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In summer 2005, Time Warner Inc. announced they were setting aside $3 billion to settle lawsuits from shareholders who alleged that they were wrongfully misinformed by executives at TimeWarner and AOL at time of AOL/ Time Warner "merger".  This all dates back to height of dot-com "bubble" in early 2000 when combined market valuation of both companies (outstanding common stock times market price of stock) exceeded more that $300 billion, now, Company's market valuation is much less. Lawsuits were really brought against TimeWarner in 2003 and 2004 at which time Company had said they were "vigorously" defending these lawsuits.

Suppose that "Setting aside" mean that Company set-up liability for eventual settlement of lawsuits with corresponding charges that was run through 2005 income statement. Also suppose that when this amount is actually paid-out it will be deductible for tax purpose. Answer the following problems

1) What type of accounting change is this? It appears that TimeWarner suddenly changed its position with regard to these lawsuits. Is this change in accounting principle? An error? An estimate?

2) How must this have impacted 2005 cash flow statement? (Suppose TimeWarner used indirect method and also suppose a 40% tax rate)

3) How will this impact future cash flow statements when lawsuits are actually settled, that is, money I paid - out to plaintiffs?

Accounting Basics, Accounting

  • Category:- Accounting Basics
  • Reference No.:- M916417

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