How Litigation Confirmation Works
Litigation confirmation generally occurs as part of the audit's procedures for evaluating contingencies and legal exposures. Management first provides the auditor with information about known legal matters and identifies the entity's relevant external legal counsel. The auditor then prepares confirmation requests and sends them to the appropriate attorneys, typically with management's authorization.
The legal counsel's response can address matters such as the nature of a proceeding, the current status of the case, the likelihood of an unfavorable outcome, and an estimate or range of potential loss when such information can be provided. The auditor compares the response with management's records and other audit evidence.
- Management representation: Management identifies known claims, litigation, and legal advisers.
- Confirmation request: The auditor requests relevant information directly from external counsel.
- Legal response: Counsel provides information within the scope of the request and applicable professional obligations.
- Audit evaluation: The auditor considers the response when assessing financial statement recognition and disclosure.
Information Covered by a Confirmation
A well-designed confirmation request focuses on information that can affect the financial statements. Depending on the circumstances, it may ask about pending or threatened litigation, claims and assessments, the status of proceedings, management's description of the matter, and the legal counsel's evaluation of the likely outcome.
The response can also help identify differences between the legal department's understanding of a matter and the information recorded by finance. For example, an auditor may discover that a legal proceeding identified by counsel was not included in management's litigation schedule. That difference can prompt additional audit procedures and an evaluation of whether the related accounting or disclosure requires adjustment.
Litigation Confirmation and the Audit Process
Litigation confirmation forms part of a broader Litigation Process, which can include the filing of claims, discovery, negotiations, hearings, settlement discussions, judgment, and appeals. From an accounting perspective, the auditor is particularly interested in developments that could affect whether a loss should be recognized or disclosed.
Legal matters can also arise in specialized areas. Tax Litigation, for example, involves disputes concerning tax positions or assessments and can create accounting considerations for tax liabilities, contingencies, interest, and related disclosures. A legal confirmation can provide evidence about the status of such matters when external counsel is involved.
Financial Reporting Implications
The information obtained through litigation confirmation can influence how an entity evaluates contingent liabilities and related disclosures. The accounting treatment depends on the applicable financial reporting framework and the specific facts of the legal matter, including the likelihood and potential amount of loss.
Consider a company facing a legal claim for $2M. Management may initially estimate that the probability of an unfavorable outcome is remote. External counsel's response could provide updated information indicating that the matter has progressed materially. The auditor would then evaluate the new evidence alongside management's assessment and determine whether additional audit work or financial statement adjustments are appropriate.
Litigation-related amounts may also affect notes to the financial statements. A Litigation Expense Disclosure can provide users with information about relevant legal expenses or litigation-related financial effects when disclosure is required by the applicable reporting framework.
Best Practices for Litigation Confirmations
Effective litigation confirmation procedures depend on complete legal-matter inventories, accurate contact information for external counsel, clear requests, and timely follow-up. Finance, legal, and audit teams should maintain consistent records so that significant developments are reflected in financial reporting assessments.
- Maintain a current schedule of pending and threatened legal matters.
- Identify all external counsel handling matters that could affect financial reporting.
- Ensure confirmation requests clearly describe the information sought and relevant reporting period.
- Compare counsel responses with management's litigation schedules and accounting records.
- Investigate material differences and document the resulting accounting conclusions.
Summary
Litigation Confirmation provides auditors with information from external legal counsel about an entity's legal claims, disputes, and potential obligations. By comparing legal responses with management's records and financial reporting assessments, auditors can obtain evidence relevant to contingent liabilities, recognition, and disclosure. The procedure therefore supports reliable financial reporting and informed evaluation of legal exposures.