Consider the following scenario: The auditors of ABC Manufacturing have almost completed their fieldwork. John Smith, ABC's controller, tells Jane Jones, the assistant controller, "I think this year's audit went very smoothly. I don't think there should be any audit adjustments and our earnings figures are right on target."

Suddenly, the director of transportation comes in and asks "have you heard about Maislin? With all the contracts we have negotiated with common carriers, I wonder if we have an exposure for unbilled shipping costs."

Smith and Jones ask what Maislin is and are informed that it is a recent Supreme Court decision that may allow common carriers to recover "undercharges"--the difference between the rate actually charged and the rate filed with the Interstate Commerce Commission (ICC).

Upon hearing this, Jones states, "We may have a significant liability that is currently unrecorded. What do you think we should do?"

The Filed Tariff Doctrine

The filed tariff doctrine forbids a motor common carrier from charging rates for its transport services other than those properly filed with the ICC. Prior to 1980, the filing of interstate motor carrier tariffs with the ICC was a routine process except in those rare cases in which a shipper protested that the filed rate was too high. In this period of regulated rates, a collectively set tariff was filed with the ICC by the Motor Carrier Rate Bureau on behalf of a number of motor carriers, or a carrier filed its own rate with the ICC; and unless challenged (an infrequent occurrence), the tariff became the effective rate.

The Motor Carrier Act of 1980 (the Act deregulated the industry and permitted price competition. However, this deregulation did not abrogate the filed tariff doctrine for the motor carrier industry. As a result any motor carrier holding ICC certificates continues to be required to file its interstate tariffs with the ICC to make the tariffs effective. A failure to file a tariff means that the previously-filed tariff rate continues to be in effect.

After the deregulation of the motor carrier industry, motor carriers engaged in price cutting measures in order to attract traffic in the newly-competitive environment. In doing so, many motor carriers contracted with shippers in a fashion illustrated by the following scenario:

An interstate motor common carrier enters into a contract with a shipping customer to provide transportation freight services for a container of the shipper's product from Miami, Florida to Denver, Colorado. Because of the carrier's competitive interest in obtaining this particular shipper's business, the carrier contracts to provide this service at a rate lower than what the carrier usually charges other shippers and different than the tariff rate which the carrier has filed with its regulatory authority--the ICC.

The courts have, since inception of the filed tariff doctrine, continuously upheld it. For example, in 1982 the Supreme Court ruled that carriers have "not only the right but also the duty to recover proper charges for services performed." As such, when a shipper contracts with a common carrier for a negotiated rate that differs from the filed rate, the question may be which rate is the "proper" rate, the negotiated (and hence the billed) rate, or the filed rate? It had been the ICC's position that the negotiated rate constituted a "reasonable" tariff under the Act.

The Case of Maislin

In 1983, Maislin Industries, Inc., (a motor common carrier) filed for bankruptcy. Through an audit of its records it was determined that Maislin had "undercharges" (the negotiated rate was less than the filed rate) of $187,923 for services provided to Primary Steel, Inc. Maislin's bankruptcy trustees billed Primary Steel for these undercharges, which Primary Steel refused to pay citing the negotiated rate agreement. Maislin's trustees filed suit in an attempt to collect the undercharges.

Primary Steel contended that since the parties had negotiated the lower rates in good faith, having to pay the undercharges would constitute an unreasonable practice that would be in violation of the statute because the filed rates were not "reasonable" within the meaning of the statute. The District Court found that the issues were under the primary jurisdiction of the ICC and referred the case to the ICC for resolution.

The ICC ruled in favor of Primary Steel, thus rejecting Maislin's argument that the ICC lacked the statutory power to release a shipper from liability for any undercharges. The ICC found that Maislin and Primary Steel had negotiated rates other than the filed tariff rates and that Primary Steel had relied on Maislin to file these negotiated rates with the ICC. Since Primary Steel reasonably believed that the negotiated and billed rates were proper for the services performed, the ICC ruled that payment of the negotiated amount by Primary Steel satisfied its obligation.

The case was returned to the District Court which held that the ICC's policy of determining on a case by case basis whether the collection of undercharges would be an unreasonable practice under the statute was permissible under the Act. The Eighth Circuit Court of Appeals agreed, whereupon Maislin's bankruptcy trustees appealed to the Supreme Court.

On June 21, 1990, (just two months after the oral agruments), the Supreme Court ruled on the case. Justice William Brennan wrote in the first paragraph of the opinion:

"Under the Interstate Commerce Act (Act) ... motor common carriers must file their rates with the ... ICC and both carriers and shippers must adhere to these rates. This case requires us to determine the validity of a policy recently adopted by the ICC that relieves a shipper of the obligation of paying the filed rated when the shipper and carrier have privately negotiated a lower rate. We hold that this policy is inconsistent with the Act."

As a result of this decision, shippers have been stripped of their immunity from undercharge liability and can be required to pay these undercharges. It has been speculated that the undercharges could result in payments by shippers well in excess of $100 million-- perhaps reaching into the billions.

It would seem, then, that the Supreme Court's ruling in Maislin raises accounting

issues for shippers and their auditors. Some of those include: the question of recognition of a liability or disclosure of a contingency, any related recognition of the expense not recognized in prior periods, and the participation by the shipper in an action now judged to be in violation of the filed tariff doctrine.

Financial Statement Implications

for Shippers

Since Maislin, shippers have begun exploring their alternatives, including marshalling an effort to petition Congress for legislative relief. This, of course, serves to further substantiate the potential magnitude of the issue of undercharges resulting from negotiated rates that were not in accordance with the common carrier's filed rates.

In the meantime, the first significant accounting question for shippers is: should financial statements reflect this potential liability and if so, how? In paragraph 35 of SFAC 6, "Elements of Financial Statements," the FASB defined liabilities as:

". . . probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets . . . to other entities in the future as a result of past transactions or events."

Based on the Supreme Court's ruling, it would appear that if the common carrier (or its trustee) asserts a claim for the undercharges, that the shippers would be required to pay the amount of the undercharge. Further, the majority opinion holds that the statute "requires the carrier to collect the filed rate."

In SFAS 5, "Accounting for Contingencies," the FASB established the accounting and reporting principles for both contingencies and unasserted claims. SFAS 5 requires that loss contingencies be accrued if they are both probable and reasonably estimable. If, however, these conditions are not both met (such as the likelihood is deemed to be reasonably possible), SFAS 5 still requires disclosure in many instances.

While the provisions apply for existing conditions (contingencies currently asserted), the FASB also discussed the reporting considerations applicable to unasserted claims:

"Disclosure is not required of a loss contingency involving an unasserted claim or assessment when there has been no manifestation by a potential claimant of an awareness of a possible claim or assessment unless it is considered probable that a claim will be asserted and there is a reasonable possibility that the outcome will be unfavorable."

On the surface, it would seem that if the common carrier has not yet asserted a claim to collect the undercharges that the shipper does not need to accrue a liability. In fact, financial statement preparers would be more likely to argue that the undercharges are unasserted claims and do not even warrant disclosure until the common carrier asserts its claim. Additionally, the shipper may argue (with some validity, perhaps) that since there is an ongoing relationship with the common carrier, the carrier will not want to assert the claim.

Does that mean that shippers (if they successfully argue that the condition represents an unasserted claim and it is not yet probable that the claim will be asserted) will be able to avoid making any disclosure of its exposure from the undercharges? While it is still an emerging concept, another disclosure standard that may bear on this issueis SFAS 105, "Disclosure of Information about Financial Instruments with Off- Balance Sheet Risk and Financial Instruments with Concentrations of Credit Risk," issued by the FASB in March 1990.

If a financial instrument exposes an entity to off-balance sheet risk (i.e., the company could record a charge to income greater than the amount currently reflected on the balance sheet), SFAS 105 requires disclosure of the instruments. Because shippers do not have a recorded liability for the undercharges, the undercharges may constitute of financial instrument with off-balance sheet risk and require disclosure in accordance with SFAS 105. Again, because this is a newly emerging disclosure issue, shippers and their auditors should consider the applicability of this requirement for their financial statements.

Given current accounting and reporting requirements, it would appear that shippers would have to consider the appropriateness of making disclosures of the unasserted claims related to these undercharges. What, then, would be the responsibilities of the shippers' external auditors?

Audit Implications

Consider the following scenario applicable to ABC Manufacturing.

The auditors of ABC Manufacturing are completing their fieldwork when the audit manager learns about Maislin. This causes the audit team to question the need to make additional inquiries about any exposure ABC may have from such undercharges. As the discussion continues two questions emerge: 1) what must we do to satisfactorily complete our audit of ABC Manufacturing, and 2) are there implications of this case that should be incorporated into our general audit plan to allow audits to be conducted in accordance with existing standards?

SAS 53, "The Auditor's Responsibility to Detect and Report Errors and Irregularities," specifies that the auditor should assess the risk that errors and irregularities could cause the financial statements to contain material misstatements. Included in this is, of course, a consideration of the adequacy of the financial statement disclosures.

As can be seen, the negotiated rates (which result in the undercharges) have been deemed to be invalid if the negotiated rate has not been filed. Because these undercharges can result in additional payments by the shippers, they clearly could have a material financial statement effect. As such, the auditor would need to consider the adequacy of the related disclosures.

In determining whether disclosures are needed, the auditor should carefully consider the guidance of SAS 12 (AU 337), "Inquiry of a Client's Lawyer Concerning Litigation, Claims, and Assessments." Because these undercharges should be within the direct knowledge of management, SAS 12 specifies that the auditor should inquire of management because management represents the primary source of information about the existence of such matters.

In addiiton to the inquiries of management, the auditor should obtain written representations from management that management has disclosed to the auditors all unasserted claims that may require financial statement disclosure as part of the information in the client representation letter.

Additionally, the auditor may wish to include in the letter sent to the client's lawyer specific inquiries by the client's management about the potential liability for these undercharges.

In evaluating the information received from management and the client's lawyrs, the auditor also should consider information obtained from reading minutes of board, stockholder, and relevant committee meetings; reading contracts (notably the negotiated rate contract; and from other procedures (such as analytical procedures).

In rendering an opinion on the financial statements, the auditor may need to perform other procedures on these items to obtain reasonable assurance that the accounting and disclosures are appropriate, including consideration of the potential monetary effect that might have to be disclosed in accordance with SFASs 5 and 105. It can be argued that since the filed rates (collectible under Maislin) are public information, companies and their auditors have access to information that can be used to determine the monetary amount of the undercharges.

By George D. Saunders, Assistant Professor of Accounting; Rene Sacasas, Assistant Professor of Business Law; and Paul Munter, KPMG Peat Marwick Scholar and Professor of Accounting all of the University of Miami at Coral Gables