Pending Litigation, Claims and Assessments
The term pending litigation, claims, and assessments refers to a potential near-term liability due to possible, threatened, or pending assertions, lawsuits, or monetary charges. Pending litigation, claims, and assessments are classified as a contingent liability and appear on the balance sheet as a current liability if the debt obligation is reasonably expected to come due in a single operating cycle or one year.
Current liabilities are defined as debts that must be paid within one year or one operating cycle, whichever is longer. In order to be classified as contingent, the debt obligation depends on one or more future events to confirm the amount owed. If the likelihood of the future event is probable, and the obligation can be reasonably estimated, the company should accrue the expense and place the current liability on their balance sheet.
Before recording a lawsuit, claim, or assessment as a current liability, a company needs to consider the following factors:
- Timing: to report a loss and liability in the current accounting period, the cause for the litigation or claim must have occurred prior to the date of the company’s financial statements.
- Likelihood of Occurrence: this includes the probability of an unfavorable outcome for the company. Factors such as the advice of the company’s litigation team or prior success or failure should also be considered.
- Measurability: the company should be able to reasonably quantify the amount of loss, if any.
Since the outcome of pending litigation can rarely be predicted with any precision, companies typically refrain from disclosing an estimate of the potential loss. Such disclosures can also weaken the company’s position. For this reason, disclosure is usually limited to notes appearing alongside the company’s financial statements.