Monday, November 24, 2008

New Accounting Standards (FIN 47) Provide Useful Environmental Liability Information

Beginning in 2006, more detailed financial information is required to be disclosed by companies relating to their financial liabilities. Many of these liabilities can be related to environmental issues. This information will be significant to the practice of due diligence –however, the application of the new standards is not limited to disclosures associated with mergers & acquisitions.

In March 2005, the Financial Accounting Standards Board (FASB) issued a technical interpretation (FIN 47) to provide better clarity on the expectations for disclosures of future liabilities. These liabilities were associated with likely future costs related to properties, buildings, equipment and other assets Prior to the issuance of FIN 47, liabilities which were difficult to estimate or to predict timing for may not have been disclosed. Often, large environmental liabilities were left undisclosed because ultimate costs and schedule was uncertain. However, statistical methods to estimate probable cost range for liabilities have become an acceptable approach to overcome the uncertainties in reporting these liabilities.

Two general types of liabilities are recognized:

ARO (Asset Retirement Obligations). AROs are liabilities associated with the ultimate closure, dismantling, disposal and clean up associated with a company’s assets. These could include real estate, buildings or other structures or equipment.

ARO example: A company generates a hazardous waste in its process. These wastes are piped to an on-site process which stabilizes the waste, allowing it to be disposed of a non-hazardous waste at a much lower cost. As a condition of operation, once the equipment is no longer used, the company is required to conduct an extensive and expensive decontamination of the processing equipment and all processes that generated the waste. Because the timing of this liability could not be predicted, the company did not recognize these costs. Under the new accounting requirements, this may be an ARO, and may need to be included in financial disclosures.

CARO (Conditional Asset Retirement Obligations). These are a subset of AROs; however, in this case, the magnitude of the costs and/or the timing of the obligation are outside the direct control of the company.

CARO example: A company has been named as a Responsible Party (RP), along with several other companies for a landfill Superfund site. The agency responsible for the cleanup is conducting studies and implementing some preliminary cleanup actions, however, it may be several years before the final remedial plan is developed. This case may clearly represent a CARO. The company has been identified as an RP and will ultimately be required to reimburse the agency for their portion of cleanup cost. However, the overall cost, their proportional cost and the timing of the obligations are all uncertain.

One of the reasons that the FASB felt that AROs should be accounted for, even considering these types of uncertainties, is the availability of accepted mathematical and statistic approaches to generating reasonable estimates for the liabilities. These tools will combine the existing available information with the level of certainty to prepare an overall liability projection. These projections typically represent the likelihood of specified costs being exceeded (e.g., 10% likelihood that costs will exceed $15M).

For further information contact Caltha LLP at
Caltha LLP Website

No comments: