A Proposed Model for Measuring Expected Losses from Litigation Contingencies

Abstract

According to the Securities and Exchange Commission (SEC), financial reporting has become an exercise of compliance with the copious number of rules prescribed in accounting standards rather than doing what is necessary to effectively communicate to investors. The communication of the financial impact of loss contingencies is one of the areas mentioned by the SEC that needs significant improvement. The rules specified in the accounting standards for loss contingencies are quite flexible and allow a considerable amount of interpretation. This flexibility has allowed companies to comply with the rules by providing only vague and overly broad statements about their contingencies. Companies have also commonly reported that they do not expect to incur losses right up to the time a large settlement is announced. In this paper, the authors propose a way to improve the communication of one class of loss contingencies--the litigation contingency.