10-K Minute: Target, Data Breach, and Contingent Liabilities

Background

In the fourth quarter of 2013, hackers broke into Target Corporation’s system and stole the names and credit card information for up to 70 million customers. This data breach is among the largest data breaches in U.S. history and lawsuits against Target Corporation are being filed by several parties including customers, credit card companies, State Attorneys General, and others. The financial effects of the data breach at Target is a good opportunity to see how contingent liabilities are accounted for under U.S. GAAP. Next are excerpts from Target Corporation’s 10-K for 2013 (Source: Target Corporation, SEC filings, 10-K filed 03/14/14, Notes to Financial Statements, pages 46 – 47).

Excerpts from 2013 Target Corporation 10-K Notes to Financial Statements

Note: Omitted words and phrases indicated by …

“In the fourth quarter of 2013, we recorded $61 million of pretax Data Breach-related expenses, and expected insurance proceeds of $44 million, for net expenses of $17 million ($11 million after tax)…. These expenses were included in our Consolidated Statements of Operations as Selling, General and Administrative Expenses (SG&A)… Expenses include costs to investigate …, provide credit-monitoring services…, increase staffing in our call centers, and procure legal and other professional services.”

“The $61 million of fourth quarter expenses also include an accrual for the estimated probable loss related to the expected payment card networks’ claims by reason of the Data Breach. The ultimate amount of these claims will likely include amounts for incremental counterfeit fraud losses and non-ordinary course operating expenses (such as card reissuance costs) that the payment card networks believe they or their issuing banks have incurred… Currently, we can only reasonably estimate a loss associated with settlements of the networks’ expected claims for non-ordinary course operating expenses. The year-end accrual does not include any amounts associated with the networks’ expected claims for alleged incremental counterfeit fraud losses because the loss…, while probable in our judgment, is not reasonably estimable… We believe that it is reasonably possible that the ultimate amount paid on payment card network claims could be material…”

“…State and federal agencies, including the State Attorneys General, the Federal Trade Commission and the SEC are investigating events related to the Data Breach, including how it occurred, its consequences and our responses. Although we are cooperating in these investigations, we may be subject to fines or other obligations. While a loss from these matters is reasonably possible, we cannot reasonably estimate a range of possible losses…we do not believe that a loss from these matters is probable; therefore, we have not recorded a loss contingency liability for litigation, claims and governmental investigations in 2013.”

Contingent liabilities

FASB provides guidelines for accounting for contingent liabilities:

1)    Accrue if the loss/expense is probable AND the amount can be reasonably estimated.

2)    Disclose if it is reasonably possible (less than probable but more than remote) that a loss/expense will occur.

3)    If the loss/expense is unlikely to occur, there is no need to report or disclose.

Explanation

What we see in the excerpts from its 10-K is that Target Corporation is acknowledging at least three possible liabilities resulting from this data breach:

1)    A liability to the credit card companies for the expenses associated with credit card reissuance and other operating expenses;

2)    A liability to the credit card companies for the losses resulting from fraudulent use of the stolen credit card information; and

3)    A liability for fines or other obligations from regulatory agencies.

Credit card reissuance expenses

Target acknowledges in its 10-K that it is accruing for the liability related to the expenses associated with credit card reissuance and other operating expenses.  Target specifically states that the loss related to credit card reissuance is both “probable” and the amount is reasonably estimable. The amount of liability for these expenses is found in the current liabilities on Target’s balance sheet and the related expense is on the income statement.

Fraudulent use of stolen credit card information losses

Target then goes on to state that, while losses from the fraudulent use of the stolen credit card information are probable, the amount of these losses cannot be reasonably estimated.  Target is therefore making no accrual for these potential losses in the fourth quarter of 2014. These probable losses do not appear in Target’s balance sheet, nor do the losses appear on its income statement.

Fines or other obligations

Finally, Target discloses that fines or other penalties from regulatory bodies are reasonably possible but the amount of such penalties is not reasonably estimable.  Therefore, Target only discloses the possibility of fines in the notes to the financial statements (no appearance on the balance sheet or income statement.)

Instructor Resources

These resources are provided to give the instructor flexibility for use of Accounting in the Headlines articles in the classroom. The blog posting itself can be assigned via a link to this site OR by distributing the student handout below.  Alternatively, the PowerPoint file below contains a bullet point overview of the article and the discussion questions.  The YouTube video link below is a narration of the blog post article (no discussion questions are included in the YouTube video; those can be assigned separately.)

  • Student handout (pdf) (doc) – contains background, 10-K excerpts, and explanation
  • Student handout (pdf) (doc) – contains background and 10-K excerpts (no explanation)
  • PowerPoint file (pptx) – overview including explanation
  • YouTube (URL) – contains background, 10-K excerpts, and explanation

Creative Commons License
This work is licensed under a Creative Commons Attribution-NonCommercial 3.0 Unported License.

About Dr. Wendy Tietz, CPA, CMA, CGMA

Dr. Wendy Tietz is a professor of accounting at Kent State University in Kent, Ohio, USA. She is also a textbook author with Pearson Prentice-Hall.

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