07/22/2010
Exposure Draft re Topic 450 (formerly, FAS 5, Disclosure of Certain Loss Contingencies)
By Cydney Posner
FASB has issued its exposure draft on Statement No. 5, Disclosure of Certain Loss Contingencies, now referred to as Topic 450 under the Codification. (For more background, please refer to News Briefs posted 7/18/08, 9/26/08, 12/19/08 and 4/15/10.) The topic has been highly controversial because it would expand both the number and type of loss contingencies required to be disclosed and the extent of disclosure of specific quantitative and qualitative information about those loss contingencies. In particular, many were concerned that the disclosure could have prejudiced a company's position in litigation or settlement talks (for example, where the company's adversary may have underestimated the full potential of the claim). Concerns were also raised that the disclosures would have presented the risk of waivers of the attorney-client or work product protections. To some extent, these issues were taken into account by FASB in the new exposure draft.
For public entities, the new guidance would be effective for fiscal years ending after December 15, 2010, and interim and annual periods in subsequent fiscal years. (For nonpublic entities, the new guidance would be effective for the first annual period beginning after December 15, 2010, and for interim periods of fiscal years after the first annual period.)
According to the exposure draft, the objective of the proposed amendments is to require an entity to disclose sufficient qualitative and quantitative information about loss contingencies so that readers can understand the nature, potential magnitude and potential timing (if known) of the loss contingencies.
The following principles would be applicable in determining appropriate disclosures :
- During the early stages of a loss contingency, to achieve the objective above, an entity would disclose information that is available. Available information may be limited in the early stages and, therefore, disclosure may be less extensive. In subsequent reporting periods, disclosure would be more extensive as additional information about a potential unfavorable outcome becomes available.
- An entity may aggregate disclosures about similar contingencies (for example, by class or type) so that the disclosures are understandable and not too detailed. The entity would have to disclose the basis for aggregation.
An entity would include more robust qualitative disclosures in situations in which quantitative disclosures are limited because of inherent uncertainties.
The proposed amendments were issued because of concerns expressed that, under the current guidance, information provided was insufficient to allow a timely assessment of the likelihood, timing and magnitude of potential liabilities associated with loss contingencies. To address those concerns, FASB was originally toying with the idea of changing the disclosure threshold for asserted claims and assessments from a likelihood of loss that is "at least reasonably possible" to a threshold of "more than remote." However, FASB decided to maintain the existing requirement and not to introduce the new phrase "more than remote" to describe the disclosure threshold because everyone seemed to think that it had the same meaning as the phrase "at least reasonably possible." Accordingly, the draft requires an entity to "disclose information about a contingency if there is at least a reasonable possibility (that is, more than remote possibility) that a loss may have been incurred regardless of whether the entity has accrued for such a loss (or any portion of that loss)."
FASB continued to believe that, to improve timeliness, disclosure of certain asserted remote loss contingencies would be necessary to inform users about the entity's vulnerability to a potential severe impact. As a result, the draft provides that disclosure of "asserted but remote loss contingencies may be necessary, due to their nature, potential magnitude, or potential timing (if known) to inform users about the entity's vulnerability to a potential severe impact. An entity will need to exercise judgment in assessing its specific facts and circumstances to determine whether disclosure about a remote contingency is necessary. Factors that an entity should consider in making this determination include any of the following:
a. The potential impact on the entity's operations
b. The cost to the entity for defending its contentions
c. The amount of effort and resources management may have to devote to resolve the contingency.
A plaintiff's amount of damages claimed, by itself, does not necessarily determine whether disclosure about a remote contingency is necessary, although it could be one of the factors to be considered in this determination." The proposed guidance includes examples of factors that an entity would consider in making this determination. In assessing materiality, an entity would not take into account the possibility of recoveries from insurance or other indemnification arrangements.
The draft would not require disclosure of a loss contingency involving an unasserted claim or assessment "if there has been no manifestation by a potential claimant of an awareness of a possible claim or assessment unless both of the following conditions are met:
a. It is considered probable that a claim will be asserted.
b. There is a reasonable possibility that the outcome will be unfavorable."
The substance of the disclosure would be enhanced by requiring additional information. With regard to qualitative information, in the case of litigation contingencies for example, the draft would require disclosure of the contentions of the parties and how users can obtain additional information. Quantitative information would also be enhanced, depending on the likelihood of the contingency. For contingencies that are at least reasonably possible (that is, more than remote), the following quantitative information would be required:
"1. Publicly available quantitative information, for example, in the case of litigation contingencies, the amount claimed by the plaintiff or the amount of damages indicated by the testimony of expert witnesses
2. If it can be estimated, the possible loss or range of loss and the amount accrued, if any
3. If the possible loss or range of loss cannot be estimated, a statement that an estimate cannot be made and the reason(s) why
4. Other nonprivileged information that would be relevant to financial statement users to enable them to understand, the potential magnitude of the possible loss
5. Information about possible recoveries from insurance and other sources only if, and to the extent that it has been provided to the plaintiff(s) in a litigation contingency, it is discoverable by either the plaintiff or a regulatory agency, or it relates to a recognized receivable for such recoveries. If the insurance company has denied, contested, or reserved its rights related to the entity's claim for recovery, an entity shall disclose that fact."
For remote contingencies that meet the disclosure threshold, the same quantitative information would be required, except that no estimate of loss would be necessary.
FASB had also considered requiring disclosure of the entity's estimate of its maximum exposure to loss, but, in light of comments that the information could be prejudicial, decided to eliminate that requirement in the proposed amendments. Negative input also convinced FASB to focus the quantitative disclosures on non-privileged information and not to add any new quantitative disclosures that are based on management's predictions about a contingency's resolution. Accordingly, the proposed amendments are generally consistent with many currently required disclosures (such as the amount accrued, if any, and an estimate of the possible loss or range of loss) but they also enhance the current requirements with publicly available or non-privileged information, as well as additional information regarding insurance recoveries.
A public company would be required to provide, in interim and annual financial statements, tabular reconciliations of recognized (accrued) loss contingencies that present the activity (e.g., increases or decreases in accruals and estimates) in the account during the reporting period. To address concerns about prejudicial disclosure of individual contingencies, FASB determined that the reconciliation could be prepared by class. Public companies would also be required to describe the significant activity in the reconciliations. All loss contingencies recognized in a business combination would be included in the reconciliations but shown separately if they have a different measurement attribute, for example, fair value.
The update material states that the FASB staff will continue to work with the ABA, among others, to identify and address any potential implications of the proposed requirements for the ABA's Statement of Policy Regarding Lawyers' Responses to Auditors' Requests for Information.