No. 2011-01
5 January 2011
Hot Topic
Update on major accounting
and auditing activities
Loss contingency
disclosure
Contents
Overview ............................................... 1
SEC staff views on loss contingency
disclosures ............................................ 1
Current disclosure guidance ................... 2
Loss is probable ................................... 2
Loss is reasonably possible ................... 2
Loss is remote ..................................... 3
Unasserted claims or assessments ........ 3
Overview
After receiving over 300 comment letters,
the Financial Accounting Standards Board
(the Board) recently delayed its
controversial loss contingency disclosure
project. At the same time, the Securities and
Exchange Commission (SEC) has stated they
will be placing a renewed focus on enforcing
compliance with existing loss contingency
disclosure requirements. We expect the SEC
initiative to result in a significant increase in
registrant comment letters as the SEC staff
seeks to assess, as well as enforce,
registrants’ compliance with existing
disclosure requirements. The remainder of
this release provides a more in-depth view of
the SEC staff’s actions and expected actions
in this area as well as a brief reminder of
current disclosure requirements.
various public forums1, issued comment
letters to individual registrants and sent a
“Dear CFO letter” to a group of registrants
in the banking industry in October 20102. In
those communications, the SEC staff has
emphasized that the disclosure
requirements of US GAAP and Regulation SK are different and it expects a registrant’s
footnote disclosure to reflect the differing
requirements3.
1
SEC staff views on loss
contingency disclosures
In the past several months, loss contingency
disclosures have been a key area of focus
for the SEC staff. The SEC staff has
discussed loss contingency disclosures in
2
3
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The SEC staff has commented on the adequacy of loss
contingency disclosures at various CAQ SEC
Regulations Committee meetings and at the 2010
AICPA National Conference on Current SEC and
PCAOB Developments (2010 AICPA National
Conference) that was held December 6-8, 2010. The
full text of the CAQ SEC Regulations Committee
meeting minutes for June and September 2010 can
be accessed directly from the CAQ’s website at
http://thecaq.org/resources/secregs/highlights.htm.
Highlights of SEC speeches made at the 2010 AICPA
National Conference are in our AICPA Conference
Compendium issued in the Accounting and Auditing
News on 13 December 2010.
The “Dear CFO” letter is available at:
http://www.sec.gov./divisions/corpfin/guidance/cfofo
reclosure1010.htm
Item 103 of Regulation S-K requires registrants to
briefly describe any material pending legal
proceedings to which the registrant or any of its
subsidiaries is a part or of which any of their property
is subject whereas GAAP requirements, as discussed
later, are often more detailed.
Loss contingency disclosure
The SEC staff has challenged registrants for
failing to:
►
Make required footnote disclosures when
loss contingencies are considered
reasonably possible of occurring
►
Disclose the range of reasonably possible
loss, including when there was a
reasonable possibility of a loss in excess
of the amount accrued
At the 2010 AICPA National Conference,
the SEC staff commented that US GAAP
does not require a level of “certainty” or
“confidence” when estimating the range
of loss.
If the facts and circumstances support that a
range of loss cannot be estimated, the SEC
staff has noted in various speeches that they
expect registrants to follow a sufficient
process, including reassessment each
period, to determine that an estimate
cannot be made. The SEC staff also expects
management to evaluate loss contingency
disclosures (or lack thereof) each reporting
period and expects that the disclosures will
evolve to include more quantitative
information as the loss contingency
progresses. Examples of potential updates
to loss contingency disclosures as new
information becomes available could include
a new disclosure about a reasonably possible
loss that could not be estimated in previous
periods or a revised disclosure about an
estimate that was previously disclosed.
The SEC staff has also noted in various
speeches that registrants can expect the
adequacy of historical disclosures to be
challenged when loss contingencies are
settled. In particular, the SEC staff may
review prior-period disclosures and make
inquiries to understand whether appropriate
disclosures were made in the past and
whether an accrual was recorded in the
appropriate period (e.g., the SEC would
question registrants in instances where a
large settlement occurred with no disclosure
in earlier reports).
2
How we see it
Registrants should expect the SEC staff to
continue to question the adequacy of loss
contingency disclosures in its review of
public company filings during the year-end
reporting cycle. Registrants should pay
particular attention to disclosures of loss
contingencies that are either reasonably
possible of loss or probable of loss when a
range of loss exists. In situations where
disclosure of an estimate of the possible
loss or range of loss is required but not
provided because an estimate cannot be
made, registrants should document their
reasoning behind the conclusion that a
range of loss cannot be estimated. As
time passes and more information
becomes available, there is a greater
presumption that quantitative information
would be available and the disclosures
should be updated and expanded.
conditions must be met for a loss
contingency to be accrued. If a loss is
probable and the reasonable estimate of the
loss is a range, an amount should still be
accrued. If there is a point within the range
that appears at the time to be a better
estimate than any other point in the range,
that amount should be accrued. However,
if no amount in the range appears to be a
better estimate than any other, the minimum
amount in the range should be accrued.
The disclosure requirements for material
loss contingencies are based on both the
likelihood of occurrence as well as the
estimated loss. The following summarizes
key aspects of the disclosure requirements
based on those factors:
Loss is probable
►
Amount can be reasonably estimated Disclosure of the nature of the accrual
recognized is required but the amount
has to be disclosed only if not doing so
would make the financial statements
misleading. If there is at least a
reasonable possibility that a loss in excess
of the amount recognized exists, the
company is required to disclose an
estimate of the possible loss or range of
loss or a statement that such an estimate
cannot be made.
►
Amount cannot be reasonably
estimated — Disclosure of the nature
of the contingency and a statement that
an estimate cannot be determined are
both required.
Current disclosure guidance
The disclosure guidance for loss
contingencies is located in Accounting
Standards Codification Topic 450,
Contingencies (ASC 450). While this
guidance has largely been unchanged for the
last 25 years, we believe that companies will
want to take this opportunity to review their
existing and proposed disclosures anew
given the anticipated focus by the SEC staff.
ASC 450 categorizes loss contingencies
using three terms based on the likelihood
of occurrence:
►
Probable — The future event or events are
likely to occur
►
Reasonably possible — The chance of the
future event or events occurring is more
than remote but less than likely
►
Remote — The chance of the future event
or events occurring is slight
If it is probable that a loss will result from a
contingency and the amount of the loss can
be reasonably estimated, the estimated loss
is accrued by a charge to income. Both
Hot Topic No. 2011-01, 5 January 2011
Loss is reasonably possible
When a loss contingency is assessed as
reasonably possible, the following
disclosures are required:
►
The nature of the contingency
►
An estimate of the possible loss or range
of loss or a statement that an estimate
cannot be determined
Loss contingency disclosure
Loss is remote
Unasserted claims or assessments
While the loss contingency guidance in ASC
450 does not specifically proscribe
disclosures related to remote loss
contingencies, such items may be within the
scope of ASC 275, Risks and Uncertainties
(ASC 275). Under that guidance, if it is
reasonably possible that an estimate made
as of the balance sheet date will change in
the near term4 due to one or more future
confirming events AND the effect of the
change would be material to the financial
statements, the following disclosures are
required:
If a company has identified an unasserted
claim or assessment, but there is no
indication that the potential claimant is
aware of the possible claim or assessment,
the above disclosures related to reasonably
possible and probable losses would be
required only if both of the following
conditions are met:
►
The nature of the uncertainty, including
an indication that it is at least reasonably
possible that a change in the estimate will
occur in the near term
►
An estimate of the possible loss or range
of loss or a statement that an estimate
cannot be determined (Disclosure of the
factors that cause the estimate to be
sensitive to change is encouraged but not
required.)
►
It is considered probable that a claim will
be asserted
►
There is a reasonable possibility that the
outcome will be unfavorable
This guidance also could apply to reasonably
possible or probable loss contingencies.
4 The master glossary in the ASC defines near term as “a
period of time not to exceed one year from the date of
the financial statements.”
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2011
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