Accounting for Loss Contingencies Alison T. Spivey Associate Chief Accountant Office of the Chief Accountant

2 The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. Therefore, the views expressed today are my own, and do not necessarily reflect the views of the Commission or the other members of the staff of the Commission. Disclaimer

3 Presentation overview Use of estimates in financial statementsUse of estimates in financial statements Accounting for loss contingenciesAccounting for loss contingencies SEC viewsSEC views Assumptions used in accounting estimatesAssumptions used in accounting estimates The role of disclosuresThe role of disclosures Recent activities in OCARecent activities in OCA Consulting with OCA staffConsulting with OCA staff

4 Use of Estimates Financial statements include estimates of underlying values of assets, liabilities, and equityFinancial statements include estimates of underlying values of assets, liabilities, and equity v Financial instruments v Contingencies v Compensation programs (e.g., stock options) Current accounting standards provide guidance on preparing estimates.Current accounting standards provide guidance on preparing estimates.

5 Loss Contingencies - Current Accounting Model Statement 5 issued in 1975.Statement 5 issued in Requires accrual of estimated loss from loss contingencyRequires accrual of estimated loss from loss contingency v Probable v Reasonably estimable Disclosure of estimated possible loss or range of loss required when accruals not recorded.Disclosure of estimated possible loss or range of loss required when accruals not recorded.

6 Recent Accounting Standards and Other Guidance Statement 143 – Asset Retirement ObligationsStatement 143 – Asset Retirement Obligations Statement 146 – Exit or Disposal ActivitiesStatement 146 – Exit or Disposal Activities FIN 45 – GuaranteesFIN 45 – Guarantees Concept Statement 7 – Cash Flow Information and Present Value MeasurementsConcept Statement 7 – Cash Flow Information and Present Value Measurements

7 Proposal Stage Literature FASB:FASB: v Fair Value Measurements v Business Combinations v Conceptual Framework IASB:IASB: v Business Combinations v Provisions and Contingent Liabilities

8 Loss Contingencies - Commissioner and Staff Views 1998 – Chairman Arthur Levitt, The “Numbers” Game1998 – Chairman Arthur Levitt, The “Numbers” Game Staff Accounting BulletinsStaff Accounting Bulletins Recent staff speechesRecent staff speeches

9 Assumptions Assumptions underlying accounting estimates – guidance in specific accounting standardsAssumptions underlying accounting estimates – guidance in specific accounting standards v Pension accounting v Share-based payment (stock options) Staff Accounting Bulletin 107Staff Accounting Bulletin 107

10 Disclosures Financial statementsFinancial statements MD&AMD&A Critical Accounting EstimatesCritical Accounting Estimates

11 Study and Report on Off-Balance Sheet Arrangements Overview v Mandated by Section 401(c) of Sarbanes-Oxley v Extent of off-balance sheet transactions, including the extent to which SPEs are used to facilitate such transactions v Assessment of GAAP and Commission rules in providing transparency of such transactions to investors v Assessment of GAAP consolidation of SPEs by sponsors who have majority of risks and rewards

12 Study and Report on Off-Balance Sheet Arrangements Topics Addressed v Leases v Retirement arrangements v Consolidation issues v Contingencies v Transfers of financial assets with continuing involvement

13 Study and Report on Off-Balance Sheet Arrangements Improvements to Financial Reporting v Discourage transactions and transaction structures motivated by accounting and reporting considerations v Expand use of objectives-oriented standards v Expand use of objectives-oriented standards v Improve consistency and relevance of disclosures v Improve consistency and relevance of disclosures v Focus financial reporting on communication with investors, rather than just rule compliance

14 Share-Based Payment Market Instruments  A market instrument is an instrument that is designed to be sold into the market at a value intended to be reasonably equivalent to the fair value of employee share options.  A statement providing the former Chief Accountant’s views on market instruments available at  Chairman Cox’s statement available at

15 Insurance Risk Transfer v Not only an issue for insurance companies u To ensure appropriate accounting for insurance contracts under FAS 5, noninsurance companies need to assess whether the contract indemnifies the company against loss u AICPA Technical Practice Aid, Accounting by Noninsurance Enterprises for Property and Casualty Insurance Arrangements That Limit Risk

16 Valuation Issues MEASUREMENT: v Valuations must be in accordance with appropriate U.S. GAAP standards and related guidance v Reliability of measurement u Not looking for precise measurements u Reasonable range of estimate based upon available information v Use of “Concepts 7” approach u Very rare to use risk free discount rate v Materiality assessment cannot be made unless try to do some analysis calculation

17 Valuation Issues v SFAS 141 – immaterial items may collectively materially misstate goodwill v SFAS 123 – very rare that option is so complex that unable to value using option pricing models USE OF EXPERTS: v Valuator’s role: independent/unbiased valuations u Whether prepared by management or use of outside experts v “Indication of value” level of assurance is not sufficient if primary valuation evidence v Management is responsible for valuation assumptions in SEC filings u Any reference to valuator raises valuator expertization issues in SEC filings

18 Consultations with OCA Guidance for Consulting with OCA v Most companies just “want to get the accounting right.” We want to help. v Guidance for resolving ‘pre-filing’ questions is posted on the SEC’s website u v Companies should provide OCA with a written submission (commonly referred to as a “pre-clearance” submission) u Auditor participation is required v Registrants can request their SEC reviewer to consult on specific matters during a Corp. Fin review process

19 Consultations with OCA Consulting with OCA v Recommended form and content of correspondence to expedite the process v What to expect from OCA u Team leader will contact the company within 3 days of receipt of submission; entire process usually takes 2 – 4 weeks but depends on nature of the issue u Team, Senior Associate and Deputy Chief Accountants may be involved u Company may request Chief Accountant review of conclusion reached by OCA staff