Reference no: EM139680

In summer 2005, Time Warner Inc. announced they were "setting aside" $3 billion to settle lawsuits from shareholders who alleged that they were wrongfully misled 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 valuation of both companies (outstanding common stock times market price of the stock) exceeded more that $300 billion, now, the Company's market valuation is much less. The lawsuits were actually brought against TimeWarner in 2003 and 2004 at which time the Company had said they were "vigorously" defending these lawsuits.

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

1. What kind of an accounting change is this? It seems that TimeWarner suddenly changed its position with regard to these lawsuits. Is this a change in accounting principle? An error? An estimate?

2. How should this have impacted the 2005 cash flow statement? (assume TimeWarner used indirect method and also assume a 40% tax rate)

3. How will this impact future cash flow statements when the lawsuits are actually settled, i.e, money I paid - out to the plaintiffs?