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Accounting for environmental costs: a hazardous subject.

In the 1990s, corporate America began to face the environmental costs of industrial practices and consumer preferences that had seemed, only a few decades ago, to be the legitimate rights of a growing nation. This article deals with a pragmatic and critical aspect of environmental protection: corporations'accounting practices in reporting the costs of past, present and future environmental activities. Based on our 1990 survey of 125 major U.S. corporations, the article is designed to help financial and business executives better understand the environmental issues their accounting departments wrestle with daily.

According to the survey, companies that recognize their environmental responsibility by chartering board-level committees generally are viewed more favorably by shareholders. Arguably, corporations choosing this strategy will be better positioned in a future in which environmental issues occupy an increasing share of the U.S. regulatory and legislative agendas, public concern and scientific research.

Despite the growing importance of environmental issues, only 14% of survey respondents had a formal board committee. Since these issues often involve litigation, companies clearly preferred to assign oversight responsibilities to the general counsel's office. Further, only 11% had accounting policies specifically addressing environmental accounting; fewer than a third of those disclosed the policies in financial statement footnotes.


Hazardous waste remediation (or cleanup) under the Comprehensive Environmental Response Compensation and Liability Act of 1980 (CERCLA), the Resource Conservation and Recovery Act (RCRA) or similar state or local statutes often is a company's largest cost and the most difficult to estimate. The materiality of the amounts involved, CERCLA'S joint and several liability provisions and often protracted legal proceedings surrounding such cases complicate the required accounting judgments.

The most important accounting pronouncements directly addressing the recognition and measurement of environmental cleanup liabilities are Financial Accounting Standards Board Statement no. 5, Accounting for Contingencies, and the limited focus of Emerging Issues Task Force Issue no. 90-9, Capitalization of Costs to Treat Environmental Contamination. Also, FASB lnterpretation no. 14, "Reasonable Estimation of the Amount of a Loss," provides guidance on recording a liability when a range of probable loss can be estimated. However, while environmental matters may receive greater FASB attention in the future, the near-term likelihood of a formal FASB standard is quite low.

The survey asked at what point respondents recorded hazardous waste remediation liabilities from prior activities. The results appear in exhibit 1, page 53. Accounting practice was mixed regarding timing of cleanup liability recognition, possibly due to the difficulty of estimating the costs' components. Some companies recognized liabilities at the sale, disposal or abandonment of facilities; others recognized them at or before completion of a remedial investigation and feasibility study (RI/FS).

Practice variations between companies reflected not only the emerging nature of environmental liabilities but also the unique nature of individual cleanup sites and environmental problems. When viewed in the context of Statement no. 5, the responses indicated measurability (the ability to reasonably estimate) rather than probability was most often the deciding factor in determining when to record a liability.


Recognizing a liability for hazardous waste remediation frequently depends on being able to estimate remediation costs reasonably. Although current accounting literature provides some guidance, many other aspects must be considered.

Developing a reliable estimate requires evaluating technological, regulatory and legal factors, each of which calls for exercise of management judgment to reach a supportable accounting conclusion. The potential for third-party recoveries makes it difficult to estimate an environmental obligation's ultimate cost. The survey asked the relative importance of the variables involved in recognizing and measuring environmental remediation liabilities (see exhibit 2, page 54).

Other key factors in the recognition and measurement process included

* Evolving remediation technology.

* Changing regulatory standards.

* Experience at similar sites.

* Existence and quality of records supporting amounts and types of waste contributed.

* Materiality of waste contributed.

Among the factors influencing estimates, some factors favored achieving reasonable estimates while others heightened uncertainty. The survey results showed recording a loss net of expected insurance recoveries was accepted in practice, depending on individual facts and circumstances (see exhibit 3, page 54).

The Securities and Exchange Commission staff, which has taken a more active role monitoring appropriate accounting for environmental liabilities than in the past, says Interpretation no. 14 should be given careful consideration. Registrants must take reasonable steps to identify the minimum end of the loss range with a higher priority on studying sites where a known problem exists.

The SEC says registrants should assess the probability of an environmental obligation and any insurance recovery independently. In assessing the probability of an insurance recovery, companies should consider the success of similar claims and the insurer's financial viability. When an environmental contingency meets the criteria in Statement no. 5 and insurance recoveries are not probable and reasonably estimable, the liability should be recorded. The SEC staff says it is inappropriate to reduce a probable liability with a reasonably possible insurance recovery.


Depending on the remedy and substances involved, postremediation site monitoring for 30 years or more may be required. Three different approaches to accounting for postremediation monitoring at closed sites have been adopted by survey respondents. Exhibit 4, page 55, illustrates how many respondents used each approach. Frequently, these costs were not considered in establishing environmental cleanup liabilities. Since long-term monitoring of closed sites is not elective but integral to the remediation process, immateriality is the only persuasive argument for excluding such costs from remediation accruals.

Among companies reporting postremediation monitoring or other perpetual-care costs recorded as part of the cleanup obligation, there was no clear preference for recording the total future value or net present value of established costs. At present, discounting is not permitted by current accounting rules except when the future obligation is fixed and the timing of settlement is reasonably determinable.


Future exit-cost expenditures can include reclamation, wastewater pond closure and the ultimate closure of production sites. Companies reporting such accruals were asked to specify the nature of events or costs being accrued and the method for estimating future liabilities. They also were asked whether they used the units-of-production or a similar method to record the estimated cost.

A majority of companies (68%) said they did not accrue currently for future environmental expenditures. Among those reporting accruals 32%), the following was noted:

* Over 1/2 of the accruals were reported by companies with operations in the extractive industries, principally coal and oil and gas. Most of these respondents said such accruals were recorded by units of production, based on engineering estimates.

* Several utility companies reported the accrual of nuclear power plant decommissioning costs over the facility's useful life.

* Most of the remaining respondents reported accruals for known environmental incidents at operating facilities, when a reasonable estimate of the response cost could be made. These accruals addressed tank ruptures, soil and water contamination and underground storage tank leaks. Estimates were based on engineering and consulting studies as well as on negotiations with regulatory authorities.

While accounting literature can be interpreted to accommodate accruing currently for future environmental obligations, the survey reflected an unwillingness to accrue because

* The environmental regulations and related obligations concerning site disposal were not always regarded as firm and unchangeable; some circumstances were not covered by existing regulations.

* The common expectation was most facilities would operate indefinitely.

* Companies often took the view site restoration costs in general were more properly recognized when a decision to sell, abandon or otherwise dispose was made.

While such rationales may make sense in specific circumstances, accruing currently for determinable future obligations may become more common as companies become increasingly concerned with environmental compliance costs.


Environmental cleanup and other site restoration obligations need to be considered in measuring the results of sale, abandonment or other disposal transactions. Accordingly, the survey asked if respondents in such situations applied different recognition and measurement criteria for recording environmental cleanup obligations. The vast majority (92%) reported they treated these obligations the same as obligations related to ongoing operations.

Several survey respondents said they recorded environmental liabilities as an assumed liability in a purchase business combination. Environmental obligations that are contractually or legally assumed and reasonably estimable normally would be treated like any other assumed obligation in recording assets acquired and liabilities assumed. The current trend toward commissioning comprehensive environmental assessments as a part of due diligence should result in a better basis for recognizing environmental obligations assumed in business combinations.


The burden of complying with evolving environmental regulations is increasing for many U.S. corporations. While such costs do not pose significant accounting problems, how broadly can environmental costs be defined? The survey listed 20 distinct categories of administrative costs, ranging from internal payrolls to various outside consulting fees, and asked respondents to identify which would be treated as environmental costs for disclosure or accrual purposes, or both.

For accrual purposes, the majority of companies would include outside legal fees, consulting fees and other soft costs related directly to a specific environmental problem. They would exclude internal payroll costs except those incurred for remediation. In addition, a majority of respondents believed more generalized activities as well as the ongoing cost of waste reduction programs were period-operating costs and not environmental costs for accrual purposes.


The survey results provided new insight on an increasingly important accounting challenge. The following broad guidelines should be considered in evaluating environmental exposures.

Cash basis accounting. The pay-as-you-go approach for environmental cleanup obligations is inconsistent with accrual accounting and Statement no. 5. It should be questioned unless the amounts involved clearly are immaterial.

Amortization of costs. No conceptual or practical support exists for amortizing environmental cleanup costs related to past activities through periodic charges to future income.

Expense recognition. For environmental cleanup costs under CERCLA, RCRA or similar statutes, a strong presumption exists for recognition no later than completion of the RI/FS or similar phase. Other variables, such as participant share and third-party recovery, also should be assessed to determine if there is a basis for delayed recognition or recording less than the gross estimated liability.

Net versus gross. Recording an environmental liability net of expected recoveries is often accepted in practice, depending on recovery likelihood.

Plant shutdowns and other disposals. Environmental cleanup and other site restoration obligations should be considered in measuring sale, abandonment or other disposal transaction results. Most companies include environmental costs in measuring a net gain or loss on site disposal, using the same recognition criteria as in accounting for on in facilities.

Business combination liabilities. To the extent reasonably estimable environmental obligations are assumed in a purchase business combination, they should be treated like any other assumed obligation in recording assets acquired and liabilities assumed. Increased use of environmental assessments in negotiating business transactions may lead to more frequent recognition of environmental obligations.

Present value approach. Use of present value techniques, other than those called for under Accounting Principles Board Opinion no. 16, Business Combinations, and no. 21, Interest on Receivables and Payables, is currently the subject of a FASB project. Until additional guidance is provided, accruing remediation costs at present value should be approached cautiously and restricted to times when future cash flows are highly predictable. Recognizing a liability for hazardous material remediation depends on developing a reliable estimate of the liability-evaluating numerous technological, regulatory and legal variables. A complex regulatory structure has evolved in the United States that has an impact on virtually all enterprises. Financial and business executives must learn to manage, control and, most important, predict uncertainties to ensure their enterprises' future competitiveness. As the spotlight on environmental issues becomes more focused, cleanup technology and equipment improve and estimating cleanup costs becomes easier, earlier recognition of liabilities in financial statements may result, bringing greater structure and consistency to environmental accounting.
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Article Details
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Author:Vondra, Albert A.
Publication:Journal of Accountancy
Date:Mar 1, 1992
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