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Full disclosure: Commitments and contingencies · PwC's accounting podcast

• 0:00
  SPEAKER_00: Thought Leadership from PWC.
• 0:07
  SPEAKER_02: Welcome to PWC's Accounting Podcast.
• 0:11
  SPEAKER_02: I'm Heather Horn.
• 0:12
  SPEAKER_02: Thanks for tuning in to the last episode in our full disclosure series, a show all about presentation and disclosure from the top of the financial statements down to the last footnote.
• 0:23
  SPEAKER_02: Hopefully, throughout this series, as I've promised, you've learned something new each episode.
• 0:29
  SPEAKER_02: Today's focus commitments and contingencies.
• 0:33
  SPEAKER_01: We see feedback that cautions that the first time that a contingent liability is disclosed probably shouldn't be when a loss accrual is recorded.
• 0:42
  SPEAKER_02: That's my guest, Jay Celeber, a PWC National Office partner.
• 0:46
  SPEAKER_02: Before we wrapped up our full disclosure series, we wanted to cover commitments and contingencies because it's an area almost every company needs to consider.
• 0:55
  SPEAKER_02: And not only that, this topic is especially timely as companies head into the final quarter of the year and are starting to think about the full year financial statements.
• 1:05
  SPEAKER_02: There's a lot of different guidance included in this area, so let's get ready to cover some serious ground as we dive in.
• 1:28
  SPEAKER_02: Since I think you were also our most popular guest on this series.
• 1:44
  SPEAKER_02: So let's just start things off.
• 1:47
  SPEAKER_02: What are we talking about exactly?
• 1:49
  SPEAKER_01: Well, thanks for having me here.
• 1:51
  SPEAKER_01: It's good to be bringing up the uh the caboose here on this uh the summer series, as I guess we're done with summer now.
• 1:58
  SPEAKER_02: So exactly.
• 2:00
  SPEAKER_01: I'm uh always glad to join you here for these.
• 2:03
  SPEAKER_01: So as we as we talk about these areas of commitments and contingencies and guarantees, there really is a lot of different guidance involved here.
• 2:10
  SPEAKER_01: And and while I normally don't try to include a lot of uh of specific gap references in my podcast, I think just because there's different topics here, I I may at least mention the numbers.
• 2:22
  SPEAKER_01: Um so one of the topics is is commitments, and that's covered under ASC 440.
• 2:29
  SPEAKER_01: And that includes discussion of two categories, both general commitments as well as something that it calls unconditional purchase obligations, that I'm sure we'll get into.
• 2:40
  SPEAKER_01: The second topic is contingencies, which is covered in ASC 450, and that includes guidance on both loss and gain contingencies.
• 2:49
  SPEAKER_01: And then the guidance on guarantees is in ASC 460, and that covers both the accounting and disclosures of guarantees.
• 2:59
  SPEAKER_01: And that's a pretty broad topic, too, because it includes things like financial guarantees, like on the debt of a borrower, uh, performance guarantees like construction bonds, indemnification for damages that might happen, and even product warranties.
• 3:14
  SPEAKER_01: So there's a lot of things covered in that as well.
• 3:18
  SPEAKER_01: And then I would say, along with those three main topics of FASB guidance, there is also a hodgepodge of other guidance throughout the codification that applies here too for disclosures in areas like leases and letters of credit and assets pledges, collateral for loans, commitments to fund pension plans, and even preferred stock dividend cumulative arreages are all kind of a category of commitments that should be part of a company's overall disclosures.
• 3:49
  SPEAKER_02: All right.
• 3:49
  SPEAKER_02: That's a good uh background.
• 3:51
  SPEAKER_02: And then, Jay, this is not my question to stump you, but I am curious.
• 3:55
  SPEAKER_02: So people of our, I'll say vintage of accountants will know a lot of this as being FAS5, but were all of those uh commitments, contingencies, and guarantees coming from FAS5 or a few different places to get into the qualification?
• 4:10
  SPEAKER_01: They were from different places.
• 4:11
  SPEAKER_01: So guarantees in particular was a FIN, a FASB interpretation.
• 4:16
  SPEAKER_01: That was FIN 45 that set up guarantees.
• 4:19
  SPEAKER_01: And I think commitments came from some old, older FASB guidance as well about purchase obligations, purchase commitments and the like.
• 4:28
  SPEAKER_01: I don't remember the exact number, but it was not uh it was not FAS5.
• 4:31
  SPEAKER_02: It was not FAS5s.
• 4:32
  SPEAKER_02: Okay, Jay, that's helpful because I do think a lot of people uh still think of those old terms.
• 4:37
  SPEAKER_02: I think this is one area I I I personally have struggled to lose the FAS5 reference at least.
• 4:42
  SPEAKER_02: So uh, Jay, maybe since this is on presentation disclosure, we can start with presentation.
• 4:48
  SPEAKER_02: And I'm sure most people are you know familiar with that line of commitments and contingencies that we see on the face of the balance sheet between liabilities and equity, at least for public companies, and you know, with some footnote references sometimes and maybe not even a balance, but there are also amounts that should be recognized in the financial statements.
• 5:10
  SPEAKER_02: So can you walk us through where this is the case?
• 5:13
  SPEAKER_01: Sure, sure.
• 5:14
  SPEAKER_01: And I'll start with commitments.
• 5:16
  SPEAKER_01: And although a lot of what's covered in the commitments guidance is not on the books for take or pay contracts and the like, uh, there are some that could be.
• 5:26
  SPEAKER_01: So they could be uh either an embedded lease for some of these sort of take or pay type arrangements, could be a derivative, and those can end up being on the books.
• 5:36
  SPEAKER_01: And then you could also have a loss on inventory purchase commitments.
• 5:41
  SPEAKER_01: Since the net realizable value losses on inventory, when you're evaluating those, you also have to include consideration of any firm purchase commitments.
• 5:50
  SPEAKER_01: So it is possible that you could have some amount of uh commitments end up on your balance sheet.
• 5:56
  SPEAKER_02: Okay, so that's commitments.
• 5:58
  SPEAKER_02: And then how about contingencies?
• 6:00
  SPEAKER_01: So this is one listeners are probably a bit more familiar with, like the FAST 5 references that you mentioned before.
• 6:08
  SPEAKER_01: Uh so in that, of course, loss contingencies are the ones we see the most.
• 6:13
  SPEAKER_01: Those are accrued if they're both probable and reasonably estimable.
• 6:17
  SPEAKER_01: And probable is the sort of the accounting definition around that of being uh likely to occur, which is generally in the 70, 75, 80% uh threshold.
• 6:30
  SPEAKER_01: Now, if any particular amount in the range of losses is considered to be the better estimate within the range, you're supposed to accrue that if it's probable and estimable.
• 6:41
  SPEAKER_01: If there's no amount within the range of losses that's a better estimate than any other amount, then the guidance says you should accrue the minimum amount in that range.
• 6:50
  SPEAKER_01: So that's in terms of how much you record.
• 6:53
  SPEAKER_01: In terms of where it goes in the balance sheet, the classification would depend on when it's going to be settled.
• 6:59
  SPEAKER_01: If you expect to settle it within one year, then you'd expect you we'd expect to classify that as a current liability and otherwise be a long-term liability.
• 7:08
  SPEAKER_02: All right.
• 7:09
  SPEAKER_02: And then, Jay, I know a question that sometimes comes up with loss contingencies is discounting.
• 7:15
  SPEAKER_02: And this is not really about recognition and measurement, but how does discounting fit in here?
• 7:21
  SPEAKER_01: Well, I will say it's a pretty limited situation where you end up being able to discount a loss contingency, just because it's often a bit of a an estimate, so it's hard to discount that.
• 7:30
  SPEAKER_01: But for some type of environmental or product liability claims where the amounts that are going to be paid are relatively fixed or reliably determinable, the SEC guidance does allow for discounting on that.
• 7:43
  SPEAKER_01: And if you do discount, then the accretion to bring that up over time can either be presented as interest expense or in the same line item as wherever you recorded the loss in the first place.
• 7:56
  SPEAKER_01: And that's more of an accounting policy decision to apply consistently.
• 7:59
  SPEAKER_02: All right.
• 7:59
  SPEAKER_02: So there is a presentation element of that.
• 8:01
  SPEAKER_02: And then, Jay, I know another very common uh question that we get is that someone suffers a loss, but they are anticipating insurance recoveries.
• 8:11
  SPEAKER_02: So can you net those?
• 8:12
  SPEAKER_01: Right.
• 8:13
  SPEAKER_01: So um yes and no, depending on which statement you're talking about.
• 8:17
  SPEAKER_01: So claims for loss recovery, like an insurance claim, they are an interesting situation.
• 8:23
  SPEAKER_01: Because a lot of times people often think of these like gain contingencies, but in many cases, they're not.
• 8:29
  SPEAKER_01: Uh the idea being that if you've recognized a loss in the financial statements, like a product liability issue or damage to a property or factory or something like that, and it's clear that the situation is covered by insurance, then you can recognize a loss recovery asset up to the amount of the booked loss, assuming that recovery is considered probable.
• 8:55
  SPEAKER_01: So it's kind of a mirror image to the loss.
• 8:59
  SPEAKER_01: Now, if the claim with the insurance company is subject to dispute or litigation, or it's not so clear they're going to cover it, then there's a rebuttable presumption that recoverability is not probable.
• 9:12
  SPEAKER_01: And then you might have to wait until you resolve the issue with the insurance company to be able to book the asset.
• 9:17
  SPEAKER_01: So, in terms of the netting question on the income statement, you can.
• 9:22
  SPEAKER_01: So the generally speaking, the loss recovery can be recorded in the same income statement line item as the original loss, uh, except in one special case we see at times involving indemnifications of income tax uncertainties that sometimes we see, say, in a business combination.
• 9:40
  SPEAKER_01: Uh, in that case, the tax charge has to go through the tax line, but the recovery goes through the pre-tax line.
• 9:46
  SPEAKER_01: But most other types of insurance recoveries or indemnification recoveries we see go through the same line item.
• 9:52
  SPEAKER_01: But the balance sheet is definitely a different story.
• 9:55
  SPEAKER_01: So before the payments actually made, and you have a probable loss to accrue and an anticipated insurance recovery from the insurance company, you cannot net those against each other in the balance sheet.
• 10:09
  SPEAKER_01: Because the idea here is that the company owes money to some third party for the loss, but it has a contractual receivable from the insurance company.
• 10:19
  SPEAKER_01: And those are two different parties.
• 10:21
  SPEAKER_01: And so it doesn't meet the rules for balance sheet offsetting under GAP.
• 10:26
  SPEAKER_01: And so the company would have to separately show the loss contingency accrual and the receivable from the insurance company.
• 10:33
  SPEAKER_01: And that's true even if the insurance company is going to write the check directly to the other party and the company is not even involved in it.
• 10:40
  SPEAKER_02: Right.
• 10:40
  SPEAKER_02: So I think since we're talking about old references, I think now you're talking about Fin 39 and some of those rules.
• 10:47
  SPEAKER_02: But also, Jay, when you were talking, I realized I'm fairly certain when I was still uh serving clients that I consulted with you on a question about insurance recoveries and recognition.
• 10:58
  SPEAKER_02: So it all it all came back to me.
• 11:00
  SPEAKER_02: But then so let's dig a little bit more into this because you were pretty specific that the loss recovery model applies some of the time.
• 11:10
  SPEAKER_02: So then what else do we need to think about?
• 11:13
  SPEAKER_01: Well, some losses are clearly covered by insurance and can be recognized the way uh I went through.
• 11:19
  SPEAKER_01: You know, think like property damage or a covered accident, right?
• 11:23
  SPEAKER_01: That's clearly covered and you can follow that model.
• 11:25
  SPEAKER_01: But others aren't so simple.
• 11:27
  SPEAKER_01: And there could be a lot more subjectivity about what is covered and how much would be covered.
• 11:34
  SPEAKER_01: So a good example of that is business interruption insurance.
• 11:38
  SPEAKER_01: So in that case, there's no recorded loss in the books.
• 11:41
  SPEAKER_01: It's more of just an opportunity cost for lost profits, and it's pretty gray sometimes as to what's covered in the insurance policy and exactly how the amounts will be calculated.
• 11:52
  SPEAKER_01: So in that case, it's generally viewed more like a gain contingency and recognized following that model.
• 11:58
  SPEAKER_01: And then also, even if it is clearly covered, uh, what I was talking about before in terms of the recovery was just recovery of the book losses.
• 12:08
  SPEAKER_01: So in many cases, the potential recovery might exceed that loss, like fair value replacement of a damaged building, which would probably be higher than the book value that's written off.
• 12:19
  SPEAKER_01: So that excess amount, recovery of that excess amount, that is also considered more of a gain contingency.
• 12:26
  SPEAKER_01: And then just in terms of presentation-wise, you know, while I said that the loss recovery can go through the same line item in the income statement as the loss itself, so it tends to neutralize it.
• 12:36
  SPEAKER_01: Any excess amount that you would receive, that would typically need to go through some other income type of line.
• 12:42
  SPEAKER_02: All right.
• 12:42
  SPEAKER_02: That's helpful.
• 12:44
  SPEAKER_02: And then I guess another point there is you do sometimes have where the loss and the insurance are recorded in different periods, but you still could use that same line item.
• 12:53
  SPEAKER_02: Is that right?
• 12:54
  SPEAKER_01: That's right.
• 12:54
  SPEAKER_01: So for example, um, you know, maybe there was a dispute over a claim that's associated with the loss, and ultimately, ultimately when it's resolved, it could still be viewed as a recovery of the loss if you can kind of show enough I'll call approximate uh connection between them.
• 13:09
  SPEAKER_02: Okay, that's good.
• 13:10
  SPEAKER_02: And then, Jay, since we're talking about gain contingencies, how about that model?
• 13:16
  SPEAKER_01: Well, here the bar is definitely much higher.
• 13:19
  SPEAKER_01: So, as listeners probably uh are familiar with gain contingencies can only be recognized when they are realized or realizable.
• 13:28
  SPEAKER_01: Uh realize is pretty easy.
• 13:30
  SPEAKER_01: That basically means you have cash in hand without any contingencies or possible repayment of that money.
• 13:36
  SPEAKER_01: Uh, it doesn't have to be cash, sometimes it's other assets or financial instruments or the like as well.
• 13:41
  SPEAKER_01: Uh but then realizable, that's a little bit more judgmental.
• 13:45
  SPEAKER_01: So that basically means there's a fixed commitment of the other party to pay a known amount of cash or other assets.
• 13:53
  SPEAKER_01: And so maybe some things you'd think about would be whether there's a signed agreement or a legally enforceable contract or a court judgment that lays out the terms of the settlement and what's going to be paid, and whether the settlement is subject to any pending or expected appeals in the future.
• 14:13
  SPEAKER_01: Uh, you'd probably want to think about whether the counterparty has the ability to pay, just because you want a judgment, doesn't mean you're necessarily going to get any money about it.
• 14:21
  SPEAKER_01: And broadly, whether the right to receive the proceeds meets the definition of an asset in the concept statements.
• 14:28
  SPEAKER_02: All right.
• 14:29
  SPEAKER_02: So definitely a lot to think about.
• 14:31
  SPEAKER_02: So then sticking with presentation, let's pivot over to guarantees.
• 14:36
  SPEAKER_02: And I feel like sometimes this area doesn't quite get as much attention.
• 14:40
  SPEAKER_02: So maybe can you give us some common examples of where you see this coming up?
• 14:43
  SPEAKER_01: Sure.
• 14:44
  SPEAKER_01: Yeah, and it's tricky because the definition of what a guarantee is in the guidance is it's really a mouthful.
• 14:50
  SPEAKER_01: And I won't try to cite the words, but sort of in general terms, what it's talking about is contracts that contingently require you to pay somebody else based on some event happening or not happening, or based on the movement and the value of some asset or liability of the guaranteed party.
• 15:12
  SPEAKER_01: So some of the common ones that we see include things like a debt guarantee, where you might agree to make a payment to the bank if the other party fails to pay off their loan, or an indemnification if the other party ends up being subject to a lawsuit or to a tax issue.
• 15:30
  SPEAKER_01: It also technically includes product warranties, but those are scoped out, at least from the measurement side of the guarantee literature, because there's already well-established guidance on those.
• 15:42
  SPEAKER_01: So it's it's surprisingly broad, actually, when you look at the definitions and look at some of the stuff around it.
• 15:48
  SPEAKER_01: But there's also a lot of other scope exceptions in the guidance, too.
• 15:51
  SPEAKER_01: Um, you know, generally for things that are covered by other gap already or more related to your own performance.
• 15:57
  SPEAKER_01: You know, you don't have to recognize an obligation where you've guaranteed that you will perform because you're already agreeing to do that.
• 16:04
  SPEAKER_01: So it is a good idea to take a look at the scope paragraphs in ASC 460 if you if you run into one of these to see if you're in or you're out.
• 16:11
  SPEAKER_02: Right.
• 16:11
  SPEAKER_02: And I think as I kind of alluded to, I just know in practice, these things tend to pop up in places where maybe you're not looking or the accounting team's not involved.
• 16:21
  SPEAKER_02: So always good to have a great relationship with your legal department and get them to keep an eye out for these types of things.
• 16:28
  SPEAKER_02: So at least you can do the analysis.
• 16:30
  SPEAKER_01: Right, good advice.
• 16:31
  SPEAKER_02: Um so, Jay, assuming you found the guarantee and it is in the scope of the guidance, then what is the accounting model that you should be following?
• 16:40
  SPEAKER_01: Well, if you have a guarantee, then the general model is to record the fair value of that guarantee when you enter into it.
• 16:48
  SPEAKER_01: Now, what's interesting is while it tells you to record a credit for the fair value of that guarantee, it doesn't tell you to where where to put the debit.
• 16:56
  SPEAKER_01: And that kind of depends on the nature of the relationship and the reason why you entered into the guarantee in the first place.
• 17:03
  SPEAKER_01: So it could, for example, be a reduction of revenue.
• 17:06
  SPEAKER_01: I've seen it if maybe you've guaranteed the debt of a customer who's buying something from you but needing to borrow money from a bank to do it.
• 17:13
  SPEAKER_01: Uh could be part of an investment if you guarantee the debt of your joint venture, for example, as part of your equity method investment.
• 17:20
  SPEAKER_01: Uh could reduce the gain on the sale of a business if you indemnify the buyer for some tax or legal issue.
• 17:28
  SPEAKER_01: Or it could just be some expense if you indemnify a vendor or some other third party for something or another.
• 17:34
  SPEAKER_01: And the guarantee really has two components in it.
• 17:37
  SPEAKER_01: Uh, there's both an obligation to stand ready to perform in the event a triggering event occurs, and then there's also the obligation to make a future payment if it actually does.
• 17:49
  SPEAKER_01: And while those are a little bit nuanced, similar to each other, the idea is that, well, the first part is sort of the promise to stand ready to make a payment down the road and sort of give some value of to that guarantee to to somebody who might be trying to borrow money from a bank and you know can't get credit on their own.
• 18:09
  SPEAKER_01: But by providing the guarantee, you provide some value.
• 18:11
  SPEAKER_01: There's often a fee for doing that.
• 18:14
  SPEAKER_01: And so that item, that value is released to income over time as the company is released from risk over time.
• 18:24
  SPEAKER_01: Now, that could be over time as the underlying activities take place, but in some cases, it may also be at more of just a discrete time, like when the guaranteed loan is paid off.
• 18:34
  SPEAKER_01: Maybe that's when you realize or conclude that you can relieve from that risk.
• 18:38
  SPEAKER_02: Right.
• 18:39
  SPEAKER_01: Now, the second part, on top of that, some say from that day one value, there's sort of sometimes a day two value if things go sour, and maybe now it's more likely that you're gonna have to pay, uh, pay out under that guarantee arrangement.
• 18:52
  SPEAKER_01: That's viewed as more of a loss contingency and gets recognized as a further loss when it's probable.
• 18:58
  SPEAKER_01: Although now, uh, over the last year or two that the Cecil guidance has been applicable, a number of guarantees, like debt guarantees, are covered under the Cecil literature, the credit loss literature.
• 19:12
  SPEAKER_01: And that credit loss would have to get recognized following that model, really no differently than if you had a direct loan receivable from the guaranteed party, which you kind of do, because if they don't pay off the loan and you have to pay the bank on their behalf, then you have to try to get the money back from them.
• 19:28
  SPEAKER_01: So it basically follows the Cecil model and gets recognized in that fashion.
• 19:32
  SPEAKER_02: So, Jay, I appreciate all that insight.
• 19:34
  SPEAKER_02: I'm sort of laughing to myself though, because I think we've done about 20, or maybe even a couple more of these full disclosure episodes, and we've been vigilant about it's only presentation and disclosure, no measurement and recognition.
• 19:48
  SPEAKER_02: And then now this episode, last one, we've opened the floodgates, you know, talking about everything.
• 19:53
  SPEAKER_02: So it's it's probably good we didn't do this sooner since we're trying to stick to um our our limited scope.
• 20:00
  SPEAKER_02: But in any event, on that note, I think we're done with recognition and measurement.
• 20:06
  SPEAKER_02: And let's move from presentation over to disclosure, again, starting with commitments.
• 20:13
  SPEAKER_01: Right.
• 20:14
  SPEAKER_01: So as I mentioned before, commitments can sometimes be a bit of a catch-all category.
• 20:19
  SPEAKER_01: Uh so before maybe getting into a couple of specific requirements that the guidance has for unconditional purchase obligations, there are some general disclosure requirements in that literature that are kind of a cross-reference to other parts of GAAP.
• 20:34
  SPEAKER_01: Uh so you're supposed to disclose things like unused letters of credit or leases, right, which might already be covered by your lease disclosures, anyways.
• 20:44
  SPEAKER_01: Uh, assets, pledges, collateral for loans, maybe funding commitments to pension plans or employee stock ownership plans, any cumulative preferred stock dividends that you might have out there, uh, as well as any obligations under contracts to either reduce debt, maintain working capital, or restrict dividends.
• 21:07
  SPEAKER_01: Those are all things that would be sort of broadly in the category of a commitment.
• 21:11
  SPEAKER_02: All right.
• 21:11
  SPEAKER_02: And then Jay, unconditional purchase obligations actually is the area I know we're getting more questions now because we've been getting them about ESG items such as carbon offsets and recs and otherwise, uh, if if you need to have disclosure.
• 21:26
  SPEAKER_02: So what are the rules there?
• 21:28
  SPEAKER_01: So the the guidance here uh around unconditional purchase obligations, which are things like take or pay contracts and throughput contracts that commit the company to make minimum levels of payments to buy goods or services in the future.
• 21:45
  SPEAKER_01: And the guidance here says that you have to make certain disclosures for these when certain characteristics are met, and they all have to be met to be in the scope of this.
• 21:54
  SPEAKER_01: One, it has to be last longer than a year, or so anything less than a year, is scoped out, like a lot of a lot of other things we run.
• 22:00
  SPEAKER_01: Into an accounting.
• 22:00
  SPEAKER_01: You get some certain exceptions there.
• 22:03
  SPEAKER_01: It's non-cancelable, other than sort of for either remote things or with the approval of the counterparty.
• 22:10
  SPEAKER_01: So it's not up to you to unilaterally cancel it.
• 22:13
  SPEAKER_01: As well as, and this is kind of an interesting one, it's a little bit harder to work through.
• 22:16
  SPEAKER_01: And that's it, was it negotiated as part of arranging financing for the facilities that were built to provide the goods or services, which you might certainly run into in the utility industry, for example.
• 22:30
  SPEAKER_01: Or is it for costs that are specifically associated for those goods or services and the holding costs associated with it?
• 22:37
  SPEAKER_01: Won't get into all the details here, but there is some discussion and the guidance around that, around that.
• 22:42
  SPEAKER_02: All right.
• 22:42
  SPEAKER_02: It seems like that last item probably takes a lot of things out of the scope of this disclosure.
• 22:46
  SPEAKER_02: So definitely if you're dealing with one of those, something to understand.
• 22:50
  SPEAKER_02: And then, Jay, I know you mentioned earlier that some of these are actually recognized in the balance sheet, and then of course some aren't.
• 22:58
  SPEAKER_02: And so do we see different disclosure requirements depending on whether or not they're recognized?
• 23:05
  SPEAKER_01: We do.
• 23:06
  SPEAKER_01: There are specific paragraphs for each in the guidance.
• 23:08
  SPEAKER_01: And what it says is that if you have a recognized commitment, which could be say inventory losses or things accounted for as derivatives, what the guidance says there is that you have to disclose the aggregate amount of payments under those obligations for each of the next five years following the balance sheet date.
• 23:30
  SPEAKER_01: But if they're unrecognized commitments, then you have to do that as well as the total amount of all your future payments over the life of the contract.
• 23:42
  SPEAKER_01: But then you also have to disclose some other things like the nature and term of the arrangement, the nature of any variable components of the fees you might have to pay beyond fixed ones, as well as the amounts that have been purchased under this obligation for each period that an income statement is presented in your current financial statement.
• 24:04
  SPEAKER_01: So it's got both forward-looking as well as uh historical-looking disclosure requirements.
• 24:09
  SPEAKER_02: So then, Jay, there's a lot to think about.
• 24:12
  SPEAKER_02: Let's move on to contingencies, though.
• 24:14
  SPEAKER_02: And I know that this, you know, we often see different fact patterns.
• 24:18
  SPEAKER_02: I also know there's many cases companies prefer not to be disclosing too much information about um contingencies, particularly lost contingencies.
• 24:28
  SPEAKER_02: So what are the basic requirements?
• 24:31
  SPEAKER_01: Well, maybe let me start with ones that a company has accrued, and then we'll maybe get into ones where they haven't accrued them.
• 24:41
  SPEAKER_01: Uh and you're right, it is an area often of great sensitivity, uh, because there's concern that the more you disclose, the more likely that something's gonna come after you.
• 24:51
  SPEAKER_01: Right based upon that.
• 24:52
  SPEAKER_01: So there is always a fair bit of tension around that, fair, fair point.
• 24:56
  SPEAKER_01: You have to work together with your attorneys uh you know to get comfortable with what can be said.
• 25:02
  SPEAKER_01: But assuming you you have something on the books, maybe maybe I even start with a little bit of nomenclature that the guidance talks about.
• 25:10
  SPEAKER_01: Uh so if you have something on your books, because those are estimates and not something you definitively owe, in many cases, right?
• 25:19
  SPEAKER_01: Obviously, you might already be the subject of a of a you know, of a judgment that you haven't paid yet.
• 25:24
  SPEAKER_01: But in many cases, these are anticipated amounts that you think you might have to pay.
• 25:29
  SPEAKER_01: So the FASB actually recommends using terms like estimated liability in describing it and not using the term reserve, because the FASBE considers that word to be associated with assets that are held for a specific purpose, like an appropriation of retained earnings.
• 25:48
  SPEAKER_01: So that's presentation and the footnote disclosures.
• 25:51
  SPEAKER_01: And then even if you do accrue an amount, assuming that it's possible, or at least reasonably possible, that you might have to pay more than what you've accrued, the guidance actually does say you're supposed to disclose what that the additional future loss could be over and above what you've actually accrued.
• 26:08
  SPEAKER_02: You know, Jay, in the beginning of this podcast, and I know you've listened to them, we promise the listeners are going to learn something.
• 26:16
  SPEAKER_02: And I I do generally learn something each episode.
• 26:19
  SPEAKER_02: And in particular, I don't think I knew this guidance about estimated liability versus, I mean, I think I knew not to say reserve, but I'm not sure I knew the alternative.
• 26:28
  SPEAKER_02: So very good reminder, and uh definitely something I encourage people to uh make sure they are considering uh in their disclosures.
• 26:36
  SPEAKER_02: So, Jay, now let's move on then.
• 26:39
  SPEAKER_02: And this is again where I think we start to get into more of the judgment.
• 26:42
  SPEAKER_02: So it's not both probable and reasonably estimable.
• 26:47
  SPEAKER_02: So, in other words, we have not, you know, the company would not have recorded an accrual, then what disclosures are required?
• 26:54
  SPEAKER_01: Sure.
• 26:55
  SPEAKER_01: So in this case, I would say it probably depends in part on the degree of probability and why you haven't accrued anything.
• 27:03
  SPEAKER_01: So if there's a material loss contingency that's probable but not reasonably estimable, then you're supposed to disclose the nature of what the contingency is and the fact that an estimate could not be made.
• 27:17
  SPEAKER_01: Now, if the material loss contingency is reasonably possible, but not probable, so you're kind of in that wide area in between more than remote, so it's reasonably possible but not probable, then you are supposed to disclose the nature of the contingency and an estimate of the possible loss or range of loss or the fact that an estimate can't be made.
• 27:43
  SPEAKER_01: And I will mention that for these kinds of contingencies that are reasonably possible but not probable, we we definitely see, I know this isn't a comment letter podcast, that's a different series, but we definitely see comments uh from the SEC on what they think might be incomplete or omitted disclosures, uh, specifically about the nature of the contingency and the possible range of loss.
• 28:09
  SPEAKER_01: And in particular, we see feedback that uh the the cautions that the first time that a contingent liability is disclosed probably shouldn't be when a loss accrual is recorded.
• 28:19
  SPEAKER_01: So it's typically expected there'd be some degree of foreshadowing disclosures before actually booking the accrual.
• 28:26
  SPEAKER_01: But again, always a bit of a tension point, I would say.
• 28:29
  SPEAKER_02: Right.
• 28:30
  SPEAKER_02: The way to promote our upcoming comment letter podcast series, Jay.
• 28:33
  SPEAKER_02: Thank you.
• 28:34
  SPEAKER_01: That's right.
• 28:35
  SPEAKER_01: Um, one other thing maybe I'd mention in this area too, Heather, is that if a loss contingency comes up after the balance sheet date, but before the financial statements are issued, then disclosure might be necessary for that, including things that maybe didn't even arise until after the balance sheet date.
• 28:52
  SPEAKER_01: So that's why they're not accruable.
• 28:54
  SPEAKER_01: Um and if you have to disclose that, again, you should describe the nature of the loss contingency and an estimate of the loss or the range of loss or the fact that you can't make an estimate.
• 29:04
  SPEAKER_01: That should all be part of your disclosure.
• 29:06
  SPEAKER_02: All right.
• 29:06
  SPEAKER_02: So then how about the final category?
• 29:08
  SPEAKER_02: What if the possibility or excuse me, probability of loss is remote?
• 29:13
  SPEAKER_01: Right.
• 29:13
  SPEAKER_01: So here the guidance says that disclosure is not required for uh remote loss contingencies, although we'll probably come back to that in a little bit when we get to guarantees.
• 29:26
  SPEAKER_01: Uh and the guidance also says that disclosure is generally not required for contingencies that at the moment are unasserted claims or assessments, but maybe you know they're going on.
• 29:40
  SPEAKER_01: Uh unless it's probable, you think that a claim will be made, right?
• 29:45
  SPEAKER_01: Something's happened, no one's made a claim yet, but you think it's probable someone will make a claim, then you probably should be disclosing it.
• 29:52
  SPEAKER_01: But if you don't think it's probable that people will make claims for whatever it is you think you might have done or not done, then you don't have to disclose that.
• 30:01
  SPEAKER_01: But I'd say like a lot of things in this area, especially that you should consider disclosing information in the footnotes, if that would help keep the financial statements from being misleading.
• 30:12
  SPEAKER_02: All right, good reminder.
• 30:13
  SPEAKER_02: And then, Jay, when we talked about this from a presentation perspective, obviously we also talked about insurance recoveries.
• 30:20
  SPEAKER_02: So, how would you think about insurance recoveries from a disclosure perspective?
• 30:25
  SPEAKER_01: Well, there is one specific requirement to disclose business interruption recoveries, uh, because there was some guidance that came out around that and some flexibility provided about where you present it.
• 30:38
  SPEAKER_01: Uh, so you are supposed to disclose the nature of the event that gave rise to the circumstance, as well as how much money was recognized in each period you have an income statement, as well as what line item in the income statement it's included in.
• 30:53
  SPEAKER_01: And then I would say we also see our share of SEC comment letters here about disclosures related to settlements of lawsuits that might be covered by insurance.
• 31:06
  SPEAKER_01: I think here the undercurrent is that maybe companies think that, oh, if it's covered by insurance, it's not really gonna have any big net impact to me.
• 31:14
  SPEAKER_01: Maybe I don't need to disclose a lot about it because it's not gonna net, net cost me any money or much money.
• 31:20
  SPEAKER_01: But if you remember from before, when we were saying about the balance sheet presentation, that loss contingencies and insurance coverage for those are considered two separate things.
• 31:30
  SPEAKER_01: And just because you have insurance to pay for a claim doesn't mean that the claim itself isn't relevant to readers.
• 31:37
  SPEAKER_01: And of course, there's always the risk the insurance company may not be able to pay, and you'll be on the hook for it.
• 31:41
  SPEAKER_01: So we often do see requests for more disclosure of how insurance arrangements have might have affected your conclusions about settlements and whether you're going to settle or not, and sort of the likely effect that that might have on the financial statements.
• 31:57
  SPEAKER_02: All right.
• 31:57
  SPEAKER_02: So good reminder that the insurance and the loss contingency are two separate units of account.
• 32:03
  SPEAKER_02: We don't use too much of that terminology here, but I think it's very key.
• 32:06
  SPEAKER_02: Uh okay, fine, I guess I said final category too soon because we do have gain contingencies.
• 32:12
  SPEAKER_02: So what how do we think about those?
• 32:14
  SPEAKER_01: You know, it's interesting here uh when you actually get into the guidance, because the guidance actually says that you should make adequate disclosures of gain contingencies, which is not usually our first reaction around that.
• 32:26
  SPEAKER_01: But it does go on to say, and this is maybe the part that we we tend to remember, it says that that uh care should be exercised to avoid making any misleading implications about the likelihood of realization.
• 32:39
  SPEAKER_01: So it really is a balancing act, right?
• 32:42
  SPEAKER_01: You you you need to provide information to readers to make the financial statements not be misleading, but you certainly don't want to create the impression that you're likely to get something that's still rather contingent.
• 32:53
  SPEAKER_01: So we don't tend to tend to see a lot of disclosures of unrecognized gain contingencies, or at least if you do, if it's a very material amount of something very important to the company, like an infringement matter that you're going after somebody for that's fundamental to your business, you'd probably expect to see a lot of caveats in those disclosures.
• 33:13
  SPEAKER_02: All right.
• 33:14
  SPEAKER_02: So then let's move on to guarantees.
• 33:16
  SPEAKER_02: And this is where there's a lot of guidance that I think intersects from different places and gaps.
• 33:22
  SPEAKER_02: So can you walk us through the considerations?
• 33:25
  SPEAKER_01: Sure.
• 33:26
  SPEAKER_01: So for guarantees that are in the scope of ASC 460, there are a number of required disclosures there.
• 33:34
  SPEAKER_01: But even if the guarantee is scoped out of the recognition guidance there, like the product warranties, there are still often disclosure requirements, either in ASC 460 itself that has specific disclosure requirements for product warranties, or in other parts of the guidance, like uh the fair value of financial guarantees that would be covered under ASE 825, or contingent losses that are reasonably possible of occurring under the loss contingency guidance that we talked about, or guarantees that are accounted for as derivatives that are covered under that guidance in ASC 815, or even sort of real important, significant risks and uncertainties that could significantly affect the amounts of the financial statements in the near term.
• 34:23
  SPEAKER_01: That's covered under the risk and uncertainties guidance in ASC275.
• 34:28
  SPEAKER_01: So there's a lot of other pieces of literature that also are sort of part of the thinking here about some of these issues.
• 34:34
  SPEAKER_02: All right.
• 34:35
  SPEAKER_02: So then, Jay, I know you know it's important obviously to consider whether any of those other topics may apply, but can you give us the general requirements under 460?
• 34:46
  SPEAKER_01: Sure, sure.
• 34:47
  SPEAKER_01: So sort of big picture, you have to disclose information about either each guarantee or group of similar guarantees.
• 34:55
  SPEAKER_01: And the guidance itself is actually silent as to whether those disclosures required for only the current period or also the comparative periods, although our view is that comparative disclosures should be made for each period that a balance sheet's presented.
• 35:13
  SPEAKER_01: So disclosures here include things like the nature of the guarantee, meaning things like the term of the arrangement, how long you're on the hook for, how the guarantee arose, uh, what events and circumstances would require performance under the guarantee, and sort of what's the current status of that risk as of the balance sheet date.
• 35:36
  SPEAKER_01: That would be sort of broadly the nature of the arrangement.
• 35:40
  SPEAKER_01: And then you would talk about things like the maximum potential amount of any future payments that you might have to make under the guarantee, uh, the current liability amount that you have recorded on the balance sheet, uh both the original fair value as well as any additional contingent amounts that you might have subsequently recorded.
• 36:03
  SPEAKER_01: So that's sort of your potential for what you might have to pay out, what you've already provided for.
• 36:08
  SPEAKER_01: And then you also should disclose any recourse provisions you might have to try to recover amounts that you have to pay out, including any assets that are held as collateral or an escrow accounts that uh might might support your ability to get some of that money back.
• 36:26
  SPEAKER_02: So then, Jay, two specific questions.
• 36:28
  SPEAKER_02: First one, what if it's remote that you're going to need to pay something?
• 36:33
  SPEAKER_01: So here, so unlike the ASE 450 guidance on lost contingencies, where you do not have to disclose information about remote lost contingencies, when you're dealing with certain types of guarantees like debt guarantees or standby letters of credit, uh the guarantees guidance says you still have to disclose the information I mentioned before about sort of the maximum exposure and ability to go after any assets if you do have to pay it out, just because you entered into them explicitly, so you got paid for it.
• 37:08
  SPEAKER_01: So you need to disclose that obligation, even though you might think it's remote that you're gonna have to pay up under some guarantees, you you do still have to disclose the nature of the arrangements you'd end you entered into under this guidance.
• 37:19
  SPEAKER_02: All right.
• 37:20
  SPEAKER_02: And then how about related party guarantees?
• 37:23
  SPEAKER_02: Because I know that's something you know we often talk about.
• 37:26
  SPEAKER_01: Well, at least from a disclosure perspective, it's always important to um to highlight any guarantees you've made for related parties.
• 37:33
  SPEAKER_01: I think the guidance from a recognition and measurement perspective scopes out uh guarantees you've made for you know, parent for sub, sub for parent, things like that.
• 37:42
  SPEAKER_01: But I do think that it's important to uh to make the disclosures for those.
• 37:46
  SPEAKER_02: I definitely agree.
• 37:48
  SPEAKER_02: All right, so then Jay, you said at the very beginning we're gonna hit these main standards, but that there was a lot of other places in GAP where we kind of see these kind of requirements for disclosure.
• 37:59
  SPEAKER_02: So where else, what other things would you focus on from a commitments and contingencies point of view?
• 38:06
  SPEAKER_01: Right.
• 38:06
  SPEAKER_01: So some of some of them we've touched on a little bit along the way, but some other areas where there might be some specific disclosures include things like an area that's called joint and several uh obligations, where maybe you are party to a debt agreement amongst maybe multiple entities within a group, and and uh each party is jointly and severally responsible for the others.
• 38:31
  SPEAKER_01: See that a lot as well in the environmental obligations world, super fund sites, right, where everybody is is uh ultimately on the hook if other people can't pay, other you know, the rest of you have to make up the difference.
• 38:43
  SPEAKER_01: And so while you only may have to account for your expected share, you do have to make certain disclosures about what the um additional potential obligations you have under those arrangements.
• 38:58
  SPEAKER_01: Um you might have to make disclosures associated with future pension or employee stock ownership plan contributions.
• 39:06
  SPEAKER_01: Uh, we've touched on leases and obviously the payments themselves you have to make for leases are going to be disclosed, but you might you also have to include disclosures about residual value guarantees that are associated with those.
• 39:18
  SPEAKER_01: Uh you might have some off-balance sheet exposures like loan commitments or standby letters of credit.
• 39:25
  SPEAKER_01: If you're a lender, maybe those aren't accounted for, but you do have to make disclosures of those as well.
• 39:30
  SPEAKER_01: So there's a there's a variety of places that uh people all throughout GAP that uh that have elements of disclosures of these various commitments and contingencies that the company may be on the hook for at some point down the road.
• 39:42
  SPEAKER_02: All right, very helpful.
• 39:44
  SPEAKER_02: So then, Jay, I know for those other areas, we would need to look at the specific guidance we've put out on those topics, but specific to commitments, contingencies, and uh guarantees and sort of the AFCs that we we're talking about today, where should people go look for more information?
• 40:03
  SPEAKER_01: Yeah, well, along with those three ASC sections we mentioned, we we do have guidance uh in our financial statement presentation guide around it.
• 40:11
  SPEAKER_01: We have put them all together in chapter 23 of our guide is a good place that summarizes all that.
• 40:18
  SPEAKER_02: All right, very good.
• 40:19
  SPEAKER_02: So now we're up to my favorite part of the podcast, and I know it's becoming a fan favorite as well.
• 40:24
  SPEAKER_02: So get ready to play our long, Jay, with our stumped guests.
• 40:27
  SPEAKER_02: I've got great questions for you.
• 40:30
  SPEAKER_02: So, first question I'm gonna do in two parts because I think it might help you at least, or maybe you could at least get the first part right.
• 40:37
  SPEAKER_02: So, what year did the FASB issue FAS5?
• 40:42
  SPEAKER_01: Hmm, good, good question.
• 40:44
  SPEAKER_01: I was I would probably say that was in the 1960s.
• 40:51
  SPEAKER_01: I'll I'll go with 1965.
• 40:54
  SPEAKER_02: All right.
• 40:58
  SPEAKER_02: Fact check 1965 was just a little too early, Jay.
• 41:03
  SPEAKER_02: The correct answer is 1975.
• 41:06
  SPEAKER_02: And to be fair, after the recording, Jay did mention that he realized that his guest couldn't possibly have been right since the FASP wasn't even established in 1965.
• 41:16
  SPEAKER_02: That happened in 1973.
• 41:18
  SPEAKER_02: So fair enough to Jay.
• 41:19
  SPEAKER_02: Just took a little extra time.
• 41:24
  SPEAKER_02: And then the second part of that question is what computer company that's well known today was founded that year?
• 41:33
  SPEAKER_01: In 1975.
• 41:36
  SPEAKER_01: Takes out some the the first one I was thinking came to mind was IBM.
• 41:39
  SPEAKER_01: I know that's a lot older than uh 1975.
• 41:44
  SPEAKER_01: Um, I'll say Hewlett-Packard.
• 41:47
  SPEAKER_02: All right, so we'll check that one.
• 41:48
  SPEAKER_02: I have to say my guess was gonna be Apple, but I think that was also much later than 1975.
• 41:54
  SPEAKER_02: So fact check.
• 41:59
  SPEAKER_02: Looks like Jay and I were both stumped on this one.
• 42:02
  SPEAKER_02: The correct answer is Microsoft.
• 42:08
  SPEAKER_02: Okay, the second one I'm also going to ask in two parts.
• 42:11
  SPEAKER_02: This one you have to really listen to.
• 42:13
  SPEAKER_02: So the first question is what year did the FASB issue a proposed ASU that would have amended the ASC 450 disclosure requirements for loss contingencies?
• 42:26
  SPEAKER_01: I do remember the process because there was, as we said, a lot of concern about the disclosures that companies were making.
• 42:34
  SPEAKER_01: And it so at one point it was considered do we need to change FAS5 or ASC 450?
• 42:41
  SPEAKER_01: Uh, although ultimately I think it was concluded that actually the guidance maybe isn't so bad.
• 42:46
  SPEAKER_01: It's just that people need to pay a little more attention, perhaps, to the disclosure requirements that already exist under there.
• 42:53
  SPEAKER_01: So I would think that was about six or seven years ago.
• 42:59
  SPEAKER_01: So I I'm gonna say 2015.
• 43:03
  SPEAKER_02: All right.
• 43:03
  SPEAKER_02: So I think you did an excellent job educating the listeners on the uh the proposed ASU.
• 43:11
  SPEAKER_02: However, it was actually issued in 2010.
• 43:14
  SPEAKER_02: So isn't that crazy how time flies?
• 43:17
  SPEAKER_02: Um, and then I'm almost not wanting to ask you the second half of this question, but I will anyway.
• 43:22
  SPEAKER_02: Which country hosted the World Cup that year?
• 43:26
  SPEAKER_01: I wish I was more of a soccer fan.
• 43:28
  SPEAKER_02: Yes, maybe I should ask you about a different sport.
• 43:32
  SPEAKER_01: Uh I have no idea who hosted it.
• 43:34
  SPEAKER_02: All right, so we'll do a fact check on that one.
• 43:39
  SPEAKER_02: Final fact check.
• 43:41
  SPEAKER_02: Looks like the house is winning today.
• 43:43
  SPEAKER_02: The FASB issued the proposed ASU in July 2010 when the World Cup took place in South Africa.
• 43:54
  SPEAKER_02: As always, thank you for playing along and thank you for all the insight and for wrapping up the last episode in our full disclosure series.
• 44:03
  SPEAKER_01: Excellent.
• 44:03
  SPEAKER_01: Glad to be here.
• 44:05
  SPEAKER_02: Thanks for tuning in to our full disclosure series.
• 44:08
  SPEAKER_02: If you missed any of the 21 episodes, that's right, 21.
• 44:13
  SPEAKER_02: You can find the full library on viewpoint.pwc.com or wherever you listen to your podcasts.
• 44:21
  SPEAKER_02: Next Tuesday, we're launching our newest series, What's Trending in SEC Comments, a show about the major themes we're seeing in wait for this, SEC comment letters.
• 44:32
  SPEAKER_02: We're starting things off strong with a look at revenue, which is consistently at the top of the list for volume of comments from the SEC.
• 44:39
  SPEAKER_02: And this Thursday, we continue our talks on ESG and we cover the findings of PWC's 2021 Global Investor Survey on driving progress in ESG.
• 44:50
  SPEAKER_02: This is an in-depth survey on what it is that investors are looking for as they consider the ESG-related disclosures of their investment targets.
• 44:59
  SPEAKER_02: Lots of interesting data that you don't want to miss.
• 45:02
  SPEAKER_02: So that you never miss an episode, follow the PwC Accounting Podcast series wherever you listen to your podcast and sign up for our newsletter at viewpoint.pwc.com.
• 45:14
  SPEAKER_02: From Thought Leadership at PWC, I'm Heather Horn.
• 45:18
  SPEAKER_02: Thanks for tuning in.
• 45:31
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