5 Questions Your Auditor Will Ask About Litigation Reserves

Audit season is stressful enough without scrambling to answer questions about litigation provisions. Auditors approach legal contingencies with particular scrutiny because they involve significant judgment, often material amounts, and carry inherent uncertainty.

Here are the five questions auditors will almost certainly ask — and how to prepare compelling answers.

1. “What is your process for identifying and assessing litigation matters?”

Auditors want to understand your methodology, not just your conclusions. They’re looking for a systematic process that would identify all material litigation and assess it consistently.

What they’re really asking:

• How do you ensure nothing material is missed?
• Who makes the assessments?
• How often are they updated?
• Is the process documented?

Strong answer elements:

• Description of how matters are identified (legal department reporting, claims notifications, etc.)
• Clear ownership of the assessment process
• Defined review frequency (quarterly at minimum)
• Written policy or procedure

Red flags they’re looking for:

• Ad-hoc processes that depend on individuals remembering
• No documentation of how matters are tracked
• Assessments that haven’t been updated in multiple periods

Example response: “All litigation is tracked in our matter management system. Legal counsel provides initial assessments, which Finance reviews quarterly. Probability and exposure assessments are updated following any material development, and the full portfolio is reviewed before each quarter-end.”

2. “How did you determine the probability of an adverse outcome?”

This is the heart of IAS 37 compliance. Auditors will probe whether your probability assessments are supported and consistent.

What they’re really asking:

• What evidence supports your probability classification?
• Are you applying the standard’s probability bands correctly?
• Have you documented the rationale?

Strong answer elements:

• Written assessment from legal counsel
• Reference to case developments that inform the assessment
• Consistent application of probability bands across matters
• Documentation of changes from prior periods with rationale

Red flags they’re looking for:

• Probability assessments without supporting rationale
• Inconsistent treatment of similar matters
• Optimistic assessments without legal input
• No documentation of judgment

Example response: “Each matter has a documented probability assessment based on legal counsel’s written opinion. We use three bands aligned with IAS 37 — remote (below 20%), reasonably possible (20-50%), and probable (above 50%). The assessment includes rationale citing specific case factors, and any change from prior period is documented with explanation.”

3. “How did you determine the amount of the provision?”

Beyond probability, auditors will examine how you measured the provision. They want to see a defensible basis for the numbers.

What they’re really asking:

• What’s included in your exposure estimate?
• Is it based on evidence or assumption?
• Have you considered ranges of outcomes?
• Did you include defence costs?

Strong answer elements:

• Breakdown of judgment exposure, adverse costs, and defence costs
• Source of exposure estimates (claim amount, legal advice, comparable settlements)
• Sensitivity analysis or range of outcomes
• Clear methodology for expected value calculations

Red flags they’re looking for:

• Round numbers without supporting basis
• Missing components (especially defence costs)
• No consideration of different outcomes
• Estimates that haven’t changed despite case developments

Example response: “The provision includes three components: expected judgment (€500K × 45% = €225K), expected adverse costs (€75K × 45% = €34K), and remaining defence costs (€60K × 100% = €60K). The judgment exposure is based on the claim amount adjusted for legal counsel’s assessment of likely outcome. Defence costs are estimated by external counsel based on expected work to trial.”

4. “What significant matters have changed since last period?”

Auditors want to understand the movements in your litigation provisions. Significant changes require explanation.

What they’re really asking:

• What new matters arose?
• What matters were resolved?
• Did any probability assessments change?
• Did any exposure estimates change materially?

Strong answer elements:

• Complete listing of new matters
• Summary of resolved matters and actual outcomes
• Matters where probability band changed with rationale
• Material changes to exposure estimates with explanation

Red flags they’re looking for:

• Inability to explain changes
• Actual outcomes consistently worse than provisions
• Missing matters that should have been tracked
• Changes without documented rationale

Example response: “Three material changes occurred this period: (1) The Smith matter probability increased from reasonably possible to probable following adverse preliminary ruling — provision increased by €150K; (2) The Johnson matter settled for €80K against a provision of €95K — excess released; (3) New IP dispute arose with €1.2M exposure assessed as reasonably possible — disclosed but not provisioned.”

5. “Can we see the legal counsel correspondence?”

Auditors will want to verify your assessments with primary evidence. Attorney letters are a standard audit procedure for litigation.

What they’re really asking:

• Has legal counsel confirmed your assessments?
• Are there any matters counsel is concerned about?
• Is there anything you’re not telling us?

Strong answer elements:

• Attorney response letters available
• Clear documentation of matters discussed with counsel
• Assessment rationale that matches legal advice
• Process for refreshing legal input

Red flags they’re looking for:

• Inability to provide attorney letters
• Assessments that contradict legal advice
• Matters where counsel hedges but you haven’t provisioned
• Long gaps since last legal input

Example response: “We’ve requested attorney letters from all external counsel handling material matters. The letters cover each matter’s status, probability assessment, and range of potential outcomes. Our provision amounts align with counsel’s assessments. For internal matters, we have memoranda from the General Counsel.”

Preparing for Audit Season

Beyond answering these questions, preparation involves:

1. Reconcile Your Schedule

Ensure your litigation provision schedule reconciles to:

• The general ledger provision balance
• Prior period schedule plus movements
• Matter-level detail

2. Update All Assessments

Don’t let audit be the trigger for updates. Review all matters before period-end and document current status.

3. Request Attorney Letters Early

Allow adequate time for external counsel to respond. Late requests create stress and may result in qualified opinions.

4. Document the Methodology

Have a written policy explaining:

• How matters are identified
• Who makes assessments
• What probability bands mean
• How provisions are measured
• When assessments are updated

5. Prepare the Walkthrough

Auditors will want to “walk through” a sample matter. Select examples that demonstrate your process working well.

What “Sufficient Evidence” Looks Like

Auditors are required to obtain “sufficient appropriate audit evidence.” For litigation provisions, this means:

Sufficient: Enough matters reviewed to draw conclusions about the portfolio Appropriate: Evidence that’s relevant and reliable

For each sampled matter, expect auditors to examine:

• Legal counsel’s written assessment
• Documentation of probability rationale
• Basis for exposure estimate
• Change history from prior periods
• Supporting documents (claims, correspondence, etc.)

Building a Better Process

The best way to handle audit questions is to have a robust process year-round:

1. Track all matters centrally — Not in scattered spreadsheets
2. Document as you go — Rationale captured when assessments are made
3. Update regularly — Quarterly at minimum, ad-hoc for developments
4. Maintain an audit trail — Every change recorded with timestamp
5. Generate reports easily — Portfolio summaries, movement schedules, attorney letter requests

This is why we built Contingent. It maintains the structured data and audit trail that makes audit season straightforward rather than stressful.

Conclusion

Auditors ask predictable questions about litigation provisions. With proper documentation, consistent methodology, and timely assessments, these questions become routine rather than challenging.

The key is preparation — not just before audit season, but as an ongoing process throughout the year. When you capture the right information in the right format as you go, audit becomes a matter of providing access rather than scrambling to reconstruct.

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