Cognitive Bias and Contingencies

Cognitive Bias and Contingencies

Cognitive bias, whether good or bad, affects how individuals make decisions on a daily basis. As individuals, we use cognitive bias when making a purchasing decision or when deciding on a plan of action for a particular situation. The amounts reported on a company’s financial statements are no exception to this bias. Cognitive bias can, and has, had a material effect on the numbers reported in the contingency notes of the financial statements. In some cases, management’s cognitive bias is strong enough to sway their decision even when there is significant evidence to the contrary. Due to cognitive bias, contingencies in the financial statement footnotes are reported at too low of an amount.

Companies who file legal proceedings or lawsuits do so with the intention of winning. Likewise, the companies who have lawsuits filed against them believe they can prove their innocence and win the case. However, someone must lose. For example, Apple Inc. and Samsung were recently engaged in a lawsuit over patent rights to certain features of their respective smart phones. Some experts believed that Apple would win this lawsuit while many other were uncertain how events would unfold. Judge Koh, who presided over the trial, made the comment “I see risk here for both sides if we go to a verdict.” (Fried). Even with the lack of certainty over who would win, Samsung wrote the following in the contingency section of their financial statements: “In addition to the case mentioned above, the Company has been involved in various claims and proceedings during the normal course of business with numerous companies including Apple Inc. The financial outcome of these matters is uncertain. However, the Company believes the outcome of these matters will not have a material impact on the financial condition of the Company” (Samsung). The outcome of these matters did have an impact on the financial condition