is this? It indicates that TimeWarner rapidly changed its position with regard to these lawsuits. Is this a change in accounting principle?

b) How did this affect the 2005 cash flow statement? Be definite and give amounts. {Consider TimeWarner uses the indirect technique and also assume a 40% tax rate.}

c) How did this affect future cash flow statements when the lawsuits were essentially settled, i.e., money was paid to the plaintiffs?