Case Study 3 (1000 words)

Disclosure of environmental liability

by Lindene Patton C.l.H., Senior vice-president and counsel, Zurich

Around the world, companies are being required to meet higher levels of disclosure of environmental liability ... In the United States, for example, the US Financial Accounting Standard Board (FASB) issued provisions in 2002 for accounting for environmental liabilities on assets being retired from service. The provision for accounting for asset retirement obligations required companies to reserve environmental liabilities related to the eventual retirement of an asset if its fair market value could be reasonably estimated.

The intent of the ruling was disclosure, but the conditional nature of estimating a fair market value caused corporations to take the position that they could defer their liability indefinitely by 'mothballing' a contaminated property. Companies effectively postponed the recognition of their environmental liabilities in the absence of pending or anticipated litigation.

Earlier this year, FASB clarified its intention by providing an interpretation that said companies have a legal obligation to reserve for environmental and other liabilities associated with the eventual retirement of manufacturing facilities or parts of facilities, even when the timing or method of settlement is uncertain. Among examples given by FASB:

An asbestos-contaminated factory cannot simply be 'mothballed' without adequate reserves to cover the eventual cost of removing the asbestos

Reserves must be established today for the eventual disposal of still-in-use, creosote soaked utility poles

As a result of what may seem like a minor technical re-interpretation, companies may have to recognise immediately millions of dollars in liabilities in their income statements to comply with this change.

In Europe, regulators have also initiated efforts to promote disclosure. In 2001, the European Commission promulgated tougher, non-binding guidance for disclosing environmental costs and liabilities, and various countries in Europe have issued additional requirements related to environmental disclosure. In 2002, the Canadian Institute of Chartered Accountants published voluntary guidance that stressed the importance of disclosing all material risks, including environmental liabilities, in companies' annual reports.

Some financial institutions have also pledged to adhere to tenets of international initiatives such as the Equator Principles, which factor environmental and social considerations into assessing the risk of a project. Also, a group of pension funds, foundations, European investors and US state treasurers have endorsed UN efforts to promote a minimum level of disclosure on environmental, social and governance issues.

Recognition of environmental liabilities may also soon emerge as an issue for companies in Asia. While environmental issues may have taken a back seat to rapid economic development over the past 20 years, that situation may change as legislation and regulation catch up with development.

The responsibility for disclosing future environmental liability is clearly a growing issue for companies around the world. However, accurately estimating cleanup costs is not an easy task due to unknown contaminants, legacy liabilities related to formerly operated property, regulatory changes or unexpected claims related to natural resource damage.

Questions

1. The article states that the US standard setter FASB requires companies to record a provision in relation to environmental costs of retiring an asset ('to reserve environmental liabilities') if its fair value could be reasonably estimated. How do you think companies would go about estimating such a provision?

2. What aspects of the requirements were used by US companies to defer recognition of a liability?

3. In what ways does the recognition of the liability in relation to future restoration activity affect (a) net profit in the current year and future years; and (b) cash flow in the current and future years?

4. The article refers to changes in disclosure requirements relating to environmental liabilities in many countries around the world. How important is it that companies recognise the liability? To what extent is disclosure about the liability sufficient?