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Assessing contingencies today · PwC's accounting podcast

• 0:00
  SPEAKER_00: Thought Leadership from PWC.
• 0:06
  SPEAKER_03: Welcome to PWC's Accounting Podcast.
• 0:09
  SPEAKER_03: I'm Heather Horn.
• 0:12
  SPEAKER_03: Thanks so much for joining us today for the next month in our new Tuesday series where we're shaking things up a bit and bringing in one of our all-star podcast guests to take over the series, picking the topics for the month, and joining me on all the episodes.
• 0:28
  SPEAKER_03: For the month of April, our takeover guest is Pat Durbin.
• 0:33
  SPEAKER_03: Pat's a deputy chief accountant in our national office, and this month he'll be sharing insights and going back to basics on some of the critical accounting areas he oversees, including contingent liabilities, subsequent events, and inventory valuation.
• 0:50
  SPEAKER_03: Spoiler alert on that last one.
• 0:52
  SPEAKER_03: It's one of Pat's favorite topics, so you'll definitely want to tune in later this month when we cover that.
• 0:58
  SPEAKER_02: As best as possible, try to approach it sort of objectively, right?
• 1:03
  SPEAKER_02: That's the challenge here.
• 1:04
  SPEAKER_01: It's probably the most successful companies I've had in dealing with this usually have a great walkthrough between legal, you know, finance and accounting, kind of going through, particularly on the legal side where you've got cases case by case, what's the current status and what's the conclusion?
• 1:19
  SPEAKER_01: So getting everyone to agree relative to that.
• 1:22
  SPEAKER_03: That was Pat and Tom Barbieri, our U.S.
• 1:25
  SPEAKER_03: chief accountant.
• 1:27
  SPEAKER_03: Our topic today, one of the oldest standards still in use, not to mention one of the most foundational to reporting, FAS 5, first issued in 1975.
• 1:39
  SPEAKER_03: And for those of you, probably most of you, who were born after that date, this standard is now known as ASC 450 contingencies.
• 1:49
  SPEAKER_03: Today we'll hear Pat and Tom share their insights and wealth of experience on accounting for contingencies.
• 1:56
  SPEAKER_03: There's lots to cover, so let's get started.
• 2:03
  SPEAKER_03: Pat, Tom, welcome back to the podcast.
• 2:06
  SPEAKER_03: And thanks so much for joining me today as we go back to the basics on contingencies.
• 2:10
  SPEAKER_03: And I had the two of you on actually four uh three, four years ago in 2019 to talk about contingencies.
• 2:17
  SPEAKER_03: And I know the guidance hasn't necessarily changed, but I think everything that's changed in the world may mean that this is a good time to revisit this topic.
• 2:25
  SPEAKER_03: So before we get into the actual accounting and disclosure models, Pat, I thought it would be helpful to actually level set on what we're talking about when we talk about a contingent liability.
• 2:35
  SPEAKER_02: Sure, Heather, and uh always uh happy to talk about such a happy topic like uh contingent liabilities.
• 2:41
  SPEAKER_02: Um, but I do think it's an important distinction to make because we don't have a lot of explicit gap for what I'll call ordinary operating liabilities.
• 2:50
  SPEAKER_02: And so since we have some specific gap in ASC 450 on contingency, sometimes people sort of default to that and they start thinking about how to apply that framework to just ordinary liabilities, but it really is only designed to deal with things that are truly contingent, subject to some uncertainty.
• 3:10
  SPEAKER_02: If you have a liability that arises out of a contractual relationship you have with a counterparty, uh subject to regulation, um a lot of taxes, those are not contingent in any way.
• 3:24
  SPEAKER_02: Now, sometimes people realize they may have had some of those obligations and failed to accrue them timely.
• 3:30
  SPEAKER_02: That doesn't in and of itself make it a contingency.
• 3:33
  SPEAKER_02: They first need to understand what was the applicable requirement, and the financial statements need to reflect those liabilities in the period they arise.
• 3:42
  SPEAKER_02: The fact that subsequently maybe a regulatory authority hasn't asserted or enforced the regulation or there's a view that they might not detect, for example, maybe sales taxes, and there's some question around Nexus, that doesn't make the liability contingent.
• 4:01
  SPEAKER_02: The first question is really, was I subject to that obligation or not?
• 4:05
  SPEAKER_02: And so just to stipulate that we're really only going to talk about those liabilities that are truly arising out of something that is truly uncertain, judgmental, perhaps an assertion of a claim against the company by another party that doesn't um explicitly arise in a contract.
• 4:23
  SPEAKER_02: So maybe just to clarify what the definition of a contingency is in GAP, it's an existing condition, situation, or set of circumstances involving uncertainty as to possible gain, and we'll talk about gain separately, or loss to an entity that will ultimately be resolved when one or more future events occur or fail to occur.
• 4:46
  SPEAKER_02: So the typical types of things we see, I alluded to some of them, like a claim arising maybe out of a relationship you had, but not explicitly described in a contract.
• 4:56
  SPEAKER_02: So you can have a claim arising out of maybe somebody views you breached the contract and caused them damages, commercial disputes, um, certainly product liability or personal injury claims, those are classic examples.
• 5:10
  SPEAKER_02: Environmental remediation, sort of a special class, and we don't see as much of that anymore.
• 5:14
  SPEAKER_02: That was prevalent maybe 15, 20 years ago, but those are you know maybe less less common now.
• 5:20
  SPEAKER_02: But those are the types of things we talk about when we're talking about contingent liabilities.
• 5:27
  SPEAKER_03: And I guess, Pat, just to clarify our last point, because I doubt you're planning to talk more, although um something that's near and dear to me because of my industry, environmental remediation has its own maybe add-on to the model we're going to be talking about today.
• 5:42
  SPEAKER_02: That's right.
• 5:42
  SPEAKER_02: There's some specific interpretive guidance specific to environmental remediation liabilities.
• 5:46
  SPEAKER_02: And maybe in that context, there's another flavor of that that has special gap, which is asset retirement obligations.
• 5:53
  SPEAKER_02: We're also not going to really cover those either.
• 5:56
  SPEAKER_03: I smiled when Pat started and then he he crushed me, but that's okay.
• 6:01
  SPEAKER_03: I guess we have plenty to talk about today.
• 6:03
  SPEAKER_03: So, Pat, with all that said then, I think this is a good level setting.
• 6:06
  SPEAKER_03: So let's go into the accounting model.
• 6:09
  SPEAKER_03: What are the sort of what's the base of the model?
• 6:12
  SPEAKER_02: Yeah, so the way ASC 450 is set up is really has kind of a three-tiered framework for what you need to think about.
• 6:20
  SPEAKER_02: Um first step is do I have anything that's a potential loss contingency?
• 6:25
  SPEAKER_02: And you you might not have any, so there's nothing to do.
• 6:28
  SPEAKER_02: If you've identified something where there is the possibility, some possibility of a loss, then you sort of have to now think through this framework.
• 6:36
  SPEAKER_02: And it starts with at the lowest level, there's a possibility, but it's remote.
• 6:42
  SPEAKER_02: And essentially that's almost the same as saying, well, there's really not a you know possibility of a loss.
• 6:47
  SPEAKER_02: I don't really have to do anything in that case.
• 6:50
  SPEAKER_02: The next threshold would be a loss is reasonably possible.
• 6:55
  SPEAKER_02: And then the third threshold is a loss is probable.
• 6:59
  SPEAKER_02: Now that's as far as the standard goes.
• 7:01
  SPEAKER_02: Those are words, they sort of have their you know plain meaning in English.
• 7:06
  SPEAKER_02: There aren't really numbers or quantifications associated with that.
• 7:10
  SPEAKER_02: There's sort of a maybe a working understanding when we get the probable, but that's the general gist of it.
• 7:16
  SPEAKER_02: I mean, there is a definition, I guess, of probable, which says the future event is likely to occur.
• 7:23
  SPEAKER_02: Again, very general kind of definition, right?
• 7:28
  SPEAKER_02: It's qualitative.
• 7:29
  SPEAKER_03: Before you go on, let me ask you about these percentages, because I do think that's probably the number one question if you're dealing with the contingency is people try to start.
• 7:38
  SPEAKER_03: And even though there aren't contingent um percentages in the guidance, I do think there is some generally understood.
• 7:44
  SPEAKER_03: So if if you were forced to give percentages, do you have any ones that you would typically use?
• 7:51
  SPEAKER_02: Yeah, I I would say in practice, people view the probable threshold as essentially or approximately 75%.
• 7:58
  SPEAKER_02: So it's certainly higher than just more likely than not, but you know, certainly less than certain.
• 8:05
  SPEAKER_02: But again, it's a it's a judgmental concept.
• 8:07
  SPEAKER_02: You can't really do math to get to what is the probability, and that's not normally how particularly in this context, the the standard is applied or supposed to be applied.
• 8:17
  SPEAKER_03: And remote, do you ever do a percentage for that one?
• 8:21
  SPEAKER_02: I don't.
• 8:21
  SPEAKER_02: I mean, I think probably you would think it's you know pretty unlikely, like less you know, than 10% single digits at best in terms of likelihood, and then in theory, reasonably possible is kind of everywhere in between.
• 8:34
  SPEAKER_03: Well, and I think when you get into some of this additional thing, I think what you're gonna show is that those percentages don't really help at all.
• 8:41
  SPEAKER_03: People like to talk about them, but how does 75% help you any more than saying probable?
• 8:45
  SPEAKER_03: Yeah.
• 8:46
  SPEAKER_03: I'm not sure it really does.
• 8:47
  SPEAKER_03: So but anyway, so let's keep going.
• 8:49
  SPEAKER_03: So from a words perspective or qualitative perspective, then how do we think about what those mean?
• 8:56
  SPEAKER_02: Yeah, so I I think really it is a judgmental qualitative assessment.
• 9:00
  SPEAKER_02: And I think what I'd really probably focus on is again, if it's remote, there's really nothing to do.
• 9:06
  SPEAKER_02: If there's some loss possibility, you probably want to be tracking that and monitoring for developments, because the the idea here is that these things could evolve and the probability or likelihood could change over time.
• 9:19
  SPEAKER_02: If you have a reasonably possible loss, you do have to make some disclosures.
• 9:24
  SPEAKER_02: There's some requirements there, and we'll get into that.
• 9:26
  SPEAKER_02: And again, you need to have a process to be kind of monitoring for developments because those disclosures need to be made timely.
• 9:33
  SPEAKER_02: And in particular, if you get to a point where ultimately you need to make an accrual, which that's where the probable threshold comes in.
• 9:40
  SPEAKER_02: If the loss is probable, you then need to accrue.
• 9:43
  SPEAKER_02: You don't want the first time somebody becomes aware of a material loss contingency to be the point at which you accrue it.
• 9:49
  SPEAKER_02: I mean, that could happen if it just arises out of the blue and immediately goes to probable, but if it's lingering out there for a while and you haven't been saying anything about it, and then all of a sudden you have a massive accrual, that's likely going to trigger some attention, particularly if you're a public company from the SEC.
• 10:05
  SPEAKER_02: They've made that point, they've issued comments to that effect, and um, you know, if it's extreme enough, they might have other responses.
• 10:12
  SPEAKER_03: All right.
• 10:13
  SPEAKER_03: So then if we get to to the probable, what comes next?
• 10:17
  SPEAKER_02: Aaron Powell So if you get to that point where the loss is probable, technically the standard has a sort of a two criteria that you need to meet.
• 10:25
  SPEAKER_02: The loss is both probable and reasonably estimable.
• 10:30
  SPEAKER_02: I will say in practice, once you uh conclude that the loss is probable, it's an extremely high bar to argue that the loss is not reasonably estimable.
• 10:40
  SPEAKER_02: I mean, if you think about the history of this guidance, it dates back, you know, over 50 years.
• 10:46
  SPEAKER_02: And really in the times since then, there are so many things that we might have argued were very difficult to measure or estimate in accounting that we readily and regularly estimate today.
• 10:59
  SPEAKER_02: So I think that's gonna be a very difficult argument to make.
• 11:02
  SPEAKER_02: And I think we know from experience um, you know, in dealing with um, you know, the SEC in particular, that that's a that's gonna be a high bar.
• 11:10
  SPEAKER_03: Well, and I think Pat, you're likely getting to this, but another key there is it's you don't have to estimate one number.
• 11:17
  SPEAKER_03: So, and you know, the rate range, it's when you can have a range, then it really is hard to say that you can't estimate something.
• 11:23
  SPEAKER_02: Aaron Powell That's a great point, Heather.
• 11:25
  SPEAKER_02: And actually there is some interpretive guidance or incremental guidance that was sort of layered into the ASC 450 framework sort of somewhere along the way, but after the original standard was uh was issued that says if you have a range and you can't come up with an estimate that in that range that's any more likely than any other estimate, then it tells you specifically use the low end of the range.
• 11:49
  SPEAKER_02: And I think it's important to remember this is an estimate because it's a subject of future uncertainty.
• 11:54
  SPEAKER_02: So nobody's necessarily holding you that that has to be the ultimate outcome, but it needs to reflect your best estimate based on the facts that you know at the you know applicable reporting date.
• 12:06
  SPEAKER_03: All right, definitely a lot to think about.
• 12:07
  SPEAKER_03: So then, Tom, if I bring you in, I think sort of my biggest takeaway from Pat is there's a lot of judgment involved.
• 12:14
  SPEAKER_03: And I know you love dealing with the counting judgments, something you do every day.
• 12:18
  SPEAKER_03: So uh, you know, very curious of sort of your perspective on this, but maybe where we can start with you is to think about measurement, like how how you measure this.
• 12:30
  SPEAKER_01: Yeah.
• 12:30
  SPEAKER_01: So so maybe first off, let's let's talk about um the fact that oftentimes loss contingencies might take a while to actually resolve and result in a cash payment.
• 12:39
  SPEAKER_01: And so the first question is okay, if I do come up with an estimate, and we'll talk about that in a second, should I discount that estimate?
• 12:46
  SPEAKER_01: And I think the answer to that is typically no.
• 12:48
  SPEAKER_01: In order to defend an approach whereby you could discount, you're you're gonna have to be able to argue that the amount and timing of the payments are fixed or readily determinable, right?
• 12:57
  SPEAKER_01: And a lot of these contingencies that we're talking about, you're not gonna have a real fixed date that you could predict, yes, I'm gonna make a payment of X dollars five years from now.
• 13:08
  SPEAKER_01: So I think in practice, for the most part, we don't see um those discounted.
• 13:13
  SPEAKER_01: Now, there can be cases in which you've got you know a large homogeneous pool of liabilities, like maybe product liabilities, where you're more able to predict, and those liabilities might run out over a period of years.
• 13:27
  SPEAKER_01: If you can make the argument that you've got a high level of confidence in the predictability of the cash flows associated with that, you could discount.
• 13:35
  SPEAKER_01: And we do see that in practice, but it's pretty narrow when it's applied.
• 13:39
  SPEAKER_03: Aaron Powell Yeah, so I wanted to ask actually both of you, because you're right, I have seen discounted product liability, but otherwise, I can't think of a lot of examples of discounted contingencies.
• 13:49
  SPEAKER_02: I'm just curious if no, in practice, no, I I really haven't seen it.
• 13:54
  SPEAKER_02: I mean, there's the specific guidance again back to the environmental space, but that's sort of when you have a defined site, you're remediating program that you're remediating.
• 14:02
  SPEAKER_02: So it almost like converts the contingency into almost more of a like a defined stream of outflows.
• 14:08
  SPEAKER_02: I mean, they're not really contractual, but they sort of start to look like that.
• 14:11
  SPEAKER_03: Aaron Powell Well, one benefit in a way is at least if you're not discounting, that's one less factor you have to take into account when you're measuring.
• 14:19
  SPEAKER_03: So maybe from that point of view, it's a little easier.
• 14:22
  SPEAKER_03: So then where do you go from there?
• 14:23
  SPEAKER_01: Aaron Powell So normally we we generally see that these um liabilities sort of come into three different um buckets.
• 14:29
  SPEAKER_01: So right the first is sort of the one-off large claim, right?
• 14:33
  SPEAKER_01: So think of one big litigation um situation, one big legal case with one counterparty.
• 14:39
  SPEAKER_01: You know, for these types of claims, it really comes down to management, like Pat said before, really determining what your best estimate is, working with your attorneys, understanding the facts and circumstances.
• 14:49
  SPEAKER_01: Now, one thing to keep in in mind, and we see this all the time, is oftentimes you might be a company who's entering into settlement negotiations or mediation with the counterparty, and um listen, we always say if you pass a paper across the table relative to an amount you'd be willing to settle, well that certainly becomes the floor relative to what your accrual is.
• 15:08
  SPEAKER_01: And that is something that we see all the time.
• 15:11
  SPEAKER_01: Um so keep that in the back of your mind.
• 15:13
  SPEAKER_01: Um the second scenario is when you've got a number of similar claims and you've got some history of the settlement of those claims.
• 15:20
  SPEAKER_01: And so this again would be an accounting estimate that you're gonna have to think about your historical or other data that might be available, and it will help inform you of what the appropriate assumptions are in developing that liability.
• 15:31
  SPEAKER_01: And then the third bucket is when you've really got a complex liability and you might have to engage actuaries.
• 15:38
  SPEAKER_01: So think of asbestos exposure or insurance companies that might have complex claims, where you've got to predict personal injury claims over time, how health care costs might be manifesting themselves over time, just how litigation will change over time, depending upon where the litigation is, changes in the laws, all that.
• 15:59
  SPEAKER_01: And so those are cases where you see a lot more complex processes and developing what those estimates are.
• 16:05
  SPEAKER_03: So Tom, you mentioned insurance, and I know it was not in the context of this because you were talking about insurance liabilities, but often uh someone will take out insurance to protect them against a contingent liability.
• 16:18
  SPEAKER_03: So how do you think about that when you're accruing?
• 16:21
  SPEAKER_03: Like if I have insurance, why am I accruing, right?
• 16:23
  SPEAKER_01: Yep, absolutely.
• 16:24
  SPEAKER_01: And and I think the first thing to keep in mind is they're separate units of account.
• 16:27
  SPEAKER_01: So the contingency we're talking about, the measurement you have on the liability side, is completely different and irrespective of the insurance that you may have uh purchased.
• 16:37
  SPEAKER_01: Okay.
• 16:37
  SPEAKER_01: You have different counterparties, um, et cetera.
• 16:40
  SPEAKER_01: And so they're subject to their own uh you know accounting, if you will.
• 16:45
  SPEAKER_01: Um so oftentimes you you know keep in mind you can't net the amount you might have in an insurance recoverable against that liability.
• 16:52
  SPEAKER_01: That's the first thing on the balance sheet.
• 16:54
  SPEAKER_01: Okay.
• 16:55
  SPEAKER_01: It's really because you do have different counterparties.
• 16:58
  SPEAKER_01: You only allow a netting and gap is probably on the balance sheet when you have similar counterparties and meet other rules around your ability to net.
• 17:04
  SPEAKER_01: Now, relative to what you could accrue or recognize w after you've had a loss event, what you could recognize from the insurance recoverable, um, you really need to demonstrate that you believe that the recoverable is probable under the policy.
• 17:17
  unknown: Right.
• 17:17
  SPEAKER_01: So for example, if you've got a policy and it's unclear whether or not you've uh you know you've actually covered for the loss, and maybe you're in dispute with the the insurance provider, you would not be able to record a recovery of that amount until um you know that really gets sort of confirmed by you that that that is um something you're able to actually um expect to collect on.
• 17:40
  SPEAKER_01: Um secondly, keep in mind that you're only allowed to record the recoverable to the extent of the loss.
• 17:46
  SPEAKER_01: And if you get if you expect to get more, for example, and just because, I don't know, maybe it's uh just the way your policy is written, you'll end up with the right.
• 17:56
  SPEAKER_01: Exactly.
• 17:57
  SPEAKER_01: That excess amount is going to be subject to gain contingency accounting, which we'll get to shortly.
• 18:02
  SPEAKER_01: Okay?
• 18:02
  SPEAKER_01: Maybe the last thing to think about is um the income statement.
• 18:07
  SPEAKER_01: We often get questions around if you record the loss to a certain line, can you take the insurance recoverable through the same line?
• 18:12
  SPEAKER_01: And I think the answer to that is generally yes.
• 18:15
  SPEAKER_01: Um, but you need to be careful, particularly if something hits multiple lines around the appropriateness of that and making sure you've got transparent disclosures around it.
• 18:23
  SPEAKER_03: Right.
• 18:23
  SPEAKER_03: And I guess so, Tom, sort of a key takeaway, it sounds like is this definitely not a case to say, okay, I have a contingent liability, I have insurance, sort of my work here is done, because you really have to address each of them separately and go through, push it all the way through the model, each one.
• 18:39
  SPEAKER_03: And you could wind up with different balances or to your point zero on one side, even if eventually you're gonna recover some insurance.
• 18:47
  SPEAKER_03: So all right.
• 18:48
  SPEAKER_03: So then you did mention gain contingencies, Pat.
• 18:51
  SPEAKER_03: You mentioned them before, and I when we went through the model, we only talked about loss contingencies.
• 18:55
  SPEAKER_03: So what from a model perspective, what do we think about with gain contingencies?
• 19:00
  SPEAKER_02: Yeah, so gain contingencies are definitely different than loss contingencies.
• 19:04
  SPEAKER_02: Um in the case of a gain contingency, and these usually, other than the case Tom was talking about, where you're talking about maybe excess insurance, these tend to be like it's a separate situation.
• 19:15
  SPEAKER_02: You're not usually thinking about a gain contingency or loss contingency together, like they're they're gonna be separate items.
• 19:22
  SPEAKER_02: In a gain contingency, and it probably reflects, at least at the time, sort of the conservative bias in accounting, you can't recognize those until they're essentially realized, meaning you got the cash or realizable, which is a pretty high bar.
• 19:37
  SPEAKER_02: In the case of insurance, like if you get some confirmation from the insurer that they're going to pay, you could probably recognize it at that point, even before you have cash in the door.
• 19:47
  SPEAKER_02: But it's it's a pretty high bar to recognize income from a gain contingency.
• 19:53
  SPEAKER_02: One one question that sometimes comes up is we talked a lot about the loss contingency, and you're estimating the amount of the loss.
• 20:00
  SPEAKER_02: And so you obviously have a number that you may have booked at some point.
• 20:04
  SPEAKER_02: And when I think about maybe developments that lead me to conclude that maybe I think the amount of the loss is actually lower than what I initially accrued, should I think of that like a gain contingency?
• 20:16
  SPEAKER_02: And I think the answer is technically no.
• 20:18
  SPEAKER_02: You're still in a loss contingency model.
• 20:22
  SPEAKER_02: That model requires you to update that estimate of your liability at each reporting date.
• 20:27
  SPEAKER_02: Now, I would be cautious if I thought I had a larger loss, and now for some reason I think it should be a lesser loss, but technically I'm still in the loss contingency guidance.
• 20:37
  SPEAKER_02: And if it's appropriate to adjust that accrual to a lower amount, I can do that without having to get to this sort of higher bar that I would need in a gain contingency context.
• 20:47
  SPEAKER_02: Trevor Burrus, Jr.
• 20:47
  SPEAKER_03: That's helpful.
• 20:48
  SPEAKER_03: Although I do think to your point, when you're in a loss contingency, those ups and downs, it can be difficult to push to push down.
• 20:56
  SPEAKER_03: And so I think it's really understanding the facts and circumstances and judgment there.
• 21:01
  SPEAKER_03: So one of you, I think Tom, maybe you mentioned this idea that you could have claims for like workers' comp or otherwise these types of contingencies.
• 21:10
  SPEAKER_03: And often in those cases, you're going to get into the lovely concept of incurred but not reported, which uh, you know, I think something can be quite confusing for people who do not have experience in this area.
• 21:23
  SPEAKER_03: And so can you just explain what that means and where we see it, how we think about it?
• 21:28
  SPEAKER_01: Sure.
• 21:28
  SPEAKER_01: And probably the easiest way to wrap your mind around incurred but not reported, and people refer to it as IBNR, is um think about situations in which an insured event may have occurred, but there it has not been reported to the company.
• 21:42
  SPEAKER_01: A claim hasn't been reported to the company yet.
• 21:44
  SPEAKER_01: So the obvious example is think about an insurance company that's provided property insurance in Florida, the Gulf Coast.
• 21:52
  SPEAKER_01: There's a hurricane that's occurred that wiped out a whole bunch of properties, that they were providing insurance coverage.
• 21:57
  SPEAKER_01: And so they know there's claims coming.
• 21:59
  SPEAKER_01: There wasn't Insured event.
• 22:01
  SPEAKER_01: They know they're contractually on the hook for it.
• 22:03
  SPEAKER_01: And as a result, they need to take that into account in the measurement of their liability today.
• 22:10
  SPEAKER_01: And so while we typically see this in insurance companies, I mentioned, we do see it in things like product liability claims, the examples we've talked about before, asbestos, tactical exposure, workers' comp, et cetera, right?
• 22:22
  SPEAKER_01: Now trying to do these estimates is not easy.
• 22:25
  SPEAKER_01: Oftentimes you rely on, you know, historical data that you have, as well as uh industry trends.
• 22:31
  SPEAKER_01: You take into account things like uh what your policies are, what your coverage limits are, to the extent those things are tight are in place.
• 22:39
  SPEAKER_01: And so you might get actuarial help to actually do it.
• 22:42
  SPEAKER_01: Um so it's very judgmental, and it you really need to be careful in in um applying your judgment, particularly where you don't have a you know kind of a run rate, you know, historical run rate in actually determining that liability.
• 22:54
  SPEAKER_01: So um, you know, that's that's an interesting thing to keep keep your mind on and uh be focused on.
• 23:00
  SPEAKER_01: Another thing to think about is unasserted claims.
• 23:02
  SPEAKER_01: These are a little bit different.
• 23:03
  SPEAKER_01: This is one where claim hasn't been asserted either because the claimant is unaware of the matter or has not yet pursued it.
• 23:11
  SPEAKER_01: Right.
• 23:11
  SPEAKER_01: So a good example might be a a personal injury claim or property damage claim where it's clear something happened, but the cause is unknown, right?
• 23:20
  SPEAKER_01: And so you really don't know whether or not you're gonna be on the hook relative to a loss that might have occurred by the by the counterparty.
• 23:28
  SPEAKER_01: And so in this context, the guy really is focused on disclosure, and that disclosure is not required for these types of situations.
• 23:36
  SPEAKER_01: Um it I'm gonna read the actual words and the standard.
• 23:41
  SPEAKER_01: If there has been no manifestation by a potential claimant of an awareness of a possible claim or assessment, unless both of the following conditions are met.
• 23:50
  SPEAKER_01: One, it's considered probable that a claim will be asserted.
• 23:54
  SPEAKER_01: And two, there's a reasonable possible outcome that will be unfavorable.
• 23:59
  SPEAKER_01: So it's really focusing on these two those two uh phrases and actually making that determination.
• 24:04
  SPEAKER_01: Um so that gets difficult, right, uh sometimes to figure out, particularly if it's something that's new that's just emerged, and you really have a hard time in figuring that out, right?
• 24:13
  SPEAKER_03: Yeah, and I mean I think the uh this topic and contingencies in general, it's a good reminder.
• 24:18
  SPEAKER_03: We spent a lot of time talking about risk.
• 24:20
  SPEAKER_03: And I think people often think of risk factors, for example, in their SEC filings as these big picture things that could impact the company, but risks in this area are the ones that accountants really need to focus on because you could have things you should be recording and they're just not even on your radar, so you don't think about them.
• 24:40
  SPEAKER_03: So this is definitely one that's like you have to scan for things you you don't know.
• 24:44
  SPEAKER_03: So, Pat, a question I wanted to ask you earlier uh that I I managed to resist on gain contingencies was related to timing if you get subsequent events information.
• 24:54
  SPEAKER_03: And I this is another place I think we may see things a little different for loss contingencies and and gain contingencies.
• 25:00
  SPEAKER_03: So, what do you do with subsequent events?
• 25:02
  SPEAKER_02: Yeah, so maybe I'll I'll I'll take it sort of uh the subsequent events topic as it relates to to both.
• 25:08
  SPEAKER_02: So if you think of the classic loss contingency and we're just talking about all these things that have happened, but maybe I don't even know if a claim's been filed yet.
• 25:17
  SPEAKER_02: In many cases, I'm not gonna know like how much I really think the claim is, if it's something that's subject to litigation, there's probably a long tail on that.
• 25:26
  SPEAKER_02: But by definition, if we think of the subsequent events model, and I know we're gonna have a separate podcast on subsequent events more broadly, but the general concept is if you get new information about conditions that existed at the balance sheet date, after the balance sheet date, but before the financial statements are issued, you're likely going to use that information to inform your accounting for that set of conditions that existed.
• 25:52
  SPEAKER_02: So in the contingency context, like I was just alluding to, in virtually all cases, those conditions are going to have existed at the balance sheet date.
• 26:02
  SPEAKER_02: So any evolution of information that occurs in that window is gonna need to be considered in the estimate of your loss or your assessment of the probability of that loss.
• 26:13
  SPEAKER_02: You know, kind of a classic case is a post-balance sheet settlement of litigation or adjudication of litigation, you're gonna push back that measurement to the balance sheet date.
• 26:22
  SPEAKER_02: That's a little different than the gain contingency concept because remember the threshold there for recognition is when it's realized or realizable.
• 26:32
  SPEAKER_02: And if it was truly still contingent at the balance sheet date, it did not become realized or realizable until that subsequent period, then the appropriate point of recognition is in that subsequent period.
• 26:45
  SPEAKER_02: So there's definitely a sort of a different model for loss contingencies and gain contingencies in the subsequent events.
• 26:53
  SPEAKER_03: Yeah, and that's actually, I think often people get all you say the word confused of why they're different, but I think the way you just framed it makes it very clear why why you're accounting for those differently.
• 27:03
  SPEAKER_03: So then, Pat, the other sticky area that I wanted to ask you about before, because I think this is often where there is judgment as well, is on disclosures.
• 27:13
  SPEAKER_03: And if let's focus in on loss contingencies for for this discussion.
• 27:18
  SPEAKER_02: Yeah, and so generally, like in this space, the first big threshold is do I have to accrue something?
• 27:24
  SPEAKER_02: And that oftentimes is somewhat emotional.
• 27:28
  SPEAKER_02: People think they didn't do anything wrong or they're not gonna be subject to a loss.
• 27:31
  SPEAKER_02: But assuming you conclude now you have a probable loss, you need to accrue something, it actually in some ways sort of mitigates a little bit of the disclosure concern because you've you've accrued a number, right?
• 27:43
  SPEAKER_02: And we would sort of generally put primacy on a recorded liability over just the disclosure of a potential liability.
• 27:50
  SPEAKER_02: So once you've accrued the amount, all you really need to do is then describe in the footnotes the nature of the contingency.
• 27:57
  SPEAKER_02: And if there's a possibility, a reasonable possibility that the ultimate number could be higher, you need to disclose that fact as well.
• 28:05
  SPEAKER_02: That's a little different than if you have a reasonably possible loss that you haven't accrued.
• 28:10
  SPEAKER_02: You need to describe it, you know, in it in sufficient detail so the reader has some idea of the potential magnitude of the loss that could arise.
• 28:20
  SPEAKER_02: And again, the nature of the contingency.
• 28:23
  SPEAKER_02: And this area gets really challenging, very judgmental, because you're inevitably dealing with a situation where perhaps there's an adversarial counterparty and you don't want to prejudice your position in the negotiations litigation with the disclosures you put in the financial statements, but the users of the financial statements need some information so they can make the appropriate judgment themselves as well.
• 28:47
  SPEAKER_02: So that's a it's a really challenging area in practice, and I'm not sure there's a really easy fix I could make.
• 28:57
  SPEAKER_03: But I guess your best advice is probably make sure you follow the disclosure requirements.
• 29:01
  SPEAKER_03: At the end of the day, that's your responsibility.
• 29:04
  SPEAKER_03: Yeah.
• 29:04
  SPEAKER_03: All right.
• 29:05
  SPEAKER_03: So then, Pat, what about you mentioned this before, but I think it's worth emphasizing here is what if something's remote?
• 29:12
  SPEAKER_02: So if it's remote, like I said before, there's really not any requirement to do anything because you're sort of saying it's such a low probability.
• 29:19
  SPEAKER_02: I don't really need to um provide any disclosure of that.
• 29:24
  SPEAKER_02: But as we mentioned a couple of times, if there's some exposure there, you need to have some process for monitoring the evolution of it to the extent that you don't miss the point at which it becomes reasonably possible, and therefore you would need to make some disclosure about it.
• 29:40
  SPEAKER_02: So it's kind of back to your point on the unasserted claims as well.
• 29:44
  SPEAKER_02: You need to have some sort of process to identify when these things happen, run them through the screen in the guidance of whether I need to disclose something or not, and sort of have a process for tracking them, even if they're in that kind of remote bucket.
• 29:59
  SPEAKER_03: All right, definitely a good reminder.
• 30:00
  SPEAKER_03: And then Tom, how about uh if I have a gain contingency, I'm sure there's more interest in disclosing disclosing those.
• 30:08
  SPEAKER_01: Yeah, i interesting.
• 30:09
  SPEAKER_01: Uh you know, there is guidance that speaks to disclosures around gain contingencies.
• 30:14
  SPEAKER_01: Um that being said, I think in practice, we don't see a lot.
• 30:17
  SPEAKER_01: The answer is why.
• 30:18
  SPEAKER_01: Well, the the language that's actually included in the standard says care should be exercised to avoid misleading implications as to the likelihood of realization.
• 30:29
  SPEAKER_01: And in practice, I think most people stick to that, right?
• 30:31
  SPEAKER_01: They don't want to mislead the user, that they're going to be sitting on these gains that are just coming, um, et cetera, given given the fact that you're really waiting until the 11th hour to book the gain, right?
• 30:41
  SPEAKER_01: Until there is this realization event.
• 30:44
  SPEAKER_01: So, you know, where do we see it?
• 30:46
  SPEAKER_01: We see it sometimes where there might be a company that might have a product infringement case or something that's critical to their underlying business, where they might message to the reader the importance of that case in their ongoing business model, right?
• 31:01
  SPEAKER_01: That's the one exception.
• 31:02
  SPEAKER_01: And generally we've seen that.
• 31:04
  SPEAKER_01: There's generally been a whole host of caveats around that, and really not context around what the potential amount could be, et cetera, but more in words around the importance of that case.
• 31:14
  unknown: Aaron Powell Yeah.
• 31:15
  SPEAKER_03: And I guess in that case as well, the company is trying to make sure they're uh communicating that they're defending their rights to whatever property we're talking about.
• 31:25
  SPEAKER_03: So that's in many cases equally important.
• 31:28
  SPEAKER_03: Tom, what else do you think about as you're so broadly on this topic?
• 31:32
  SPEAKER_01: Aaron Powell We We talked a little bit about this before you talked about risks.
• 31:35
  SPEAKER_01: I guess the thing to think about is that commitments and contingencies should be considered under the risk and uncertainty disclosures as well as critical accounting estimates.
• 31:42
  SPEAKER_01: And these are areas, again, particularly in critical accounting estimates, where you might not have had a litigation case for a period of time.
• 31:47
  SPEAKER_01: And so it might not be there today, but then as a new case emerges, you might need to consider including it.
• 31:53
  SPEAKER_01: So it's careful for you to think about your situation at each balance sheet date and making that determination.
• 31:58
  SPEAKER_03: All right.
• 31:59
  SPEAKER_03: So listening to you guys, this seems like such a straightforward area of gap.
• 32:03
  SPEAKER_03: There's models, we you know, we know how to account for them, but obviously we've mentioned the word judgment a few times, and I think at least three of us know that in practice that is not so easy with dealing with contingencies.
• 32:14
  SPEAKER_03: So I always like to ask for advice on behalf of the listeners on when you're dealing, let's call it the stickier case, a loss contingency.
• 32:23
  SPEAKER_03: Maybe we don't have to talk about gains.
• 32:24
  SPEAKER_03: What do you see working well in practice in terms of how companies are managing through this?
• 32:30
  SPEAKER_03: And maybe Pat, I'll go to you first.
• 32:32
  SPEAKER_02: Well, certainly it's going to require some cross-functional involvement.
• 32:36
  SPEAKER_02: You're going to need help from usually some people in the legal organization.
• 32:41
  SPEAKER_02: Um, I think it's important to have someone relatively senior from the financial reporting lens and as best as possible, try to approach it sort of objectively, right?
• 32:52
  SPEAKER_02: That's the challenge here.
• 32:53
  SPEAKER_02: Like inevitably, it sort of feels like, well, I know I didn't do anything wrong.
• 32:57
  SPEAKER_02: I know I don't owe anything, but the reporting framework requires you to sort of step back and dispassionately judge these situations and try as best you can to apply the reporting framework.
• 33:11
  SPEAKER_02: And like anything, the facts definitely matter.
• 33:14
  SPEAKER_02: So making sure you have a good handle on the facts.
• 33:16
  SPEAKER_02: One thing we didn't really talk about that, you know, even though these things evolve over time, new information comes to light, you can't just uh sort of get a pass because you didn't know or you didn't really try to get the information.
• 33:31
  SPEAKER_02: You know, once you're aware of the claim or the case, you need to go get whatever information you can get and make your evaluation as completely as possible.
• 33:41
  SPEAKER_02: You know, you can't just wait for everything to happen.
• 33:44
  SPEAKER_02: Yes, like discovery takes a long time and you don't have an obligation to like accelerate that or delay your financials, but as much as you can determine about what happened with the information inside the organization, that needs to inform your accounting judgments.
• 33:58
  SPEAKER_03: Aaron Powell Yeah, so I think what you're saying there, Pat, to that point is you don't want to be in a position next quarter when you find out someone in the organization knew something last quarter that would be impacting your evaluation there.
• 34:12
  SPEAKER_03: Yeah.
• 34:12
  SPEAKER_03: Good advice there.
• 34:13
  SPEAKER_03: Tom, how about from your perspective?
• 34:15
  SPEAKER_01: Aaron Powell Similar.
• 34:15
  SPEAKER_01: In my experience, probably the most successful companies I've had in dealing with this usually have a great walkthrough between legal, you know, finance and accounting, kind of going through, particularly on the legal side where you've got cases case by case, what's the current status and what's the conclusion?
• 34:31
  SPEAKER_01: So getting everyone to agree relative to that.
• 34:34
  SPEAKER_01: And then secondarily, they'll have a good process of doing what Pat talked about before, the subsequent events analysis and not forgetting about that.
• 34:42
  SPEAKER_01: Because oftentimes we see things happen up to the 11th hour before the financial statements are issued, and you need to take into account most current events and determining what your accrual is.
• 34:53
  SPEAKER_01: And that's where I see oftentimes companies don't necessarily always have that process.
• 34:57
  SPEAKER_01: They really need to make sure they've got a crisp process there that any any developments are taken into account.
• 35:02
  SPEAKER_03: Yeah, I think uh accountants hate dealing with things at the last minute, but this is definitely an area where you don't want to uh to miss that because it's gonna be more painful next quarter if you do.
• 35:13
  SPEAKER_03: So all right.
• 35:13
  SPEAKER_03: Well, gentlemen, thank you so much for your perspective.
• 35:16
  SPEAKER_03: Very helpful, and I appreciate you joining me today.
• 35:19
  SPEAKER_03: Sure.
• 35:19
  SPEAKER_02: Happy to join.
• 35:20
  SPEAKER_02: Thanks, Heather.
• 35:21
  SPEAKER_03: That's our show for today.
• 35:24
  SPEAKER_03: Tune in next week for more fresh episodes so that you never miss any of our audio content.
• 35:29
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• 35:34
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• 35:44
  SPEAKER_03: From Thought Leadership at PwC, I'm Heather Horn.
• 35:48
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