Originally published 4th Quarter, 2005
In the past, generally accepted accounting principles (GAAP) did not require companies to report liabilities for environmental conditions, such as contaminated facilities or buildings with asbestos-containing materials, unless there was a pending or threatened legal proceeding associated with the condition. Now, companies must account for environmental legal obligations associated with their assets, even if government enforcement or private litigation is considered unlikely to occur. Under the new standard, companies that prepare audited financial statements are required to report previously undisclosed environmental liabilities when one can reasonably estimate the fair value of the obligation. The brownfields redevelopment movement may benefit from this reporting obligation if "mothballing" – the practice of fencing-off contaminated property indefinitely to delay or avoid cleanup costs – becomes a thing of the past. Indeed, companies may now decide to remediate or sell previously mothballed properties to avoid disclosure of these environmental liabilities in their financial statements.
In 2001, the Financial Accounting Standards Board (FASB) issued the Statement of Financial Accounting Standards No. 143, Accounting for Asset Retirement Obligations (AROs) (FAS 143), requiring companies to recognize the fair value of an ARO’s liability, in the period in which it is incurred, if a reasonable estimate of fair value can be determined. AROs are legal obligations associated with the retirement of a tangible long-lived asset. Long-lived assets include property, industrial or manufacturing plants and equipment. "Asset retirement" means "other-than-temporary removal from service," whether through sale, abandonment, recycling or disposal, at or before the end of the asset’s productive life.
After FASB issued FAS 143, most accounting firms concluded that the new standard did not apply to conditional AROs. Most environmental cleanup obligations are considered conditional AROs, including the cleanup of contaminated soil and groundwater on a property, or the abatement of asbestos-containing materials in a building. These obligations are conditional on future events such that the timing or method of settlement of the obligation may or may not be within the control of the company. In the aforementioned examples, an entity may have the ability to postpone the investigation of a property with suspected soil or groundwater contamination or delay indefinitely the renovation of a building with asbestos-containing materials. Thus FASB’s implementation of the standard alone had little influence on the financial reporting of environmental liabilities.
Earlier this year FASB responded by issuing an interpretation of FAS 143, called Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations (FIN 47). The interpretation clarifies that companies are required to recognize a liability for the fair value of the conditional ARO. The interpretation specifically lists examples of environmental conditional AROs that are subject to the standard. In one example a telecommunications company uses chemically-treated poles and replaces the poles periodically. There is no specific legal requirement to replace the poles but once they are removed existing laws require a special type of disposal. The company has sufficient information to estimate the dates, methods and costs of properly disposing the treated poles; therefore, the company is able to reasonably estimate the amount of the liability and is required to recognize the liability on the date it purchases the poles.
FIN 47 is effective for fiscal years ending after December 15, 2005, for companies reporting for a fiscal year, and December 31, 2005, for companies reporting for a calendar year. In the near future, FIN 47 will affect the way companies account for environmental conditions at their properties and facilities and will likely accelerate the cleanup, transfer and redevelopment of contaminated sites.
The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.
