Deciding whether to disclose pending litigation, a government investigation or another contingent liability is a highly sensitive matter, especially for public companies. Investors and other stakeholders want information about impending risks that may affect your company’s future performance. But you want to avoid alarming investors with losses that are unlikely to occur or disclosing your litigation strategies.
The Securities and Exchange Commission (SEC) and Financial Accounting Standards Board (FASB) continue to focus on the required disclosures. In fact, the SEC has noted that many companies aren’t providing the required information related to reasonably possible losses. Here’s what you need to know to comply with the financial reporting rules.
Under U.S. Generally Accepted Accounting Principles (GAAP), a company is required to classify contingent losses as “remote” (meaning the chances that a loss will occur are slight), “probable” (that is, likely to occur) or “reasonably possible” (falling somewhere between remote and probable). If a contingent loss is remote, no disclosure or accrual is required.
If a contingent loss is probable, the company must record an accrual, provided it can reasonably estimate the amount or a range of amounts. Otherwise, it should disclose the nature of the contingency and explain why the amount can’t be estimated.
If a contingent loss is reasonably possible, the company must disclose it but doesn’t need to record an accrual. The disclosure should include an estimate of the amount (or range of amounts) of the contingent loss or an explanation of why it can’t be estimated.
In 2010, the FASB proposed controversial amendments to GAAP that would have required companies to disclose remote contingencies if the potential impact was “severe” — that is, disruptive to the company’s normal functioning. This proposal was met with fierce criticism, and the FASB ultimately abandoned its proposal.
The SEC and FASB continue to explore the possibility of requiring additional contingencies disclosure. In the meantime, your company may still choose to disclose certain remote contingencies that would result in a material loss. Without revealing litigation strategies, such disclosure may help protect your company against shareholder claims in the event a loss occurs.