In its December 31, 2020, Form 10-K, O’Reilly Automotive, Inc. included this disclosure about Litigation Accruals in it Summary of Significant Accounting Policies:
Litigation Accruals:
O’Reilly is currently involved in litigation incidental to the ordinary conduct of the Company’s business. The Company accrues for litigation losses in instances where a material adverse outcome is probable and the Company is able to reasonably estimate the probable loss. The Company accrues for an estimate of material legal costs to be incurred in pending litigation matters. Although the Company cannot ascertain the amount of liability that it may incur from any of these matters, it does not currently believe that, in the aggregate, these matters, taking into account applicable insurance and accruals, will have a material adverse effect on its consolidated financial position, results of operations or cash flows in a particular quarter or annual period.
While this seems like an ordinary enough accounting policy, the use of the term “material” when talking about outcomes seems to qualify when probable losses are accrued. This prompted the SEC to ask O’Reilly this question in a December 21, 2021, comment letter:
- It appears based on your disclosure that you only accrue for litigation losses that are material. Please tell us and revise your disclosure to clarify that your litigation accrual policy is in accordance with ASC 450-20-25-2.
The company’s response letter included this explanation and proposed revised disclosure:
Response:
The Company respectfully advises the Staff that it performs an analysis under the provisions of the FASB ASC Topic 450-20, Loss Contingencies (“ASC 450-20”) for all matters. ASC 450-20 requires an estimated loss from a loss contingency to be accrued as a charge to income if both of the following conditions are met: (a) information as of the date of the financial statements indicates that it is probable (i.e., the future event is likely to occur) that one or more future events will occur confirming the fact that a liability had been incurred, and (b) the amount of the loss can be reasonably estimated. If the reasonable estimate of the loss is a range, then condition (b) is still deemed to be met. If an amount within the range appears at the time to be a better estimate of the loss than any other amount within the range, such amount shall be accrued. However, if no amount within the range is a better estimate than any other amount, the lowest amount in the range shall be accrued. In accordance with the above analysis, the Company accrues estimated losses as charges to income when the criteria in ASC 450-20-25-2 are met.
On the other hand, disclosure of the contingency, but no accrual, is required if there is at least a reasonable possibility that a loss or an additional loss will occur and either of the following conditions exist: (a) an accrual is not made for a loss contingency because the conditions described above are not met or (b) an exposure to the loss potentially exists in excess of the amount accrued. If disclosure is required under either of these conditions, the Company discloses the nature of the contingency and an estimate of the possible loss or range of loss or a statement that such an estimate cannot be made.
While the Company has consistently followed the guidance of ASC 450-20-25-2, in future filings the Company will revise its disclosure to clarify that its litigation accrual policy is in accordance with ASC 450-20-25-2.
The proposed revised disclosure is updated as follows:
Litigation accruals:
O’Reilly is currently involved in litigation incidental to the ordinary conduct of the Company’s business. Based on existing facts and historical patterns, the Company accrues for litigation losses in instances where an adverse outcome is probable and the Company is able to reasonably estimate the probable loss in accordance with ASC 450-20. The Company also accrues for an estimate of legal costs to be incurred for litigation matters. Although the Company cannot ascertain the amount of liability that it may incur from legal matters, it does not currently believe that, in the aggregate, these matters, taking into account applicable insurance and accruals, will have a material adverse effect on its consolidated financial position, results of operations or cash flows in a particular quarter or annual period.
After this response the SEC sent their normal closing letter.
As always, your thoughts and comments are welcome!