On April 20, 2010, an explosion at BP PLC’s Macondo well in the Gulf of Mexico caused the largest oil spill and one of the worst environmental disasters in U.S. history. Because the incident occurred at the Deepwater Horizon drilling rig, this incident is often referred to as the Deepwater Horizon spill. Approximately 4.9 million barrels of oil were released, threatening the marine environment of the Gulf of Mexico as well as the environment and communities of the Gulf Coast region of the United States. In addition, 11 workers died and 17 were injured in the explosion. While BP bore primary legal responsibility for the spill, Transocean Corporation (the drilling rig operator) and Halliburton Company (the construction contractor) were also held partially responsible. 

The spill’s financial costs to BP were enormous but also highly uncertain in the years that followed. Initially, the company incurred large costs to respond to the explosion and contain the spill. As time passed, the disaster set in motion a complex set of investigations and court cases that resulted in numerous fines and damage awards. In addition, BP made expensive commitments to support various environmental initiatives in the Gulf Cost region. 

BP—formerly named British Petroleum and headquartered in London —reports under IFRS and accounted for many of the spill’s costs using IAS 37, Provisions, Contingent Liabilities, and Contingent Assets. As noted earlier in this chapter, IAS 37 requires accrual of Contingent Liabilities when they are probable and can be reliably estimated. From the 2010 fiscal year onward, the company disclosed among its significant judgments and estimates those required to account for the spill under IAS 37. Through 2014, KPMG, BP’s auditor, included warnings of the uncertainties presented by these Contingent Liabilities in its auditor’s reports. The following passage taken from KPMG’s audit opinion in the 2014 annual report expresses these concerns: 

Informing our opinion on the group financial statements we have considered the adequacy of the disclosure in Note 2 to the financial statements concerning the provisions, future expenditures which cannot be reliably estimated and other Contingent Liabilities related to the claims, penalties and litigation arising from the Gulf of Mexico oil spill. The total amount that will ultimately be paid by BP in relation to all obligations arising from this significant event is subject to significant uncertainty and the ultimate exposure and cost to BP is dependent on many factors, including but not limited to, the determinations of the Courts and Regulatory authorities in the US. Significant uncertainty exists in relation to the amount of claims that will become payable by BP and the amount of fines that will be levied on BP (including any ultimate determination of BP’s culpability based on negligence, gross negligence or willful misconduct). The outcome of litigation and the cost of the longer term environmental consequences of the oil spill are also subject to significant uncertainty. For these reasons it is not possible to estimate reliably the ultimate cost to BP. Our opinion is not qualified in respect of these matters.

The following table reports the costs recognized by BP through 2014 across four categories. The first—spill response—summarizes the amounts spent directly responding to the explosion and spill. The other three categories are costs initially recorded as Contingent Liabilities— environmental, litigation and claims, and Clean Water Act penalties. As of December 31, 2014, expenses recognized in the four categories had totaled $47.8 billion.

The following are summaries of the main spill-related Contingent Liabilities disclosed in BP’s 2014 annual report: Environmental - As of December 31, 2014, provisions in the Environmental category included the following significant items: A commitment to fund the Gulf of Mexico Research Initiative (GoMRI). This was originally a $500 million dollar commitment, of which $279 million had yet to be paid out as of December 31, 2014. The GoMRI is a 10-year environmental research program to study the impact of the spill’s long-range environmental impacts. Grants were made to a variety of research institutes, including those affiliated with Louisiana State University, the University of South Florida, Mississippi State University, and the National Institutes of Health. A framework agreement between BP, the federal government, and five Gulf Coast states to fund restoration projects in the Gulf Coast region. As of December 31, 2014, $798 million remained of commitments to fund “assessment costs and early restoration projects.” However, BP’s disclosure for this commitment notes that cost of later restoration projects has not been accrued, or even estimated: 

Until the size, location and duration of the impact is assessed, it is not possible to estimate reliably either the amounts or timing of the remaining natural resource damages claims other than the assessment and early restoration costs noted above, therefore no additional amounts have been provided for these items. 

Required:

1. How did the spill-related costs recognized by BP in its financial statements through 2014 differ from a statistical estimate of the total expected costs that the company’s senior management might have prepared and used internally over the same time frame? 

2. For each category of contingent liability—environmental, litigation and claims, and Clean Water Act penalties—BP asserts that it is not possible to reliably estimate the full extent of the company’s ultimate economic exposure. Identify a specific reason for this uncertainty for each category. 414 

3. Why did BP maintain the $3,510 million provision for the penalty it will have to pay under the U.S. Clean Water Act after the district court’s finding of gross negligence and willful misconduct called this amount into question? 

4. In 2015 and 2016, BP recognized additional spill-related costs of $18.6 billion, bringing the total cumulative costs recognized across the four categories to over $66 billion. Based on the above information, make an informed guess about how these newly recognized costs were distributed across the four cost categories. How might accounting recognition and disclosure of Contingent Liabilities be improved to enable readers to formulate better estimates?

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(In $ millons) Spill response 2010 2011 2012 2013 2014 Total 2010-14 $13,628 671 118 (113) 14,304 Environmental 1,004 1,184 B01 42 192 3,223 Litigation and claims Clean Water Act penaltles 15,123 3,430 5,164 1,926 1,137 26,780 3,510 3,510 1,329 47,817 Total 33,265 6,083 5,285 33,265 38,550 4,633 46,488 1,855 47,817 Cumulativo Total