In analyzing the case, please respond to the following questions:
- Consider the following dates in the evolution of the Pentium chip flaw during 1994:
June 30: Intel discovered the flaw
October 31: Dr. Nicely posted information about the flaw on the Internet and started an active discussion group
November 24: Article in Electrical Engineering Times appeared, a story has been broadcast on CNN and articles have appeared in the New York Times and Boston Globe
December 12: IBM announces that it has stopped shipments of its computers with the flawed Pentium chip
At any of these dates, did Intel have a contingent liability as defined by FAS No. 5?
- At the end of the December 17 meeting, what should Intel management do? Should they expand their Pentium chip replacement program by (i) covering more individuals; and/or (ii) providing or paying for some or all of the (non-chip) incidental costs of replacing the defective chips?
- Independent of your answer in question 2, assume that in December 1994, Intel’s management decided to expand its program by offering to supply a replacement chip to all purchases of a defective Pentium chip, regardless of how they use it. Intel will provide a new chip free of charge, but will not pay for any other costs. What expense/liability should Intel reflect on its 1994 financial statements?
- How would your answer to question 3 change if Intel also offered to pay for the labor and direct incidental costs in addition to offering to supply a new chip to all individuals?
- After the December 17 meeting, how should Intel’s management communicate its decision to the financial markets? Should Intel file a form 8-K?
- On December 20, 1994, XYZ corp. had a chemical spill in a field adjacent to their factory. They completed and paid cash for the immediate clean up prior to their December 31 year-end. However, they have consulted with an environmental engineering firm that indicated that there is a 90% chance that XYZ will have to perform a further clean up in six months. The cost of such a clean up would most likely be $100,000. If the weather is perfect during the clean up, it could cost as little as $95,000. On the other hand, there is a small chance that soil contamination could spread, increasing the costs to $150,000. Should XYZ recognize a liability in their 1994 financial statements? Assuming they do, what amount should be recognized? How would XYZ record such a liability on their books? What impact would the subsequent cash payment have if the liability were settled for the amount accrued? What if the actual clean-up costs are more or less than was accrued in 1994?