Accountants: How does a company account for an ongoing lawsuit?

[CookingWithGas]

100% hypothetical. A publicly traded company is being sued for $100M. Do they make an accounting entry for the potential liability, or is there no entry until the case is settled or adjudicated? Seems like a big chunk to be hanging in the air yet not be on the books in some form. (I would assume that this kind of thing would have to be disclosed in an annual report, regardless of whether it’s on financial statements.)

[Bone]

@CookingWithGas

100% hypothetical. A publicly traded company is being sued for $100M. Do they make an accounting entry for the potential liability, or is there no entry until the case is settled or adjudicated? Seems like a big chunk to be hanging in the air yet not be on the books in some form. (I would assume that this kind of thing would have to be disclosed in an annual report, regardless of whether it’s on financial statements.)

In US GAAP, ASC 450 controls recording and reporting loss contingencies. ASC 450 states:

450-20-25-2. An estimated loss from a loss contingency shall be accrued by
a charge to income if both of the following conditions are met:
a. Information available prior to issuance of the financial statements indicates
that it is probable that an asset had been impaired or a liability
had been incurred at the date of the financial statements. Date of the
financial statements means the end of the most recent accounting period
for which financial statements are being presented. It is implicit in
this condition that it must be probable that one or more future events
will occur confirming the fact of the loss.
b. The amount of loss can be reasonably estimated

So, probable AND estimateable are the triggers. Probable is typically >50% and estimateable can also be a range of values, where if all values in the range are equally likely then the midpoint would be appropriate.

Both must be met for a loss contingency to be recorded. Potential litigation falls under loss contingencies. Disclosure of loss contingencies without taking a charge may be required based on other circumstances as well.

[Tim_T-Bonham.net]

I’ve seen Annual Reports where the Notes section mentions ongoing lawsuits, and then has wording like "management (or ‘our legal advisers’) believe this suit is without merit and expect the company position to be upheld in court". Which I understood to mean that the report does not include any accounting entries to cover the contingency that the company may lose.

[Blue_Blistering_Barnacle]

Ouch! That would hurt your negotiating position in a lawsuit if you had to publicly disclose that you thought it was more likely than not that you’d lose.

[l0k1]

It depends. If I have one lawsuit that I’m booking a contingency liability for, then it might look bad, but if I have dozens every year, then it’s booked based on history. If someone is going after me for $100m, chances are it’s not me first lawsuit.