Earlier this month I attended Financial Executives International's annual conference on current reporting issues. FEI's conference is always good for a sense of the latest, most pressing headaches that financial reporting departments are worried about—but this time around, the latest and most pressing headache is actually one that has been irritating corporate accounting and legal departments for more than two years: loss contingencies.

First, a refresher. Loss contingencies are amounts a company must disclose for possible losses the business might incur, where nobody knows precisely how much those costs might be or when uncertain outcomes might clarify themselves; essentially, you disclose how much money you are salting away for some unpleasant scenario that might strike the business later, such as environmental cleanup of a polluted site or a high-stakes lawsuit that goes the wrong way. Or, alternatively, you disclose that any possible loss is immaterial, or that you can't make an intelligent estimate of the loss.

Investors rightly want to know more about contingent losses, so they aren't surprised by a billion-dollar loss on, say, a patent infringement lawsuit or disposal of asbestos in that storage facility nobody has inspected since the Nixon Administration. The Financial Accounting Standards Board has long been unhappy with the quality of disclosure companies have made about contingent losses, and in 2008 decided to do something about it: strengthen Accounting Standards Codification 450, Contingencies.

The situation has gone downhill ever since. And while discussion at the FEI conference suggests we may have halted at a precarious plateau, don't be surprised if things start tumbling down again early next year.

FASB's original proposal in 2008 called for companies both to disclose more contingent events and to pin estimated dollar values to those contingencies. Corporate legal departments spat nails over that idea, fearing that it would allow litigants to extract settlements from corporations more effectively. FASB quickly retreated from that position, and published a lesser proposal in July 2010 that would give companies more flexibility in disclosing dollar amounts when litigation is in its early phases. Legal departments and law firms denounced that idea too, so earlier this fall FASB announced that it would delay any further action on contingencies until further notice—that is, after the 2010 annual reporting season next spring.

This is the precarious plateau upon which we are now perched. Corporate America and its outside counsel have been arguing for years that the current version of ASC 450 works just fine and needs no amending. Well, now is your big chance to prove it.

FASB's fundamental debate about loss contingencies is this: Is the problem in the standard, that it doesn't require enough disclosure? Or is the problem in compliance, that companies aren't obeying ASC 450 correctly? FASB had believed since 2008 that the problem was in the standard; critics had countered that the rule was fine—which implicitly puts compliance with the current ASC 450 under the microscope. All you financial reporting executives preparing for the reporting season next spring should plan accordingly.

And how does one comply with ASC 450, you ask? Wayne Carnall, chief accountant for the Division of Corporation Finance, gave an answer at the FEI conference. He offered three ways you can comply with ASC 450:

Disclose your range of contingent losses;

Disclose that any extra losses beyond what you have already accrued will be immaterial to the financial statements;

Disclose that you can't give an estimate.

Not surprisingly, most companies select option No. 3 once they know that it's available. And in many cases, you can legitimately say that you don't have enough information to make an estimate. But, Carnall stressed, that excuse will only go so far: “We do expect that as time goes on, you will have more information to make an estimate. You at least have to try to comply.” At several different sessions during the conference, Carnall and other regulatory speakers warned that they will be keeping a sharp eye on the matter.

Several questions come to mind on that point. Foremost, if Company A and Company B are suing each other, and both are making disclosures about the same litigation—will the SEC staff compare those contingency disclosures to see whether any discrepancies exist?

I tried posing that question to Carnall in a Q&A session, but never got an answer. This isn't a far-fetched hypothetical, after all, especially in disputes over patents or non-compete agreements for key employees. But if Company A is accruing contingent losses every quarter while Company B says it can't give an estimate, I'm hard-pressed to see how Company B won't get a phone call from Carnall's people with Company A's disclosures in hand.

Even better: What if the same auditor handles two litigants—say, a manufacturer suing a supplier? Should that auditor compare their disclosures and flag possible discrepancies? I don't know how often this happens; given the complicated web of litigation stemming from the financial crisis, I suspect the possibility could arise. I'm not familiar enough with auditing best practices to know whether a protocol already exists for this particular headache, but I wouldn't want to be the engagement partners faced with the question.

The auditing firms aren't rushing to wade into this morass, either. They know that most of their staffers aren't lawyers with the requisite expertise to audit disclosures around litigation—that is, the requisite expertise to know when a client's legal and accounting departments are trying to blow smoke up the investors' annual report. They would just as well have FASB keep ASC 450 in its current form, with plenty of vagueness available as necessary. As one comment letter from PwC phrased it: “We believe any improvement in reporting over the current standard would be marginal.”

You and lots of others, PwC. Now you just need to go out there and prove it.

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