Losses, recoveries, and offsetting new rules for reporting contingencies.

Recent pronouncements from the FASB and SEC could signal a dramatic departure from the way many companies have traditionally applied SFAS 5, "Accounting for Contingencies." This article highlights these developments and describes the applicable reporting requirements.

Suppose your company or client suddenly faced a billion dollar litigation settlement. Would accruing a liability of this magnitude mean the collapse of the balance sheet? If the enterprise in question is Eastman Kodak, the answer is no. In fact, Kodak recorded a loss of roughly this amount in the fourth quarter of fiscal 1990 after finally agreeing to settle a patent infringement suit brought against it by Polaroid Corporation some 15 years earlier. Although it marked the largest such award in U.S. legal history, the liability had no immediately obvious impact on Kodak's financial position since it did not appear in the year-end balance sheet.

How was Kodak able to achieve this financial reporting paradox? No accounting wizardry was involved. Instead, Kodak simply employed "offsetting," a financial statement technique that is much more common than users may realize. Recent developments at the FASB and SEC have now placed new restrictions on the practice, however.

These pronouncements are likely to change the way many companies have traditionally resolved reporting dilemmas involving contingent liabilities. Contingencies related to environmental matters are those most directly affected, but companies can expect the new accounting guidelines to be broadly applied. As one SEC commissioner was quoted in the financial press, firms failing to comply "will be drawn and quartered."

This article identifies the problems from practice that prompted the new rules in this historically troublesome area and summarizes the key reporting requirements. It also explains the financial statement impact these features are likely to have for both public and private organizations.

The Contingency Dilemma

Most companies have at some time had to grapple with the question of whether or not to accrue and/or disclose loss contingencies. The many uncertainties that often surround these potential liabilities make the decision all the more difficult. Over the last several years, the increasing incidence of environmental damage has magnified the difficulties involved, making contingency reporting one of the most pressing problems facing the accounting profession.