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One aspect of the trend towards fair value accounting is a requirement for companies to record the fair value of contingent liabilities, such as lawsuits, on their balance sheets. This used to be a footnote disclosure, unless the contingent liability met two criteria: 1) It is probable that the liability has been incurred (in practice meaning > 50%) and 2) the amount of loss can be reasonably measured. The new approach will require a probability weighted calculation of the expected value of the loss. As an example, if a company has a lawsuit against it, and there is a 75% chance it will prevail (i.e., no liability) and 25% chance it will lose $40 million, the company would have to book a $10 million liability. However, after the lawsuit is over, and assuming that the company prevailed, it would actually recognize income of $10 million (because the liability would go away). This may give companies an incentive to over estimate the value of the liability, especially in the case where the contingency gets on the company's books due to an acquisition, with the expectation that they will be less likely to recognize a loss down the road, and possibly realize a large gain on their income statement for doing nothing!

Category(s): Fair Value Accounting
Posted by Jim Connors at 09:08 PM | Permalink | Comments (0) | TrackBacks (0)