Introduction
In June 2023, 3M agreed to pay between $10.5 billion and $12.5 billion over thirteen years to settle claims by US public water suppliers over per- and polyfluoroalkyl substances (PFAS), the so-called forever chemicals. Two months later it agreed to pay $6.0 billion through 2029 to resolve litigation over combat earplugs sold by a subsidiary. It recorded pre-tax charges of $10.3 billion and $4.2 billion for the two settlements, in the second and third quarters of 2023, and by the end of 2025 had paid $8.2 billion under them. Meanwhile, for respirator mask and asbestos claims, it carried an accrual of $473 million and stated that it could not estimate how far the eventual liability might exceed it.
The two cases show the range of what the accounting for contingencies can say. A settlement with agreed amounts and dates becomes a measurable liability; a stream of future claims of unknown size may produce an accrual that is explicitly a floor. Reading a company's contingency note means knowing which kind of number is in front of you. Disputes over income taxes are excluded from these rules and follow a separate model, covered in uncertain tax positions and tax reserves.
When a Loss Must Be Recorded
Accounting Standards Codification (ASC) 450 sorts contingencies by how likely they are to produce a loss:
| Likelihood | Meaning | Accounting |
|---|---|---|
| Probable | The future event is likely to occur | Accrue a liability if the loss can be reasonably estimated, and disclose it |
| Reasonably possible | More than remote but less than likely | Disclose the nature and an estimate of possible loss, or state that no estimate can be made |
| Remote | The chance is slight | No accrual and generally no disclosure |
- Loss contingency
An existing condition, situation or set of circumstances involving uncertainty about a possible loss that will be resolved when future events occur or fail to occur, such as pending litigation, a product warranty dispute or a government investigation. Under ASC 450 it is recorded as a liability only when the loss is probable and reasonably estimable.
Both conditions for an accrual must be met, as Deloitte's guide to recognizing loss contingencies explains. A loss that is probable but cannot yet be estimated is disclosed, not recorded, until an estimate is possible. The standard sets no numerical threshold for probable, so the judgment rests with management and its lawyers, and it typically moves as litigation develops: a court ruling, a failed motion or the start of settlement talks can turn a reasonably possible loss into a probable one. Routine, recurring obligations such as product warranties are estimated in the same way but from statistical experience across many claims, as covered in reserves and allowances.
Measuring the Accrual
When a loss is probable, the company accrues its best estimate. If it can estimate only a range, and no amount within the range is a better estimate than any other, it accrues the minimum of the range and discloses the possible additional loss.
Accruals are generally not discounted, because the timing of payment is uncertain. A settlement with a fixed and determinable schedule is different: 3M recorded its settlement obligations at present value and imputes interest on them, which is why the $10.3 billion water charge was below the $12.5 billion of nominal payments (the earplug charge was also net of an accrual already on the books). Legal fees to defend a claim are usually expensed as the services are received rather than included in the accrual, although companies may choose a policy of accruing expected defense costs; 3M's asbestos accrual includes them.
Environmental Remediation
Obligations to clean up contamination from past operations are loss contingencies too. They are accrued, usually undiscounted, when remediation is probable and its cost can be estimated, which 3M says is generally no later than the completion of feasibility studies, its commitment to a plan of action or approval by regulators. They differ from the legal obligations to dismantle or restore an asset at the end of its life, which are recorded when the asset is put in place, as described in asset retirement obligations. Remediation estimates often rise as investigations reveal more contamination, so the accrual history matters as much as the balance.
Insurance Recoveries and Gains
An expected insurance recovery is recorded as a separate asset when it is probable, not netted against the liability, and it cannot exceed the loss recognized unless the gain contingency rules are met. Gain contingencies, such as a lawsuit a company expects to win, are not recognized until they are realized or realizable: the accounting records probable losses as soon as they can be estimated, but waits for gains.
What the Disclosures Do and Do Not Say
For each material matter, or group of similar matters, the note describes the nature of the contingency, the amount accrued and, for reasonably possible losses beyond the accrual, an estimate of the possible loss or range, or a statement that no estimate can be made. Many companies disclose a single aggregate range for all their reasonably possible losses. The Securities and Exchange Commission (SEC) staff regularly presses companies that say no estimate can be made, especially when litigation is well advanced.
3M's 2025 annual report shows both ends of the spectrum. The settlements have stated totals and payment schedules. The asbestos accrual reflects claims expected to be filed through about 2050, and the company explains that it cannot estimate the upper end of the range because future claims are hard to project and damages are rarely attributed to individual defendants.
How Bankers Treat Litigation
Large settlements and litigation accruals are usually treated as debt-like items in valuation: the present value of the remaining payments, after any tax deduction the company will receive, is subtracted in the bridge from enterprise value to equity value, as described in the equity value to enterprise value bridge. For a lawsuit that deduction comes only as payment is made, under the economic performance rules, not when the accrual is recorded. The charges themselves are excluded from adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) and adjusted earnings, as covered in one-time items: restructuring, impairments and gains, but the cash payments are real and continue for years: 3M's run through 2036.
In mergers and acquisitions, contingencies that cannot be priced reliably are handled in the deal terms. Sellers may give indemnities for specific matters, part of the price may be held in escrow, or the buyer may insure against breaches of the seller's representations. In spin-offs, the separation agreement decides which company bears each legacy liability.
Guarantees of others' obligations, which can create a liability even when no loss is probable, are covered in off-balance-sheet arrangements and guarantees.
