Accounting for the Intel Pentium Chip Flaw

The case for this week is a HBS case study; the instructions to access the case are found in the syllabus. Note that you are permitted to work on this case in small groups (preferably no more than three), if you would like to. If you work in a group, please submit only one case analysis and make sure that you reference the entire team on the front page of the case write-up.

In analyzing the case, please respond to the following questions:
1. 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?

2. 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?

3. 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?

4. 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?

5. After the December 17 meeting, how should Intel’s management communicate its decision to the financial markets? Should Intel file a form 8-K?

6. 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?

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