In the course of performing an audit, accounting firms will send to the clients' legal counsel a request for information that should be disclosed in the client's financial statements. This information includes "loss contingencies", which are usually pending or threatened litigation. In responding to such a request, legal counsel will typically state that the loss "cannot be estimated." But, accountants have found this not very helpful in estimating the possible loss.

As a result, the Financial Accounting Standards Board (FASB) recently proposed an amendment to the rule governing disclosure of loss contingencies. Under the proposed amendment, attorneys would need to disclose "quantitative information about the entity's exposure to loss from the contingency", "the entity's best estimate of the maximum exposure to loss", "a description of the factors that are likely to affect the ultimate outcome of the contingency along with their potential effect on the outcome", and "significant assumptions made by the entity in estimating" the potential loss.

But attorneys are very concerned about the risk to clients of disclosing this type of information. Gary Santella, Chair of the firm's Litigation Group, believes disclosure of this information for purposes of the audit could be harmful to the client if it could be discovered in ongoing litigation. Gary notes, "In fact, any disclosure of a worst-case scenario could conceivably then become self-fulfilling. Although the proposed amendments include an exemption from disclosure for certain information that relates to on-going litigation, the use of the exemption will likely be limited. So there is cause for concern."

The new rule is scheduled to be effective for fiscal years ending after December 15, 2008. But, before that, FASB has put the rule out for comment, with a comment period expiring on August 8. Attorneys and accountants are following the result with great interest.

More information on FASB’s proposed amendment can be found at the FASB website at http://www.fasb.org/news/nr060508.shtml