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Meaningful Loss Contingency Disclosure Could Head Off a FASB Intervention

Scott Taub | January 25, 2011

The Financial Accounting Standards Board suspended deliberations in November on its project to improve disclosure of loss contingencies, including contingencies relating to litigation. The sigh of relief in the corporate reporting and legal communities was palpable.

Most companies will respond to this development by making no changes to the way they prepare disclosures related to loss contingencies. They figure the bullet has been dodged, at least for now.

That reaction is a mistake. Given the reasons why FASB put the project on hold, the prudent reaction would be to improve disclosures and attempt to address the concerns that led FASB to take up the project in the first place, demonstrating to the board that new guidance isn't necessary.

First let's look at the reasoning behind FASB's decision to delay any new proposals on loss contingencies. FASB's minutes are worth quoting at length: “The board directed the staff to work with the staffs of the Securities and Exchange Commission and the Public Company Accounting Oversight Board to understand their efforts in addressing investors' concerns about the disclosure of certain loss contingencies through increased focus on compliance with existing rules. The board also directed the staff to review filings for the 2010 calendar year-end reporting cycle to determine if those efforts have resulted in improved disclosures about loss contingences.”

So FASB didn't halt its work because it decided that current disclosures are sufficient—far from it. Instead, FASB handed the topic over to the SEC staff for this reporting season. The SEC staff, in turn, is prodding companies to make improved disclosures. The staff issued so-called “Dear CFO” letters in October covering some areas where disclosures could be enhanced. SEC staff members have also repeatedly alerted constituents to the focus on contingency disclosures through speeches and other public statements. Many companies have already received SEC comment letters, and some of them have increased disclosures as a result. Many more companies should be receiving comment letters addressing their contingency disclosures in the coming months.

Nor did FASB simply punt the topic over to the SEC. Later this year, it will consider whether 2010 disclosures are better than past disclosures, and then decide how to proceed. If companies take the status-quo approach, the investor concerns that led to the project will remain, and FASB will revive the project again once it finishes the other projects on its early 2011 agenda.

Justified Concerns

Investors have long worried that companies don't provide sufficient disclosures on the true nature and potential effect of loss contingencies. And those concerns appear justified, since we've seen repeated settlements where the company in question gave no previous disclosure of possible losses. In other cases litigation disclosures relate the filing of motions, claims, counterclaims, and briefs in painstaking detail, each one including page after page of arguments—and then end with language as uninformative as “management cannot estimate the likelihood or range of potential loss.”

Too often, companies read the current standards looking for ways to avoid disclosure, rather than trying to determine what disclosures would actually meet the objectives of financial reporting.

While I worked at the SEC from 2002-2007, I heard those concerns over and over. Look at the comment letters on FASB's July 2010 proposal that came from investors and groups representing investors, and you'll see that the concerns remain.

But Do We Need New Standards?

In general, commenters agreed with the stated objective of the FASB proposal: to help readers of financial statements understand the nature of loss contingencies, their potential magnitude, and their potential timing. But while investors continued to support changes to current requirements to achieve that objective, many others, including some large companies and law firms, say the objective could be achieved without rewriting the standards. For example, some suggested that current requirements in Accounting Standards Codification Section 450-20, Contingencies – Loss Contingencies, provide a sound set of principles under which the objective in the proposal can be achieved.

Those who favor this approach generally say that better application and enforcement of existing standards, or guidance in the form of examples or advice on how to apply the principles in the current standards, is what's needed. The fact that compliance with existing standards could be improved is illustrated by comment letters, including some from sophisticated organizations, that complained about the effect of “new requirements” of the proposal that were essentially provisions just being carried forward from the existing standards.

I have long believed that loss contingency disclosures are poor. (Some of my unsuccessful attempts to get companies to increase disclosures are memorialized on the SEC's Website.) Still, I didn't believe then, and I still don't today, that new standards are the answer. Instead, I've advocated that companies improve their financial statements because it is in keeping with the principles and objectives of financial reporting, rather than wait until new standards are published to make improvements.

If companies continue to insist, however, that the standards don't specifically require additional disclosure, then FASB will have no choice but to finish this project. If companies and their legal advisers really want to keep changes at bay, now is the time to improve disclosures under the current standards. I offer below a few of the prime candidates for improvements.

Range of Losses

One disclosure that is provided far too infrequently is the range of reasonably possible losses that have not been accrued. ASC 450 requires disclosure of such a range unless it cannot be estimated. The word “estimated” in the standards is not qualified by “reasonably,” “precisely,” “reliably,” or any other word. Nonetheless, companies are quick to declare the range of reasonably possible losses “inestimable,” or to argue that the estimates they have are so uncertain that users would be sure to put more trust in them than is warranted.

But a reasonable attempt to help financial statement users understand the nature of the loss contingency, its potential magnitude, and its potential timing—the objective that virtually all commenters to the FASB proposal agreed with—would result in disclosure of a company's estimates, along with cautionary language about the uncertainty of those estimates.

In other situations, companies may have partial information about the range of possible losses—for example, only the lower or upper end of the range, or only the most likely loss amount when the range of possible losses is not estimable. Too often, I've seen this situation interpreted as a reason to conclude no disclosure is necessary because the entire range is not estimable. Again, a reasonable attempt to inform investors would result in disclosing what can be estimated, along with the reasons why the rest of the information is not being included.

In short, instead of looking for reasons to disclose nothing about the possible losses, companies should look to the principles of the disclosure requirements and disclose what they can.

Did You Accrue Something Already?

ASC 450 does not require that the amount of an accrual be disclosed unless such disclosure is “necessary for the financial statements not to be misleading.” Many who commented on the FASB proposal objected to the provision that would always require the amount of accruals to be disclosed. But the existing guidance seems to require disclosure of the fact that an accrual was made, even if it doesn't require disclosure of the specific amount. The example in ASC 450-20-55-18 through 55-22 would seem to make that clear. But figuring out if an accrual has been booked is often impossible from disclosures in financial statements. That ought to be an easy thing to fix, as the information is clearly available.


Public companies have been offered an opportunity to stop the project by improving disclosures, in 2010 Form 10-Ks that you are all drafting right now. The needed changes aren't extensive; a few sentences can make the difference. Adding those few sentences won't be difficult if those responsible for the disclosures remember that the purpose of financial reporting is communication, not merely compliance. But too often, companies read the current standards looking for ways to avoid disclosure, rather than trying to determine what disclosures would actually meet the objectives of financial reporting.

A final note: If your legal or compliance department is making the final calls as to whether disclosures are sufficient to meet accounting requirements, it might be time for accounting personnel to take a bigger role.