When to Record Settlement Expenses?

To foster greater transparency in corporate bookkeeping, top leadership adopts policies with extensive capabilities to detect and react to fraudulent transactions and point-in-time financial breaches. Company principals also work in tandem with department heads to instill in personnel the need to monitor non-recurring items, such as settlement expenses and regulatory penalties.

A settlement expense may be associated with a real estate transaction or a charge a business incurs as part of a legal proceeding. Mortgage-related settlement costs refer to cash a borrower pays for things like land surveying, property appraisal, legal work and insurance. Settlement charges coming from a legal arrangement cover money a company remits to accountants, lawyers, consultants and other entities that actively participated in the settlement of a contract or purchase order. For a company, monitoring settlement expenses may pose an operating challenge, because these charges often are unpredictable and relate to events that management cannot foresee or has limited latitude to change once they unfold.

Under accounting rules, a company records settlement expenses -- and all operating charges, for that matter -- when it incurs them. In other words, it posts expense entries when service providers have fulfilled their part of the contractual agreement. For example, if a business wants to buy a commercial building and lawyers have finished preparing all legal documents pertaining to the transaction, the company will record legal fees when it receives attorneys' bills -- not when it pays them. To record a settlement cost, a corporate bookkeeper debits the corresponding settlement expense account and credits the vendors payable account.

An operational dilemma may arise if a company cannot precisely determine the amount it will pay to settle a contract or purchase order. This situation generally happens in legal proceedings, and corporate finance managers work with in-house counsels to estimate the amount of money the business ultimately must dole out. Financial regulations have come to managers' rescue by prescribing a set of rules to account for contingencies. Financial managers record settlement costs when they are both probable and reasonably estimable. If not, managers disclose the extent and nature of the settlement contingencies at the bottom of a corporate balance sheet. They also tell investors whether settlement losses are probable, reasonably possible or remote.

Recording settlement expenses often call for a matrix type of hierarchical arrangement, one in which personnel with diverse skills and reporting lines work together to accurately compute operating costs and record them on time. For example, accountants, budget supervisors and corporate lawyers may work collaboratively when a company is party to a lawsuit.