Reconsidering loss contingency postponement

Under FAS 5, Accounting for Contingencies, companies have been able to postpone recognition and disclosure of loss contingencies if they are uncertain about liability costs. Being uncertain keeps liabilities off company books and out of financial statements in the near term, which understandably has appeal.

Companies that postpone loss contingency liability recognition, however, likely also are postponing liability management, including cost management. Favorable cost situations that may develop for resolving unrecognized liabilities are being missed. Dates for resolving and removing those liabilities from company books and financial statements following their eventual recognition are being pushed further into the future.

More problematically, costs to resolve liabilities may increase with time, particularly costs for environmental cleanup liabilities. Cleanup requirements may become more stringent and thereby more costly to meet, for example. Additional cleanup may be necessary where contamination sources have been insufficiently secured, e.g., against human and animal intrusion, wind transport, surface water erosion and infiltration. There may be more exposure of personnel to contaminated materials or more subsurface migration of contaminants as time passes.

As a result, companies inclined to postpone recognition (and management) in the near term—from uncertainty about costs—may find themselves vulnerable to higher environmental liability costs over the long term.

FAS 141R, Business Combinations (Revised), a new standard effective in 2009, demonstrates a different approach to uncertainty about loss contingency liability costs. For liabilities like environmental cleanup, uncertainty (as probability) is made part of cost estimation.

FAS 141R has only limited direct applicability, i.e., for the loss contingencies of acquired properties in business combinations (e.g., mergers and acquisitions). Meanwhile, FAS 5 continues to be broadly applicable, as before.

It may be smart, however, for companies to consider FAS 141R’s role for uncertainty in cost estimation—and look again at their postponement of loss contingency liabilities under FAS 5. Is postponement contributing to good financial management? Is there opportunity to improve management of liability costs? What about vulnerability to cost increases?

Might a company “raise its game” by shifting emphasis in its FAS 5 implementation from minimization of liability recognition in the near term to minimizing liability costs over the long term?

[See the March 3, 2009, post in Knowing Disclosure for FASB's change of heart about cost uncertainty under FAS 141R.]