Big 4 and FAS 5 – What We Don’t Know Can’t Hurt Us

Project: Contingencies
Reference Number: 1600-100

Disclosure of Certain Loss Contingencies—an amendment of FASB Statements No. 5 and 141(R), has prompted 226 comments as of today and my posts on the subject prompted one reader to write with a question:

Hello Francine…What is the likelihood of the Gnomes of Norwalk being successful in passing this new amendment? In the media, it seems like the point of view is that trial lawyers get a hold of information regarding opportunities to sue the entities as well as what legal strategies appear likely to be used in the future. However, it seems like FASB/IASB envisioned this risk in ‘Objective 11’.   Do you agree?  Where do the Big 4 stand on this?

Atlanta Falcon

Well, Mr. Falcon, you prompted me to do some work. I had a lovely weekend, full of summertime fun in Chicago, including BBQs, sunsets, tequila, and family time. So, needless to say I was feeling rather ‘perezosa” and ‘floja’ today. But your email got me back in my seat and doing my homework, with some help from one of my most trusted technical advisors.

No, I don’t think it’s going to pass. What a shame for investors…

It seems that the attitude of the Big 4 is, “What we don’t know can’t hurt us.”

And also, “We don’t know if we can ever know what we don’t know, so please don’t make us or at least give us more time.”
And finally, “If you make us know what others don’t want us to know, we don’t know what we’ll do with that information and can’t guarantee we can ever know anything well again.”

I’ve excerpted the comments from EY, Deloitte, PwC and KPMG. All are pretty much on message with only slight variations. So much for looking out for their client, the shareholders. Do they have the same lawyer? Maybe Mike Young?

Actually, KPMG’s seems to be the most thoughtful and the most open minded about what it would take to make better disclosure happen without shutting the door completely.

I guess when you’ve got nothing to lose…


As auditors, we need information from legal counsel to evaluate the appropriateness of the entity’s accounting for and disclosure of litigation, claims, and assessments. The proposed Statement will result in a need for more information, including information about the prejudicial nature of the related disclosures. These assessments are not within the realm of an auditor’s expertise.


…The proposed Statement includes an exemption in “rare instances” from providing information that may be deemed prejudicial. We agree that an exemption from disclosing prejudicial information should be provided; however, we anticipate that it would be used more often than in “rare instances,” and that auditing these types of assertions may prove challenging and potentially harmful to an entity’s defense because of potential breach of attorney-client privilege….

We are concerned about an auditor’s ability to obtain a reasonable level of assurance in auditing some of the proposed disclosures, such as (1) estimates of the entity’s maximum exposure to loss, (2) underlying assumptions used in arriving at that estimate, (3) the most likely outcome, and (4) whether a disclosure meets the prejudicial exemption. The information that management might use to develop estimates and support amounts included in the related disclosures could come from sources to which the auditor does not have access. For example, management may have conversations with attorneys that are covered by attorney-client privilege and in which auditors would not be able to participate…


…We acknowledge that the proposal will provide users with considerably more information about loss contingencies than they currently receive. However, some of this information will be quite fluid because of the evolving nature of most contingencies and therefore could be misleading, despite management’s best efforts in developing it. That will place undue strain on the user community as it struggles to evaluate the extent to which it can base decisions on such information. And, largely because of the unique nature of the U.S. legal environment, the proposal is likely to place undue strain on preparers, the legal community, and the auditing profession due to the fact that maintaining the privity of what is typically highly sensitive information is critical to a company’s successful legal defense. …The nature and subjectivity of the proposed disclosures will create a challenge for auditors to understand management’s assessments and obtain sufficient evidence to support them.

Further, management may hesitate to provide this evidence based on concerns that the information constitutes legal advice the company has received from counsel. We have been informed that providing such information could jeopardize the attorney-client privilege, attorney work-product doctrine, and other legal protections. We understand that if disclosure is made and information is provided to the auditors, that information might be held to be subject to discovery by the plaintiff. On the other hand, by withholding such information, management runs a risk that the company’s auditors would be unable to opine on financial statements containing the proposed disclosures…


...However, the ABA Treaty does not compel a lawyer to provide information relative to certain disclosures proposed in the Exposure Draft. Accordingly, absent substantive amendment to the ABA Treaty, lawyers likely will not provide the information necessary for an auditor to corroborate management’s representations supporting such disclosures. In addition, AU 337, paragraph 13, states that, “[a] lawyer’s refusal to furnish the information requested in an inquiry letter would be a limitation on the scope of the audit sufficient to preclude an unqualified opinion”.

In addition, the ABA Treaty does not recognize the Board’s more-likely-than-not threshold for recognition of certain loss contingencies in business combinations and the related fair value measurement approach for recognized contingencies in Statement 141 (R). Rather, the ABA Treaty references outcome probabilities in the context of “remote” and “probable”. Accordingly, financial statement preparers will be required to determine, and
auditors will be required to assess, the propriety of accounting and disclosure matters associated with loss contingencies by reference to a benchmark that is different from the one lawyers use when responding to auditor inquiries on the same subject… We believe that amendments to existing auditing literature and the ABA Treaty must be addressed before the FASB finalizes revisions to the disclosure requirements of Statement 5…

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