Change of heart about uncertainty under FAS 141R

Must companies proceed with estimation of liability costs under FAS 141R, Business Combinations (Revised), despite cost uncertainty?

The new answer appears to be no. Formerly, it was yes.

The Financial Accounting Standards Board (FASB) has decided to require that liabilities (and assets) arising from loss contingencies in business combinations (e.g., mergers and acquisitions) be measured at fair value—if fair value can be reasonably estimated.

Formerly, under FAS 141R, being reasonably estimable was not a consideration. That is, FAS 141R simply instructed measurement at fair value.

Under FASB's new decision, if fair value cannot be reasonably estimated, then liabilities will be recognized (and disclosed) in accordance with FAS 5, Accounting for Contingencies, and FIN 14, Reasonable Estimation of the Amount of a Loss.

“Reasonably estimated” will replace the word “determined” in FAS 141, which FAS 141R was being drafted to revise. (“Reasonably determined” was considered in FSP FAS 141Ra.)

FAS 5 already applies "reasonably estimable" to loss contingency decisions, i.e., enabling companies to postpone recognition if liability cost cannot be reasonably estimated.

This development appears to mark a retreat by FASB. Formerly, in FAS 141R guidance, FASB had indicated how overcoming cost uncertainty might proceed. By reference to FAS 157, Fair Value Measurements, it showed that cost uncertainty could be incorporated into cost estimation for liabilities in which active markets were not available to establish values. This would have pertained to environmental cleanup liabilities.

Concerns raised about determining fair value of liabilities arising from litigation-related contingencies, including environmental litigation, were part of what affected this reconsideration by FASB.

This despite other contingencies having less inherent cost uncertainty, e.g., environmental cleanup. Proceeding with measurement and recognition of environmental cleanup liabilities could lead to cost control and liability resolution, which are potentially favorable financial management outcomes.

It appears, however—with FASB's change of heart—that companies can continue to postpone liability cost recognition, citing cost uncertainty—with wording in FAS 141R no longer set to nudge them into overcoming that uncertainty, where possible.

[See the February 26, 2009, post in Knowing Disclosure for FAS 141R's formerly different approach to cost uncertainty.]