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Disclosure of litigation contingencies faulted.

Publicly traded companies are required to disclose all litigation contingencies when eventual loss from a lawsuit is reasonably possible or probable. Under Financial Accounting Standards Board Statement no. 5, Accounting for Contingencies, the loss is at least reasonably possible when "the chance of the future (confirmatory) event or events occurring is more than remote."

How well are businesses complying with this disclosure requirement? There's room for improvement, according to a recent study by Robert D. Fesler, a professor at Tennessee Technological University in Cookeville, Tennessee. Fesler identified 126 lawsuits lost by publicly traded companies and then examined disclosures about the suits in the prior years' annual reports.

All the lawsuits that were lost by the defendant companies involved a material and noninsurable loss and spanned at least a two-year period. According to Fesler, a totally unbiased evaluation of each of these suits would indicate a loss to have been reasonably possible--and financial statement disclosure thus appropriate.

Below are the results of the study. Exhibit 1 shows the five types of financial statement disclosures during the predisposition years, when the suits were in progress before the year of court adjudication or settlement. The five categories are grouped as either satisfactory or unsatisfactory in meeting the literal requirements of FASB Statement no. 5.

While the majority of companies provided satisfactory disclosures a significant minority gave no signal of the upcoming loss.

Exhibit 2 at left categorizes the lawsuits according to the charges involved, suggesting the type of action had some impact on the disclosure decision.

Fesler speculates corporate officials and their legal counsels may have difficulty providing an auditor with appropriate information concerning litigation contingencies for the following reasons:

1. A high level of emotion may be present.

2. They fear financial statement disclosure of pending litigation will be construed as admission of guilt.

3. There is a separate legal framework for evaluating litigation outcomes that varies significantly from that used by the accounting profession.

4. More appropriate channels exist for disclosure of such information (such as the business press).

5. FASB Statement no. 5 disclosure requirements are only viewed as a guide and therefore need not be taken literally.

"As long as 'reasonably possible' serves as the reporting threshold," Fesler said, "wide reporting diversity will continue."
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Publication:Journal of Accountancy
Date:Jul 1, 1990
Words:375
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