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As Accounting Rules Often Surface in Deal Litigation, Some Suggest FASB Study

Denise Lugo  Editor, Accounting and Compliance Alert

· 6 minute read

Denise Lugo  Editor, Accounting and Compliance Alert

· 6 minute read

U.S. accounting rulemakers should routinely study why certain accounting topics keep surfacing in corporate lawsuits to assess how rules that require significant use of judgment are holding up in today’s economic climate, some say.

Accounting rules related to fair value estimates, purchase price, deferred revenue, leases, accounts receivable reserves, goodwill, impairment and contingencies are “frequent flyers” in litigation, lawyers said in October 2023.

“In my own experience it’s certainly never anyone intentionally getting things wrong, or intentionally misapplying GAAP, it tends to be good faith disputes over application of particularly complex standards involving a significant degree of professional judgment to a complex set of facts,” said Gibson Dunn Partner Monica Loseman, who has worked for decades on securities litigation accounting disputes. “So that’s where I tend to see accounting centered disputes, it’s really in the hard stuff.”

Loseman, also a member of the Financial Accounting Standards Advisory Council (FASAC), the FASB’s main advisory body, was not addressing the topic from that role.

“We just tend to see the same types of issues again and again in a variety of litigation matters, whether that’s shareholder class actions, or SEC enforcement investigations, and ultimately proceedings or purchase price disputes when you’re dealing with deal litigation, that sort of thing,” she said.

Other lawyers partially agree, adding that when a company announces an impairment or a revision of an estimate, this can lead to a private lawsuit, or if it is a public company, the SEC might get interested “in any area in which there is judgment that gives people the opportunity to second guess that judgement.”

Focus: Deal Litigation

In general, the topic surrounds two different perspectives: one from securities class actions or shareholder class actions under federal securities laws; and a separate and distinct area for deal litigation like purchase price disputes.

In shareholder class action, the accounting issues typically surround fair value, loan loss contingencies, goodwill or anything involving a significant degree of judgment. Lawyers acknowledge that because federal securities laws have a very high bar for any complaint alleging the misapplication of U.S. GAAP in terms of getting past a motion to dismiss and therefore such cases tend to be resolved early.

Thus, the cases whereby an academic study by the Financial Accounting Standards Board (FASB), which develops GAAP, would be beneficial surround deal litigations to determine whether an accounting issue is driving a dispute, was one suggestion.

“So where you have two sophisticated companies, there’s a seller, selling a business unit to a purchaser, those sophisticated parties, they agree that there will be a closing balance sheet and there’s negotiation over what or whether representations are made with respect to that closing deal sheet,” Loseman said.

“But often times those representations involve the application of GAAP – whether there’s a good faith or consistent application of GAAP standards some sellers will negotiate for a historically consistent application of GAAP so they’re not necessarily guaranteeing their accounting is consistent with GAAP but they’re saying this is the way we’ve been doing it for years, and years, and years,” she said. “So I think from a standard-setting perspective, from the FASB’s perspective, the frequency with which particular accounting issues come up might be informative in terms of whether there’s a problem with GAAP, versus a dispute or a problem that’s really driven by just a unique set of facts.”

Contingencies Rules Always Come Up

Weighing in at a high level, academics flagged rules around contingencies as tricky, pointing out the tension between the intention behind GAAP to provide relevant and timely information to financial statement users about issues that may lead to the need to disburse cash in the future related to matters that are uncertain at the balance sheet date and the actual economic consequences of the underlying issue – such as lawsuits.

Specifically, if an entity discloses details about a pending lawsuit to inform investors, they are also sharing those details with the plaintiffs, which could directly harm the case, said Ray Pfeiffer, Professor of Accounting School of Business at Simmons University in Boston, Mass.

“The accounting rule puts companies in a difficult spot, but companies already seem to have found mechanisms to comply with the rules without having to say things in their financial reports that would be detrimental to their chances of winning in court,” he said on Oct. 24. “For that reason, I don’t know that either the FASB or companies would feel the need to push for amendments to the rules.”

The FASB has considered revisiting the accounting rules for contingencies in recent years, but this never made it to the board’s active agenda.

“The pendulum currently has swung a bit too far toward allowing companies to minimize the usefulness of what they share about contingent liabilities, but again, there are big issues that would make it hard for the FASB to try to get companies to be more forthcoming about those contingencies – could be an unwinnable battle,” Pfeiffer said.

What can Accountants do?

According to Cornerstone Research’s recent Accounting Class Action Filings and Settlements report, the number of securities class action filings involving accounting allegations increased slightly in 2022 over the prior year – a signal that the topic is timely.

But some lawyers said that the accounting rules may not make much of a difference in terms of lawsuits, stressing that a measure of judgment will always be needed—whatever the rule. They suggest that instead accountants should habitually do the following three things:

  • Process is important. Plan a robust process and follow through on that process from period to period. For example, if a reserve is set up in year one, consider the level of that reserve in year two. “Having a consistent process in place that allows for an apples-to-applies comparison is worthwhile,” one lawyer from a major law firm said, speaking on condition of anonymity.
  • Document. “I don’t think you necessarily write ‘War and Peace’ but having well documentation in place so that it is clear what you did and what you considered and how you got to where you got I think that is helpful because in most of these cases the issue is going to be ‘what was the basis for what you did’ – even recognizing that maybe subsequent events have demonstrated that a different judgment would have been better, and pulling out what you did and being able to demonstrate that is helpful,” he said.
  • Critically assess. Assessing “where you’re landing and coming back at the end and rethinking and challenging the various assumptions and being disciplined in doing that sort of helps as well.”


This article originally appeared in the October 26, 2023 edition of Accounting & Compliance Alert, available on Checkpoint.

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