Summary
Should the FASB ultimately adopt either of the two cited approaches aimed at obtaining more timely and forthright financial statement recognition of loss contingencies, numerous public companies will finally be required to remove their rose-colored glasses and provide a more realistic and transparent accounting for their various loss contingencies (e.g., lawsuits, environmental remediation exposures, etc.). And, for certain companies operating in higher-risk industries (e.g., chemical, mining, medical, tobacco, etc.), the implications may be comparable to having to fully recognize their pension liabilities.
Analysis
For decades, SFAS 5 of US GAAP has required that a company accrue for a loss contingency only if such loss was deemed “probable” of occurrence and the dollar amount of loss could be “reasonably estimated.” Over my twenty plus years of practice, including nearly nine years with the SEC’s Division of Corporation Finance, I have repeatedly encountered instance after instance whereby companies have blatantly used the “fuzziness” of SFAS 5’s existing thresholds to evade recognition of their loss contingencies until their fates were sealed, e.g., exhaustion of all legal appeals after repeated adverse judgments. Compounding the problem has been the concurrent evasiveness by many companies of not even providing quantified note disclosure as to the estimated dollar range of “reasonably possible” loss which is required even if a company deems a loss to not meet the “probable” threshold for accrual.
Historically, many companies have blatantly ignored SFAS 5’s accrual and disclosure requirements as complying with such has been viewed as compromising their defense and/or negotiation postures. Instead, such companies routinely provide long-winded, non-quantified legalistic disclosure concluded by representations that they deny all allegations and intend to mount a vigorous defense. Then, in all too many cases after exhaustive court or regulatory appeals, the previously improbable material adverse judgment is received by a company necessitating the previously avoided loss accrual. Regardless of whether the FASB lowers the recognition threshold from “probable” to “more likely than not” or adopts an IAOB-like probability-weighted fair value standard, I believe it will be a vast improvement!
