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Firm Overview Significant New Litigation Disclosures Proposed
June 2008
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The Financial Accounting Standards Board (FASB) proposed expanded disclosures regarding contingencies, most notably those arising from litigation. Unless delayed or altered, litigators and in-house lawyers will be asked for significant additional information for 2009 fiscal periods (including interim financial statements).
FASB Statement 5 is the current pronouncement for addressing contingencies. SFAS 5 requires entities to “give an estimate of the possible loss of range of loss or state that such an estimate cannot be made”. In practice, actual disclosures usually state that the possible loss cannot be estimated. Not liking this result, the FASB proposed disclosure of the entity’s best estimate of the maximum possible exposure to loss. If the entity believes the amount of the claim is not representative of the actual exposure, the reporting entity would be permitted (but is not required) to disclose the possible loss or range of loss.
The proposed accounting measure affects disclosures only. It would NOT change the recognition and measurement criteria for when contingencies are recorded on the face of the financial statements, versus when disclosure is limited to the footnotes. It also does not affect treatment of gain contingencies.
Key provisions of the proposal are as follows:
- Expand the population of loss contingencies that are required to be disclosed - The proposal would also NOT change the existing rule that no disclosure is required when the likelihood of a loss is remote. However, an entity would need to disclose all loss contingencies (even if remote) if (i) the contingency is expected to be resolved in a year from the date of the financial statements, and (ii) the contingency could have a significantly disruptive financial effect on the normal functioning of the entity.
- Require disclosure of the following quantitative information:
a. The amount of the claim, including punitive damages, and
b. If there is no claimed amount, the reporting entity’s best estimate of the maximum loss.
The FASB acknowledged that the amounts disclosed are likely larger than what will ultimately be realized, but believes the additional information is better than what is currently occurring. In the event that the entity also wants to provide its own range of loss, it may do so. - Require disclosure of the following qualitative information:
a. A description of the contingency,
b. Its current status,
c. The anticipated timing of its resolution,
d. A description of the factors that are likely to affect the ultimate outcome, and the effect of each such factor,
e. The entity’s assessment of the most likely outcome of the contingency,
f. Significant assumptions used in estimating the amounts disclosed.
Much of this qualitative information is already disclosed, although the proposal makes the requirements more explicit. - A qualitative and quantitative description of the terms of relevant insurance or indemnification arrangements, including caps, limitations or deductibles.
- Require a tabular reconciliation of recognized loss contingencies that shows:
a. Increases for loss contingencies recognized during the period
b. Increases resulting from changes in estimates of the amount of losses previously recognized
c. Decreases resulting from changes in estimates of the amount of losses previously recognized
d. Decreases resulting from cash payments (or other settlement forms)
Qualitative description is needed for all significant activity in the above table. The specific caption on the balance sheet where these accruals are included shall be disclosed.
Disclosures can be aggregated by the nature of the loss; for example, product liability or antitrust matters.
The proposal provides for a “rare” exemption from disclosing certain required information if disclosing that information would be prejudicial to an entity’s position in a dispute. “Prejudicial” means that the entity’s position in the dispute could affect the outcome of the contingency. The typical solution for prejudicial disclosures is to aggregate the disclosure with other contingencies. In no event shall this “rare” exemption allow nondisclosure of information regarding something that the opposing party would already know.
Of course, the proposal does not address the legal issues of how such information is to be communicated from the lawyer to his client so as to not provide a waiver of any legal privileges. However, the rationale contained in a recent tax case involving tax contingencies (See IRS Loses another Case Involving Auditor Work Papers) might also be applicable to work papers and records involving accounting for contingencies such as litigation.
Comments regarding the proposal can be made by August 8.
Fulcrum Inquiry performs litigation damages analysis, and financial investigations.