British American Tobacco (BAT) plc is the second largest tobacco company in the world, after U.S.-based Philip Morris International Inc. Its contingent liabilities note runs 12 pages long in its financial statements.
The following selected information about contingent liabilities has been extracted from the notes to its financial statements:
In cases where the Group has an obligation as a result of a past event existing at the balance sheet date, it is probable that an outflow of economic resources will be required to settle the obligation and the amount of the obligation can be reliably estimated, a provision would be recognised based on best estimates and management judgment. . . .
While it is impossible to be certain of the outcome of any particular case or of the amount of any possible adverse verdict, the Group believes that the defences of the Group's companies to all these various claims are meritorious on both the law and the facts, and a vigorous defence is being made everywhere. . . .
Having regard to all these matters, the Group (i) does not consider it appropriate to make any provision in respect of any pending litigation and (ii) does not believe that the ultimate outcome of this litigation will significantly impair the Group's financial condition.
Instructions
(a) British American Tobacco is a defendant in thousands of cases against tobacco companies. Management holds the view that there are good defences against all the claims and states that it will defend each case vigorously. Given that the tobacco industry is the target of so many lawsuits, does it make sense to you that BAT only discloses information about its legal disputes rather than accruing the amounts of the lawsuits as liabilities? Explain.
(b) British American Tobacco's debt to total assets ratio is 65.7% and its times interest earned is 9.7 times. What implications do the contingent liabilities reported in BAT's financial statements have for an analysis of its solvency?
(c) Two of BAT's top competitors are Philip Morris International Inc., headquartered in the United States, and Japan Tobacco, headquartered in Japan. What general areas related to the recording and reporting of liabilities might you want to check regarding each country's financial reporting standards before you compare BAT's results with those of Philip Morris and Japan Tobacco?