Loss Contingencies: How Will They Be Disclosed in the Future?

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For many years, investors have complained that public companies fail to warn them early enough, or at all, about risks relating to litigation and other claims that ultimately result in large settlements. Investors have asserted that such warnings are needed so that they can make informed investment decisions based on their understanding of the losses that companies may incur.

In recognition of these concerns, on June 5, 2008, the Financial Accounting Standards Board (the “FASB”) proposed amendments to Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies” (“FAS 5”), and Statement of Financial Accounting Standards No. 141(R), “Business Combinations” (“FAS 141R”), to enhance the disclosures about claims, including litigation, and threatened claims (the “FAS 5 Proposal”). The FAS 5 Proposal generated 242 comment letters, of which 201 were unfavorable. Unfavorable comments expressed concerns about, among other things, the prejudicial impact of the proposed additional disclosures about the likely outcome of loss contingencies, particularly litigation, the difficulties in estimating losses, particularly in light of the inherently unpredictable nature of lawsuits, the possible adverse consequences to assertion of the attorney-client privilege and the inability of auditors to audit the required disclosures. In response, the FASB delayed the proposed effective date of the FAS 5 Proposal from fiscal years ended after December 15, 2008 to fiscal years ending after December 15, 2009, field-tested alternative disclosure requirements, held roundtable discussions about the proposal on March 6, 2009, and began reconsidering the proposals. At a meeting on August 19, 2009, the FASB agreed on various broad disclosure principles and directed its staff to develop specific language.

This article summarizes existing accounting requirements applicable to loss contingencies under generally acceptable accounting principles in the United States (“U.S. GAAP”) and International Financial Reporting Standards (“IFRS”), describes possible changes to those requirements being considered by the International Accounting Standards Board (“IASB”) and FASB, including the FAS 5 proposal and FASB’s decisions made on August 19, 2009, and recommends consideration of an alternative approach to enhanced disclosure about loss contingencies.

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