FAS 5's opportunity to postpone loss contingencies

What is the opportunity under FAS 5, Accounting for Contingencies, for companies to postpone recognition of loss contingency liabilities, for example, environmental cleanup loss contingencies?

FAS 5 requires a company to recognize and disclose a loss contingency as a liability if it is probable that a liability has been incurred and the amount of loss, i.e., the liability cost, can be reasonably estimated. Both criteria must be met before recognition (and disclosure) is necessary.

A company may determine that incurrence of a liability is probable, but that it cannot reasonably estimate the liability cost, i.e., that it is too uncertain about cost. In which case, the company may postpone recognition of the liability (until liability cost can be estimated).

Being uncertain about cost is, in general, defensible, for several reasons. First, being uncertain is not an unlikely development. There is normally considerable uncertainty about factors affecting costs for environmental cleanup, for example.

Second, FAS 5 makes it a company’s judgment what is reasonably estimable. It does not define reasonable estimability nor describe its characteristics. It offers guidance about unhelpful estimation, i.e., that being reasonably estimable “…is intended to prevent accrual in the financial statements of amounts so uncertain as to impair the integrity of those statements.” (FAS 5, paragraph 59)

Third, FAS 5 makes it a company’s choice how to go about cost estimation, i.e., it give no instructions about liability measurement. So it is up to a company to choose an estimation approach that does (or does not) enable it to overcome cost uncertainty.

Here is the question that remains. While it may be defensible—using the opportunity available under FAS 5 to postpone liability recognition—is it compatible over the long term with sensible liability and financial management, i.e., is it sensible?

[For more information, see Raymond Rose's "Reconsidering Loss Contingency Postponement—Raising the Game," Environmental Claims Journal, Corporate Environmental Disclosure Column, Scheduled for Vol. 21, Issue 2, Apr-Jun 2009.]