When Should You Disclose a Contingent Liability?
For public companies, disclosure of contingent liabilities — such as those associated with pending litigation or governmental investigations — is a highly sensitive matter. It’s important to keep investors and other stakeholders informed of risks that may affect a company’s future performance. However, companies want to avoid alarming investors with losses that are unlikely to occur or disclosing their litigation strategies. The SEC has continued to focus on the required disclosures, and has noted that many companies aren’t providing the required information related to reasonably possible losses.
What GAAP requires
Under Accounting Standards Codification (ASC) Topic 450, Contingencies, 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 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. The SEC has indicated that, for those unable to estimate the amount or a range, there should be enough disclosure about the potential contingent loss so the disclosure’s reader can understand its magnitude.
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. If a contingent loss is remote, no disclosure or accrual is required.
Assessing each requires judgment. Be sure to consider all scenarios and document management’s analysis of classification.
Disclosure of remote contingencies
In 2010, FASB proposed controversial amendments to ASC 450 that would have required companies to disclose remote contingencies if the potential impact was “severe” — that is, disruptive to the company’s normal functioning. The proposal also would have required companies to disclose additional details about contingent losses, including the:
- Basis for the claim,
- Basis for the company’s defense, and
- Anticipated timing of the claim’s resolution.
FASB’s proposal was met with fierce criticism. The legal community, in particular, complained that the proposed disclosures could expose privileged information, reveal a company’s litigation strategies and its assessment of its chances of prevailing, and affect settlement negotiations. In the face of these and other criticisms, FASB ultimately abandoned its proposal. The SEC and FASB have continued to explore the possibility of requiring additional contingencies disclosure.
Even though FASB dropped its proposal years ago, your company may choose to disclose certain contingencies that would result in a material loss — even though you conclude that the likelihood of such a loss would be remote. Without revealing litigation strategies, such disclosure may help protect your company against shareholder claims in the event a loss occurs.